This is another in my continuing series of excerpts from Joseph E. Stiglitz‘s excellent 1988 textbook, Economics of the Public Sector. I’ve previously posted about this textbook here and here.
Thus an income tax that taxes interest can be viewed as a differential commodity tax in which future consumption is taxed more heavily than current consumption. The question of whether it is desirable to tax interest income is then equivalent to the question of whether it is desirable to tax future consumption at higher rates than current consumption.
Just as, with a well-designed income tax, there may be little to be gained by adding differential commodity taxation, so too there is little to be gained from taxing consumption at different dates at different rates. This means, in effect, that interest income should be exempt from taxation. An income tax that exempts interest income is, of course, equivalent to a wage tax, and we showed in Chapter 17 that a wage tax was equivalent to a consumption tax (in the absence of bequests. This suggests that it may be optimal to have a consumption tax.
That’s very tight reasoning on Stiglitz’s part.
Even though I hate taxes, I love analyzing the economics of taxation.
Co-blogger Scott Sumner is, I believe, an advocate of consumption taxes. If you’ve read me closely over the years, you’ll know that I’m not. I’ve been very critical of a VAT, for example, which comes close to a consumption tax.
So why am I not a fan? Because the analysis of a VAT that finds a VAT to be superior, on efficiency grounds, to other taxes, holds constant something that empirical evidence says should not be held constant: the amount of revenue raised. Because VATs tend to be less visible, they lead to less political resistance and result in a much larger amount of government tax revenue and government spending. Because so much of government spending is inefficient–how much do you value, relative to cost, the occupation of Iraq and Afghanistan or defending wealthy Germany or the middle-speed train in California’s central valley or agricultural subsidies?–the inefficiencies from higher government spending probably outweigh the inefficiency of a less-efficient form of collecting government revenue.
READER COMMENTS
Jerry Brown
Jan 10 2021 at 6:19pm
I think you make a good point here but that it is conditional on two things.
One is that government spending is very much less efficient than private spending. Which often seems to be true at least from the examples we hear about that make it to the news. But then there are plenty of examples of where government spending seems to be as or more efficient than private sector spending that tries to provide the same outcomes. Things like administrative or sales costs of pension plans vs Social Security, or Medicare vs costs of private insurance. Or even the costs of private mercenaries vs regular US Army- not that I agree with any of the wars we have been involved in lately- I don’t.
The other thing you are assuming is that the US government needs the ‘money’ to spend rather than what I think is more accurate- that the US government often needs to reduce private sector spending in order to increase government spending without causing inflation. And then you look at taxes in light of how much they reduce private sector demand- not necessarily how much money the government collects. And a VAT looks better in that light. But of course there are many questions of fairness about who pays a tax and I agree that if the incidence of a tax are hidden then increasing government spending is easier to do. Which is important if you are sure that government spending is very wasteful of resources.
Thomas Hutcheson
Jan 11 2021 at 5:18am
Better said, government taxes to reduce private spending (ideally, just private consumption) so that [at full employment] the Fed does not have to cut back on private spending to meet its inflation target.
Jerry Brown
Jan 11 2021 at 10:14am
Thomas, I like saying it my way but if you find it more understandable your way then that is even better 🙂
David Bellkin
Jan 10 2021 at 6:29pm
It has also been argued that nations with VATs tend to have larger public sectors directly because the tax is relatively efficient. Whether the addition public spending is inefficient is a matter of opinion. In any case, a wage tax or cash-flow consumption tax or X-tax of the sort Stiglitz was recommending would not incur the fiscal illusion you claim that a VAT involves. (Viard is also very good on this subject, as is Zodrow.)
Thomas Hutcheson
Jan 10 2021 at 7:03pm
Consumption taxes have a bad ring because they are assumed to be regressive. But there is no reason not to tax consumption progressively.
OTOH there is no reason to believe that they would be especially easy to administer. There would still be argument about what is consumption (bequests?), averaging over time, favored kinds of consumption (charitable contributions?)
Philo
Jan 11 2021 at 12:34pm
Obviously, bequests (and gifts) are not consumption.
robc
Jan 10 2021 at 7:22pm
Ditto, although from a lay perspective. I agree with you on VAT.
While I dont know if it is more economically efficient, the only tax I can morally support is the Single Land Tax.
It has two practical advantages — it is upper bounded at a level that would require governments at all levels to cut soending dramatically. Also, no deadweight loss.
Juan Manuel Perez Porrua Perez
Jan 10 2021 at 11:37pm
I have to disagree with this. In Mexixo, we have a 16% VAT on most goods and every single receipt from stores, websites, etc. breaks down the price into a VAT component and a price component. Moreover, politícians, pundits and lobbyists like to keep track of which goods are taxed at 16%, which at 0% and which are excempt.
Sergio Martinez
Jan 11 2021 at 2:16am
I did a quick search on the effects of a consumption tax on the size of government and I found this: https://www.ntanet.org/NTJ/66/3/ntj-v66n03p541-570-tax-structure-government-spending.pdf?v=%CE%B1&r=19426893815398216. The authors suggest that a low price elasticity of demand for public goods limits the effect of a given tax structure on government growth. This is part of the abstract:
“Our analysis suggests that introducing the VAT, despite the fact that it is a relatively efficient tax in comparison to the income tax alternative, has little impact on government growth due to two factors: (1) the substitution of the VAT for other tax sources, and (2) the low price elasticity of demand for public goods. In contrast, demand-side changes may have a more significant impact on government size, thus reversing the direction of causality”.
Thomas Hutcheson
Jan 11 2021 at 5:25am
Not to disagree, but to note the implicit assumption here that “consumption taxation” is something flat like a VAT rather than progressive.
A VAT would, however, be a slightly more progressive way to finance SS, Medicare than the employment-dampening capped wage tax,
David Henderson
Jan 11 2021 at 4:03pm
Sergio,
Thanks. That’s very interesting. It’s possible I’ve been wrong for a long time and even got a Wall Street Journal publication out of being wrong. 🙂
I’m a big fan of Tom Borcherding’s work generally. I’ll take a look.
Floccina
Jan 11 2021 at 3:54pm
I hate matching FICA worst of all.
Floccina
Jan 11 2021 at 3:57pm
I think a visible progressive consumption tax can be done.
Knut P. Heen
Jan 15 2021 at 10:41am
I like his point. Whether you tax the budget before it goes into the wallet (the income) or after it comes out of the wallet (the consumption) should not matter much. Taxation of interests does however reduce the budget while it is in the wallet (or to be pedantic, it grows less than the opportunity cost of capital). I put less money in a wallet with a hole in it than in a wallet without a hole in it.
Comments are closed.