IMF Urges Wider US Tax Base

by Mike Godfrey, Tax-News.com, Washington

12 July 2010

The International Monetary Fund (IMF), in its latest Article IV consultation with the US, saw the central challenge to be the development of a credible fiscal strategy to ensure that public debt is put on a sustainable path without putting the recovery in jeopardy.

Since 2007, the debt held by the public has almost doubled to 64% of GDP, the highest level since 1950, and under current policies could reach 95% of GDP by 2020, said the IMF. The IMF expected the impact of the aging population and rising health care costs to be increasingly felt, with debt rising further to over 135% of GDP by 2030 and continuing on a rising trend.

The IMF saw health-care reform as a welcome basis for cost control, but initial savings would be modest and hinge on the implementation of many measures. The Independent Payments Advisory Board needed to play a key role in monitoring and re-mediating excess cost growth, the IMF suggested. If excess cost growth persisted, other measures such as reducing tax exemptions for employer health insurance contributions may be needed.

The IMF welcomed the commitment to halve the budget deficit by 2013 and to stabilize public debt at just over 70% of GDP by 2015, but much remained to be done, it said. The IMF used less optimistic economic assumptions than the US government, and thought a more ambitious adjustment to stabilize debt was needed; the IMF would like to see a more ambitious primary balance target - a federal primary surplus of about 0.75% of GDP by 2015.

In this context, the IMF saw the need for an underlying fiscal adjustment (excluding the normal cyclical rebound) of about 8% of GDP during that period, some 2.75% of GDP more than presently planned. The IMF thought some of this adjustment could be achieved through expenditure reductions and welcomed the freeze on non-security discretionary spending.

The IMF believed revenue could be increased by broadening the tax base through:

• Cuts in deductions, particularly for mortgage interest;
• Higher taxes on energy;
• A national consumption tax; or
• A financial activities tax (which could also mitigate systemic risks).

Looking beyond 2015, the IMF believed the aim should be to put public debt firmly on a downward path to rebuild the room for fiscal manoeuvre (especially given the risks from large funding shortfalls in state and local government pension and health schemes), but the timing and composition of the adjustment would need to be carefully designed to minimize the impact on demand while ensuring credibility.

In this connection, the IMF saw a credible fiscal plan as having three basic elements:

• First, an upfront adjustment beginning in FY2011; in current circumstances, the IMF believed that the 2% reduction in the structural deficit proposed in the FY2011 budget was broadly appropriate;
• Second, a clear commitment to the further measures needed over coming years, for instance through enshrining targets and/or measures in legislation; and
• Third, further measures to address entitlement pressures, notably imbalances in Social Security, where the needed policies were well known.

Immediate measures should be designed to have the smallest impact on demand, said the IMF, (for example, reduction of exemptions for high-income households and later, if thought necessary, substantive entitlement reform).

In the interim, the IMF would like to see additional measures to support activity more carefully targeted within the framework laid out in the FY2011 budget, and to the maximum extent possible, offset in future years.

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