One of the most persistent questions I get when I write or am interviewed about consumption taxes is how to make them progressive. In most people’s minds, this is either difficult or impossible. Consumption taxes, it is assumed, must be regressive because poorer people spend more than wealthier people on the necessities of life. The tax will hit them harder.
The belief that a consumption tax must be regressive arises from the, very understandable, notion that a federal consumption tax must be levied like a state sales tax. In other words, it would be a point-of-sale tax that would be paid at the time an item is purchased. Some politicians, Mike Huckabee being the most recent example, have advocated this form of taxation. It has its advantages, but one large disadvantage to this particular incarnation of the consumption tax is that it is indeed difficult to make progressive. But there are other ways to accomplish a consumption tax and to do so without moving towards a more regressive tax system.
Here is the most straightforward way to accomplish this. It is similar to the “Unlimited Savings Allowance” proposed by Senators Domenici (R), Kerry (D) and Nunn (D) about a decade ago. Allow all Americans to designate an account or set of accounts “Unlimited Savings Accounts.” These accounts, much like other tax-sheltered vehicles, could contain anything (stocks, bonds, CD’s etc.). But, unlike retirement accounts, there would be no restrictions on when or how much money one could put into these accounts nor restrictions on when or how much money one could withdraw. At the end of each tax year the financial service provider at which your account(s) is held would be required to inform you, and inform the government, your total net contributions or net withdraws from the account. Net contributions could be deducted from your income taxes and withdraws would be added to your income taxes. Because there are no restrictions on additions to or withdraws from these accounts everyone would put all of their savings under this tax shelter — there would be no reason to do anything else. Only money that you did not save would be taxed under the current income tax system. You can make the marginal tax rates on that income as progressive as you would like; set the top tax bracket to 50% or more if that makes sense. My point is not to suggest what that rate should be, but to point out that you can engineer a de facto consumption tax that is highly progressive, high regressive or anything in between.
Are there any problems with this? Not huge problems, but as with any fundamental tax reform you have to think some things through carefully. The biggest issue to solve with this type of tax system is how to treat borrowing. Allowing individuals to borrow and at the same time contribute to this account would lead to some savvy, but socially counterproductive, tax strategies for individuals. But this is a problem that can be solved.
Moving to consumption taxes would encourage savings, discourage conspicuous consumption, increase economic efficiency by building a domestic base of investment capital……and could be done without increasing tax burdens on the poor.