Common around the world, including in Europe, such a tax — called a value-added tax, or VAT — has not been seriously considered in the United States. But advocates say few other options can generate the kind of money the nation will need to avert fiscal calamity.

At a White House conference earlier this year on the government’s budget problems, a roomful of tax experts pleaded with Treasury Secretary Timothy F. Geithner to consider a VAT. A recent flurry of books and papers on the subject is attracting genuine, if furtive, interest in Congress. And last month, after wrestling with the White House over the massive deficits projected under Obama’s policies, the chairman of the Senate Budget Committee declared that a VAT should be part of the debate.

“There is a growing awareness of the need for fundamental tax reform,” Sen. Kent Conrad (D-N.D.) said in an interview. “I think a VAT and a high-end income tax have got to be on the table.”

A VAT is a tax on the transfer of goods and services that ultimately is borne by the consumer. Highly visible, it would increase the cost of just about everything, from a carton of eggs to a visit with a lawyer. It is also hugely regressive, falling heavily on the poor. But VAT advocates say those negatives could be offset by using the proceeds to pay for health care for every American — a tangible benefit that would be highly valuable to low-income families.

Liberals dispute that notion. “You could pay for it regressively and have people at the bottom come out better off — maybe. Or you could pay for it progressively and they’d come out a lot better off,” said Bob McIntyre, director of the nonprofit Citizens for Tax Justice, which has a health financing plan that targets corporations and the rich.

A White House official said a VAT is “unlikely to be in the mix” as a means to pay for health-care reform. “While we do not want to rule any credible idea in or out as we discuss the way forward with Congress, the VAT tax, in particular, is popular with academics but highly controversial with policymakers,” said Kenneth Baer, a spokesman for White House Budget Director Peter Orszag.

Still, Orszag has hired a prominent VAT advocate to advise him on health care: Ezekiel Emanuel, brother of White House chief of staff Rahm Emanuel and author of the 2008 book “Health Care, Guaranteed.” Meanwhile, former Federal Reserve chairman Paul A. Volcker, chairman of a task force Obama assigned to study the tax system, has expressed at least tentative support for a VAT.

“Everybody who understands our long-term budget problems understands we’re going to need a new source of revenue, and a VAT is an obvious candidate,” said Leonard Burman, co-director of the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution, who testified on Capitol Hill this month about his own VAT plan. “It’s common to the rest of the world, and we don’t have it.”

Advertisements –> Naples Real Estate | Atlanta Web Design

Seeking New Revenue

The surge of interest in a VAT is testament to the extraordinary depth of the nation’s money troubles. While some conservatives have long argued that a consumption tax would provide a simpler and more efficient alternative to the byzantine U.S. income tax code, this time it’s all about the money.

The federal budget deficit is projected to approach $1.3 trillion next year, the highest ever except for this year, when the deficit is forecast to exceed $1.8 trillion. The Treasury is borrowing 46 cents of every dollar it spends, largely from China and other foreign creditors, who are growing increasingly uneasy about the security of their investments. Unless Congress comes up with some serious cash, expanding the nation’s health-care system will only add to the problem.

Obama wants to raise income taxes for high earners and impose new levies on business, but those moves would not generate enough cash to cover the cost of health care, much less balance the budget, and they have not been fully embraced by Congress. Obama’s plan to tax greenhouse-gas emissions could raise trillions of dollars, but again, Congress is balking.

Key lawmakers are considering other ways to pay for health reform, including new taxes on sugary soda, alcohol and employer-provided health insurance. The last proposal could raise a lot of money — nearly $1 trillion over the next five years, according to White House budget documents. But options on the table would raise a fraction of that sum. And while it might pay for health care, it would barely dent deficits projected to total nearly $4 trillion over the next five years and to grow rapidly in the future, as baby boomers draw on Social Security and Medicare.

Enter the VAT, one of the world’s most popular taxes, in use in more than 130 countries. Among industrialized nations, rates range from 5 percent in Japan to 25 percent in Hungary and in parts of Scandinavia. A 21 percent VAT has permitted Ireland to attract investment by lowering its corporate tax rate.

The VAT has advantages: Because producers, wholesalers and retailers are each required to record their transactions and pay a portion of the VAT, the tax is hard to dodge. It punishes spending rather than savings, which the administration hopes to encourage. And the threat of a VAT could pull the country out of recession, some economists argue, by hurrying consumers to the mall before the tax hits.

A VAT’s Bottom Line

What would it cost? Emanuel argues in his book that a 10 percent VAT would pay for every American not entitled to Medicare or Medicaid to enroll in a health plan with no deductibles and minimal copayments. In his 2008 book, “100 Million Unnecessary Returns,” Yale law professor Michael J. Graetz estimates that a VAT of 10 to 14 percent would raise enough money to exempt families earning less than $100,000 — about 90 percent of households — from the income tax and would lower rates for everyone else.

