Robert Frank: We Need a Progressive Consumption Tax

Is a progressive consumption tax the answer to our problems?

Why Not Shift the Burden to Big Spenders?, by Robert Frank, Economic View, NY Times: ...As even veteran supply-siders now concede, the president’s tax cuts have added hundreds of billions of dollars to the national debt. ...

As all serious participants in this debate now agree, no strategy can succeed without increasing federal revenue substantially. The leading Republican presidential aspirants, advocating further tax cuts, have elected to skip this debate. Their Democratic counterparts have proposed allowing Mr. Bush’s tax cuts for top earners to expire as scheduled. That step alone, however, would not be nearly enough.

Given the political risk of proposing painful tax increases in an election year, many fear that the crisis will remain unresolved. Yet a simple remedy is at hand. By replacing federal income taxes with a steeply progressive consumption tax, the United States could erase the federal deficit, stimulate additional savings, pay for valuable public services and reduce overseas borrowing — all without requiring difficult sacrifices from taxpayers.

Under such a tax, people would report not only their income but also their annual savings, as many already do under 401(k) plans and other retirement accounts. A family’s annual consumption is simply the difference between its income and its annual savings. That amount, minus a standard deduction — say, $30,000 for a family of four — would be the family’s taxable consumption. Rates would start low, like 10 percent. A family that earned $50,000 and saved $5,000 would thus have taxable consumption of $15,000. It would pay only $1,500 in tax. Under the current system of federal income taxes, this family would pay about $3,000 a year.

As taxable consumption rises, the tax rate on additional consumption would also rise. With a progressive income tax, marginal tax rates cannot rise beyond a certain threshold without threatening incentives to save and invest. Under a progressive consumption tax, however, higher marginal tax rates actually strengthen those incentives.

Consider a family that spends $10 million a year and is deciding whether to add a $2 million wing to its mansion. If the top marginal tax rate on consumption were 100 percent, the project would cost $4 million. The additional tax payment would reduce the federal deficit by $2 million. Alternatively, the family could scale back, building only a $1 million addition. Then it would pay $1 million in additional tax and could deposit $2 million in savings. The federal deficit would fall by $1 million, and the additional savings would stimulate investment, promoting growth. Either way, the nation would come out ahead with no real sacrifice required of the wealthy family, because when all build larger houses, the result is merely to redefine what constitutes acceptable housing. With a consumption tax in place, most neighbors would also scale back the new wings on their mansions.

A progressive consumption tax would also reduce the growing financial pressures confronting middle-class families. ... The problem is not that middle-income families are trying to “keep up with the Gateses.” Rather, these families feel pressure to spend beyond what they can comfortably afford because more expensive neighborhoods tend to have better schools. A family that spends less than its peers on housing must thus send its children to lower-quality schools.

Some people worry that tax incentives for reduced consumption might throw the economy into recession. But total spending, not just consumption, determines output and employment. If a progressive consumption tax were phased in gradually, its main effect would be to shift spending from consumption to investment, causing productivity and incomes to rise faster.

Should a recession occur, a temporary cut in consumption taxes would provide a much more powerful stimulus than the traditional temporary cut in income taxes can. People would benefit from a temporary consumption tax cut only if they spent more right away. In contrast, consumers who fear that they might lose their jobs in a recession are often reluctant to spend the dollars they are no longer paying as income tax.

Failure to address the current fiscal crisis is not an attractive option. With baby boomers retiring and most voters now favoring universal health coverage, budget shortfalls will grow sharply. Annual borrowing from abroad, now more than $800 billion, will also increase, causing further declines in the slumping dollar. And the personal savings rate, which has been negative for the last two years, will fall still further, causing future reductions in economic growth.

The progressive consumption tax is perhaps the only instrument that can reverse these trends at acceptable political cost. It has been endorsed by a long list of distinguished economists of varying political orientations. It was proposed in the Senate in 1995 by Sam Nunn, the Georgia Democrat then serving his final term, and Pete V. Domenici, Republican of New Mexico, who called it the Unlimited Savings Allowance tax. In short, this tax is not a radical idea. ...

I'd prefer to see this tax justified on the economics (i.e. it provides superior incentives) rather than as a relatively painless way to provide higher revenues (becasue it may not be painless, and because the maginiture of the required increase in future revenues is subject to some dispute and is a political minefield). But it's hard to imagine a change of this magnitude being implemented anytime soon in any case.

Comments

[James Killus]

Extreme concentrations of wealth are not worrisome because they lead to excessive consumption by a small group of people; they are worrisome because they confer extreme political power to that small group of people. And because extreme political power can also be used to acquire (and maintian) even greater wealth, the process feeds upon itself.

