Brad DeLong's Semi-Daily Journal: A Weblog

I had heard that Graetz had pitched his proposal to O'Neill, so I'm intrigued to see it written up here. This makes for interesting reading, but it's not clear that it really has any relevance to what Bush might do in a 2nd term. This is a policy analysis document written for O'Neill, and we know that neither O'Neill nor policy analysis were taken seriously by anyone with any pull in the administration.

Remember that with Bush, you are either for him or against him. So if you are for any sort of tax overhaul plan, Bush will interpret that to mean that you are for his plan (or else you might become a flipflopper). There are certain things that the American people should not entrust this president to do and drasticallly alter the tax cut is one of them. Note this is not an argument that the tax code needs no reform. It is an argument that no reform is likely to be a far less odious choice than a reform drawn up by the Bush administration. Just say no.

I haven't read through those pages yet, but I will try to at some point. I have to wonder, though, how can a consumption tax be really progressive?

"I have to wonder, though, how can a consumption tax be really progressive?"

At the (serious) risk of being corrected by my betters :^), take a macro-like approach and calculate consumption rather than taking a sales-tax sort of view. Start with your income, earned and unearned. Add in any money that you borrow or dissave (remove from an "investment"). Subtract out money that you save (put into an "investment"). What's left must be "consumption". Tax that consumption in a standard progressive sort of way -- 0% on the first $10,000, 20% on the next so much, 40% on the rest.

Most of the figures needed are already provided to the federal government by employers, brokers, and financial institutions. There will be issues around defining investments -- any sort of savings account (including IRAs and such) certainly is, a house probably is, a car probably isn't. There's a fairly obvious way to handle the problem with double taxing wealth that has been accumulated outside of tax-sheltered accounts: when we change the tax strategy, you add up your non-sheltered money and that sum is available for you to use as "deductions" against your consumption total until it's gone.

This also avoids one of the biggest points of contention for most progressive sales taxes -- there's no differentiation between necessities and luxeries, the rates are based purely on the total amount of consumption.

I appreciate the theoretical merits of not taxing savings. But what's the magnitude of the incentive effect? The vast majority of foregone tax revenue will be on savings that would have happened anyway. How many thousands of dollars of tax revenue must be given up to get an extra thousand dollars of savings that would not otherwise have happened? And how much of that extra savings will actually go into new investment, as opposed to just bidding up prices on the existing stock of wealth?

A prime tenet of liberalism is a concern for others, and in that spirit, I offer a favorite conservative subject revised liberal style -- the flat tax.

First, revise the most punitive and unfair tax, Social Security. Exempt the first $10,000, then, flat-tax all income. Apply a generous means test for benefits eligibility, assets of $15M, or income of $200K would disqualify yearly. It's supposed to be a social safety net insurance -- run it that way.

Now, the income tax. There are few deductions: The first $15,000 income, additional $10,000 per dependent, other taxes paid, charity and social beneficiaries, maybe medical expenses, maybe mortgage interest.

Retain a high threshold inheritance tax: $10 million each recepient?

Corporate and business taxes are similar, few deductions beyond R/D and charity/social work.

Each Congress sets a two-year tax rate.

Bush's current policies simply don't respect salary or wages -- this will equate all income. Deficits or surpluses will be planned. State income taxes address the infrastructure. The true costs of our health care aren't yet decently allocated. The costs of defense, social programs, health care and infrastructure will be more open.

The Republicans may find that they have made a grave mistake by opening up tax reform to a genuine public debate, because the results will undoubtedly be more progressive.

how can a consumption tax be really progressive?

Easy. Start with a graduated income tax. Allow unlimited IRA contributions with no penalties for early withdrawal. What you are left with is a sytem that taxes income when you spend it, not when you earn it. Ergo, a progressive consumption tax.

Neither Michael nor Luke has addressed the point that subtracting investment from the tax base is itself regressive: the rich benefit more because they have greater discretionary income available for saving. Applying a progressive rate to the remaining base is helpful, but hardly ensures overall progressivity. Since this is the (or at any rate my) major liberal concern about a consumption tax, and Prof. DeLong appears to think it can be overcome, I'd be very interested in a sketch of how--given all the other benefits of a consumption tax.

Part of whether you think a flat tax can be progressive depends on whether you think the relevant income for determining progressivity is current income or lifetime income.

College kids (who have low current income and high lifetime income) will spend a greater share of their current income than middle-aged retail sales clerks. The same is true of relatively well-off retirees.

In short, a consumption tax appears more progessive in the context of lifetime (permanant)income than current income.

