What's wrong with taxing consumption?

Great Debates
1

I have always thought that the fairest way for the government to raise funds for itself would be to tax consumption. Of course with the exception of necessities such as food, medical stuff, and a minimal limit on housing.

No one would be able to weasel out of paying a share, as I read every year about the some of the big corporations who pay nothing on their profits (i.e., Pepsico and one of the big drug manufacturers.)

As it stands now, only people who own businesses can weasle out of their taxes, and us wage-earners have every penny we make right out there.

Any thoughts?

2

Another word for “consumption tax” is “sales tax”. And sales taxes obviously fall more heavily on the poor, even with deductions for food and neccesities.

The “rich” consume far less as a percentage of their income than the “poor”. Scrapping the income tax and going to a sales tax would greatly favor savings and investments…what the rich already have plenty of.

3

I see the merit in a consumption tax as opposed to the current income tax… However I also see the merit in any tax as opposed to the current tax system.

Here is one for you to think about.

A relatively large non-taxable base, it can be any number but let’s say $30,000 for a couple. (plus $5K per kid). This income is not taxed and is considered the earners 100%. Now anything over $30,000 is taxed a certain amount… for ease lets say 20%. Absolutely positively no loopholes. Now what is the result:
For ease we will consider a couple no kids making:

$10,000 pays NO TAX
$20,000 pays NO TAX
$30,000 pays NO TAX (see the poor pay no tax)
$40,000 pays 5% TAX i.e. $2,000 (20% OF $10,000)
$50,000 pays 8% TAX i.e. $4,000 (20% of $20,000)
$75,000 pays 12%TAX i.e. $9,000 (20% of $45,000)
$100,000 pays 14%TAX i.e. $14,000 (20% OF $70,000)
$200,000 pays 17%TAX i.e. $34,000 (20% of $170,000)
$400,000 pays 18.5%TAX i.e. $74,000 (20% of $370,000)
$1,000,000 pays 19.4%TAX i.e.$194,000 (20% of $970,000)

Such a smooth curve of tax rates get rid of potential problems associated with the tax bracket system…for example : taking home less money when you make more money because you made it into the next bracket.

This is basically the flat tax system with a large tax free base. Unfortunately when you call it a flat tax it gets demonized. I think we should call it the Graduated Tax or the Perfectly fair tax.

Numbers are subject to change but the basic fairness of the system remains intact. And talk about political legs. Dems say they are for the poor. This Conservative system says POOR pay Nothing in Taxes. There must be a large minimum salary which cannot be touched by the govt. as means of providing the basic necessities and a comfortable and free life.

4

But STILL - the rich would pay much more tax on their Mercedes than I would on my used Escort. And there is nothing wrong with savings and investment - that’s what the economy is built on. It STILL seems fairer than taxing the income of someone who makes 8 bucks an hour.

5

I agree mashie. But I’m not standing on one foot waiting for the feds to let me keep all of my 300 bucks a week. Further, the rich consume much more than I ever will. Even if they have plenty left to save and invest.

6

A tax on consumption would be easy and fair.

First of all, you do not have to collect the tax at the sale but can do itessentially once a year as is currently done. However, instead of measuring current income you measure current consumption, like this…

C(t) = S(t-1) + I(t) - S(t-1)

Where,
C(t) = Consumtion in year t
S(t) = Savings at the begininning of year t
I(t) = Income earned during year t

This identity works because income must either be spent or saved.

Example,

Going in to 2000 I had $5,000 in savings. Going into 2001 I have $7,000 saved. During 2000 I earn $50,000

Then it is easy to see my consumption is $48,000 (5000+50000-7000).

SO now we have a tax base, differnt from income, that measure consumption. Now you can apply whatever graduated marginal rates you like to thsi base. You can also include exmeptions and credits as you like.

Some advantages include the fact that consumption is smoother over a lifetime, while income is not. A progressive income tax punishes those who have varying income from year-to-year. For example someone who earns $75,000 and $25,000 over two years will pay more in tax then someone who earns $50,000 each year.

Since a principle of equity in taxation would be that similiarly situated individuals should be treated the same, a consumption tax is better suited to meet this requirement then an income tax.

I don’t expect to see a consumption tax anytime soon, but I would be all in favor of it.