That is the primary social goal of progressive taxation. Any scheme that claims to be progressive that does not address that problem is not that helpful.

says...

"As even veteran supply-siders now concede, the president’s tax cuts have added hundreds of billions of dollars to the national debt."

The craziness begins here and continues through; but this is after all Robert Frank who is all freakonomics while never meaning to be. Show me the veteran supply-siders who concede now and what they concede. I am all a-twitter waiting to be shown. Then, having given over the actuality of a progressive income tax for the wealthiest and hoping possibly for a revival since the theory is still there, we are supposed to punish the wealthy for spending progressively so. Analysis? Realism? Please, happily though writing on unreality is less dangerous than....

[anne]

Darn, that was me no matter my computer thinking or hoping otherwise.

[Bruce Wilder]

In an earlier historical moment, when "honest conservative" was not a contradiction-in-terms, right-wing economists lectured us on how, to spend is to tax, and how the government bonds issued to finance a deficit cannot make the representative taxpayer wealthier, becuase the value of the bonds exactly matches the future taxes, which must be paid.

Some conservatives reading that literature figured out that if the tax cuts and the tax increases fall on different people, one can become wealthier from tax cuts and deficit spending. Tax cuts and deficit spending became the favored Republican policy. Funny how that works. (Except when it came to Social Security, where the tax increase came first, and the proposals for benefit cuts and privatization came second.)

In the great bait-and-switch, the time is coming, when tax increases will be necessary. So, there are great career opportunities opening up for economists, who can come up with tax schemes that don't take the money back from the top 1/2 of 1%.

The really far-sighted, however, will be honing explanations for why increasing inflation is a really good thing, after all, or is so mysterious that nothing can be done.

[Mark Thoma]

I think you are too hard on him, e.g. it is only the real hacks who are still insisting that tax cuts pay for themselves (and even some of them have started to word their statements carefully, though deceptively). I doubt you could find a reputable economists identified with supply-side ideas who would say that.

There are ways to argue against a consumption tax, and there are a few who use these arguments whenever it comes up, but for the most part it does have better incentive properties than an income tax. Like I said, it won't happen, but purely from a theoretical point of view it's hard to argue against it. And since he's arguing for even more progressivity (and the actuality of our current system is subject to some question), it's hard to argue on an equity basis as well (unless, of course, you think he goes too far).

[anne]

Fine; I have read the column carefully but now will reverse perspective and think. I may well be missing the sensitivity.

[pgl]

Isn't this the Bradford X-tax? I think David Bradford made a very good case for this version of tax reform.

[esb]

First things first ...

First must come the highly progressive consumption tax on the use of motor fuels in private automobiles.

First five gallons consumed each month to be untaxed ("lifeline use") ... next five gallons to be taxed at present rates ... next ten gallons to be taxed at twice present rates ... next ten gallons to be taxed at four times present rates ... next ten at six times present rates ... next ten at eight times present rates ... next ten and above at ten times present rates. "War surtaxes" and other surtaxes may apply in brackets above the bottom three.

Say goodbye to the personal-use SUV. Say hello to the Honda Civic LX manual 4.

[Noni Mausa]

I didn't notice in this column whether Mr. Frank said anything about catastrophic spending. Health care costs would have to be ceded as nontaxable, since no matter how prudent a middle-class family is in their savings and their control of spending, a single major illness would wipe out their savings -- and at the same time leave them on the hook for a huge tax bill. The same goes for any other catastrophic expenditure.

Noni

[anne]

Actually the idea is strange enough to be interesting. We are a society that dotes on consumption, expressly conspicuous consumption at every income level, and suddenly we are supposed to changed generations of who we have been conditioned to be. Sort of like vows of chastity only governmentally enforced making them all the more questionable. I am playing, but the idea is interesting from this Tolstoyian perspective. (Wishing we were monks and somehow not able to be.)

[anne]

Noni is playing too. Health care? College? Graduate school? Notice also, that Robert Frank is incapable of understanding that ws are in the midst of a fabulously expensive war an occupation. I would be so pleased to have these conscience driven folks who will tell me what to buy and what not to buy for the sake of the kiddies, at least toss in a line about my buying guns guns guns at the expense of health care.

Guns and butter, but for these moralists there is only butter that matters.

[Ian]

The "steepness" of progressivity is just another ruse that will lead to more manipulation and political control by the privileged class (politicians and lobbyists for the wealthy and special interests).

The freedom of enterprise in this country is being systematically destroyed by our "social activists" in Washington.

The plan that truly returns power to the people is the FairTax plan which untaxes income, scraps the tax code, eliminates 53% of the Washington lobbyists that game it, and it eliminates hiding taxes in the cost of goods and services by eliminating income and payroll taxes for business.

