The voices of Tax Policy Center's researchers and staff
Maybe it’s just because Congress is on spring break and tax wonks don’t have much to talk about, but suddenly the idea of a consumption tax is getting a new look. The tax plan proposed earlier this month by senators Mike Lee (R-UT) and Marco Rubio (R-FL) is one form of the levy. And tax journalists are combing out the pros and cons of the model (see this piece in Vox and this one in The Wall Street Journal). Could policymakers, who are going nowhere in their efforts to reform the income tax, cut the Gordian knot with a consumption tax?
The answer is probably no, at least not any time soon. If you think fixing the income tax is hard, just try to win political support for the kind of changes you’d need to build a consumption tax. How about taxing health care? Or eliminating the business deduction for interest costs?
That’s not to say that a tax on consumption is a bad idea. Not at all. Most economists believe that, of all the reform ideas, it might have the best chance of boosting economic growth. After all, if you think the future of the U.S. economy depends in large part on savings and investment, it makes sense to reduce taxes on those activities. That's why the idea of a consumption tax has been floating around Washington policy circles for decades.
But before you get too giddy about its immediate future, consider a few issues.
It isn’t an either/or choice. Yes, we currently have what we call an income tax. But it already has many elements of a consumption tax. For instance, trillions of dollars in retirement savings are tax-free. And we allow many firms to write off the cost of capital equipment in the year it is acquired. Both of these are hallmarks of a consumption tax. Similarly, whatever new tax Congress finally adopts would likely include elements of an income tax, even if it becomes more consumption-based.
The fairness challenge. Many proponents of a consumption tax promote its fairness. For instance, GOP presidential hopeful Senator Ted Cruz is backing a single-rate levy dubbed the Fair Tax by its promoters. But in the real world, this idea is impossible. Such a tax would be hugely regressive, giving the rich a big tax cut while substantially raising taxes for low- and middle-income households (who by necessity spend far more of their income than the wealthy). This makes neither political nor economic sense. To get a rough idea of the distribution of a consumption tax, take a look at the Tax Policy Center’s analysis of GOP 2012 Presidential candidate Herman Cain’s 9-9-9 plan.
The fairness problem is not insurmountable. For instance, one way to fix it would be by giving most households a tax credit to offset the tax on consumption. See Michael Graetz’s Value-Added Tax and TPC’s analysis of it for how this could work. A consumption-based income tax could also employ multiple rates for individuals, but such a design would detract from the political appeal of that flat rate.
Simplicity: A VAT or other consumption tax can be far simpler than the current tax code. But, sadly, it probably would not be once Congress got done with it. There is no reason to believe that lawmakers could leave a pure consumption tax alone. Just as it does regularly with today's income tax, Congress would likely add exceptions and special interest goodies—either in the name of fairness (see above) or competitiveness.
The politics. The politics of tax reform is all about winners and losers. Just ask Dave Camp. Any version of a consumption tax would create vast numbers of both. And the losers already have their talking points. For instance, it would take VAT critics five minutes to cry that this tax would raise the cost of….(food, health care, housing-- just fill in the blank with your favorite form of consumption) by double-digits. This, of course, ignores the fact that consumers would have more money in their pockets because they no longer owed income tax. But never mind.
None of this is to say a well-designed consumption tax is a bad idea, or that reformers should not take a hard look at the concept. They should, and they could vastly improve the revenue code by incorporating elements of a consumption tax into whatever reform they eventually draft.
But the idea that a consumption tax will solve all of the political and substantive problems of tax reform is as evanescent as Washington’s cherry blossoms. Once Congress returns, it will blow away with the first stiff breeze.
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