Jason Harrison has a post that makes the case for a specific type of consumption tax:
At the heart of the blueprint was the Destination-Based Cash Flow Tax (DBCFT), a model born from years of academic work and championed by economists like David Bradford, Alan Auerbach, and Jim Hines. The DBCFT represents a synthesis of decades-long debates on optimal taxation, incorporating principles designed to raise substantial revenue to finance what the government deems worthy without throwing wrenches into business decisions.
It’s a fairly long post, but it provides one of the clearest explanations of the rationale for consumption taxes that I have encountered. The Destination-Based Cash Flow Tax has some interesting features:
But unlike a VAT, the DBCFT provides relief for labor costs through a wage deduction, which effectively works like a subsidy to wages at the tax rate. This means that while a VAT taxes all consumption, the DBCFT only taxes consumption financed from non-wage sources—mainly existing wealth (wealth accumulated before the reform that has already faced the income tax) and above-normal returns to investment.
In the conclusion, he explains that a DBCFT is actually a wealth tax:
There’s a funny tidbit at the end of the last section, that you can view a cash flow tax as a tax on “existing wealth.” Turns out, when you dip into “consumption tax world”, you find these sort of weird equivalences and similarities. Well, they’re not as weird to me, since many become ‘obvious’ (like the payroll tax) when working through our precise definition of consumption. But what’s actually important to note is that, technically, everything is a consumption tax. On the infinite time horizon, everything must be consumed eventually, right? Wealth is just the present value of all future consumption—yours, your heirs’, or whoever you donate it to. So a consumption tax is effectively a one-time tax on wealth, measured at its present value. (Real-world wealth taxes, by contrast, impose recurring levies, making them fundamentally different in how they hit deferred versus immediate consumption.)
In popular mythology a wealth tax is good because it “hits the rich”, and a consumption tax is bad because it falls more heavily on the poor. But this is a wealth tax that is also a consumption tax. Harrison points out that this means a DBCFT might have some appeal to both progressives and conservatives.
Harrison finds another appealing symmetry in the way a DBCFT treats border adjustments. Imports are taxed while exports are exempt from taxes. That sounds like a mercantilist’s dream, right? Actually, that tax/subsidy combination is equivalent to completely free trade:
When import taxes and export rebates are applied together, they interact through the exchange rate. The import tax reduces demand for foreign currencies, while the export rebate increases demand for U.S. dollars. These forces reinforce each other, leading to a stronger dollar that neutralizes the effects of both adjustments. For example, if the export rebate lowers prices abroad by 20%, and the import tax raises prices domestically by 20%, the dollar’s appreciation cancels out these changes. As a result, trade flows, consumption patterns, and production decisions remain largely unaffected.
It also eliminates many of the distortions under our current policy regime:
Under a border-adjusted system, manipulating export or import prices provides no tax advantage since the border adjustment would still apply to the transaction.
Furthermore, border adjustments eliminate the incentive to relocate production to low-tax jurisdictions.
Cash flow taxes are very appealing because they eliminate many of the complexities of current tax law, such as depreciation schedules. Of course no tax regime is perfect, but the DBCFT seems to have found a sweet spot that could appeal to progressives, conservatives, mercantilists, free traders, and fans of tax simplification. Not many other proposals have the potential to gain such wide support.
Read the whole thing.
READER COMMENTS
robc
Dec 23 2024 at 4:55pm
As far as I could tell, there was no discussion of deadweight loss in the article. That would be a key factor for any tax change. It is part of the reason I prefer the Single Land Tax.
Arqiduka
Dec 24 2024 at 4:33am
It behoves me as a champion on the VAT to intervene.
In the the search for a serious tax that can replace the current menu, whatever exempts labour income is a non starter. It will be piled up on top of the rest as insufficient to make a dent on its own.
Just do VAT.
Jason Harrison
Dec 24 2024 at 4:41am
The nice thing here is that you’re not piling on to the system, but rather altering existing taxes. You are converting the corporate tax into a cash flow tax. This is a labor excluded VAT… ideally you pair this with a progressive payroll tax (and you get the X-tax) as I describe. This, again, would just be fiddling with the current income tax system. A VAT is nice, but I see it as less politically viable than this (And really, this system is equivalent to just installing an VAT) Admittedly, border adjustment would take some work.
Arqiduka
Dec 24 2024 at 9:37pm
Extremely kind of you to reply.
If I may ,would this tax work akin to the corporate income tax (declare and deduct) or VAT (pay and claim if you have the receipt)?
Scott Sumner
Dec 24 2024 at 10:08am
The problem with VAT is political. It is seen as exempting capital income, and thus being “unfair”. This proposal picks up income from already existing capital and land. But it’s still 100% a consumption tax.
Why not both?
Arqiduka
Dec 24 2024 at 9:41pm
Politically speaking, and I’m glad to be shown the error of this, I guess the super unpopular one is the income tax, and whatever has a chance of superseding it can fly.
Recently, tariffs where floated. VAT would be better, I think, but whatever the alternative, it has to somehow compare to the income tax inflow. In afraid this tax could supplant income tax.
Rick
Dec 29 2024 at 12:33pm
VAT or DBCFT, it won’t replace income taxes. In the real world it will end up being additional to them.
tpeach
Jan 3 2025 at 2:14am
I do like the idea of a DBCFT, but I see some issues.
Like if I’m a billionaire who goes on a spending spree in the French Riveria, buying expensive watches and handbags and luxury boat, this consumption won’t be captured.
Comments are closed.