Rubio-Lee is great, so why not make it even greater?

If the tax reform proposal of Rubio and Lee were to pass it would easily be the best thing the Federal government has done since the civil rights laws of the 1960s.  And yet we see the usual suspects like Jonathan Chait trashing the bill.  Instead Chait should have said that with one tweak the bill would be awesome, and Dems like Elizabeth Warren should be racing to support the general idea.  I’ll get to the minor tweak in a moment, but first some of the good things it does:

1.  Ends the marriage penalty.

2.  Ends the taxation of capital income.

3.  The corporate tax becomes based on income earned in the US, (which is the approach used by most other countries.)  The rate would be similar to European tax rates.  Interest would no longer be expensed.  (Recall that interest income is no longer taxed (point #2), so it balances out.)

4.  Capital investments are expensed, no depreciation schedules.

5.  Ends most itemized deductions.

6.  AMT eliminated.

I haven’t been this excited since I was single!

Is it perfect?  No, there’d still be deductions for health insurance and mortgage interest and charitable deductions. However their statement says those issues also need to be addressed.  They should also treat everyone as single, to end the marriage bonus.

Under Rubio/Lee, someone like me with no mortgage would have the following 1040:

Wage income minus charitable contributions = taxable income.

That’s it.

The tax code would no longer hammer savers and married people.  It basically turns the income tax into a progressive consumption tax.  Isn’t a progressive consumption tax what liberals have been calling for?

Now for the supposed flaws.

1.  It’s not progressive enough.

2.  It doesn’t raise enough revenue.

There’s a very simple fix for both problems—add a third bracket!  The proposal calls for a 15% rate up to $75,000, and 35% above that level (or above $150,000 for couples.)  Simple solution—add a 50% rate for income above $250,000 (or $500,000 for married people.)

A note on progressivity:

Liberal arguments on the progressivity of various tax changes are basically worthless. Ignore everything you read, as they are using “income” as the benchmark of economic well-being.  Thus suppose I earn $100,000 a year for 20 years, and then sell my house for a capital gain of $500,000.  (I live in a two family, so I must pay taxes on the gain.) Liberals would have you believe I am suddenly “rich” in the year of the sale, with an income of $600,000.  That’s nonsense for two reasons.  The actual gain occurred gradually over 20 years.  And adding wage and capital income is as nonsensical as adding blueberries and apples, and calling it the number of “fruit.”  Taxes on capital income are double taxing the same earnings.

Conservatives might complain that a 50% top rate is too high.  The current top rate is 43.4% (don’t believe the liars who claim it’s 39.6%.)  But that is the top rate for an income tax system.  Rubio and Lee are proposing that we switch to a consumption tax system.  Consumption is less than income, especially for the rich, or should I say the “rich.” (How much will I consume the year I finally sell my house?  Not $600,000.)  So the top rate should be higher with any switch to a consumption tax.  Indeed you can argue that people with consumption levels in the $100s of millions per year should face an even higher tax rate.  And don’t tell me they “deserve” the 500 yachts earned through legal barriers to entry like intellectual property laws, there is no such thing as “deserve” in a cold heartless universe composed of nothing but subatomic particles, where most people are born into peasant families in places like Nigeria and Bangladesh.  If conservatives won’t be hardheaded realists, who will be?

Yes, I’d prefer a lower set of tax rates.  I wish our total government spending were 20% of GDP, like the 4 Asian tiger economies, not the 35% to 40% we seem stuck with.  I wish we’d eliminate the tax deductibility of mortgage interest and health insurance, which would allow for lower rates than what I’m proposing.  Ideally the government would simply withhold income taxes, like they do with the payroll tax.   No 1040 forms to fill out.

The other potential flaw in Rubio and Lee is business/self-employed income, and especially preventing tax avoidance.  An alternative way to a progressive consumption tax would be to treat all savings and investment in a 401k-type structure, taxing income only when it is consumed.  That would make it much harder for the hedge fund guys and the self-employed to avoid taxes.

PS.  I have a new post on inequality at Econlog.

HT:  TravisV


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83 Responses to “Rubio-Lee is great, so why not make it even greater?”

  1. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    7. March 2015 at 09:34

    Apropos your Econlog post on inequality, tomorrow is International Women’s Day.

    http://www.wsj.com/articles/antony-davies-and-james-r-harrigan-for-gender-equality-you-cant-beat-capitalism-1425684094

    ‘In its annual Economic Freedom of the World Report, the Fraser Institute, a Canadian free-market think tank, assesses degrees of economic freedom within countries. The United Nations Development Program, in its Human Development Reports, evaluates countries’ degrees of gender equality. Fraser does not consider equality when ranking economies according to economic freedom, and the U.N. does not consider economic freedom when ranking economies according to equality. But when the two reports are combined, a fascinating pattern emerges.’

    Which pattern is, in a nutshell, that in freer countries (whether rich or poor countries) women do better for themselves;

    ‘As compared with men, women in economically freer countries hold more elected seats in government, have longer life expectancies, achieve higher education levels, and earn higher incomes than do women in less economically free countries. In short, in freer economies, women’s lives are longer, more prosperous and more self-directed.’

    Women of the world, unite around Adam Smith, not Marx and Lenin.

  2. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    7. March 2015 at 09:37

    Anyone else find this as amusing as I do;

    http://www.insurancejournal.com/news/national/2015/03/06/359737.htm

    ———quote——–
    Thousands of drones flown without government approval by real estate companies, movie studios and other businesses are getting coverage by insurers writing their own safety rules to fill a void left by regulators.

    One insurance broker in Colorado has already written policies on 2,600 drones, and a San Francisco-based company said it has assembled an Uber-like list of 1,000 trained operators businesses can hire to do the flying for them.

    …. “We’ve been insuring them for going on four years,” said Terry Miller, owner and president of Transport Risk Management Inc., which had to invent safety requirements for its drone clients.

    Purchasing insurance for commercial drones, which isn’t prohibited under FAA rules, doesn’t make flying them legitimate, the agency said.

    Whether drone operators’ actions are legal doesn’t affect Miller’s willingness to write insurance. He said that, while he welcomes more FAA oversight, there’s no point in waiting for the rules to be completed and that the standards his company sets for insurance policies often exceed what the government has proposed.
    ———–endquote———–

  3. Gravatar of Miami Vice Miami Vice
    7. March 2015 at 10:48

    How is taxing capital income double taxing the same earnings?

    Or, are you saying earning $10 is different from earning $10? (Curiously the same units; is a dollar not a dollar?)

    How exactly have you differentiated income and capital income, leading you to emote this perceived double taxation?

  4. Gravatar of Libertarian Conservative Libertarian Conservative
    7. March 2015 at 10:55

    Scott, wouldn’t a rate of ~50% strongly discourage labor, especially in states such as California with very high top MTRs, resulting in significantly lower growth and in the long-run lower revenue? Also I’m a bit disappointed that the 35% rate applies to a very low threshold, but overall I agree it is a good plan since it eliminates capital taxation (although I’d love to see the corporate tax eliminated, too.)

  5. Gravatar of Scott H. Scott H.
    7. March 2015 at 11:01

    Hmmm… technically capital income is taxed, but only once, and only upon realization of the sale (unless the proceeds are reinvested).

    I would relabel this treatment as: Single taxation of capital gains. First, it’s the truth. Second, it is less likely to be dismissed immediately by likely opponents.

  6. Gravatar of Miami Vice Miami Vice
    7. March 2015 at 11:04

    You’ve only made the case the gain should be spread over the holding period and taxed at the coincidental marginal tax rate. What am I misunderstanding about capital income vs wage/salary income? Is it substantially different or simply a philosophical/emotional/political difference?

  7. Gravatar of Libertarian Conservative Libertarian Conservative
    7. March 2015 at 11:10

    @Miami generally capital income is the result of saving/investing labor income, thus penalizing/discouraging it when compared to consumption. It isn’t just that it’s technically a double taxation – but that increases in the capital stock improve the well being of all of us, being that capital is critically important to economic/wage growth. See this graph (https://danieljmitchell.files.wordpress.com/2012/04/capital-means-higher-income.jpg)

  8. Gravatar of Miami Vice Miami Vice
    7. March 2015 at 11:17

    @scott h

    +1

  9. Gravatar of ssumner ssumner
    7. March 2015 at 11:25

    Patrick, Thanks for the links.

    Miami, As far as I know all experts on tax theory agree that it’s nonsense to combine wage and capital income. Capital income is earned out of investments with after tax dollars. That’s why liberal tax experts favor a progressive consumption tax, with no taxation of capital income.

    The confusion here is that people think in terms of income (a meaningless concept) whereas theory suggests that consumption is what matters. If you tax capital income then you are taxing future consumption at a higher rate than current consumption.

