Wednesday, April 26, 2017

A progressive VAT

A VAT (value added tax) with no other tax — no income, corporate, estate, etc. etc. etc. — is pretty much the economists’ ideal. But how do you make it progressive? A bright — or perhaps lunatic— idea occurred to me.

A progressive VAT

Everyone pays the maximum VAT rate — 40% say, equal to the maximum marginal federal income tax rate. Then, as you spend money over the year, you turn in your receipts — figuratively, we’re going to do al this electronically in a second. So, for the first (say) $10,000 of purchases in each year, you get a refund of all VAT taxes paid. For the next $20,000 of purchases, you get $30 out of every $40 tax payments back, so you pay a 10% rate. And so on. Finally, after (say) $400,000 you don’t get anything back, so you pay the 40% maximum rate.

As you see, I give people an incentive to declare all their consumption.  That incentive completes one of the main advantages of a VAT over an income or sales tax. In a VAT, each business in the production chain pays the VAT on its inputs, and charges the VAT on its sales. It then deducts the VAT payments on its inputs against the VAT it has to pay on its sales. That gives the business a strong incentive to collect the VAT on sales, and for its business customers to demand proof the VAT was paid so they in turn can deduct VAT payments against their VAT collections. Now people will also demand “receipts,” proof of tax payment.

Clearly this works only if everything is electronic. I would not inflict expense reimbursement drudgery on the American taxpayer. But that largely is the case. We have a sales tax reporting mechanism, so adding or substituting VAT tax reporting is not that hard.


The big change is that each transaction must report the buyer as well as the seller. As a civil libertarian, this initially struck me as a deal killer. We have already lost far to much privacy and anonymity of transactions. But on second thought perhaps it is not that bad. We already report to Leviathan every source of our income, and under e-verify and other immigration controls we have to ask Leviathan for permission to work. Just how much worse is it to report every purchase too? Especially since, once this progressive VAT replaces the income tax, we no longer have to report sources of income. Furthermore, only the amount of the tax payment needs to be reported, not the nature of the purchase, or even who the seller was.

For those of us who already use debit and credit cards for transactions, this would be easy — the card company can simply forward to the IRS that you paid x much VAT. It does not have to report where you paid it or what you bought. It can separately report that the store paid its tax, without saying who to. For those who don’t use electronic transactions, well, it’s high time they did.  If India can set up debit cards and cell phone payments for all its citizens, the US can do so as well. That would make social security, disability, and all other government payments much safer and more secure, and undercut the fees charged by check-cashing businesses in poor neighborhoods. If you pay with cash, swipe your card to record and report the transaction and tax paid. Your incentive to do so is then you get the refund.

I’m sure creative blog readers can do better. Stored value cards or blockchain technology might securely and report taxes paid even better.

It could even be instantaneous. The store pays the VAT electronically, and the Treasury credits your debit-card account with the VAT refund immediately.

Obviously, also, large payments like houses and cars will carry forward over several years, so as not to bump people in to higher expenditure categories.

Of course, reporting individual’s purchases is only required from the desire to make a VAT directly progressive. If you’d be happy with a flat VAT and then achieving redistribution by sending people checks, we don’t have to report anything. Everyone pays (say) 20% VAT, and the government sends checks, on budget, to worthy people.

But I’ll assume that this isn’t enough, and you want to tax the rich more than this allows, so we also have to make the VAT progressive. That goal requires keeping track somehow of how much you consume.

Standard approach

The standard approach to a progressive consumption tax works through the income tax system. Collect information on all income as now, exempt capital income from taxation (dividends and capital gains) then allow people to deduct savings. Roughly, remove all the limits on 401(k) and similar schemes.

This approach is much less clean. People have an incentive to hide income. Furthermore they have an incentive to make what is really taxable labor income look like capital income. Any professional can incorporate and pay him or herself outsize “dividends” on the investment rather than “wages.”

People also have an incentive to make what is really consumption look like business investment. That yacht is really somehow a corporate investment. Well, incorporate yourself, offer just enough paid cruises to keep the IRS happy, and it is. In my world, we pay VAT on investment goods just as we do on consumption goods. And charge VAT on the cruises. If the VAT charged does not cover the VAT paid, it’s consumption and it’s taxed.  And many other gnarly problems.

Similarly, my first idea was to track consumption electronically, as above, and then force high-consumers to pay a higher rate at the end of the year. But then they have an incentive to try to hide consumption, which might be easier than hiding income. By paying taxes and filing for refunds, everyone has an incentive to declare everything.

The European system is even less clean; A flat VAT (20% or so), also a payroll tax (40% or so) and also income and estate taxes on top of that (50% or so). They achieve progressivity with the latter, but suffer all the consequences of an income tax.

It's also important not to let the VAT get screwed up by responding to political pressure for different (lower) rates on different goods, to try to transfer income indirectly or to subsidize pet industries.

Why is a consumption tax so important? 

Fundamentally there is no reason to tax or to redistribute high incomes. If you want redistribution, you want to redistribute consumption. If you have a high income but leave it all invested in a business and live like a pauper, good for you.  The wealth is out there doing good.

Conversely, there is no reason to exempt high consumption that somehow comes from low income. President Trump, according to media reports, managed to get the income tax deductions associated with billions of dollars of his investor’s losses, perfectly legally, and hasn’t paid much tax since. Under a progressive VAT, all those houses and helicopters would be taxed.  

The original sin of the US tax code was to tax income not consumption. Once we tax income, we have to tax corporations, since otherwise individuals incorporate to hide their income. (In case you’re late to the party, The right corporate tax is zero. Every cent of corporate tax comes form higher prices, lower wages, or lower returns to shareholders. Since shareholders can most easily avoid it, my bet is all higher prices. If you understand that you pay higher prices because of sales taxes, then it immediately follows that you pay higher prices because of corporate taxes.)

