Weisbach on The Case for a Consumption Tax

David A. Weisbach (Chicago) has published Claims of Right:  The Case for a Consumption Tax, 110 Tax Notes 1357 (Mar. 20, 2006), also available on the Tax Analysts web site as Doc 2006-4988, 2006 TNT 54-30:

The debate over the choice between income and consumption taxation has been ongoing since the beginning of the modern economy, seemingly without end. Those who argue for an income tax usually claim that taxing capital income is central to a fair tax system because those with capital income appear to have a higher ability to pay. Moreover, reducing taxes on investment income would seem to reduce the progressivity of our tax system, a result that is particularly worrisome at a time of growing inequality.

I will show here, through a simple example, that those arguments are wrong. They miss a basic point: A tax on investment income is implicitly a tax on labor earnings because it reduces the amount that can eventually be purchased with those earnings. By replacing that implicit tax on earnings with an equivalent explicit tax, such as a consumption tax, we can make everyone better off.1 Equally progressive consumption taxes that raise the same revenue as an income tax would have the same effect on incentives to work but would not distort savings decisions. They retain progressivity but are more efficient. Indeed, because the tax system would be more efficient, we could actually increase its progressivity. That should be a tantalizing prospect for those concerned about progressivity and the poor -- those who paradoxically seem to most favor taxing investment income.