Adrian wrote, "Neither Michael nor Luke has addressed the point that subtracting investment from the tax base is itself regressive: the rich benefit more because they have greater discretionary income available for saving. Applying a progressive rate to the remaining base is helpful, but hardly ensures overall progressivity."

Exactly.

There's obvious tension between progressivity and revenue neutrality. I've argued with Luke Lea about these issues in the comments to this page:
http://angrybear.blogspot.com/2004/09/tax-simplification-as-cure-to-all-ills.html

For what it's worth, Slemrod and Bakija give the USA Tax (which is the consumption tax Lea is referring to) very mixed reviews in their useful primer _Taxing Ourselves_ (second edition).

Other problems with the USA Tax (the consumption tax favored by Lea):

(1) Truth-in-advertising: It's not a pure consumption tax. It has a small VAT.
(2) Transition: something will have to be done for the elderly, who accumulated savings under the current income tax regime and would effectively be taxed twice.
(3) Avoidance.
(4) Fairness: the tax continues the mortgage interest deduction and, as far as I know, doesn't tax the imputed rent involved in owning a home. This discriminates against those too poor to own a house, and in addition continues the current market distortions favoring home ownership over renting.

Finally, I have yet to see *any* reference to a detailed analysis of whether the proposed rates would be revenue neutral and what their distributional impact (impact on people of varying incomes) would be. All I got from Lea was an argument from authority, namely that the two congressmen who were behind the USA Tax were serious legislators.

I just enjoy watching all the talking heads on CNBC rave about how great it would be to copy our tax systym on the "French" system.

"The keys to the debate are to note (a) that a very solid majority of economists would enthusiastically endorse a shift toward a consumption tax that preserved (or increased) total revenue and that preserved (or improved) the progressivity of the tax code"

It has been so long since I took economics that I acorns have grown into oak trees. I am genuinely puzzled about this. One argument for cutting taxes is that it increases the disposable income available to citizens to save (creating capital that fuels growth) or spend (consuming the capacity produced by growth.)

I keep reading that the US economy is sustained by consumer spending. But why won't a consumption tax discourage consumer spending?

I don't understand why there isn't a Kerry commercial out there attacking Bush on his National Sales Tax idea. It would CREAM Bush. Kerry wouldn't have to explain much about how it worked or how regressive it would be.

Just the mere mention that Bush has been planning to add a "new tax" to our landscape would hurt Bush badly. Bush would have to explain it away, in terms of getting rid of the income tax and all that. It would be fun as hell to watch that.

KE04... are you listening???

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The tax cuts that have already been passed, along with the fast increasing problem of the Alternative Minimum Tax, which must be fixed, have assured there will be a growing structural budget deficit.

We have a serious problem looming and I can not imagine how the coming Congress could chance enacting massive tax reform. The coming Congress will be extremely reluctant to add to tax revenue, while the AMT problem will have to be fixed. Likely the AMT problem will be fixed, taxes will in effect be lowered, and the deficit will be allowed to grow faster than general economic growth.

http://www.nytimes.com/2004/09/10/opinion/10krugman.html?hp

Question from Paul Krugman's article:

"Paul Volcker, the former Federal Reserve chairman, says there's a 75 percent chance of a financial crisis in the next five years."

When Paul Volker speaks of a high chance of a financial crisis, what might set off such a crisis and where are we most vulnerable? Is the issue here entirely the growth of public and private debt?

To any tax-reformer: Under your proposal, who will pay more, and who will pay less? (If the rich pay less, then your proposal sucks.)

Ignorant but Curious Newbie wrote, "I keep reading that the US economy is sustained by consumer spending. But why won't a consumption tax discourage consumer spending?"

It will, insofar as it will favor saving over consumption.

However, the impact of any tax isn't as simple as it seems---one has to consider the incidence of the tax. A classic example is the employer-side payroll tax, which is nominally remitted by the employer, but which most economists view as actually falling on the employee (in most labor market situations).

http://www.pbs.org/wsw/tvprogram/

John Rutledge:

[I]f Bush is re-elected, he's going to make another try for the zero dividend tax, and the zero dividend tax is probably worth about a trillion dollars in the stock market.

Imagine the idea of no dividend tax. Already dividends are taxed more favorably than interest. Dividends are taxed at 15%, while interest is taxed at your income tax bracket. The more you lower dividend taxes, the more wealthy Americans will secure dividends as opposed to interest on bonds. Congressional majority leaders would also like to end the capital gains tax. So much for tax reform that does not lose revenue.

Ownership society in a country where a Texas utility has decided to charge higher rates to customers who have the lowest credit scores?