With a consumption tax in place of an income tax, corporate taxes can disappear; the whole issue of non-profits dissappears — goodby Lois Lerner, goodbye shady “charity” tax dodges — there is no need for the vast confusing array of 401(k), 526(b), IRA, 1031 exchanges (rules delaying capital gains realizations) etc. We don’t need health savings accounts — all savings accounts are tax free!  This vast simplification appeals to me most of all.

There is also the standard economic argument for consumption taxes. If you tax investment returns, people just save less, the capital stock falls, and the rate of return is the same. People can avoid capital gains in particular by just not selling stock.

An income tax made sense in 1914, when it was a small tax aimed only at high incomes, and when incomes were much easier to measure than consumption. But that is no longer the case.

It is possible. Imagine the huge bonfire of hundreds of thousands of pages of the tax code, replaced by one simple VAT -- essentially a sales tax. Now the obstacle of progressivity is gone too.

Starve the beast? 

The main argument I hear against a VAT is that it is too efficient. It can raise so much revenue that government will expand. Starve the beast, these authors say.

I think  this is wrong.

First, it is not a great success.  Government spending seems hardly constrained in the US by lack of revenue, or the specter of a debt crisis.

Second, think just how little faith this reveals in democracy. Shhh, economists, don’t advocate a much more efficient tax system, because a democracy will always operate at the top of the short-run Laffer curve given its tax structure. If democracy is so incapable of self-governance, we might as well hand the keys to western civilization to the Chinese communist party, as we are doomed.

Third, remember that US government overall (federal state and local) spends about 40% of GDP already. If you add in all the hidden spending — tax expenditures, deductions such as mortgage interest, health insurance, charitable, energy deductions, and mandates on business — we’re probably at least a European 50%. I’m proposing a VAT and nothing else, and let’s put all the cross-subsidies and mandates on budget where we can see them. If we make it progressive, the highest rates hit levels that would please Piketty. I’m not sure there is a lot more to squeeze out of this!

So, I am coming to the opposite view. Not: If you want to cut spending, suffer a vastly complex, growth-killing, disincentive-riddled tax system, which produces little revenue at maximal distortion, so as to try to scare the spenders away with a debt crisis. Yes: if you want to cut taxes, cut spending. Once surpluses pile up, they’ll cut taxes.

But let us admit that economists on both sides of this debate are playing amateur (very amateur) political science. We should stick to economics — The VAT is the most efficient tax system, and here is a way to make it progressive too, if you so wish.

Someone must have thought of this already? If so, let me know who! Or there is a fatal flaw I haven't thought of?

Updates: 

Bob Hall reminds me that the Hall Rabushka tax achieves much the same objective, though by a different mechanism.

Kevin Williamson has an excellent essay in National Review explaining some of the many reasons the corporate tax should be abolished.

Nina Olson has a nice WSJ oped on the complexity of the US tax code. The code includes
six “family status” provisions ..filing status, personal and dependency exemptions, the child tax credit, the earned-income tax credit, the child- and dependent-care credit, and the separated spouse rule. …
“at least 12 savings for education incentives—far too many for most parents and students to make an informed choice.”
There are now at least 15..incentives that encourage savings for retirement (IRA, roth, 401k, etc.) 

Of course that’s just the beginning, and even just the beginning of personal income tax complexity, let alone the corporate tax. Oh, and
In 1955, there were 14 civil penalties in the tax code. Today, there are more than 170..
Ms. Olson has been the “national taxpayer advocate” since 2001. But even she has to hedge with “at least” and “more than” — apparently even she doesn't really know just how many there are!




83 comments:

  1. I think it's a great idea, and it can definitely operate instantaneously. But to do that the Treasury would need to pay part of your bill at the point of sale, because deposits into bank accounts are not instantaneous in the US system. And let's not forget the unbanked poor people who would lose out yet again due to their lack of access to financial services.

    Perhaps the best way to think of it is like store discount cards that track spending, except that this one is run by the government, and the discount varies with the total amount spent up until the point of the current purchase. As with store discount cards, the amount due from the consumer could be paid in cash.

    ReplyDelete
  2. In Brazil (for example) full time workers get a "meal card" that is to be used to purchase pre-cooked food. (Long story there.) To ensure that income is reported, you write your ID# on the receipt. Then, when it is reported by the merchant, you get a small amount back. If it is not reported by the merchant, you turn them in and get a large amount back.

    I love the enforcement mechanism.

    So what occurs to me is that we should allow the banks to track and report the spending and inform the merchant of the VAT amount to be added to the check. The bank could keep a small amount of the VAT for processing the transaction and sending the money on to the gov't.

    -XC

    ReplyDelete
    Replies
    1. Brazil actually has something even closer to his VAT proposal (http://blogs.worldbank.org/impactevaluations/incentivizing-consumers-against-tax-evasion-guest-post-joana-naritomi)

      In the state of Sao Paulo, customers can (optionally) provide their tax id number during a purchase. Then later in the year they get a refund for the state sales taxes they paid.

      This was initially designed as a mechanisms to fight tax evasion and was very successful at that. As it is optional, privacy concerns are less of a worry

      Delete
  3. This is really interesting but I see two main flaws :
    1) It loses efficiency in an open economy. I think high value consumption is more mobile across borders than capital & labor income.
    2) It does not prevent the type of political power that extremely concentrated capital provides.

