Income versus consumption taxes
In a commentary last fall in the NY Times, Robert Frank makes the case for consumption taxes to replace the income tax in the US. Yet, while this sounds revolutionary on first reading, what Frank is describing is essentially the Canadian tax system:
Under such a tax, people would report not only their income but also their annual savings, as many already do under 401(k) plans and other retirement accounts. A family’s annual consumption is simply the difference between its income and its annual savings. That amount, minus a standard deduction â€” say, $30,000 for a family of four â€” would be the family’s taxable consumption. Rates would start low, like 10 percent. A family that earned $50,000 and saved $5,000 would thus have taxable consumption of $15,000. It would pay only $1,500 in tax. Under the current system of federal income taxes, this family would pay about $3,000 a year.
As taxable consumption rises, the tax rate on additional consumption would also rise. With a progressive income tax, marginal tax rates cannot rise beyond a certain threshold without threatening incentives to save and invest. Under a progressive consumption tax, however, higher marginal tax rates actually strengthen those incentives.
I had thought the US system was much like the Canadian one, in allowing deductions for retirement savings (401k there, RRSP here). And of course there is no federal consumption tax in the US. In Canada, generous deductions for RRSPs are such that only families with incomes in six digits have a chance at maxing out that deduction.
As tax economist Jon Kesselman points out this means we already have a largely consumption tax based system, some of it administered through the income tax system, some at the cash register. Here is Kesselman in recent testimony to the House of Commons Finance committee (no link as he sent me these remarks electronically):
[A]n economically efficient and socially equitable taxation system hinges on its overall structure and design â€“ not on its overall level.Â Other countries have applied taxes at levels significantly higher than Canada while still attaining very good levels of productivity growth and enviable standards of social programs. The key to achieving an efficient and growth-oriented tax system â€“ whatever the desired overall level of taxes and size of government â€“ is to shift the taxable base further toward consumption and labour income and away from capital and investment income.
… Canadian governments at both the federal and provincial levels made significant progress in pushing the tax system in the desired direction, and further constructive changes have been made in the four years since .Â Some examples include large reductions in corporate income tax rates, reduction and elimination of corporate capital taxes, expanded allowances for depreciation of business capital, modest reductions in personal tax rates, and the introduction of Tax-Free Savings Accounts.Â All of these measures move the tax system further toward consumption-based levies and away from income- and capital-based levies.
That said, Kesselman’s argument is a theoretical one rooted in the flawed “savings leads to investment” model. But as an empirical matter, it is far from clear that such shifts have any demonstrable economic benefit (ie any empirical linkage to higher and sustained economic growth or productivity rates). There are huge distributional issues that are neglected in this perspective, and these arguably have a much more profound impact on economic outcomes. Any changes that further expand RRSP ceilings (or new accounts like the TFSAs) tend to be of benefit only to the wealthiest families. Meanwhile, most ordinary families have little or no savings.
Anyway, coming back to Frank’s piece, it is interesting to note that in addition to desires by Paul Krugman and others to emulate single-payer health care on the Canadian model, here is another economist wanting to emulate the Canadian tax system (though we get not credit there). The think is, I doubt it will have the impacts Frank is claiming:
Â If a progressive consumption tax were phased in gradually, its main effect would be to shift spending from consumption to investment, causing productivity and incomes to rise faster.
The biggest benefit would be from higher overall taxation levels if used to finance single-payer health care; that is, the gains are on the spending side not through a more “efficient” tax system.