Reader Scott asks:
Why isn't your tax plan consumption based? (IRA's without restrictions)
Because with a decent tax code, there's no reason for the government to artificially bias peoples' choices towards savings and away from consumption. The bourgeois moral affection for savings is a socially useful cultural belief, but it is not actually a moral law. Savings is just time-shifted consumption. I see no moral difference between consumption now and consumption later. As Anatole France said, "If the hangover preceded the inebriation, drunkenness would be a virtue."
Savings are taxed twice under an income tax- once as income when earned, again on the returns from the savings. Please explain to me how a consumption tax artificially biases people toward savings, and how the current system doesn't favor current consumption over deferred consumption.
... moral affection for savings is a socially useful cultural belief, but it is not actually a moral law ...
From a moral point of view, yes.
But from practical point of view, considering that consumption is going to go up by >6 points of GDP just for Social Security and Medical programs by 2030, it would be nice to think that somebody was saving a little bit more today to help pay for all that spending then.
I mean, more saving could be really socially useful.
Uh... I don't think you're immoral if you don't save. But squirrels gather nuts for a reason. True, they're shifting consumption now for consumption later, but it also allows them to live later.
If you spend all your money without trying to save any, and then when something happens you expect someone who saved their money to bail you out, that is immoral.
Saving is good. We shouldn't encourage it at the complete expense of spending today, but savings should be encouraged. Otherwise when bad times happen people look to the government (ie someone else) to pay for it.
Increased saving rates increase the availability of capital for investment, increasing economic growth, which dominates almost everything else in determining welfare in the long run.
This debate over incentives to save reminds me of this David Brooks article , which seems somehow wrong to me. I'm not sure personal finance should be viewed as a matter of virtue: in the good old days of thrift, we also had debtors' prisons. Couldn't there be troublesome economic consequences to enforcing usury laws, as he suggests? And, from a libertarian perspective, don't we want to be very careful about how we "encourage" saving? (E.g. do we want regulators to tell credit card companies where they can advertise?)
Yes, the U.S. has a low savings rate compared to other industrialized countries, and I'm sure that harms growth. And it could be argued that the tax code is "artificially biased" towards consumption, especially in the way it handles mortgages. But something seems wrong with too enthusiastic an embrace of enforced thrift.
What Anon said. A consumption tax isn't an artificial bias in favor of savings any more than an income tax is an artificial bias in favor of current consumption.
In fact, by inflating the currency and then not adjusting the cost basis of investments for inflation, the government is arguably actively discouraging savings.
In a field one summer's day a Grasshopper was hopping about, chirping and singing to its heart's content. An Ant passed by, bearing along with great toil an ear of corn he was taking to the nest.
"Why not come and chat with me," said the Grasshopper, "instead of toiling and moiling in that way?"
"I am helping to lay up food for the winter," said the Ant, "and recommend you to do the same."
"Why bother about winter?" said the Grasshopper; we have got plenty of food at present." But the Ant went on its way and continued its toil.
When the winter came the Grasshopper found itself dying of hunger, while it saw the ants distributing, every day, corn and grain from the stores they had collected in the summer.
Then the Grasshopper knew...
It is best to prepare for the days of necessity.
http://www.umass.edu/aesop/content.php?n=0&i=1
the above is def. #1 in http://www.thefreedictionary.com/fable
the post, itself, is def. #3
Absent a consumption tax, there is an anti-savings bias when individuals decide whether to consume now or consume later. A consumption tax is actually neutral in this regard. This is one reason why one of the theoretical underpinnings to the current income tax system is that it is a proxy for taxing consumption.
"...reminds me of this David Brooks article which seems somehow wrong to me...."
Yes, there was something very wrong with that Brooks article. It totally ignored the great welfare benefits that have resulted from the reduced financial costs of, and structural obstacles to, borrowing -- that have led to the increased borrowing he bewails.