    It is a good system for a broad domestic middle class, but you want to tax income for people who earn income in the US - and are protected by US laws, enjoy US infrastructures ... - but do not consume there (they can always deduct the eventual VAT they actually pay when they are in the US), and I would add some kind of tax on capital stock.

    ReplyDelete
    Replies
    1. I think the current system also leads to concentration of power. Not sure this proposal has to address that? It is still interesting from efficiency/transparency/incentives pov.

      For sure there is a question over mobile labour that is able to earn in one place under this proposal and live (and consume) in a conventional tax system.

      Delete
  4. Ben Cardin from the great state of Maryland introduced a 'lite' version of the progressive VAT in 2015. It doesn't do away with federal income or corporate taxes, but it's a step in the right direction? Let me know what you think:

    https://taxfoundation.org/analysis-senator-cardin-s-progressive-consumption-tax/

    ReplyDelete
  5. The simplest option is a uniform cash transfer to preserve progressivity. If you give everyone £1,000 then the combined after transfer tax rate rises for the rich. Doesn't get much simpler. Of course, you don't have to give cash, you can give stuff (i.e. health insurance) too.

    Another good alternative is the Bradford X TAX. Split the VAT into 2. First, you have a Destination-Based Business Cash Flow Tax. That's a VAT with a labour deduction. Second, you have a progressive Pay Roll Tax. You eliminate the incentive to disguise labour income as corporate income by setting the Cash Flow Rate at the top rate of the Payroll Tax. That's economically identical to VAT.

    I think the sheer level of transaction costs and form-filling will be the death of your proposal. John Stuart Mill actually mentioned this idea in Parliament once, but dismissed the prospect of tracking each purchase. I think Kaldor and his brother were the ones who came up with the Income Tax minus consumption solution.

    ReplyDelete
  6. Excellent. This entire debate around wages (ordinary income) vs. business income (S-corp, LLCs, partnerships) misses the point that taxing income (as opposed to consumption) distorts incentives.

    ReplyDelete
  7. Arbitrage would become a pretty hard problem to deal with. A progressive VAT would open a market where poor people offer rich people to buy stuff for them in exchange of a fee. They would be able to compute how much VAT credit they'd have left, and they'd be able to use sell it as a tax shield for others.

    ReplyDelete
    Replies
    1. The main problem with this problem is that it would need quite a few people in a low spending bracket to equal one in a higher spending bracket. More people mean more possibility for leaks, and then also imagine trying to cover a yacht with this arrangement. What low-wage person is going to be able to take that on?

      Delete
    2. It doesn't have to be yachts. Televisions, computers, cars, etc. could all be bought by poor people and sold sold under-the-table to rich people.

      Delete
  8. I haven't thought this through but I worry about the stuff v service consumption and how a VAT may create unintended consequences for the later. Does anyone have an incentive to report service based consumption or does everyone have a large incentive to pay in cash?

    ReplyDelete
    Replies
    1. This was dumb. The whole point is that the spender up to 400k reports. The issue is w/ cash services OVER 400k and then foreign spending. Will rich people just only buy vacation houses and yachts abroad? Do you mandate that disclosure? Still a better system than ours today.

      Delete
    2. This comment has been removed by the author.

      Delete
    3. Mr. Chochrane, I would also be interested to hear your thoughts on how your proposal would apply to services.

      Delete
    4. Yes, what about services, or anything that has a labour component. Which is pretty much everything... Does it matter that VAT is being paid on the labour portion of the good/service? Say a doctor or hairdresser? Or a tradesman?

      Delete
  9. I've been thinking about this idea for quite some time, and I got as far as you. The main problem that remains unsolved is that VAT only taxes private consumption, whereas corporate consumption is tax-free. At first sight, this is not so clear because companies have to temporarily pay VAT when they buy something. But they can reclaim everything again afterwards. So your private car comes with 40% VAT, but your corporate car is tax-free. A private diner comes with a hefty VAT charge, but a corporate diner is tax-free. Thus, your scheme creates enormous pressure to shift consumption from private contexts into corporate contexts, thereby distorting economic decision taking.

    ReplyDelete
    Replies
    1. This sounds like an implementation issue, not a fatal flaw. If a corporation pays VAT on its inputs, including investment goods, and must collect VAT on its outputs, then funneling consumption to a corporation won't work. If the corporation just buys a car, there is no VAT on sales to offset the VAT on the car purchase. The IRS is also pretty good at monitoring this kind of thing these days. The same temptation exists under an income tax.

      Delete
    2. The car manufacturer charges VAT to you and also to the company that buys a car. The restaurant likewise charges a VAT on all meals served, both to private citizens, corporate accounts, and drum roll here - Government accounts.

      Delete
    3. What's the point in making it progressive? If I can afford and purchase a $20,000 car then I'm paying my share at say 25% or $5K. If I can afford and purchase a $200,000 car than I'm paying at say 25%, a whopping $50K on that car. What could be more fair?

      Delete
    4. Hi John,
      VAT is well known specific implementation of consumed-income tax. What you have described in your blog is some sort of "excise tax".

      Delete
    5. Im not fond of progressive -- I'd rather charge a flat tax, then send people who need help checks, on budget (see the post). The point of the post is, IF we're going to require a progressive tax, here is a simple way to do it.

      Delete
    6. @John: Thanks for reply. Unfortunately, this works differently, at least with European-style VAT. In your example, the company could buy the car and still get the VAT back. In fact, some companies even get more VAT back than they collect. If you have a system in mind where companies cannot reclaim VAT, anonymous is right and this is not VAT at all, but some kind of excise tax, which comes with a whole set of different issues, for example the flaw that it favors large conglomerates with lots of internal (untaxed) transactions.

