Clear thinking about taxes

It’s clear from my comment sections that people just don’t understand taxes.  In this post I’ll try to explain a few basic concepts, so that we can have an intelligent discussion.

The biggest confusion is that people don’t understand why capital income should not be taxed, and why a wage tax is equivalent to a consumption tax.  Consider someone with $100,000 in income, who can choose to consume, or invest in a fund that will double in value over 20 years.  Suppose we want to raise revenue with a present value of $20,000, from this person.  We could have a wage tax of 20%, and raise $20,000 right now.  Let’s also assume that this person decided to spend 1/2 of his after-tax income—leading to $40,000 in consumption today, and save the other $40,000, leading to $80,000 in consumption in 20 years.  Note that both current and future consumption are reduced by 20% relative to the no tax case.

Alternatively, we could directly tax consumption at the same rate (say with a VAT). Let’s assume the person saved $50,000 and spent $50,000 on consumer goods.  After paying VAT they consume $40,000 today, and the government gets the other $10,000. After 20 years the $50,000 saved turns into $100,000, but you must pay $20,000 in VAT, leaving consumption of $80,000.  Exactly the same as with a wage tax.  The total revenue to the government looks bigger, but is the same in present value terms.

In contrast, an income tax doubles taxes the money saved, once as wages, and again as capital income.  So now it’s $40,000 consumption this year, and only $72,000 in 20 years ($80,000 minus 20% tax on the $40,000 in investment income), an effective tax rate of 28% on future consumption.  And of course with inflation the effective real tax rate is still higher.  Income taxes make no sense at all; if you want progressivity, tax big consumption more than little consumption.

People also get confused when we try to link these abstract concepts to real world aspects of the tax code, like IRAs and depreciation.  Consider the wage tax and the VAT tax discussed above:

1.  Wage tax = Roth IRA with no restrictions–pay when you earn

2.  VAT = 401K with no restrictions–pay when you spend

An unlimited Roth IRA would allow you to put all of your savings into IRAs, as would an unlimited 401k.  And you would not be forced to withdraw at retirement–you could have your heirs spend the money, and pay the tax.

What about depreciation?  Why should capital investment be expensed?  The IRAs I just discussed are financial investments.  But we know that saving equals investment, so there is a corresponding physical activity associated with financial saving.  Consider a simple example:

A utility spends $1 billion on a huge solar facility in the desert.  For simplicity assume they can sell $100,000,000 in electricity each year, and there are no there costs.  If we treated this like the 401k, the utility would deduct the expense of the initial construction from its current taxable income, just as you deduct money you put into a 401k.  But then they’d have to pay taxes on the full $100 million in annual revenue (unless reinvested), just as you must pay taxes on the full cash flow of your 401k (unless reinvested).  If the utility later sells the solar facility to another company, obviously the full sales price is taxable, just as money you withdraw from a 401k is fully taxable.

Note that even though you pay tax on money you withdraw from a 401k, this is not a tax on capital income; it is a deferred tax on labor income.

In principle, you could tax consumption, or you could tax all of GDP.  We’ve adopted a weird intermediate scheme, to tax GDP minus depreciation, sometimes called net income.  If there’s a rationale for this I’d love to hear it.  Now of course we don’t actually deduct depreciation, as it’s hard to know how fast assets are deteriorating in value, so we simply make up numbers, like a sliding 30-year depreciation schedule.  This is lots of busywork for accountants, with no practical value that I’m aware of.  I can think of two things that accountants might be interested in:

1.  Cash flow

2.  Value of a company’s assets

The later might involve “depreciation,” but it might just as well involve “appreciation,” especially in real estate.

If you allow companies to expense all investments, then you have essentially turned an income tax into a consumption tax.  (Unless I’m mistaken, that’s what Rubio/Lee is trying to do.)  If you allow no write-offs of depreciation at all, then you have a tax on GDP, or gross income.

I get hit from both the left and the right, both sides making errors:

1.  The left complains my proposal is too regressive, as it LOOKS LIKE income taxes would hit heavy saving rich guys more than a consumption tax.  But people only absorb the burden of a tax to the extent that it reduces their consumption.  If Bill Gates pays an extra $10 billion in taxes, and doesn’t reduce his consumption, but instead gives $10 billion less to the poor in Africa, then he hasn’t really absorbed the burden of this tax. Look, a country can’t consume more than it consumes.  Does anyone disagree with that?  But lots of liberals believe in the following combination of statements, which is logically impossible:

1.  Most Americans live right on the edge, consuming all their income.

2.  Rich fat cats have lots of extra income they don’t need, which could be given to average Americans.

3.  Lots of redistribution would not hurt investment.  OK, that means it won’t boost consumption.

4.  Even paying lots more taxes, the rich would consume almost as much.

So if the rich consume almost as much, and total consumption doesn’t change, how are the rest of us helped?  If all those things are true then it’s logically impossible for the average people to be better off, as we’ve assumed they consume all their income, and you’ve told me that aggregate consumption and investment don’t change.  Liberals simply aren’t thinking clearly about the true burden of taxation.  Gates and Buffett aren’t bearing the burden of the taxes they do pay, someone else is.

From now on liberal commenters must tell me why so many brilliant liberal economists have favored replacing income taxes with progressive consumption taxes, and what’s wrong with this argument.  If that can’t do so, I won’t respond to their complaints.

2.  Conservatives complain my proposed tax rates are too high.  I agree.  Let’s reduce loopholes and lower government spending.  But the GOP doesn’t want to do this.  And that means we need much higher tax rates than Singapore.  All that Medicare spending and military adventurism and no-child-left-behind from the Bush administration must be paid for.

Their second mistake is to confuse consumption tax rates with income tax rates.  Yes, a 50% income tax rate for the rich is too high.  Hell a 1% income tax rate for the rich is too high.  But a 50% marginal consumption tax rate for the rich is not too high, given the amount of revenue we need to collect.  Also recall that the rich don’t pay payroll taxes above about $120,000 or so, and they pay relatively little tax on gas, booze, cigarettes, etc.  But again, convince the GOP and Dems to reduce the size of government, and I’m all for lower MTRs.

Another mistake is to complain that some plans are hard to enforce, because of tax evasion.  Yes, but that’s equally true of YOUR plan.

1.  If we go the wage tax route, tax should be paid on all cash and financial assets you receive from the company you work for.  Period.  If you’ve paid taxes on the fair market value of company stock that you get in year one, then no more tax should be paid if the stock later appreciates.  I understand that people will look for loopholes AS THEY ALREADY DO, but the IRS needs to do the best job it can.

2.  If we go the VAT route, then you must distinguish between consumption and investment.  I propose all business meals be treated as consumption.  Ditto for company cars that can be used off hours.  For air travel, it should be the difference between actual cost of travel and an economy class ticket.  The extra luxury is consumption.

Arguments over “who pays” are usually ill informed.  People simple assume that just because big corporations write out checks to the IRS, that corporations must be bearing the burden of the corporate income tax.  Well cigarette companies write out big cigarette excise tax checks to the government, does than means smokers don’t pay? The fact is that no one knows who ultimately bears the burden of the corporate (and to a lesser extent personal) income tax.

In a better world both parties would agree on an efficient tax regime, and then fight over progressivity.  When the GOP won elections they could cut taxes, and when the Dems won elections they could raise taxes.

In a better world.

 


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110 Responses to “Clear thinking about taxes”

  1. Gravatar of Gordon Gordon
    9. March 2015 at 13:02

    Scott, in case you hadn’t heard, Puerto Rico is considering moving to a consumption tax. http://www.dailymail.co.uk/wires/ap/article-2950006/Puerto-Rico-prepares-debate-value-added-tax-proposal.html

  2. Gravatar of Matt Waters Matt Waters
    9. March 2015 at 13:34

    With the current scheme with income taxation, it truly seems like eliminating the capital gains tax would be disastrous. In the case of Bill Gates, he never got billions in wages from Microsoft. Instead, Microsoft was first incorporated with him as a major shareholder. As far as I know, he “invested” zero dollars into Microsoft. Then his wealth came purely from capital gains on a basis of zero.

    Sure, in a pure VAT or consumption tax scheme, he would eventually pay taxes. But the Rubin scheme seems to have him paying absolutely zero taxes. That’s even if he does somehow consume all his wealth instead of giving it away, he would pay zero taxes.

    As far as depreciation expensing, it’s there probably because the IRS got a one-time windfall in PV terms from switching to depreciation. Old investments which expensed all their costs have to pay taxes on their full income, while the new investments have to pay more taxes today. And practically, politicians will always discount future cash flows FAR more than the market would, especially from corporations whose tax incidence is hidden.

  3. Gravatar of Libertarian Conservative Libertarian Conservative
    9. March 2015 at 13:47

    “In a better world both parties would agree on an efficient tax regime, and then fight over progressivity. When the GOP won elections they could cut taxes, and when the Dems won elections they could raise taxes.”
    Indeed, and this is what frustrates me the most. A lot of liberals seem to think that consumption taxes are worse than, or equal to income taxes in regards to inefficiencies. They use anecdotal data I.E. Kansas, the W years, and now Minnesota, to “prove” “trickle-down” (whatever that means) doesn’t work.
    Of course conservatives deserve some blame too, they seem to favor lowering rates/closing loopholes more than switching to consumption taxes, and often oversell the pro-growth effects of tax cuts in a way that makes people think they are just flat-out lying about their stimulative effects.

  4. Gravatar of Adam Adam
    9. March 2015 at 13:50

    I’ve not spent a lot of time thinking about this, but it seems to me there are (at least) two ways that the proposal differs from a consumption tax:

    1. Some people with sufficiently large savings may never really have their consumption reduced, to the extent that their lifetime savings exceed their lifetime consumption.

    2. A person who has only capital income (whether via friendly definitions regarding the “fees” they charge for their investment advise or inherited wealth or whatever) pays no taxes.

    Number 1 may not really matter, I guess. But does it mean there is a difference in an individual’s relative incentive to save versus consume?

    Number 2 is going to create a significant appearance of unfairness to a lot of people, and to the extent that it’s the result of friendly rules, means that some class of well-compensated people will not have their consumption reduced at all. Those with inherited wealth can argue all they want that their consumption was reduced when the wealth was taxed as wages, but that’s going to be a tough sell too, and requires assumptions about how the wealth came to be.

    Regardless, as soon as this proposal passes (it won’t), I will begin strenuously lobbying that legal fees are not wages but rather interest paid on knowledge capital lent to clients. I’ll even magnanimously make the same argument for economics consulting fees if you want to join me.

  5. Gravatar of Ray Lopez Ray Lopez
    9. March 2015 at 13:55

    “But we know that saving equals investment…” – not true except in the long-run. Savings != investment today. And who cares about progressive taxes except bleeding heart Boston liberals anyway? A study once showed the best tax to raise money for the government is a Philips curve centered at the middle class: it gives incentive to either get richer or get poorer (which most people won’t do).

  6. Gravatar of bill bill
    9. March 2015 at 14:17

    I have one concern with switching to a consumption tax. I pity the people that paid income taxes their whole working lives that then get hit with consumption taxes their whole retired lives. But I guess some eggs will get broken to make an omelette.

  7. Gravatar of Vivian Darkbloom Vivian Darkbloom
    9. March 2015 at 14:21

    “With the current scheme with income taxation, it truly seems like eliminating the capital gains tax would be disastrous. In the case of Bill Gates, he never got billions in wages from Microsoft. Instead, Microsoft was first incorporated with him as a major shareholder. As far as I know, he “invested” zero dollars into Microsoft. Then his wealth came purely from capital gains on a basis of zero.”

    As regards investment in a corporation such as Microsoft, Bill Gates’ “capital”has been taxed even before he sold any corporate stock (or got any corporate dividends). The capital was taxed at the corporate level in the form of corporate income tax. That capital was taxed again when Bill sold his stock or got a corporate distribution. Under the Lee/Rubio proposal, the second level of tax on Gates’ capital would be eliminated, but the corporate level tax would remain. The example raises some valid transition issues—those who have appreciated stock would gain the most from this proposal, absent transition rules. Too bad for those who sold their stock before such a rule would be effective. For this reason alone, the proposal has about a nil chance of enactment. But, make no mistake, because the corporate income tax would not be eliminated, Bill’s capital would still be taxed. If it is not Bill’s capital, whose is it? And, if it is not capital, what is it? We can quibble over how much of the incidence of that corporate tax is actually on Bill’s capital (as opposed to, for example, labor), but I’ve never heard any economist claim that it would be zero.

    As far as expensing investments turning the income tax into a consumption tax, that’s confused. We already have expensing under section 179, and less extreme, we have accelerated depreciation. In both instances, an asset that has been expensed or depreciated is taxed when sold (with zero or reduced cost basis) and tax will be imposed on the difference between the basis and the proceeds, whether the asset is in the corporate solution or not. Expensing does not eliminate income tax and it does not convert tax on “capital” to a tax on “consumption”. Lee/Rubio allows expensing (basically, section 179 for all business assets, including land), but it does not change that basic basis/sale formula that exists today (and we certainly don’t claim today that it is a “consumption tax”). I am not “consuming” anything when I sell that machine any more than I am consuming something when I sell corporate stock.