    Perhaps this post would help:

    http://www.themoneyillusion.com/?p=7091

    Libertarian, Those tax rates are really deceiving. Right now my “official” tax rate is probably around 40%, but in fact it’s way above 50%, as I’m a high saver and get double taxed on savings. These new rates would be consumption tax rates, so they can’t be compared to an income tax rate. Yes, it would discourage labor to some degree, which is why I suggested closing loopholes and cutting spending so we could get taxes down to East Asian levels. But it’s a vast improvement over the current system.

    Scott, It says the following:

    “Since the businesses’ income would be taxed at the entity level,
    dividends and capital gains on stock would not be subject to additional tax at the individual level.”

    And since investment is expensed, the corporate income tax becomes a consumption tax, unless I’m mistaken. (Which is very possible.)

  10. Gravatar of Ironman Ironman
    7. March 2015 at 11:26

    Quick clarification for those playing along at home! SSumner writes:

    The current top rate is 43.4% (don’t believe the liars who claim it’s 39.6%.)

    SSumner is correct – here’s how that works. For wage and salary earners, Medicare payroll taxes are levied on every dollar of earned income, which is equal to 2.9% of income (the self-employed pay that full percentage, while that percentage is equally split between employees and employers. Meanwhile, the government considers the employer’s portion of the tax to be part of the employee’s compensation, which is why the combined percentage matters for those who are not self-employed.)

    The Affordable Care Act then levies an additional 0.9% of income on high income earners as the “Additional Medicare Tax”, but that’s a misnomer – none of that additional money goes anywhere near Medicare’s trust funds.

    Together, these Medicare payroll taxes add 3.8% on top of the top ordinary income tax rate of 39.6%, setting the effective top marginal income tax rate in the U.S. to be 43.4%.

    What we just described is how to get to that 43.4% figure for people with just wage and salary income. People with high incomes who earn a significant portion of which through investments have their own special 3.8% net investment tax (also because of the Affordable Care Act), which is also added on top of the topmost 39.6% marginal tax rate for ordinary income, which is how those people are hit with the full 43.4% marginal tax rate.

    And like the “Additional Medicare Tax”, none of that money ever goes into Medicare’s trust funds.

    We’re going to do a post soon that models the personal income side of the Rubio-Lee tax reform proposal. We can confirm however that we were somewhat influential in its shaping – we know from our site traffic that someone from the Senate test-drove it using one of our “Build Your Own Income Tax” tool.

    If you want to test drive SSumner’s plan, in the Progressive Tax Bracket Data table, enter “75000” and “15” on the lowest tax bracket line, “150000” and “35” on the middle “optional” line and “250000” and “50” on the maximum tax bracket line, and set the individual tax credit to 3500. You’ll find out that it “overcollects” with respect to personal income taxes, but that’s okay because you’re replacing other taxes.

  11. Gravatar of Miami Vice Miami Vice
    7. March 2015 at 11:26

    @Libertarian Conservative

    Are you saying that increases in the capital stock are more likely if there’s more saving and less consumption?

    What’s your point besides the obvious one.

    You do understand that investment creates savings, too; and that businesses invest when they’re inundated with demand?

  12. Gravatar of dtoh dtoh
    7. March 2015 at 11:36

    Scott,
    What is the difference between investing in a law degree or a laundromat. Why should the income be taxed differently. Taxing investment in physical capital and human capital differently has no logical basis; and furthermore, it’s trivial to convert wage income into capital income and vice versa. You could never stop that kind of tax avoidance.

    As I have suggested before a progressive consumption tax in the form of a national sales tax with a tax credit card for everyone exempting the first $10k ~ $15k annually in purchases would be much simpler and much more effective.

  13. Gravatar of Tax Lawyer Tax Lawyer
    7. March 2015 at 11:37

    @Miami

    Capital income consists of (1) dividends and interests paid by corporations and (2) gains realized on the sale of appreciated property.

    Taxation of the first kind of capital income is what is normally considered double taxation because the corporation is a legal fiction. Income earned by the corporation is actually earned by the corporation’s owners, i.e., the debt and equity holders with residual claims after all vendors, employees, trade creditors, etc. are paid. Taxing the same income again simply when it’s distributed from the corporation’s bank account to the debtholders’ and shareholders’ bank accounts simply represents a second imposition of tax on the same income generated by the corporation.

    Taxation of the second kind of capital income is also double taxation, but in a different sense: it is taxation of the choice to defer consumption. To understand why, consider Prof. Sumner’s previous example of 2 identical twins who each earn $100,000 labor income and then make different consumption and investment choices: http://www.economist.com/economics/by-invitation/guest-contributions/proper-tax-rate-capital-income-zero

  14. Gravatar of Libertarian Conservative Libertarian Conservative
    7. March 2015 at 11:38

    @Miami Yes, I absolutely am saying that, given that savings are the funds for investment.
    I agree that businesses chase consumer demand, however I also believe in the long-run the economy needs more investment goods to boost consumption (based on Say’s Law.) Furthermore, businesses do not need new consumption before investing, but rather will invest to improve productivity so they can lower prices and undercut competitors – getting new demand that way.

    If your logic was correct, highly redistributive European countries would have higher (or at least similar) GDP Per Capita and growth rates, as the increased consumption would boost the economy and also lead to more investment, further boosting the economy. Yet, the countries with similar or higher GDP Per Capita (PPP) are low tax countries (excluding countries like Norway which has over 20% of its GDP coming from oil) like Singapore, Hong Kong, Switzerland, etc.

  15. Gravatar of Jon Jon
    7. March 2015 at 12:04

    Good step would be change the 1040 so as to omit capital income from AGI. The current structure of the tax forms to maintain the fiction that income includes capital returns is needlessly opaque which leads to strange disputes such as 39.8 vs 44,3.

    Once we can get sane on agi, we can have a seperate capital tax form for interest, dividends, and capital gains and start the debate from there.

  16. Gravatar of LK Beland LK Beland
    7. March 2015 at 12:13

    I generally agree with the idea of a progressive consumption tax. I understand how the 401(k)-type structure makes sense.

    However, I don’t understand why a payroll tax actually is equivalent to a consumption tax. Here’s the way I see it:

    Say that there are scenario A and B. In both scenarios, I make 100k$ in year #1, which is taxed at an average rate of 20%. I get to keep 80k$. I spend 40k$ and save 40k$. I decide not to work in year #2. Thus, I pay no tax in year #2.

    Scenario A)
    I invest it in a stock which price decreases through the year. I end up selling it all at an average 10% loss. I spend all the proceeds from the sale. In total, I spent 40$+36$=76$ and paid 20$ in tax. That’s equivalent to a 26% consumption tax.

    Scenario B) I invest it in a stock which price increases through the year. I end up selling it at an average 10% gain. I spend all the proceeds from the sale. In total, I spent 40$+44$=84$ and paid 20$ in tax. That’s equivalent to a 24% consumption tax.

    In these scenarios, not only did I not tax consumption at the same rate, but I actually taxed the individual that consumed less at a higher rate.

    I am sure that you have thought this kind of scenario through (to be clear, I am not being ironic). What am I missing?

  17. Gravatar of Miami Vice Miami Vice
    7. March 2015 at 12:35

    @ LC
    America’s savings rate is low. I never said anything about wanting higher taxes or redistributing anything. Just that income is income and that investment also creates savings and vice versa. I never said businesses need new consumption before investing or that investing in productivity wasn’t good idea.

    Ever heard of kick starter? Consumption spending transformed into consumption goods.

  18. Gravatar of LK Beland LK Beland
    7. March 2015 at 13:17

    BTW, here is an example of how I see the 401k-like case. Suppose a 20% flat tax on income. In year 1, I earn 100k$ during the year. I save 50k$. I pay 10k$ in taxes. I spend 40k$. In year 2, I decide not to work.

    Scenario A) I invest it in a stock which price decreases through the year. I end up selling it all at an average 10% loss. I spend all the proceeds from the sale. In total, I spent 40k$+36k$=76k$. I paid 10k$+9k$=19k$ in taxes. This is equivalent to a 25% tax rate on consumption.

    Scenario A) I invest it in a stock which price decreases through the year. I end up selling it all at an average 10% gain. I spend all the proceeds from the sale. In total, I spent 40k$+44k$=84k$. I paid 10k$+11k$=21k$ in taxes. This is equivalent to a 25% tax rate on consumption.

    Under the 401k-like scheme, in both scenario, I pay the same tax on my consumption. I don’t see how this is equivalent to a payroll tax.

  19. Gravatar of Major.Freedom Major.Freedom
    7. March 2015 at 14:49

    This blog post is not pragmatic. Here we have to deal with a particular tax reform proposal that is being called great, and instead of making do with what we have, the blog post instead advocates for an idealistic solution that has less of a chance to pass muster.

    It is almost as if an ideologue wrote it. Since it is now OK, apparently, to be an ideologue, then how about this:

    A free market in computers and cars and food and housing is great. So why not make it greater by freeing up money? Of course we see the usual suspects trashing that proposal.