      Delete
    7. H,

      "What's the point in making it progressive? If I can afford and purchase a $20,000 car then I'm paying my share at say 25% or $5K. If I can afford and purchase a $200,000 car than I'm paying at say 25%, a whopping $50K on that car. What could be more fair?"

      You are not paying your fair share. You are paying 25% of $20,000 ($5,000) and then giving the federal government an interest free loan of 15% of $20,000 ($3,000). In this interest rate environment it does not matter much, but consider if interest rates were at 5%, 10%, 20% - would you honestly buy a new car at the beginning of the tax year or would you wait until the end of the tax year to purchase?

      And so under this proposal, you would likely see a lot of end of tax year shopping.

      An income tax (even a progressive on) does not have this problem because income taxes are withheld for people with regular 8:00 to 5:00 jobs.

      It wouldn't be difficult to postpone all of your shopping until the end of the tax year - say the last month of the year are your shopping days. I don't know of anyone that could possibly cram a full year of work (and associated wages) into one month of time.

      John,

      "The point of the post is, IF we're going to require a progressive tax, here is a simple way to do it. "

      Not to put too fine a point on it - We already have a progressive system of taxation!!! This is about the third or fourth time you have brought up a progressive VAT. What you have not established is why a VAT is better than an income tax.

      John,

      "In case you’re late to the party, the right corporate tax is zero. Every cent of corporate tax comes form higher prices, lower wages, or lower returns to shareholders."

      I have been hearing the same ear splitting music from your party the whole time and the correct corporate rate is not 0%. The reason is that tax revenue ultimately pays for our legal system.

      A corporation enjoys legal protections that are above and beyond what an individual owner / employee has access to. One of the biggest is limited liability.

      If I build bicycles out of the back of my garage and sell them, I can become fully liable for a death that occurs on one of my bikes and be found criminally negligent. With a corporation, that level of indictment rarely occurs.

      There are countries (India for example) where criminal liability extends up the corporate ownership ladder. See:

      https://en.wikipedia.org/wiki/Bhopal_disaster

      Delete
    8. "What you have not established is why a VAT is better than an income tax."

      Without wishing to answer for JC, I think it as all to do with incentives. If you can, tax 'bad' things (consumption) and avoid taxing good things (labour, investment, savings).

      Really, JC addresses this in the blog at "Why is a consumption tax so important?"

      Delete
    9. Paul,

      "If you can, tax 'bad' things (consumption) and avoid taxing good things (labour, investment, savings)."

      First economics is not a morality play - 'good' versus 'bad' is fine in religious and legal contexts, but there is no such thing as good / bad in economics.

      Second real gross domestic product relies on both production and consumption. If we produce goods that no one consumes, we are not better off.

      Third, any form of taxation merely transfers the consumption decision from the individual to the government. And so, with either an income or consumption tax, you don't change the level of consumption - instead individuals consume less and the government consumes more.

      And that is the biggest knock against a "consumption tax", it does not do what it claims to do - reduce consumption.

      Delete
    10. Frank, it seems to me that the goal of taxation is to move some consumption from individuals to Government. I think it is good to do that as directly as possible because the less direct the more difficult it is to know on whom the tax incidence falls.

      Delete
    11. @Frank Restly,

      "I have been hearing the same ear splitting music from your party the whole time and the correct corporate rate is not 0%. The reason is that tax revenue ultimately pays for our legal system.

      A corporation enjoys legal protections that are above and beyond what an individual owner / employee has access to. One of the biggest is limited liability."

      The fact that a corporation has limited liability seems to be completely unconnected to paying for the legal system. Limited liability doesn't affect the costs of filing the suit or how much time a governmentally paid judge must spend on the case.

      Perhaps you meant something more like this. By incorporating one gains insulation from personal loss should the company go into debt and it is only fair for the corporation to pay for this insurance.

      However, in the usual case it does pay. Usually, it is the people who lent the corporation money who don't get paid and the corporation already pays for that privilege via the higher interest rates. I mean if Jeff Bezoes (sp?) told people lending Blue Origin money that he would personally be on the hook to pay them back he would get a better interest rate then if he approaches them and tells them they are lending money just to Blue Origin and if that concern goes south they are out of luck and they go into that with their eyes open.

      I think it is certainly fair to be concerned about liability judgements not being covered but there is an easy and more equitable way to handle this. Require anyone engaged in that business to purchase liability insurance (as we require from doctors). This forces businesses to pay for any advantage they gain from limited liability (if the insurance terms require you to personally reimburse the insurer for any payments you will gain a lower rate).

      It also deals with corporate and personal bankruptcy in the same way. It is equally unfair if I don't pay a victim of my negligence because I don't have any assets (maybe my wife has all the money in the family) or because of the protection of the corporate entity.

      ---

      More generally citing advantages the corporation gets in no way is an argument for taxing the corporation. It is an argument for taxing those who ultimately benefit from those legal protections, i.e., the stockholders.

      Delete
    12. Yes, fair enough, good reply. I tried to write something succinct.

      Given that we need a govt of some size to provide public goods then we need to transfer some consumption to the government; so need to collect taxes. Question is then, what is the best way to collect those taxes; that distorts the market least or perhaps tends to correct market failures.

      I would argue that a consumption only tax regime tends encourage sustainability (less consumption) which is often not fully priced. At the same time, savings and investment might have a bigger incentive to reduce consumption for a given amount of utility.

      As for your point on the zero sum of private v govt consumption, where does borrowing fit in to this? My instinct is that higher VAT will tend to reduce consumption.

      Delete
    13. J. Oliver, Peter, and Paul...

      Thanks for all of the replies.

