Tax Rascal

Sales Tax / Consumption Tax / FairTax — A Good Idea?

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Sales Tax / Consumption Tax / FairTax — A Good Idea?

A New York Times editorial by Robert Frank suggests a higher future tax on consumption in order to pay for higher government spending now. He makes a few good points, but seems to miss the larger picture.

  • It is better to tax consumption than savings, because this encourages responsible behavior. As far as the US tax system is concerned, investing in a startup is as economically useful an activity as buying a huge amount of Fritos (the difference being that if your Fritos turn out to be more delicious than you expected, you aren’t hit with a capital gains tax).
  • It’s not a good idea to raise taxes during a recession, even if you plan for the tax increases to take effect later. Someone who is considering, say, an advanced degree in mechanical engineering might be discouraged by the fact that his future earnings will be taxed, even if current earnings aren’t. Sadly, the people whom this affects the most (the ones who make long-term plans, and stick with them) are also responsible for a huge fraction of total tax revenues.
  • On a related note, defining investment is pretty difficult. A ‘prestige’ stock someone buys so they can look down on people who didn’t (think dot-coms last decade, solar power last year) is more like consumption than investment. But spending countless hours and tens of thousands of dollars getting a masters degree can be a very valuable investment. Even countries that use consumption taxes often find themselves fiddling with the details.
  • Finally, it’s crucial to realize that improving the tax code will, at best, mitigate harm and not add benefits. If we’re spending money (Frank cites a $300 billion stimulus plan), this money comes from somewhere, and if (Frank again) the burden on the middle class goes down, the burden on the rich must go up. That might be the right thing to do — perhaps when the top 1% pay only 40% or so of the tax burden, they’re getting away with too much — but it’s not a good idea to gloss over it.

Frank’s proposal is a fine start, and it’s probably a good thing for Americans to be talking about a consumption-based tax system rather than a savings-and-consumption tax. But such a complex issue requires clear writing and clear thinking, and Frank offers neither.

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