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U.S. tax policy should encourage growth.

As we move toward the 21st century, American businesses face opportunity on an unprecedented scale. But our ability to take advantage of these opportunities will be lost if the national deficit is at an unprecedented height, and if Congress continues to create uncertainty with a wishy-washy approach to economic growth and taxation.

Left unresolved, our current problems will erode our entire economic infrastructure. Yet we have been fiddling with a tax policy that does not address the most basic economic problems we face. in fact, I think it is safe to say that we really have no tax policy at all. What we have is a collection of reactions to a mixed bag of political considerations.

To turn things around, we must reduce the deficit, increase productivity, provide incentives to grow our economy, and provide incentives for educating our young. Without a tax policy designed to encourage these goals, we face the reality of a slow but steady decline in our economic influence, a decline that could lead directly to the decline of our political influence.

Our tax laws have become very complex. Some might think that, as head of an organization with close to $800 million in tax service revenues this past year, it would be odd for me to argue in favor of a less complex tax law. But the degree of complexity, one way or another, is not really the central issue. Virtually all businesses, including my own, ultimately do better in a stable, prosperous economic environment. So what is really important is not how simple or complex our tax laws are, but how consistently those laws encourage a well-defined economic strategy.

The Tax Reform Act of 1986 did not do this, because it did nothing to increase the national savings or decrease the deficit. Caught in the middle between pressures to reduce the deficit on one hand, but not raise tax rates on the other, designers of the law aimed to make it "revenue neutral:" to generate neither more nor less revenue than previous law. At the same time, it lessened the desirability of IRAs and other kinds of tax-sheltered savings, and scaled back investment incentives such as the investment tax credit.

So the deficit continued to grow, aggravated by financial crises, and our overall competitiveness continued to decline.

The 1990 budget battle

In 1990, the deficit became too big to ignore. So, in May, President Bush and Congressional leaders met in a summit to develop a budget for 1991.

On the surface, the agreement they finally came to appears to attack the deficit by reducing federal red ink by nearly $500 billion over a five-year period, The provisions include $140 billion in tax increases; $180 billion in defense cuts; $100 billion in cuts in such domestic programs as Medicare and Medicaid; and about $64 billion in interest savings on the national debt.

But the question is: Will this do the job? To a large extent, it depends on the economy, which, in turn, depends on the political situation. For example, the final law locks in considerable spending savings over the years, but virtually all of the savings come from cuts in defense. What will become of those cuts with the situation in the Middle East and the crisis in the Soviet Union?

Furthermore, the agreement failed to address some of the fundamental budget problems that led to the recent deficit crisis. A key example is the way cuts were claimed in programs. Under the agreement's formula, the baseline projection from which cuts are made is calculated to grow each year based on inflation and program usage. Any cuts are measured off this baseline, rather than the level of spending for the previous year.

As a result, budget cuts do not necessarily translate into spending cuts. For example, the $42 billion in Medicare "cuts" does not mean that less money will be spent than in the previous year. It merely means that the originally budgeted $100 billion increase has been reduced to a $58 billion increase. No one could run a business very long trying to "save" money in this way.

In any event, it is not at all certain that OBRA 90 will do much to reduce the deficit in real terms over the next five years. To achieve such a goal, interest rates must be cut in half and the economy must grow 3.5 percent annually. Neither of these events is probable during the next five years.

In the short term, the Federal deficit is projected to exceed $320 billion for this fiscal year ending September 30. This is the largest such deficit in history - even though it comes on the heels of the largest deficit-reduction bill in history. And it does not count the impact of the Gulf war.

So, while significant deficit reduction may not be on the Congressional agenda in the near future, revenue-raisers probably will be necessary for some time to come, considering that economic growth was not a priority of the budget agenda. With the kind of deficit we will be facing, there is no practical alternative, at least for the short term, to a new tax or a tax increase.

I know that "tax" is supposed to be a dirty word. But we must get away from the idea that taxes are inherently good or bad - or that any specific resolution of tax issues will guarantee economic health. Tax laws can help solve our problems, but only if they are designed with a long-term view that focuses on deficit reduction, and only if they provide business with incentives to improve the productivity and quality that would allow us to compete effectively in the global marketplace.

Quality must be our true focus. We have lost our competitive edge largely because we have neglected our commitment to quality. While foreign competitors were making investments to improve quality and productivity, American businesses acquiesced to an environment that favored speculation.

Value-added tax

One way to set the stage for quality improvements would be to adopt a tax focused on deficit reduction and savings and investment initiatives. One such measure is a national sales tax, or value-added tax.

I realize that VAT scares a lot of people, but it has a number of significant advantages. First, it would raise money, perhaps as much as $150 billion to $175 billion annually at a 5-percent tax rate. Second, it is "neutral." Unlike n income tax, a VAT does not discriminate against investment or savings. And, being a consumption tax, it will discourage such spending and be more conducive to investment, economic growth, and productivity. Third, a VAT would help improve the U.S. trade balance. By reducing the federal budget deficit and encouraging capital formation, it would work to reduce the trade deficit and make U.S. industry more competitive.

Like any other tax, there are disadvantages to a VAT. It is regressive; it will probably cause prices to rise, at least initially; it will be opposed by state and local governments that have their own sales taxes; and, finally, the simple passage of such a tax would not preclude the government from taking the money and spending it.

Some of the negative,, regressive aspects of a VAT can be minimized. For example, food, clothing, or medical care could be partly or fully exempted to reduce the tax's regressivity, a commonly used exemption in other nations with VATs. But no tax will ever be pain-free. Indeed, the professional services industry, of which I am a member, would itself be subject to a VAT, which would likely diminish our profits in the short term.

But government spending is the heart of the matter. If VAT or any other revenue-raising measure is to address our fundamental economic problems, it must be preceded by the political will to apply those revenues to reducing our deficit. Without a commitment to deficit reduction, the time spent wrangling over tax laws might just as well be spent on a debate about how to dig ourselves a deeper hole.

Over the long term, an intelligently applied VAT could do much to help heal the American economy, providing it is combined with investment tax credits, savings incentives, and incentives for educating our populace.

Our competitiveness depends directly on our ability to invest in new technologies, in training and education, and in research and development. These are the steps that are needed to ensure quality - and quality is what we need to ensure competitiveness.

Without such continuing investment, U.S. competitiveness will inevitably fall behind and, with it, our standard of living. It is vital that our tax policy do everything possible to encourage investment and similar growth-enhandng measures.

The 1990 budget battle did result in some positive measures, But they will not be enough to solve the economic problems that diminish our competitiveness. We must make a strong case for a fundamental approach to creating an economic policy for our future.

-Lawrence A. Weinbach

Mr. Weinbach is managing partner and chief executive of Arthur Andcesen & Co., S.C. His remarks are excerpted from his address before FEI's New Jersey Chapter
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Author:Weinbach, Lawrence A.
Publication:Financial Executive
Date:May 1, 1991
Previous Article:Bring U.S. tax law into the 1990s.
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