During the first week of March Fed Chairman Alan Greenspan aired his views on tax reform in front of Bush’s appointed panel on the topic. Greenspan advocated the introduction of consumption taxes, to which I replied with this letter to the Financial Times of London.Sir-Federal Reserve Chairman Alan Greenspan’s comments advocating the introduction of a consumption tax represents not reform but a repackaging of the status quo (“Greenspan calls for consumption tax”, March 4). Indeed, the tax reform movement’s quest for simplicity defies economic sense.
Mainstream economists and politicians fail to grasp that every tax impairs economic activity. Concerning consumption taxes, the seller is incapable of passing the excise on to patrons, whose decision to purchase a product is predicated on the full price, including the tax. Because the law of demand dictates that individuals buy less of a product as its price rises, a consumption tax falls squarely on sellers, crimping the profitability of firms all the way up the chain of production.
Tax reformers also contend slashing marginal rates and introducing a flat tax-as some Central and Eastern European countries have done- is a prescription for robust economic growth.
However, tax reformers are not clamouring for a reduction in the level of taxation, but a mere reshuffling of burdens. There is no simple, innocuous or fair ways to extract by force roundabout $2 trillion a year from American taxpayers. It is indisputable that taxation in whatever guise is distortionary, for it deprives individuals a portion of the money they would otherwise employ to consume or save, placing the loot in the hands of individuals only nominally accountable at the ballot box.
Hence, $2 trillion is absent from America’s private economy -the engine of growth- with only ballot papers and inefficiently provided government services as recompense.
As for the aforementioned European countries, stellar growth rates are less a function of the tax system than competitive wages. Taxes, chiefly consumption, income and payroll, annually confiscate 30% or more of their subjects’ property.
No tax reform reduces distortions or augments growth unless some taxes are abolished and corresponding spending cuts are enacted. Absent these conditions taxpayers are wise to clench their pocketbooks when government luminaries, whom live by tax dollars themselves, broach the topic.
-Grant M. Nülle
Research Fellow
Ludwig von Mises Institute
Regrettably, the letter was not published -as my submissions to the FT usually are. It is nonetheless here on display for the Mises.org audience.
For a more thorough and extended treatment of Bush’s tax reform racket, consult Lew Rockwell’s article on the subject http://mises.org/daily/1727
As for the taxonomy, no pun intended, of the methods utilised by the state to confiscate private property and how each tax uniquely distorts the free market, Rothbard’s timeless classic, Power and Market http://mises.org/rothbard/mes/chap16a.asp, is the ticket.
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I am afraid I must disagree on two points here.
First it is not true that consumption taxes falls only on the sellers. I know Rothbard argued this, but this is one area where I think he was wrong.
While they certainly do harm sellers, they harm buyers too. In fact, all experience suggest buyers are hurt even more.
Every experience I’ve seen with increases and cuts in consumption taxes in Sweden and other European countries suggest that the increase or cut is basically completely passed on to consumers.
And there is good theoretical reasons to expect this result. Since the cost of sellers to sell to consumers increases dramatically with concumption taxes the optimal price from a profit-maximization perspective rises dramatically. If you have a company which has a 20% margin and they get slapped with a 30% consumption tax it can certainly not be expected that the company would agree to continue to sell their products at the previous price since this would imply a loss. Instead the company will likely raise prices by nearly 30%, taking into account of course the likely fall in the demand from such a price increase but likely concluding that the new optimal selling price is nearly 30% higher.
This is particularly so since any competitor would also face the same tax and would be unable to compete on price the way they would have been able to given a price increase uncorrelated with a consumption tax.
Secondly, it is not true that *given* a certain level of tax revenue all tax systems are equally harmful to the economy.
A system with high marginal tax rates and many deductions unrelated to productive activities will discourage productive efforts a lot more than a system with lower tax rates and less deductions.
Because what matters to individual actions are not the total level of taxes you pay but the way in which your actions affect the level of tax payments the crucial issue in this context is marginal tax rates.
For other reasons, it is certainly reasonable to focus on lowering the government’s tax revenues-namely the reduction in economic freedom that any tax payments imply and the likely waste that government spending implies.
And given the nature of the political process it is of course unlikely that any tax reform will really be revenue-neutral, much less revenue-reducing.
