What would be wrong with dropping the income tax entirely?

Great Debates
81

You put a lot of seeds in the ground, not all of them will grow to healthy plants.

Still, there’s zero reason that the collapse of a housing bubble has to put so many people out of work who aren’t in the construction industry. That’s a cyclical problem that can be fairly easily fixed with the right policy. It’s not a question of long-term growth.

Long-term growth is based on investment (along with some other deeper things like institutional integrity and culture). That’s true despite the fact that some investments inevitably fail.

Absolutely not.

Think about the history: if they’d figured out a way to levy a consumption tax in the 19th century to encourage investment, and it were permanent, would people today still be permanently living with less consumption than they’d had in the 19th century? No. Some investments fail, and as an absolute measure, more will fail if you have more investment. Even as a percentage, you’re likely to see a higher percentage of failures with more investment, as all the low-hanging fruit is used up first. But we’re not at the frontier of what we can accomplish technologically. Not even close. Eventually you have enough successes that we can create things more efficiently despite the tax, which means ultimately more is consumed despite the tax. The way to raise living standards, long term, is now and will continue to be more investment. (Eventually that will end, as the physicists remind us. But not yet.)

I happen to think that we’re rich enough now that the most blessed among us can help out the poorest in areas like access to food and health care. I’m hardly alone in that opinion.

Yet investment still drives long-term growth. Growth is a tricky topic in some ways, but we know at minimum that we have to plant now to harvest later. We need to invest now to consume later. And how much we consume is going to be much more a function of long-term growth than it is dependent on a tax on consumption, even if the tax is permanent.

Not “supposedly”.

It unequivocally encourages investment.

That doesn’t mean it’s practical in the real world. That doesn’t mean real people in real tax bureaus would be able to make it work. But if we eat fewer seeds, we have more to plant. That is necessarily true.

There’d certainly be lobbying, just as there is lobbying for loopholes right now.

How successful would it be? I’m not in a position to say but I have a few thoughts about that below.

A VAT is going to be a significantly flatter tax. You can carve out a few exceptions here and there, especially with a standard rebate (similar to a Progressive Consumption Tax standard deduction), but all things considered, a VAT will be a much flatter tax than a PCT.

That’s why the more conservative budget wonks like the VAT so much. (I’m not talking the hacks here, but the real wonks. There aren’t many but they do exist.)

There is no bureaucracy keeping track of all these items.

There are no excluded items. Everything counts. They keep track not of all purchaes, but simply of money flowing out of a private individual’s account, which is assumed by default to be consumption. For enforcement purposes, they’d also have to make sure that business expenses are genuine investment, not extra consumption on the side, but they try to enforce that now already, yes?

You don’t need special exceptions for things like groceries if the standard deduction is made large enough that people at the bottom don’t have to pay. The government doesn’t need a list of everything you buy in this system, it only needs to know whenever money leaves an account. The big trick, to my mind, is making sure that US vendors only accept payment from valid accounts (or cash), but even that doesn’t imply a master list of everything bought in the US, all in the hands of the evil bureaucrats.

If you still have the possibility of itemized deductions, those could be listed separately, with proof of those individual items filed at tax time every year, similar to what’s done now. But the thing about many of those deductions today? They’re explicitly intended to encourage more investment, along with the definition of “income” itself. Why is capital gains income taxed differently? Investment. Why the mortgage interest deduction? Housing investment. Buy an electric car? Green investment. Have kiddies? Human capital investment. (Okay, that last one is a little different.)

If you start the conversation by saying to conservatives, “Okay, investment is good and we’re going to allow it… but for conservative economic reasons, we’re going to tax the hell out of any big consumption, just like your economists say we should do”, then every standard conservative (economic) argument vanishes. If people show up at Congress to lobby for less taxes for the rich, then they are, by necessity, lobbying that rich people be allowed not only to earn more, but also to consume more at lower rates. Do you really think that would fly? If we had a consumption tax system, and Congress-critters threw in special exceptions for consumption by the rich, when they’re already not getting taxed on their income, do you think that would work politically?

I can’t say I’m very good with politics, but one of the things that appeals to me about this is that there are no legitimate economic arguments left from conservatives if you institute this system. If the rich industrialists want to spend a billion dollars on an election, that is free speech, apparently, according to SCOTUS. But it’s also, quite obviously, a large-scale consumption of advertising. Currently, it’s not taxed as such… but it would be under a PCT system, just the same as all other chunks of large-scale conspicuous consumption. That means it would come with quite high marginal rates of taxation.