  8. Gravatar of Matt Waters Matt Waters
    9. March 2015 at 14:38

    Well, in one respect, I feel like a complete idiot for not thinking about the corporate tax. I was concentrating too much on capital gains vs. income taxation. Particularly how Sumner specifically talked about Bill Gates paying $10 billion. Some corporate tax would be incident on Bill Gates, but he wouldn’t pay any tax directly. That is still a true statement.

    Also, the corporate tax rate in the proposal is 25% while the top marginal rate is 35%. Having income only taxed in the US could also lower the effective rate, depending on if corporations can exploit subsidiaries in places such as Ireland. I’m not clear on the issue honestly.

    In all, taxation is horribly complex and I still haven’t wrapped my mind around it. I tentatively agree with Sumner theoretically, but the Rubio-Lee plan just seems way too regressive almost any way you cut it. Even if it’s closer to ideal in form, with the supposed elimination of many deductions, in substance the regressivity just seems like too much.

  9. Gravatar of John Hall John Hall
    9. March 2015 at 14:39

    I’ll admit I was a little confused in the previous post when you said that eliminating depreciation on corporate assets would be equivalent to a tax on consumption. This post makes things a little more clear, but not completely.

    Rubio-Lee takes the existing corporate tax (plus capital gains/dividends) and converts it to a system with just a corporate tax (no capital gains/dividends) without depreciation or interest deductions, but where you may expense all capital costs up front (there’s also a change to a territorial system, which is important, but not so relevant here). If I’m clear, your argument is that this transformation makes corporate income like the 401k where you reduce your income by how much you are investing. Correct?

    I’m also not sure what you mean when you say “you could tax consumption or you could tax GDP.” Are you trying to equate the two, or are you trying to say it’s one or the other? You proceed to then focus on GDP vs. GDP ex depreciation, so I’m supposing I’m meant to equate taxing consumption with taxing GDP, which I find confusing as GDP includes investments.

    You also make the point that the 401k utility example is taxing deferred wage income rather than taxing capital income. I was just thinking about if you structured the program like a Roth IRA how is it different. In that case, you’d just eliminate the corporate tax, but you wouldn’t bother with any expensing.

    The 401k approach has the benefit of giving the government a steady stream of income per year, but the downside is that it might encourage more lobbying to grant exceptions. The Roth IRA approach difficulty is in the transition. Current investors would have to pay taxes up front and then put it in a Roth to grow tax-free. There might be an incentive to fudge with valuations. You would also need the government to be able to commit to maintaining the system in the future (which is not believable, frankly). The benefit is that there would be no more corporate income tax. The Roth approach might be better for a new tax system, but the 401k approach might be better for when a country is transitioning and you need something the government could reasonably commit to.

    I think in terms of selling a proposal like this, you would need a clear example of the current system vs. the new system for someone who is already wealthy as well as a new entrepreneur.

  10. Gravatar of Vivian Darkbloom Vivian Darkbloom
    9. March 2015 at 14:51

    Actually, Matt, I would not feel like an idiot. The case of Gates is actually a very special one and you were, I think, correct to point it out. As you pointed out, unlike most folks, Gates didn’t pay much cash for his stock. Arguably, the appreciation, at least initially, was due to his brilliant ideas and expert execution and perhaps a bit of luck, So, is this properly “capital? So, if Bill’s capital gains tax is eliminated, he would suffer corporate income tax on his appreciated “capital” , but he would not have had to pay (much) tax on the actual cash he invested and nothing when he sells stock or gets dividends. This would, I think, be a huge practical problem for any system attempting to completely eliminate capital gains tax and tax on dividends (and perhaps corporate income tax, too). How does one differentiate between “wages” and “capital appreciation”? The problem exists under the current code, but such a system would create even more tension between “wage earners” and “idea earners”. I don’t think, as a practical matter, the issue is easily resolved in practice.

  11. Gravatar of Bob Bob
    9. March 2015 at 14:59

    Like all arguments between conservatives and liberals, it all comes down to what points one finds emotionally/aesthetically unacceptable.

    An inheritance tax, for instance, is seen by some by robbing a grave, but by others, it’s seen as the accumulation of fortunes across generations without bounds.

    As far as taxes, conservatives dislike not seeing the poor pay taxes, while liberals dislike seeing the rich find ways to dodge taxes. For instance, if we switched to a full VAT, I could dodge an American VAT it by doing major savings to day, and retire at 55 in Sunny Spain. I earn my money in one country, spend it in another, and the place where I spend in gets the taxes.

    So I do not see how any number of explanations of how taxes work will change anything: It’s all really about what we find aesthetically displeasing. Your view is that ‘double taxation’, is aesthetically displeasing. Ok then, other people find other things more displeasing.

  12. Gravatar of Jim Glass Jim Glass
    9. March 2015 at 15:07

    I have one concern with switching to a consumption tax. I pity the people that paid income taxes their whole working lives that then get hit with consumption taxes their whole retired lives.

    The AARPers have already well noted this — talk about double taxation(!) — and if we were anywhere near as close to doing it as we were to reforming Social Security back during the Bush years they would be howling just as loud now as they did then. But they are silent because we aren’t anywhere near that close. And we weren’t anywhere near close to reforming Social Security then.

    We aren’t going to switch from the income tax to a consumption tax (however desirable that might be). The real- world issue is whether we will add a consumption tax such as a VAT to the income tax system we have.

  13. Gravatar of TravisV TravisV
    9. March 2015 at 15:07

    Dear Commenters,

    Any explanation for why inflation expectations (5-year breakevens) keep going higher and higher and higher????

  14. Gravatar of Tommy Dorsett Tommy Dorsett
    9. March 2015 at 15:15

    Scott, slightly off topic. Do you think the rising dollar is partly the result of a positive supply side shock (energy collapse), partly the result of ECB / BOJ easing, and partly the result of Fed tightening expectations? Never reason from an exchange rate change. Ask why the exchange rate changed. And I’m asking. What say you?

  15. Gravatar of bill bill
    9. March 2015 at 15:18

    A carbon tax is a tax on a particular form of consumption.

  16. Gravatar of Tommy Dorsett Tommy Dorsett
    9. March 2015 at 15:19

    Travis V – the crude price is stabilizing after a big collapse. This collapse definitely had an impact on tips Breakeven spreads. So, as a consequence, breakevens are bouncing up a bit but still are at levels consistent with an undershoot of the Fed’s 2% inflation goal. See Scott’s post on Justin Wolfers’ NYT column from Sunday.

  17. Gravatar of Kevin Erdmann Kevin Erdmann
    9. March 2015 at 15:52

    So, if we just tax wages, and no capital gains or corporate income, we can avoid all the confusion with depreciation, etc.?

    Do I understand you correctly that you’re just taxing corporate income because you’re giving a tax deduction for savings and then taxing subsequent capital income instead of just ignoring savings and capital income?

  18. Gravatar of benjamin cole benjamin cole
    9. March 2015 at 16:03

    Seems to me a simple national final sales tax (no VAT) is the easy way. Exclude groceries and medical for progressivity. Maybe Pigou taxes, but who decides what is vice….I like onerous gasoline taxes…
    Why the comlicated AGI’s and MTR’s…loopholes…egads.

  19. Gravatar of Emerson Emerson
    9. March 2015 at 16:47

    There was mention of a progressive consumption tax. It seems that this would be very difficult to implement.

    Given the above discussion, isn t it true that a progressive income tax is in fact a progressive consumption tax?

  20. Gravatar of Andrew Andrew
    9. March 2015 at 17:37

    I apologize if you’ve addressed this elsewhere. Not taxing capital income does seem to make sense in a world where money predictably doubles every twenty years, as you describe. But this is obviously not the case in the real world. As one commenter pointed out, most of the wealth of Bill Gates or Mark Zuckerburg is due to massive appreciation of stock (of MSFT or FB respectively). This is true for many people who are compensated with stock options. Or what about someone who renovates and flips houses? Is that capital income or wage income? The question matters even with our current tax regime but becomes all the more urgent when the difference in marginal tax rates could be as high as 50 percentage points. Finally, it just seems wrong to me that someone who, through genius, blind luck, or both, makes a 1000x return on his investment is not taxed at all.

    This would obviously add complexity, but what about taxing capital income above a certain dollar figure, or percentage of assets? For example, you could say that if you have capital income of over $50K then you must pay some tax on any income above that deduction. If you wanted to, you could further stipulate that the taxpayer could elect to use a deduction of 5% of total assets instead of $50K, if that would be higher. That way someone wouldn’t be penalized for having below average returns. But I think something like this would address most of the issues I raised in my first paragraph.

  21. Gravatar of ssumner ssumner
    9. March 2015 at 17:56

    Gordon, That’s great.

    Matt, Those are tough cases. It’s hard to know how much of the income being earned by Microsoft is actually Gates’s labor income. We may want to handle owner’s income in some sort of 401k structure. Or we could just assume that capital income from the company you work for is labor income.

    Adam, Fees for investment advice are clearly labor income. I have no problem with the idea that people who don’t consume a lot shouldn’t pay a lot of taxes. That seems very fair to me. The big consumers ought to pay. It’s not what you put into society, it’s what you take out.

    Vivian, You should write that up as a paper, maybe you’ll win a Nobel Prize in economics.

    John, Sorry, I should have been clearer. I meant either tax consumption or tax GDP, which would be very different. Consumption is just C, whereas GDP also includes I. So a tax on GDP covers a wider range of goods.

    John, You asked:

    “If I’m clear, your argument is that this transformation makes corporate income like the 401k where you reduce your income by how much you are investing. Correct?”

    Yes.

    You asked:

    “In that case, you’d just eliminate the corporate tax, but you wouldn’t bother with any expensing.”

    Yes, the simplest approach is to eliminate the corporate income tax, and just go with a wage tax. But it’s tricky to calculate the wages of the self-employed. What’s Gates’s labor income? How about a contractor who buys an old house, fixes it up, and sells it for more. He’s earning an implicit wage. Of course the IRS already faces that problem, but it’s tricky.

    You raise other good points. Unless you are Singapore, these things are not easy to do. But it would be VERY easy to go a long way in this direction. Why limit IRA contributions? Why force people to take money out at 70? Why not allow expensing? Etc. Canada is already ahead of us on this.

    Jim, You said:

    “The real-world issue is whether we will add a consumption tax such as a VAT to the income tax system we have.”

    There might be worse outcomes than this, but I can’t imagine any. I’d just shoot myself.

    Travis, Probably because the recent fall in the CPI is behind us now, whereas 2 months ago people knew it was coming, but it wasn’t yet in the data.

    Tommy, I’d guess it’s a mixture of stronger growth in the US and monetary stimulus in Europe/Japan.

    Bill, I favor a carbon tax.

    Kevin, See my earlier discussion of the tricky issue of Gates’s wage income. That might be one reason to tax corporations. The problem with taxes all along is that the theoretical concepts are hard to measure in the real world. But I’m just trying to at least get people clear on the theoretical concepts. That’s a precondition for any discussion. It’s frustrating to have commenters who don’t even understand that in THEORY a wage tax is identical to a VAT. After we are on the same page then we can see that each has their advantages and disadvantages. Each is prone to mismeasurement issues, tax evasion, etc.

    Emerson, No, not even close.

  22. Gravatar of Steve Steve
    9. March 2015 at 18:00

    Can you elaborate on “Also recall that the rich don’t pay payroll taxes above about $120,000 or so”? I haven’t found that to be true, what am I missing?

  23. Gravatar of ssumner ssumner
    9. March 2015 at 18:09

    Andrew, There are really two issues there, both good ones. The huge fortunes are being taxed under my plan to the extent they are spent. But let’s start with the measurement issues—see my discussion above, which agrees with some of your points.

    In other posts I’ve suggested that people with capital income of less than their labor income, or perhaps less that $50,000, $100,000, whatever, could simply be taxed on wages. Then the big fish like Gates (who have massive capital income) could be treated differently, with the IRS taking a close look. All of their income would go into a 401k-like structure, i.e. it would all be assumed to be labor income. But it would be taxed when Gates actually took it out and consumed it. Now he pays a low cap gains tax when he sells stock to build his $40 million house. Under my plan he’d pay a higher tax rate when he sold stock to build his home. Under either plan he pays no tax on stock he gives to charity, which is like 99% of his stock in the long run, or so he claims.

    The second issue is whether it’s fair for someone with massive wealth but almost no consumption to pay very little tax. I say it’s very fair, in fact the opposite is unfair. Others disagree, but I don’t think they’ve really thought it through.

    I know that liberals don’t trust me on this, so they should read DeLong, Yglesias, or someone like that on the case for the progressive consumption tax, at least read them from back when they supported the idea.

  24. Gravatar of Mike Sax Mike Sax
    9. March 2015 at 19:49

    (I put this comment on another post by mistake so I’m transferring it here)

    Yeah, I never get this argument-and still don’t, honestly. LOL. I maybe feel like I follow it better than in the past but I’m still far from totally there. I do think that part of the disconnect that many people have is what ‘Saving’ means under the standard Neoclassical model.

    I get it from what you’ve said before that how you-and most establishment economists-define savings and investment are different from how most people think of it.

    What might help bridge the divide then would be if you could simply unpack the terms-in the interest of the understanding you’re trying to foment.

    For example one thing that I’ve finally figured out is that the standard model doesn’t consider stocks as ‘investing’ but as ‘savings.’ Probably most people think of that as ‘speculating’

    So I don’t know if you can give a basic list of what activities count as ‘saving’ vs. ‘investment’ etc. That might be the way to get it.

