Friday, March 04, 2005

Consumption Tax?

The New York Times reports that Greenspan "Gives Consumption Tax Cautious Backing." Basically I like the idea of allowing people to put income into a non-taxed account and not be taxed on it until they spend it. But I also favor progressive taxation. This would make it very hard to tax people with very high incomes unless they spent a great deal of money.

There are other problems as well. If we retain the mortgage interest deduction, then as William Gale of the Brookings Institution pointed out,
'If interest income isn't being taxed and interest payments are deductible, you and I could just lend each other $1 million,' Mr. Gale said. 'Neither of us could be taxed on our income, and both of us could deduct the interest payments.'

A primary argument in favor of a consumption tax (and a savings incentive) is that it would encourage savings, which would promote capital formation. But is that really a problem? Interest rates are so low (and apparently the Fed has no problem keeping interest rates low) that access to capital is quite easy. There is no shortage of capital these days. If there were more savings, interest rates would be even lower. But how low do we want interest rates to be?

I think the fundamental issue is how to encourage productive work, i.e., work that builds value rather than work that builds waste. I know that's a difficult distinction to make, but wouldn't it be better to have more people working on building better computers than building better soft drinks?

One way to encourage value work is to support work that is paid for by businesses. Presumably, businesses only pay for work that increases value. But that includes people who work for the Coca Cola company, so this is not a an easy solution. Also, we probably do want to encourage work that produces cultural artifacts, artistic works, and scientific results. Often these are not done by profit-making organizations. I don't see an easy answer.

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