My column in tomorrow’s issue of The Daily is about the president’s proposed new Buffett Rule, and I’ll be sure to share the link with you tomorrow. For now, I’ll just say that the president’s call for a large increase in taxes on high earners strikes me as badly misconceived.
It did, however, remind me of the virtues of a progressive consumption tax, a proposal that President Obama essentially ruled out in his Rose Garden speech. I’ve long been a fan of the X tax, which Glenn Hubbard and Alan Viard, who has co-authored a forthcoming book on the subject, have championed, among others on the right. Yet it’s not just conservatives who are drawn to a progressive consumption tax. Robert Frank, who is known for positing the theory of “expenditure cascades” as the mechanism through which income inequality negatively impacts the middle and working class in any given society, has also made the case for it, in a 2008 essay in Democracy Journal and elsewhere. The following is from Frank’s essay:
Replacing the current income tax with a progressive consumption tax is the only way to cover our current revenue shortfall without demanding painful sacrifices from voters. Such a tax, which has been proposed both by conservative economists like Milton Friedman and liberal economists like Edward Gramlich, would be simple to implement. Families would report their incomes and their annual savings to the IRS, just as many now do with 401(k) and other similar retirement savings accounts. Their taxable consumption would then be calculated as income minus savings minus a large standard deduction–say, $30,000 for a family of four. For example, a family that earned $50,000 and saved $5,000 during a given tax year would have taxable consumption of $50,000–$5,000–$30,000, or $15,000 total. Tax rates on taxable consumption would start off low–say, 10 percent for the first $30,000 of taxable consumption. Under the consumption tax, this family would owe $1,500, about half of what it would pay under the current income tax.
Because the progressive consumption tax exempts savings from tax, it cannot generate even the same revenue as the current income tax unless marginal rates on the highest consumption levels are significantly higher than the highest current rates on income. But higher marginal rates would be problematic under the current income tax, because they would undermine people’s incentives to save and invest. In contrast, higher marginal rates on consumption, as opposed to income, would actually encourage savings and investment.
Moreover, a steeply progressive consumption tax would raise additional revenue without causing significant reductions in consumer welfare. For families that already consume at a high absolute level, evidence suggests that psychological well-being depends much more on relative consumption than on absolute consumption. By encouraging an across-the-board reduction in high-end consumption, a progressive consumption tax would thus have little effect on the relative consumption levels that shape well-being. [Emphasis added]
In the years since Frank published his essay, we’ve grown more concerned about global imbalances and America’s persistent current account deficits. A progressive consumption tax might contribute to redressing that problem, among others.
Moreover, a progressive taxation gets at the spending behavior that I suspect motivates popular objections to the existing tax code on fairness grounds. The notion that wealthy taxpayers aren’t paying their fair share derives, I suspect, more from an unease regarding high levels of consumption among the rich rather than high levels of wealth accumulation per se, though of course there is an ideological minority that does object to wealth accumulation or normative and what we might characterize as democratic grounds.
Will Wilkinson addressed these themes in a post on Frank published last year:
It should be noted, however, that a Frank-style progressive income tax does nothing on its own to reduce income inequality. And it reduces consumption inequality by goading the rich to save more and spend less, straightfowardly leading to an increase in wealth inequality. Too many commentators naively suppose that all dimensions of inequality wax and wane together, but it is not so. The great virtue of Mr Frank’s argument is that, unlike most champions of equality, he specifies the relevant dimension of inequality, posits a mechanism through which it does its alleged ill, and offers a policy remedy that plausibly reduces harm by keeping the mechanism in view. Better still, Mr Frank offers a proposal that is attractive even to sceptics of his particular theory about inequality, creating the possibility of compromise across philosophical lines.
I’ll add that a progressive consumption tax might also be part of an effort to rethink the structure of Social Security, as I suggested earlier this month.