      "Frank, it seems to me that the goal of taxation is to move some consumption from individuals to Government."

      I disagree. The economic role of taxation is to create a demand for currency sponsored by the government. An additional role of taxation is to pay for legal services provided by government (system of laws, courts, enforcement). I don't agree that taxation should be used to perform consumption shifting from individual choices to government choices.

      "More generally citing advantages the corporation gets in no way is an argument for taxing the corporation. It is an argument for taxing those who ultimately benefit from those legal protections, i.e., the stockholders."

      I disagree. Ultimately, both shareholders and employees gain (in terms of limited liability) from organization as a corporation. Without a corporate umbrella, criminal liability can be extended to both the individual employees (past and present) as well as the ownership (past and present) in a corporation.

      The issue that I have is that if we are going to treat corporations strictly as pass through vehicles in an economic sense, then we should also treat them as pass through vehicles in a legal sense - for instance bankruptcy by a corporation should result in the liquidation of assets held by it's owners and employees or faulty products that are the proximate cause of death should result in the employees / owners of that corporation be held criminally responsible.

      There is also the persistence issue. Employees change jobs over time, ownership (share holdings) within a corporation change over time. If a new airplane is designed and built and 5 years later a crash occurs revealing a design / construction flaw, it is likely that some of the individuals involved are no longer employees / owners in the manufacturer.

      "Require anyone engaged in that business to purchase liability insurance (as we require from doctors)."

      Liability insurance works fine where culpability can easily be established in one on one relationships (for instance doctor / patient). It doesn't work so well in manufactured goods with long supply chains, changing ownership / employees, and numerous intermediaries.

      "As for your point on the zero sum of private v govt consumption, where does borrowing fit in to this? My instinct is that higher VAT will tend to reduce consumption."

      Even with borrowing involved, the federal government tends to borrow at better terms than an individual in the private sector (credit spread). A consumption tax will likely widen that spread, lessening the incentive for individuals to fund consumption with borrowing. Whether government fills in the gap with additional borrowing would be difficult to predict.

      Delete
  10. What about the Fair Tax?

    ReplyDelete
  11. I thought your article was fine, until the second sentence. Progressive taxes share the same ethical foundation as Willie Sutton's famous quote, "I rob banks because that's where the money is."

    When you tax one sub-group at a higher rate than another you are essentially creating a type of slavery. The higher taxed group is denied the fruits of their labor in favor of giving it to others. If an individual were to do this, it would be theft. For a national government to do it is "progressive".

    The best attribute of the VAT idea is it taxes all income of an individual at the same rate, removing the arbitrary distinction between money earned by labor vs. investment. One other note to consider is that by its nature, a VAT falls more heavily on the young than the old. At 70, I buy very little beyond food. My son, on the other hand, has a young family and is making many purchases.

    ReplyDelete
    Replies
    1. Not so fast. I can claim my salary is too low, my employer is robbing me by stealing my labor. Therefore, I cannot afford my health insurance, so the Government has to subsidize it. Also, most of the time the capitalist system we have cannot provide enough jobs to keep people employed. So the Government has to step in with various welfare assistance programs.

      Delete
  12. John, could you walk through the second para more thoroughly?

    ReplyDelete
  13. The Left would love this, it would create a massive bureaucracy that produces nothing. Of course the real question is why would someone who claims to be a libertarian want a progressive tax.

    ReplyDelete
  14. I am a little slow: You say "Everyone pays the maximum VAT rate — 40% say, equal to the maximum marginal federal income tax rate. Then, as you spend money over the year, you turn in your receipts — " First, at startup, I pay 40% of what? And, where do I get the money to pay it upfront?

    ReplyDelete
    Replies
    1. Think of it like a sales tax. You buy a $1 widget, you pay $1.40. You get the money upfront from your wages or income, which are no longer taxed.

      Delete
  15. While I can see this working once implemented, I am having a hard time envisioning the transition. Setting aside tax sheltered income, most of us spend funds that have already been taxed. Let's say a retired person is living off of savings that have been previously taxed. Their $1000 rent is now suddenly $1400 with nothing to compensate. Waiting to get some kind of credit at tax time might not be viable. I am not saying a transition plan is impossible but it could get pretty cumbersome having people apply for a VAT exemption each time they pay with taxed money.

    ReplyDelete
  16. It appears to me that HR 25 The fairtax does everything your VAT would do with far less complexity, record keeping and reporting.

    ReplyDelete
  17. I'm rather hyped! I thought of this exact idea a few years ago but, not being a card-carrying phd economist, assumed there was probably some obvious reason why it wouldn't work that explains why no country has implemented such a tax system.

    Luckily, this blog gets a lot of exposure; if the rest of the Econ blogosphere discusses the merits of this proposal, I'll be very interested to hear their feedback.

    ReplyDelete
  18. Not sure how this is different than a sales tax, but fine. HOWEVER, the 13th Amendment would have to be repealed or the income tax will be back before you can say "Woodrow Wilson." Good luck with that.

    ReplyDelete
  19. Seems like a sales tax, but fine. HOWEVER, the 13th Amendment would have to be repealed or the income tax would be back before you could say "Woodrow Wilson." Good luck with that.

    ReplyDelete
  20. We have already have a massive bureaucracy that produces nothing (IRS, and tax departments of EY, PwC, KPMG, Deloitte, RSM, etc).

    I think it was clear that making it progressive was done because that would likely be required to get it passed.

    ReplyDelete
  21. This is a really, really good idea. I appreciate the time you took to address the transaction documentation (and how it contrasts with the current system) and how privacy could be maintained.

