How Would a Consumption Tax Be a Good Thing?

I’ll probably have to pick up a copy of Robert Frank’s The Darwinian Economy simply for the title. But Frank has a New York Times op-ed where he argues for a consumption tax to replace the income tax. A consumption tax would work like this:

What’s a progressive consumption tax? First of all, it’s not a sales or value-added tax, neither of which takes individual income into account. Those taxes are imposed on the spot when someone buys a good or a service.

Under a progressive consumption tax, taxpayers would report their incomes, much as they do now. They’d also report their annual savings, much as they do for tax-exempt retirement accounts. The tax would be based on “taxable consumption” — the difference between their income and annual savings, less a standard deduction of, say, $30,000 for a family of four. Rates on additional expenditures would start low and rise gradually with taxable consumption.

Here are the supposed benefits of the consumption tax:

Because savings would be tax-exempt, the biggest spenders would save more and spend less on luxury goods, leading to greater investment and economic growth, without any need for government to micromanage anyone’s behavior. Consumers in the tier just below, influenced by those at the top, would also spend less, and so on, all the way down the income ladder. In short, such a tax would attenuate the expenditure cascade that has made life for middle-income families so expensive.

Adopting a progressive consumption tax would be like creating wealth out of thin air. Its magical quality stems from the fact that luxury spending is strongly context-dependent, just as antlers are. If everyone spends less, you can still have the biggest mansion — or antlers — on the block, but you’ll also be able to do many other useful things. The money saved could help resolve the current fiscal impasse. And it could also be used to fix roads and bridges and support a host of other genuine improvements.

I don’t understand how this would be the case.

If people end up spending less, there will be less tax revenue, so it’s not clear how we could “fix roads and bridges and support a host of other genuine improvements.” There are always plenty of ways to raise more revenue in total, although perhaps this would be more palatable to conservatives (though I find that really hard to believe–if you believe Baby Jesus sheds a tear every time a federal tax dollar is spent, it doesn’t matter how you raise revenue).

Second, we have to consider the balance of accounts. If we increase private savings, then either the trade deficit will decrease (not necessarily a bad thing, depending on how that decrease occurs), or the deficit will rise. I’m not adverse to deficit spending at all, but it seems that will need to occur, otherwise we’ll have an economic slowdown. After all, corporations are sitting on piles of money, and, currently, private savings as a percentage of the total economy are quite high–and the economy is booming! Um, yeah. Increasing private savings seems to be a solution in search of a non-existent problem.

Which brings me to point #3. Banks don’t need more reserves. They’re not reserve-limited, in the sense that banks can always balance their books either in the overnight markets, or, in extremis, by going to the Fed. The idea that banks will be able to loan more because we’ve all stuffed our savings accounts full of money isn’t how the markets work. Banks are capital limited, but not reserves limited.

Finally, sunny point #4. Rich people most likely won’t make capital investments such as build a new factory. Much of their unspent income will be put into the markets. This will cause inflated asset prices, and I’m not sure how this will help anyone.

Mind you, I haven’t even touched on how this would be implemented, although presumably, it’s discussed in the book (I can imagine lots of arguments over whether private education is ‘consumption’, for instance). If we do want to reduce conspicuous consumption by the wealthy, it’s just not going to be this easy.

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2 Responses to How Would a Consumption Tax Be a Good Thing?

  1. andrewD says:

    I suspect that a consumption tax would be regressive as the poor can not save as they have little unused income(which is what savings are).We already know that, in the UK, the marginal tax rate for the poor is much higher than for the rich (around 80% from memory, the top tax rate is 50%). A consumption tax would not penalise the rich or give a better yield, the only way to increase tax yield is a very progressive wealth tax (or land tax which has advantages as land is Real and a land tax would be harder to evade). Strong estate/death duties would also be a way of bringing in revenue painlessly.

  2. Phoebe Fay says:

    First, we’re already seeing a big increase in savings. Economically, paying down debt is the same as saving, and we’re back up to something like 5 percent.

    Second, where does the notion that high savings is automatically an economic good come from? (Obviously, a society needs some level of savings, but what’s optimal is a big question.) Japan had very high savings rates and that didn’t save it from the lost decade.

    Finally, why in the world would a consumption tax suddenly made people okay with having less? Why would people suddenly go back to living with less? As long as we have massive income inequality and as long as conspicuous consumption remains a status symbol, the drive to have more will continue. The drive to middle-class mini-mansions is a cultural shift that can’t really be tackled with the tax code.

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