Consumption Taxes

By now, you’ve probably seen somewhere that Dennis Hastert is floating the idea of abolishing the IRS and replacing income taxes with a consumption tax (or, alternatively, a VAT). Kevin Drum’s already given this idea the treatment it deserves.

But since this issue is resurfacing now, it seems like a good time to point out that I have a series of posts from the first month of this blog’s existence on the issue of consumption taxes (see “Topics” in the left sidebar), an idea that was originally floated in the 2003 Economic Report of the President. Of the five posts, the two that are most relevant to the debate today are Static and Dynamic Analysis of Consumption Taxes and The Much Ado About Nothing? Post. In the latter, I concluded that

Eliminating income taxes on seniors would generate less savings for them precisely because they pay so much less in income taxes than the under-65 population. They do, of course, consume—that’s half of what retirement is about, right? (Presents for the grandkids count as consumption.)

I just don’t think the political will or audacity exists to implement this. Add to this the black-market problems that would surely arise with a combined federal and state tax that, conservatively estimated, would have to exceed 25%, and it’s a no-go.

Yes, a carefully crafted set of tax exemptions could alleviate the disparate impact that a consumption tax would have on seniors. Similarly, a well-crafted set of exemptions could also make a consumption tax progressive (CalPundit makes this point correctly). But, a few points are in order:

1. Almost nothing about using exemptions in the consumption tax made it into the Economic Report of the President (on page 196, the authors mention possibly retaining favorable tax treatment of nonprofits)
   
2. The only compelling case for a consumption tax is its theoretical simplicity. As soon as you start talking about favoring seniors, nonprofits, making the rate increase with the value of the sale, exempting some goods and services, applying regional adjustments to adjust for regional price and income variation, continuing to encourage the social goal of home ownership, favoring families with children, the popular R&D credits… it starts to look a lot like the current tax code morass.

I haven’t really changed my mind on the issue since then — it’s not really politically feasible. So why bother? Probably because “Down with the IRS!” seems like a good campaign slogan and might help Hastert sell a few books.

AB