7

Granted…But, the point is that the poor spend a larger percentage of their income than the rich do, which means a flat sales tax is regressive…It results in a tax rate (i.e., percentage) that decreases with increasing income rather than the other way around. Right now, the income tax is the most progressive part of a tax system that overall is only slightly, if at all, progressive (once you include income taxes, lower rates for capital gains, payroll taxes, etc.)

Having said that, the sort of consumption tax that Tretiak talks about, which is similar to that proposed by a professor at Cornell, can be made quite progressive, for example if there is a high deduction so that those spending less than that amount pay nothing. [And, by the way, the formula he notes is the one that I have used over the last few years in order to see how much I am spending…I am not disciplined enough to keep track of all expenses, but it is easy enough to figure out the total income I got and the amount paid in income and payroll taxes. The rest is then what I spent.]

One problem, of course, is whether a suitably progressive consumption tax would have political “legs” given that most of the interests with lots of money to exert influence in politics have…well…lots of money!

As for Mashie’s proposal: Mashie posted it in the “Bush tax” thread also and I noted there that the one problem it is specifically cited as solving (that of taking home less money when you earn more) does not even exist in our current system, because the tax brackets are marginal rates. I.e., if you fall into the 31% tax bracket, you don’t pay 31% on all of your taxable income; you just pay it on the part that is above the tax bracket boundary.

8

Urgh…I forgot to include the amount that got put into savings and investments…but you know what I meant, right?

9

Umm, sounds great- but where are we gonna get the money to run the Gov’t? I contend that any tax reform plans must be 'revenue neutral" ie take in about what the taxes do today- your does not. Next- without deductions, it penalizes those who bought a home with a large mort, counting on the mort int ded- and would have to get rid of the home, and declare bankruptcy under your plan. Great.

poh- you cannot replace the income tax with a sales/VAT tax- in nations where they have a VAT tax, it supplements the income tax. The reason for this is- there would have to be about a 20% national sales tax (+ local sales taxes) in order to replace the FIT. And with the food, etc exclusions you propose- the VAT would have to be higher. At a near 30% sales tax- there would be so much avoidance it would be ridiculous.

When folks come up with these great tax plans- remember they have to bring in about the same amount of money that we collect today, and be collectable.

10

Taxing Observations:

  1. Anybody proposing a tax system that raises less revenues than the current one should say so: presumably they are also advocating either spending cuts or greater deficit spending.

  2. Replacing our tax system with a value-added tax or a sales tax is regressive: those with less income, who save less, would pay a greater share of their income in taxes.

  3. To offset this problem, Hall and Rabushka proposed, “The Flat Tax”, in 1983. Businesses are taxed (at 17%) on their revenues, less the costs of their inputs and their wage payments: if it weren’t for that last part, this would be a “Value Added Tax”. The progressive part comes in when wage-earners are granted a fixed deduction before being taxed (17%) on the remainder of their wages. Those with very low incomes thus pay zero tax. There are no taxes on interest or dividends: that aspect of taxation is handled by the aforementioned business tax. There are no home mortgage, charitable or any other sort of tax deduction: the entire personal tax return fits on a post card.

  4. Under the H-R flat tax proposal, Bill Gates faces the same tax on an additional dollar of income as everyone else does. This strikes many (though not all) as inappropriate.

  5. The Personal Consumption Tax (PCT) as advocated by Tretiak is another alternative. A version of it, dubbed the USA tax, was floated by Sam Nunn and Pete Domenici in 1995. An individual’s annual consumption is calculated from their earned income as well as changes in their savings and borrowing. Consumption is then taxed at an increasing rate, so that the progressive features of the existing tax system can be retained.

  6. A 1984 Treasury Department study concluded that measuring changes in an individual’s net savings (as PCT requires) would be more difficult and far-reaching than the current system. The USA tax in particular apparently contains great scope for tax-dodges by high income individuals. So PCT definitely should not be considered tax simplification.

  7. The efficiency benefits of the flat tax come primarily from the elimination of the home-mortgage deduction. This is politically unpopular. If there is no transition period, it is also likely to spark a pronounced and destabilizing plunge in home prices. If there is a transition period, then tax simplicity is once again postponed.