  25. Gravatar of Steve Steve
    9. March 2015 at 21:06

    Capital taxation forces companies to spend more on dividends and buybacks (all else being equal to balance share supply/demand), reducing money for wages and capex.

    The incidence of bank taxation (including DOJ lawsuits) appears to fall mostly on renters… but maybe a little on depositors too.

    BTW, will the real “Steve” please stand up? I am the regular Steve and the above Steve is not me.

  26. Gravatar of Jon Jon
    9. March 2015 at 22:02

    Scott you write: “Or we could just assume that capital income from the company you work for is labor income.”

    Isn’t this already a regime the IRS enforces for self-directed IRAs. For instance, if you buy a property in your IRA, you can hire people to maintain it, etc and collect rent in your IRA as capital return. But if you step on to the property and bend a finger–put in a light bulb, etc. You contaminate and disqualify the investment. For this reason you have to keep sufficient records to defend in an audit that it is reasonably likely you paid people for the up-keep of the property our of IRA assets rather than using your labor.

    Another model is that if the business is IRA like, any distribution from the business is wage income including selling it, unless you roll it over into another IRA like structure. The goal being that money should always be taxed when it gets somewhere you can spend it on yourself.

  27. Gravatar of J.V. Dubois J.V. Dubois
    10. March 2015 at 01:56

    I understand your point that wage tax and consumption tax is identical. My own quibble is that both terms (wage and consumption) are basically impossible to define on some consistent, conceptual basis. You can only make some arbitrary decisions about those.

    Like for instance that water purchased by people is consumption but cars bought by firms is investment. Or that all houses are investment etc. Or that coffee machine in office is investment but coffee machine at home is consumption. And for coffee machine at home office … who knows what it is. Maybe half-consumption and half-investment? That has some nice ring to it.

    In the same way all income is result of some combination of labor and capital. Even income from stocks is result of your labor in selecting the stock to invest in a similar way salesman’s income stems from his ability to sell some stuff for more than he bought it.

    So to sum it up I think that in the end it is not that useful to think about taxes in these terms. I say – let’s have an efficient tax that has low dead-weight loss and then redistribute based on your preferred measure of progressiveness (consumption, income etc.) Which I think is the reason why VAT is so widespread.

  28. Gravatar of Dan W. Dan W.
    10. March 2015 at 03:24

    Scott,

    I like how you frame the argument on the consumption tax. One of the most helpful tax reforms would be to enable anyone to setup tax deferred savings / investment accounts where taxes on the gains made in the account are only paid when money is withdrawn from the account. Similar to the traditional IRA arrangement but with much less strings attached.

    As a matter of tax fairness I am not so keen on the Roth structure for such accounts. Don’t get me wrong, the Roth is a very nice tax avoidance mechanism! But the Roth is not fair for the basic reason that the gains in a Roth are not necessarily due to actual gains in the value of capital.

    First, one can day-trade a Roth account. Such realized gains have nothing to do with capital appreciation. Second, the gains in stock prices can be realized through financial engineering, such as stock buybacks fueled by debt issuance. The piece of electronic paper increases in price but there is no increase in the value of actual investment capital. In these two cases one can pretend the increase in account value is due to investment gains but in fact the gains have nothing to do with investment!

    It is one of the great lobbying successes of all-time that the financial industry managed to tailor the tax code to its needs. That millionaires and billionaires can structure their nest egg to deliver sizable, but low taxed, income based on “dividend” and “capital gain” distributions is a credit to their political success. Yet at a certain point income is income, whether it is Warren Buffett or Mitt Romney spending a dividend check or Salesmen Joe spending a bonus check. Only with idealistic assumptions is the dividend check different than the bonus check. Yet it is based on these assumptions that the bonus check gets taxed at 50% and the dividend check gets taxed at 20%.

    It is inequity that justifies a radical rethinking of “income” and a transition to a consumption tax model, as you have presented.

  29. Gravatar of Ben Ben
    10. March 2015 at 05:00

    Thanks for writing this Scott. I wrote yesterday a bit confused by your claim that the Rubio plan was a consumption tax.

    Your examples are of course correct and clear thinking, but I worry about transition. If I already have $10mm in savings that was taxed at lower rates that are somewhat/kinda offset by the current regime’s future capital gains taxes, then I’m in great shape if the ladder gets pulled up now on lower marginal “income” taxes! Is the unfairness of the transition worth it?

    Maybe a high inheritance would correct for this over time.

  30. Gravatar of ssumner ssumner
    10. March 2015 at 05:49

    Steve, I meant on any income above that threshold.

    Mike, If you don’t know what saving and investment are then I’d suggest reading an intro to economics textbook.

    Steve, I can never keep all these names straight, unless they are unusual. I have lots of people named John, Jim, Bob, etc, commenting.

    Jon, Good points, you know more about the tax code than I do.

    JV, Yes, but VAT is a consumption tax. So that regime is fine with me. But liberals would not find it progressive enough.

    Ben, Some people favor a one-time capital levy at the point of transition, but I don’t think that’s needed.

  31. Gravatar of Njnnja Njnnja
    10. March 2015 at 06:25

    @Steve @ssumner:
    Also recall that the rich don’t pay payroll taxes above about $120,000 or so
    Not quite right – OASDI has a cap on payroll at about $120K, but Medicare payroll deduction has no cap, and in fact with PPACA is more progressive. Medicare tax is 2.9% plus 0.9% on wages over $200K.

    http://www.irs.gov/taxtopics/tc751.html

  32. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    10. March 2015 at 06:30

    Mr. Sumner, I think it is great that you clarify that capital gains taxation, particularly taxation on unrealized gains, is in fact double taxation. I fully agree that taxing consumption, particularly luxury itens, is the way to go, although you raise the question about what is really a luxury item. But I think that the real criticism on taxing only consumption is that it would be cyclical, which would make government revenues volatile. But, since you advocate NGDP targeting, that would not be the case, since NGDP targeting would keep nominal consumption (and taxation) less volatile. Can you comment on that ? Thank you.

  33. Gravatar of Brian Donohue Brian Donohue
    10. March 2015 at 06:31

    Great post, great comments.

  34. Gravatar of ssumner ssumner
    10. March 2015 at 06:35

    Njnnja, Yes, I forget about that. I think of it as more of an income tax, as it also applies to capital income. But it’s collected as a payroll tax, as you say.

    Jose, Good question, but I think it actually might be less cyclical. I’m not certain, but I believe C is less cyclical than GDP (or income), due to the very high cyclicality of investment.

    Of course G must also be considered.

    Thanks Brian.

  35. Gravatar of Ben Ben
    10. March 2015 at 06:45

    A debt… credit? might be relevant too. People entered into all kinds of financial agreements with expectations about future cash flows. Tricky stuff.

  36. Gravatar of LK Beland LK Beland
    10. March 2015 at 06:59

    Does’t a Roth-IRA-style system with progressive rates favor those with stable labor income from year-to-year?

    And doesn’t a 401k-style system with progressive rates favor those with stable consumption spending from year-to-year?

    With a flat tax rate, I agree it makes no difference. But with a progressive tax rate, this is a significant difference, no?

  37. Gravatar of Nick Nick
    10. March 2015 at 07:08

    Prof Sumner,
    I realize this isn’t practical, but if we had a way to compare each financial asset sold to the average performance of that type of asset, would it be ok to tax outsized gains even though its ‘double taxation’?
    I seem to remember something about ‘fair’ being meaningless in a world of particles in the first post. I assume that what’s bad about capital taxation is that it discourages capital formation–not that it’s ‘double’–and that you mention the doubling aspect just to show that a nominally higher consumption tax is equivalent.
    So, isn’t taxing good luck sort of a fine idea? You can’t disincentivize luck very easily, if I properly understand the term…
    I’m not trying to say we should actually impose a scheme like this. I’m just trying to do some clear thinking about taxes. It’s the incentives that matter, right? Not ‘double taxation’?
    I think this is what a lot of everyday liberals are trying to get at when they say they want to tax large capital gains. It’s a bit of pure desire for equality of outcome meets a sin tax on luck.

  38. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    10. March 2015 at 07:49

    Don’t forget the very human desire to reduce the good fortune of your neighbor;

    http://piketty.pse.ens.fr/files/Piketty2015AER.pdf

    ‘An alternative to progressive taxation of inheritance and wealth is the progressive consumption tax …. This is a highly imperfect substitute, however. First, meritocratic values imply that one might want to tax inherited wealth more than self-made wealth [the kind Piketty has just earned on royalties?], which is impossible to do with a consumption tax alone. Next, the very notion of consumption is not very well defined for top wealth holders: personal consumption in the form of food or clothes is bound to be a tiny fraction for large fortunes, who usually spend most of their resources in order to purchase influence, prestige and power [unlike French intellectuals?]. When the Koch brothers [yawn] spend money on political campaigns, should this be counted as part of their consumption? When billionaires use their corporate jets, should this be included in consumption? A progressive tax on net wealth seems more desirable than a progressive consumption tax, first because net wealth is easier to define, measure, and monitor than consumption, and next because it is a better indicator of the ability of wealthy taxpayers to pay taxes and to contribute to the common good….’

    This comes AFTER Piketty totally capitulates to his critics about ‘r>g’. What do ‘meritocratic values’ have to say about the millions Piketty amassed before this admission?

  39. Gravatar of Jeremy Goodridgde Jeremy Goodridgde
    10. March 2015 at 08:14

    You say:

    “The biggest confusion is that people don’t understand … why a wage tax is equivalent to a consumption tax.”

    I think you are assuming that wages aren’t the result of human capital investment. If someone takes a training class, using their wages, and increases their wage as a result, taxing the additional wage income is no different than taxing capital income. The additional wages in this case are not because additional work but because of an investment they made. In a consumption tax regime, the training class would be excluded from taxation but in a wage tax regime, you are taxing human capital investment returns. So a wage tax is not the same as a consumption tax.

  40. Gravatar of Majromax Majromax
    10. March 2015 at 08:25

    @LK Benard:

    Don’t we want to incentivize stable consumption? If people smooth consumption over time, that’s precisely what happens.

    @Nick:

    If we tax “excess gains,” then logically we should subsidize “excess loss.” This seems unreasonable. Also, it only makes sense if we legally believe the EMH, such that there is no discernment in investing and only luck.

    @Patrick Sullivan:

    I don’t see the problem. First, it’s not obvious that we want to tax inherited wealth *more* than self-made wealth. This is a distributional concern, and tax policy can affect distribution in only the crudest of ways. I don’t think it’s necessarily sensible to call a $100 inheritance of a single savings bond to be more deleterious than a $1bn capital portfolio. If we want to avoid wealth concentration as a social negative, then progressive tax rates on consumption would do a fair job.

    A consumption tax is actually perfect for taxing influence-purchasing. Imagine that everyone had a tax-sheltered 401k, where all withdrawals were subject to the consumption tax rate (and deposits given equivalent subsidy). That campaign donation would then be a kind of consumption. As a tax expenditure, we’d probably wish to allow certain exemptions to “all withdrawals,” such as for donations to registered charities.

    @ssumner:

    One potential problem in such a system is proper taxation of capital that provides consumption services, especially for owner-occupied homes. A 401k system would effectively apply the VAT rate to property appreciation in one’s home; a Roth system would not tax the implied housing service provided by ownership.

    Another possible gap in this sort of tax system is the peace-of-mind service by simply having wealth. Even with identical spending on consumer goods, someone with $1bn in the bank will live a much easier life than someone with $0 in the bank, because the former knows that they are at no risk of destitution. It is probably very difficult to quantify this effect.

  41. Gravatar of glasnost glasnost
    10. March 2015 at 08:29

    Okay. Thanks for the example re VAT and income taxes. I get the idea. I’m previously familiar with it, actually.

    Now, to get through the boilerplate:

    –“From now on liberal commenters must tell me why so many brilliant liberal economists have favored replacing income taxes with progressive consumption taxes”– ,

    Probably for reasons similar to yours. But this argument doesn’t cut a lot of ice. I’m not here to worship idols, liberal or otherwise. Unless brad delong made an actual argument that addresses the substance of my problems with this idea, I’d still deeply dislike it regardless of who is saying it. I get the point that your points are widespread.

    “and what’s wrong with this argument.”

    Well, let’s start here:

    “The second issue is whether it’s fair for someone with massive wealth but almost no consumption to pay very little tax. I say it’s very fair, in fact the opposite is unfair. Others disagree, but I don’t think they’ve really thought it through.”

    You describe a very negative outcome, and it’s not because of obscure reasons of fairness. This is a highly inefficient outcome.

    Let me give you an example. The foundations of the welfare state are about individual people getting more in then they give out. The very concept of insurance is based on similar points. Unemployment insurance, for example, allows people to take entreprenurial risk without being deterred by the chance of falling into unrecoverable financial consequences, leading to a net efficiency gain.

    China, where the savings rates are hugely high due to the complete lack of a safety net, is a macroeconomic nightmare of government-controlled misallocation and towns built with no one to live in them – and that is because consumer spending is very low, because of the need to save huge portions of your income for emergencies.

