A consumption tax

One of the most frequently discussed public policies are those related to taxes and changes to the tax code. Some say the tax code needs to do more to promote saving, and, therefore, there are big fans of relying more on the sales tax. But critics say the sales tax hits lower-income households harder. Is there a resolution between these two viewpoints? N.C. State University economist Mike Walden weighs in.

“There may be one, and it’s called a consumption tax. Now a consumption tax works like an income tax in a sense that you would have monthly withholding, and you would then file a tax return at the end of the year. But rather than the income tax, which taxes essentially all your income except for deductions and exemptions and credits, only that part of your income that you don’t save is taxed by the consumption tax.

“So in other words , what you would do is take your income, subtract out that amount of money from your income that you maybe put in the stock market, that you buy CDs with, go into an IRA, whatever, and that would leave you technically with that money that you spend. That is consumption. And then that would be taxed. And you could have one rate or you could have several rates.

“Now to handle your point about a sales tax hitting lower-income households more because they tend to spend more of their income: What you could do with a consumption tax is have a very large so-called household deduction. So in other words, if you were under certain levels of income or maybe everyone would be able to take this deduction, that would be a further subtraction from your income. So this would also avoid some of the issues with a sales tax. Or, for example, taxing internet sales or taxing services, since there’s no distinction — you’re not actually specifying what people spend their money on, you’re simply saying everything that you earn other than what you put in investments is going to be taxed.”

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2 responses on “A consumption tax

  1. Frank Kern says:

    Much as the idea is great in theory, would the consumption tax essentially effect the middle income families most – as a greater percentage of their pay packet gets taken up with a combination of essentials and “luxuries” than that of the higher income families?

    The lower income families would be exempt, the higher income families wouldn’t care so much and would probably find loopholes, leaving the brunt of the tax on the majority of Average Joe Americans.

    They would in turn reduce spending on luxuries to avoid an additional tax and then this would impact on manufacturing, retail etc and the problems we are currently facing in manufacturing and retail would become amplified?

  2. Mike Walden says:

    One idea to address this concern would be to scale the household deduction to income of the household. The size of the deduction, and the cutoffs, could be made at whatever levels of income policy-makers deemed best.

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