Among the biggest benefits is this: The real measure of welfare is consumption, and consumption inequality has not grown with the rising income inequality of recent years (although the "inequality warriors" of the left never, never mention this), largely because the greater availability of credit that Brooks laments smoothes consumption.
Here's a snip from an article on this in the Times a while ago. It's really impressive how little the people on the editorial pages at that paper read of the economics reporting inside.
~~~
... To see how well-being is distributed, consumption provides a better long-run picture than income.
In a paper titled ''Does Income Inequality Lead to Consumption Inequality?'' Professor Perri and Dirk Krueger, an economist at Stanford, look at the distribution of consumption ... The article, now a National Bureau of Economic Research working paper, can be downloaded ...
"We wanted to see whether this rise in income inequality had in fact given rise to an increase in consumption inequality," Professor Krueger said. "We were fairly surprised that it hadn't."
... Even as the distribution of income changed significantly, the distribution of consumption barely budged.
... consider the ratio between the top and bottom. In 1972-73, the top 10 percent of earners made about five times as much as the bottom 10 percent. In 1997-98, they made more than nine times as much -- a sharp increase that, again, barely shows up in spending. The top 10 percent of households spent about three times as much as the bottom 10 percent in 1972-73, a ratio that inched up to 3.35 in 1997-98...
...the economists propose an explanation: Permanent income differences have increased just a little, while short-term fluctuations have increased a lot. What looks like increasing income inequality turns out to be mostly increasing income instability.
As incomes have become more unstable, consumers have benefited from more efficient ways to borrow and save. Better credit markets have kept consumption from becoming as lopsided as current income... [my emphasis]
~~~
Brooks is totally blind to all this.
Megan,
you've gotten basic optimal taxation theory wrong here. Having a tax base that includes capital income changes teh relative price of current and future consumption away from the marginal rate of substitution that the economy can provide between current and future consumption: it raises the price of future consumption. People hence choose a lower level of future consumption, and that choice is inefficient given the economy's production possibilities. Taxing labor income or consumption doesn't change the relative price of consumption today and consumption in the future and avoids this distortion while raising as much revenue as the tax you propose, at a lower welfare cost.
See any graduate write-up of the optimal taxation literature, thought sometimes the basic argument gets hidden in technicalities. This is a very strong result and one of the basic insights of 20th century economics.
There are complicated models with private information about personal tastes and productivity shocks along with restrictions on what tax authorities can do that do at times give rise to positive optimal capital tax rates schedules, see for instance work by Kocherlakota, who also reviews the relevant literature.
http://www.econ.umn.edu/~nkocher/research2.htm
Hi -
As always, a consumption tax is regressive, scarcely a positive attribute.
Further, savings are never taxed (in the sense of a tax being placed on the accumulation of capital): income is taxed but once, and then interest income or speculative profits are taxed. This reduces the real return, but the capital is not affected.
But never "savings". I *do* wish people would learn to use their language precisely...
And the one poster notes that consumption doesn't vary much in comparison to income: this is absolutely correct. Consumption is driven in no small amount by demography, rather than income, as banks are more than willing to agree with you that you will be able to afford to pay off your current consumption with future earnings handily.
I think an overlooked benefit of our tax code is the vast amount of information that is gather through it. If it is over simplified, we loose a lot of good data.
That's a good argument, but given that we have to substitute any savings-discouraging tax with a labor-discouraging tax, I'm not convinced, especially since consumption taxes require a lot of added complexity to make them non regressive. But I'm open to being convinced; I just stated why I don't currently subscribe.
Because with a decent tax code, there's no reason for the government to artificially bias peoples' choices towards savings and away from consumption.
You are assuming something contrary to fact. To wit, that people who choose consumption over savings will be left to live with the consequences of their choice. In fact, the government will not allow them to starve in penury in their old age. Which means that there is an excellent reason to bias people towards choices that will avoid government costs in the future.