    The point is that individual fairness has nothing to do with optimally efficient distribution. When very rich people pay almost nothing – even leaving aside deep skepticism about whether you’ll actually be able to capture the less visible, more sophisticated consumption they do relative to ordinary people – the system is deeply harmed because nonrich people are forced to pay more. An extra 1000 in taxes can change the course of a median wage earner’s life, preventing the next degree, or the human capital upgrade. Less so the billionaire. You would disagree, but the next point is related.

    Moving back to the point, I don’t accept the basic premises of your abstracted model. In an economic textbook, when John Q spends X dollars on “consumption”, that X dollars is dead weight, and maybe that makes sense in an agrarian community circa 1600. But in modern times, there’s very little difference for net systemic investment between $1 in consumption and $1 in savings. My $1 in consumption goes into the accounts of an enormous multinational corporation and adds to their profits, which (according to the very theories you push at me) should now be plowed back into investment, or given back to shareholders as capital gains, who will then have that extra $1 to invest. Just like they would have if you had taxed the consumption and gotten more savings instead. In short, my consumption is a corporation’s profit and an investor’s wealth gain.
    So I get your basic model, I just don’t accept it.

    Having said that, I honestly am pretty indifferent to taxing consumption vs income for the mass of americans who have very little savings. The problem is how you treat capital, which needs to be heavily taxed.

    There’s a broader point here that I know you don’t like, which is that we’re at a point in the economy where gains in net liquidity and accumulation are outright harmful, period.

    Please see this link:

    http://www.moneyandbanking.com/commentary/2015/3/9/finance-is-great-but-it-can-be-a-real-drag-too

    I’ll quote a section for you:

    “The second part of the story is about the growth rate of finance. Here, the evidence appears stronger and more damaging than it is for the scale of finance: as you can see in the chart below, the relationship between the growth in financial sector employment and the growth of productivity is unambiguously negative.”

    Our current macroeconomic problems stem from excessive accumulation of capital and lack of release/transformation of that capital into real creation of tangible assets. We suffer from a hoarding problem and an overaccumulation problem. Eliminating taxes on capital or reducing them makes this problem worse, not better. It’s antithetical.

    So, we’ve already covered two severe concerns:

    #1. Reducing the tax incidence on very wealthy people means less services or higher taxes on less wealthy people, regardless of their consumption. When you massively cut taxes on low-consumption wealthy people, this has severe fiscal implications for everyone else. You want this consumption tax to be progressive, but it can’t actually be progressive. Wealthy people consume at low marginal rates relative to their income. I’m making this up, but instead of taxing Warren Buffett at 21% (capital gains) you’re now taxing him at 0.05%. This is not progressive, it just isn’t. Taxing billionaires less = not progressive.

    #2. Encouraging greater asset accumulation in the current economic climate is a bad thing, despite the abstract model saying otherwise.

    There’s a further point to make, #3 – your plan will lead to a net exacerbation of inequality of income and wealth, and this is also a net economic harm. Highly unequal distributions of income and wealth suffer from a whole swarm of economic problems to a greater degree than more equal distributions, such as:

    #1. Greater volatility
    #2. larger speculative boom and bust cycles
    #3. Stronger tendencies towards “financialization” of the economy
    #4.Larger problems with capital flight, reinforcing all the other problems
    #5. A shrinking revenue base, because the rich people have greater ability re capital flight and tax avoidance, while the nonrich have less wealth and income to tax
    #6. Human capital stagnation
    #7. Ultimately, lower growth, period
    #8. Cost disease – the price of the median human capital investment is higher in a more unequal wealth and income distribution (this is why the “this guy becoming a billionaire doesn’t hurt you” argument is wrong).

    So, that about sums it up. I could go with a switch from a wage income tax to a progressive consumption tax combined with very high taxes on capital.

  42. Gravatar of Doug M Doug M
    10. March 2015 at 09:01

    While I agree with our Professor in theory, I have a problem in getting there.

    As pointed out, people have made their plans based on the current scheme. To radically change that scheme would be to punish the prudent (and the retirees), would create a lot of dead weight.

    Politically, it won’t happen. DC is too gridlocked. The AARP lobby is too powerful.

    Repubilicans are reflexively for any tax cut, regardless of whether or not the proposal is well thought out. The Democrats are against it.

    As Ssumner has pointed out, fixed taxes does not fix spending. Spending is where the hard decisions must be made.

    What I would rather see, is a lockdown on the current (bad?) tax scheme in order to end the continuous noise over tax cuts.

    Supermajorities should be required to change the tax code.

  43. Gravatar of LK Beland LK Beland
    10. March 2015 at 09:04

    Majromax

    I agree. My point was that with progressive tax rates, the 401k tends to stabilize consumption, while the Roth-IRA tends to stabilize labor income.

  44. Gravatar of Mike Sax Mike Sax
    10. March 2015 at 09:19

    I’ve read textbooks-Mankiw, Krugman. I just notice that the use of these terms tend to shift depending on who’s using them.

    As it’s so basic why don’t you simply name 5 things you consider saving vs. the same as investment.

    In any case, I think that’s part of the confusion you’re talking about.

  45. Gravatar of Cliff Cliff
    10. March 2015 at 09:25

    “This is not progressive, it just isn’t. Taxing billionaires less = not progressive.”

    So in other words, you don’t like billionaires and you want them to suffer? Otherwise I can’t make sense of your position.

    Warren Buffett, let’s say he lives on $40k/year and has the lifestyle of your average janitor. However, he also has billions in investments, which he eventually donates to effective charities, saving millions of lives etc.

    If I understand it, your complaint is that Warren Buffett should be taxed more than the janitor making the same amount with no savings, because what? He’s not virtuous enough for you? He’s not saving enough lives? Government could do a better job with his money than he can in spite of the (enormous) deadweight loss? Oh right, because Warrenn Buffett is not “progressive” enough for you.

  46. Gravatar of AbsoluteZero AbsoluteZero
    10. March 2015 at 09:26

    Scott,
    First, thanks for the post. Finally there is something short and easy to understand I can point people at. In particular, the point about taxing withdrawals from something like a 401K not being a tax on capital income but a deferred tax on labor income is important. And, for what is worth, I completely agree, including your point about fairness.

    Having said that, I agree with Doug M’s point about getting there from here.

    glasnost said: “China, … due to the complete lack of a safety net, …”
    This is not true. For those who read Chinese, see
    http://baike.baidu.com/view/1712656.htm
    Also, from the SSA,
    http://www.ssa.gov/policy/docs/progdesc/ssptw/2010-2011/asia/index.html
    Social Security Programs Throughout the World: Asia and the Pacific, 2010.
    Get the PDF and check the country summary for China. This came out in 2011, with information up to 2010. An update is supposed to come out in March of this year, so there’ll be a new version soon. There’s been a lot of changes since 2010. In particular,
    http://www.asiabriefing.com/store/book/social-insurance-in-china-429
    http://blogs.wsj.com/chinarealtime/2011/08/10/chinese-social-insurance-will-foreigners-be-able-to-opt-out/

    Just yesterday, Yin Weimin (尹蔚民), head of the Ministry of Human Resources and Social Security (人力资源和社会保障部) held a press conference and answered questions about the latest changes. Again, for those who read Chinese,
    http://www.guancha.cn/society/2015_03_10_311701.shtml

  47. Gravatar of TallDave TallDave
    10. March 2015 at 09:50

    But the GOP doesn’t want to do [cut spending].

    Well, the Tea Party did manage to call Obama’s bluff on Sequestrageddon (otoh I’m told the world probably ended as a result). I don’t think we can just throw out GOP spending cuts as a possibility, particularly if Walker, Paul or Cruz were to win in 2016.

  48. Gravatar of TallDave TallDave
    10. March 2015 at 09:55

    Taxing billionaires less = not progressive.

    Nonsense, progressives love giving tax breaks for alt-energy to billionaires.

    But Cliff really nailed this point above — no one really cares about income inequality. The real issue is consumption inequality. A system that rewards investment (which raises all living standards) over consumption will benefit everyone, most especially the poorest, as the lion’s share of productivity gains from investment must always flow to consumers.

    Unfortunately too many progressives seem more bent on punishing the rich than in raising the living standards of the poor.

  49. Gravatar of glasnost glasnost
    10. March 2015 at 10:11

    Pages 3 and 4 of this story are an excellent basic primer on the visible symptoms of overliquidity, hoarding, and overaccumulation – debt-fueled stock buybacks dominating the choice portfolio of what american corporations are doing right now with their money; the giant pool of money endlessly recycling itself, getting ever larger, disinterested in real investment.

    http://www.politico.com/magazine/story/2014/11/overtime-pay-obama-congress-112954_Page3.html#.VP8vO_nF_HU

    “Forget everything you’ve been told about how the rich are job creators””that the more money we have, the more we invest, the more jobs we create, and the better the economy is for everybody. As our epidemic of stock buybacks clearly illustrates, capitalists like me already have more money than we know what to do with. Indeed, smart investors are struggling to cope with what Bain & Co. has termed “capital superabundance,” marked by a tripling of global capital since 1990 despite the ongoing stagnation of the underlying economy. Meanwhile, even as this glut of financial capital continues to grow, new technologies are dramatically reducing demand for capital.”

    Global net liquidity gets larger and larger while the economy stagnates. The lack of investment opportunities percieved to be worth investing in is directly related to forecasts for stagnant or declining consumption, which is directly caused by the fact that returns to capital and billionairies continue to grow while returns to labor continue to shrink, while rich people don’t consume. Since my consumption is your profit, there’s nothing left but asset bubbles and stock buybacks, except perhaps for short-term credit predation on the weak and the resultant asset confiscation.

    “So in other words, you don’t like billionaires and you want them to suffer? Otherwise I can’t make sense of your position.”

    To briefly reply to this great example of emotional trolling without reading my comment, greatly reducing the current taxes on capital means greatly reducing net taxes on extremely wealthy people, leading to a large loss of government revenue, leading to cutbacks in government services, mostly used by nonwealthy people, or increases in taxes on nonwealthy people.

    Furthermore, this exacerabates the pre-existing trend of massive increases in inequality, which leads to about eleven different hamrful macroeconomic phenomeona listed specifically in my last comment and reiterated now:

    #1. Greater volatility
    #2. larger speculative boom and bust cycles
    #3. Stronger tendencies towards “financialization” of the economy
    #4.Larger problems with capital flight, reinforcing all the other problems
    #5. A shrinking revenue base, because the rich people have greater ability re capital flight and tax avoidance, while the nonrich have less wealth and income to tax
    #6. Human capital stagnation
    #7. Ultimately, lower growth, period
    #8. Cost disease – the price of the median human capital investment is higher in a more unequal wealth and income distribution (this is why the “this guy becoming a billionaire doesn’t hurt you” argument is wrong).

  50. Gravatar of glasnost glasnost
    10. March 2015 at 10:17

    —But Cliff really nailed this point above “” no one really cares about income inequality. The real issue is consumption inequality. A system that rewards investment (which raises all living standards) over consumption will benefit everyone, most especially the poorest, as the lion’s share of productivity gains from investment must always flow to consumers.

    Unfortunately too many progressives seem more bent on punishing the rich than in raising the living standards of the poor.—

    Every sentence in this statement is individually and literally incorrect, but the irony of a long series of responses to me failing to read or address anything I’ve posted in a blogpost scott made to complain about liberals failing to understand his argument is rich and appreciated.

  51. Gravatar of Mike Sax Mike Sax
    10. March 2015 at 11:18

    It’s a confusion that even two presumably knowledgeable economists like you and David Glasner seem to have when discussing it.

  52. Gravatar of TravisV TravisV
    10. March 2015 at 11:23

    Prof. Sumner,

    You da man, thank you Sir!

  53. Gravatar of dtoh dtoh
    10. March 2015 at 12:09

    Scott,
    The biggest problem with your analysis is your assumption of future of consumption. With a growing economy, there will be an increasing base of capital….i.e. no future consumption for some portion of production. For the most efficient allocators of resources, that portion will be very high. A tax on wages, will result in a much higher tax burden than a tax on actual consumption.

  54. Gravatar of dtoh dtoh
    10. March 2015 at 12:15

    Scott, Additional problems.

    1. There is no way of effectively determining what portion of income derives from capital and what derives from the labor of the owner of the capital. You can never design a tax system that captures this.

    2. Since you want to tax the difference between actual airfare and economy airfare, will you also tax the difference between the cost of an office chair and a wooden stool, any office space in excess of 12 square feet per person, employer provided parking, air conditioning below 90 degrees, safety glasses and ear protection for factory workers?

  55. Gravatar of dtoh dtoh
    10. March 2015 at 12:23

    Scott,

    The way to implement a progressive consumption tax is to eliminate all taxes on production and directly tax personal consumption instead.

    Why do keep pushing these complex tax structures that will never work efficiently?

  56. Gravatar of Miami Vice Miami Vice
    10. March 2015 at 13:50

    Never mind that if you tax both income and capital gains you obviously need a lower tax rate then if you tax income alone, if you want to raise the same amount in present value terms. Given your example…

    If you had a tax rate of approx 14% on both income and cap gains then you would raise slightly more than $20 and life time consumption would be $3 higher since you would obviously be taxing the previous generation’s cap gains to spend in the present.

  57. Gravatar of Miami Vice Miami Vice
    10. March 2015 at 14:00

    Every year the government would be raising $14 in income tax and $6 capital gains tax for a total of $20 in the present, continuously.

