Puts and Calls: Republicans on the VAT and the unintended consequences of regulatory ‘reform’

Tom Karol Occasional Political Commentator
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A tax even a Republican can like: A hot topic in certain circles is the possibility of the federal government enacting a “value-added tax,” or VAT, as one solution to America’s fiscal mess. Basically, a VAT is a more easily enforced (and collected) retail sales tax. Democrats tend to love it and Republicans tend to hate it, because it adds revenue to fund more federal programs. Paul Volcker, head of President Obama’s economic advisory board, said a VAT was “not as toxic an idea” as it used to be. In April, Sen. John McCain, Arizona Republican, offered a “sense of the Senate” resolution expressing opposition to a VAT, which passed in the Senate by an 85 to 13 vote. So it interesting that five Republican House members are co-sponsoring a bill by Rep. Pascrell, New Jersey Democrat, that would impose a VAT on imports from countries that use the tax. In the Senate, Republican Senator Voinovich, Ohio Republican — who was the sole Republican vote in opposition to that sense of the Senate resolution — now has suggested that replacing income taxes with a VAT could be one way to streamline the tax code.

“You can’t fix what you can’t explain:” The Senate debate on financial reform continues Tuesday, and members may want to heed that warning from Nicholas F. Brady, the treasury secretary who led the investigation into the 1987 stock market crash. Democrats have agreed to open the process to more debate, but many financial experts say that the proposals may not address the right problems and could result in the financial system becoming more vulnerable. Such experts note that the current financial reform package fails to address some of the major issues that led to the financial crisis. They point to the instability of capital markets that provide money for lenders, and the government’s role in the housing market, including the $125 billion lost by the housing finance companies Fannie Mae and Freddie Mac, since being placed in government conservatorship in 2008. Academics and others believe that it may be dangerous to enact dramatic changes to the system when so many inquiries are in progress. There are political points to be scored in the short run, but the causes of the financial crisis remain a subject of great debate. The Financial Crisis Inquiry Commission, a bipartisan panel created by Congress to “examine the causes, domestic and global, of the current financial and economic crisis in the United States,” is charged with conducting a comprehensive examination of 22 areas related to the crisis. The commission has held numerous hearings, issued a number of ongoing reports and is not scheduled to report until December.

What could possibly go wrong? The perils of rushing financial reform were highlighted on Monday as a senior banking regulator sent a warning about a proposal in the Senate financial legislation that would require banks to spin off their derivatives operations. The provision has been called one of the most aggressive efforts in legislation to regulate the multitrillion-dollar market for financial derivatives. In a letter to senators, Sheila Bair, the chairwoman of the Federal Deposit Insurance Corporation (FDIC), said that the proposal would only move almost $300 trillion (that’s “trillion,” with a “t”) to riskier nonbank financial firms from banks. “If all derivatives market-making activities were moved outside of bank holding companies, most of the activity would no doubt continue, but in less regulated and more highly leveraged venues,” Bair wrote in a letter to Senate Agriculture Committee Chairwoman Blanche Lincoln, Arkansas Democrat, and Senate Banking Committee Chairman Chris Dodd, Connecticut Democrat. Bair is not alone. Comptroller of the Currency John Dugan has said he disagrees with the provision and in a recent Fed staff analysis said the proposal could prove costly to both banks and customers. Sens. Mark Warner, Virginia Democrat, and Kirsten Gillibrand, New York Democrat, have also warned of the consequences of the provision.

But we can just fix any mistakes, right? The unintended consequences from a hurried approach to financial reform are exacerbated by the torpid rate at which Washington acknowledges and addresses its missteps. Consider H.R. 3506, the “Eliminate Privacy Notice Confusion Act,” which has passed the House and is awaiting consideration in the Senate. This bill fixes problems that resulted from Gramm-Leach-Bliley (GLB), which was enacted in 1999. In a well-intentioned bid to protect consumers and privacy and other stuff, GLB required financial firms to send annual privacy notices, even if they did not share any customer information. For 10 years, financial firms were required to spend millions of dollars to send out annual notices to customers saying, “We are NOT sharing your information.” After a decade of costs and duplicative work harmful to both consumers and financial institutions, and providing no value to firms or clients, the legal requirements to send these negative notices has a fair shot at getting fixed by H.R. 3506. If it takes Congress 10 years to consider fixing a fairly straightforward legislative error, it is unrealistic to think that more complex lapses can be addressed with the necessary speed to protect the financial system.