If a consumption tax taxed all good at the same rate, and individuals consume all of their lifetime income (which is not a bad approximation for much of the income distribution), then everyone would pay the same percentage of their income in taxes. That is, a consumption tax is neither regressive nor progressive. The government could simply add progressivity by granting a lump sum rebate of the same amount to all individuals.
I'm less concerned about the benefits that come from savings than I am about the distortions to productivity that result from an income tax. Additionally, I'm concerned about the level of complexity that is inherent in an income tax. Taxing consumption removes both the income distortions as well as the payment and compliance complexities. Those two benefits alone point me to preferring a consumption based tax.
It's tough coming up with a "good" tax. All taxes influence behavior in one way or another, and take away some personal prerogatives on spending and put it in the hands of government officials. Taxes that capture negative externalities could be considered good, but I doubt that they alone would be able to cover our budget. I think the best we can hope for is a government that promises less benefits and needs less money to spend.
Solving entitlement problems is hard. Should we eliminate the payroll tax and make benefits "means tested"? Should we up the age of retirement to make SS and Medicare some kind of lottery for those lucky enough to live to 90? Can we introduce some kind of market reforms to minimize the moral hazard of 3rd party payer w.r.t. health care without leaving people that need it "out in the cold"?
What about the military? Do we really need to spend so much on it? Or could we use it to supplement our income ("sorry Iraqis, we need this oil to pay for our military and our old people")?
It's unclear to me why making a consumption tax regressive has to be a terribly complex process. Just withhold income at the same rates that the current system does. As part of your tax return at the end of the year, you include the value of all deposits and withdrawals that you made to bank and investment accounts. If you made more deposits than withdrawals, then you are a net saver and you deduct this from your gross income. If you made more withdrawals than deposits, then you are a net dissaver, and you add this to your gross income. Then, apply a progressive tax rate to the adjusted income. Since your consumption is essentially your income minus your net savings, you're basically being taxed at a progressive rate on your consumption, and this doesn't seem any more complicated than the current tax system.
Of course, my first sentence should have said that making a consumption tax progressive doesn't need to be a complex process.
Depending on how often you drink the hangover does precede inebriation, and according to Baudelaire drunkeness is a virtue. So much for French writers and drinking.
I kind of like the idea of getting rid of direct tax and instead have the government create new money for all its cashflows. Then they just need to watch for inflation.
This would never work.
They did a study in which children were offere a small portion of candy. They then told the children the tester was going to leave the room, if the candy was still there they would get a much larger portion of candy. The children who waited ended up doing much better academically and financially as adults.
A consumption tax would lead to far greater inequality, as the people who are doing well financially and who are frugal, and like living modestly, would become fabulously rich.
The people with poor impulse control would be left in poverty.
Stefan's exactly right - a consumption tax doesn't so bias consumers towards saving as much as it removes the bias against saving created by a tax on capital income.
It's actually very simple to build progressivity into a consumption tax. The system proposed by Steve Forbes in the '90s - which taxes corporations based on their profits and individuals based on their wage income - effectively taxes exactly the same base as a simple Value-Added Tax. What's more, since you can easily change the marginal tax rates on individuals, the tax code can be as progressive as you'd like.
Also, if you buy Forbes' argument, this system would lead to economic growth large enough to dwarf any of its potential disadvantages. That said, it's never been tried in the real world, so it's tough to say exactly how it would work out.
Stefan's exactly right - a consumption tax doesn't so bias consumers towards saving as much as it removes the bias against saving created by a tax on capital income.
It's actually very simple to build progressivity into a consumption tax. The system proposed by Steve Forbes in the '90s - which taxes corporations based on their profits and individuals based on their wage income - effectively taxes exactly the same base as a simple Value-Added Tax. What's more, since you can easily change the marginal tax rates on individuals, the tax code can be as progressive as you'd like.
Also, if you buy Forbes' argument, this system would lead to economic growth large enough to dwarf any of its potential disadvantages. That said, it's never been tried in the real world, so it's tough to say exactly how it would work out.