Last Friday, the President Bush issued his annual Economic
Report. Press coverage focused heavily on the chapter relating to taxation.
The lead was that President Bush favors a shift toward consumption taxation.
As is so often the case, the news stories gave the barest hint
of what the report actually said. And the spin was designed to frighten
voters into thinking that a new tax was being imposed on top of all the
others, one that will be especially injurious to the poor.
In fact, the Economic Report was more of a philosophical
discussion than a concrete proposal. But the points that it makes will be
central to any effort at fundamental tax reform.
The idea of taxing consumption rather than income has been
around for almost 500 years. In 1651, the philosopher Thomas Hobbes wrote in
"Leviathan" that taxing what people consume is more fair than taxing what
they earn. The former, he thought, represented what people take out of
society, while the latter showed what they contributed.
Hobbes asked, Why should a rich man who saves much and consumes
little be more heavily taxed than one of modest means who consumes all he
earns and more by going into debt? The first is giving something to society
by saving, while the second makes society poorer.
At almost the same time, Sir William Petty also made a strong
case for taxing consumption on the grounds that the goods and services that
people consume are a truer measure of their well being than what they earn.
"Every man should pay according to what he actually enjoyeth," Petty wrote
in 1662. And taxes should be light on those "who please to be content with
In the 18th century, the great Scottish philosopher David Hume
argued that a principal benefit of consumption taxes is that they are to a
certain extent voluntary, because people can choose whether or not to
consume the taxed commodity. This view was endorsed by Alexander Hamilton in
Federalist No. 21. Consequently, he thought that taxes on consumption were
less likely to become excessive.
I bring this history up only to indicate that taxing
consumption, rather than income, is not a radical new idea, but one that has
a long and distinguished pedigree. It fell out of favor in the 20th century
because of Keynesian economics and the popularity of income redistribution
as a central tenet of liberalism. Keynes saw saving as bad for growth, and
income taxation discourages saving by including it in the tax base, which
would not be the case under a consumption tax. And income taxation also
supported liberalism by justifying heavy taxes on forms of income mainly
accruing to the wealthy, such as capital gains and dividends.
Unfortunately, the 20th century's greatest champion of taxing
consumption, economist Irving Fisher, got the reputation of being a bit of a
crank and thus did not have the influence that those favoring income
taxation had. The latter had their greatest success in the 1960s, when the
tax expenditures concept was developed. Henceforth, all deviations from a
theoretically perfect income tax would be considered illegitimate and
Congress often abolished them when looking for new revenue.
The case for taxing consumption had a revival in 1977, when the
Treasury Department issued a study titled, "Blueprints for Basic Tax
Reform." However, since it was a Ford administration initiative that came
out just three days before Jimmy Carter took office, it went nowhere
legislatively. But it did have a profound impact on those who think about
tax policy and really made the idea respectable again. The principal author
of the Blueprints study, economist David Bradford of Princeton, has
continued to write extensively in favor of its basic outlines.
Consumption-based taxation would have made more progress in the
years since except that a few eccentrics got the idea that the entire tax
system needed to be rooted out and replaced with a retail sales tax, like
those at the state level. This is a silly idea that never had any chance of
enactment and would be impossible to implement if it were ever tried.
What the Bush administration proposes is something much more
sophisticated and workable. It wants to work within the existing tax system
to get rid of taxes that burden saving and investment. If this were done
consistently, we would have a tax system that falls only on consumption,
without the administrative and political problems inherent in trying to tax
Supplementing the effort to explain this initiative, President
Bush has included a section in his new budget detailing specific deviations
from a consumption tax base. (Look on page 130 in the Analytical
Perspectives volume.) Taken together with the Economic Report, these
constitute the most powerful case for consumption taxation since the 1977
Blueprints study, and the first to come out of the White House itself.