CONSUMPTION TAXES….Just a quick note about the idea of a “consumption tax” replacing our current income tax.
There are lots of different kinds of consumption taxes. The most obvious one is a sales tax, and 20 years ago there were some conservative fans of consumption taxes who promoted this idea. As it turns out, however, it’s a crank idea on the same level as returning to the gold standard and it never got much real support. Ideology aside, the biggest knock against it is that it just wouldn’t work. A national sales tax would have to be in the range of 20-30% (or higher) to replace the income tax, and all sorts of previous experience has shown that sales taxes above 10% just don’t work. There’s too much incentive to cheat and the system eventually breaks down completely.
A different type of consumption tax is a Value Added Tax, which resolves the cheating problem by giving both the buyer and seller in each transaction an incentive to make sure the other is paying their taxes. It works OK on a practical level, but it’s always been a little “too European” to get any traction in America.
That brings us to the third type: an income tax that doesn’t tax savings, investments, or corporate profits. For all practical purposes, the income that’s left over is all the money that’s spent buying goods and services, so this amounts to a sales tax.
Why bring this all up? Just to make the point that consumption taxes can indeed be progressive. In fact, the third type of consumption tax, which is the direction the Bush administration seems to be heading, can be made progressive the same way as an income tax: by having higher rates for higher incomes. Since rich people don’t spend all their income, it would be less progressive than the current system unless the marginal rates at the high end were increased, but in principle it could be made pretty progressive.
There are plenty of other good reasons to oppose the elimination of taxes on savings and investments, but I’m not sure the progressivity argument is a very good one. I have a feeling it doesn’t really hold up under much scrutiny.
Hopefully a tax guy like Max will weigh in on this at some point.