Should we move toward a consumption-based tax system?

You may or may not recall that our own Fritz Hollings has long been an advocate of a VAT tax on the federal level.

Well, Fritz is probably pleased by this story in the WSJ today:

U.S. lawmakers on both sides of the aisle increasingly are finding appeal in an ambitious concept for overhauling the nation’s income-tax system: a tax based on consumption, a tool long used around the world.

The tax-writing Senate Finance Committee is giving new consideration to the consumption-tax idea with the hope that its promised boost to economic growth would ease the way to a revamp.

As lawmakers have examined a tax overhaul, “it becomes extremely difficult to see a political path to accomplish it” within the confines of the current income-tax system, said Sen. Ben Cardin (D., Md.), co-chairman of a Finance Committee working group negotiating a possible overhaul of business taxes.

As a result, the idea of a consumption tax “is getting a great deal more respect, and it is in the discussions,” he said.

Mr. Cardin introduced legislation last year to create a type of consumption tax known as a value-added tax and at the same time lower business taxes and scrap income taxes completely for lower-income Americans….

What do y’all think?

27 thoughts on “Should we move toward a consumption-based tax system?

  1. Kathryn Fenner

    If the VAT were truly designed to tax luxuries, so that it would not penalize the poor, it could be a great thing. It would encourage the wealthy to invest rather than buy stuff, the economic effects of which I am not sure of, but I suspect would be generally advantageous–luxury manufacturers are not a big market segment.
    Add some tax incentives for investing on shore, and tax the outrageous salaries of CEOs, and we might actually get somewhere.

    1. Mark Stewart

      Luxury manufacturing / Image creating is a huge part of the economy. All people are aspirational.

      What would any economy be if people didn’t spend proliferately?

      VAT taxes are for countries that don’t understand market economics. Not to sound snide about it, but this is a really counter-productive approach to feel-good socialism. Are the only “honorable” jobs those that produce “necessities”? Silly stuff…

      All the politicians are saying is their work ahead is hard. Poor babies; we elected you to make hard decisions. Overhauling our lobbied tax code is a hard task. So face up to that and begin to get to work.

      1. M.Prince

        “VAT taxes are for countries that don’t understand market economics.”

        Right now, around 150 of the world’s countries have some form of VAT. Of those that don’t, many are oil-rich Gulf states. The US is also the only member of the OECD (i.e. advanced economies) that does not have a VAT. I would like to see the reasoning as to why having a VAT is evidence that the great majority of the world’s economies “don’t understand market economics.”

        1. Mark Stewart

          Check out their anemic domestic economic growth rates, or lack thereof.

          If you punish consumption you punish production. The same can be said of punishing earnings, but people, generally, have a natural inclination to want to keep earning even if they are taxed on that incrimental income. People are far more amenable to consumption substitution.

          1. M.Prince

            The statistics don’t appear to bear out your critique. According to 2013 data, for instance, some 150 countries (the vast majority of which have a VAT, including Japan, Brazil, Switzerland, the UK, Australia, New Zealand, Israel, China, India, Turkey, etc.) showed higher GDP growth rates than the US. And the numbers aren’t greatly different if you look at 5-year averages. If it’s the Eurozone you’re referring to, then you really need to look elsewhere for the weakness of economic performance there, not simply point to the VAT.

            As for the larger point, any kind of tax on products or services can dampen consumption if set too high. But, basically, the VAT produces no greater dampening effect simply by collecting taxes at each step along the production chain than does a sales tax that collects it only at the end of that chain.

          2. Pat

            I think you are correct – a tax on consumption would probably reduce production depending on what rate would be the tipping point. I would rather investment income to be treated just like other income, and a reduction of taxes on manufacturers and even more reduction on companies who increase their number of employees.

  2. Brad Warthen Post author

    Depends on what you consider to be a luxury item. If you’re just counting yachts, I suppose that’s not such a big part of the economy.

    But what if you’re talking about iPhones and iPads? Those DO make up a significant part of the economy, don’t they? And they’re certainly far more of a luxury item than groceries.

    Or how about trips to Thailand? That was a huge stretch for us financially, and was certainly the biggest-ticket “luxury” we’ve ever allowed ourselves (if you count going to see your daughter that you haven’t seen in more than a year a “luxury”). Should that be taxed to make it even MORE expensive?

