Consumption Taxes are Progressive
Avraam Jack Dectis
November 12, 2022
Why Consumption Taxes are Progressive
It is widely asserted that consumption taxes are regressive and that this is why income taxes, which seem progressive, are better.
This is wrong.
A simple illustration of a progressive consumption tax will illustrate the point.
(These numbers are for illustrative purposes and not an actual proposal.)
The first step is to decide what sort of progressivity you want to implement. Recent news articles are now stating that those earning 90K cannot afford to buy a house, so 90K seems like a decent cutoff for effective landless peasant poverty and a fair demarcation for those whom the economy is failing.
The second step it to decide what the rate should be for the consumption tax. For simplicity, we will use a very high 80 percent.
This means that every expenditure made for consumption, not an intermediate use or financial investment, will be taxed 80 percent.
The way this is made progressive is that all income earners receive a payment from the government equal to 80 percent of the first 90K that they earn.
Thus, everyone making 90K or less, will be given the money to pay their consumption taxes and their effective tax rate is zero.
If someone earns 135K, they get the rebate on the first 90K and pay the 80 percent tax on their expenditures for the additional 45K consumption, giving then an effective tax rate of about 26 percent.
If someone earns 180K, they get the rebate on the first 90K and pay the 80 percent tax on their expenditures for the rest, giving then an effective tax rate of 40 percent.
If someone earns 360K, they get the rebate on the first 90K and pay the 80 percent tax on their expenditures for the rest, giving then an effective tax rate of 60 percent.
Of course, their effective tax rates are subject to actually spending the money they earn, which is fine. All money eventually gets spent so it is just a matter of time until the taxes are paid.
So in terms of progressivity, income taxes and consumption taxes are exactly the same, since the level of progressivity is a function of how those taxes are implemented.
What makes a consumption tax superior is the inherent inflation controlling aspects. Also, unlike with an income tax, where various ploys can be used to hide income, and produce misleading statistics on effective tax rates, all consumption is taxed.
Also note that with a 90K cut off, about sixty percent of the USA working population would pay zero income tax. (1) The tax rate then climbs robustly toward the maximum rate thus providing a level of progressivity that far outshines the income tax.
The irony is that those who consider themselves progressive oppose consumption taxes because they consider them to be regressive when, if properly implemented, they are extremely progressive.
Why This is Important
The income tax regime in the USA and elsewhere is extremely flawed. It is a byzantine mess of regulations combined with an inadequate economic control performance.
To understand this, you should consider that with a consumption tax environment, when the economy overheats, and prices go up, consumption taxes also go up, which has an intrinsic cooling effect upon the economy. When the economy get excessively chilled and economic activity goes down, consumption taxes collected also go down, which has an intrinsic heating effect on the economy.
Income tax does not have these effects and so we have to rely on the overly harsh interest rate cudgel that the Federal Reserve uses to beat down the economy — which we are now experiencing, yet again.
Further understanding of the point can be attained by appreciating the Theorem of Proper Taxation, which is:
The Theorem of Proper Taxation
The Theorem of Proper Taxation consists of four assertions:
1) The purpose of national taxation is to control inflation.
2) The only time money causes inflation is when it is spent.
3) Therefore, the only time nationwide taxes should affect is when money is spent.
4) Ergo — consumption taxes are far preferable to income taxes
The Theorem is discussed further here: https://trillionstrillions.medium.com/optimizing-growth-theorem-of-proper-taxation-and-why-we-should-prefer-consumption-taxes-over-4e39d746a079?source=friends_link&sk=7e4b86ab5fa388524818ed8a94ea7b0b
National taxes should not be thought of as a mechanism to fund the government. National taxes are a way to compensate the economy for the inflationary effects of consumption.
Taxing income to control inflation is ridiculous, because income can be hidden and the real cause of inflation, consumption, is unregulated.
Two additional articles I wrote complete the argument, the first is an elaboration on why consumption taxes are better and the second is a mechanism to prevent untaxed capital flight as well as advantage domestic industries and workers:
In summary, if we want a more robust economy, a more stable economy and an economy that works for the average citizen, the first step is to abolish the national income taxes and move to a consumption tax.
The only hard part you have to get over is rebating the consumption taxes to lower income groups.
Subtle points:
1) Nominal consumption tax does not equal nominal income tax. If you earn 100K and have a 50% income tax, you have 50K of spending power. In a consumption tax regime, you need a 100% consumption tax to reduce 100K of income to 50K of purchasing power. A 50 percent income tax equals a 100% consumption tax.
2) Black market profits currently do not pay income tax. In a consumption tax regime, those profits, when spent, would pay consumption tax, so unless they were smuggled out of the country, they would pay their fair share.
3) Informal employment that is not reported to the government does not pay income tax, giving it an advantage. In a consumption tax regime, informal employment would be disadvantaged, since it would not receive the consumption tax rebate for poor people. This would provide an incentive to workers to become formal documented workers.
4) The true cost of things is not hidden with a consumption tax. With an income tax, you are usually deprived of the money before you get it, so you do not calculate it as part of the cost. With a consumption tax regime, the true cost is obvious, as you add the consumption tax to your purchases.
5) Consumption tax also discourages excessive real asset speculation. In an income tax environment, investors can buy up real estate, bidding it up, and only have to pay local taxes. In a consumption tax environment, the investors would have to pay consumption tax on each capital outlay, significantly increasing their cost and significantly discouraging the activity.
This is extremely relevant to our current situation of repeated housing bubbles and busts.
Excessive real asset appreciation is economically useless since it disadvantages the productive sectors of society and advantages those who genuinely produce nothing.
6) If you can accept that income tax promotes the appreciation of real assets, which is an effective tax on anyone everyone who needs a place to live and therefore, in terms of its systemic effects, extremely regressive ; if you can accept that consumption taxes discourage the accumulation and appreciation of real assets, which in terms of the systemic effects, is extremely progressive; then you are in agreement that income tax is regressive and consumption tax is progressive — which is the exact opposite of the orthodox view.
We need to dump the income tax and move to consumption taxes.
References:
1) https://www.taxpolicycenter.org/statistics/household-income-quintiles