By giving up the notion of taxing income, we actually open some very interesting possibilities. Again, this is worth some consideration. A lot of our kneejerk notions of “fairness” are bound up in the present system, but that doesn’t mean a new system would automatically be unfair. There are certain advantages here that are worthy of more careful thought.

82

Interestinglink. I think a lot of non-economists intuitively understand that infinite growth is a foolish idea, but our business culture tries to beat that common sense out of us.

83

Most of this is just a product of the recession. As financial insecurity is high, and interest rates are low companies are borrowing money at low interest rates rather than spending their cash now and risking higher costs later. This is just part of the business cycle. It does not change the fundamental facts of the economy.
Another reason that businesses have so much cash is that almost a trillion dollars of the cash is from overseas profits. When that money is repatriated they have to pay taxes on it. As long as it stays overseas they do not have to pay taxes on it. One of the recommendations from the panel of economists was to eliminate the corporate income tax. If that happens a good bit of that trillion dollars would be repatriated and used in the US. Combining a progressive consumption tax with an elimination of the corporate tax like in the X-Tax plan would be a huge improvement in the tax code.

84

This is a silly link. The physicist posits that over the last 400 years economic growth has led to energy use per capita going up, and population going up. Therefore if trends continue in 400 years the earth will have 50 billion people on it each using the energy of two suns. The truth is per capita energy use in the US and many other countries has gone down in the last 30 years and population growth for the planet is predicted to stop in about 25 years.
It shows the physicists ignorance of economics that just because he can extrapolate from a graph, he thinks he can tell the future.

85

I’m a gardener, and some things, like radishes you plant lots of seeds of and winnow out all but the best. But that doesn’t mean you plant any in sand.

Absolutely. First, some adherence to regulations could have cooled it by controlling access to credit. Second, interest rate increases might have helped a soft landing when the market was already overheated. (Krugman repeatedly called for this before the crash.) And after it crashed infrastructure investment could have helped with unemployment.
I was talking about the 1990s bubble which made me theoretically rich for a while.

Sorry, I was not clear. I meant relative to consumption levels without the tax. Consumption levels will increase due to population growth if nothing else.
I live and work in Silicon Valley. There is some ideal mean of investment. Too little, and good ideas get starved. Too much, and bozos who couldn’t tell an Ethernet cable from a rubber band put money into stupid ideas. Basic technological growth does not depend on venture capital very much, since it is too risky. (At least not in the electronics area.) Advances happen when they happen. New applications do grow relative to funding. The Internet, the IC, and the Web were not venture funded. Things like Facebook were, but they are not fundamental technical advances.
I certainly agree on the need for more investment. I don’t see how putting a system in place which will at least temporarily drive down demand is going to help private investment.

Please don’t take me for a Republican! I recovered from that disease quite some time ago. Sure we do, we just need the political will.

I worked 15 years for Bell Labs, usually 50% research funded - and I’ve seen since is that there is less and less interest in long term investments (which clearly have higher risk) and more interest in short term investments. My old CEO spent some money on medium term investments got got screamed at by Wall Street about it. What he did turned out good, and if he followed his advice I’d not be here now.
In the long term … well, you know. If we were in a situation where the rich were stressed for investment funds, a tax increase on them would be a bad idea. We’re not. If we were in a situation with rampant consumption, a tax on that would be a good idea. 2005 or so would have been an excellent time for this. Not now.

Do you consider buying treasury bills investment? If so, sure - more free money means more to put somewhere instead of spend, and that could be considered an investment. I meant productive, job increasing, investment.

I grow squash. I’m up to my ass in squash right now. People run from me. I throw some in the open windows of cars stopped next to me. Don’t try to sell me ways of making my squash more productive. My demand is not great enough to justify that investment.

In an ideal world a PCT is far better than a VAT. For one thing, those taxed more are less sensitive to prices, so the reduction in demand will be less.

If I write a check from my checking account to my investment account, is that consumption? People have brought up stock purchases - is that consumption? Is a birthday present of money to my daughter consumption?
Standard deductions are a serious flaw. For people like me and you, with good cash flow, it is no big problem. But someone living paycheck to paycheck has a much higher internal discount rate than we do, and investing extra money today in necessities for a refund an average of 6 months in the future is going to be very painful.