    1. Kathryn Fenner

      I think there’s a lot of precedent for what’s a luxury item in other countries. Yes, i-anything is a luxury. Maybe not a Tracfone, but i-anything. I think the concept is “luxury” vs. “necessity”—groceries vs. eating out, a cloth coat vs. a leather or fur one.
      And yes, we tax air travel, maybe with a bereavement exemption. It’s a luxury.

  3. M.Prince

    Since the VAT elsewhere often takes the place of sales taxes, I’m wondering if state sales taxes would go away in exchange for some sort of national revenue sharing program. I’d also be concerned whether the plan incorporates sufficient progressivity and whether potential exemptions and opt-outs (like Mr. Warthen’s trip to Thailand) could create problems – not unlike those the legislature in SC has created through sales tax exemptions, for instance.

  4. Jeff Mobley

    This is not necessarily a full-throated endorsement, but the folks behind the FairTax go out of their way to explain why it’s different than a VAT (in particular, a good or service is only taxed once, rather than at several stages of production), that it includes a mechanism (the “prebate”) designed to alleviate the regressive nature of a consumption tax, and that it should replace ALL Federal taxes, not be a supplement to them.

    1. Bryan Caskey

      Seems like a flat consumption tax would make the IRS entirely unnecessary, right? If so, that’s probably the best part of the whole deal. 🙂

      1. Kathryn Fenner

        Well, we’ve paid off our mortgage, but you’d lose your interest deduction. Ready for that?
        No more exemptions for your dependents. Etc.

        1. Bryan Caskey

          Sure. There would also be no more tax on my income and the IRS would be history. I’d take that deal in a heartbeat.

          1. Kathryn Fenner

            But I suspect, as a younger person with a young family, you have a fairly high propensity to consume, compared to us old farts…..

            1. Bryan Caskey

              Probably. But I think it’s a better system overall, even if my ox gets gored a little. It would encourage me to save more, and that’s not a bad thing.

              But don’t worry about me if we scrap the labyrinth that is our income tax code. Worry about all the tax lawyers and CPAs who will be out of work. Also, we wouldn’t have those guys dressed up like the Statue of Liberty dancing on the corner.

  5. Harry Harris

    In a political system largely controlled by monied interests, what’s the surprise here? Every attempt imaginable to shift the tax burden downward on the economic scale is in play these days. From gas tax hikes coupled with income tax cuts to labeling inheritance taxes a “death tax” and trying to kill it. I can’t think of a time in my lifetime when a larger share of our national income was “off-the-books” or getting favorable tax treatment. Salaries/wages above about $110k exempt from FICA while the hamburger-flipper or trash collector pays on every cent he makes. Realized capital gains and dividends taxed at a lower rate (20%) than money earned by labor – with no FICA. “Carried interest” income by hedge-fund managers taxed at capital gains rate. Unrealized capital gains untaxed, but often passed on to heirs tax-free under $10M. The tax laws passed from the ’80’s forward were supposed to spur dynamic economic growth that would “lift all boats.” Unfortunately, high-wealth people haven’t started companies, they’ve bought them. Small companies, started by ambitious entrepreneurs, when successful are bought-out, usually making the principal players wealthy, often leaving the lower tier employees behind as the business is run by corporate managers and their minions who take a big slice for themselves. Income disparity has hyper-accelerated. The biggest drag on our economy overall is lack of demand. Less money in the hands of people who spend it to live, and more money in the hands of folks who use it to by companies (invest), lend it at low but safe rates (safe bonds), or at high but risky rates (junk bonds, capital corps, and payday lenders).
    It’s a path to a third-world, old world economy.

    1. Bryan Caskey

      “Realized capital gains and dividends taxed at a lower rate (20%) than money earned by labor – with no FICA.”

      You realize that the money that is invested has already been taxed once, right?

      1. Harry Harris

        Yes. I have some of it myself. The gains or dividends it makes are the only part taxed, not the principle. Dividends are paid on income after corporate taxes, but the bigger drag on dividends is the cut taken by corporate upper-management. Limited partnerships, energy trusts, and some real estate entities don’t pay taxes before distribution. In addition, a lot of invested money was never taxed. Over 50% of inherited wealth is never-taxed capital gains. For every Bill Gates, there’s at least two Paris Hiltons; for every Warren Buffett, there are four Walton children and 3 or 4 “trust fund kids” as in my small town.