    Would it be perfect? No, there would still be instances of fraud, theft, and deceit.

  20. Gravatar of Morgan Warstler Morgan Warstler
    7. March 2015 at 15:09

    Libertarian Conservative (Scott please tell me if I got this wrong I might have so I’m checking),

    Basically, Scott’s argument is this:

    1. Rich guy earns $10M, he pays 50% of it over $500K, and then never pays taxes on that $5M+ again

    2. When you scream “oh noes! – rich *ssholes are going to earn gains off that capital” – Scott thinks EMH means that in the long run, the avg rich guy won’t do better than staying level with inflation so he make no real gains. he is just deferring consumption. For every lucky duck there is a loser who gets no cake from his lost savings.

    Scott, is this right?

  21. Gravatar of Vivian Darkbloom Vivian Darkbloom
    7. March 2015 at 15:14

    “Thus suppose I earn $100,000 a year for 20 years, and then sell my house for a capital gain of $500,000. (I live in a two family, so I must pay taxes on the gain.) Liberals would have you believe I am suddenly “rich” in the year of the sale, with an income of $600,000.”

    Actually, if you live in a two family and we assume that one-half of the gain is attributed to the rental and the other half to your principal residence, your income in the year of sale would be only $350,000 (up to $500K of gain may be excluded from income on the portion attributable to your principal residence). Liberals could still claim you are rich, but perhaps not as rich as you suggest. Depreciation allowed in prior years reduces your basis in the rental portion of the property and, generally, to the extent the depreciation was in excess of straight line depreciation, any gain attributable to such excess depreciation is treated as a section 1250 ordinary gain (not capital gain). Thus, your gain on the rental portion of the property is likely higher than on the portion you occupy, and part of the gain, depending on prior depreciation methods and the date placed in service, might be ordinary gain.

    We need a lot more details on this Lee/Rubio plan. Literally, if business property were allowed to be expensed, you could take a 100 percent deduction on the cost of that rental portion of that property in the year of purchase and defer any gain until the property is sold. Is that too generous? Sounds like this simple plan could entail a lot of legitimate “tax avoidance”. :-)

    Just say’in.

  22. Gravatar of BC BC
    7. March 2015 at 15:30

    LK Beland, to understand the impact of the tax, you need to compare your consumption in the *tax-free* case with your consumption in the taxed case. The difference is the effective tax rate.

    Scenario A) with no tax, you could consume $50k in year 1 and $45k in year 2 due to the 10% loss. With a payroll tax of 20%, you instead consume $40k in year 1 and $36k in year 2 (since the 20% payroll tax reduces the amount of stock you can buy by 20%). With a 401k-tax, you similarly consume $40k in year 1 and $36k in year 2. In each case, your consumption is reduced in each year by 20%, the effective tax rate.

    Scenario B) tax-free case is that you consume $50k in year 1 and $55k in year 2. With a payroll tax of 20%, you consume $40k in year 1 and $44k in year 2, a decrease of 20% in each year. With a 401k tax, you also consume $40k in year 1 and $44k in year 2, again a decrease of 20% in each year.

    That’s why the 401k and payroll-only taxes are equivalent and why taxing capital “gains” is a double tax. The mistake in your calculation is that you are adding year-1 and year-2 dollars together, and they are not the same. We know they are not the same because we trade one for the other at a (usually) non-zero interest rate. If you want to add them together, you need to add *present values*. Another way to avoid confusion is to replace year-1 with “US” and year-2 with “Canada”. If you consumed $50k USD of your $100k USD wages in the US and traded the remaining $50k USD for CAD, whether it was for $45k CAD or $55k CAD, you wouldn’t add those together (or talk about $5k in “income” or “losses”).

  23. Gravatar of Jon Jon
    7. March 2015 at 15:37

    Morgan, no.. Scott’s clearest summary of his position is “If you tax capital income then you are taxing future consumption at a higher rate than current consumption.”

    You are saying, you think it is because the NPV of asset is the discounted future returns and this equals the sales price. I think Scott’s statement merely requires that the sales price be greater than (or equal) the NPV. So his argument is more relaxed than the EMH. Furthermore, the higher the inflation-rate is the more certain the inequality will go his way.

    Its a utilitarian argument.

  24. Gravatar of benjamin cole benjamin cole
    7. March 2015 at 16:07

    Well, maybe all well and good. But if the proposal still so complicated that intelligent people argue over whether it is a positive or a negative, then I say go to something more simple.

    How about a national sales tax and no income taxes? Perhaps Social Security and Medicare retain their funding through payroll taxes. The rest of the government is financed by a simple national sales tax. And yes, the rest of the government should be cut in half.

  25. Gravatar of LK Béland LK Béland
    7. March 2015 at 16:13

    BC

    In other words, the whole thing depends on discounting assumptions.

    The 401k-like system garantees that you actually pay taxes on what you consumed that year, while the tax-free system doesn’t.

    This has important consequences for government budgets.

  26. Gravatar of Jim S. Jim S.
    7. March 2015 at 16:57

    I suspect there is almost no chance of any major tax reform in the next two years. It appears to me that the only chance for tax reform in the near future would be if the next president is a republican and the senate holds a republican majority. Almost everyone on both the left and the right knows our tax system is mess, but to change it would take a grand bargain that looks imposable in the current climate. So I think your excitement is premature. However, it never hurts to dream
    I don’t share your enthusiasm for consumption taxes, in part because I think that’s what a lot of people are already paying, and in part because I don’t think there is any real shortage of investment money. Given that bottom 40% spend all their income, any form of taxation that falls on them is in effect a consumption tax. A lot of people I know max out their tax deferred saving options (IRA and 401K) and then spend the rest of their income. So one could also think of the taxes those middle income folks are paying is equivalent to a consumption tax.
    So far what I’ve read in your blog hasn’t convinced me that a consumption tax isn’t significantly better than a highly progressive income tax that captures all income (regardless of source), has very few deductions, and indexes capital gains to inflation.

  27. Gravatar of Kevin Erdmann Kevin Erdmann
    7. March 2015 at 17:02

    To nitpick:

    If we were to eliminate half the taxes on capital, I wish it were corporate taxes and not the capital gains part. Even though it is mostly passed through to customers and workers, corporate taxation is the source of a lot of rent seeking, because it creates a potential advantage for individual corporations. Also, eliminating corporate and business taxes is really the only way to eliminate the biggest tax advantage of owning a home verses renting – the lack of taxation on imputed rent.

    It also would mean that, if we are keeping some portion of taxation of capital, at least the version we are keeping is the part that makes it harder to avoid taxes on income by claiming it as capital gains.

    Also, the depreciation thing seems a bit problematic. It seems like this would induce mature firms into suboptimal investments for tax deferment, instead of releasing capital for use by more entrepreneurial firms.

  28. Gravatar of ssumner ssumner
    7. March 2015 at 18:19

    Ironman, Thanks for that info.

    dtoh, As I’ve said before:

    1. I’m not worried about human capital formation, we heavily subsidize education.

    2. No, it’s not easy to convert labor income into capital income, otherwise I’d be doing so.

    3. You plan faces exactly the same tax avoidance issues. Do you tax education? How about company cars? How about the three martini lunch? How about business jets?

    LK, Sorry, can you make that example simpler. I don’t follow it.

    Morgan, No, I’m saying if he invests that $5 million and it turns into $50 million, then he’s paid $50 million in taxes. Because if he hadn’t paid the original $5 million tax, he would have had $10 million invested, which would have turned into $100 million.

    Vivian, Yes, I know that, I was referring to the rental unit portion. I’ve never met an economist who doesn’t think investments should be expensed. Depreciation is so insane it pains me to even think about it.

    Jim, Even if you don’t understand the efficiency argument for a consumption tax, there’s also 2 other arguments:

    1. Basic fairness.

    2. Simplification.

    Doing taxes is one of the worst things I have to deal with every year.

    BTW, terms like “shortage of investment money” are meaningless, or at least don’t mean what you think.

    Kevin, I believe this proposal eliminates all taxes on capital. Someone correct me if that is wrong.

  29. Gravatar of Scott Freelander Scott Freelander
    7. March 2015 at 18:36

    Scott,

    I’m glad you wrote this post, because otherwise I’d probably ignore anything coming from those two brain-dead charlatans. I’ll call my members of Congress and tell them I support this tax plan, with the changes you suggest.

  30. Gravatar of Kevin Erdmann Kevin Erdmann
    7. March 2015 at 18:37

    Scott,

    Isn’t corporate profit a return on capital? From the point of view of the investor, is there any difference between taxing the corporation 50% then not taxing the dividends or not taxing the corporation then taxing the dividends 50%?

  31. Gravatar of Kevin Erdmann Kevin Erdmann
    7. March 2015 at 18:49

    Scott, I’m surprised by your comment on depreciation. Economists are really that united against it? How can that be? Non-cash value and matching revenues and expenses are core financial concepts.