Or housing consumption. Houses as investments that appreciated faster than inflation is a relatively new concept. Proof: all investments can go down. Wall Street risk models for the housing market seemed to have neglected that possibility.

Conservatives today (as you can see in this thread) that an increase in the top marginal rate to the high 30s is going to destroy the incentive to invest and is unfair. And they are more successful with this argument than they should be, because in part I think people put themselves in the shoes of the poor, oppressed, 1%. Now a top consumption tax is going to be a lot higher than 38%, and we all pay sales tax every day, so the problem would be much worse. .
And look at what the House is doing, and tell me that a proposal has to be economically sane to work politically.

Industrialists don’t buy advertising. The contribute to PACS which do buy advertising. Would that be taxed? Charitable donations? I must admit that the notion of Meg Whitman (who did buy advertising) helping to fund Jerry Brown’s budget is appealing.

I agree that a new system need not be any less fair than the current one. I am less than convinced that just monitoring the input and output of accounts will work without a bit of a deeper dive. I also fail to see how any remotely feasible level of taxation at the high end will make up for the loss of income tax revenue. I think my analysis if the situation in California makes that very clear.

Maybe we should do an analysis of what the rich spend their money on and bring back the luxury tax, which is progressive. We can start by slapping a big tax on car elevators in private homes.

86

Best not to get caught up in zero-interest-rate thinking. What we have now is (should be) an exception, not the rule.

If you buy Treasuries, or stocks, or gold ducats, or whatever, you are right that that does not count as Real Investment in the strict economic sense (where investment is the purchase of potentially productive capital goods). But in the normal situation?

Every buyer has a seller. They receive your money when you make an asset purchase. And what do they do with it? Maybe they’re only rebalancing their own portfolios, so they sell one piece of paper to buy another. Again, that’s not Real Investment. But… there will be another buyer and another seller. That seller? Maybe they’re rebalancing their own portfolio. Etc. The dominoes fall, one by one.

Eventually, you hit the last domino. Eventually, you hit the person who is selling their financial asset not to buy another dead piece of paper, but to add to GDP. People don’t sit on cash for no reason, in ordinary times. That last domino person must necessarily exist somewhere at the end of the chain of transactions. It doesn’t matter if you’re only buying Treasuries yourself, because the guy at the end of the chain is going to be buying something tangible, something real. It’s probably going to be consumption. But if there’s a consumption tax, this final domino might shift away from consumption and decide to purchase a newly-issued security, a new stake in newly created capital goods. And that is, in fact, Real Investment. So yes, increasing the incentive for you to buy treasury bills does create an incentive for Real Investment.

Granted, today the seller can just sit on cash. It’s bizarre. The situation today is weird, we’re talking Great Depression weird. Obviously, it won’t last forever.

The whole purported point of financial markets is to transfer squash away from people who are ass deep in it, and to people who can use it productively.

Everyone realizes this doesn’t always work out so swimmingly. If you think genuine financial reform is a higher priority than tax reform, that’s great, because I agree entirely.

I obviously wasn’t clear about this earlier, so let me break it down with a few examples. There are lots of technically equivalent ways in which you could set up the administration of this system. I don’t know which would be most efficient in practice for real-world tax collectors and citizens, but here is my way of thinking, which is a fairly simple way to approach it conceptually.

You have INCOME. All income of all kinds must be reported: all wages, all capital gains, all dividends, all inheritances, everything. If you earn it, they know about it. Hardly unusual, since that is largely what happens today with a few exceptions. There is in addition a SAVINGS account. This doesn’t have to be one account, it can be an umbrella account with lots of subsets: bank checking, bank savings, stocks, bonds, foreign currencies, pirate treasure, etc. Putting money into SAVINGS comes with no tax incidence. If the money is there and it stays there, you don’t have to pay Uncle Sam.

You get hit with the consumption tax any time money moves out of SAVINGS, or indeed, if recorded INCOME never shows up in the first place.

Buying a stock? Nothing changes. You aren’t moving money out of the umbrella account, you’re just moving things around, moving some money out of checking and into stock ownership. You’re rearranging your savings inside the box, but it stays in the box. That’s the same for any other kind of security purchase. It’s only when you stop pushing paper around, and actually pull money out, make a withdrawal, that you get hit. The account balance can go down if an investment goes bad, but that’s obviously not consumption. It counts as consumption for the purpose of the tax if there is a withdrawal. Any withdrawal.

