Wednesday, November 19, 2008

Pondering a Consumption Tax

This article is not all that recent anymore, but it's one I found intriguing and worth going back to:
Just What This Downturn Demands: A Consumption Tax

The first reform that Barack Obama should consider is replacing the progressive income tax with a progressive tax on consumption. A family would report its income to the Internal Revenue Service as it does now, and also its savings, as it now reports contributions to retirement accounts. Annual consumption would then be calculated as the family’s income minus its savings. Its taxable consumption would be that amount minus a large standard deduction — say, $30,000 for a family of four.

A family that earned $60,000 and saved $10,000, for example, would have taxable consumption of $20,000. Initial tax rates on consumption would be low, and would then rise steadily with consumption, topping out at higher levels than the current top rates on income.

Such a tax could raise more revenue than the current system, yet would be far less burdensome for families at nearly all income levels. Because of the large standard deduction, middle-income families would pay less than they did before, and high-income consumers could limit their tax increases by saving more.

How painful would that be? Some wealthy families now spend millions of dollars on coming-of-age parties for their children. A steeply progressive consumption tax would encourage them to spend less, which would not be much of a sacrifice, since the main effect would be to lower the bar that defines an acceptable coming-of-age party for people in their tax bracket.

What do you think of this idea? One problem that might be pointed out is that those million dollar coming of age parties generate some employment. But perhaps the other benefits of such a plan could outweigh that? I'm no economist, so I'll let others argue these points. But I can see some good points to this concept.

22 comments:

Adrienne said...

LOL..good luck! every sector of retail would lobby the hell outta that one.

Anonymous said...

Lunacy. Taxing people for feeding the capital wheel, and rewarding people for hoarding wealth?

If you consider how the FED funds rate works in controling money supply you'd know when interest rates are low people will 'save' less in the bank and go look for other places to put their money. When rates are high people have more of an incentive to keep money at a bank rather than other areas.

Your consumption tax has a benefit to individuals who are saving, but what benefit is it for the common nation? You receive tax breaks to consume less in the short-term and than consume more in the long-run?

I did not vote Obama because his tax policies. Classifying people with $250K+ income as the wealthy is crazy talk. Work hard, spend a lot on education, by a home, raise kids, pay for their college, you reach a level of success in the capitalism society and now Obama wants dip in your pocket and take some of your wealth.

Shuchong said...

I'm no economist, but I agree with the above poster: this really sounds like it would encourage wealthy people to hoard money. If I made a million dollars last year, and saved most of it (or all of it, and lived off interest from my nest egg) I would owe virtually nothing in taxes.

Wealthy people hoarding money sounds like a bad idea, both because we already have a high enough income gap in America, and because wealthy people spending money stimulates the economy.

Not to mention the huge headache that would result from having to report your savings to the IRS.

Middle Class Hick said...

I agree with the anonymous poster above. I am considered the "wealthy" only because the $250k is for married people. Single semi successful people get screwed in his formulas. $125k and you are taxed into the oblivion (as his upper 3% state).

As for a consumption tax? I am all for a Value Add Tax, Flat Tax, or Fair Tax. Each one has its intricacies. This tax scheme is just plain stupid on so many levels. The only thing it does is make figuring your taxes easier to figure. Yes, you want people to save, however, at what cost? There are 100 ways to milk this system. Put money in a n UGMA/UTMA account and use that for your daily allowance. "Hey, I saved 50% of my money" and guess what, your kids accounts are paying for everything as you are the supervisor of the account.

There are lots of other ways. If you really want to stick it to the rich, you make what they buy more expensive. I cannot believe when people tell me that this is not fair. A 17% VAT or fair tax would solve all our problems financially. You leave off food, a car up to lets say 20K, and clothes under $50 an item. Then guess what. Everything else is taxed at 15%. So, you go to the grocery store, you don't pay taxes on your food. You buy beer or a fifth of crown royal, then you pay your 17% tax as it is not food. You go out and buy your toyota prius, it is under 20k, you don't get taxes. You buy your 70k mercedes, you pay 17% on 50k. Simple. Then the people that want to pay for the "rich" things, then pay their taxes. You want that 3k TV, then you pay the taxes on it.