    So, if you buy a machine for a million dollars that will provide $100,000 a year in value, you should show a million dollar loss in year one, and an extra $100,000 gain each year after that? Strange.

    What if, instead of buying a machine, you buy a bond for a million dollars that pays you $100,000 a year? Do you claim the same loss with the same following gains?

    Do you dislike depreciation just for taxes, or do you dislike it for all purposes? Should the asset ledger of a corporation just show cash?

  32. Gravatar of Aidan Aidan
    7. March 2015 at 19:48

    You really could not have picked a worse day to write that first sentence.

  33. Gravatar of Derivs Derivs
    7. March 2015 at 20:21

    ” I’m surprised by your comment on depreciation.”

    I could not agree more. Depreciating an asset is completely logical. I had made a comment recently about how an economists definition of consumption completely disregards FASB. If I had to purchase an asset for a million and had to take a complete loss on it, but did not have the income in the year that the loss would offset, so then the following year if I sold the asset I would have to take it as a profit and be taxed on it? Makes no sense. I would never purchase the asset. Accounting standards are far from perfect but are extraordinarily detailed and have developed over time for reasons.

  34. Gravatar of Jim Glass Jim Glass
    7. March 2015 at 21:31

    @ Miami Vice

    How is taxing capital income double taxing the same earnings? … How exactly have you differentiated income and capital income, leading you to emote this perceived double taxation

    The capital value of an asset is the future expected income to be earned from it discounted to present value.

    Thus, if increase in its capital value is taxed as ‘capital gain income’ then that future income is taxed twice, first when the change in its capitalized future value is taxed now and then later when it is taxed again itself as current income when received.

    Note that “capital gain” is not included in national income in the National Accounts compiled by the BEA, for this reason.

    Note also that in the early days of the income tax the Supreme Court repeatedly ruled that capital gain was not income (four times, IIRC, e.g., “Enrichment through increase in value of capital investment is not income in any proper meaning of the term.” _Eisner v Macomber_ (1920)) heeding the advice of the leading economists of the day.

    That remained the law until Congress explicitly changed it. (Congress has the power to enact a ‘fish tax’ and apply it to dogs by defining dogs to be fish for tax purposes, if it wishes.)

  35. Gravatar of dtoh dtoh
    8. March 2015 at 00:11

    Scott,
    1. I’m not worried about human capital formation, we heavily subsidize education.

    I WOULD SAY WE HEAVILY SUBSIDIZE EDUCATORS…. BUT THAT’S A SEPARATE PROBLEM. AND IT’S ONLY PART OF THE PROBLEM. IF YOU HAVE DIFFERENTIAL TAX RATES ON DIFFERENT FACTORS OF PRODUCTION, YOU CREATE DISTORTIONS. WHY WOULD YOU HAVE A HIGHER TAX BURDEN ON CARS PRODUCED BY HUMANS THAN ON ONES PRODUCED BY MACHINES.

    2. No, it’s not easy to convert labor income into capital income, otherwise I’d be doing so.

    NO – YOU DON’T DO IT BECAUSE THERE IS NO TAX ADVANTAGE. IF THERE WERE, YOU’D SET UP AN COMPANY TO SELL TEACHING SERVICES AND HAVE THE COMPANY PAY YOU A DIVIDEND. YOU DON’T DO SO SIMPLY BECAUSE THERE IS NO TAX SAVINGS. ALL YOUR SCHEME WOULD DO IS CREATE NON-PRODUCTIVE WORK FOR LAWYERS AND ACCOUNTANTS.

    3. You plan faces exactly the same tax avoidance issues. Do you tax education? How about company cars? How about the three martini lunch? How about business jets?

    EXACTLY THE SAME AS NOW. IF IT’S NOT FOR A BUSINESS PURPOSE IT GETS TAXED.

    Doing taxes is one of the worst things I have to deal with every year.

    SO WHY MAKE A CONSUMPTION TAX COMPLICATED BY KEEPING A WAGE TAX? OR A CORPORATE TAX?

    I believe this proposal eliminates all taxes on capital. Someone correct me if that is wrong.

    IT WOULD TAX CAPITAL (E.G A ROAD) BUILT BY PICK AND SHOVEL BUT NOT ONE BUILT BY BULLDOZER.

  36. Gravatar of Garrett M Garrett M
    8. March 2015 at 00:35

    I wonder what the impact would be in the tax-exempt municipal bond market. Right now AAA munis trade through treasuries. If all bonds got tax-free interest then I’d expect investors such has HNW’s and insurance companies to significantly rebalance their portfolios. The follow-on impact on municipals from potentially higher borrowing rates would be interesting as well.

    Another interesting implication would be for the corporate bond market. My quick econ 101 analysis is that demand would shift right from taxable investors rebalancing their portfolios and supply would shift left as corporations lose the ability to expense interest paid.

  37. Gravatar of Major.Freedom Major.Freedom
    8. March 2015 at 02:12

    Sumner:

    “Vivian, Yes, I know that, I was referring to the rental unit portion. I’ve never met an economist who doesn’t think investments should be expensed.”

    That is because most economists focus their mental energies on dollars and money flows, and quantifable sums, and also on general equilibrium modeling.

    In this mindset, non-cash flow, accrual based accounting that incorporates time, where equilibrium is not even on the radar, is often difficult for them to grasp. They have more trouble understanding costs that have no cash flow associated with them and that take place over time.

    What economists believe about depreciation should of course be made subservient to the opinions of Accountants who are in a much better position to provide meaningful and helpful advice to business managers, and fund managers who value companies. Accountants and asset managers universally believe that accrual based accounting, of which depreciation is a core component, to be vital in understanding a businesses’ ongoing health and affairs.

    To them it would be insane to expense an asset with a 20 year life all in the first year.

    What utilizing depreciation does is so incredibly helpful to so many people that only the insane would want to abolish everyone grom using it!

    The concept of depreciation enables, for example, fund and asset managers to compare companies so as to make more informed capital allocations and portfolio constructions on behalf of their clients.

    Leave the accounting to the accountants. They use it for a good reason.

  38. Gravatar of J Mann J Mann
    8. March 2015 at 03:05

    Kevin, I’m not sure if this is Scott’s concern as well, but the Tax Foundation posted a piece last year arguing that depreciation functions as an extra tax on capital investment because the investment has to be paid for in present money (or financed) but most of the deduction is realized in future money.

    http://taxfoundation.org/blog/bonus-depreciation-bonus-full-expensing-ideal

  39. Gravatar of Assorted links Assorted links
    8. March 2015 at 04:09

    […] 4. Scott Sumner on Rubio-Lee tax reform. […]

  40. Gravatar of Assorted links | Freedom's Floodgates Assorted links | Freedom's Floodgates
    8. March 2015 at 04:50

    […] 4. Scott Sumner on Rubio-Lee tax reform. […]

  41. Gravatar of jsfny jsfny
    8. March 2015 at 05:14

    Major: No one said you can’t use depreciation to make financial comparisons and to inform investment plans, only that it is irrelevant to tax policy. Corporation maintain separate tax and FASB financial reporting books already, right?

  42. Gravatar of Ben Ben
    8. March 2015 at 05:48

    Scott, this looks like an income tax, not a consumption tax. What am I missing?

  43. Gravatar of LK Beland LK Beland
    8. March 2015 at 06:33

    “Sorry, can you make that example simpler. I don’t follow it.”

    I’ll give it a shot.

    A 401k-like system with a 20% flat tax is equivalent to a 25% sales tax. A no-capital-income-tax system (let’s call it a Roth-like system) is not.

    An example:

    Say you have Mr. Lucky and Mr. Unlucky. They both earn 100k$ through work in year 1. They both spend 40k$ and save what’s left. They do not work in year 2.
    Mr. Lucky doubles his investment within one year. Mr. Unlucky loses 50% of his investment.
    At the end of year tow, they sell their investments and spend it all.
    Suppose a 20% flat tax rate.
    For simplicity, let’s neglect the time-value of money when comparing year 1 dollars to year 2 dollars, since it is much smaller than the gain/loss of Mr. Lucky and Mr. Unlucky.