But still, this does not take away the fact that given a certain level of revenues a system with low tax rates and no deductions will discourage production less than a system with high tax rates and many deductions.
Grant, I agree that “No tax reform reduces distortions or augments growth unless some taxes are abolished and corresponding spending cuts are enacted,” but that’s not really what’s at stake here—and I think you’d do well to understand that the most promising debate isn’t over whether or not to tax—remember, “death and taxes”—but how to do it in the least damaging manner.
The national sales tax advocated by http://www.fairtax.org/ and before both houses of congress (as HR25 and S25) has several advantages over the present income tax, including the abolition of the IRS and filing, which themselves drain the US economy of billions each year. It further would remove the differentiation of income spent for health care, which would put customers back directly in touch with their insurance companies so that they feel direct market pressure from their customers again, thus helping the free market correct imbalances in that industry (and depoliticizing it in the process).
These are only two of numerous advantages the free market would gain by switching from a production tax to a consumption tax, but I’d encourage you to read the research at the above web site to get a more pragmatic picture of consumption tax. I think it’s at least a necessary stop-gap while those of us who favor lower taxes overall keep honing our lances for another go at the windmill.
While the IRS might still be gone, now we’ll have the federal government in every transaction we make on a daily basis. This will force states with no sales tax to create new agencies, and those with sales taxes will have to overhaul their systems to handle the new bureaucracy needed for the national sales tax plan. Furthermore, there’s no reason to believe that special tax regulations will be created for specific businesses, such as health care, for example. Or that the tax rate will go up.
Remember, the sales tax aims to be a replacement, not a reduction of overall taxation. So we’ll still be taxed the same amount, just in different ways.
Politically, even if this becomes a reality, there will be fighting on how much of a percentage will be charged anyway. And, initially, both systems might coexist, costing us all a lot more. Finally, even if such a system were to be enacted and the previous one immediately abolished, the size of government would not decrease, while its scope would, arguably, increase.
While I oppose all taxation, I think it’s still easier to lower income taxes than try to lower a nationwide sales tax.
Manual, all your objections have already been answered (many in the frequently-asked questions document, in fact) at the URL I posted above. Please give it a read. It is true that states would individually be responsible for collecting the national sales tax, but most states already have tax-collection systems in place to handle the state sales tax. The savings realized by requiring the few remaining sales-tax-free states to adapt, and eliminating all income tax legislation, collection, enforcement, etc. would be tremendous—only stockholders in Intuit or H&R Block could believe this objection honestly!
Politicizing exemptions is part of what makes the income tax so inherently unfair, so simply refunding all tax paid on consumption up to the poverty level is what’s being proposed in Congress this year.
You are, of course, correct that we’d just be shifting the tax burden, rather than lowering the tax amount, but this is why I take exception to Grant’s article: it’s a straw man. The primary benefits of a consumption tax are the elimination of the IRS (thus saving billions) and freeing those who use their money for investment and capitalization instead of consumption. Taxes are built into the prices of all products, whether it’s part of the cost of labor as an income tax, or directly tacked on as a consumption tax. Prices, then, will probably stay the same, as will wages. The only differences will be a freer market for those popularly over-regulated industries like health care, more savings, more investment, and a greater number of exports. Anyone who opposes these goals needs to have their motives checked!
And yes, the benefits of a consumption tax are negated by merely adding it to the income tax, which is why it’s such a dismal failure in Europe and Canada. The Fair Tax bill as offered would require the repeal of the income tax.
I used to be wedded to the FairTax for as long as Britney was with what’s-his-face. If we’re talking about taxing consumption, then a flat tax is all that’s needed, such as the Hall-Rabushka flat tax. The only difference between a sales tax and a flat tax is that the revenue is collected from the consumption base at different times. The sales tax collects the money at the point of sale, while the flat tax collects it up front, but it doesn’t go on to tax savings through taxation of dividends and interest. As for the IRS being abolished, two points need to be made. First, you don’t think that there will be an Internal Sales Tax Service that runs around looking for black market purchases? Second, a flat tax is really simple to fill out, so we could save about as much by just getting rid of most of the code which causes these enforcement and compliance costs. But I have to ask ld two questions. Are you seriously implying that those of us at Mises.org need to have our motives checked because we are secretly wanting to destroy savings, investment, and export industries? All I’ve read from these posters is that they want to focus their energy on cutting spending instead of “reforming” the tax structure. Cutting spending will do more for encouraging saving than a FairTax will ever do. Second, do you think that the budget savings associated with abolishing the IRS will result in a similar decrease in taxes? I’m sure it will be a great new funding source for the next Cowboy Museum or Big Dig somewhere in America.
