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Is It Time for a Consumption Tax?

I don't agree with every line of it, but David Brooks's column today is really very good. In particular, his framing device -- that we're moving from an era defined by leverage to an era defined by the unwinding of that leverage -- strikes me as exactly right. And so do most of his policy prescriptions. In particular, this doesn't get enough attention:

The U.S. is going to have to move toward a consumption tax, to discourage spending and encourage savings. There’s also a crying need for tax reform. As economist Douglas Holtz-Eakin points out, the tax code is rife with provisions that encourage leverage and discourage investment. The government will have to spend less on transfer payments and more on investments in science and infrastructure.

The U.S. doesn't "have" to move to a consumption tax. You can certainly imagine the country surviving atop the income tax. But it probably should move to a consumption tax. And I'd urge people to read Cornell economist Robert Frank's excellent article outlining how we can build a post-consumption boom economy that will actually make us better, rather than worse, off. There's been a belief, I think, that the next few decades have to be miserable. They don't. But they will be if we spend them trying to recapture the last few decades.

By Ezra Klein  |  June 12, 2009; 3:31 PM ET
Categories:  Economic Policy , Solutions , Taxes  
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Note that this is based on the simplistic "Puff the Magic Savings" model of the macroeconomy, in which there is some need for a fund of savings to exist in order to finance investment.

That is, of course, based on getting either intentionally confusing financial "investment" ... primarily buying existing financial assets from their previous owners ... with real investment ... the acquisition of new productive capacity ... or acquiring that confusion from those who spread it.

And while it is fundamentally idiotic to treat Saving as some kind magic force that is capable of creating real investment, it remains quite popular to pretend that it can, because, as JK Galbraith often noted, those that have money to save have more money than those that lack enough money to save ...

... and so while policies to "encourage saving" by pretending that it will encourage investment in new productive capacity will certainly not encourage investment in new productive capacity ... they will reliable shift the tax burden away from those with wealth and larger incomes and toward those without wealth and with smaller incomes.

Posted by: BruceMcF | June 12, 2009 4:41 PM | Report abuse

The bottom line is that consumption-based taxes are good policy. Economists of all stripes agree on that. I don't know if we have the political will to do it, though.

Posted by: SteveCA1 | June 12, 2009 4:41 PM | Report abuse

There's no such thing as a progressive consumption tax.

If you want a progressive tax, why would you try to do it circuitously through consumption when you could just tax wealth or income directly?

Are we only taxing material consumption, and not services? If so, why?

If we discourage people from spending money, aren't we in effect reducing the average income, since all spending is someone else's income? And if so, isn't a consumption tax functionally equivalent to an income tax, except that it hits the poor and middle class much harder than it does the wealthy, who tend to spend a much smaller fraction of their income?

Posted by: bluegrass1 | June 12, 2009 5:46 PM | Report abuse

Overconsumption is the result of social and psychological forces. People like buying things.

If someone is determined to spend $X on themselves, they are not going to spend less money if you make what they want to buy more expensive; they are just going to buy less of it. So people will still be maxing out their credit cards, they'll just get less for what they spend.

Yeah, great idea.

Posted by: bluegrass1 | June 12, 2009 5:51 PM | Report abuse

Sin taxes are a different matter, because they change the relative cost of goods, rather than making all goods more expensive. So a soda tax encourages people to drink something else instead of soda; likewise, a carbon tax (or carbon cap) encourages people to buy lower-emission goods and energy, and a gas tax encourages people to drive more fuel-efficient cars or to take transit. The critical criterion for a successful sin tax is that the consumer must have a reasonable alternative available to avoid incurring the extra cost. Thus soda drinkers can switch to tap water, and people can take transit instead of driving, if convenient transit is available to them. However, if someone has no choice but to drive--if transit is unavailable or unreasonably inconvenient--a gas tax does not have the desired effect, and only adds extra burden instead of changing behavior. Likewise, if someone has no choice but to buy a car so they can commute to work, a consumption tax that raises the cost of the car is going to hurt them financially without changing their behavior.

Posted by: bluegrass1 | June 12, 2009 6:01 PM | Report abuse


this was discussed at length at the time of the Tax Reform Act of 1986 (AFAIR Boskin Report).

First, there is precious little empirical evidence that a tax of consumption would increase saving for the same reason that aggregate saving is pretty insensitive to changes in the interest rate (income and substitution effects tend to cancel out).
Second, the tax base would be smaller which would require highter tax rates.

Compliance is also a bet. What if you consume the proceeds of your savings abroad?

Ezra, you are too young but David Brooks is at least 15 years older than me...

Posted by: g12341 | June 12, 2009 10:19 PM | Report abuse

"you want a progressive tax, why would you try to do it circuitously through consumption when you could just tax wealth or income directly?"

bluegrass1 asks the looming question of the day. From each according to their abilities, eh?

So, why try to mask the Marxism of the left's motives and just go ahead and tax wealth and not income. Oh, tha's right, Ted Kennedy and others like him would not want that.

Posted by: ElViajero | June 13, 2009 8:39 AM | Report abuse

You got me, ElViajero, I'm a communist. Boo!

Wealth is of course harder to tax because it's easier to hide. There are easier ways to check that someone's income is what they say it is than their wealth. But if you could manage a way to do it, I guess I'd be for it. You have to tax something or you don't have a state (and if you don't have a state, you don't have a court system and law enforcement to defend your property rights, so it's the law of the jungle). We could tax everyone the same, but common sense tells us that poor people need their money more than rich people do (higher marginal utility at lower incomes), hence a progressive tax system is deemed morally desirable. You're free to disagree, but the odds aren't in your favor. At any rate, it makes sense as a form of social insurance, especially since wealth is largely the result of luck in one form or another.

My point was that if you're aiming to make a tax progressive with respect to income, then just make it a tax on income, rather than trying to take a consumption tax, which has a mind of its own, and force it to be progressive, which is at best difficult and at worst impossible.

Posted by: bluegrass1 | June 14, 2009 1:57 AM | Report abuse

The point about taxes on income rather than wealth is that it is incomes that we are always taxing. Taxing is either destroying nominal income in order to bring purchasing power into line with a limited production capacity, or shifting nominal income from one person to another.

Taxation that is required in order to avoid inflation is, of course, primarily in defense of financial assets held by the wealthy, so a "user pays" principle would suggest that much of the progressive component should be on wealth incomes ... precisely the type of incomes that receive a substantial tax benefit if we shift from personal income tax, corporate income tax and capital gains income tax to a steep VAT.

And that, after all, is the big issue ... David Brooks is not going to be focusing on this as a way of promoting a shift of the tax burden from regressive payroll income taxes to VAT ... which would reduce the net tax burden on median wages and below ... but a shift from taxes on financial wealth income to VAT, so that with a "modest" VAT of 10%, the working poor can pay 22%+ on their incomes, instead of the current 12%+, as a side effect of avoiding progressive taxes on financial wealth income.

Posted by: BruceMcF | June 14, 2009 12:03 PM | Report abuse

Ah yes, the old conservative gimmick. A ax the poor regressive tax. That's what a consumption tax does. It's regressive and taxes the poor who spend more of their income on goods and service than the rich who can save a greater portion of their money.

Posted by: diamond2 | June 15, 2009 10:56 AM | Report abuse

It's well past time we moved to a VAT.

Posted by: Dellis2 | June 15, 2009 1:38 PM | Report abuse

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