    All numbers below in 1000s of $ (except %):

    *** Mr. Unlucky ***
    401k-like:
    Spending // Tax // Equivalent sale-tax-rate
    year 1 // 40 // 10 // 25 %
    year 2 // 20 // 5 // 25%
    Total // 60 // 15 // 25%

    Roth-like:
    Spending // Tax // Equivalent sale-tax-rate
    year 1 // 40 // 20 // 50%
    year 2 // 20 // 0 // 0%
    Total // 60 // 20 // 33%
    *** ***

    ***M.r Lucky***
    401k-like:
    Spending // Tax // Equivalent sale-tax-rate
    year 1 // 40 // 10 // 25 %
    year 2 // 80 // 20 // 25%
    Total // 120 // 30 // 25%

    Roth-like:
    Spending // Tax // Equivalent sale-tax-rate
    year 1 // 40 // 20 // 50 %
    year 2 // 80 // 0 // 0%
    Total // 120 // 20 // 17%
    *** ***

    From the governments point of view:
    401k-like:
    // Sales in economy // Tax receipts // Effective Sales tax rate
    year 1 // 80 // 20 // 25%
    year 2 // 100 // 25 // 25%

    Roth-like:
    // Sales in economy // Tax receipts // Effective Sales tax rate
    year 1 // 80 // 40 // 50%
    year 2 // 100 // 0 // 0%

    We see that, if the discount rate is zero, the government gets 5k$ more under the 401k-like system than the Roth-like plan. As long as the overall return on capital is larger than the government’s discount rate, the 401-like system is better for government.

    I agree with you and BC that the amount of spending that Mr. Lucky and Mr. Unlucky could afford was independent of the choice of Roth or 401k. But the 401k-like system is equivalent to a 25% sales tax, while the Roth isn’t.

    I hope this example was more transparent than the first one.

  44. Gravatar of liberalarts liberalarts
    8. March 2015 at 06:41

    Scott–as you obviously know, a wage tax and a consumption tax are theoretically equivalent in a steady state, so taxing wage income is a consumption tax. However, the transition from our current system to each is different. If we tax consumption directly, such as with a VAT, then previous savings get taxed when consumed. On the other hand, if we switch to a wage-only tax, then spending from savings is not taxed. Putting aside the obvious issues of which transition is more fair, do you know how much the average tax rate would need to differ if we aimed to collect the same revenues going forward using either a wage tax or a consumption tax.

  45. Gravatar of Mike W Mike W
    8. March 2015 at 08:39

    Beyond an academic exercise in economic purity (e.g., consumption is a better measure than income), is the benefit of such a comprehensive reform…vs. incremental changes…worth the cost? In this plan, who gets taxed more and who less; why should political capital be expended on this effort rather than, say, reducing government “fraud, waste and abuse”; and, why should the country open itself up to the unintended consequences of the inevitable negotiated results?

  46. Gravatar of ssumner ssumner
    8. March 2015 at 10:08

    Kevin, I believe the fact that investment is expensed makes it a consumption tax.

    As far as depreciation, for tax purposes I don’t like it because expensing is the way to get a consumption tax. As far as accounting is concerned, I’d look at the current market value of the asset when trying to measure the value of the company (many assets like buildings actually appreciate), otherwise I’d say cash flow is what matters.

    Aidan, What was special about yesterday?

    Derivs, Can’t losses be carried over to the next year?

    dtoh, You said:

    “WHY WOULD YOU HAVE A HIGHER TAX BURDEN ON CARS PRODUCED BY HUMANS THAN ON ONES PRODUCED BY MACHINES.”

    I’m not proposing that. A consumption tax is completely unbiased in terms of the capital intensiveness of production. In contrast, an income tax leads production to me more labor intensive and less capital intensive than optimal.

    You second point seems to agree with me, it’s not easy to turn labor income into capital income.

    I don’t agree that it’s easy to establish which types of consumption are legitimate business expenses. As long a a business person gets utility from a car, plane ride or meal, it’s consumption. Period. If you derive utility, it’s consumption and should be taxed.

    Wage taxes are not complicated, I spend zero minutes doing my social security taxes each year. In Sweden people don’t even have to do their income taxes, the government does them for you.

    Garrett, My sense is that the effect on bonds would be a wash. Right now munis are neither an expense (as governments don’t pay taxes) nor a taxable earning to bondholders.

    Corporations would tend to switch from debt to equity. Homeowners would do the same if we got rid of the stupid mortgage interest deduction.

    Ben, It doesn’t tax capital income, that makes it a consumption tax.

    LK, As long as the consumption path is the same in both cases, then the tax burden will have been the same. It looks different because the taxes are paid at different points in time.

    liberalarts. Shifting to the wage tax would be fairer, but more costly. Some argue that the switchover should be accompanied by a one time tax on wealth, to make up the shortfall. I don’t know how big it is.

    Mike, The tax system is so inefficient and causes so much waste that reform is badly needed, but I agree that it’s unlikely we’d get the optimal sort of reform that economists would like to see.

    It’s not just that the system is bad, it’s getting worse almost every year.

  47. Gravatar of TallDave TallDave
    8. March 2015 at 10:15

    Sorry, but your “tweak” is going to enrage the professionals working 70 hour weeks through their peak earnings years. Even the Democrats would balk at that number.

    The better solution is to cut spending. As we found out when Sequestrageddon did not actually cause mass riots, biblical calamity, or the universe itself to cease function, spending can actually be cut significantly with minimal consequences. Democrats won’t like their numero uno special interest group getting bludgeoned Scott Walker style, but fortunately the American people have blessed us with fewer and fewer of them around to object.

  48. Gravatar of Kevin Erdmann Kevin Erdmann
    8. March 2015 at 10:48

    Scott,

    I can’t believe this is standard thinking for economists. I don’t think you’ve thought through the implications of your thinking on depreciation. For now, I will choose to believe that Ray Lopez has hacked your WordPress account. Do you have a link to a more in depth explanation of this idea?

    And, you didn’t answer about corporate taxation. You seem to be saying that corporate taxation is not capital taxation.

  49. Gravatar of Derivs Derivs
    8. March 2015 at 10:59

    “Derivs, Can’t losses be carried over to the next year?”

    I think it is back 2 and forward 20?? I never had to work with large capital purchases but I did have to deal with bringing in non volatile EPS. That’s the part I don’t like.
    There are a lot of excellent conflicting arguments in this thread. One that conflicts with what I said above is 2 sets of accounting books (although more expense for small start up company). Almost all of them have some sort of argument both ways. Tax code, I have always found to be really brutal. Not my favorite topic. Although I did enjoy taking advantage of the Section 179 stimulus act in 08-09. Amazing what one can expense if they are really careful.

  50. Gravatar of LK Beland LK Beland
    8. March 2015 at 11:19

    Yeah, it makes sense now. Thanks.

    And you are right that the advantage of the 401k-type system is to make tax-avoidance more difficult. This would be especially important in a world with low/zero corporate tax.

  51. Gravatar of Mike W Mike W
    8. March 2015 at 13:42

    @ Dervis “…2 sets of accounting books (although more expense for small start up company)…”

    Actually, unless a “small start up company” has plans for an IPO, most only need to…and do…keep their books on a tax basis.

  52. Gravatar of Mike W Mike W
    8. March 2015 at 13:50

    @ssumner: “It’s not just that the [tax] system is bad, it’s getting worse almost every year.”

    The latest contributions to it getting worse are the stealth tax provisions…e.g., additional Medicare tax, Net Investment Tax, phase-outs of itemized deductions and personal exemptions…being inserted in order to raise revenue from “the middle-class” while politicians tell them it is coming from “the rich”.

  53. Gravatar of Vivian Darkbloom Vivian Darkbloom
    8. March 2015 at 14:11

    Scott,

    Oh, how much simpler and accurate if would have been to have written “if I sell my rental property.” :-)

    But seriously, do you really think that a system that allows expensing of capital investments (number 2) *and* elimination of taxation on capital assets (number 4) can be fully reconciled? There are some details missing here, obviously. I think I would like to buy your rental property. You’d be exempt when you sell, I’d get to fully deduct the cost of the property upfront (and offset ordinary income at that 50 percent rate you propose–otherwise, what’s the point of expensing?) *and* eliminate any capital gain on my subsequent sale. I could claim to be “poor” in both years! And, think of all the additional consumption that could fuel!

    It doesn’t appear your plan would generate much revenue, at least not from me.

    Obviously, such a result would make no sense. A more careful reading of the Lee/Rubio “plan” suggests to me that you would not be exempt when you sell your rental property even though it is a “capital asset” (that means, alas, that you would still be “rich” in the year of sale). It is also not clear whether they would retain the passive activity loss rules introduced by the 1986 Tax Reform Act (failure to do so would really open the barn door to avoidance). The proposal they made appears to be restricted to ending shareholder tax on corporate distributions and interest paid by businesses. The former to eliminate double tax on corporate earnings and the latter to account for the fact that interest incurred by businesses would generally no longer be deductible. I do not read it as “ending the taxation of capital investment” completely.

    dtoh, I think the last para partially answers your question–as I read it, the plan only ends the taxation of some types of capital assets (as defined in section 1221).

  54. Gravatar of Vivian Darkbloom Vivian Darkbloom
    8. March 2015 at 14:16

    “The proposal they made appears to be restricted to ending shareholder tax on corporate distributions, and interest paid by businesses.”

    add “and sale of corporate stock”

  55. Gravatar of Bob Bob
    8. March 2015 at 15:17

    While it sure seems that it’d be very positive for me (married with similar incomes, one of which is saved in its entirety), I’d like a proposal like this to be shown in a way that is easier to understand across the board:

    Is it revenue neutral? If not, why not?