Your poor people who cannot afford the 3k TV and stuff and cannot make rent, don't pay taxes on what they NEED, they pay taxes on what they WANT. This is where we are in the good on this style of system. It is a lot fairer than saying you make xyz, you pay this after you take out 2500 deductions all predicated that you follow some freaking government social conformity program (get married, have kids, buy a house). If you don't do exactly that, BOHICA when tax time comes.

Oh well. We will never get a person in the White House who will have the Cahones to try to float that one past. Too many special interests and earmarks out of the current tax system. Viva la Ron Paul, at least he said things that made sense, and was not some Washington bureaucrat.

Miss M said...

Also this would tax housing costs, which are really high in some parts of the country. When you are paying rent or a mortgage is that consumption?? If you're talking a consumption tax I would think of it like a sales tax, any time you buy something, ie consume a good, you pay tax.

I don't buy a lot of stuff, mainly just groceries and gas, but my housing costs are $30k a year. I can't imagine being taxed on that, and what affect would this tax have on housing markets?

Liz said...

This sounds unnecessarily complicated. Isn't one of the "wins" from a consumption-based tax the elimination of filing tax returns? Why not just apply a sales tax to everything? This plan sounds like it would be even more complicated (and would therefore contain more potential loopholes) than the current situation - a feat I didn't think was possible.

Middle Class Hick said...

I totally forgot the other main point in this that a flat or VAT tax would add. It would train people to save their money, instead of buying WANTS. It would teach people to save their money. If you save your money, put it into the market, you are not taxed on it. If you spend it on your 4th TV for your bathroom, then, you get taxed on it. Then you have to make a value judgment on if you need to spend your money. The final benefit is investment money is not taxed, as, it is income, and if you spend it, then you spend it.

I also forgot education up to $xx is not taxed. People that send their kids to private schools for kindergarten, that is not something that is a need - it is a want when there is public schools.

Caleb Nelson said...

How could you possibly try to justify a million dollar commin-of-age party? There are way more productive things we could be doing with that labor and that money, don't you think.
I understand the plan, but I don't see how it raises more revenue than the old system. I don't see how everyone could benefit from paying less taxes, and the government still collect more. Maybe I just didn't follow it well enough.

Caleb
www.blueprinteconomics.com

finance girl said...

absolute insanity.

you cannot at all do this and expect any type of economic recovery.

the only way you can stimulate an economy is to cut taxes for businesses this is why we have sections 121, 1245, and 1250 of the tax code, to mention just a few.

BizBlogged1 said...

It’s not as radical as it sounds: it would eliminate double-taxation of dividends, attract job-creating investment capital from around the world, and help Canada to close some of its prosperity gap with the USA.

Finance blog,finance,economics,Corporate finance,Personal finance,Investing,Marketing/

Anonymous said...

i agree with a VAT tax instead. The basics are not taxes (like food, which isn't taxed now). I also like that this will capture taxes on money gained illegally. Drug dealers will suddenly pay taxes!

Middle Class Hick said...

Along with Illegal aliens. Then the whole "They aren't paying taxes, so why should they get federal money?" Debate goes away.

scotttheorange said...

Caleb, who cares what people spend their money on. If they've earned it, they can do with it as they please.

Also, one of the few "benefits" of the current tax system is that families roughly know what their tax burden is or will be, and can plan accordingly via payroll deductions. The government at least gets a steady income stream as opposed to one lump sum in April and then balances its books from there.

