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Kenneth Rogoff: The benefits of a progressive consumption tax



It’s time for the United States to consider switching from an income tax to a progressive consumption tax as a way of addressing growing wealth inequality.

Many economists have long favored a consumption-based tax system, which for individuals essentially uses the same information as the income tax system, but exempts savings (after all, income minus savings equals consumption), on the grounds of its efficiency and simplicity. Higher saving should help investment and growth, and it would be vastly more transparent than our current Byzantine system. However, the progressive consumption tax has never gained political traction.

But now may be the moment.

One of the main objections is that switching systems would require a complex transition in order not to penalize existing wealth holders, who would otherwise be taxed again when they spent savings on which they had already paid income taxes. Yet in an environment where wealth inequality is rising inexorably, that double taxation may be a virtue.

There are certainly other, more straightforward, ideas for tackling wealth inequality. US Senator Elizabeth Warren has proposed an ultra-millionaire tax on the 75,000 wealthiest American households, which would amount to a 2 percent annual wealth tax for those with more than $50 million, rising to 3 percent for billionaires. Warren’s bold proposal has set off an intense debate among economists on just how much revenue it would bring in. Emmanuel Saez and Gabriel Zucman of the University of California, Berkeley — heavy hitters in the inequality literature — have endorsed Warren’s plan, estimating that it would raise nearly $3 trillion over 10 years.

But Harvard’s Lawrence Summers, a former US Treasury Secretary, has argued that such estimates are wildly optimistic. Summers and his coauthor, University of Pennsylvania law professor Natasha Sarin, say that a better path to the same revenue-raising end would be a broad range of more conventional fixes, including an increase in the corporate tax rate and eliminating the ability of ultra-wealthy families to avoid capital-gains taxes through bequests.

It is true that, however compelling the moral case for a wealth tax may be, it has historically proved difficult to garner large revenues from that public-policy mechanism. But Saez and Zucman have held their ground, arguing that much depends on the resources the US Internal Revenue Service is given to implement the tax.

Although I am not unsympathetic to either approach, both are complex to implement. So why not target the same aims with a better system that enjoys broader support and will therefore prove more enduring?

Back in the mid-1980s, Stanford University’s Robert Hall and Alvin Rabushka advocated what was essentially a twist on a value-added tax (VAT) that allowed for greater progressivity. A progressive consumption tax system is simple and elegant, and could save a couple hundred billion dollars a year in deadweight accounting costs.

Importantly, a consumption tax can contain a large exclusion so that lower-income families pay no tax at all. Progressivity can also be achieved by providing a large lump-sum transfer (as in a universal basic income), as suggested by leading Portuguese macroeconomist Isabel Correia, who estimates that her plan would result in both higher growth and greater income equality than the current tax system.

Until now, it has mostly been a smattering of Republicans who have favored switching to progressive consumption taxes, though a variant was championed by Bill Bradley, the former Democratic US senator from New Jersey.

Many on the left, however, respond to the idea in knee-jerk fashion, believing that a consumption tax must ipso facto be regressive because sales taxes are regressive. They fail to understand that a consumption tax can be very progressive if the transfers and exemptions are designed with equity in mind.

Of course, any large change in federal taxation has complex effects. Further, the US Congress probably has an innate bias in favor of a complicated tax system with lots of loopholes and exemptions, which gives members leverage over potential donors. But that is all the more reason to jump at the opportunity to clean up the swamp and help mitigate wealth inequality at the same time.

Kenneth Rogoff, a former chief economist of the IMF, is professor of economics and public policy at Harvard University.


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Posted: September 19, 2019 Thursday 05:00 AM