    I think current ACH rules would actually support this system - transactions clear in the order they're received. A very poor person wouldn't lose 'purchasing power' because they're stuck waiting for the refund to materialize. If you had $2 in your account, you could buy a $1 iced tea from one store and a $99 cent bag of chips from another and

    And I suppose you could actually make this system work with cash (just that it'd be more inconvenient). You could probably integrate this with a sort of 'post office' bank and extend the benefits of having financial standing to more people / people who really need it.

    ReplyDelete
  22. Any guess as to what this may raise in revenue annually if adopted in the US?

    ReplyDelete
    Replies
    1. It depends on how much we want to spend, and therefore what rate you set the VAT.

      Delete
  23. If we are going to replace all taxation with a single tax why can't it be land tax?

    ReplyDelete
  24. Cochrane's proposal is pretty much fiscal economics 101. One point that one would want to add is taxing "merit consumption" less than ordinary consumption. Presumably it is a pretty settled policy preference that spending on charity contributions and home buying is better than the marginal ice cream cone so that will add back some complexity. Finally, I suspect that to achieve anything like the progressiveness on the current system -- and many people think the current system is not nearly progressive enough -- will require a pretty steep schedule of "refunds" at the top. I suppose the same groups that want to reduce taxes on rich people today will not be happy with this proposal if it truly is progressive.

    ReplyDelete
  25. Nice idea. I appreciate the simplicity of the solution, particularly if there is a single, flat rate and if you can find a way to tax foreign expenditure, where there is zero incentive for anyone to report.

    However, while it is an improvement on today's tax mess, it by no solves compliance problems. A high rate of VAT creates a strong incentive to hide transactions. How many people do you think would add 40% to peer-to-peer cash transactions? And what fraction of economic activity would shift to the low productivity black market from the high productivity formal economy under such a regime? At a 40% rate, it would probably be cheaper to buy most things from a guy with a wheelbarrow than from Amazon or Walmart. The implications for labor productivity and overall economic wellbeing of such a shift in resources are self-evident.

    If you're redesigning the tax system, why not go for a land value tax, which, it seems to me, would be impossible to evade and would not interfere with the price signals that regulate production, consumption and investment decisions in a market economy? Add to that tax on externalities (pollution, congestion, crime) and you might reach utopia.

    ReplyDelete
  26. There is no reason to have a FEDERAL income tax. Currency is not fungible. There is no king paying people in gold who needs to tax to get the gold back to him.

    Why is this so hard to understand?

    Look at Japan and its QE. QE is tantamount to FED governments issuing cash. Where is the inflation?

    Debt is issued so the likes of Goldman can make money peddling it and taxes are required so government can attempt to control us. Both are stupid.

    ReplyDelete
  27. The best argument I have seen for redistributing income rather than just consumption is that there is insurance value to savings that should count as a sort of consumption. The person who makes a lot of money and squirrels it away gains the peace of mind that comes from knowing that whatever happens to them, they can still consume in the future. Various sorts of insurance policies deliver similar peace of mind, and we know that peace of mind has significant consumption value because people are willing to pay high premiums for such policies, and those premiums are typically (as I understand it, happy to be corrected if wrong) categorized as consumption. So making savings tax-free treats buyers of insurance policies unfairly relative to those who self-insure through savings.

    ReplyDelete
  28. Why wouldn't a smart tax evader just set up a lot of entities and spread out his purchases over those entities, so that he always stays at the lowest rate. You could make this illegal, but the only way to figure out that it is happening is to have the federal government get a lot more information than they have now. The feds would have to know who owned or had a beneficial interest in every corp or LLC in the country. It would have to know what those purchases were for and whether that corporate entity had a legitimate purpose for the purchase. I cannot even imagine how the government would get enough information to even start an investigation. They could not investigation everyone with a beneficial interest in multiple entities. In particular, I think it would be even easier for the wealthy to structure their consumption through various entities. My one LLC pays for my lunches, my other corp buys a car for me. My ten different trusts buy an apartment for me. I know tax avoidance happens in our system, but what I cannot figure out is even how to police your system, which would mean everyone engages in tax avoidance and no one pays the top rate. Accordingly, your progressive VAT is not progressive. But, maybe I am too pessimistic.

    ReplyDelete
  29. Ultimately this has to go hand in hand with some sort of modern ID system linked to the payment system. So at point of sale there can be a reliable link to appropriate ID. Maybe this would kill it for some libertarians.

    ReplyDelete
  30. What if we got rid of all the special savings accounts and instead had a consumption account? All income from all sources would go into your usual accounts which are tax free. You would hold your investments in tax free accounts. To make a payment for goods or services or to withdraw cash, it must come through your consumption account. As soon as the funds appear in the consumption account, the VAT rates (progressive if desired) apply immediately. Funds transferred​ to the consumption account pay all the taxes upfront.

    I've always found all the special savings and investment accounts somehow exactly backwards. Can't we just reverse the nature of accounts?

    ReplyDelete
  31. Seems to me the following this would be simpler:

    So one way to achieve the goal might be to make it so a person is allowed to put as much money as they want, pre-tax, into an IRA. Then allow people to take as much as they want out of their IRA at any time but tax all withdrawals. You tax income not put in an IRA and tax the withdrawals at a same progressive rate. You could also allow people to buy a car or home in their IRA and rent them at market rates. The result would be a progressive consumption tax.
    http://un-thought.blogspot.com/2011/10/how-is-this-for-progressive-consumption.html

    ReplyDelete
  32. My Canadian wife used to get sales tax rebates from Alberta. I'm not sure how they calculated it. I don't think she had to track receipts. Maybe they based it on reported income in individuals' income tax returns. Not sure, but might be a good place to look.

