Consumption tax

Consumption tax.

I've seen a number of different blogs recently mentioning the possibility of a consumption tax - in essence, a federal sales tax.

There is one good thing about a consumption tax, one fallacy, and two problems with a consumption tax.

The good thing about a consumption tax is that it would raise money for a government with a massive, massive deficit. I've talked about this a lot, and I won't touch it further.

A major fallacy spread by proponents of a consumption tax is that it would prompt people to save more, which would be good in a society with a (until recently) negative savings rate. The reason this is a fallacy is that unlike choosing between two goods, where you choose one and you've done it, choosing to save is functionally choosing future consumption. On a macro, societal level, people will only choose to save more if a) they can expect to grow their money faster than inflation, which is generally a reasonable assumption but results in a far smaller increased-savings impact than is being touted, and b) if they think the savings tax will go away in the future. Introducing a national sales tax is a big deal, and I don't know if it'd be easy to get rid of once the political system had adjusted to having it. Thus, the saving more argument doesn't hold much water, and it CERTAINLY doesn't make much sense to reduce income taxes along with it.

The first problem is that instituting a consumption tax incentivizes leisure as an alternative. If people choose between leisure and consumption (not working and working, if you will), then making consumption more expensive makes people work less. If people work less, they earn less and spend less, which means on a tax basis, the consumption tax won't raise as much as the government thinks, income tax receipts will drop, and GDP/standard of living rate of improvement will drop.

The other problem is one of incentivizing saving. A new consumption tax punishes people who chose to save not expecting a consumption tax who would have otherwise spent more in prior periods. If we need the US savings rate to be higher, then setting a precedent of punishing savers for not expecting government profligacy makes it less likely the public will save, not more, as we see increased risk of increasing consumption taxes in the future to offset a ballooning national debt.