And in a paper published last month in the Virginia Tax Review, Burman suggests that a 25 percent VAT could do it all: Pay for health-care reform, balance the federal budget and exempt millions of families from the income tax while slashing the top rate to 25 percent. A gallon of milk would jump from $3.69 to $4.61, and a $5,000 bathroom renovation would suddenly cost $6,250, but the nation’s debt would stabilize and everybody could see a doctor.

Sales Tax Gains Momentum

Burman, who helped House Democrats craft an unsuccessful 2007 plan to repeal the alternative minimum tax, said he’s received a number of phone calls from lawmakers interested in his idea, though “they can’t quite imagine how to make it happen politically.” Burman said the 25 percent rate has caused some sticker shock, and he’s trying to figure out how to bring it down.

Graetz’s proposal drew an endorsement from Volcker, who last year called it “a sensible plan for reform.” (Volcker did not respond to a request for comment.) It also has piqued the interest of Conrad, the Senate Budget Committee chairman who argues that it could be modified to accommodate Obama’s pledge not to raise taxes on families who make less than $200,000 a year.

“I think interest is quietly picking up,” Graetz said. “People are beginning to recognize that the mathematics of the current system are just unsustainable. You have to do something. And a VAT has got to be on the table if you want to do something big and serious.”

Still, the Senate Finance Committee declined to include a VAT among the options it is considering to pay for health reform. And even VAT supporters doubt the tax will find a place among the tax-reform proposals the Volcker panel has been asked to produce by Dec. 4.

Though the nation’s fiscal outlook is grim, Burman said “the situation will have to get more desperate” before lawmakers are likely to consider a new levy aimed directly at the pocketbooks of every one of their constituents.

Most lawmakers are still looking for “a painless source of revenue” to overhaul the health-care system and dig the nation out of debt, Burman said. “Who knows?” he added. “Maybe the tooth fairy will bring that to them.”

The above chart shows the projected sources of funding (receipts) for the U.S. Government for 2009.  Borrowing (the federal budget deficit) is projected to account for nearly half of all funding.  If you read yesterday’s post, you also know that the amount of borrowing in 2009 is likely to increase (because the Obama administration’s budget assumptions are too optimistic).

Advertisements | Space Coast Lawn Care | Exchange Hosting | Naples Computer Repair

Let me be abundantly clear.  We still have a Pay Option ARM and Alt-A mortgage problem.  This will hit in full force in 2010 and we are already seeing many mortgage holders having trouble with actual recasts brought on by negative amortization.  Yet there is a crew of people saying that Alt-A mortgage products will not bring any trouble because of the low interest rate environment.  Unfortunately the low rate misses the bigger issue.  Low rates are helping but the problem that we will be seeing is the massive onslaught of recasts, not resets that will be occurring over the next few years.  This is a big reason why we won’t see a housing bottom in California until 2011 at the earliest.  Many of these loans were made to supposedly better qualified borrowers in mid to upper priced areas.  These areas will begin to crack like an egg dropped on the floor late in 2009.  The Notice of Default tsunami will guarantee this much.

I’m am stunned that some people are actually saying that Alt-A mortgages or Pay Option ARMs will create little problems in the market.  Okay.  Then how about we remove the public-private investment program that conveniently has a cap with the FDIC of $500 billion?  After all, if there isn’t any problem with toxic mortgages why should we have a toxic mortgage program that has the design to eat up $1 trillion in loans.  Exactly.  Let me break down the latest figures from data by none other than the Federal Reserve:

California

At the end of March 2009

Subprime loans active:  $119 billion

Alt-A loans active:            $288 billion

U.S.

Alt-A active:       $469 billion

When we talk about the $500 billion in Alt-A mortgages this is what we are talking about.  Last time I checked $469 billion does not mean the problem has gone away.  Businessweek came out with a chart only last month showing how Pay Option ARMs will be recasting over the next few years:

Click for sharper image

I’ve added a reference point for all those people who seem to think that Option ARMs and Alt-A loans have somehow disappeared from the market.  The game is just starting.  Currently, we are seeing less than $2 billion per month of these loans recasting.  However, in 2010 we are going to start seeing $8 to $10 billion per month recast, nearly 5 times the current rate.  The chart states “months to 1^st reset” but they are referring to recasts brought on by negative amortization.  And as you will see, since the majority of these loans are in California the bulk are underwater Jacque Cousteau style.

