We need a progressive consumption tax

Reuters

Shoppers look over items on sale at a Macy's store in New York, November 23, 2012.

Article Highlights

  • In the long run, we should ease the tax burden on saving & investment by moving toward some form of consumption taxation.

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  • The best approach would completely replace the income tax with a progressive consumption tax.

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  • Embracing progressive consumption taxation offers a way to promote both tax fairness and economic growth.

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Editor's note: This article originally appeared in The New York Times' Room for Debate series in response to the question: If Washington is serious about tackling the budget deficit and growing the US economy, how would our tax system need to change?

In the short run, reform efforts are likely to focus on improving the income tax. We should curb ill-designed tax breaks, like those for expensive homes and Cadillac health insurance plans, and reform business taxes.

In the long run, we should ease the tax burden on saving and investment by moving toward some form of consumption taxation. But complete replacement of the income tax with a sales tax or value-added tax is not the way to go - that would unacceptably shift the tax burden to those who are worse off.

A somewhat better approach would replace part, but not all, of the income tax with a value-added tax. Many countries have done this and we may eventually follow suit, but it's not an ideal approach. Even with a progressive income tax still in place, the value-added tax's regressivity is problematic. And, giving the government another revenue source may spur spending.

The best approach would completely replace the income tax with a progressive consumption tax. We can do this by adopting a personal expenditure tax, which requires taxpayers to file returns on what they compute their consumer spending by subtracting saving from income. Spending above an exemption amount is taxed at graduated rates, with higher brackets for those with higher spending. Or, we can adopt a Bradford X tax, which splits consumption into two pieces, wages and business cash flow, and taxes them separately. Workers are taxed on wages at graduated rates, above an exemption amount, and businesses are taxed on cash flow at a flat rate, equal to the highest wage tax rate. Under either system, tax credits can be paid in cash to poorer households.

Thinking outside the box and embracing progressive consumption taxation offers a way to promote both tax fairness and economic growth.

Alan D. Viard, a former senior economist at the Federal Reserve of Dallas, is a resident scholar at the American Enterprise Institute. 

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