Since, as Greenspan has instructed, only citizens end up paying taxes, it is VISIBILITY that will ensure our economic system's survival. Renown economist Laurence Kotlikoff believes that failure to enact the FairTax - choosing instead to try to "flatten" what he deems to be a non-flattenable income tax system - will eventuate into an irrevocable economic meltdown, because of the hidden aspects of the current system that make political accountability impossible.

[anne]

Housing? A house in New York City against a house in Topeka? Rent? Farm land? Food? Utilities? How would interest costs count? Children cost money; the more children, the most money; progressively so?

[anne]

"The freedom of enterprise in this country is being systematically destroyed by our 'social activists' in Washington."

Say what? Say who? Say why? Say when? The only thing that strikes me as more comical on consideration of the dread progressive tax is the more dread fair tax or fairtax or whatever. Good grief.

[anne]

Is the irrevocable economic meltdown revocable? Time will tell. "Power to the People." We are in the presence of the new flower children, taxing us fairly revocably.

[anne]

Find me a neo-economic-moralist who can spell Iraq and a $650 billion military budget, and I'll take any of this radical tax nuttiness the least seriously, otherwise this is less than farce.

[Greg]

Revenues, like expenditures, do not exist in a vacumn. Quite simply, revenue ~= expenditures over the business cycle. The feedbacks between the two probably take many years to dampen out. Until that happens, we are flying blind, fiscally speaking. So changing the system drasticly on a whim is truely irresponsible.

Right now we need to increase revenue. We also need to attack GHG emmissions. A carbon tax fulfills all the requirements and it is economicly well understood.

So a major consumption tax can make an appearance and we can institute it in a responsible manner.

Once the carbon tax is in place, the income tax and carbon tax rates can be tweeked because we will have a finer grained understanding of the responses.

[anne]

Fine, just let the President and fellow Republicans know and all will be done. A fierce carbon tax will be proposed by George Bush. Democrats however are not going to be raising taxes. But, then, neither are Republicans.

Me, I am not going to be voting for anyone raising my taxes. Worried about the budget? Then, end the insane war and occupation. For now, I am consuming and carbon burning all I can. I love the smell of burning carbon, hate the thought of being in Iraq. Notice the linkage.

[anne]

All these economic moralists and can't none of them spell Iraq and military spending. Robert Frank will save me from buy buy buying, but never a thought to save me having to buy another blasted life in Iraq. No mention. Phooey.

[anne]

We will have directly spent $800 billion on Iraq and Afghanistan by December, and imagine the indirect spending. So, the heck with worrying about the costs of health care and carbon burning and the heck with tax solutions when direct controls and subsidies and decent alternative energy reaearch and program development budgets and green infrastructure budgets will be more effective for carbon control.

Enough moralism with no morality.

[Green Marketeer]

All you fellow liberals-
Before your knee jerks at the sound of "consumption tax" I suggest you review Frank's book "Luxury Fever" as well as Stiglitz' treatment of the consumption tax in "Economics of the Public Sector". You might find that there is a lot to recommend it: it encourages savings and equalizes treatment of lifetime income. There are issues regarding the transition from savings to consumption as the basis of taxation, and regarding home ownership (which is an investment), but these are not insurmountable. If we instituted a steeply progressive consumption tax, a value-added tax, taxes on all pollution (not just GHG)and distance-based fees on vehicle travel, including congestion pricing (a la Todd Litman at the Victoria Transport Policy Institute) we could raise plenty of revenue while eliminating counterproductive taxes on things such as wages and corporation profits (before you get into a snit, see Stiglitz about the waste and distortion caused by corporate taxes). Pigouvian taxes on pollution and road use would drastically reduce (up to 50%) the Vehicle Mile Traveled, reducing oil consumption and our dependence on the Middle East. To insure progressivity, you merely have to include a refundable tax credit up to (insert your figure here). Tax consumption and externalities, not work, savings, or profits.

[Chris]

It's a PROGRESSIVE consumption tax! Progressive! It's not a sales tax! Basically if you're a rich dude like Warren Buffett who hardly spends money on himself (except for private jets), you won't pay much. If you're a lazy heir who spends $10 million/year on yourself, you might pay $15 million in taxes. I love it!

The bottom line is you can be as rich as you want, but when you start throwing your money around lording it over everybody then you're going to pay for it. This is good for social equality. If you get rich and reinvest your wealth in the economy (like Buffett) the government stays off your back. That's good for economic growth.

It's totally understandable that people would be confused by it, since no one is really advocating it and out there explaining it. I highly recommend Frank's "Falling Behind." It's a short book and very enjoyable. There's a tax chart in the back that should be any liberal swoon (I know I did).

