Monday, February 17, 2003

Consumption taxes

This Slate article is a good example of how people don't like consumption taxes, or any taxes, because they are regressive. But there is more you want from a tax system than merely "progressivism" -- you also want it to be cheap. Whatever your position on how large government should be, it is clearly beneficial for taxation to be as efficient as possible (because this lets you tax more, or because this makes the tax burden lighter to bear, whichever you prefer).

Taxes become expensive when they 1) are applied to things that can avoid them and 2) become big (more precisely, when the marginal rate becomes large). Consumption taxes, whatever their regressive drawbacks, are more difficult to avoid than income taxes because there are more ways to hide income than consumption. They also have the benefit of broadening the tax base and letting marginal rates come down, and marginal rates, at ~45% are high. Given that the inefficiency (dead weight loss) caused by taxes increases to the square as the marginal rate increases linearly, reducing a high tax by even a few % can boost growth by a lot, benefiting everyone in the long run.

But in the long run, we are all dead. This post does not take a stand on what the right tax level is, but points out that its valuable to tax efficiently, and there are real tradeoffs between efficient taxation and progressive taxation.

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