    If it is revenue neutral, who is going to end up paying quite a bit more on taxes? Who gets to pay less?

    As far as the difficulty in turning income gains into capital gains, it really depends on your industry. I have worked with people in finance, and income that easily looks like capital is something that comes with the territory. It’s a bit like how some people can make tax preferred college funds to grow 40x better than market rates by spending post tax money to raise the valuation of their funds. All easy things if you are Ray Dalio, hard to do for you and me.

  56. Gravatar of dtoh dtoh
    8. March 2015 at 16:52

    I’m not proposing that. A consumption tax is completely unbiased in terms of the capital intensiveness of production. In contrast, an income tax leads production to me more labor intensive and less capital intensive than optimal.

    But you’re not proposing a pure consumption tax. Unless you’re saying that all net savings should be deducted from wage income…in which case your argument about the simplicity of a wage tax goes out the window.

    You second point seems to agree with me, it’s not easy to turn labor income into capital income.

    That’s not what I said at all. If corporate tax rates are significantly lower than the wage tax rate and dividends are exempt, then everyone will be selling services through a company and paying themselves a dividend rather working for wages.

    I don’t agree that it’s easy to establish which types of consumption are legitimate business expenses. As long a a business person gets utility from a car, plane ride or meal, it’s consumption. Period. If you derive utility, it’s consumption and should be taxed.

    Sure if it’s for personal use then it should be taxed as personal consumption. Just like now… for the most part it gets taxed as income. Just keep the same enforcement mechanisms that are already in place. And….this idea of business people getting personal benefits from three martini lunches is totally overblown. Corporate controllers these days make the IRS look like a bunch of sissies. Just ask any business person how much “utility” they get from corporate travel and meetings.

  57. Gravatar of TallDave TallDave
    8. March 2015 at 18:10

    Depreciation is so insane it pains me to even think about it

    Depreciation won’t go away even if the tax law changes. GAAP is a whole different set of rules governing how income is reported, which are intended to give investors some idea of whether an entity is profitable.

    I’d look at the current market value of the asset when trying to measure the value of the company (many assets like buildings actually appreciate)

    LCM is used because otherwise it’s too easy for a company to claim its assets are increasing in value. Many assets do not have an easily definable “market value.”

    otherwise I’d say cash flow is what matters.

    That’s why every publicly traded or funded company is required to publish an official statement of cash flows.

    Interesting though, as a CPA certificate holder (nonpracticing) I’ve been wondering lately how much accounting background most economists have gotten.

  58. Gravatar of ThomasH ThomasH
    8. March 2015 at 18:23

    I wonder if a 50% top consumption rate makes the schedule progressive enough. Since with a consumption tax we don’t need to worry about deterring savings and investment, rates could be considerable higher than on income.

    And I rather suspect that for Rubio-Lee, the lack of progressivity and the fact that the consumption tax will raise less revenue than the present income tax is a feature not a bug that can be “tweaked.” And will the new tax have a negative rate range, an Earned Consumption Tax Credit to help off set regressive payroll and state and local taxes?

    And will getting to give away the assets in your estate on death to whomever you want be counted as “consumption?”

  59. Gravatar of Rubio-Lee Isn’t Great, David Henderson | EconLog | Library of Economics and Liberty Rubio-Lee Isn't Great, David Henderson | EconLog | Library of Economics and Liberty
    8. March 2015 at 18:51

    […] Co-blogger Scott Sumner, over at his TheMoneyIllusion blog, has a post titled "Rubio-Lee is great, so why not make it even greater?" […]

  60. Gravatar of Bob Murphy Bob Murphy
    8. March 2015 at 18:53

    Scott,

    I think I know what your answer will be, but I’d like to be sure (if you have the time to clarify). Why are you saying a tax on wage income is a consumption tax?

  61. Gravatar of dtoh dtoh
    8. March 2015 at 20:30

    It’s simple…. you just get rid of all income tax (capital, wage and corporate) and have a simple consumption tax in the form of a national sales tax on all non-business expenditures.

  62. Gravatar of Tax Roundup, 3/9/15: The dark side is very powerful. And: conventional unwisdom, unwise candidacies. « Roth & Company, P.C Tax Roundup, 3/9/15: The dark side is very powerful. And: conventional unwisdom, unwise candidacies. « Roth & Company, P.C
    9. March 2015 at 05:31

    […] Co-blogger Scott Sumner, over at his TheMoneyIllusion blog, has a post titled “Rubio-Lee is great, so why not make it even greater?” […]

  63. Gravatar of glasnost glasnost
    9. March 2015 at 06:13

    John Chait is right, and you’re wrong. This tax plan is an insane, horrible nonstarter. Ending taxes on capital is a ludicrously regressive proposal that will exactly exacerbate everything already wrong with the global economy. Your suggestions do almost nothing to fix it.

    The US macroeconomy is literally awash in excess capital. We’re so oversupplied that it’s almost impossible to earn a decent return. Excess liquidity has led to financialization and high volatility in our speculation economy. But nobody’s doing anything with it, because of the general hoarding environment – because saving is overly encouraged. This proposal would take that problem and compound it.

    This proposal would virtually exempt most of the top thousandth and above in wealth from taxation. Not to mention the end of the estate tax.

    And to state the obvious, any elimination of taxes on capital would leave most of our 1% almost literally untaxed. You may, somehow, not be aware, but most very wealthy people in this country earn a trivial portion of their income in taxable wages. Something like 90% or more comes in capital gains.

    The low savings rate in this country won’t be fixed by lower taxes on capital. Again, that’s nuts. Most of the country has very little disposable income. They won’t suddenly develop that disposable income because you lowered taxes on stocks. The very wealthy already have very high savings rates. You’re trying to solve a nonexistent problem via the wrong method.

    Raising the top rate on income will in no way solve these problems. Taxes on capital need to be much higher, not lower. They need to be specifically higher on capital than on labor, to discourage the substitution of labor with capital. You may have noticed we already have a severe problem of surplus labor because of too much capital, leading to a declining net employment rate. This plan would, again, severely exacerbate the largest problem of our current economy.

    I’m honestly surprised that Scott would promote this. I credited him with some level of good judgment.

    This proposal is literally emblematic of the antithesis of a sound macroeconomic plan.

    But hey, it makes doing your taxes easier, so apparently that’s as far as you need to think.

    I feel literally ill.

  64. Gravatar of ssumner ssumner
    9. March 2015 at 06:14

    TallDave, I don’t think people realize how much higher the actual tax rates (under an income tax) are than the advertised rates. My proposal would not mean higher taxes on the affluent.

    Kevin, Any good grad public finance book should explain this stuff.

    I’m not certain, but I believe if you allow expensing of investment you turn a corporate tax into a consumption tax. Expensing of investment means you are not taxing investment goods, just consumer goods.

    Mike, The various phaseouts are perhaps the most idiotic of all the idiotic ideas that Congress has come up with. There is no conceivable justification for this nonsense, other than to give jobs to tax accountants.

    Vivian, That’s too bad. If they didn’t plan to eliminate taxation of capital gains, they should not have said they were eliminating taxation of capital gains.

    Bob, Their proposal is not revenue neutral, I’m not sure about mine.

    dtoh, A wage tax is identical to a VAT type consumption tax. And I’m not necessarily advocating that saving be deducted from wage income for tax purposes, I’m saying money should be taxed on one place or the other, but not both. Either taxed in a Roth IRA location of a 401k location, but not both.

    You said:

    “That’s not what I said at all. If corporate tax rates are significantly lower than the wage tax rate and dividends are exempt, then everyone will be selling services through a company and paying themselves a dividend rather working for wages.”

    When you work for a company, any income you receive from that company should be considered labor income. I knew someone who once got income working for a biotech company that was in the form of stock options. The IRS rightfully demanded that they consider it wage income. They even had to pay payroll taxes on it. This isn’t as hard as people are making it out to be.

    As far as utility, if they are flying first class instead of economy class for reasons other than utility, then please explain what those reason are. I honestly don’t see it. I’ve had restaurant meals on trips to economics conventions that my school was able to write off. That’s an outrage.

    Thomas, I’m getting attacked from both sides. It’s hard to do reform because consumption taxes look far less progressive than income taxes. Make them equally progressive, and you lose the conservatives.

    Bob, Because that’s what I was taught in grad school.

    And because when I ran the numbers I found that it was true.

  65. Gravatar of ssumner ssumner
    9. March 2015 at 06:18

    glasnost, There as so many idiotic ideas in your comment I don’t really have time to comment, other than to point out how insane this is

    “The low savings rate in this country won’t be fixed by lower taxes on capital. Again, that’s nuts. Most of the country has very little disposable income.”

