Consumption tax?

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trfie
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Consumption tax?

Post by trfie »

I was watching the last presidential debate and one of the candidates proposed to eliminate the US income tax, medicare and medicaid tax, social security tax, and just replacement everything with a single consumption tax. I did some research online and it looks like a great suggestion. While some criticize it for being worse on the poor, most of the proposals I have seen give a "prebate" to everyone which is equal to the amount of taxes on the poor.

For EREs, I think it is particularly good, because consumption is low. And because of all the waste created from consumer products, it makes sense to tax this behavior more. Also it creates a big second-hand market which is beneficial for the economy. The only downside i see is enforcement and if it creates a black market for goods and services.

vexed87
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Re: Consumption tax?

Post by vexed87 »

Giving with one hand generally leads to taking with another. The books need to be balanced after all.

Even if someone comes along promising reduced taxes rates, unless they reduce wastage/bureaucracy, you'll probably be out of pocket one way or another elsewhere. For instance, the current Conservative government in the UK is all about cutting public services, reducing taxes and empowering society, which sounds great in principle until you realise it means inevitable higher individual healthcare costs, greater social disorder and inequality. Great if you're the target audience, i.e. fit and healthy, wealthy and have a good support network, not so great if your lacking any of these. Successive governments come and go, and so do their tax policies.

Rarely do they make a difference to the individuals, because the books need to be balanced! :roll:

jacob
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Re: Consumption tax?

Post by jacob »

Sales tax is nice and simple but too easy to abuse. Value added tax (VAT) is harder to abuse but adds a lot of bookkeeping cost down the chain. In particular, it requires small business to engage in long division instead of just adding and subtracting. Not trying to be flippant here ... but the bookkeeping of many "Joe the Plumbers" is not exactly exemplary.

As it is, the US tax system functions as a kind of "reverse rent-seeking" scheme in that it favors those who are capable of handling the complicated tax law to minimize the taxes they pay. The complexity is how some corporations manage to pay almost no taxes despite the fact that the US has some of the highest corporate tax rates in the world (surprisingly!).

[The US health care system functions in a similar way.]

By spending some 100 hours studying the tax code, it's possible for some individuals to arrange their income (W2, 1099, Business, capital, ...) so as to pay almost no taxes either. E.g. live off of qualified dividends (0% tax) and send all earned (W-2) income into tax deductible retirement plans to bring AGI under the personal/standard deductions. Done right, you can make high five figures paying very little tax.

Basically, the big payers are those with simple income and expense structures (e.g. a high-income W-2 renters) and/or those who don't bother to learn the tax code.

PS: In a perfect world, I'd totally tax at either the point of consumption or preferable at the "well-head" (point of resource extraction). But currently there are too many benefiting from a complex structure and too many who don't understand why that is to make any reform likely.

black_son_of_gray
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Re: Consumption tax?

Post by black_son_of_gray »

Just curious, has any well-established large economy ever successfully overhauled its taxation laws? If so, did this require a revolution/collapse/social upheaval (fall of USSR? I'm completely ignorant here...)? Any relatively smooth transitions to a simpler system?

The tax code has lots of lock-in features, in that as it becomes more complex, more and more people become beholden to it. And now in the US, it is clearly quite complex. Because the job of legislative branches (Congress) is to write laws, and most of these are just tacked on to existing laws, this lock-in seems like an inevitable bug of the system.

Perhaps a palatable transition would be to add the consumption tax to all other taxes, but at a very low level, and work out the kinks of enforcement, etc. Then, phase out other taxes while slowly ramping up the consumption tax.

Riggerjack
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Re: Consumption tax?

Post by Riggerjack »

It's a nice idea, that just won't work.

On the enforcement, it would be simpler, as most businesses already collect sales tax. If I remember right, the "fair tax", as this was marketed years ago, would be something along the lines of 23%. Whether you break this down in pieces for VAT, or collect as sales tax at retail is up to the uptopian you are listening to.

It would lower compliance costs, and enforcement costs. It would boost the economy, in that tax avoidance would no longer factor into consumer or business behavior.

But it won't work, because congress is in the business of selling tax breaks. The investment in a senatorial seat pays off when you take contributions to push this issue or that. One of those issues is tax breaks. How do you get congress to eliminate one of their most profitable lines of business?

This would take a Constitutional amendment. Like the income tax did. You know, the one that would only tax the rich, and even then, top out at 7%...

Dragline
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Re: Consumption tax?

Post by Dragline »

It happens about every 30-50 years in the US, but even then there is nothing so drastic as completely dumping one system for another.

The last big tax reform in the US was in 1986. But even all that really did was lower base tax rates and get rid of a load of deductions. Ever since then, its been more creeping deductions/breaks for the most part.

I agree with RJ that the overall system is unlikely to change, because there is more pressure to maintain deductions than there is to simplify the code or replace it with something else. You would only see wholesale changes right now if one party were to achieve a super-majority in both houses and the presidency, which seems unlikely. If you want to get an idea of what it looks like on a small scale, though, you can see that happening in Kansas right now.

ether
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Re: Consumption tax?

Post by ether »

Once you're living off dividends and long term capital gains, you pay essentially zero taxes if you're in the 15% tax bracket. If a consumption tax were implemented, our effective tax rate would definitely go up significantly! Our food, rent, utility, and entertainment costs would probably go up 20-25%!

Also a major aspect of the tax code is to allow the governments to incentivize certain activities [getting a mortgage, buying solar panels, matching your employees 401k contributions, etc.] A flat consumption tax would destroy all those carefully crafted incentives!