Withdrawing cash to give as a present? That counts. Withdrawals count as consumption. That is not the definition for GDP purposes, but no matter. It’s the right definition for ease of enforcement. It’s safe to assume that if you’re withdrawing money, it’s to consume something, so that is the tax presumption. Your daughter might buy a Toblerone (consumption) or she might stick it in her own account (savings), but to keep track of which would require a Master List, and administratively, that’s out of the question.

There are lots of equivalent ways to work this, and all sorts of devilish details that would have to be worked out – especially with respect to people with no access to traditional banking! – but the general idea is, you get hit whenever money leaves the SAVINGS account (or never shows up to begin with).

No need to make things over-complicated. PACs don’t count as charitable donations now. Nothing changes.

Money must leave their account to enter the PAC’s account.

Money out of the account = presumption of consumption.

If they were donating more than 30k or whatever to help starving AIDS-stricken children in Africa, they could file the paperwork to overturn that presumption and get the itemized deduction. But donating to PACs? Free speech, sure, but buying a bigger megaphone so that more people can hear the freeness of your speech is still consumption, by definition. There is no deduction for that now, and there would be no deduction for that under a PCT. If they want to give a billion dollars to a PAC, they’re free to do so, but they’ve gotta pay the piper, same as with any other kind of massive consumption. It doesn’t matter that they’re not buying the advertisements directly, it’s still headed for consumption eventually, and the easiest way to enforce this is to charge at the beginning of the process, to hit the very people who make the conscious decision to move money out of their SAVINGS.

You take cash out to give to your daughter as a present, that counts as taxable consumption. They take cash out to give to a PAC, that counts as taxable consumption. Them’s the rules. The tax authority doesn’t have to have any idea where the money goes. They don’t have to keep a master list of where you send the money. It’s just that the withdrawal shows up plain as day in the account records, and that is what matters.

Maybe implementation would be a real bear, but the essence of the idea is fairly simple.

87

If the money from selling those T-bills went to productive government investments, we’d be in much better shape. Today they are going to make up for the inadequate tax rate we have. And unfunded adventures in times of relativel prosperity when we should have been running a surplus or close to a surplus.

But many of my neighbors grow squash too!Inadequate demand for the supply.
If you don’t like squash, think tribbles.

That’s one hell of a box. Don’t get me wrong - the company I work for would make a fortune selling stuff for such a system (even bigger than the fortune it already makes) but there seems to me to be real privacy concerns. Yes, you report all income, but that is a relatively small number of inputs to the government. You report interest, but not your balance. You report stock sales, but not stock ownership. I’m not paranoid about privacy, but I think a lot of people would think this too much.

Oh, it could be implemented all right. (Though the FBI still doesn’t have their computer system working, so maybe not.) It is the politics that would kill it.
And you still haven’t told me where the money to make up for the effectively reduced taxes on the top earners would come from.

88

You don’t have reduced income if marginal rates are high enough.

You did the back-of-the-envelop calculation yourself. I didn’t argue with it. A 100% income tax means we earn no income, but the same rate for consumption just means that people like you and me pay twice the sticker price for one last gallon of milk. Bill Gates pays even more. Considering that there would be zero taxes on bond interest, stock dividends, capital gains, salaries, etc, that hardly seems onerous to these eyes.

If you like, you can do a more careful calculation whenever you want. The one thing you’d have to remember is that the data you were using, a state sales tax, is going to be levied only at stores, which means it leaves off certain other kinds of consumption like rent. For owner-occupied housing, that means…

…huh…

It can’t work.

Like, a traditional security? Like a bond? It’s an asset: it pays a stream of income. For a bond, this is interest payments. That income isn’t taxed with a PCT. Only if people want to consume will it be taxed. A housing investment, i.e. building a damn house? It’s an asset: it pays a stream of income. This stream of income is “rent”. If you’re a landlord, you’re not consuming the stream of income yourself (that is, you’re not living in the house yourself). That consumption comes out of other people’s pockets, the renters. But if you own the house, that means you are literally consuming the stream of income yourself by living in the house. That is honest-to-god consumption.

