Even though a progressive income tax system is better than a flat or regressive tax code (as I recently argued on PolicyMic), it does have many drawbacks. Income taxes at high enough levels discourage work, while taxes on investment discourage savings, though conservatives often exaggerate the extent of these distortions. The economist Robert Frank has a better alternative: the progressive consumption tax.
The progressive consumption tax would operate under a system similar to our current tax structure with a few key differences. You'd report your income and savings to the IRS. Then, using the formula "Income - Savings = Consumption," you'd calculate your total consumption for the year. After subtracting a deduction at the "basic necessities" level of consumption, you'd arrive at your taxable consumption. Rates would start very low and rise steeply from there.
What's so great about the progressive consumption tax? First, unlike income and capital gains taxes, the progressive consumption tax would discourage neither work nor savings. For example, consider the effects of a 100% marginal tax rate on income and consumption. If the government taxed your income at a top marginal rate of 100%, you'd almost assuredly stop working before entering that bracket. But, what would happen if the government taxed your consumption at a top marginal rate of 100 percent?
Robert Frank has an illustrative example: "Consider, for example, how the tax would affect a wealthy family that had been planning a $2 million addition to its mansion. If it faced a marginal consumption tax rate of 100%, that addition would now cost $4 million—$2 million for the job itself, and another $2 million for the tax on it."
In other words, the only thing a progressive consumption tax would discourage is conspicuous consumption. Under this system, Donald Trump may be less likely to spend money on gold-plated seat belts for his private jet, but there's little reason to think that society would be much worse off overall with fewer private jets, yachts, and multimillion dollar mansion additions.
But, the progressive consumption tax is not perfect. It does have one big drawback that many progressives may not be comfortable with: It would almost assuredly increase wealth inequality. Because wealthy folks would be consuming less and investing more, they'd grow their net wealth even faster than the current pace.
But we should still embrace the progressive consumption tax because its benefits overcome this drawback. The most important kind of inequality progressives should care about is inequality of consumption. When Donald Trump buys gold-plated seat belts, it doesn't benefit the average Joe and that money would probably get more social utility if it were spent elsewhere. But when money is invested, it allows credit to flow through the economy resulting in better goods and services for everyone. This doesn't mean that we shouldn't care about wealth or income inequality at all. Other taxes, like the estate tax, would have to be large enough to ensure that opportunity isn't grossly unequal.
In short, the progressive consumption tax would discourage the kind of zero sum status competitions that don't advance social welfare and result in a lot of wasteful spending. It's a system that's gained support from both liberal economists who like its progressivity and conservative economists who like its effect on incentives to work and save. Last, the progressive consumption tax would be easy to implement because of its similarity to current tax enforcement, and workers wouldn't feel that they're facing a new tax.
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