However, homeowners also consume housing in the same way, but as they pay down a mortgage, the payments are classified as savings, not consumption (because equity is being built in an asset). Inflation in the United States and elsewhere has generated a great deal of commentary. Some, such as Senator Elizabeth Warren (D-Mass) and Marxist economist Richard Wolff have attributed inflation and increased prices to the greed of capitalists and corporations and corporate concentration. “But in both cases, people are deferring consumption.”Not in aggregate.

Looking at families with children, we estimate that on a conventional basis, after-tax income increases by 4.0 percent for the bottom 20 percent of income earners and by 2.1 percent on average overall. Consumption tax reform can boost after-tax income for families with children, simplify the tax filing experience, and ensure a robust system for raising revenue for government programs. Bird also notes that while administration of the tax is considered good compared to other countries, the administrative problems that are encountered are most prominently due to tax design rather than management. In particular, decisions to narrow the base and provide complex rebates increase the administrative costs of the tax, offering another lesson to U.S. policymakers of the importance of a broad, simple tax base. The heightened salience of the VATs may help create political pressure to keep rates from rising. International experiences with VATs, varied as they may be, all point to the lesson of maintaining as broad a consumption tax base as possible with a single standard rate, and using direct policy means to achieve other goals.

Additionally, discussions about implementing a progressive consumption tax are ongoing, which would shift the tax focus from earnings to spending. The current federal tax code is not a pure version of either a consumption tax or income tax. It most closely resembles a broad income tax, generally taxing a person’s current earnings (whether spent or saved) plus the change in the value of their existing assets (such as dividends, capital gains, interest, etc.).

State Tax Systems: A Patchwork of Approaches

Likewise, Roth IRAs tax contributions immediately but do not tax returns to those contributions when withdrawn. If lawmakers excluded certain categories of goods or services from the VAT base, it would require a higher tax rate to generate the same revenue as the option we simulated. Appendix Table 2 illustrates one such example of a narrow tax base. Embedding much of the social safety net in the income tax code, however, creates complexities for families and limits the effectiveness in providing support to households who do not file taxes.

How Taxing Consumption Would Improve Long-Term Opportunity and Well-Being for Families and Children

One such proposal was to temporarily reduce the VAT on electricity from 24 percent to 10 percent. A central repository for questions about economic theory, research, and policy.Please read the rules before posting, as we remove all comments which break the rules. Answers must be in-depth and comprehensive, or they will be removed.

• This seems obvious, but it’s complicated by disagreements about what government should do and how much it should spend.
• Income would include wages and compensation, investment income that is spent, and net borrowing, while saving would include increases in bank deposit accounts and purchases of business assets, financial assets, and owner-occupied housing.
• The states that don’t collect a sales tax are Alaska, Delaware, Montana, New Hampshire, and Oregon.
• A withholding system may be put into place in order to approximate the average tax liability, smoothing payments.

Oregon Measure 118 Is an Aggressive Sales Tax—and Worse

That is why the reform reduces hours worked, even as it results in higher economic output, investment, and wages through its reduction in the cost of capital. In July 2000, Australia cut personal income taxes and abolished several harmful excise and sales taxes and replaced them with a 10 percent Goods and Services Tax (GST, another name for a VAT). The reform included bonus payments to retirees, increases in pensions, child tax offsets and family benefit increases, and payments to individuals outside the tax and pension systems, in part to relieve the transitional impact of the GST on particular groups. A consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or income taxes where all savings are tax-deductible.

One Big Beautiful Bill Act Makes the Individual Income Tax More Complex

In a world with no taxes, Taxpayer A would immediately consume $100, and Taxpayer B would later consume $110 (after receiving a 10 percent return). The Brookings Institution is a nonprofit organization based in Washington, D.C. Our mission is to conduct in-depth, nonpartisan research to improve policy and governance at local, national, and global levels. There’s also when you get outside of the economist models, there’s a concern that if we switch, the current system we have now encourages a lot kinds of savings, you get a special break if you put money into a 401-K or your employer puts money in a pension or an IRA. However compelling the moral case for a wealth tax may be, it has historically proven difficult to garner large revenues from it.

Detractors claim that wealth redistribution could continue endlessly because the highest earners will always be more financially viable than the lowest earners. On the other hand, people who support progressive taxes claim they do not want everyone to have the same amount of wealth, but they do want all people to have what is the progressive consumption tax the ability to meet basic needs. Sales tax is a consumption tax applicable to sales of goods and services. A sales tax typically applies to the sale of goods, and sometimes includes the sales of services. The tax amount is usually ad valorem, that is, it is calculated by applying a percentage rate to the price of a sale. When a tax on goods or services is paid to a governing body directly by a consumer, it is usually called a use tax.

Consider a person determined to save 40% of their wage income, which is $100,000 before taxes. Also assume the invested money increases 5-fold over 40 years, before being spent. On a dynamic basis, after-tax income of taxpayers overall would rise by 1.8 percent due to increased economic growth and higher incomes.

• All itemized deductions and the CTC, EITC, and CDCTC would be eliminated.
• Even if the intention is to support those who earn little income, individuals across the income distribution will also benefit from the reduced rates.
• Other excise taxes are applied to people who benefit from a program or infrastructure.
• For example, New Zealand has the broadest tax base covering nearly 100 percent of total consumption.

”I certainly favor this, but as with ending the Fed it requires careful thought. Just to take one example, lots of old people currently rely on Social Security and Medicare. But even replacing the income tax would require a pretty high VAT, especially if it were partially rebated. The phrase “no differentiation based on source of income” might suggest that Yglesias sides with the progressives that favor a higher capital gains tax rate. But things are not quite that simple, as when you reframe taxes as a function of consumption, everything looks very different. In recent years, the basic tax policy question facing federal lawmakers has been whether to repair the federal income tax, or abandon it and move toward one of the consumption-style tax systems favored by most economists.

Regressive Taxation: When the Poor Pay More

In the context of spending policy, the way you determine whether a spending program is progressive or regressive is by adding up how much money each person gets from the program. If those amounts go up as incomes go up, then that is considered a regressive program. If those amounts go down as incomes go up, then that is considered a progressive program. If the amounts are the same across the income distribution, then that is considered a flat benefit.

Say their $120,000 in income was taxed at 24%, which would be $28,800. The consumption tax vs. income tax really causes a lot of debate. Proponents of the consumption tax say that it is fair because everyone pays taxes.