  58. Gravatar of Miami Vice Miami Vice
    10. March 2015 at 14:07

    And you’d have $3 more consumption. Good grief.

  59. Gravatar of Miami Vice Miami Vice
    10. March 2015 at 14:09

    14% not “approx 14%”

    Oops

  60. Gravatar of Miami Vice Miami Vice
    10. March 2015 at 14:55

    Your VAT should be about 15%. Otherwise you’ve over taxed if you want to raise $20K each year, given your assumptions. Life time consumption would be higher,obviously, as well.

    It’s just math

  61. Gravatar of Miami Vice Miami Vice
    10. March 2015 at 14:58

    Why on earth would you be trying to hold consumption constant through time? That’s just stupid.

  62. Gravatar of Miami Vice Miami Vice
    10. March 2015 at 15:15

    Thanks for splainin it to me

  63. Gravatar of Don Don
    10. March 2015 at 16:23

    Tax wealth instead of income and then you can eliminate the linguistic gymnastics of trying to justify zero rates on investment income. Instead, all income has a zero rate. A wealth tax is more “fair”, since government exists to produce and protect wealth. Thus, wealth should pay for government.

  64. Gravatar of Major.Freedom Major.Freedom
    10. March 2015 at 16:45

    Sumner wrote:

    “The fact is that no one knows who ultimately bears the burden of the corporate (and to a lesser extent personal) income tax.”

    Have you asked everyone on Earth?

    That is actually not a fact, because you or anyone else can in fact learn who ultimately bears the burden of a corporate income tax.

    Speaking strictly in material terms, subject to a division of labor, capitalist economy, the people who ultimately bear the burden are the consumers, which of course means everyone. Everyone bears the burden.

    A wage tax reduces consumption. But this does not mean a wage tax “is” a consumption tax! That A causes B does not mean A is B.

    Think of a counter-factual world of a slave driver kidnapping Steve Jobs and Bill Gates when they were both young teenagers. That action on the part of the slave driver would have prevented him from benefiting from all the wealth Jobs and Gates have actually brought about in our world, if he would in fact enjoy those products more than Jobs and Gates cleaning his floor and cooking his dinner.

    The recognition of the benefits of cooperation is what enabled humans to move forward beyond its brutish evolutionary roots.

    Taxing productive activity hurts everyone. That is who ultimately bears the costs of taxing production.

    But who bears the “most” burden? That is a meaningless question. A $100 loss to you is not the same thing as a $100 loss to me. Steve Jobs being taxed was judged, valued, differently by you than it was by me. His loss in turn was judged differently by him that it was by either of us.

    Markets are a process where disagreements find harmony and balance. Too often there is this notion that there is a single mind, a single reason, behind it all. No. Two people trading with each other disagree, they don’t agree, on the value of the goods being exchanged.

    Back to taxes. A wage tax is NOT a consumption tax. Sumner is confused about this because of at least two reasons. One, he is incorrectly holding constant the split between investment and income when taxation is introduced. Doing this gives the illusion that there is no change to present value of consumption. However, introducing taxes on wages from a baseline of no taxation, cannot be assumed as leading to no change in the consumption-investment ratio. This is important, and ties to the second confusion, which concerns real variables in addition to nominal variables, not just nominal variables.

    A tax on wages will have, on average, a lower effect on tax induced depressed lifetime consumption as would a tax on corporate income. This is the case because, on average, there is less savings and investment out of wages as compared to out of business revenues. Pre-tax business profits average about 10% to 20%. This figure may fluctuate beyond this range, but as long as it is anything less than the percent of wage incomes that are saved and invested on average, we can say that taxing only corporate incomes will result in less output than if only wage incomes were taxed. This is because a 10% profit means 90% of every dollar of revenue is being invested, in the long run. The rate of saving out of wages tends to be significantly less than 90%.

    If all Sumner is saying is that taxing wages will reduce a wage earner’s consumption then he is only referring to a basic truism of economics.

    It is not quite right to say a wage tax IS a consumption tax however. While shooting at a person’s body and shooting at their food will both have the effect of killing the person, that does not entitle us to say that shooting at people’s food IS shooting at their bodies. Similar effects of two different actions do not imply the actions themselves are the same. Sumner is exacerbating the confusion. He should instead say that taxing a person’s wages has the same lifetime effect on their consumption as taxing their consumption directly, provided all else is held equal, and then proceed to explain what happens when all else is not equal, as they almost always end up being anyway.

    Taxing my wages instead of taxing my consumption may, indeed will likely, lead to me consuming less over time as compared to taxing my consumption. This is because I may very well change my investment-consumption ratio if only my consumption is taxed. So here, because the effects of the same rate of tax on different incomes leads to different consumption, a wage tax is not a consumption tax in terms of equal reduced consumption. Here, at most, we go back to the truism.

  65. Gravatar of Major.Freedom Major.Freedom
    10. March 2015 at 16:49

    Don:

    “Tax wealth instead of income and then you can eliminate the linguistic gymnastics of trying to justify zero rates on investment income. Instead, all income has a zero rate. A wealth tax is more “fair”, since government exists to produce and protect wealth. Thus, wealth should pay for government.”

    That is a myth derived from Marxism. No, the state is not “here” to protect “wealth”, I.e. the capitalist class, and it certainly isn’t here to produce it. The state produces nothing on net. It incurs losses on net.

    The state exists to extract wealth from those who produce it. To live as a parasite, which all those who put power over productivity must do in their actions. It is an elaborate delusion akin to the church’s power from the past.

  66. Gravatar of Major.Freedom Major.Freedom
    10. March 2015 at 17:33

    Sumner wrote:

    “This is lots of busywork for accountants, with no practical value that I’m aware of.”

    Of course you’re not aware of any! You have not studied enough accounting, or fund managing, or investment banking, or company management in general. No offense, but you study political strategy, with a minor interest in pseudo-economics called macro-economics, and within that, you specialize yourself in the tactics of money counterfeiting legalized by those you plead to and seek recognition from as an advisor/strategist.

    “I can think of two things that accountants might be interested in”

    “1. Cash flow”

    “2. Value of a company’s assets”

    You forgot cost management, pricing, and capital allocation, to name a few.

    “The later might involve “depreciation,” but it might just as well involve “appreciation,” especially in real estate.”

    Might? EVERY company that has so-called “fixed assets” other than land, would involve depreciation. It is a core component of cost management.

    “If you allow companies to expense all investments, then you have essentially turned an income tax into a consumption tax.”

    Haha haha, sorry, but that is just lol funny. You say “allow” as if company managers everywhere are just itching to expense capital investments. On the contrary! There is a game for income statements that are given to investors. Company managers and their accountants, if they had the choice, if they were “allowed” to capitalize costs, they would almost all capitalize and then depreciate everything down to toilet paper.

    If GAAP “allowed” company managers to expense more items, it is not like they will all follow suit to a “t”. They would likely be reluctant and still capitalize what they are “allowed” to capitalize. You’ve got it backwards.

    Regulators and GAAP executives/managers almost always have to fight tooth and nail to make certain costs mandatory expenses, or else the company managers would tend to capitalize them. There have been quite a few companies in the news, not so much recently but in the 2000s there were a number of stories, of company managers capitalizing items that should have been expensed, and committing crimes as a result. Remember?

    That is the income statement.

    On the statement submitted to the IRS on the other hand, you tend to see more items expensed. Here the game goes the other way. Here the game is to maximize expenses, so as to minimize taxable income, so as to minimize taxes payable.

    “Allowing” companies to expense more costs would likely have a minimal effect. On the other hand, allowing companies to capitalize more costs would likely have a significant effect.

    Again, leave the accounting to the accountants. It is awkward to read a macro-economist wading into territory which he is clearly in way over his head. (Depreciation being “Busywork” is a dead giveaway by the way).

    You know what I think? I think the sole premise for why Sumner is antagonistic towards depreciation is because it doesn’t gel with NGDPLT. NGDP is a cash flow item. The only thing that matters is cash flows. Depreciation is of course a non-cash flow item, which can therefore only be a fetter to his socialist plan. It is only busywork with no practical value because the only practical value is what can be shown by cash flows. While cash flows are important, and investors by and large consider the cash flow statement to be the “most revealing”, it is nevertheless the case that depreciation also tells us a lot about a company.

    For example, a company that has high cash flow investments, but low depreciation, might be valuing their assets as either long lived or with a high future sale value. Or, a company that tells us it uses accelerated depreciation would enable us to value their expected operating earnings differently from a company in the same industry with similar financials but instead used straight line. There are good reasons why an asset would be better valued with accelerated versus straight line. Proprietary computer equipment for example.

    Depreciation is a vital, if not necessary tool, in valuing a company’s assets that are relatively illiquid. Accountants all over the world use depreciation. If they did not find it useful, then they would have stopped using it a long time ago. Busywork? Ha! What is busy work is socialism, of which market monetarism belongs.

  67. Gravatar of Cliff Cliff
    10. March 2015 at 18:43

    Glasnost, the only irony is you complaining about other people not reading your post or addressing your posts when every person who responded to you did read your post and addressed specific points in your post, which by the way is basically a load of horse shit in its entirety.

    Even more ironic is that you apparently did not read MY post and are not addressing MY point, which is about whether it is inherently progressive to tax a billionaire. Instead you played hide the ball and trotted out some unrelated and nonsensical copy-and-paste talking points.

  68. Gravatar of Matt Waters Matt Waters
    10. March 2015 at 20:25

    I keep thinking about the case of Bill Gates. Or, more generally, when the capital increase itself is a byproduct of labor.

    In the most absurd possibility, let’s say an employee makes $X a year. They could incorporate a new company, with 100% ownership and zero investment. Their employer contracts with the company for $X a year instead of salary. The employee could work for the company for a much lower wage, say $0.1X. Then the employee happens to pay themselves out a dividend.

    The simplest answer would be to make some capital gains labor income, but that leaves the IRS to have to apply complex decisions. Not taxing capital gains is equivalent to letting anybody open up a Roth IRA with post-wage-tax money, invest in anything and not pay taxes on the returns. For officers of a company who can buy much of the stock in their company, they could invest some of their income in their own company. Then some of their labor could go to increasing their non-taxed capital income rather than their taxed wage income.

    All the different scenarios make my head spin after awhile. An idea I’m trying to figure out is some sort of normalized capital gains tax. The capital gains tax would be the same rate/schedule as the tax on labor, but the capital gains would be reduced by a normalized general rate of return.

    Investors have different risk appetites and all that, but bear with me. Let’s say a “typical” investor earns 1% over inflation. An investor buys some stock for $100 and sells for $150 10 years later. The inflation rate was 2% every year. So a typical investor would expect $100*(1.03)^10, or $134. The capital gains of $50 would then be normalized to $16. Then that $16 would be taxed at the same rate as labor. If the investor earns less than the “typical” investor, then the government would actually reduce their tax liability or write them a check.

    If all investors were merely passive investors delaying consumption, and the average investor over the ten earned 3% a year, then this system would not generate any net revenue. Some investors would be luckier in the market than others (with the EMH saying it is, in fact, luck). But the total revenue would be zero. But the “investors” who get labor income in the form of capital income would expect an above-average “return” as compensation. They would have to pay the labor tax rate.

    In the end, I’m not sure if there’s any truly practical system which matches the theoretical perfect wage or consumption tax. If nothing else, putting all the eggs in one basket makes tax evasion easier. Tax revenue generated only through one tax means one step for evasion, while a hybrid income/consumption/capital gains/corporate tax system needs multiple different evasions. One could say the US’ current income/capital gains/corporate tax scheme implements significant progressivity by taxing most rich people’s incomes three times. One time through labor income or consumption would be less distortionary, but that theoretically perfect system may not be on the table practically.

  69. Gravatar of NotTheRegularSteve NotTheRegularSteve
    10. March 2015 at 22:49

    Scott,

    Sorry to stay on this since it’s not central to your post, but I still don’t understand.

    You said “Also recall that the rich don’t pay payroll taxes above about $120,000 or so”, then “I meant on any income above that threshold.”

    Out of the (30-50) people I know who have W-2 income above that threshold, I have no reason to think any of them are not paying payroll taxes on their full gross wages. It is possible they are keeping some secret from me. How do you think the rich are accomplishing their payroll tax reduction??

    -NotTheRegularSteve

  70. Gravatar of BC BC
    11. March 2015 at 01:12

    Scott, great post. From the comments, it seems that many people are now starting to understand why wage-only tax = 401k taxation = consumption tax, at least in principle. Previous posts like this from both you and Landsburg would get lots of denial on even the principle/theory. Now, most of the comments are about tax avoidance.

    On tax avoidance, it seems like 401k taxation prevents most of the tax avoidance issues. If Bill Gates put his Microsoft stock in a 401k, he (or his heirs) would still have to pay tax on it when he withdrew it for consumption. The only way to avoid tax on an amount in the 401k would be to never withdraw/consume it, which is equivalent to never having had it. (If you doubt this, ask yourself if you would ever put money into an account from which you could never make withdrawals!)