    ReplyDelete
    Replies
    1. It is based on income (a certain amount up to a an income cap, then declining up to a phase out cap). Basically is the give a lump of money to make a VAT progressive with a bit more aggressive phase out. THe values are not high enough to do much though, and it has the problem of only showing up a few times a year.

      Delete
  33. What about 40% VAT + UBI? Progressive, but less intrusive.

    I know you want to leave politics out of it, but the reporting/registration requirement of a progressive-VAT approach will not go over well in the US. With a VAT + UBI, however, anybody could choose not to "register" and just pay full VAT w/o UBI. Or, you can "register" to get your UBI and also the option to spread VAT for certain types of expenses (home purchase, etc) over time.

    The transition to progressive-VAT would be hell. Could you imagine the craziness in the economy if everybody knew that a 40% VAT would be introduced next year?

    Combining VAT + UBI also gives the advantage of phasing everything in over years, starting with a low VAT, small refundable tax credits, and across the board tax cuts. Then, over several years, a greater VAT, increasing refundable tax credits, and lower tax rates until VAT reaches 40%, income tax rates are 0%, and the refundable tax credit becomes UBI.

    ReplyDelete
  34. Does a consumption tax noticeably slow the velocity of money? If one has taxable income, they can try to offset it by consuming in a tax-deductible way. If people are already eager to defer taxes, would we see a savings glut / lower GDP caused by deferred consumption?

    ReplyDelete
  35. I like this idea a lot, but how would it work in an international context? At what rate are exports taxed? Can people move to the us, work tax free, then take their money and spend it in other countries?

    ReplyDelete
  36. This doesn't really address the problem that we have too much investment and not enough consumption. Maybe we need a negative VAT with a cap on it.

    ReplyDelete
  37. What about Amish, Mennonites, old order dunkard sects etc., that deal with only chash and check? Some sects allow businesses to pay using credit cards, but in rural Ohio, I don't know of any that accept CC as payment.

    ReplyDelete
  38. Why so hell-bent on making it progressive?

    ReplyDelete
    Replies
    1. Juan Manuel - why so hell-bent to make it progressive? To please the progressive crowd. A flat rate will never fly politically. The idea that a flat consumption tax is regressive, is cemented with steel into the current political minds. You simply cannot change it.

      Delete
  39. You want to charge people their highest rates during Christmas? You are the biggest Grinch in the universe right now...

    ReplyDelete
  40. One observation: the VAT might just discourage spending, especially by the wealthy. What would be its estimated impact on demand?

    ReplyDelete
  41. I have often wanted sin taxes along these lines. Each beer you drink, the tax goes up. First beer is nearly free, tenth beer costs a fortune.

    ReplyDelete
  42. What about moving to the Canadian border (or directly to Canada) and then just do your heavy shopping on the other side of the border (or have a "business trip" to Asia)? That's pretty common in the EU actually, especially for gas.

    ReplyDelete
  43. There is a very big practical hole in this otherwise decent proposal.

    The rich will have both a HUGE incentive to consume in a foreign country, and to consume through a corporate shell. Both things can't be easily controlled or avoided.

    ReplyDelete
  44. Doesn't your system essentially just reduce to the system in which everyone pays a flat VAT tax and the government doles out universal basic income?

    Presumably, on a VAT system I pay the government no tax if I buy some durable good (say gold) and resell it for the same value. That makes any consumption rebate fully transferable. Any year I fail to use my entire consumption rebate I should purchase extra goods and resell them online to pocket that rebate. Thus, we might as well assume that each and every person receives the maximum rebate each year so why not further simplify the system and not bother tracking purchases at all and simply issue each person a rebate.

    Now you might try something clever and say that you only receive the rebate on the net of your purchases minus sales. However, if you try this you resurrect the incorporation problem with a vengeance. If I don't eat through my entire consumption rebate I use the remainder to purchase xboxs and then contract to provide entertainment services, i.e., rent the xbox out at a rate which completely amortizes the cost over the period of the rental. The income from my rental is indistinguishable from income from personal services (as far as the government is concerned I could be playing the xbox myself and dancing to entertain these customers).

    Don't get me wrong. I'm a fan of VAT + UBI but let's just adopt it directly and avoid all the consumption tracking.

    ReplyDelete
  45. To put the problem more simply. For your system to work as advertised it must be able to compute rebates as a pure function of payments to individuals minus payments made by them (otherwise you can no longer claim the virtue of being blind to the type of purchase/transaction). Yet this means it can't distinguish income made by application of personal services, e.g., earning money by doing your job as a plumber or hooker, and the sale of goods. Thus, the system can't prevent people from always eating through their entire consumption rebate and reselling the purchased products. To avoid this outcome you would need audits that determined the fate of all the items you purchased and verified that any claimed personal service income wasn't merely resale of those items. Any attempt to deal with these problems is going to run into serious problems with interactions with things like inheritance and other complications (e.g. what happens when I want to sell off things Grandma bought to consume).

    Also as a matter of public perception your system will APPEAR to be deeply anti-progressive. Richer people will get a larger check from the government each year. Even though they are getting a smaller percentage of their tax rebated it won't serve the psychological goal of making it seem the rich are more on the hook.

    ReplyDelete
  46. The border shop is very imported for the market.

    ReplyDelete
  47. Any scheme that relies on debit card companies reporting my transactions to the government so I can a tax refund feels like a tax on people who use cash. Cash is still legal tender in this country and exchangeable overseas. I still use cash for everything. I'm going to have to save all my receipts and file them? That sounds like a serious pain....