Well, if you consider money spent in an endless arms race for status (positional goods), everybody is better off with a system to reduce those incentives. That's how arms control agreements work. So yeah, there is an economic efficiency argument too. Plus as a macro tool a temporary progressive consumption tax cut is pretty cool.

[James Killus]

All right, let me try this again, with details.

When Exxon spends money through various front organizations to propagandize against the "global warming hoax," that money would not be considered "consumption," because it is protected behind corporate ownership and buying stocks is not "consumption" it is savings, at least according to the way consupmtion taxes work. When the tobacco industry does the same thing, only attacking medical research, ditto.

Purchasing and controlling newspapers and media outlets, same thing. Non-profit foundations? I'd certainly like to see the details.

But the bottom line is that great wealth will still be used to control other people's lives. I'd vastly prefer for the rich to engage in all the conspicuous consumption their minds can devise. There's a limit to how many yachts you can own; there's no limit to the amount of meddling you can do.

[Lafayette]

Article: The progressive consumption tax is perhaps the only instrument that can reverse these trends at acceptable political cost.

Inducing income equity for ALL corporate personnel

No, it is not the ONLY option. There is the Value Added Tax (VAT), that taxes consumption directly.

It has the value of being easy/cheap to collect, like a sales tax. It would require an accommodation with the states (to kick back revenues that they depend upon). It has the advantage (over that proposed) in that it requires no declaration whatsoever, so no constant verification and no lengthy/costly collection process.

Income tax imposition could then start at a much higher revenue, since the VAT will generate a considerable revenue, if established a 10 to 15%. Say, the threshold could be established at 1.5 times the national wage average (which is presently around $35K), or $53K. (And, why not exempt retirement compensation, but instill a very high level of inheritance tax, say 95%?)

From this income threshold, then, it would be necessary to ensure that marginal rates were increasingly aggressive until they became confiscatory above 3, 4 or 5 million dollars per annum.

Once the onus is taken from "making all the money one can", then there will be, I suggest, a propensity for companies to share profits (by means of either performance related stock options for everyone in the company, or simply dividends) more equitably amongst all staff/workers.

This profit sharing could be induced by a corporate tax write-off for all profits distributed to employees in this manner -- but according to a generally recognized (and IRS accepted) formula. Total personnel compensation would have thus two components; performance stock-options or stock-purchase discounts, which ties a person more tightly to the company's overall performance. The stock related income could be as much as 50% of total compensation.

More so, presume the stock was registered with the IRS before accorded to the employee. If the stock was resold after a minimum period of two years, then the capital gain/loss would be imputed as income (gain/lost) and taxed accordingly. (I.e., no more exceedingly low capital gains tax.)

By separating, within total personnel compensation, both wage and stock-related income, there might be the advantage of containing wages -- since the stock-related income component was also generating income. If total income was reduced because a company had a poor performance, at least wages will not be affected and corporate competitiveness retained.

Yes, the employee is thus asked to assume the risk that the company will perform poorly, but that risk is associated with the fact that as stock-owners they also become stake-holders. What is the difference from an employee obtaining equity gains directly from their ownership of stock in the company they work for, and taking disposable income to buy Mutual Funds? Equity related income is equity-related income, regardless of the source -- and it contains risk.

[Icarus]

A 95% tax on inheritance?

Again, craziness. Confiscating wealth is the usual silly response. No wonder the wealthy offshore their money.

[zinc]

In the short time it took to read the comments, the social engineers increased the complexity of the progressive consumption tax by a few orders of magnitude. That's the real problem with our current tax policy - special interests make it far too complicated.

I don't want the government deciding whether or how much to consume or save.

The progressive income tax remains the best overall system. Reduce the social engineering costs ( carbon taxes, SUV taxes, blah, blah, blah, but increase taxes on Honda Civics) and increase progressivity as needed.

We tax all unearned income, whether from lottery winnings or by happenstance of birth. The inheritance tax should stay.

[robertdfeinman]

I have a problem with definitions. What is consumption and what is savings?

If I put money in the bank that's savings. How about if I buy stocks, is that savings or gambling? How about a home?

I see the categories as arbitrary and based upon some sort of vague populist morality. If the goal is foster investment what difference does it make if I put the money in the bank and the bank decides where to invest it or I buy a widget and the widget company uses the income to invest in making more widgets?

Many people regard their home purchase as an investment. I'm not talking about flipping, I'm talking about downsizing when they retire and using the profit in the house to finance part of their retirement. What happens if they are rich enough to buy several homes as "investments"?

If you want to raise government revenue than propose an "efficient" policy. The progressive income tax, the estate tax and the corporate tax all worked well in the past.

