During yesterday’s Rose Garden speech, President Obama presented a plan for cutting the deficit that relies heavily on increasing taxes for high earners. Among other things, the president made the case for the Buffett Rule, designed to guarantee that households earning $1 million or more in any given year don’t pay less in personal income taxes than a middle income household. One potential problem is that not every millionaire household is the same. While some millionaires fritter away most of the money they earn on fine wines and diamond-encrusted SUVs, others save and invest the bulk of their income, thus contributing to overall economic growth. It should be obvious that we want to encourage savings and investment and discourage excessive consumption, particularly if we want the U.S. economy to flourish in a more competitive world. But the current tax code does the opposite, and the president’s proposals could make matters worse.
There is, however, another way forward. Economists from the left, like Robert Frank of Cornell University’s Johnson School of Management, and from the right, like Mitt Romney adviser and Columbia Business School professor Glenn Hubbard and Alan Viard of the American Enterprise Institute, have called for a progressive consumption tax that would eliminate taxes on savings and investment. Rich spendthrifts, who spend every dollar they have in the present, will wind up paying taxes on their total income, as per usual. Rich penny-pinchers, who use their hard-earned money to help grow new businesses, will only pay taxes on what they actually spend.
This could mean that a penny-pinching millionaire household will pay a smaller share of its income in taxes than a middle-income household in some years, thus violating the Buffett Rule. But when those rich penny-pinchers decide to spend down their savings and live the high life, say in retirement, they will wind up paying a much bigger share.
The Buffett Rule presents a huge roadblock to this kind of pro-growth tax reform, and that will leave us all worse off.