    Tell that to people in China, where they save 50% of their much smaller incomes.

    Also please explain to me why so many liberal economists have advocated a progressive consumption tax with no tax on capital income. If you can’t do that, then I have no reason to take your rant seriously.

  66. Gravatar of Vivian Darkbloom Vivian Darkbloom
    9. March 2015 at 06:34

    Scott,

    You replied:

    “Vivian, That’s too bad. If they didn’t plan to eliminate taxation of capital gains, they should not have said they were eliminating taxation of capital gains.”

    But, that is not what the Lee/Rubio summary that you linked to said. The discussion appears under the rubric “Creating Parity in the Taxation of Business Income”. Their specific comment was:

    “Since the businesses’ income would be taxed at the entity level, dividends and capital gains on stock would not be subject to additional tax at the individual level.”

    Thus, the point was to eliminate double taxation on business income (primarily corporate/individual)–not to eliminate all “taxation of capital gains”. “Capital gains”comprises much more than corporate stock (or debt). Capital gains are derived from the sale of capital assets as defined in section 1221. Your rental property is a capital asset but exempting it from gain in the your hands (an individual owing the property directly) is not necessary to achieve what appears to be their goal–to eliminate entity level (corporate) and individual double tax. You seem to be concentrating on eliminating tax on anything but wages, but I don’t see that as their way of thinking or their focus. If they said somewhere else they want to eliminate tax on *all* capital gains, I have not seen it.

  67. Gravatar of Scott Sumner Scott Sumner
    9. March 2015 at 06:48

    Vivian, I strongly disagree. i don’t know how this could be any clearer:

    “Our Changes:
    This plan allows firms to deduct 100% of expenses, immediately accounting for the costs of capital investments in the year they are made and requiring businesses to pay taxes only on earnings after all expenses have been deducted from the business’s taxable income. These new expensing rules will apply to all investment in equipment, structures, inventories and land. In years after the expenditure is made, there are no allowances for economic depreciation of the capital investment.
    Why We Make These Changes:
    The strength and health of an economy depends largely on the extent to which businesses choose to invest a portion of their earnings in their own growth and expansion – for example, by buying new equipment, upgrading their inventory, giving current employees raises or hiring new workers, or making infrastructure improvements. Business will make capital investments only when they can reasonably expect immediate costs to yield higher returns in the future. By taxing capital investments in the year they are made, and thereby
    raising the short-term costs of such investments, current law discourages businesses from investing in their own growth and creates a drag on the economy.”

    They say “all investment” which means no more depreciations schedules for anyone.

    Elsewhere they say:

    “We will also allow for full expensing of capital purchases. Under this structure,
    businesses will immediately be able to write off the costs of purchases, resulting in greater investment, higher employment, and more robust economic growth.This provision will also mean eliminating the frequently outdated and sometimes-arbitrary depreciation schedules created by the IRS.”

    Not reducing, but eliminating. For any business, not just corporations.

  68. Gravatar of Vivian Darkbloom Vivian Darkbloom
    9. March 2015 at 07:24

    Scott,

    You are confusing and conflating *expensing of an asset* with the subsequent *taxation of capital gains*. Not at all the same thing–or do you think so?. It is no more the same thing than would be a section 179 expensing under current law and subsequent sale of that expensed asset. Expensing does not mean the subsequent sale is exempt. Quite the contrary. Your cost basis is reduced to zero.

    As I noted above, in my example of your rental property, allowing expensing (or even depreciation) on a capital asset and then *also* exempting a subsequent gain on that same asset when it is disposed of makes no sense. Property that a business holds for the production of income (say a building) could be a type of “capital asset” that type that could be expensed under the plan (under current law corporations don’t get preferred rates on their capital assets, unlike individuals). And, actually, their plan refers to land as well which is currently not even depreciable. But, that plan does not exempt the subsequent sale of that asset from tax if held by a corporation or by a sole proprietor. As I read it, the plan exempts double entity level/individual tax and combines this with expensing (the latter is a separate issue). If a corporation would expense an asset and then sell it at a gain (they would have zero basis), then they would be taxed. Distribution of those post-tax earnings would not be taxed again in the hands of the shareholder. That’s the point of the proposal. Do you really think that a corporation (or an individual) would be able to expense an asset and then sell it without paying any tax? That’s crazy. The proposed system would ensure that all capital assets (excluding, perhaps, some break for principal residences as under current law), are not taxed at the entity *and* individual level, but it certainly does not say *no tax*.

    If this is what you are basing your assumption that this is a “consumption tax”, I think you are very wrong.

  69. Gravatar of Scott Sumner Scott Sumner
    9. March 2015 at 07:43

    Vivian, With a pure consumption tax you fully expense saving and investment, and then pay tax on 100% of the sale price. An income tax combined with 100% 401k freedom is an example of a consumption tax. Yes, if you expense investments of course you pay tax on 100% of the sale price, but that’s not a tax on capital income, unless you think 401ks tax capital income, which no economist believes.

  70. Gravatar of glasnost glasnost
    9. March 2015 at 07:47

    Whatever the savings rate is in China and whoever is doing said saving, the cost structure of basic living requirements is arranged such that it’s realistic to live on a smaller fraction of your income, relative to a wealthy country like the US that suffers from heavy cost inflation for anything you can’t put in a box. That’s one possibility.

    Another possibility is that Chinese people have much lower standards of living than we do, but save a lot anyway due to the high risk nature of living in China – from exporpriation, to lack of subsidized medical care and/or education, lack of Social Security, etc etc.

    Either way, increasing the cost of consumption will lead to a sharp decline in consumption – otherwise known as a massive recession – while failing to encourage people who don’t have extra income to save. Scoff all you like, but local costs are fixed, entangled, and not subject to significant change in a nongenerational timeframe. When the median wage is barely more than housing + food + childcare + gas, the median person won’t be saving much money. You’ll get consumption cutbacks already because of increased consumption costs, but if you think you’ll get even more consumption cuts in order to save extra money in response to this stimulus, you are not considering human psychology.

    My other points – that we are macroeconomically oversupplied with capital and liquidity and undersupplied with labor demand – I don’t expect you to address them. I know I’m not being nice, and I don’t see you as psychologically flexible.

    But you’d hear a nicer version of these exact criticism from any liberal policy wonk. The bottom line is that despite your maybe good-faith attempts, this proposal is still regressive. It might be progressive between the 80% and 20% brackets – maybe – I’m not sure and would look to a wonk for advanced analysis – but it’s very much
    not progressive at the 1% level.

    Sorry.

    Oh, and this:

    “Also please explain to me why so many liberal economists have advocated a progressive consumption tax with no tax on capital income. If you can’t do that, then I have no reason to take your rant seriously.”

    I am genuinely ignorant of a liberal economist who has advocated this. I think that our definition of ‘liberal’ may vary. My other explanation would be that a lot of liberals liked a lot of things in, say, the 1990’s, that seemed okay in a world of rising median wages and high employment, but no longer look so good in 2015.

    Here is a think tank I trust, saying literally the opposite of your proposal:

    http://www.cbpp.org/cms/?fa=view&id=3837

    and here is jared bernstein, one of my favorites:
    http://jaredbernsteinblog.com/dividends-capital-gains-and-the-growth-of-income-inequality/

    “The largest single contributor to the growth of inequality, 1996-2006, was dividends and capital gains”.

    Modern politically liberal economists want to vastly raise taxes on capital, not lower them. I continue to state that a realistic look at the modern economic environment shows a gigantic surplus pile of excess liquidity, and the case for adding to that pile seems entirely abstract. What we want to do is shrink it. In a first world of hoarding, we need to disincentivize hoarding, not the reverse.

  71. Gravatar of glasnost glasnost
    9. March 2015 at 08:00

    I apologize for the obnoxious tone. I blame the internet.

  72. Gravatar of Vivian Darkbloom Vivian Darkbloom
    9. March 2015 at 08:21

    “Vivian, With a pure consumption tax you fully expense saving and investment, and then pay tax on 100% of the sale price.”

    Scott, you are all over the map here and, I hate to say it, but you are approaching Raydom on this one. Simply acknowledging a mistake is ok–we all make them; but, all this evasive obfuscation is not. We were talking about the Lee/Rubio proposal–not your theories and your own peculiar nomenclature which you tend to unpack when you get into difficulties. It’s not really clear what the above sentence means, but it appears now that you are saying, without really saying so, that “well, yeah, under the proposal if one would fully expense an item and then sell it, well, I guess, well, maybe you would be fully taxed after all under that plan (as seller, not consumer) but let me think of a clever way not to admit that directly. Let me unpack my theory of a “pure consumption tax” instead of what was under discussion and throw in to boot my own definitions. So, when the fog is cleared away, we’re back to where *I* started.