  8. In short, to hell with it. That is, we should stick with the current framework, preferably augmented by piecemeal adjustments (e.g. 1986 Tax Reform, taxes on pollution, etc).

Recommendation for tax boffins: Slemrod and Bakija (1996)Taxing Ourselves: A Citizen’s Guide to the Great Debate over Tax Reform. I hope that I have faithfully recounted their arguments in 1-7 above.

11

Why would anyone want to “take home” less money under the current system? While the tax brackets are not smooth, they are continuous. That is to say, pushing into the next tax bracket will never cost you more than not earning that money. For example, if the tax bracket were (made up numbers)
$0-25,000 0%
$25k-50k 10%
50k+ 30%

Under the current system, earning $25,001 would mean you tax $1 at 10% (and $25,000 at 0%). This was how my business math book explained it, at least.

My suggestions for revenue generating taxes:

(i) Highly progressive for-profit business tax on revenue with no exceptions.

(ii) Highly progressive, but low tax on people’s income (earnings, dividends, interest payments etc.)

(iii) Social cost taxes. That is taxes which compensate for the “tragedy of the commons,” or activities which otherwise cost the rest of us something; carbon taxes, packaging disposal taxes, as well as taxes on alcohol, cigs, and <ducks> :slight_smile: guns are a few examples. Applied primarily to producers, rather than to consumers (though it will likely raise prices for consumers).

12

[QUOTE]
*Originally posted by Danielinthewolvesden *
**
[QUOTEUmm, sounds great- but where are we gonna get the money to run the Gov’t? **[/QUOTE]

First of all income tax is not the only source of Govt money.

Second, if you read my post you would see that I was outlining a tax strategy. I did not claim to give actual numbers. Translation, change the tax free-base #; or change the %tax to a level equal to what the current govt requires. The system would still be better.

But the real answer (it would have to be phased in) is to REDUCE the size of govt. Making the IRS less complicated would be a good step in that direction.

13

This came up on another thread, but a progressive consumption tax is currently being advocated by, among others, economist Robert Frank of Cornell. From a press release about his proposals:

And Mashie, I am not convinced that “REDUC[ing] the size of government” is really the “answer” to anything except the most simple, superficial issue, namely how to make government cost less. Yes, it’s an excellent idea to save money by reducing that perennial evil Waste and Bureaucracy, but I have yet to see evidence that there are practical cost-cutting measures which will really reduce the cost of national government by a significant amount without removing some of its functions. And before I get behind any proposal to remove some of government’s current functions, I would like to see some better evidence than the anti-tax/libertarian crowd can usually muster that the problems these functions address would really be solved better and more reliably by market forces.

14

  1. Either argue a new tax plan, or argue a way to reduce the size of government. Do not give us this malarky about- “well. my plan won’t bring in enough $$, but we will JUST cut spending to make up for it”. If hundreds of congresscritters can’t agree about how to cut spending- then there is no “JUST” about it- there is no simple answer. Try another thread, and watch us tear apart yous spending cuts- also.

  2. How would “making the IRS less complicated” reduce the size of government? It is not the IRS that make Tax laws- it is Congress. Heck- the IRS wants simple Tax Laws- easier to enforce. It is Congress that gives us a huge Tax Code.

15

This is how the system works in the UK (and, I believe, many other European countries). In the UK I didn’t pay any tax on income at all until I’d earned £4,500 for the year (this sum is called the “personal allowance”). My next £1,500 in income was taxed at 10% (or £150 in all). After that I paid 23% in income tax (for what I earned on top of the £6,000). If I had been fortunate enough to earn more than £23,000 in a year, I would have paid 40% for what I earned on top of that. I found this system much fairer than the US system, as, if you’re just starting work, you are able to earn a bit more right off the bat and start to pay off debts or buy some necessary things. Furthermore you don’t have the problem of earning, say, £23,001 and paying 40% on everything.

PS: The way of getting around the “earn $1 more than the tax bracket” problem in the US is to donate $2 (or whatever) to charity and write that off on your tax return. Bingo!