In my opinion the politicians that are pushing for a flat consumption tax are the same ones that want to greatly curtail the power of the federal government by starving it of tax money. That way it can't fund major social programs, incentivize certain activities and our economy would return to laissez faire capitalism.

IlliniDave
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Re: Consumption tax?

Post by IlliniDave »

I like the idea of a flat/consumption tax in place of income tax, even though I'm close to being retired and it would probably cause me to pay more tax in retirement than I might otherwise. I don't like a system where people can effectively vote to raise someone else's taxes/tax rate (but not their own), so I'm also a proponent of the so-called fair tax. I also like that savers essentially given an unlimited 401k with no contribution limits or early withdrawal penalties under such plans. I don't disagree that the hurdles are immense.

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GandK
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Re: Consumption tax?

Post by GandK »

IlliniDave wrote:I like the idea of a flat/consumption tax in place of income tax, even though I'm close to being retired and it would probably cause me to pay more tax in retirement than I might otherwise. I don't like a system where people can effectively vote to raise someone else's taxes/tax rate (but not their own), so I'm also a proponent of the so-called fair tax. I also like that savers essentially given an unlimited 401k with no contribution limits or early withdrawal penalties under such plans. I don't disagree that the hurdles are immense.
Ditto every word of this. Well put.

trfie
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Re: Consumption tax?

Post by trfie »

black_son_of_gray wrote:Just curious, has any well-established large economy ever successfully overhauled its taxation laws? If so, did this require a revolution/collapse/social upheaval (fall of USSR? I'm completely ignorant here...)? Any relatively smooth transitions to a simpler system?
I used to think that the reason major problems weren't solved was because they were complex. Now being an expert in my field, interacting with people who have interacted with government at the highest level, and having thought about and studied a wide range of topics, I know that there are solutions to the vast majority of problems commonly discussed, and the reason they have not been solved are politicians. But in many places, the politicians are voted in by a democratic process. So the reason for not having positive change is that the vast majority of people vote for mediocre candidates. I have no doubt that the tax system would be completely overhauled if a certain politician or group of specific politicians were elected. So I don't think about what has happened before, I focus on voting for the best candidates in all elections.
Also a major aspect of the tax code is to allow the governments to incentivize certain activities [getting a mortgage, buying solar panels, matching your employees 401k contributions, etc.] A flat consumption tax would destroy all those carefully crafted incentives!
It has been cogently argued (and I agree with this position) that the government is causing harm by incentivizing things that they think should be incentivized, instead of allowing the market system to determine it. Clearly there are many places where government regulation and intervention is required in a market economy, but I don't think these areas are it. Mortgage interest deductions have contributed to housing bubbles and foreclosures and the 401k system is set up against the idea of ERE, which is having drastically negative effects on countless people.

ether
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Re: Consumption tax?

Post by ether »

It has been cogently argued (and I agree with this position) that the government is causing harm by incentivizing things that they think should be incentivized, instead of allowing the market system to determine it. Clearly there are many places where government regulation and intervention is required in a market economy, but I don't think these areas are it. Mortgage interest deductions have contributed to housing bubbles and foreclosures and the 401k system is set up against the idea of ERE, which is having drastically negative effects on countless people.
I hope I don't derail this thread but I don't understand why you think the 401k system is against ERE? In what way? I have always seen 401k as a system that promotes responsible, self directed savings, reduces tax liability, and helps make sure that SS isn't your only form of income in retirement. Again not trying to derail this thread, but giving tax breaks to home owners wasn't the main cause of the housing crisis from my understanding. From my limited reading it stemmed from government and banks collaborating in marketing mortgages towards subprime borrowers, which triggered a massive increase in eligible home buyers, which drove up demand, price and speculation that culminated in a price shock that left many debtors owing the bank more than the market value of the property, which triggered defaults and repos.Giving people tax breaks for paying mortgage interest didn't cause the bubble as much as lowering lending standards did in my understanding.

enigmaT120
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Re: Consumption tax?

Post by enigmaT120 »

ether wrote:Once you're living off dividends and long term capital gains, you pay essentially zero taxes if you're in the 15% tax bracket. If a consumption tax were implemented, our effective tax rate would definitely go up significantly! Our food, rent, utility, and entertainment costs would probably go up 20-25%!
Ugh. One of the cute tricks about 401Ks is that, though most of the gain in them are in fact capital gains, the money is taxed as regular income when you draw it out. At least that's how mine (actually the Thrift Savings Plan) works.

Riggerjack
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Re: Consumption tax?

Post by Riggerjack »

One of the cute tricks about 401Ks is that, though most of the gain in them are in fact capital gains, the money is taxed as regular income when you draw it out. At least that's how mine (actually the Thrift Savings Plan) works.
True, but since the basis of the fund was untaxed (income), and most folks make less income in retirement than during accumulation, it is still advantageous.

Try it yourself. Take out income tax, accumulate returns, pay "only capital gains" of 15% on gains. Or make returns on the money that would have been paid in income taxes, and then pay income tax at withdrawal. With deductions, it is pretty easy to stay under a flat 15% tax in retirement, unless you are going for a high income retirement.

For most folks, the 401k works best at today's tax rates. Nobody knows what tomorrow will bring...

enigmaT120
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Re: Consumption tax?

Post by enigmaT120 »

My regular tax rate is 15% so my capital gains tax rate is zero. Most of the money in my 401K is from returns, not from my contributions. I can't beat the 100% return I get on the 5% of my income I put in though!

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