Plus, this could have the further unintended consequence of lowering tax revenues. Let's say a family doesn't know their tax burden, so saves money to cover it (and thus doesn't spend it.) Their tax base goes down because they didn't spend money they thought they needed to save, thus lowering their "taxable income" in this scenario. At some point, families will spend this money, and may face a higher "tax bracket" because they did so in one lump sum as opposed to spreading it out over 3, 5, 10 years.

Also, there will surely be some exemptions for spending categories (mortgage, health care, educational expenses). Think a family of four won't have a kid in college and a mortgage to pay at the same time And I have the feeling someone is going to propose a method of tracking our spending by attaching some sort of personal ID to everything we buy. I wonder what sort of number they could use with that.

Anonymous said...

I was intrigued by this article, as well! I actually think it might be a fairly reasonable idea. A couple of points:

1) "Saved" money is almost never idle. For every $100 you keep in the bank, more than that is lent out again. Unless the rich are hiding their money under mattresses, it's not disappearing from the economy.

2) I very much like the idea of policies that encourage decreasing the consumption of stuff. In an ideal world, I agree with the poster who pointed out that this would include things like housing - and I would prefer a tax that were more specific to the use of consumables. If there were a way to implement a gas/carbon tax in a way that didn't just penalize companies in nations that participated, this would be idea. But, until there's a way to do that, this is a good start...

2) You who are complaining that making over $125k or $250 for a couple doesn't make you "wealthy" - I'm sorry. I know there's some imbalance between how that plays out in NY or Boston vs the midwest, but even so - you're still in the upper 2% of the US population. If you don't think that counts as wealthy, then you're misunderstanding the term....

Timothy Gill said...

Great post and discussion! This is along the lines of the Fair Tax (www.fairtax.org) which I am for. If you tax based on consumption rather than income, you will actually receive tax payments from those in the Underground Economy. Right now there are billions of dollars being made on illegal drugs, weapons, and copyrighted material.

Also, this would be great for small businesses. The high taxes (and probably higher with Obama in office) are usually the straw that broke the camel's back in failed business ventures.

Middle Class Hick said...

@scotttheorange -

While the idea of "knowing your tax burden" is a cool idea, at the end of the day, does it matter? If you are talking about a consumption tax from the article, then yes, that will suck. You have to know what you keep and what to pay from the government, at the one time a year payment. I say with a flat/fair tax, you get rid of this burden. People don't need to know their tax footprint as it is factored into what you buy. Who cares if you are paying 35% of your income to tax, it is in the price of the item.

So for example, you buy 100 pairs of sneakers. They all cost $25 including tax. Does it matter how much of that is tax? The money is spent, the government taxes its cut, and you have done your duties as a tax paying citizen.

The biggest problem with how the USA does its taxes is that it is in your face. No other country has huge industries based on taxes (HR BLOCK, TURBO TAX, IRS) as we do. We don't even put the price of tax in the items we purchase. So when we go to the cash register, we don't know what things cost (unless you are good at mental math or carry a calculator). The price should be the price, labeled including taxes. Nothing more, nothing less.

That is part of the reason we, as Americans, have such an aversion to taxes. We see them where ever we go. Look at your gas pump, look at your phone bill, etc. The price is the price, and that should be what is told to people. When I call AT&T for a phone, they tell me it is $14.99 - that should be what I am paying, not $25.64 due to taxes and fees. Then they need to tell me the cost is $25.64. That way I can make my determination with all the information - and not with only have the information in the free market economy.

Oh well. Rant done :)

Kate@LivingTheFrugalLife said...

The other type of consumption tax that I've heard of is a graduated sales tax. The way it would work is that different types of goods and services are taxed at different rates. The basic necessities of life (real food, medicines, basic clothing) would have no sales tax assessed at all. Items and services farther up the non-necessity/luxury scale would be assessed higher and higher sales tax. So if you buy a music CD, you'd pay, oh say 8% tax. Junk foods and prepared foods might carry a 15% sales tax. If you buy a fur coat or have a swimming pool installed, you'd pay maybe 70% sales tax. Buy a yacht and you might pay 100% sales tax.