  6. bud

    Harry, those were some really astute comments. The tax code probably goes a long way toward explaining why income inequality has become so extreme over the last 35 years. The big problem with any type of consumption tax is that it places a big burden on those who consume. That may seem obvious but consumers tend to be those in the lower income classes. The rich really don’t spend a particularly large proportion of their income on things that would be taxable but instead invest in stuff that is subject to lower tax rates or perhaps none at all. I could support a consumption tax of some sort if there was some mechanism to extract more money from the rich. Perhaps some type of national property tax on mansions and yachts. And of course the obvious taxes on stock market trades, capital gains and carried interest should all be increased substantially.

    1. Bryan Caskey

      Not to get drawn into a pointless debate, but you’re not really thinking it through as far as wealthy people go. A consumption tax would significantly increase the amount of taxes that the super-wealthy pay.

      Take a hypothetical family that has had lots of money tied up in trusts due to large income back in the 1930s that set the family up for good. We’ll call them the Gennedys. They have a massive net worth, but they don’t really earn income – because they don’t need to. Accordingly, they don’t pay income tax because they don’t have income. They already have the assets and live off the interest. They live well, and spend lots of money, but it’s money that’s already been taxed. As a result, the Gennedys don’t really pay much in the way of federal income taxes despite spending millions each year.

      However, if you change the hypothetical and go from an income tax based system to a consumption tax based system, then it becomes abundantly clear that the Gennedys will be paying taxes every time they spend that money. Spending money on fancy wine? Tax. Fancy food? Tax. Spending money on yachts and trips to Martha’s Vineyard? Tax. Spending money on fancy furniture and art? Tax. Spending money on new cars? Tax.

      1. Harry Harris

        Wow, Bryan, the Gennedys don’t even consider their interest income as income? They like give it away and eat into their wealth and don’t pay sales taxes or luxury taxes on yachts and fancy food and such? They sound like over-resourced hypothetical dummies to me, and certainly not like any rich folks I know.
        I wonder if the shock of converting to a consumption tax (increased final price of everything) will affect the Gennedys more or the $45K family who pays little of their earnings now on income tax, but about 8% FICA/Medicare on every cent and 5-10% sales tax on everything they buy with the 99% of the income they must spend to live. If the consumption tax will disadvantage them, they had better get a better tax lawyer and a lobbyist or two to help them out. Wait! They aren’t the ones calling for this stuff – it’s the wealthy group, especially the top point 1% of wealth holders.

        1. Bryan Caskey

          Sure, their interest income is taxable income, so there’s a trade-off on some level. And the sales taxes/luxury taxes are state taxes, not federal, right? So the federal consumption tax would be in addition to whatever the states decided to do.

          I’m no CPA, but I would bet you that having a consumption tax would generate a higher amount of tax from the Gennedeys than they would pay under the status quo. You could also come up with some credits or other measures to offset the impact on lower-income people.

          1. Harry Harris

            Bad bet. If you think that monied interests will lose out in any tax shift scheme in today’s political environment, you just are not paying close attention. It has been clearly shown by actuaries that an elimination of the lid on FICA earnings would wipe out the SS future issue and fully fund SS past the next century. Applying a small (maybe 1%) FICA tax on unearned income would yield enough to take a nice bite out of the deficit. Adding a .25% (1/4th of a percent) transaction tax on securities trades would take another bite. Would those moves hurt the highest 1% or earners? Yes, but only a tiny bit. Would it hit the financial industry? Yes, some, and they have the clout to prevent it.

            1. Bryan Caskey

              If you think that monied interests will lose out in any tax shift scheme in today’s political environment, you just are not paying close attention.

              I agree with that statement on a practical level. Which is why we’ll probably never get a pure consumption tax. I don’t disagree with the balance of your comment, either.

              1. Brad Warthen Post author

                Monied interests will always be represented in deliberations regarding money because they CARE so much about it, and never stop paying intense attention to the process.

                Those of us whose eyes glaze over at the mention of money will not have much impact on the proceedings.

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