“It is indisputable that taxation in whatever guise is distortionary….”
Sir, I think perhaps you meant extortionary?
One source of confusion is the very term “consumption tax”, which is Orwellian language to disguise the nature of the beast. In particular, VAT/GST type taxes are not intrinsically consumption taxes at all but production taxes, falling on the stages of production in the value chain (no matter how many adjustments are made later with their own costs).
This has large consequences for investment, notably in working capital. I explore it in detail in this article/
Sorry – the link didn’t come through. The article is at http://member.netlink.com.au/~peterl/publicns.html#NWKART2.
One problem, in addition to the others mentioned, with implementing a “consumption tax” is that one can be almost certain that the government will not end the income tax before starting the new tax. That creates a dangerous situation since the government could easily convince everyone into going along with the new tax, then decide, perhaps in the face of some sort of convenient “crisis,” not to do away with the old tax. We would then be stuck with not just a tax increase, but also a new system of taxation.
Additionally, many who favor this sort of taxation argue that it is more fair because it does not punish people for being productive and earning a lot of money. Instead it waits to punish them when they try to spend their hard earned money. Am I alone in failing to see what makes the second system morally superior to the first?
I know that this might be a little off topic (but does have to do with the Bush budgeting/policy making) but does anyone on here besides me get frustrated over the constant hoopla about ‘privatizing social security’? What the heck is private about public accounts?
I think that this is a way for conservatives to hold onto the banner of being market friendly, when a lot of them really aren’t. The one million dollar question that none of them are asking is this; why bother having it in the first place?
Ha – private social security accounts. It’s like being a Jewish Nazi – just doesn’t work.
Logan: no, I’m not trying to say that mises.org participants should have their motives checked because they secretly want to abolish savings, investment, and exporting. The problem is that people may oppose a plan to aid these activities because they’re focused on another plan—like a flat tax, which does nothing to make our exports cheaper in other countries—to the detriment of the fair tax plan. This isn’t a case of “the perfect being the enemy of the good;” this is an even sadder case of “the good being the enemy of the good!” We gain nothing by not signing the petitions and writing congresspeople and showing support, not even a stronger foothold in a more ambitious plan to lower taxes or implement another form of tax reform. So… why oppose it at all?
Highly recommended sites on this matter:
DONT YOU MIND THE TAX BURDEN PERHAPS ?
Despite high productivity Europe’s economic performances are weak.
Europe’s prosperity and employment stagnates. A wrong tax policy is the cause.
http://landelijkwonen.bkln.net/DONT-YOU-MIND-THE-TAX-BURDEN-PERHAPS.html
SHOULD WE STIMULATE CONSUMPTION OR PRODUCTION?
Consequences for employment and prosperity of two economic strategies
http://landelijkwonen.bkln.net/SHOULD-WE-STIMULATE-CONSUMPTION-OR-PRODUCTION.html
CAUSES OF GROWTH DIFFERENTIALS IN EUROPE.
Tax policies for growth and job creation.
http://landelijkwonen.bkln.net/CAUSES-OF-GROWTH-DIFFERENTIALS-IN-EUROPE.html
just a couple of comments that came up when reading through the threat.
First of all it seems to me that consumption tax would not work as a flat tax. This would be because lower income families would still be spending more in percentages on taxes then high income families would do.
Second there would be a very big incentive to enlarge the black market for basic life support commodities. As consumption tax would be the only tax around it would be quite high and as such would force people to find ways to obtain them without tax.
One thing that i did not include in the above is that luxury goods would be taxed higher, this would still impair the financially weak as the percentage spend on luxury goods is still small for the financially strong.
My apologies for my english, just not my native language.
Onno Huiskamp
Tilburg Netherlands
I’m also not so crazy about the idea of everyone getting a nice big check by the government while robbing you blind through lots of tiny taxes here and there. We have this “pass the hot potato” nonsense already with fica and eitc. Dump the fica tax for these people and there won’t be any need to give their money back through eitc
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