April 8, 2002
Throughout most of American history, taxes were levied principally on consumption, rather than income.
What are the advantages of consumption taxes?
- Alexander Hamilton said "It is a signal advantage of taxes on articles of consumption that they contain in their own nature a security against excess....If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great as when they are confined within proper and moderate bounds."
- Confining taxation to a form that is inherently hard to raise to excessive levels meant that the size of government would be severely limited.
- Another advantage of consumption taxation is that it does not double tax saving as income taxes do (by taxing interest or dividends as well as wage income).
However, in the 1960s, the Europeans developed the valued-added tax (VAT). It is collected from producers, rather than retailers, and is included in the prices of goods, rather than being collected separately at the checkout. Now some European countries have VAT rates as high as 25 percent on top of their income taxes. The United States is now the only major country on earth without a VAT tax, and U.S. consumption taxes are a smaller share of government tax revenues than in other developed countries (see figure).
In a new book, "Fair Not Flat" (University of Chicago Press), Edward McCaffery argues for a consumed income tax -- it looks like an income tax, but actually falls on consumption.
McCaffery would remove taxation from saving by allowing people to have saving accounts like Individual Retirement Accounts, except with no restrictions. All net contributions would be fully deductible on one's tax return, and all withdrawals would be taxable.
McCaffery argues that this would give the U.S. a de facto consumption tax without the problems inherent in taxing consumption directly.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, April 8, 2002.
For McCaffery's new NCPA tax study
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