Conservatives for Consumption Taxes?

by Reihan Salam

My Economics 21 colleague Chris Papagianis has an article on the broader implications of the corporate income tax reform debate:

The pivot away from discussing taxes on income and toward consumption is a logical extension of the current corporate tax debate. The more you cut back deductions and broaden the base, the more the current corporate tax regime will resemble a consumption tax. In many respects, a value-added tax (VAT) is the same as a corporate tax where the only allowable deduction is for the cost of inputs (i.e., materials for production or manufacturing). Put another way, corporations are taxed on sales minus deductions today. If most or all deductions are eliminated, then just sales are left. At the risk of oversimplifying, all that really separates the corporate income tax from a sales tax are the current deductions and credits.

There is already a champion for a business consumption tax (BCT) in the House. While most have forgotten, Rep. Paul Ryan proposed replacing the entire corporate tax code with a BCT in his Roadmap for America’s Future. Ryan’s version would have businesses determine their tax liability by subtracting total purchases from total sales. The BCT is then applied to the net receipts figure, which is also a way of expressing the added value contributed by the company.

As 2012 unfolds, look for conservatives to start wrestling with the pros and cons of a business consumption tax. While some conservatives are in favor of a flat tax on the individual side, others remain skeptical of relying on any VAT-like tax regime if that means it will then be easier for the government to raise revenue in the future to support a larger (and growing) government footprint. This discussion could lay the groundwork for a broader negotiation on consumption taxes in 2013, one that also covers the individual side of the tax code. (See David Bradford’s on the “X Tax”.)

This is a debate worth having. And Rep. Paul Ryan is set to lead (just as he has on Medicare) on designing a tax system that allows the economy to allocate resources efficiently and that isn’t biased against the future by discouraging savings, investment and economic growth.

One wonders if Michael Graetz’s Competitive Tax Plan, which replaces the current federal personal income tax with combination of a 10-15% VAT and a single- or dual-rate income tax limited to high-earners, might eventually win favor. Anti-VAT sentiment has meant that the plan hasn’t really stood a chance. But if broad-based consumption taxes become new normal, why not use it to eliminate personal income taxes for the vast majority of households? A key part of the plan would be to make the approximate amount paid in VAT visible in all transactions, which will help prevent stealthy increases. 

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.