If you want to control behavior then don't do it with a tax, or with one explicitly meant for this purpose. If you don't like people buying yachts big enough to have a helicopter on them as a fashion accessory, then impose a luxury tax. Notice that when sin taxes are imposed their purpose gets muddled. Is the tobacco tax to force people to quit or to fund expanded child health care? What if it works and people stop smoking? Where is the revenue for health care then?

As I said the other day we know conspicuous consumption when we see it, but no one has yet been able to define it in a non-moralistic way.

[wogie]

Don't know much about this (obviously), but I wonder about how it would actually work, i.e., the incentive to save rather than consume. If there is a huge shift to save, including investment, the yield on saving (and maybe investment) could be driven down to lows never seen. Continuing inflation at the long run 3 to 3-1/2 percent rate would erode the value of savings. Individuals could take that into consideration making the consume/save decision I would think. Also, is income from saving really "untaxed", or is the tax merely deferred? At some point saving would be drawn down for consumption (say to pay for college or buy a home or pay medical bills. Maybe the wealth could just be passed down from one generation to the next. However, under current tax deferral plans, 401K - IRA, the savings must be drawn down and taxed. Maybe that is what would result

[Tim Worstall]

"As all serious participants in this debate now agree, no strategy can succeed without increasing federal revenue substantially."

What? You mean that everyone has given up on any possibility of cutting spending? Like BBQ the Farm Bill, for a start?

Tsk, talk about lack of ambition.

(BTW, I thoroughly support the idea of a consumption tax as outlined: The Economist was arguing for this all through the 80s. But that doesn't excuse the selling of the pass in the first place).

[calmo]

Don't pre-empt us like that wogie

Don't know much about this (obviously),

you have no idea about the heights (and depths, don't forget our depths!) of our knowledge...let us make that "obvious" call...in due time of course, now that we suspect you may be a master of understatement...maybe more. Don't brain us before we are warmed up.
Ok, I'm too nervous to continue with you...rdf I know somewhat better:

What is consumption and what is savings?

Consumption is when you unload your paycheck on depreciating assets...savings is when you put it in the bank and allow them to lend it (ok, times 10) to others who unload it on depreciating assets...unless there is an appreciating asset in which case we leap for joy and call that "investing"...putting on airs (the dog) like we were walking around like bankers...who never experience "losses", only "write downs". Some dog.
I don't think "morality" has much to do with it...and "savings glut" has that wet dog smell which forbids the usual pain-staking examination you seem to require.
I'm not sayin it's obvious (not anymore), just overwhelming.

[Bruce Webb]

Everything is simple if you ignore the complexities.

Consider a family that spends $10 million a year and is deciding whether to add a $2 million wing to its mansion. If the top marginal tax rate on consumption were 100 percent, the project would cost $4 million. The additional tax payment would reduce the federal deficit by $2 million. Alternatively, the family could scale back, building only a $1 million addition. Then it would pay $1 million in additional tax and could deposit $2 million in savings.

Under current tax rules if that addition is financed then the interest is deductable, which in the early years of a loan means a 35% savings, after tax that $2 mil is really only $1.3 million. If you are not subject to AMT in which case who knows. But you capture the appreciation on the entire $2 million in value, assuming of course that $2 million addition actually added $2 million in value, some additions do and some don't add value equal to their cost. And of course assuming there is any appreciation to start with.

Is the overall economy better off by injecting $2 million in labor and material costs plus $2 million in taxes as opposed to $1 million to the economy, $1 million in taxes and $2 million in the bank? Is the family? Depending on how the $2 million 'in the bank' is invested the government might capture little to nothing on the earned interest. On the other hand government at all level will capture substantial portions of that extra $1 million dollar in spending. Once you figure out how much of that comes back in income tax for the labor component, sales tax for the material component, and property tax on the increased value you might end up with the government folk shouting 'build it!' and depending on appreciation the owner might shout back 'damn right!' and then depending on how the addition affected property prices in the area you might get neighbors shouting everything from 'Go For It!' to 'NIMBY!'.

Economics is hard. We get that. It comes with equations and Greek letters and everything. So why do certain economists still try to sell policy based solutions with cartoon explanations? Economists get peer reviewed versions crammed with data which are unintelligble to outsiders. Outsiders get a curve drawn on a napkin.

I am not an economist but I at least vaguely understand the concept of first, second, and third degree order effects. Frank et al need to do a little more lifting here, that I don't understand his technical work doesn't mean he can simply insult my intelligence.

[Bruce Webb]

Well I kind of muddled the before and after aspects. Perhaps I underestimated my depth of ignorance (thanks Calmo!).

