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Friday, September 30, 2005

Marginal Utility on Consumption Taxes

Tom Bozzo at Marginal Utility explains why he is not sold on the consumption tax:

Marginal Utility: Coming At You From The Econoverse (Maybe): The Consumption Tax: ...A consumption tax has been a darling of long standing for some economists. The main idea, as articulated by Alan Greenspan here, is that taxing consumption as opposed to income — thereby deferring tax on saved income until it's consumed — increases saving (by lowering the price of future consumption relative to present consumption) and, by extension, investment and economic growth. ... One idea with more than a little currency is to replace the income tax system entirely with a "progressive consumption tax." This is often presented as a simplification of the income tax system in that you just subtract (net) saving off of income to obtain "consumption," probably further subtract some personal exemptions, hit the result against a tax table, and voilà, a tax return in ten lines or less. While some forms of consumption taxes are "regressive" in that they disproportionately fall on the not-rich who have little choice but to consume ... their income in order to live, the rates in a "progressive consumption tax" ... can be set to ensure that the rich pay their fair share ...  Moreover, the top tax rates would specifically discourage some of the conspicuous consumption ... which drives portions of the non-rich classes to the poor house, making some forms of consumption taxation amenable ... to ... economists like Mark Thoma and Cornell's Robert Frank (author of Luxury Fever).(*)

You might ask, if this is such a damn great idea, why wasn't it implemented yesterday? There are a few candidate answers:

  1. Just wait. The tax reform commission launched earlier this year is due to report its findings soon, notwithstanding the various preoccupations of the Bushist "policy" shop. Given that promoting savings and growth are explicitly listed elements of its remit, its quite conceivable that consumption taxation in some form will be among the recommendations.
  2. There are big transition issues (also cited by Greenspan), particularly relating to the treatment of assets acquired under the income tax system. Really, any material tax reform will have some sort of transition problem, since even if the system were designed to be as distributionally neutral as possible, someone's oxen will be gored and the Flying Spaghetti Monster help the politicians who do it.
  3. As a replacement for income taxation, consumption taxes aren't obviously so great after all.

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I'll make some of the case for #3... One problem is that the simplicity argument in favor of a consumption-tax replacement for the income tax can be a chimera: The simpler the consumption tax in the length-of-the-tax-form sense, the less clear it is that its economic distortions are smaller than those from a well-designed income tax. ... That measuring net savings is potentially complex is well-enough known that it's mentioned in pro-consumption tax sources like this EconLib article. The solution proffered by the article's author — a sort of unlimited IRA, ... amounts to little more than a wave of a magic wand. ... Under a consumption tax, it becomes necessary to track and net out all contributions and distributions from every possible savings vehicle. This doesn't bother me, but then again I can figure out my AMT on my own if I have to. I would predict a bonanza for tax preparers and tax software providers.

There also arises an issue of just where does consumption end and saving begin. It's not so simple. ... Nor is it necessarily easy to measure economic consumption. ... consumer "durable" goods like appliances, cars, and (in some respects) houses account for large shares of expenditures and are mostly consumed in tax periods other than the year of purchase. If the consumption tax is essentially a cash-flow tax (i.e., simpler from an accounting perspective), then it will tend to overtax durables in the year(s) of purchase, and then undertax them once they're paid off ... This could be seen variously as excessively discouraging durable goods acquisition ... Did I mention that for a given level of revenue, consumption tax rates would need to be much higher than income tax rates, other things equal, given that consumption represents a smaller tax base than income? The more economically efficient alternative of gradually taxing durable goods consumption would itself be a colossal administrative undertaking, ... Again, this is not necessarily so simple. As for the necessity argument, since a consumption tax system eliminates tax distortions affecting savings returns at the cost of increasing them (via higher tax rates) in various goods markets, the net benefits would appear to be ambiguous...

So I'm not especially inclined to buy. I'd prefer a simplified progressive income tax that traded off some of the present mess of deductions, credits, and tax-preferenced forms of income for as low a set of rates, applied to a broad income base, as will approximately balance the federal budget along 'trend' growth. (That'll require a lot more revenue than is presently being raised, in the absence of a reversion to fiscal discipline...) To be sold, I'd need convincing that any feasible consumption tax will outperform that counterfactual.


(*) ...Frank's article ... proposes an untraditional mechanism by which the consumption tax might promote savings. The progressive rate structure would tend to reduce consumption inequality which ... pushes people to spend themselves into oblivion to try to keep up with higher-income, higher-consuming peers who ratchet up general expectations of what constitutes a reasonable lifestyle. Social acceptance of financially modest consumption is, then, a collective good that's under-provided by the "market." ...Mark Thoma doesn't completely buy the collective good argument , and I'd certainly view the need for a tax remedy to the "problem" with extreme suspicion, but I'm not inclined to dismiss the relevance of the social context of consumption.

Good points.

    Posted by on Friday, September 30, 2005 at 01:35 AM in Budget Deficit, Economics, Income Distribution, Taxes | Permalink  TrackBack (0)  Comments (23)

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