October 9, 2005


A Twist on the Consumption Tax Gains Traction: The X tax is just one option that a panel advising Bush is considering as it looks for ways to overhaul the current system. (Joel Havemann, October 9, 2005, La Times)

Bush has said a reconstructed tax code should be simple and progressive — that is, wealthier people should pay higher tax rates than lowerincome people. Bush has also said that the tax system must promote economic growth.

And he has said the new system must raise as much money as the present system — a particular challenge because most members of the panel seem to support abolishing the alternative minimum tax. That tax was initially aimed at the wealthiest taxpayers, but in recent years it has raised the annual bill for an increasing number of middle-class taxpayers. Eliminating it would cost the government $1.2 trillion over the next 10 years.

Some commission members say a consumption tax could be structured to meet all of Bush's criteria. "We're not pursuing a consumption tax to plug a revenue gap," said former Republican Sen. Connie Mack of Florida, chairman of the commission, known formally as the President's Advisory Panel on Federal Tax Reform. "We're pursuing it because it arguably creates a superior economic climate."

By shifting more heavily to taxes that people pay when they buy things, a consumption tax would encourage people to save, some economists say. And that, in turn, would spur investment and encourage economic growth, they say.

Not all panelists are convinced. Liz Ann Sonders, chief investment strategist for Charles Schwab Corp., said Congress had enacted 20 tax breaks for savings in the last 30 years — and the public's collective savings rate had fallen from 10% to close to zero.

In addition to predicting that a consumption tax would bolster economic growth, supporters say it could also meet the commission's mandate that a new tax system be simple.

The simplest form of consumption tax is a sales tax, such as the 7.25% tax levied in California on all consumer purchases except food and drugs. Rep. John Linder (R-Ga.) has introduced legislation to replace the income tax with a national sales tax.

Many commission members, however, do not favor a national sales tax. Former Sen. John B. Breaux (D-La.), its vice chairman, said the tax would land disproportionately on the poor.

But consumption taxes come in other forms. One is the value-added tax — known as VAT — popular in Europe.

Like a sales tax, the VAT is a consumption tax on goods and services. The difference is that the tax is determined by calculating what each business involved in creating a product adds to its value. If a company buys raw material — say, a piece of untreated wood — for $20, and then turns it into a chair and sells it to a retailer for $30, it pays the VAT on its $10 contribution.

In the end, the consumer pays the accumulated VAT taxes when buying the product, reimbursing the businesses.

It is harder for businesses to cheat on a VAT than a sales tax. But the VAT has many of the same drawbacks, including the fact that it tends to hit lowerincome people harder than wealthier ones.

Unlike sales taxes and the VAT, the X tax could be imposed at escalating rates, making it more progressive. The concept is the work of Princeton University economist David Bradford, who died last year.

Bradford proposed two rates, one for income below an unspecified annual amount and a higher one for income above the cutoff. He wrote last year that an X tax could generate as much revenue as does the current income tax system, while keeping the maximum tax rate on individuals at less than 30%. Business profits would be taxed at a single rate, equal to the top rate on individuals.

I don't get it. How is the X tax a consumption tax if it's levied on income?

Posted by Orrin Judd at October 9, 2005 3:57 PM


Because you deduct savings and investment from taxable income. You also, under msot models, keep deductions for at least the most popular tax preferences, such as charitable deductions, home mortgage interest, etc. So, what is left of income is what you spent. Comprende?

Posted by: Dan at October 9, 2005 4:25 PM

Linder's proposed consumption tax includes credits for low income workers, mooting Breaux's concerns.

Every time the Fair Tax is mentioned these credits are omitted, making it look like it hits low income people harder.

It's exasperating that coverage of the Fair Tax is consistently wrong, and always on the same point.

Posted by: JackSheet at October 9, 2005 4:33 PM


Ahhhhh....tyhat would be especially good if it's not deducted from your income but paid in a lump sum.

Posted by: oj at October 9, 2005 4:39 PM

That's not a consumption tax, just an income tax with juggled adjustments and deductions.

What is needed is a tax on spending as identified by the act of spending, not spending as identified by deducting certain dispositions of wealth from income, which would still rerquire having the government get inside your pants. The main ideas are to make the tax simple and to make it unevadeable. We want everybody to pay taxes: whether you are a pimp, a drug dealer or a congressman, if you spend, you pay.

Progressivity can be achieved by exempting necessities of life. Anyone so needy as to require more than that can be helped honestly.

Posted by: Lou Gots at October 9, 2005 5:29 PM

Consuption = Income + Net Proceeds of Asset Sales + Net Borrowing. If you deternine the tax by allowing the deduction of savings and repayment of borrowing and adding the proceeds of borrowing. It is a consumption tax.

The difference between a VAT and this type of Consumption Tax is that the VAT does not vary by individual circumstance. OTOH, the VAT is imposed on imports and rebated on exports.

Posted by: Robert Schwartz at October 9, 2005 5:59 PM

Robert: Such a tax still involves putting an I.D. tag and a G.P.S. sender on every dollar moving anywhere in the economy. If it would not increase government's intrusion, it would do little to reduce it. Simplicity, remember?

Posted by: Lou Gots at October 9, 2005 6:31 PM


I assume you would favor something like hte concept being floated by Boortz and Lindner, the "Fair Tax." In the abstract, I would , too. However, I think most people who are serious about tax reform have come to the conclusion that it would be seen as a sales tax, and they all remember the fate of Al Ullman, the Democrat Chair of the Ways and Means Committee who lost his safe seat for merely talking about a VAT. I'm not sure they are right, but no one wants to undertake the task of educsting voters about anything.

Posted by: Dan at October 9, 2005 7:17 PM

I was just explaining not advocating. Personally, I would like to see a VAT, a $2.50 gas tax and a real deemphasis on the income tax.

Posted by: Robert Schwartz at October 10, 2005 12:56 AM

For a government-liberal type, the beauty of the VAT is that it's virtually invisible, so people don't really complain about it. As opposed to a pure sales-tax, which hits you in the eye with every purchase you make.

Plus, of course, that the VAT somehow becomes an addition to the income tax rather than replacing it. For the gov't, this is good, because they get two bytes at your apple.

Posted by: fred at October 10, 2005 1:53 PM

I agree with fred.

While a consumption tax is appealing from an egghead economic-efficiency angle, from a political angle I don't see any way to prevent the system from morphing into a consumption-AND-income tax scheme.

After all, most states have both income and sales taxes.

Posted by: Michael Herdegen [TypeKey Profile Page] at October 11, 2005 4:52 AM