Author: Martha C. White

When House Speaker Nancy Pelosi told Charlie Rose last October that a value-added tax was “on the table” as a possible way to solve the nation’s fiscal woes, the remark didn’t generate much interest. But as recent budget figures have put the depth of America’s problem into black and white, and with former Federal Reserve Chairman and White House adviser Paul Volcker nearly seconding Pelosi’s view recently, the idea of a VAT — already in use in nearly 160 countries — is gaining traction. And some progressives are sounding an alarm.

The prospect of a VAT is likely to be discussed by the fiscal commission established by President Obama. The Wall Street Journal’s opinion page has already sarcastically labeled the consortium the “VAT Commission.” At a recent event organized by the Scholars Strategy Network, a left-leaning think tank, an MIT political scientist floated the prospect of VAT as a solution to the federal revenue crunch. Volcker just last week fueled the fire even more, noting that a VAT tax was not as toxic an idea as it once had been. (Sen. Charles Grassley, R-Iowa, responded this week by coming out against the tax.) All the attention has not been welcomed by progressive groups, who worry that a VAT would unfairly burden the already-struggling working poor. “It crushes the low-income and the elderly,” said Robert McIntyre, director of Citizens for Tax Justice.

Since VAT is a tax on consumption rather than income or investments, it’s considered a regressive tax. Poor people, who tend to spend a higher percentage of their income than wealthier ones, are disproportionately affected by consumption-based taxes. In the U.S., regressive sales taxes are balanced out by a progressive income tax structure.

Proponents of a VAT, though, contend that it wouldn’t hurt lower-income Americans if implemented properly, and that the additional revenue it generates would prevent cuts to social-service and welfare programs.

Left-leaning think tanks such as the Center for American Progress express concern that adding a VAT to the country’s existing tax code or using it to replace the majority of the income tax, as Michael Graetz, Columbia University School of Law professor and author of “100 Million Unnecessary Returns: A Simple Fair and Competitive Tax Plan for the United States,” proposed to the Senate Finance Committee in 2008, would tip the balance in favor of the rich and drop a staggering weight on an already-struggling demographic.

While value-added taxes are common throughout the rest of the world (including Europe, Canada and Australia), many Americans are still fuzzy about what exactly this tax is and how it works. A VAT is essentially a tax on all or nearly all goods and services. Many European countries exempt certain items such as groceries from VAT collection — a mistake, according to economists who counter that a laundry list of exemptions only serves to make the rate higher. What makes a VAT different from a sales tax is the way it’s collected.

The tax is levied on every company that participates in the development of a product, but each participant gets credit for the VAT that has already been paid. If a retailer in a country with a 10 percent VAT buys goods from a vendor, they pay an extra 10 percent on those goods. That retailer is then responsible for collecting 10 percent VAT on sales to customers. When each company in the supply chain pays taxes, though, they get to deduct the VAT they paid from what their customers paid. These somewhat complicated mechanics create a lengthy paper trail that thwarts would-be evaders. Since each company in a supply chain has to collect the tax, there’s also a certain degree of self-policing.

Although right-leaning lawmakers tend to favor regressive tax policies, some conservatives dislike the concept of a VAT because they worry it would inflate the size of the government. “Conservatives think VAT is a hidden tax and therefore a money machine,” said Gilbert Metcalf, professor of economics at Tufts University. In reality, analysts say that concern is overblown. The U.S. debt load has mushroomed so substantially that even adding a new revenue stream in the form of a VAT wouldn’t generate huge surpluses.

The cost of Social Security, Medicare and other entitlement programs is predicted to skyrocket in the coming decades. “The largest programs in the budget support older people,” said Eric Toder, a fellow at the Urban Institute and the Tax Policy Center.

For the nation’s working poor, that’s bad news, says Will Marshall, president of the Progressive Policy Institute. “What’s happening now is the automatic growth of entitlement spending is squeezing out space in the budget for everything else, which includes programs for low-income families.”

Toder and others dismiss the notion that ratcheting up existing taxes will be enough to fill the revenue gap. “You’re running against how high you can squeeze income tax. You don’t want to push it too much further. If you tax investment income too high, we’ll start seeing capital fleeing the U.S.”

If the administration and Congress do consider a value-added tax, some experts do hold out hope that it can be levied in such a way that doesn’t disproportionately impact the disadvantaged. While a VAT itself will never be progressive, there are ways to offset its burden on the poor. “There’s no reason low-income people should bear the burden of getting our nation’s finances in order,” said Columbia’s Michael Graetz. “There’s no inherent reason a VAT has to disproportionately burden low-income people,” he said.