    It also seems pretty seamless to transition to a 401k tax system. Just remove all contribution and withdrawal limits on 401(k)s (and traditional IRAs) and eliminate all capital “income” taxes. People that have already paid income taxes on past wages could still save that after-tax money in non-401k accounts to avoid double-taxation when they spend it in the future. Any stock in your current or past employer(s), however, would have to be held in a 401(k). (We could have a grandfather exception for those that bought employer stock in the past with after-tax dollars when it was publicly-traded and had a well-defined fair market price.) Finally, raise marginal tax rates to make revenue neutral (if desired).

  71. Gravatar of Major.Freedom Major.Freedom
    11. March 2015 at 01:51

    Cliff’s mad.

  72. Gravatar of J.V. Dubois J.V. Dubois
    11. March 2015 at 03:33

    Matt Waters: the capital/labor distinction is really hard to make. Take for instance David Beckham. If he goes and makes money doing advertisement for some product that should be labor income. But if he creates let’s say perfume company where he is 100% owner, and makes the same advertisement but collects payment as dividends then it is suddenly capital income.

    This brings to my mind latest discussion by Nick Rowe about human capital. David Beckham invested in his own image and developed huge brand value attached to his person. You can say similar things happens to many star professions such as actors but even for people who have the right social networks for high-level work such as sales, consultancy etc.

  73. Gravatar of ssumner ssumner
    11. March 2015 at 06:07

    LK, Yes, it’s slightly different.

    Nick, You’d also have to subsidize investment losses. No thanks. In any case a progressive consumption tax already taxes luck.

    Jeremy, True, but as a practical matter education is heavily subsidized. But your point is accurate.

    Majromax, The piece of mind factor is an argument for making any sort of tax regime progressive. But yes, it’s a valid point.

    Also good point about housing. Of course we also have property taxes. The best thing we could do is eliminate the mortgage interest deduction.

    Glasnost, Your comment is full of false claims. You suggest I’m proposing making the tax regime less progressive. Not true. You say China has no safety net, not true. You say I oppose unemployment insurance. Not true. Your discussion of savings and investment is incomprehensible to me. Etc., etc.

    This sentence isn’t just wrong:

    “Our current macroeconomic problems stem from excessive accumulation of capital and lack of release/transformation of that capital into real creation of tangible assets.”

    it’s meaningless gobbletygoop.

    Doug, You can expand the 401k program, without hurting seniors.

    Mike, People don’t “do things” that I consider saving. Saving is the funds spent on investment projects. If I put $100 in the bank that may or may not be saving, depending on whether it funds an investment project.

    Absolute zero, Good comment, see my reply to Doug.

  74. Gravatar of ssumner ssumner
    11. March 2015 at 06:20

    dtoh, You asked:

    “Since you want to tax the difference between actual airfare and economy airfare, will you also tax the difference between the cost of an office chair and a wooden stool, any office space in excess of 12 square feet per person, employer provided parking, air conditioning below 90 degrees, safety glasses and ear protection for factory workers?”

    No, and how about you? You say that you favor a consumption tax. How do you define consumption. My college provides a company house for the college president. Is that consumption? How about the chairs in the house?

    And a growing economy has no bearing on the claim that a wage tax is equivalent to a VAT.

    Don, You said:

    “A wealth tax is more “fair”, since government exists to produce and protect wealth. Thus, wealth should pay for government.”

    I don’t see the logic of that. Government is also there to protect lives. Should we have a head tax? And it also protects consumption . . .

    Matt, The IRS already has to differentiate between wage and capital income. So that’s nothing new.

    Notrealsteve, Yes, they are keeping secrets from you. Check out this link to find out the truth:

    http://www.ssa.gov/planners/maxtax.htm

    BC, Good comment.

  75. Gravatar of Floccina Floccina
    11. March 2015 at 07:45

    Notrealsteve, Yes, they are keeping secrets from you. Check out this link to find out the truth:

    http://www.ssa.gov/planners/maxtax.htm

    A few weeks ago I was taking to a guy (he is about 60 years old and smart) and the subject of FICA came up and I mentioned matching FICA he was shocked that it existed.
    Much of the USA tax system is designed to hide the true tax burden from the majority of citizens. If you look at as a system designed to fool the majority of voters and yet pull in a lot of money it is really brilliantly designed. That is why a consumption tax is a hard sell, perhaps if you made employers write the checks just like is done with matching FICA, it would work. many of not most people would think that they pay no payroll taxes.
    It angers me that FICA is not all shown coming out of the employee’s wages or all hidden. If the employee knows how much he is paying that is good and honest and If the employee thinks he is not paying, you can make sensible changes to the payout but as it is we have neither honesty or flexibility.

  76. Gravatar of dtoh dtoh
    11. March 2015 at 11:59

    Scott, you said,

    “No, and how about you? You say that you favor a consumption tax. How do you define consumption. My college provides a company house for the college president. Is that consumption? How about the chairs in the house?”

    Absolutely. If it is used for personal consumption, it get’s taxed. To elaborate a bit, I would favor a fixed assets tax on any asset (land, houses, boats, cars, planes, etc.) with a value greater than $50,000 that is used for non business purposes. These assets would be exempt from the sales (consumption) tax. Anything less than $50,000 that gets purchased for personal consumption is subject to the sales tax.

    You need to think this through. This is an extremely easy taxation system to implement.

  77. Gravatar of dtoh dtoh
    11. March 2015 at 12:16

    Scott,
    And to put the numbers in perspective. Federal tax revenue is $3 trillion. Personal consumption is $12 trillion. So you need an average consumption tax rate of $25%. With a $5k per person exemption, you would need a tax rate on remaining consumption of 29% or 33% if the exemption was $10k (no taxes on a family of four earning/spending $40k).

  78. Gravatar of Potpourri | Freedom's Floodgates Potpourri | Freedom's Floodgates
    11. March 2015 at 20:50

    […] Scott’s treatment of taxation would totally screw you up.) He presented a cleaned-up version here, which I will critique formally elsewhere. For now, let me just bring to your attention an […]

  79. Gravatar of Prakash Prakash
    11. March 2015 at 22:35

    Prof. Sumner,

    You favoured a land value tax in one of the posts. How does it gel with the consumption tax? Does the government postulate an average land value beyond which people are taxed for the usage of land?

    dtoh, Tough questions on the consumption level beyond which the tax hits. I think that a deliberately egalitarian government would set it at the consumption basket of the median or 40th percentile, beyond which the tax hits. If the median person’s meal is a hamburger, then anything beyond the hamburger’s value in the business lunch is taxed. That is what sounds fair. But it will get complicated with time.

    Prof. Sumner, In the classical liberal conception, a government does not exist to protect consumption. It does exist to protect life and assets. A head “tax” is already assumed in the conduct that every citizen is supposed to observe in that society, a minimal level of civic sense. Does the head tax need to be higher than that, I don’t know..There is a deeper logic in asset taxes which should be considered.

    I also think that a consumption tax system (or even an asset taxation system) which does not tax money leaving the country will inevitably be beset with issues of people choosing to consume outside the country in lower tax jurisdictions, whether it be by retiring at 55 in spain like the other commentor said, or via annual vacations where people really blow their lid off.

  80. Gravatar of Matt Waters Matt Waters
    11. March 2015 at 23:21

    The IRS does make a distinction between capital and labor income, but the difference between the tax rates now is small. In the case of a company getting paid instead of an individual, there has to be a corporate tax and a capital gains/dividend tax. If the difference is, say, 40% for labor income vs. 0% for capital, then the incentive for avoidance becomes much higher.

    I’m not sure how a 401k solves the issue. In the case of zero capital gains tax, why would somebody volunteer to invest in a 401k, where the gains are taxed as income? I presume people would still have a right to invest their own post-tax money in capital, aside from 401k and possibly in capital they get labor income from indirectly.

  81. Gravatar of Potpourri – The Liberty Herald Potpourri - The Liberty Herald
    12. March 2015 at 00:20

    […] Scott’s treatment of taxation would totally screw you up.) He presented a cleaned-up version here, which I will critique formally elsewhere. For now, let me just bring to your attention an […]

  82. Gravatar of ssumner ssumner
    12. March 2015 at 07:15

    dtoh, You are still missing my point. You haven’t even defined what consumption is. Suppose I eat lunch at work, is that consumption? Does it depend on whether I pay for it or my company pays for it?

    And the tax rates would have to be far higher than you contemplate, unless you plan to keep the payroll tax.

    Prakash, I like a land tax because the supply of land is inelastic.

    I don’t follow your comment about classical liberal conceptions. Why would their conceptions matter?

    Also recall that wealth is the present value of future consumption.

    Matt, They’d invest in 401ks because the contributions are deductible. It’s like the difference between Roth IRAs and 401ks, Some prefer one and some prefer the other. I like the 401k because my tax rate will be lower when I retire.

  83. Gravatar of Cory Hoffman Cory Hoffman
    12. March 2015 at 10:39

    Professor Sumner,

    The very best type of blogging IMHO.

    But I am sympathetic to this point made by Adam:

    “Number 2 is going to create a significant appearance of unfairness to a lot of people, and to the extent that it’s the result of friendly rules, means that some class of well-compensated people will not have their consumption reduced at all. Those with inherited wealth can argue all they want that their consumption was reduced when the wealth was taxed as wages, but that’s going to be a tough sell too, and requires assumptions about how the wealth came to be.”

    You replied writing this:

    “Adam, Fees for investment advice are clearly labor income. I have no problem with the idea that people who don’t consume a lot shouldn’t pay a lot of taxes. That seems very fair to me. The big consumers ought to pay. It’s not what you put into society, it’s what you take out.”

    It seems you focused on the investment fee aspect of his post as opposed to his concern that the conspicuous consumption by rich heirs with low marginal utility could escape taxation since all of their income is derived from capital income.

    What I think Adam was suggesting is that there would indeed be folks with solely capital income who consume quite a lot without it being taxed (or sufficiently progressively taxed in a VAT scheme).

    It seems like we would have very wealthy heirs with lots of capital income only being “big consumers” who “take a lot out” but escape taxation.

    So I pose the following question:

    Given that the most efficient tax regime for aggregate utility is to leave investment income like interest, dividends and capital gains free from taxation and the fundamental characteristic of a consumption tax is that it reaches labor income only, how might we reach the conspicuous, luxury consumption of, say, a rich heir who has no labor income and solely relies on investment income like interest and dividends to finance this luxurious consumption when this is the very type of consumption that has the lowest marginal utility?

    I don’t see how this person’s conspicuous consumption with low marginal utility is adequately reached if capital income accrues to the non-laboring heir tax free.

    ________________________________________________

    Nevermind, I think you covered this with your proposal for a 401(k) like structure writing this:

    “Then the big fish like Gates (who have massive capital income) could be treated differently, with the IRS taking a close look. All of their income would go into a 401k-like structure,”

    So let me see if I have this right:

    Rich consumption-loving heir does not labor but earns interest and dividends from a trust passed on by parents. He uses this income solely for conspicuous consumption and posts pictures of his yachts, mansions, escorts, fine food, clothing, parties, drugs etc. on Instagram to put his luxurious lifestyle on display for the proles.

    Rather than this investment income accruing directly to the heir at 0% rates, it would accrue directly to a 401(k) type vehicle at 0% rates. If and when the heir uses it for consumption purposes and withdraws from this vehicle to use the funds for conspicuous consumption, that is when the high marginal rates on consumption would be imposed? If instead consumption-loving heir changed his ways and began using the funds in the 401(k) vehicle to build orphanages, invest in technology, etc. it would escape taxation.

    If this is right, I think this is a brilliant idea and is a clever way to avoid the potential problem.

  84. Gravatar of dtoh dtoh
    12. March 2015 at 11:34

    Scott, you said,
    “You are still missing my point. You haven’t even defined what consumption is. Suppose I eat lunch at work, is that consumption? Does it depend on whether I pay for it or my company pays for it?”

    Scott, there are already a well defined set of rules in place for what constitutes a legitimate business expense versus compensation/consumption for the employer. Why reinvent the wheel. You can certainly tweak the rules, but the amounts involved are a rounding error in the grand scheme of things.

    “And the tax rates would have to be far higher than you contemplate, unless you plan to keep the payroll tax.”

    Why are my numbers wrong?

  85. Gravatar of dtoh dtoh
    12. March 2015 at 11:38

    Prakash, you said,
    “I also think that a consumption tax system (or even an asset taxation system) which does not tax money leaving the country will inevitably be beset with issues of people choosing to consume outside the country in lower tax jurisdictions, whether it be by retiring at 55 in spain like the other commentor said, or via annual vacations where people really blow their lid off.”

    Simply tax overseas remittances (including credit card payments) and cash carried out of the country. There are already very good systems in place for monitoring and reporting this.

  86. Gravatar of dtoh dtoh
    12. March 2015 at 11:43

    Matt, you said,
    “The employee could work for the company for a much lower wage, say $0.1X. Then the employee happens to pay themselves out a dividend.”

    Which is exactly why an actual tax on personal consumption in the form of a national sales with no taxes on income (labor, capital or corporate) is better than the kludge solutions which Scott is proposing.

  87. Gravatar of dtoh dtoh
    12. March 2015 at 12:00

    Cory, you said,

    “A person who has only capital income (whether via friendly definitions regarding the “fees” they charge for their investment advise or inherited wealth or whatever) pays no taxes. ….It seems like we would have very wealthy heirs with lots of capital income only being “big consumers” who “take a lot out” but escape taxation.”