I'm sure there are plenty of problems and potential loopholes to this tax scheme. But I have to admit that the basic idea sounded pretty good to me. I think it would be a good tool to make people stop and think about what's a want and what's a real need. It might produce a nation of more mindful consumers.

Retiredebetfreehappy said...

I think Consumption tax rate remains at one of the lowest rates among the thirty members of the OECD.

Retirement Plans, Retirement Savings,Retirement Investments,Home based Business

MAD CAT MOM said...

I disagree with the consumption tax because it clearly depends on what the taxpayer is consuming. I make 85k a year and I'm only able to save roughly 5-7k after my 401k is maxed. It's not because I'm dripping with designer clothing, but rather that I'm supporting myself and a law student, paying tuition out of pocket, and paying off my own 50k in student loan debt. Believe me - the only thing consumed in this house is a huge stack of Cup-o-Noodles.

I can also see this affecting wealthier families. As it stands now, the ultra-wealthy are encouraged to participate in many philanthropic adventures because it gives them a very large tax deduction. If you reward vast savings with even bigger tax breaks, it discourages philanthropy. That would devastate a lot of charitable organizations as their main benefactors are the ultra-wealthy.

From a corporate (and consumer as well) perspective, banks depend on a delicate balance between deposits and credit lending. Deposit rates are determined by the profit margin between the cost to borrow money from consumers (CD rates) vs. the rate the banks can charge to lend it back out (mortgages, credit cards, business loans, etc). If a consumer has a larger savings account, they generally tend to pay for things out-of-pocket rather than financing the purchase. It decreases the demand for loans, thus decreasing the amount of cash the bank NEEDS to keep on its books to cover the loans it is underwriting. If a bank gets in the position where it has more money on deposit than it needs - it cuts the CD rates. You end up with lower CD rates that are grossly outpaced by inflation and your hard-earned (and saved) money is not worth the same amount it would be in 10 years.

The consumption tax, in theory, would be a great thing to curb the ridiculous spending of the ultra-wealthy, however it allows a lot of wiggle room to also punish those who are on a tight budget or try to avoid paying interest on their goods!

ownerfinancedloans said...

It’s not as radical as it sounds: it would eliminate double-taxation of dividends, attract job-creating investment capital from around the world, and help Canada to close some of its prosperity gap with the USA.

Owner Financing, owner will carry, Home Seller Assist, Home Owner Assist, sell note, Owner Carried Notes, Home Sales Expert, Temporary Seller Finance Program

Anonymous said...

hey folks another hair brained scheme to make the rich richer and poor poorer. rich people hoard wealth. thats why they are rich. they don't invest unless a high enough tax structure exists that forces them to make more money to maintain and or incresase their wealth. flat tax fair tax are nothing more than guaranteed ways to destroy our country. eventually you keep crushing the little guy he gets togehter with his buddies and starts killing all the rich folks. pay attention to what is going on around the world fools.

Anonymous said...

My god most of the comments on this blog are stupid. A consumption tax would be far better than an income tax. You seem to be forgetting the bottom line of what a consumption tax does: it gives the taxpayer more control over their tax burden. Don't want to pay higher taxes? Then don't consume. It also re-aligns the corporate sector with the taxpayer rather than a competing interest, as any massive drop in consumption because of tax policy would be something they want to avoid. The notion that somehow taxes is what generates the motive to generate wealth is idiotic. Thank god none of you are in charge of economic policy, as it would be far worse. The only challenge that a consumption tax presents is creating one that doesn't unduly burden the lower income end (who are buying necessities over luxuries -- and I mean those terms in the strict sense, not the "but I can't live without it" sense that so many of us apply to things we don't really need). And that's only a problem because we refuse to ever entertain the notion of reducing the size of government.

But the comemnts on this post are just beyond comprehension.