For GDP calculations, “imputed rent” is added for owner-occupied housing. People are consuming the ability to live in that residence for a year. Nobody argues about this because there’s nothing at stake if imputed rent calculations are a little off. But if you’ve got a consumption tax of this sort? Imputed rent should be included. If you don’t include it, then the whole thing doesn’t work. Without imputed rent, this particular stream of income, the ability to live in a house, can be consumed tax free, which means the whole damn system is distorted so all that money floating around is channeled into over-large homes instead of jet-skis.

Taxing this sort of consumption, the ability to live in a stupidly big home, is essential. But I can’t see homeowners agreeing to that. Imputed rent would be an absolute nightmare. It’s a huge, huge political problem. Economically, it still seems like a good idea, but there’s no way you’re going to get homeowners to pay accurate imputed rent values.

Okay, yeah. Political dead-end. Interesting but hopeless.

89

Let me quote myself.

We’d need about a 900% sales tax on the 1% to make up for their lost income tax contribution. I think I made it clear that 100% sales tax, unlike income tax, is theoretically feasible. Now raising tax rates on the rich is not going to affect demand as much as raising them on the poor, but 900% is going to have some impact!
The gap between income and consumption for the very wealthiest is so great that a consumption tax cannot practically bridge it.

Oops. :slight_smile:
We could charge a mortgage consumption tax while taking away the mortgage tax break (from eliminating the income tax.) And taxing mortgages - which might be like taxing rent - would encourage people to pay them off faster - especially the rich. Around here it was big news that the CEO of Facebook got a 1% mortgage. I’m not offended, because he is probably a pretty good credit risk.
But he could obviously buy outright.
Now if someone could just come up with a means of taxing fully paid off property …

How about if you own an abandoned house? It is hard to argue that this is consumption. Fortunately we already know how to tax such things. One advantage of property taxes is that they are more stable than either income or consumption taxes, and don’t fall as much during a recession when the government needs the money for stimulus. One of California’s many problems is that property taxes are less of a contributor to revenue than they used to be. As my cite showed, they are less progressive than income taxes but much more progressive than sales taxes, even at the high end.

Progressivity is a good thing, and PCTs would be good as a supplement. But the only way I can see to make them work is a luxury tax technique, or maybe a sliding scale based on purchase price. Maybe progressive property taxes would be good also, normalized to the state market. I’ve seen talk of making capital gains taxes progressive, that seems reasonable. So my objection is replacing income taxes with consumption taxes, not the concept itself.

90

The names don’t really matter. You could call the imputed rent portion of the consumption tax a “progressive property tax”, and that would basically be accurate. Basically. It could quite possibly even make the numbers feasible. (I still got a hunch it would work, but I don’t have the time or inclination to be thorough on this one right now.)

It’s still a political non-starter. Homeowners would balk at the size of it. Regular property taxes are hard enough.

When you’re adding these supplements, things get very complicated very quickly. Too complicated.

That means a VAT. Governments have already figured that one out. That’s the supplement that will eventually be coming.

They’ve tried luxury taxes many times. The demand is generally too elastic. The yacht-construction workers lose their jobs, while the wealthy just find something else to buy to show off. You can’t list everything that’s luxury… except with something like a PCT.

Round and round it goes.

91

Hellestal, you’re my hero. You came in here with this grandiose cockamamie idea; we were all (well, at least I was) thinking, “What? Why is Hellestal pushing this silliness? Isn’t Hellestal smart?” and then you talked yourself out of it. Bravo.

I sort of see why you think it would work in theory. It looks like the implementation would be horrendous, and people would complain about it for the same real reasons they complain about income taxes (which it would resemble). It would mean rebuilding a significant part of the tax code from the ground up, setting off an enormous amount of small-c conservative animosity, just to counter one political argument which isn’t important to most people. Is that fair to say?

92

Most homeowners wouldn’t be affected. And back in 1980 Louisiana had an exemption for the first $50K or so of home value, which makes property taxes slightly more progressive. We paid something like under $100 a year in property taxes (local) on our house, which was under the limit.

Agreed - but the tax would be on purchases above a certain level, which would keep any one industry from being too hard hit.
And I see the practical problems already!

Thanks it’s been fun. And you almost got me to argue for the PCT out of contrariness.

93

If an income tax were to be eliminated or greatly reduced, I’d favor a 100% estate tax. Let people keep the money they earned but not get money they did not earn.

I’d call that about as close to tax fairness as its possible to get.