    ReplyDelete
  48. When thinking about how to make a VAT progressive, it is important to remember that the working poor often face severe liquidity/credit constraints. The box of diapers that now costs $20 will sell for $28 under John’s system, with a refund of about $8 paid to the minimum wage Mom. But when…next week? April of the following year? This isn’t a big deal for people who have a wallet full of paid-up of credit cards (gotta get those rewards points) but it is a very big deal to someone raising 3 kids on $30 k per year. The problem is not unique to John’s proposal and can be (imperfectly) solved, but it’s a real problem.

    Timing of rebates also makes the kind of VAT tax arbitrage that Anonymous mentioned less of an issue. The computer that will cost me $2800 will cost the homeless guy hanging out by the Apple store $2000. But when we go into the store, we will have to come up with $2800. The tax arb requires that I front the homeless guy $2800 and then he gives me some share of his VAT rebate whenever that arrives. Could happen…organized crime is a thing but organized crime involving long-term contracts between homeless and hipsters is less of a thing.


    One other Comment. High on the long list of reasons to replace the current income tax is that the doing so would very quickly eliminate the insane practice of linking health insurance to employment.

    ReplyDelete
  49. How would the resale of a house be taxed? I would hope that only the sale of a new house would be taxed. You mentioned spreading that out over many years. I would love to hear more details on this. Thanks.

    ReplyDelete
  50. I like the general idea.

    But it makes for a big incentive to hide consumption using low income individuals. I'd give cash to my kids or retired parents to buy the big ticket items. Even easier than getting an accountant to hide my income, no?

    ReplyDelete
    Replies
    1. Quite a few of the commenters came up with this idea -- hire low-consumption shoppers to go get things for you. I don't think this is a first order problem. Remember, they have to stay low consumption or they start paying your taxes. So you can't get any big ticket items that way -- if they buy your maserati, they pay your taxes. If you hire an army of people to each buy $1,000 of stuff for you, keeping each one of them under the limit, you're going to get caught. You can't advertise this on ebay. Yes, bring the homeless guy in to sign the check for your dinner at Spiaggia? It's not going to work.

      If this would work, you could collude with your employer to "hire" 100 people at minimum wage, and they rebate their salaries to you. Try it and you'll get caught.

      Likewise buying everything in Canada. VATs are border adjusted. Yes, there is some slippage. But compared to the slippage in the current tax code these don't seem like realistically large problems.

      To be clear, I prefer a flat tax and do all our transferring on budget, with carefully and comprehensively targeted social programs. This is a second best. But the current system is about 100th best.

      Delete
  51. Prof,
    If you start thinking about medium-term growth or longer-run growth, it doesn’t have anything to do with monetary policy. It has to do with human capital, physical capital, I think some elements of tax reform. I think you could get better business formation in the country. I think, actually, you could use immigration policy to your advantage.
    Regulation, absolutely. And, generally speaking, better human capital development in the economy. All these things would feed into medium- and long-term growth. And these are all areas where we know the U.S. is not as good as it could be.
    You would not be for, for instance, we’re talking about a big infrastructure project as maybe spurring growth and productivity. In other words, you’re—and I tend to agree with you—you’re seeing this as a big supply side phenomenon, where really, got aggregate demand pretty much to full employment. The problem with growth is really on the supply side here. Then, not VAT. Brgds

    ReplyDelete
  52. Interesting idea, but I fear you've self-identified the fatal flaw: economists do not make good political scientists. And as you note, this is only an ideal solution in political terms (i.e., if one assumes a flat consumption tax combined with highly progressive spending fails).

    Further, while I'm also no political scientist, it strikes me this will not help all that much. I do not think any plan that requires an implicit shift towards using consumption inequality as the new "economic justice" measuring stick will be deemed acceptable by the very people you are trying to appease. Consumption inequality is a much tougher rhetorical sell in U.S. politics, and the left knows it, so I'd not expect them to let you take them there willingly.

    ReplyDelete
    Replies
    1. Anonymous,

      "Interesting idea, but I fear you've self-identified the fatal flaw: economists do not make good political scientists."

      Good thing I am neither an economist (by trade) nor a political scientist (by trade).

      Delete
  53. If we completely replace the income tax with a VAT, how would we implement means-testing: college financial aid, EITC, other means-tested welfare? Without income tax returns, we would not know people's incomes. Would we use their reported consumption? How would we condition benefits to working, as with the EITC?

    On the reporting and record-keeping, is the IRS up to the task of tracking everyone's purchases over the year? I know that a lot of income is currently reported to the IRS (W-2, 1099, etc.). Are they actually able to track everyone's income or is that data just available for audits? I thought that our system depended on "voluntary compliance" (filing our own returns) precisely so that the IRS wouldn't need to track everyone's income. Obviously, most people have many more consumption transactions than income sources, so tracking all of those is even more complex. I thought that existing sales tax reporting is mostly done by stores: they total their sales and periodically self-report? Also, they do not need to track and report sales broken down by customer.

    It seems like the "standard approach" of working through the income tax system by removing all limits on 401(k)s and IRAs is actually cleaner in that it's a simple change to our existing system. The way we prevent people from hiding labor income as capital income currently is that their IRAs cannot hold stock in a firm in which they have a controlling interest. Even if they could, as long as we tax withdrawals (traditional IRA instead of Roth IRA), won't that income be taxed anyways when they try to consume it? To consume, one needs to withdraw cash to pay for the consumption.

    ReplyDelete
  54. It seems to me that what you are suggestting is equivalent to what is proposed in this paper: https://www.aeaweb.org/articles?id=10.1257/aer.100.4.1673

    At least in the part where consumption taxes are coupled with Government transfers.

    ReplyDelete

Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.