Should the United States Move to a Consumption Tax?

August 26, 2013

Would-be tax reformers on Capitol Hill are taking a "blank slate" approach to the issue. Dave Camp and Max Baucus, the House Republican and Senate Democrat in charge of the tax law committees, say that every tax break is on death row unless a strong case can be made for it. This method rightly recognizes that not all tax breaks are the same: Some of them have better justifications than others. What the blank-slate approach misses, though, is that not all supposed tax breaks are even tax breaks, says Ramesh Ponnuru, a senior editor for National Review.

The tax-reforming duo counts the deferral of taxation on contributions to 401(k) retirement plans as a tax preference, for example, and thus something that is presumed to be a bad idea until proved otherwise. But plenty of economists would argue that this provision of the tax code isn't a break at all. In their view, we should tax income when it is consumed.

  • Taxing savings instead creates a bias in favor of consumption today over saving for consumption tomorrow, and even more over saving for consumption the day after tomorrow.
  • So the alleged tax preference for 401(k) plans isn't a "break" in the sense of a departure from the ideal tax base. It's a partial corrective for a tax code that doesn't define the base properly to begin with.

Fewer economists would defend the tax credit for children, which reformers also sometimes put on the chopping block. Yet it too should be seen not as a break but as another partial corrective to a bias in federal policy, which is a bias against the investment we call parenting.

  • This bias is a side effect of something that most people consider a blessing of modern life: government programs to take care of the elderly.
  • Before such programs, provisions for the elderly usually took the form of a generational bargain within families, and then parents took care of their children before they grew old enough to work, and they were in turn taken care of when they grew too old to work.
  • Entitlements (in the United States, Social Security and Medicare) socialized this bargain but didn't erase it.
  • We depend on the next generation, collectively, to take care of us in our old age. But we don't all contribute to the same degree in raising the next generation.

Tax reform should move us in the direction of taxing consumption rather than saving and investment. It's important to remember, though, that investments don't just include stocks and bonds and factories. Tax reformers should pay at least as much attention to the most important investments in the future that most people ever make.

Source: Ramesh Ponnuru, "Raising Kids? Your Taxes Are Far Too High," Bloomberg News, August 19, 2013.

 

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