Offering refundable tax credits for Americans living below a certain income threshold, for instance, would help equalize the burden. Graetz also proposed distributing debit cards similar to those on which food stamps are issued to lower-income consumers that would exempt a certain dollar amount of purchases from value-added taxation.

While many of the European VAT structures exclude necessities like food and clothing in the name of making the tax more progressive, many analysts say this just makes administration harder. Exempting certain categories of purchases also means that the rate on everything else is pushed higher. For instance, some European countries have VATs of up to 20 percent, a rate that can be attributed to numerous exemptions.

One of the most sweeping proposals is that put forth by Graetz, who suggests implementing a VAT of 10 to 14 percent and eliminating income taxes for households making less than $100,000 annually. Graetz, who also co-authored a book lambasting the 2001 repeal of the estate tax, maintains that his plan would simplify the tax process for 150 million Americans, and a combination of credits and offsets for lower-income people would keep them from bearing the brunt of the new tax.

While Graetz’s plan is revenue-neutral, he says it offers a better way to tackle the revenue crunch because a VAT is easier to increase than the current income tax. It would also relieve many current taxpayers of the annual burden of preparing and filing their returns. “Americans feel better about taxes that they feel they can pay without undue burden,” Andrea Louise Campbell, a political science professor at the Massachusetts Institute of Technology, wrote in a recent paper. “Easing payment not only helps public acceptance but also encourages compliance.” There’s also no way for the wealthy to avoid paying their share via tax shelters or accounting tricks, since the tax is collected at the point of purchase. This still isn’t convincing for some progressives. Yes, credits could offset the burden on America’s poor. But, they argue, those credits could be rescinded at the whim of a right-leaning Congress. “One concern has to be, will there be political pressure to eliminate those kinds of credits?” said Michael Linden, associate director of tax and budget policy at the Center for American Progress. “Having a VAT replace income tax entirely is a terrible idea,” he said. “If VAT becomes a solution it will have to be part of a larger tax system, ideally part of a larger tax reform effort.”

Graetz argues that draconian spending cuts in social and support programs would hurt low-income people more than an incremental tax increase. “You’ve got to look not just at the way revenues are collected but at the way those benefits are distributed,” he said. Credits or exemptions for the poorest Americans would protect them from paying a higher percentage of their income towards a VAT, and the revenues raised could keep social-service programs off the chopping block.

Despite years of efforts to rein in the practice, lightly regulated tax preparers will be permitted to continue peddling high-cost refund anticipation loans once again this tax season to the most vulnerable filers, as tougher rules to curb the practice languish in bureaucratic purgatory.

Refund anticipation loans, or RALs, promise near-instant refunds, but the catch is that they’re very short-term and very expensive loans, according to Christopher Kukla, senior counsel for government affairs at the Center for Responsible Lending. “In terms of APR, these things carry a rate of 50 up to 1,000 percent,” he said, adding that the rate is often hidden in a bevy of ancillary fees. Watchdog groups have been waging a policy battle against RALs for years, working with agencies like the IRS and the Office of the Comptroller of the Currency. The government has been slow to respond to concerns, despite an ever-growing body of evidence about the harm these loans cause low-income filers.

Groups including the National Consumer Law Center and the Consumer Federation of America have mounted multifaceted campaigns to remove refund anticipation loans from the marketplace, but reform efforts have only crept forward. The OCC, which oversees many of the banks that provide the loan funding — including industry giants like HSBC and JPMorgan Chase — issued internal guidance for its examiners back in 2007 pertaining to the training and supervision of third-party tax prep firms, but it wasn’t declared public policy until this year. The office also waited until this year to issue a consumer advisory about RALs. “This was in direct response to the advocacy we’ve been doing, but it’s still really weak,” said Dory Rand, president of the Woodstock Institute.

The IRS has previously examined whether or not it should be legal for tax preparers to sell financial products. This January, though, in a move that frustrated watchdog groups, the agency decided to establish a task force to study RALs and the legality of allowing tax preparers to share filers’ financial information with lenders. Advocates like Jean Ann Fox, director of financial services for the Consumer Federation of America, are unhappy with the longer timeline creating this task force will entail. “We were disappointed this is as far as they went,” she said. “The IRS could have dealt with this to put a stop to it.” The IRS also announced plans in January to regulate the tax preparation industry, requiring tax preparers to follow ethical guidelines, undergo professional education and testing. Creating and implementing these standards will take a few more years, despite the six months’ worth of research that preceded the January announcement.