    Adam, you said,
    “A person who has only capital income (whether via friendly definitions regarding the “fees” they charge for their investment advise or inherited wealth or whatever) pays no taxes.”

    Which is exactly why an actual tax on personal consumption in the form of a national sales combined with a fixed assets tax with no taxes on income (labor, capital or corporate) is better than the kludge solutions which Scott is proposing.

  88. Gravatar of dtoh dtoh
    12. March 2015 at 12:05

    @JV Dubois

    “Matt Waters: the capital/labor distinction is really hard to make. Take for instance David Beckham. If he goes and makes money doing advertisement for some product that should be labor income. But if he creates let’s say perfume company where he is 100% owner, and makes the same advertisement but collects payment as dividends then it is suddenly capital income.”

    Exactly the point I made in an early post. The distinction between human capital, labor and other forms of capital is arbitrary, illogical and would lead to huge distortions if you tax only wages. What is the difference between investing in a law degree versus investing in a laundromat.

    Which is exactly why an actual tax on personal consumption in the form of a national sales combined with a fixed assets tax with no taxes on income (labor, capital or corporate) is better than the kludge solutions which Scott is proposing.

  89. Gravatar of dtoh dtoh
    12. March 2015 at 12:08

    Scott,
    One other thing. Assuming that the distinction between a business expense and personal consumption is actually a significant problem (which it is not), how does your proposal (which has differential rates of taxation on wages and corporate income) solve the problem?

  90. Gravatar of dtoh dtoh
    12. March 2015 at 12:15

    Implementing a direct progressive consumption tax is so mind boggling simple and solves every objection that has been raised in this post and the comments. Why does it feel like everyone on this blog has become collectively moronic. Sorry but it is incredibly frustrating to see everyone overlooking the obvious solution.

  91. Gravatar of Vivian Darkbloom Vivian Darkbloom
    12. March 2015 at 12:58

    “”The employee could work for the company for a much lower wage, say $0.1X. Then the employee happens to pay themselves out a dividend.”

    I know Matt preceded that by saying that it was an “absurd” example, but people seem to keep forgetting that there is no integration between corporate level and shareholder level tax. Lee/Rubio’s main objective was to alleviate that by 1) eliminating shareholder level tax and 2) equalizing corporate/Individual tax rates at 25 percent (marginal).

    Thus, Matt’s example has two problems. First, we have personal holding company rules (and other rules) that would prevent that play. See sections 542 and 543. Second, under current law, the scheme would actually cost additional tax when one adds up corporate and shareholder level tax. Post Lee/Rubio the scheme would not save any tax–the corporate level tax would be the same as the tax on direct compensation so there would be little reason to do it. Existing rules encourage some arbitrage given the lack of integration and the disparity of overall rates. If you eliminate the overall rate disparity, these tax plays make no sense. This is important: eliminating dual corporate/shareholder taxes and equalising the rates (at 25 percent) is at the heart of the Lee/Rubio plan, not some theoretical concerns about whether we label it a “consumption tax” or “income tax” or “capital gains tax” system.

    With that in mind, Scott’s “improvement” to the Lee/Rubio plan to make it more progressive by increasing the individual rate to 50 percent creates rate disparity and encourages the very sort of rate disparity arbitrage that Lee/Rubio plan was designed to eliminate. The historical switches from favoring the corporate form to favoring non-corporate forms of business (e.g., partnerships, LLC’s) has everything to do with the changes in the individual tax rates.

    I’d like to come back to the example of Bill Gates. Again, what is often overlooked is the effect that the lack of integration has on the overall tax burden. The idea that Bill Gates is “avoiding” tax by “converting” compensation to capital gain or dividend income is too simple. If we assume for simplicity that the individual rate is 40 percent and the cap gains rate and dividend rate is 15, the prevailing idea seems to be that Gates is reducing his tax bill by 25 percent and the Treasury is out that amount. But, it’s more complicated than that. If Gates gets comp from Microsoft, the company gets to take that as a deduction, reducing its tax by 35 percent on the dollar. If it instead pays a dividend or Gates gets a capital gain, the corporation gets no deduction. In a non-integrated system, this is the trade-off even with rate differences. (More accurately, the complaint would likely be that Gates should have been taxed on his goodwill or intellectual property when he contributed that to Microsoft (this is tax-free under section 351). But, when a tax-free contribution is made to the corporation, there is carryover basis (zero, here). The corporation thus gets no amortisation deduction. Again, it’s a trade-off which is not necessarily an outright advantage.

    In both cases, the Treasury is not really being robbed, at least not to the extent people commonly think when they just look at the oversimplified case. But, if the other shareholders bear part of the additional corporate tax burden, is Gates advantage their loss? Given that shareholders know all this when the price is set for their stock, maybe not. The same might be said of any dilution argument.

    This sort of corporate/individual tradeoff is also present in stock option compensation.

    Much has been written about the alleged “conversion” of hedge and equity fund managers fees to capital gains. Again, this is misleading for much the same reasons. In those partnerships, there is no “manufacture” of capital gains. The general partners enter into an arm’s length agreement with the other limited partners (called a partnership agreement). The latter cede part of the capital gains (by agreeing the capital gains allocation will not be completely pro rata to capital contributed) to the general partner. Obviously, they don’t do this for nothing–they do it in return for lower fees than they would otherwise pay. If the general partner had gotten compensation, the general partners would have been taxed at ordinary rates, but the other partners would have enjoyed a deduction for same. So, why would the limited partners do this if they are subject to the same tax rates? It is because either the limited partner is a corporation for which the rate is 35 percent or, as in the majority of those deals, the limited partners are tax exempt, such as the Harvard, Princeton, Yale Endowment Funds or Calpers, to name a few, don’t care about deductions or capital gains. The arbitrage here is again about tax rate disparity between corporate taxpayers and individual taxpayers and between taxable and non-taxable partners. It has nothing to do with consumption tax theory. The common perception is that the hedge fund managers are engaged in some black box magic, but in reality, they are often engaged in tax rate arbitrage with many not-for-profit and otherwise tax-exempt investors. The hedge and equity fund managers are portrayed as evil, while their tax exempt partners who willingly participate in the arbitrage are given awards for their charitable contributions to society.

    Again, these are very real and practical issues that have nothing to do with consumption tax theory.

    dtoh’s solution of relying exclusively on a VAT would work to eliminate arbitrage, but, short of that, the key is to integrate the corporate/shareholder tax and equalize corporate and individual tax rates.

  92. Gravatar of dtoh dtoh
    12. March 2015 at 13:20

    Vivian,
    Not to mention the complications of 338 elections and the fact that “active” investors in pass-throughs are exempt from ACA taxation.

    The whole system is a total mess.

  93. Gravatar of Vivian Darkbloom Vivian Darkbloom
    12. March 2015 at 13:58

    The 25 percent rate referred to above is for business income for corporations and individuals (including pass-thus).

  94. Gravatar of Vivian Darkbloom Vivian Darkbloom
    13. March 2015 at 05:02

    Yes, dtoh, the section 338(h)(10) election is a very good example of the types of tradeoffs mentioned above. One taxpayer gets a benefit (basis step-up on assets) at the expense of the other. It’s not a zero sum game (otherwise, why make the joint election?) but it is very far from a “full sum” (fulsome?) game. Political rhetoric focuses on the tax benefits that are supposedly inappropriate, but never the costs of those tradeoffs that are usually present. The ISO is another example where the corporation loses a deduction because the optionee gets capital gain treatment. The 338(h)(10) election is not available for foreign targets (unless owned by a US group). The 338(g) election is, however, and is almost always made by US persons acquiring foreign targets. That is because the foreign sellers are not subject to US tax. I had not thought of this before, but it is to a great extent analogous to the situation between hedge and equity fund general managers in their deals with tax exempt partners in those notorious “carried interest” deals because US tax classifications and attributes are meaningless (except for UBIT for non-profits) if you are exempt from US tax. I have yet to hear anyone call the 338(g) election an unwarranted tax benefit or a “loophole”.

    I wouldn’t necessarily say the tax code is “messy” simply because of it its very intricate structure–it is actually a marvel of organization; but, I’d be the first to admit that the playing field is littered with dead moles.

    In thinking about the VAT issue further, if we were to move solely to a VAT system for revenue and eliminate the corporate income tax as well, this would be a huge advantage for foreign investors and an issue for import and export neutrality. You simply can’t make such a change unilaterally and not without amending all the outstanding tax and trade treaties. That’s why I don’t think it has been done or ever will be done in a modern developed economy. We are most likely going to have to live with most of taxes we now have. I think the road inevitably leads to adding a federal VAT, not using it exclusively. I would hope they would eliminate sales tax in the process and enter into revenue sharing agreements with the states or the states would simply piggyback. Lee/Rubio very likely does not raise nearly enough revenue, but with a VAT added on, they could equalize all the business rates as suggested (corporate, pass-thru and individual) and the non-business rate, too and achieve the desired integration by eliminating tax on dividends and capital gains for US investors, as they suggest.

  95. Gravatar of ssumner ssumner
    13. March 2015 at 05:07

    Cory, Of course the perception that the rich would not pay tax under a consumption tax is wrong, but I agree with your point that the perception would be out there. And yes, even though the Roth IRA and 401k approach are comparable, to the average person who is ignorant of tax theory the 401k approach looks more “fair.”

    dtoh, On the “what is consumption” question, I was replying to your criticism, and the criticism of others.

    You asked:

    “Why are my numbers wrong?”

    I don’t know how much you are trying to raise. Are you trying to replace all taxes?

    You asked:

    “Why does it feel like everyone on this blog has become collectively moronic.”

    That’s how I felt about monetary policy in 2008? :)

    Vivian, I don’t follow that. Under Rubio/Lee the top individual tax rate is 35%, not 25%, so there is the same incentive to move income around.

  96. Gravatar of Vivian Darkbloom Vivian Darkbloom
    13. March 2015 at 05:56

    Scott,

    (Reposting here at the right place)

    The Lee/Rubio proposal contains two individual rates, as I explained above. One is for “business income” and one is for “non-business income”. A major issue with that proposal would be how to distinguish the two. However, the examples referred to related to business income which is 25 percent for both entities and individuals (including pass-throughs). A general partner in a limited partner is considered to engage in a trade or business. In fact, it is because the general partner is considered to engage in a trade or business that the limited partners are as well by attribution in all but the most passive types of activities. While Matt referred to “employees”, the example he gave would likely 1) be prohibited under FPHC rules or, if not, would likely be considered self-employment income (business). True, there remains limited arbitrage under the Lee/Rubio proposal for translating non-business income to business income (10 percent rate differential)-see my last comment. Your proposal to raise the individual rate would make matters worse. Unlike Lee/Rubio, you did not specify that the 50 percent would only apply to non-business income earned by non-entities. Even if you meant it to apply only to non-business income, the rate differential between 10 percent and 25 percent is certainly not an improvement with respect to those seeking to arbitrage between the business and non-business rate, because the greater differential creates greater incentive.

  97. Gravatar of dtoh dtoh
    13. March 2015 at 06:50

    Scott,
    Like I said, federal tax revenues are $3 trillion, PCE is $12 trillion. That works out to a 25% average tax rate.

  98. Gravatar of dtoh dtoh
    13. March 2015 at 07:09

    Vivian,
    Not sure why eliminating corporate taxes would be an advantage to foreign investors?

  99. Gravatar of dtoh dtoh
    13. March 2015 at 07:12

    Scott,
    Do you have any objection to a direct tax on consumption other than your concern that it won’t raise enough revenue?

  100. Gravatar of Vivian Darkbloom Vivian Darkbloom
    13. March 2015 at 07:34

    dtoh,

    Briefly, if you would eliminate the corporate income tax and rely solely on VAT, foreign investors would, in effect, have zero tax on US corporate and non-corporate investments. (Maybe they would have foreign tax, but that would be subject to the rules of the non-US jurisdiction and would do nothing for the US fish). I suppose that the rules could be adjusted so that foreign investors are subject to tax on dividends, unlike US investors a la Lee/Rubio, but current US treaties typically set the rate at 15 percent and “branch profits tax” (dividend equivalent amounts deemed distributed by branches) is typically set as zero. Non-US investors are not subject to US capital gains tax on sale of US corporate stock, except for FIRPTA (US real estate companies). So, the easy get-around would be to invest in non-dividend distributing companies. Say, investing in Berkshire A rather than B (very possibly that’s one of the reasons Buffett set it up that way). Perhaps there would be some way to avoid all that, but it would be challenging, I think. That’s all I got for now–gotta run.

  101. Gravatar of Jim Glass Jim Glass
    13. March 2015 at 10:08

    @ dtoh

    “Implementing a direct progressive consumption tax is so mind boggling simple…

    ~ um, cough ~

    …and solves every objection that has been raised in this post and the comments. Why does it feel like everyone on this blog has become collectively moronic. Sorry but it is incredibly frustrating to see everyone overlooking the obvious solution.

    Whenever I feel the whole world has become moronically blind to something mind boggling obvious, I remind myself that Occam’s Razor suggests it is not the whole world missing something, and double check.

    to put the numbers in perspective. Federal tax revenue is $3 trillion. Personal consumption is $12 trillion. So you need an average consumption tax rate of $25%. With a $5k per person exemption, you would need a tax rate on remaining consumption of 29% or 33%…

    Why are my numbers wrong?…

    They don’t add up to anywhere near what you want to do. Arithmetic & reality.

