Sens. Sam Nunn, D-Ga., and Pete Domenici, R-N.M., want to scrap our personal and corporate income taxes in favor of a national consumption tax.
Usually when people talk about a tax on consumption, they mean a regressive sales tax (or its equivalent, a "value-added tax") that takes a much higher share of income from middle- and low-income families than from the rich. But Nunn and Domenici argue that they have a scheme for a "progressive consumption tax."A progressive consumption tax? How do you do that? Well actually, the mechanism is pretty clever - in theory. To retain graduated tax rates, Nunn and Domenici would eschew direct taxes on spending. Instead, they would retain the trappings of the personal income tax but allow a tax deduction for money saved or invested. The flip side is that "negative savings" - money either borrowed or taken out of savings, say to buy a car - would be counted in computing taxable consumptions. Since by definition people must either save or spend their earnings (ignoring gifts), a tax deduction for savings and an add-back for "negative savings" looks like a slick way to measure an individual's actual spending in a given year.
By properly setting tax rates, Nunn and Domenici claim, we can have a system that's just as progressive as the current income tax. At the same time, they say, a giant loophole for savings and investments would promote these desirable activities, to the betterment of everyone.
It may all sound great at first. But, unfortunately, a progressive consumption tax doesn't live up to its billing.
The proposition that huge new savings and investment "incentives" - including total repeal of the corporate income tax - would be good for the economy ought to have been disproved by our sad experience in the first half of the 1980s.
The contention that a consumption tax could be truly progressive is also a pipe dream. To be sure, mathematically the claim seems irrefutable. If we decide, for example, that people earning $30,000 a year should pay 10 percent of their income in taxes, and the average person with that income saves $3,000 a year, then a tax rate of 11.1 percent on those people's spending will give the same average result as a 10 percent income tax.
But what about people taking in, say $50 million a year? Currently, such people pay about $12 million in federal income taxes. (That's a hefty sum - but they can afford it. After all, they still have $38 million left after taxes.) But someone making $50 million probably has time to spend only a million or two of it. For a consumption tax to assess a $12 million tax on $2 million in spending, the rate would have to be 600 percent. That's hardly a likely political outcome.
Finally, advocates of a progressive consumption tax face an overwhelming practical predicament.
Were a progressive consumption tax about to take effect, rich people would be advised by their lawyers to amass as large as possible a store of cash outside of bank accounts or other places where records are kept. Then, once the new law kicked in, they would deposit their money right back into the bank and take big tax deductions.
Even non-wealthy taxpayers could manipulate the tax.
Ultimately, the notion of a "progressive consumption tax" turns out to be just as oxymoronic as it seems at first glance.
(Robert S. McIntyre is director of Citizens for Tax Justice in Washington, D.C.)