The stakes are so high because RALs prey on the most disadvantaged Americans. Groups like the Neighborhood Economic Development Advocacy Project, which offers assistance to low-income New York City residents, says RAL providers deliberately target poor, uninformed recipients of the Earned Income Tax Credit, many of whom are outside the realm of mainstream banking and rely on lightly regulated fringe products. In 2007, more than 80 percent of RALs in New York City were made to low-income citizens, and more than 60 percent went to EITC recipients. In some low-income neighborhoods, close to one in five taxpayers took out a refund anticipation loan. “These areas are some of the lowest-income areas in the country,” said Alexis Iwanisziw, NEDAP program associate. “This money should really be staying in the community and staying with the families.”

The primary concern is that tax preparers, especially independent shops, can play fast and loose with the facts they give consumers because they never come under scrutiny from the banks making the loans. According to the Woodstock Institute’s Rand, Chase, the bank responsible for supplying the loans to some 13,000 mom-and-pop tax prep outfits, only instituted a mystery shopping program this January, in response to Woodstock Institute queries about compliance with the OCC guidance.

In 2008, mystery-shopping programs conducted by watchdog groups found that customers received incomplete and sometimes inaccurate information about RALs and the costs they would incur. While new requirements on disclosures, marketing terminology and customer education have all been announced by the OCC, the agency is giving tax preparers another year to comply with these new regulations. Even the new disclosure requirements aren’t foolproof, points out Chi Chi Wu, staff attorney at the National Consumer Law Center. “The problem with any sort of written disclosures is they’re not that useful when [a customer] gets a RAL,” she said. “They get another piece of paper in the stack. It may not be something they look at right away.” By the time the tax filer looks through his or her paperwork, the charges have already been applied against their refund.

The big appeal of these loans, the Woodstock Institute’s Rand points out, is the prospect of instant money. Already, taxpayers who e-file and elect to receive their refund via direct deposit generally get their returns within two weeks. If the IRS sped up its payments to taxpayers outside the mainstream banking system and allowed them to receive that money on a debit card similar to those used for other benefits, the appeal of RALs would be diminished. “These improvements the IRS could make would eliminate a need for refund anticipation loans,” Rand said.

“We think as a federal policy change, one very obvious thing that needs to happen is that the EITC should be prohibited from being used as collateral in a loan,” said Sarah Ludwig, co-director of NEDAP. This practice is prohibited when it comes to other federal benefits like Social Security, and Ludwig says Congress should extend this prohibition to the EITC. “If that loophole was closed, it would to a large extent cut off RALs at the pass,” she said. The Consumer Federation’s Fox says legislation that would limit interest rates to 36 percent would protect taxpayers, but it has stalled in Congress. There is stiff resistance not only from fringe lenders but from mainstream financial services firms against a federal usury cap inclusive of fees and surcharges, since this would apply to other types of loans, such as credit cards, as well.

Both the number of RALs and the total cost of obtaining these loans has dropped slightly in recent years, in part due to market forces that made borrowing money everywhere harder to do. In 2006, 8.7 million RALs were issued at a cost of $833 million, which dipped to 8.4 million and $738 million in 2008. Fox says while this is heartening, leaving these loans on the marketplace makes too many taxpayers vulnerable to exploitation. “The volume’s been dropping over the years, but it’s time to take care of this at the policy level. This is deviating taxpayer money. Do you want to give part of your tax refund to a big bank?”

With the unemployment rate hovering just shy of 10 percent and Washington focused on job creation, President Obama this month called on Congress to approve a plan that would take $30 billion in repaid TARP funds and make it available for small banks to lend to small businesses.

“We’re going to start where most new jobs do – with small businesses,” Obama said at a town-hall event in New Hampshire.

There’s just one problem: there’s little indication that these banks need the money — or that making it available would stimulate lending. Further, experts from both the left and the right express concern that the funds could be lost to waste or mismanagement without ever contributing to the nation’s job rolls.

Small banks, which write more than half the nation’s small business loans, have wanted their own pool of stimulus money for a while, though they shunned TARP because of executive pay restrictions and reporting requirements they claimed would be too onerous.  But with outrage building throughout 2009 over the behavior of the nation’s largest financial institutions on everything from failing to execute mortgage modifications to hiking credit-card interest rates and paying top executives outsized bonuses, the small banks saw an opportunity.

