NCPA - National Center for Policy Analysis

MAKE WAY FOR THE CONSUMPTION TAX

March 10, 2005

Back in 1977 the notion of a consumption tax wasn't particularly radical. The argument had always been that not only are consumption taxes better for the economy -- they stimulate capital formation, which leads to higher wages in the long run -- but also that they are fairer, says Bruce Bartlett, a senior fellow with the National Center for Policy Analysis.

That's because under a consumption system, people are taxed on what they take out of the economy rather than what they put in via saving and investment. What was radical was coming up with a plan that would work in the real world:

  • Tax theorists had assumed that a consumption system required a quagmire of direct taxes -- excise taxes on gas, say, or state sales taxes.
  • As a result, most serious debates about tax reform in the postwar era centered on comprehensive income taxation; that is, taxing everything but consumption --returns to savings, investment income, even unrealized capital gains.

Economists David Bradford created an alternative that systematically removed saving and investment from the tax base. For example: Saving would be treated like individual retirement accounts, in which it is initially exempted from taxation but the withdrawals are taxed (as in a traditional IRA).

Bradford's ideas have already helped guide Bush tax policy; the reduction in tax rates on dividends and capital gains, and provisions allowing businesses to depreciate capital equipment more rapidly, are all moves towards a consumption-based tax system.

Source: Bruce Bartlett, "Requiem for a tax-reform heavyweight," Fortune Magazine, March 21, 2005.

 

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