Wachovia in their infinite wisdom swallowed up Golden West at the height of the lending insanity.  This cratered the bank which was taken over by Wells Fargo.  Just because you eat a bank doesn’t mean the toxic waste suddenly disappears.  In fact, there is still well over $100 billion in Pick-A-Pay mortgages in their portfolio.  Wells Fargo has written off a portion of the portfolio but there is still a significant amount remaining:

This is from their most recent 10-Q.  Wells Fargo alone has $42 billion in unpaid principal linked to Pick-A-Pay mortgages here in California.  The Pick-A-Pay was basically the Pay Option ARM World Savings Style.  Here were the terms:

Source:  Mortgage X

These are the crappiest loans in the world.  World Savings which was owned by Golden West thought that by simply having a little more collateral and looking at FICO scores that handing out toxic waste would be smart.  Some of these insane loans don’t have the first adjustment until 10 years later!  Of course, if Wells Fargo had any sense they would look at that absurd 152% LTV and freaking recast the entire lot.  Somehow I doubt they are doing this since they are too busy sucking up taxpayer money through the crony bailout and pretending everything is fine through manufactured stress tests.  Look at the LTV on some of the toxic foursome.  Arizona actually beats California out with a 161% LTV which is astonishing in itself.  But again, out of this little section of $61 billion in Pick-A-Pay loans $42 billion are in California, a state that has seen the median price drop by 50% in one year.

Wells Fargo seems to have the biggest amount of this crap on their books.  Yet Bank of America and JP Morgan now have a lot since they acquired toxic mortgage experts Countrywide Financial and WaMu.  Let us first look at Bank of America:

Advertisements | Naples Caterer | Naples Graphic Design | Bible Covers

Bank of America has $20 billion in Pay Option ARMs courtesy of Countrywide.  But keep in mind Countrywide was a toxic mortgage expert and other Alt-A crap producer.  They are the 31-Flavors of toxic waste.  We can find some of that junk in the whopping $261 billion residential mortgage portfolio.  If you haven’t realized it yet, if you lose your job any mortgage becomes toxic if you are underwater and can’t make the payment.  So many of these “prime” loans are equally bad.  The only difference is these Pay Option ARMs are monstrosities of epic proportions born in the laboratory of financial meth labs.  Take a look at what the California Attorney General shows through one glorious example of a Countrywide Pay Option ARM:

Here we get a firsthand look of a toxic mortgage product in action.  This is for a $460,000 loan which is what is sitting in many of those mid to upper priced areas in California.  Initially, the first year payment is $1,479 which of course is absurdly low.  But by the time we hit the first 5 year adjustment our payment jumps up to $3,747!  The payment more than doubles.  These craptastic loans were made throughout the bubble from 2004 to 2008 (yes, 2008 with freaking Wachoiva).  A large number of these will have major adjustments in 5 years (that is why we are seeing the first batch now) while some like the idiotic Pick-A-Pay loans can go on for 10 years.  Like I stated before, I highly doubt that Wells or BofA are going to push to recast many of these loans since they are going to fold the minute they do it.  Most people in these loans can’t sell and are basically renters.  That is until they hit recast and you will be seeing some massive moonwalking from homes.  Yet buyers are walking because they are not building equity (aka, renting).  If you bought a place for $500,000 and now know it is worth $250,000, you might make that $1,500 a month payment but are you going to make the payment once it goes up to $3,700?  Heck no!  You are out.  These banks are praying the market will recover.  It will not.  At least not under their delusional expectations and V-shaped bubble recovery plans.

Let us look at JP Morgan who ended up swallowing up WaMu, another Pay Option ARM fanatic.  Before WaMu went under like the titanic they had a gigantic amount of Pay Option ARMs:

Right before WaMu bit the banking dust, it had $52 billion in Pay Option ARMs.  And where were the bulk of these loans?  If you guessed California you win a prize:

Now JP Morgan wrote down a large part of this portfolio.  But how much of it?  That is the real question.  If we are to take the stress test as any guide, banks are still insanely optimistic of potential losses.  Let us pull up the latest 10-Q for JP Morgan:

According to the above, they still have $40.2 billion in Option ARMs and $21 billion in subprime loans.  But another major issue that I won’t address here but should be obvious is that massive “home equity” line item.  JP Morgan has $140 billion in these loans.  Many times, these loans are combined with Pay Option ARMs which makes for a dynamic duo of crap.  These loans are secured by home equity which doesn’t even exist anymore!  These will implode simultaneously as things get worse with these loans.  In the Pick-A-Pay portfolio with Wells, the majority of people make the minimum payment meaning negative amortization.  Meaning, the bank most likely will recast the product based on the appraised price at time of sale.  Many will say otherwise but this is the only logical conclusion.  If we are to appraise those loans in today’s current market, the vast majority of the portfolio would shatter the 110% or 125% (insane) caps and all these mortgages would hit recast oblivion.  I doubt that since banks are waiting for the PPIP so the taxpayer can assume the position at the worst time.  And that is why this problem hasn’t been solved.  I’ve heard a few misguided pundits say that most of these loans have been refinanced.  Sorry, the data above doesn’t show that.  Most of these are still out there.  The only refinancing going on with these toxic mortgages occurs in the foreclosure process.