Members of the Independent Community Bankers of America, which represents nearly 5,000 community banks, met with the president in December to lobby for a pool of money that came without the strings attached by TARP. The group appeared to get what it wanted with the White House plan, which would allow banks with less than $10 billion in assets to borrow up to 5 percent of their asset base from the Small Business Lending Fund. They could be charged as little as 1 percent in interest if they increased their lending to small businesses by 10 percent.

The problem is, these banks aren’t hurting for funds. “The assumption seems to be that banks lack the capital, but in fact, that’s not the case,” said Bert Ely, owner of Ely & Company, a financial consulting firm. “Smaller banks are well-capitalized and have plenty of liquid funds. The problem is finding credit-worthy borrowers.”

According to the Federal Reserve Board’s Senior Loan Officer Opinion Survey released last month, banks did tighten their small-business lending; banks with total assets of less than $20 billion reported cutting off credit to a greater degree than their larger counterparts. Analysts like Ely say small banks’ greater-than-average exposure to potential commercial real-estate losses could be driving this pullback. However, the Fed survey also cited a decrease in demand for loans, leading some analysts to worry that dangling an unnecessary incentive in front of small banks will tempt them to loosen their lending standards too far and make risky loans.

ICBA president and CEO Camden Fine seemed to back up this assertion, telling The Washington Post just two months ago, “We’ve got plenty of money to lend.” The problem, he told the paper, was a lack of demand from businesses.

Where did all the good borrowers go? Blame two closely related factors for the dearth of credit-worthy small businesses: The length of the recession and the commercial real-estate crash. By now, even business owners who had the foresight to build up their equity during the boom years have burned through that cushion. Those who own real estate have to deal with the fact that this collateral is now worth a whopping 40 percent less than it was in 2007, according to a new report from the Congressional Oversight Panel.

“The intent of the policy is for banks to lower their lending standards, but of course no prudent bank wants to do that,” said Joseph Mason, a professor of finance at Louisiana State University. Mason pointed out that most of the tepid economic growth the country has seen in recent months comes from manufacturing companies replenishing inventory levels, betting on an as-yet-unrealized turnaround. As a result, he said, “A loan to one of these companies is inherently very risky.”

The administration initially indicated it would only make the program funds available to healthy banks, but the ICBA’s leader is already challenging that, calling on the president this month in The Washington Post to allow what he characterizes as “less well-capitalized banks” to participate. Critics counter that this would only mean more taxpayer funds will be irretrievable if any of these banks fail and are placed into receivership by the FDIC, and many are doubtful that Congress — which would be tasked with crafting the small-business fund legislation — will acquiesce to this plea.

Opening the door to all small banks regardless of health is a risky proposition, says Gary Burtless, senior fellow in economic studies at the Brookings Institution. Burtless points out that the health of small banks correlates closely to their local commercial real-estate markets. With economists predicting that commercial real estate still has further to fall, it’s almost certain that more small banks in hard-hit parts of the country will succumb.

What’s more, the very reason small banks are as well capitalized as they are today is that they exercised caution during the go-go years, Burtless adds. These institutions passed up a quick buck in favor of what seemed at the time to be old-fashioned lending and underwriting practices. “What worked for these banks is being cautious,” he said. “Are you going to make that zebra change its stripes?”

LSU’s Mason labels the program as a cynical political move aimed more at assuaging voter anger over big bank bailouts than actually helping small banks lend or small businesses hire. “If these guys are going to go to the polls having done nothing for small banks, they really can’t evade the charge that they were a part of the large bank-centric policy that’s at the heart of this crisis,” he said. The plan is about little more than appearances, he charges. “They’re trying to throw a bone here, not a very economically effective bone, to give the appearance of a balanced policy after the fact.”

Supporters of the small-bank plan say the nation’s regional and community banks are better equipped to handle an influx of small-business loan requests than the Small Business Administration. Although Mary Landrieu (D-La.), chair of the Senate Committee on Small Business and Entrepreneurship, spoke positively of the president’s plan to increase SBA funding in a post-State of the Union release, she pointed out that this aid comes after eight years of cutbacks the SBA sustained during the Bush administration.

But even left-leaning analysts like Dean Baker, co-director of the Center for Economic and Policy Research, are skeptical that the banks would be more efficient distributors of these funds intended for small businesses. “The bank’s goal, of course, isn’t job creation,” he says, expressing concern that the real goal here — reducing a jobs gap some analysts have put as high as 11 million — could be fall by the wayside in pursuit of profits. “What you worry is, can this be gamed?” he said. “I’m not very confident that you could police it.”