Sunday, April 18, 2010

The VAT is not the only simple consumption based tax

In a post on Friday Bruce Bartlett wrote:
That being the case, it makes sense to raise those revenues, which will be raised in any event, in a way that is least damaging to the economy. Hundreds of years of analysis show that a broad-based tax on consumption is the best way to do that and a VAT is simply the best form of such tax ever invented.

No economist I know of denies this.
Well, then Mr. Bartlett doesn't know of many economists, or a very wide range.

First, the vast majority of economists expert in this area (real economists with PhDs) will tell you that the least economically harmful way to tax is to tax negative externalities and activities, like pollution and cigarettes. Here the harm from the tax is negative. The tax does good in addition to raising money; it increases efficiency and total societal utility. Here's an example of an obscure economist few have heard of speaking in favor of externalities taxes, Nobel Prize winner Paul Krugman.

Second, many economist don't like that the VAT, unlike the income tax, is completely unprogressive. And you just absolutely don't have to be unprogressive to have a tax that is consumption based and simple. This can be done with a straightforward direct consumption tax, as explained by another obscure economist, New York Times Economic View columnist and Cornell professor, Robert H. Frank. In a 1999 Washington Post Op-Ed Frank wrote:
...We can do this in a powerful yet unintrusive way by scrapping our current income tax in favor of a more steeply progressive consumption tax. Such a tax would be straightforward to administer: Each family would pay tax not on its income, but on its total spending--as measured by the simple difference between its annual income and its annual savings.
And precisely because this tax is (steeply) progressive, it also accomplishes point 1: It increases efficiency by taxing externality costs, chiefly those of the colossal positional/context/prestige externalities. In fact, this is the key point Frank makes in the Op-Ed I cite above. Mr. Bartlett, if you really are open minded as you say, then you should read it.

For more on taxation, I suggest starting here.