I keep hearing about a progressive comsumption tax and I wonder, ¿has anyone seen this mythical creature? I have to ask because I live in a country where most tax revenue is generated by comsumption taxes (Uruguay) and believe me, it's really regressive. I support a political party (which is close to winning next elections) and we are looking for a way to make the system more progressive. ¿Does anyone know of a working, functioning tax system that has the following features; a) it's progressive b) personal income taxes are inexistant or small c) most of the revenue comes from comsumption taxes.?

All of these "consumption" taxes assume that the economy is critically short of investment capital. Idea is that people invest instead of spending, money goes to expand or start businesses, businesses hire more people, everybody wins. This is basic supply- side economics.

Unfortunately, the basic premise is demonstrably false. There is no shortage of investment capital. Look at interest rates; Alan Greenspan is practically giving away toasters at the Fed.

So let's turn the consumption tax around and make it an "investment tax" and see what happens. Tax *only* accumulated capital. Lets see: poor and elderly people spend most of their income and pay little if any tax. As income goes up, people put a larger portion of their income into investments and pay more tax. People buy more Stuff, which encourages business to expand and hire more people. Everybody wins. Demand side instead of supply side.

So both wlll win in certain economic circumstances -- supply side when capital is dear, demand side when it's cheap. So howabout we campromise, and just tax income? Simpler all around.

"So let's turn the consumption tax around and make it an 'investment tax' and see what happens. Tax *only* accumulated capital. Lets see: poor and elderly people spend most of their income and pay little if any tax."

Unless a relatively large amount is made exempt, the aging upper middle class take it in the shorts. I'm one of them. I've worked hard for 25 years, lived frugally, invested carefully, had some luck regarding pensions, and managed to accumulate enough wealth that I may be able to retire in reasonable comfort one of these days. Some of it's my paid-for house, some of it's in tax-deferred accounts, some is just savings. Now you're going to tax my principle? At what rate? 5%? That's as high, or higher, than the generally accepted "safe withdrawal rate" for an IRA. Are you going to bump my property tax up to the same rate? I pay a bit under 1% of the value of my home in property tax each year already -- at 5%, I'll never be able to afford to keep the house.

No tax on principal, just interest, if it's reinvested. As to what rate, we'll have to talk to the accountants. Keep in mind that the over- $300,000/year set does a *lot* of investing.

Point is, it's not completely ridiculous, like a strict sales tax or a strict payroll tax. And somebody is *always* gonna get it in the shorts. The way it's going now, its all of us, when the East Asians decide they don't want to loan us any more money.

"Pam Olson's people seem to have done a good job ... at saying why you would want to do fundamental tax reform -- efficiency, fairness, simplicity -- and how various options would or would not achieve these goals.

"The keys to the debate are to note (a) that a very solid majority of economists would enthusiastically endorse a shift toward a consumption tax that preserved (or increased) total revenue and that preserved (or improved) the progressivity of the tax code, yet (b) one has to think that the White House's principal concerns are to (i) make the tax code less progressive and (ii) to further widen the deficit. "
~~~

Let's make this clear:

Since the Administration's people have done a good job of saying what we would want to do with fundamental tax reform, and a very solid majority of economists would enthusiastically endorse a shift towards the substance of their proposals, the "key to the debate" now is to assume their proposals are motivated by evil intent and the desire to do ill. "One has to think that", right?

Of course! That's the SOP, isn't it?

Jim Glass wrote, "the 'key to the debatek now is to assume their proposals are motivated by evil intent and the desire to do ill. 'One has to think that', right?"

No, one doesn't *have* to think that; but if one wants to have an accurate model of the world, it'd be advisable.

"Of course! That's the SOP, isn't it?"

Speaking of standard operating procedure---yours seems to be that of quoting grossly, wildly out of context:
http://groups.google.com/groups?selm=xzZWc.269%24Cc.239%40trnddc07

In most of Europe there is a hefty consumption tax called VAT (value added tax). It shows that

(a) governments enacted this tax without much of penalty in elections

(b) if a regressive indirect taxed is combined with a progressive income tax and progressive distribution of benefits, there is not much to complain about.

Of course, Busheviks want to combine regressive indirect tax with regressive direct taxes (FICA, exemptions on dividend income, special rate for capital gains etc.) and reduction in progressive distribution of benefits.

One (not me! not me!) can justify that approach as follows: it is a sound policy to encourage healthy behavior and discourage unhealthy one. All relevant studies show that the rich are healthier than the poor. Thus we should use the tax laws to encourage being rich and discourage being poor.