Tax Consumption, Not Savings

Debates around taxes usually focus on fairness. Is is fair to tax the rich more? Is is fair that the rich can pay less than workers because of capital gains and carried interest? Would a regressive flat tax unfairly target the poor? Listen to a day of talk radio and all you hear is “fairness,” with the left and right talking past each other.

I don’t mean to diminish the fairness arguments, but there is more to the tax code than pure fairness. There is also the question of, “what do we want to accomplish?” The tax code is also an incentive system, encouraging and discouraging certain behaviors. Right now Americans are drowning in a sea of consumer debt which crushes their ability to save and invest. The Average American has seen their net worth decline to the lowest levels in 20 years. Given that, our tax code should encourage savings while taxing consumption.

David Brooks explores an interesting idea that accomplishes this goal while avoiding the regressive nature of a European-style VAT.

That means asking the basic question: What is the single biggest problem with the tax code? It’s not the complexity, bad as that is. The biggest problem is that it rewards consumption and punishes savings and investment.

You can’t fundamentally address that problem within the 1986 paradigm. You can address it only through a consumption tax. This idea is off the table right now, but reality will inevitably drive us toward it. We have to have a consumption tax if we want to both grow the economy and reduce debt.

But isn’t a consumption tax regressive since poor people spend a bigger share of their incomes than rich people? The late David F. Bradford of Princeton University effectively solved that problem with his so-called X Tax, which has recently been championed by Alan D. Viard of the American Enterprise Institute and others. Under the X Tax, you wouldn’t pay the consumption tax at the cash register. Businesses would be taxed on their cash flow, taking an immediate deduction for investments rather than depreciating them over time. Households would pay tax at progressive rates on their wages but would not pay tax on income from savings.

The X Tax effectively taxes the money you spend right now and rewards savings and investment. The government could raise a chunk of revenue this way and significantly boost growth with little or no change in how tax burdens are distributed between rich and poor. Most economists vastly prefer consumption taxes to income taxes.

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