The point is that approaches like this take too narrow a view. A policy change that increases national savings and lowers federal debt might have devastating impacts on state sales tax and local property tax. It's like people who insist that poor people pay no taxes. Well except for the ones they do. Or people who insist that all corporate taxes slide frictionlessly onto the end consumer but also argue that renters don't pay property tax. (Which in turn ignores the fact that a great deal of residential investment property does not actually create real cash flow, after property taxes and interest you can be net negative, yet you can be fairly bizaarly enjoying both depreciation on the structure for tax purposes and appreciation on the property for capital gains purposes all at the same time. Do renters pay property tax? The honest answer is 'It depends'.)

It is not at all easy to identify where the incidence of any given tax fall. And laser beam focus on federal tax that ignore state and local effects don't really get us anywhere. Special pleading can be appealing to some, but not everyone is going to find it special.

[Ian]

There is no reasonable equity of distribution under the current INCOME tax system. What's more, the Tax Code has become a "tinkerer's paradise" for 53% of the lobbyists who game it in Washington DC. It's a lucrative business, and the U.S. TAXPAYER pays for ALL of it in higher prices (i.e., a hidden tax which is incomprehensible to the average working person).

Prices after FairTax passage would look similar to prices before FairTax - not "30% higher" as opponents contend - competition would see to it. So, the FairTax rate (figured as an income-tax-rate-non-comparative, sales tax) on new items would be 29.85% (on the new, reduced cost of items because business isn't taxed under FairTax - thus lowering retail prices by 20% to 30%), or 23% of the "tax inclusive" price tag - this is the way INCOME TAX is figured (parts of the total dollar).

The effective tax rate percentages, that different income groups would pay under the FairTax, are calculated by crediting the monthly "prebate" (advance rebate of projected tax on necessities) against total monthly spending of citizen families (1 member and greater, Dept. of HHS poverty-level data; a single person receiving ~$200/mo, a family of four, ~$500/mo, in addition to working earners receiving paychecks with no Federal deductions) Prof.'s Kotlikoff and Rapson (10/06) concluded,

"...the FairTax imposes much lower average taxes on working-age households than does the current system. The FairTax broadens the tax base from what is now primarily a system of labor income taxation to a system that taxes, albeit indirectly, both labor income and existing wealth. By including existing wealth in the effective tax base, much of which is owned by rich and middle-class elderly households, the FairTax is able to tax labor income at a lower effective rate and, thereby, lower the average lifetime tax rates facing working-age Americans.

"Consider, as an example, a single household age 30 earning $50,000. The household’s average tax rate under the current system is 21.1 percent. It’s 13.5 percent under the FairTax. Since the FairTax would preserve the purchasing power of Social Security benefits and also provide a tax rebate, older low-income workers who will live primarily or exclusively on Social Security would be better off. As an example, the average remaining lifetime tax rate for an age 60 married couple with $20,000 of earnings falls from its current value of 7.2 percent to -11.0 percent under the FairTax. As another example, compare the current 24.0 percent remaining lifetime average tax rate of a married age 45 couple with $100,000 in earnings to the 14.7 percent rate that arises under the FairTax."

Further, per Jokischa and Kotlikoff (circa 2006?) ...

"...once one moves to generations postdating the baby boomers there are positive welfare gains for all income groups in each cohort. Under a 23 percent FairTax policy, the poorest members of the generation born in 1990 enjoy a 13.5 percent welfare gain. Their middle-class and rich contemporaries experience 5 and 2 percent welfare gains, respectively. The welfare gains are largest for future generations. Take the cohort born in 2030. The poorest members of this cohort enjoy a huge 26 percent improvement in their well-being. For middle class members of this birth group, there's a 12 percent welfare gain. And for the richest members of the group, the gain is 5 percent."

[Peter Schaeffer]

I see several possible errors here. First, home improvements are generally regarded as capital expenditures (i.e. investments), not current consumption. Hence, they would not be subject to a consumption tax. Of course, Congress can write tax law anyway it chooses. However, standard accounting doesn’t consider most home improvements to be a consumption expenditure.

Of course, the example provided by the author doesn’t make sense, at least to me. If the family builds the smaller addition ($1 million), then the federal government gets $1 million less in tax revenue and the deficit increases by $1 million. How the federal deficit can fall from less tax revenue is not clear to me.

A better example might have been choosing to spend $50,000 versus $100,000 on your daughter’s wedding. By any measure, lavish weddings are clearly a consumption outlay.

However, I have a deeper problem with the author’s assertion that a consumption tax will diminish the pricey neighborhood / quality schools arms race. A consumption tax might move the entire schools arms race downscale a bit. However, folks who spend more will still be in better neighborhoods and (presumably) be able to send their kids to better schools. In other words, the arms race will continue unabated.

A better question is why we have a schools arms race and what, if anything, should be done

[david]

"The Economist was arguing for this all through the 80s."