    You want to collect about 18% of GDP thru your federal VAT. OK, first remember…

    Every tax imposes a deadweight cost that rises the square of the increase in the rate, and causes the tax to collapse after it rises past a maximum possible rate. As you approach that rate, collections diminish per point of tax, legal loopholes and tax shelters rapidly multiply driven by the accelerating political and economic returns of providing them, illegal tax avoidance rapidly multiplies undercutting the entire system, etc … you *don’t* just collect more tax proportionately by increasing the rate, collections fall per additional point of tax. This is as true with a VAT as with any other kind of tax.

    E.g., sales tax systems fail at about the 10% level. VATs are more efficient, but they still top out in the low 20s%, the all-time tops have been around 25%-27% and have been very hard to maintain even with *lots* of lower-rate exceptions and tax exemptions cushioning them and lowering the actual average rate. So, you just aren’t going to have a 33% VAT rate on anything, much less on everything!

    VATs worldwide in actual practice collect only single-digit percent of GDP revenue. In 2008 — the last “normal” economic year before the EU financial crises — the average OECD VAT Rate was 19.5% and collected 6.8% of GDP. That’s 1 point of GDP per 2.9 points of tax.

    The countries with the very top ~25% rates collected about 10% of GDP.

    If you could put in and sustain a 33% rate, which you can’t, and you straight-lined your projections of collections up from there, unrealistically ignoring the diminishing returns, in theory you might expect to collect around 12% of GDP — a third short of your goal.

    But now you must account for the fact that in the USA the states got there first, they use sales tax as a primary source of revenue. So you are going to have to unify state sales taxes into the VAT.

    After the states collect their 5% of GDP, your theoretical 33% VAT is theoretically producing 7% of GDP in revenue for the Feds, short of your goal by 11% of GDP. Try again!

    If you don’t understand why VATs produce so little of GDP in tax revenue per rate point, and really imagine that by taking a national account number for “consumption” and applying an arbitrarily high tax rate to the whole amount you can actually collect that much revenue, it’s “mind boggling simple” … well, all I can say is that the less one is familiar with an extremely complex subject, the simpler it can appear.

    The Gerogist land taxers do this all the time: “All our problems would be over, it’s so obvious and simple!” I’ll just repeat here what I tell them: Politicians everywhere through all history have had mighty incentives to try every possible tax scheme in every variation to get a competitive advantage on the other guys. Success is rapidly copied. Anything you can think of they’ve thought of 1,000+ times before you. If your idea really is *so* obvious and simple and great, why aren’t they using it already? If you don’t work through that question to get a clear answer that you then address and deal with, the whole world of them isn’t missing something, you are.

  102. Gravatar of dtoh dtoh
    13. March 2015 at 17:24

    @Jim Glass

    The tax system which I have suggested (a national sales on all goods and services exempting purchases by businesses and providing consumers with a tax “credit card” exempting the first $5 or $10k of annual purchases) shifts the tax burden to goods and consumers with lower elasticities of demand and hugely reduces the DWL compared to all existing VAT/Sales tax regimes. In addition, high retail concentration, tight border controls and detailed reporting of overseas remittances that exist in the U.S. all substantially mitigate the opportunity for tax evasion.

    If we buy your argument that “it’s not currently done, therefore it must be a bad idea” then we would all still be living in caves.

  103. Gravatar of Jim Glass Jim Glass
    13. March 2015 at 22:48

    @ dtoh

    …shifts the tax burden to goods and consumers with lower elasticities of demand and hugely reduces the DWL compared to all existing VAT/Sales tax regimes…

    Hmmm… to be at all convincing about that you’ll have to give some more detail about exactly how, while taxing ALL consumption, you manage to shift the tax to only those particular consumers with such lower elasticities so as to somehow produce far less deadweight loss cost than any other consumption tax regime in the world while collecting far more tax. Those words don’t add up right on their face.

    Look…

    The OECD reports an average VAT tax avoidance rate of 18%, increasing at the margin rapidly as the tax rate rises – and none of them tax at a rate anywhere near as high as you intend to.

    If you really know how to eliminate that in some “mind boggling simple” way that hasn’t occurred to any of them, they will be very appreciative! Big cash awards await you in consulting fees, at the least.

    The OECD also says average policy exemptions (lower rates and exemptions for specific items) equal 36% of collections compared to if the top rate was applied to everything. That’s official recognition of DWL, and that different items have very different elasticities so one just can’t apply the same highest rate to everything — and then of course there are all the political factors to consider…

    If you have such a simple way they haven’t thought of to eliminate that 36% as well, they will be *really* appreciative.

    If we buy your argument that “it’s not currently done, therefore it must be a bad idea” then we would all still be living in caves.

    Hey, where did those quote marks come from, being I never said any such thing? Tut, tut! Tsk!!

    What I said was: When 1,000 people have had your idea before you and none of them have actually used it, you have to ask yourself why?.

    The VAT has been adopted over and over around the world, with easily 1,000+ top expert tax designers seeking ways to minimize avoidance and maximize its reach, learning from each others’ efforts as they went along. Yet none of them have used your “mind boggling simple” yet far superior approach. Why?

    If you don’t know why then you’ve got nothing, you’re just diddling us.

    If do you figure out why and go “oh, yeah, that’s a problem”, you learn something and move on the wiser for it.

    If you figure out why, what the problem is, and a solution to it too, then you become rich and famous, go to Sweden to collect a prize and have dinner with the King, and tell celebrity interviewers how you used to slum in Sumner’s blog comments for fun.

    It happens, occasionally. I’m rooting for you!

    So *why* have none of the VAT systems of the world ever used your “mind bogglingly simple” concept?

  104. Gravatar of dtoh dtoh
    14. March 2015 at 01:40

    @Jim Glass

    There are several problems with existing VAT systems.

    1. In order to meet political demands for more progressivity, most systems exempt or have lower rates for the very goods (e.g. food and residential rent) that have the highest inelasticity of demand.

    2. Despite the exemptions and lower rates, the tax burden still falls relatively heavily on lower income consumers for whom inelasticity of demand is highest.

    3. In order to reduce the incentive for consumers to buy goods in lower tax jurisdictions, most countries have implemented a much more complicated VAT (because of the lower incremental tax rates on the final sale) rather than a retail sales tax even though they are functionally equivalent.

    4. VAT systems give rise to a particular form of fraud, which allows exporters to obtain VAT refunds while traders lower in the value chain abscond with the VAT “paid” by the exporter.

    Because of its relatively tight borders and monitoring of cash/assets transferred or held out of the country, it is much more feasible to implement a retail sales tax in the U.S. without jurisdiction shopping by consumers. This would eliminate much if not most of the fraud/avoidance problems that plague a VAT system.

    By adopting a system where each individual gets a “tax credit card”, which exempts them from the sales tax on the first $10k of annual purchases, you can achieve a high level of progressivity and at the same time have a “complete” consumption tax that does not exempt or offer lower rates on goods with high inelasticity of demand.

    By making the consumption tax truly progressive through a uniform exemption applied to the consumer (rather than to specific goods and services), you can shift the tax burden and impose higher tax rates on richer consumers for whom demand is less elastic.

    Finally if rates are sill too high the government could continue to fund social insurance programs through a wage tax. This would reduce the amount of required revenue and tax rates by a third (e.g. 33% to 22%).

    As to why the system has not been adopted, that’s a question that probably gets asked of every new good idea, but I suspect the reason is that tax architects are primarily interested in raising more revenue rather than in achieving greater utility and/or equality.

  105. Gravatar of ssumner ssumner
    14. March 2015 at 06:06

    dtoh, I don’t think you’ve adequately responded to Jim Glass’s data. You also criticized my plan for taxing education but not physical capital investment, but your plan contemplates taxing education.

    And what about those portions of consumption not purchased, such as implicit rent on owner occupied housing?

    The 2.9% ratio he provided does sometimes exclude items like food (not always) but even with everything included the ratio is surprisingly high. And that figure does NOT contemplate a $10,000 exemption per person, which would massively reduce revenues.

    And finally, the proposal would be viewed as far too regressive and have no chance of passing. I would actually support your plan if you convinced Congress to reduce spending to Singapore levels, or if you combined it with a progressive payroll tax.

    Also your percentages are for price inclusive of tax, thus a 33% tax would be like a 50% retail sales tax.

    Jim’s right, 7% of GDP is about what you’d expect, even without the exclusions making it progressive. With those exclusions it would be much less.

  106. Gravatar of dtoh dtoh
    14. March 2015 at 14:45

    Scott,

    Let’s look at the numbers.

    – US Federal Tax Revenues $3 trillion
    – Less Social Insurance Premiums $1 trillion (assume this will continue to be funded with a payroll tax)
    – Federal Revenues net of Social Insurance $2 trillion

    – US PCE $12 trillion
    – Less exemption $3 trillion ($10k per person)
    – PCE after exemption $9 trillion

    So you need an average 22% tax rate with a $10k exemption (19% with a $5k exemption which BTW is less than the EU average VAT rate of 19.5%).

    1. You said, “Also your percentages are for price inclusive of tax, thus a 33% tax would be like a 50% retail sales tax.”

    No it’s percentage of the pre-tax price. As a percentage of price inclusive of tax it would be 18% (15% with a $5k exemption.)

    2. You said, “The 2.9 ratio he provided does sometimes exclude items like food (not always) but even with everything included the ratio is surprisingly high.”

    Per Jim’s figure, exemptions and lower rates “equal 36% of collections compared to if the top rate was applied to everything.” Eliminating the exemptions and lower rates drops the ratio from 2.9 to 1.9.

    3. Jim further says, “The OECD reports an average VAT tax avoidance rate of 18%.” This is an overall rate. Countries like the UK with better enforcement report avoidance rates of 14%. Half of this is from “carousel” frauds specific to VAT systems that I described in my previous comment. Eliminating the VAT specific frauds reduces avoidance to 7% and further drops the ratio to 1.8

    4. PCE as a percentage of GDP is significantly lower in the EU than in US. 56% in France and Germany versus 68% in the US. Adjusting for higher PCE in the U.S. the ratio further drops to 1.5.

    5. Adding back in the $10k exemption, the ratio goes back up to 2.25 (or 1.8 with a $5k exemption)

    So summarizing… to achieve $2 trillion revenue (11% of GDP), you would need a 25% tax rate (or 20% with a $5k exemption), which is consistent with the numbers above after taking into account avoidance and fraud.

    With respect to the “implicit rent on owner occupied housing,” I have already stated that this could be captured with a fixed assets tax on any assets (houses, land, cars, jets) that are used for non-business purposes.

    Your point on education is well taken, but as you have said, government subsidies for education mitigates the distortion of a consumption tax on education.

    As for progessivity, I think you are wrong. In fact, I think the real objection to a progressive consumption tax would come from the trustafarians who would face higher overall taxes and from the lawyers and accountants who would need to find alternative “productive” employment. Regardless however, it would certainly be possible to make the system more progressive with additional rate level(s) for annual consumption in excess of a certain amount(s) which would be easy to implement with the “tax credit card” system, which I have suggested.

  107. Gravatar of ThomasH ThomasH
    14. March 2015 at 14:50

    “From now on liberal commenters must tell me why so many brilliant liberal economists have favored replacing income taxes with progressive consumption taxes, and what’s wrong with this argument.”

    Nothing wrong with that argument.

    There may be a lot wrong with replacing the present horribly sub-optimal tax on individual and (even worse) business income with the Rubio-Lee sort of consumption tax. Your mileage may differ, but my guess is that both the intent and likely effect of Rubio-Lee would be to collect less in taxes from presently high-consumption individuals as a group and more taxes from low-consumption individuals.

    I suspect that the “tweaks” necessary to make Rubio-Lee as progressive (in consumption terms) and raise a much revenue as the individual-business income tax would lead Rubio. Lee, and every other Republican/”conservative” to drop consumption taxation like pitcher of molten lava. Whether it would be smart politics in 2015 for Democrats/”liberals” to propose such “tweaks” in not a question that economists have any professional expertise in.

  108. Gravatar of dtoh dtoh
    16. March 2015 at 02:18

    Scott,
    Comments?

  109. Gravatar of ssumner ssumner
    16. March 2015 at 06:41

    dtoh, Doesn’t the addition of VAT result in a larger GDP, in nominal terms? I.e. GDP is inclusive of VAT.

    Unfortunately I don’t have time to research the details of your plan. As I said before I’d support it if you can sell the idea to the public, but I worry it won’t be viewed as sufficiently progressive (unfortunately.)

    Thomas, Unfortunately you might be right.

  110. Gravatar of dtoh dtoh
    16. March 2015 at 07:08

    Scott,
    I can’t imagine VAT gets double counted as both government spending and consumption.

    Regarding progressivity – Again just add a higher bracket e.g. 35% consumption tax for annual consumption in excess of of $100k or $200k

    I personally wouldn’t have a problem with an additional wage tax. Business owners could legitimately shift their income from wages to dividends. And it would claw back money from all those people who earn high wages through government funding, labor restrictions and other governmental goodies…. bankers, lawyers, doctors, actors, athletes, and… college economics professors.

    That said, I think you can raise sufficient revenue and achieve a high level of progressivity from consumption taxes alone.

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