16

Umm, Duke, I hate to break it to you, but that is exactly how the US Federal Income Tax operates (of course, the #'s are a bit different, and in dollars, not Pounds, but…). A single filer pays no tax on his first (about) $7,000. Then on the next $26K he pays 15%, then 28% on anything over that 26K, up to around 62K. Then, 31% on the next dollar earned (but not the previous) up to around 130K etc. Our taxes are quite a bit lower than yours- as you can see at some $30K you Brits are already in the 40% bracket, but we Yanks don’t get there until about $283,000 (or about 180,000 Pounds, i guess)

17

Thanks for your response, Daniel. This sort of thing infuriates me. If you don’t have the foggiest notion of how the US tax system works, you are not qualified to criticize it or propose your own system. This isn’t a knock at Duke who doesn’t know better, but at Mashie who should. I have gotten into what amount to shouting matches over this issue. I think that it rises to the level of urban myth.

Just look at the tax charts, Please! The graduated system of taxes is meant to make it more progressive and lower the tax burden on the poor relative to the rich. If anything, the system needs to be MORE graduated. This does not, in any way, complicate the tax system. Have you flat tax folks ever done your taxes? Calculating your taxable income is difficult. Looking up the amount of tax on the chart is not difficult.

I do agree with Mashie on one point, though. Any flat tax system would have to have a VERY LARGE exemption to be anything resembling fair. There are valid arguments for the flat tax system. Saying that it would eliminate the “Lose money by going into a higher tax bracket” problem is either dishinest or ignorant.

18

The trouble with (i) is that it unfairly penalizes low-margin businesses. Let’s say I’m in the sand business. I pay 99 cents a ton for sand a sell it at $1.00. My margin per ton of sand is only 1 cent, but your proposal would tax the whole $1.00. Since you are taxing my revenue, not my profit, there is no way for me to function.

(ii) would be fine, if you remove the “highly” part. How about we scrap the social security tax, which is a highly regressive and unfair tax, and fund social security payments out of general revenues like honest people. Then we should increase personal deductions by X, and increase the marginal rates by Y for revenue neutrality. What really makes our current federal system unfair is when we take 14% of every dollar off the top for social security. (You think it’s really 7%? You’ve never been self-employed then…)

(iii) As a raging free-market proponent, I heartily endorse taxing pollution, under the theory that a private person has no right to dump materials into anyone else’s property. If you release smoke, dirty water, or toxic waste into public property (or someone else’s private property), you should have to pay for the privelege, at rates set by the public. If you think the cost is too much, keep the stuff on your own property or stop producing it. Make sure that no smoke or CO2 leaks out of YOUR atmosphere into OUR atmosphere.

But this cannot be a primary source of income, because people will figure out how to stop creating taxable pollution and your revenue source will dry up, unless you go with a carbon tax, and perhaps even then if it is high enough. And you better include a personal deduction on your carbon tax if you don’t want to tax people for breathing. And then we get into perverse incentives with a carbon tax…would widespread hydro, solar, geo, nuclear, and wind power REALLY be more environmentally friendly than clean fossil fuels? We know that solar panels can create waste, wind turbines kill birds, ruin views and destroy habitat, hydro kills salmon, nuclear, well everyone knows about nuclear. I can easily imagine the social costs of alternative energy being much larger than the social costs of fossil fuels if your tax incentives are managed illogically.

19

  1. I have not conceded, I never agreed that my plan would have to result in not bring enough $$$ in. You just assumed you won that argument. A: As I said before, I didn’t give hard numbers, but only a system in which the tax rate that I used as an example could be increased if needed. B: Income Tax is not the only source of govt funds.

  2. Making the IRS less complicated (one page form for everyone) would mean that the cost of running the IRS would be reduced. By size I mean cost.

20

Why is every tax plan organized to be what might be called “socialism through taxation”?

  1. The “rich” already pay a shitload of taxes and get the least out of it.
  2. The “poor” pay the least of the taxes and get the most out of it.
    Only a “poor” person (and I mean mentally, spiritually, whatever, not money this time) could call this fair, equality, or some other such nonsense. Its a travesty against productivity, ability, individualism, and everything I wish our country stood for.

Right now the “rich” aren’t very vocal in their compaints about footing the bill. I’d leave them alone. As it stands, if it weren’t for the “rich” and the “state” there wouldn’t be any poor, there’d be dead.

Though I don’t have a silver spoon, I sure don’t bite the hand that feeds me.