Hard to imagine a better argument against.

Needs and wants. You get me a decent definition that can be applied via c. tax, then we'll see. Until then, progressive won't mean much, I expect.

[johnchx]

Robert Frank writes:

By replacing federal income taxes with a steeply progressive consumption tax, the United States could erase the federal deficit, stimulate additional savings, pay for valuable public services and reduce overseas borrowing — all without requiring difficult sacrifices from taxpayers.

You can't get there from here.

The (properly calculated) federal fiscal gap is in the neighborhood of 70%-80% of the total revenue generated by the personal income tax. That would be about 95% of all of the after-tax incomes of everyone earning over $1 million. Or 26% of the after-tax income of every household earning more than $100,000. Or 16% of the after-tax income of every household earing over $50,000. Or 11% of the after-tax income of every household.

There is no way to truly erase the federal deficit "without requiring difficult sacrifices." (I suspect that even the millionaires would notice the disappearance of 95% of their incomes.)

[johnchx]

Robert Frank writes:

Under such a tax, people would report not only their income but also their annual savings, as many already do under 401(k) plans and other retirement accounts. A family’s annual consumption is simply the difference between its income and its annual savings.

Just to clarify: I think "savings" would have to be defined as net purchases of assets minus net increase in indebtedness.

You have to capture changes in debt levels in order to avoid creating a loophole in which you "save" a certain amount of money (earning the tax deduction) while borrowing -- and spending -- an equal amount.

This has an interesting side effect: a household which borrows may be taxed on more than its income. (Which makes sense: the tax is on consumption, whether that is financed out of current income or future income -- i.e. debt).

One more accounting wrinkle: you'd have to go through the exercise of imputing rental income to owners of owner-occupied housing, because homeowners "consume" housing, no less than renters.

[Lafayette]

jcx: (I suspect that even the millionaires would notice the disappearance of 95% of their incomes.)

Not to worry, life is much more than obsessively reading one's net-worth monthly report. They will continue to maintain a Very Comfortable lifestyle. Better than all combined who read this forum.

For the moment, the game of "Getting Rich in America" consists of separating the Filthy Rich from the Simply Rich with as much media hullabaloo as possible.

And it is the rest of the nation paying the cost of that vacuous folly.

[johnchx]

Lafayette writes:

They will continue to maintain a Very Comfortable lifestyle. Better than all combined who read this forum.

Um...perhaps you misunderstand me. Those aren't marginal rates...i.e. I'm not talking about 95% of income above $1 million. I'm talking about 95% of the total income of households reporting incomes of $1 million and up.

Let's look at a two-earner family; earner one makes $800,000 and earner two brings in another $400,000, for a household AGI of $1.2 million. They pay about 25% of this in federal income tax ($400,000), leaving $800,000. We take 95% of this ($760,000), leaving two earners with a combined take-home pay of $40,000.

Have they crossed the poverty line? Well, no. But "better than all combined that read this forum" would be a bit of an exaggeration.

"Off with their heads" is fun to think about, but is perhaps not sustainable fiscal policy.

[Lafayette]

jcx: I'm talking about 95% of the total income of households reporting incomes of $1 million and up.

When pigs sprout wings, even then it won't fly.

Dis-incentivize work and you will take America back to the stone age.

Above 60 to $100M in total compensation, and that would work.

[johnchx]

Lafayette writes:

Above 60 to $100M in total compensation, and that would work.

Um...not using earth-style arithmetic.

You see, if closing the fiscal gap requires near-total expropriation of every household with incomes of $1 million and up, then you can't close the gap with similar expropriation of fewer households.

Households with AGI's of $10 million and up reported total incomes of $376.3 billion. Those above $60 million would have less. Those above $100 million would have less still.

You can't close a $700 - $800 billion fiscal gap simply by taxing those with $60 million incomes, even if take all their income (and even if they would make no change in their behavior as a result)...even the very, very rich aren't that rich.

Perhaps we're talking past each other. My original point was that closing the fiscal gap without sacrifices is total fantasy. Even if we say "we don't care about the sacrifices of the rich, tax 'em back to the stone age" (which, as a practical matter we can't) the rich simply don't have enough income to do the job.

That means taxing the rest of us. And that means sacrifice that does count.

[Lafayette]

jchx: Um...not using earth-style arithmetic.

I'm not closing any "fiscal gap". You are.

I am simply stating what is politically feasible in terms of raising taxes. You are trying to prove what is mathematically necessary. The two will never jibe.

Politics was never driven by mathematics. Or economics, for that matter.

The deficit is part and parcel of the American heritage -- like the nose on Uncle Sam's face. It just wont go away. It can be diminished to more manageable proportions, but that is about all.