So why has refinancing activity picked up?  Because buyers in no financial trouble have taken advantage of the low mortgage rate environment and this is smart.  But don’t think all the activity was because of subprime and Alt-A borrowers running to get new government backed mortgages.  They don’t qualify!

I’ll leave you with the most recent graph from Credit Suisse:

The big hit is going to be in 2010.  With 135,000 Notice of Defaults in California for Q1 of 2009, the second half of the year is going to expose the eye of the hurricane we are currently in.  The pundits who say these loans have been taken care mistake silence with a problem being solved.  The data does not back them up but since when do we expect pundits to pay attention to data?

NEW YORK (CNNMoney.com)

Note to Californians: Get ready for larger class sizes, fewer police patrolling the streets and more public offices shuttered on weekdays.

State officials are now scrambling to close a $21.3 billion fiscal shortfall, a gap that grew by $6 billion overnight after residents voted down five budget propositions Tuesday.

The state must make “severe cuts now,” Gov. Arnold Schwarzenegger said Wednesday. He and state legislative leaders will have to hammer out a budget deal before the fiscal year ends on June 30. The gap covers the rest of this fiscal year and the next.

“There will be around $5.3 billion in additional cuts in education, there will be severe cuts in health care, which is another area where you know we spend a lot of money, and then of course you have to go and look in other areas like prisons,” said the governor, who was in Washington, D.C., meeting with the Obama administration.

While most states are facing cash crunches as the economy weakens, California’s problems are larger than most. Only three months ago, state officials agreed on a budget deal that closed a $40 billion gap by cutting $15.8 billion in spending, temporarily raising the state sales tax by a penny, borrowing $5.4 billion and using nearly $8 billion in federal stimulus funds.

The state has also suffered mightily in the economic downturn. Its unemployment rate hit 11.2% in March, fourth highest in the nation, while its median home price dropped 54% over the past two years, according to the California Budget Project.

Advertisement: Mercado Naples | Bible Covers | Email Archiving Service

Meanwhile, revenues are running $2.1 billion below estimates, according to the state controller.
Back at the budget table

Now they are back at the table, facing another massive shortfall. And unless the budget problems are addressed, the nation’s most populous state won’t have enough money to pay many of its bills on time in the coming fiscal year, the California Legislative Analyst’s Office said earlier this month. The state controller already had to delay $3 billion in payments in February because of a lack of cash.

California’s options are more limited than most. Leaders are constrained by having the nation’s lowest state bond rating, which makes borrowing more expensive, and by a multitude of voter-approved propositions that dictate their spending.

“They are not flush with choices,” said Jerry Nickelsburg, senior economist with the UCLA Anderson Forecast. Officials will look to education, health care and prisons because “they are about the only places you can find the money.”

The defeated proposals would have allowed the state to divert money earmarked for early childhood education and mental health programs into the general fund and to borrow funds from the state lottery.

Even if these measures had passed, Schwarzenegger said he still needed to cut $3 billion from education spending, reduce funding for the state’s Health and Human Services department, reduce the state workforce by 5,000 people and obtain $6 billion through short term borrowing to close a $15.4 billion gap.

Last week, the governor said that if the propositions are defeated, he’d be forced to cut another $2.3 billion from the education budget, eliminate funding for substance abuse treatment, crime prevention, HIV education and prevention and outreach efforts by the state public college systems. He would also have to borrow $2 billion from local governments, forcing them to cut back their spending on law enforcement and other services.

California residents will likely see teachers laid off and a shorter school year, said Daniel J.B. Mitchell, professor of management and public policy at the University of California at Los Angeles. Already, the Los Angeles court system announced it will be closed one day a month to conserve funds.

“There’s no end to the things you can cut,” Mitchell said.

State officials are also looking to Washington, D.C., for additional help. Treasurer Bill Lockyer last week sent a letter to Treasury Secretary Tim Geithner, renewing his call for the federal government to backstop the state’s debt. This will help lower California’s borrowing costs, freeing up more money for services.

“It’s critical,” said Jean Ross, executive director of the California Budget Project. “Otherwise, you end up with California cutting deeper or taxing more.”