Research Desk explains: What would a progressive consumption tax look like?
By Dylan Matthews
Matt Lewis asks:
What would a truly progressive consumption tax look like?
Currently, the personal income tax applies, as its name suggests, to all income. Salaries, wages and so forth are taxed whether or not they are being used to buy goods and services or to save. Heavy consumption, financed largely by debt, helped fuel the economic bubble over the past decade, and more sustainable consumption patterns are probably needed. One way to produce those is to not tax income but only consumption, which would encourage savings and discourage spending.
Retail sales taxes and value-added taxes (VATs) are the most widely used consumption taxes currently. The latter has the virtue of being easier to enforce, though given how many exemptions and loopholes would probably be included in a passed version, that benefit may not be present in practice. Unfortunately, both of these are regressive, as they tax spending by the poor and rich equally, and the poor tend to spend more as a percentage of income than the rich do. Thus, proposals for progressive consumption taxes have arisen.
The most prominent of these comes from the economist Robert Frank. His proposal would work like the personal income tax, with taxpayers tallying up their income on a return, only Frank would exempt all savings from taxable income, leaving consumption as the base to be taxed. To generate the same amount of revenue as the personal income tax, much higher rates would be needed, but one of the main disadvantages of higher rates--that they discourage savings and investments among high earners--would not be relevant, so steeply progressive rates would be less economically harmful. Frank would also include a large standard deduction, so very basic consumption--food, non-luxury rent, etc.--would end up not being taxed.
The late economist David Bradford proposed an alternative model, called the "X tax" which has two parts. The first is a VAT, but with businesses deducting wage payments from their burden. The second is a personal income tax on wages. Combined, the two tax the same base as a full VAT, since the wages deducted at first are then subject to a tax paid by the workers who receive them; see the anecdote of "Patient and Impatient" here for a fuller explanation of why the income tax is effectively a consumption tax. The personal income tax can be bracketed, allowing much more progressivity than under a simple VAT. It also would not require taxpayers to track all of their savings, as Frank's proposal would.
Finally, law professor Edward McCaffery proposed a progressive consumption tax in his book, Fair Not Flat, that combines a VAT or national sales tax and a Frank-style tax. McCaffery would impose a VAT or national sales tax of 10%, but provide a rebate to taxpayers, such that the first $20,000 in consumption would be tax-free. Then, McCaffery would impose a progressive consumption tax along Frank's lines, which would work essentially like a personal income tax with an unlimited savings deduction, on consumption above $80,000, with rates varying from 10 to 50 percent. This would allow most taxpayers to avoid filing returns while ensuring that the tax is still progressive.
August 5, 2010; 4:52 PM ET
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