[Icarus]

Just reading these silly blogs makes me root further for the insanely wealthy (I'm not one). If a top income earner has a reporting income of $100 million, the idea to tax any income at 95% is absurd.

The US used to have tax brackets at those rates decades ago, and I can't imagine the horror. I, for one (and quickly), would do anything to pursue tax avoidance in that situation.

95% of anything is robbery, and nothing more.

We need to cultivate an economic environment in which high worth individuals, and high skilled (usually highly paid) individuals WANT to exist in their society.

Their skills, their wealth, their leadership are assets for the nation, and, like seeds, have to be cultivated.

[johnchx]

Lafayette writes:

I am simply stating what is politically feasible in terms of raising taxes. You are trying to prove what is mathematically necessary. The two will never jibe.

I basically agree with this.

The thing is, arithmetic always wins in the end, and things that cannot go on forever, stop. I think that, in retrospect, when the day of stopping arrives, we will wish that we had changed course sooner. Rather like global warming. But, like global warming, I tend to think that our political apparatus isn't capable of thinking that far ahead.

Icarus writes:

Just reading these silly blogs makes me root further for the insanely wealthy (I'm not one). If a top income earner has a reporting income of $100 million, the idea to tax any income at 95% is absurd.

That's actually the point. No remotely feasible "tax increase on the wealthy" is sufficient to align our tax revenues with our current spending.

Lafayette's point is that no remotely feasible tax increase of any kind is sufficient to align our tax revenues with our current spending. I fear that this may be perfectly correct. In which case, sooner or later, perhaps fifty years down the road, the federal budget is going to be written, not by Congress, but by a committee of creditors. And ask, say, Indonesia, about how much fun that is.

[Lafayette]

jcx: The thing is, arithmetic always wins in the end, and things that cannot go on forever, stop.

Kennedy tried to stop the outflow of dollars (that became Eurodollars on foreign markets, and therefore tradable) that was hurting the dollar's exchange rate. He came up with an Interest Equalization Tax to try to staunch the bleeding and support the dollar.

It never worked. There's one example of where an effort to tinker with foreign trade/finance did not work. So, when a people refuse to look at the arithmetic of deficit spending, they become the "lotus-eaters" -- that is, those who systematically refuse the bitter pill of reality.

Furthermore, we have entered into a worldwide Free Trade era, where globalization is having profound impacts on internal economic outcomes -- most of which are far beyond any individual country's ability to modulate.

Finally, raising taxes to pay for the American deficit, whilst a sane idea, is simply not politically practicable. It is a necessary condition, but insufficient solution. As you say, bilking the rich to pay for a budget deficit or a chronic current account deficit (by redeeming outstanding T-bills) will not do the job wholly. Taxing the middle-class will provoke a political backlash at the election booth.

So, what will do? Gradually bringing down the trade gap and restoring fiscal responsibility to domestic expenditures. How do we do that, aside from raising upper income taxes?

Changing patterns of consumption and relying less on imports. And, how do we do that? Good question, because unilaterally increasing import tariffs places us squarely before the jurisdiction of the World Trade Organization (by means of the GATT agreement that we signed).

To my mind, what is evolving over the past decade is the recognition (by most Americans, I would hope) that "unilateralism" is no longer a US privilege. If this lead-head of a PotUS has showed us anything, that is, if there is any tiny, tiny reason that might salvage his presidency from the dust-bin of history, it is this: That America is part and parcel of something much larger than just itself. That the multi-polarity of the globe is setting in gradually but inexorably.

And that Americans should accept that simple fact by accommodating their own lifestyles accordingly.

Pray tell ... how am I so wrong to be soooooo pessimistic.

NB: Just watch. In this upcoming election, the dire fiscal situation will spark the suggestion of a few palliative solutions. But, no real reformation of the tax base and tax regimes – to address the growing deficit; that most Americans think is a fictitious invention of economic journalists. They just cannot believe there is any fundamental reasons that their lifestyles should change – and any politician suggesting otherwise is headed for political insignificance.

[johngaltline]

Let's look at what this idiot is saying in completely different terms. You could actually implement this as an income tax, though the withholding would be harder because you don't know what bracket someone's going to end up in until the end of the year.

So, if you kept the IRS, eliminated the marginal scheduling, raised the top rate to 50%, and allowed unlimited deduction for savings, you would have exactly the same plan.

Now, is there anyone here who thinks such a plan would "erase the federal deficit, stimulate additional savings, pay for valuable public services and reduce overseas borrowing?"

Frank's a complete idiot.

[Lafayette]

: "Let's look at what this idiot is saying in completely different terms.

jq

I'll thank you to use other words in posting.

There are no "idiots" here. They are perhaps elsewhere ... go look for them.