    The simple fact is that Lee and Rubio are *not* proposing a “pure consumption tax”—or anything close to it. How you got that idea is a mystery to me. Corporate income tax is not going away under their proposal. Nor is all the tax on capital assets; outside tax preferred pension plans (that already exist) they will be taxed at least once in addition to wages, however you want to spin it. I trust your rental property is not in your 401(k). Lee and Rubio are proposing that the current *three* layers of tax (wages, corporate, investor) be reduced to two—not one—and they are not proposing that we treat your rental property as if it were in your 401(k) however much you may wish that to be so.

    I’m sorry to be so blunt, Scott, but you are hard on some of your commenters, too. Sometimes, that comes (deservedly) around.

  73. Gravatar of Mike W Mike W
    9. March 2015 at 08:34

    @ssumner: “Mike, The various phaseouts are perhaps the most idiotic of all the idiotic ideas that Congress has come up with. There is no conceivable justification for this nonsense, other than to give jobs to tax accountants.”

    But there is a justification…obfuscation. Members of Congress cannot get reelected if they support tax increases so they do them through backdoor methods.

    Which is why debating consumption tax reform or flat taxes is a static academic exercise.

  74. Gravatar of Scott Sumner Scott Sumner
    9. March 2015 at 09:11

    Glasnost, Less consumption and more investment will cause a recession? Sorry, but I don’t have time for this nonsense, life’s too short.

    You said:

    “I am genuinely ignorant of a liberal economist who has advocated this.”

    I’d take you more seriously if you’d bother to read the many, many liberal economists who have advocated a progressive consumption tax, and explain why they are wrong. The fact that income is less equal than in the 1990s has no bearing on this, we are talking about a PROGRESSIVE consumption tax.

    Vivian, I do see that you don’t understand public finance theory, but that doesn’t give you the right to be so insulting to someone who does. Here’s what all knowledgeable public finance theorists agree on:

    You can turn an income tax into a consumption tax in two ways:

    1. The Roth IRA approach. Don’t expense investment but don’t tax investment income.

    2. The 401k approach, Fully expense investment and fully tax the future cash flows from those investments.

    Everything I’ve said has been 100% consistent with these two approaches to a consumption tax. If you are too ignorant to understand that, that’s your problem not mine.

    And I see you’ve dropped you argument that depreciation is only being eliminated for corporations, I wonder why?

  75. Gravatar of Vivian Darkbloom Vivian Darkbloom
    9. March 2015 at 09:50

    Scott,

    What I find insulting is that you have a nasty habit of changing the subject when things get difficult and pretend as though you are being responsive. Only an ignorant person would fail to notice that. The issue under discussion was and is *what the Lee/Rubio plans says or does not say*, *not* what your your public finance theory is. Stop being evasive. It does not become you.

    And, I am not dropping any “argument” that depreciation is “being dropped” under that proposal only for corporations—I gave an example—previously also of your rental property, which I presume is not in a corporation. The plan suggests adopting expensing for all business assets, not merely business assets within a corporate solution. It does not eliminate subsequent tax on any gain realised from the sale of that same previously expensed asset as you originally claimed it would. I don’t know how this could be more clear.

  76. Gravatar of ThomasH ThomasH
    9. March 2015 at 11:44

    The way to have a consumption tax is to have a consumption tax. Rubio-Lee is not it. To get to a consumption tax one needs to:

    1. Eliminate the corporate income tax and impute corporate income to shareholders. [Expect a lot of regulations of corporate income to insure that expenses were being used to provide untaxed consumption to employees or shareholders.]

    2. Make (taxable) consumption will equal income minus documentable savings (= addition to wealth) minus “merit” consumption of such things as education, health maintenance costs, charitable giving, and state and local taxes. [Expect a lot of regulations to prevent hiding consumption from asset ownership and limits on levels of different kinds of merit consumption.]

    3. Adopt a progressive rate schedule (which will presumably begin with a range of negative rates. Rates would be set to be more progressive on consumption than the actual system is on income.

    4. Use the consumption tax to replace all other forms of federal taxation except fees for using Federal assets (e.g. highways, air traffic system, inland waterways) and Pigou taxes on negative externalities such as emissions of CO2 and other pollutants.

    A consumption tax COULD BE fairer, more progressive and more efficient than the personal-corporate income tax, but since the current system resulted from a political system that favors the currently wealth, the change could be either better or worse that what we have.

  77. Gravatar of Sean Sean
    9. March 2015 at 11:59

    @ThomasH

    Yes – pretty much

    I wouldn’t expect to see anything other than charitable giving being deducted.
    If a rich person does not want to be taxed then they would have to put their wealth in to a “wrapper” account that protects capital from taxation – and then taxes drawdowns from that account as consumption. Homes would go in here too. Also, you could lower the rate the longer it’s unspent.
    Not sure about the negative rates idea – although ideally it would be very low for low income folks, – 5,10,15%, etc. Progressivity should work in both directions. But it could be as high as 80% for people earning several millions a year.
    Point 4 is just right.
    It would still be difficult to prevent people having offshore funds though – can’t see a simple way around that – VAT and Land Tax perhaps but they could probably escape the main PCT.

  78. Gravatar of ssumner ssumner
    9. March 2015 at 12:18

    Vivian, You said:

    “It does not eliminate subsequent tax on any gain realised from the sale of that same previously expensed asset as you originally claimed it would.”

    As I claimed? Do I look like a complete moron? Seriously? If you think I’m that dumb why do you even read this blog. I can see a lot of this is over your head. I have a new post. Read it, you might learn something.

    You’ve pulled this stunt before, it’s not cool.

    Thomas, Lots of good points except I would not allow write offs of health and state and local taxes.

  79. Gravatar of Vivian Darkbloom Vivian Darkbloom
    9. March 2015 at 13:28

    Scott,

    I’m not pulling any stunts. Your dodging and weaving and backfilling on this is pretty incredible and I’m confronting you with that. I’m not surprised you don’t like it, but that’s not my problem.

    Your public finance theorizing is not my issue; the issue is that when you try to apply those theories to the facts of that Lee/Rubio proposal you got it completely wrong because a) you don’t seem to understand what they are proposing; and b) you don’t seem to have a clue about how the existing code works. You got your facts completely wrong, however hard you might try to now divert attention now solely to your “theory”.

    I laid the issue out at 14:11:

    “But seriously, do you really think that a system that allows expensing of capital investments (number 2) *and* elimination of taxation on capital assets (number 4) can be fully reconciled? There are some details missing here, obviously. I think I would like to buy your rental property. You’d be exempt when you sell, I’d get to fully deduct the cost of the property upfront (and offset ordinary income at that 50 percent rate you propose-otherwise, what’s the point of expensing?) *and* eliminate any capital gain on my subsequent sale. I could claim to be “poor” in both years! And, think of all the additional consumption that could fuel!”

    Obviously, such a result would make no sense. A more careful reading of the Lee/Rubio “plan” suggests to me that you would not be exempt when you sell your rental property even though it is a “capital asset” (that means, alas, that you would still be “rich” in the year of sale)…”

    To which you replied:

    “”Vivian, That’s too bad. If they didn’t plan to eliminate taxation of capital gains, they should not have said they were eliminating taxation of capital gains.”

    I then carefully explained the situation to you at 6:34 that the Lee/Rubio do not propose eliminating all taxes on capital gains. I provided you with specific definition from the code which people in the real world use. I pointed out that the proposal was designed primarily to eliminate double taxation of corporate level and shareholder taxes and pointed to the specific text of that proposal.

    To which you replied, “I strongly disagree” and then came up with some confused story about expensing. You had three chances to say what you now claim you did and you said just the opposite.

    I’m not calling you a moron. I’m saying you are not engaging in a very honest discussion.

    I’ve read your latest post and, true to form, you are now diverting attention from what you previously claimed about the actual Lee/Rubio proposal to a post about your public finance on taxation which is not relevant to what that plan actually says.

  80. Gravatar of ssumner ssumner
    10. March 2015 at 06:13

    Vivian, You said:

    “I’m not surprised you don’t like it, but that’s not my problem.”

    Actually repeatedly calling people liars is your problem, and you need to deal with it.

    I still claim Rubio/Lee is eliminating all capital income taxation. That may be wrong, but that’s my current belief. And it’s certainly not a lie.

    You said:

    I’m not calling you a moron.”

    If you are claiming that I claimed people would be able to expense something and then sell it 5 minutes later with no tax, then you would be calling a moron. That’s just idiotic. But having a tax on the sale is not capital income taxation.

  81. Gravatar of Mike W Mike W
    10. March 2015 at 11:51

    The Vivian Darkbloom/ssumner “discussion” above is an excellent example of why the Rubio-Lee proposal will likely go nowhere.

  82. Gravatar of Gene Callahan Gene Callahan
    13. March 2015 at 15:59

    “there is no such thing as “deserve” in a cold heartless universe composed of nothing but subatomic particles”

    Nor is there any such thing as economic arguments in such a universe.

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    20. March 2015 at 10:00

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