Economics, Taxes and Spending

Why conservatives should love consumption taxes

John Tamny of RealClearMarkets:

For too long the tax and revenue consensus has settled on ways for the government to raise as much revenue as possible. … But as history has revealed in ugly fashion, politicians have very little discipline when it comes to spending, and the extra revenues have largely been used to expand existing government programs, or fund new ones. … In that case it’s time to look for modes of taxation most stimulative to economic effort, but that don’t stimulate government growth through heavy revenue collection. A consumption tax would remove the existing penalty on work, would encourage savings and investment, but at the same time would make taxation a voluntary event, thus limiting not just government revenues, but also the government’s ability to deficit spend given the limits imposed.

Yes, more of this, please. A move toward a consumption tax-based code would be severely pro-growth. Now, there are many different kinds of consumption taxes, as a 2008 AEI analysis explained:

1. Personal expenditures tax. Each household would file an annual tax return on which it would report income, deduct all saving (deposits into savings accounts, asset purchases, amounts lent to others, and payments made on outstanding debts), and add back all dissaving (withdrawals from savings accounts, gross proceeds of asset sales, amounts borrowed from others, and payments received on outstanding loans). The resulting measure equals the household’s consumption, which is then taxed at progressive rates.

2. The retail sales or value-added tax. The retail sales tax is collected from the firm that sells to the consumer with no tax on sales between firms. The VAT is a modification of the sales tax. When a firm sells to another firm, a tax is imposed on the selling firm (and passed along to the buyer), but the buying firm deducts the purchase against its tax (or, equivalently, claims a credit for the tax imposed on the selling firm).

3. The flat tax. In 1983, Robert E. Hall and Alvin Rabushka proposed the “flat” tax, which is a two-tier VAT. Firms compute value added, as they would under a conventional VAT, but then deduct their wage payments to obtain a remainder called “business cash flow.” Workers are then taxed on their wages. The total tax base is the same as under a VAT and therefore the same as under a retail sales tax. Because the VAT is a consumption tax and the flat tax is simply a two-part VAT, the flat tax is also a consumption tax.

Two key departures from today’s income tax make the flat tax a consumption tax. First, the household part of the flat tax applies only to wages, not to capital income, such as interest, dividends, and capital gains. Second, the business part of the flat tax allows firms to immediately deduct (“expense”) investments rather than depreciating them over time. Expensing eliminates the tax on marginal investments that are made after the reform is introduced because the tax savings from the expensing deduction offset, in present value, the tax on the investment’s future proceeds.

4. Bradford X tax. The late Princeton economist David F. Bradford proposed that the flat tax be modified to feature a full set of graduated rates. Workers with earnings below the exemption amount would pay no tax (refundable credits could be added, if desired), and the highest earners would pay a rate equal to the firms’ tax rate, while workers with intermediate wages would face intermediate tax rates.

Now, I’m not sure which plan Tamny would prefer. I’m guessing maybe something like the personal expenditure tax. I’m a Hall-Rabushka man myself, though political realities make the Bradford X tax probably more doable in today’s Washington. Strangely, or maybe not so strangely, many conservatives are repelled by the idea of a consumption tax because they think it is synonymous with a VAT, the fave tax of European social market economies. Indeed, the VAT has many fans among Obamacrats as a way of paying for government-run healthcare. But most flat taxes originating from right of center are also consumption taxes like Herman Cain’s 9-9-9 plan or Newt Gingrich’s 15 percent flat tax.

One thought on “Why conservatives should love consumption taxes

  1. Don’t consumption taxes on specific goods provide a disincentive for politicians to keep the prices of those goods low?

    For example, having a tax on gasoline actually creates an incentive for politicians allow the price of gasoline to increase ad infinitum, because a rising price generates a larger amount of taxes for the politicians to spend.

    Now we all know that increased fuel prices has a negative effect on the rest of the economy, causing all prices to rise, but do politicians ever think of the consequences of their actions?

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>