In the US, the consumption taxes we are most familiar with are the sales tax and some excise taxes, such as on gasoline, alcohol and tobacco. We typically think of these taxes as having to be imposed at the point of purchase. There is an advantage to this because you’ll know at that time if you can afford to pay the tax. Disadvantages to this approach include that the vendor has additional compliance to collect and remit the tax (and penalties if done wrong) and the rate can’t be adjusted for the income level of the buyer (although I understand many might not view this as a disadvantage).
Another form of consumption tax that has been around in proposals and policy books and reports for a few decades is the formula approach or consumed income tax. If we consider that one’s income is saved and spent, we have this formula:
Income = savings + consumption
Simple algebra converts this formula to a consumption tax:
Consumption = income – savings
We know how to measure income, but how do we measure savings? We can look at beginning bank balances and cash stored up (in case that’s a lot; a few bucks in your wallet can be ignored). To that we add increases to savings and saving spending (such as purchase of stock). Debt must also be factored in. It might get a bit complicated, but can be managed with software and good records.
Two colleagues (Drs. Foldvary and Haight, economists) and I wrote a paper on how a sales tax might be converted to a formula approach consumption tax, how to do it and the advantages and disadvantages. One advantage is that it would remove the sales tax from businesses (they would not pay it or collect it). Another advantage is that low-income/low-wealth taxpayers can be exempt. Also, the calculation can be done as a form attached to an existing income tax return. And, as noted earlier, a progressive rate structure is possible. Disadvantages include that it won’t get at the underground economy and visitors to the state won’t pay the tax. Partial solutions to these problems is to retain the sales tax for vehicles (cars and boards). Also, the state could add a small tax to hotel stays, perhaps collected by cities that already impose such a tax.
Another challenges is that without a sales tax, local governments, at least in California, lose a significant tax source. So, a system of sharing state revenues with local governments would be needed. That won’t be popular with local governments. It can be done to have the local governmetns share in the state income tax which would align both levels of government to want high paying jobs in the state (today, local governments benefit more from big box retailers in their cities because of the sales tax generated).
The paper is posted here. Yes, it is long, but 2/3 of it are appendices should you seek more background information.
What do you think?