In Defense of Consumption Taxes

Countries with higher value-added taxes have more overall spending, and governments that adopt a VAT have experienced, on average, a 29 percent increase in the size of government. That's the conclusion of a new paper by Douglas Holtz-Eakin, a former John McCain adviser, and Cameron Smith.

Holtz-Eakin is a good economist, and it seems intuitive that higher consumption taxes correspond with larger governments, especially since they account for more than 30 percent of revenues in the average OECD country. But as the OECD itself has noted, the most significant rise in tax revenues over the last 30 years has been the rise of Social Security contributions as world citizens lived longer, healthier lives. (To be fair, VAT taxes have also increased over that time.) Isn't it more accurate to say that graying world populations are pulling government spending higher, rather than to say that consumption taxes are pushing countries to spend more?

Take the United States, for example. We have no VAT. Government spending will inevitably rise above its historical 21 percent-of-GDP comfort zone unless Washington severely cuts Social Security and defense or rations health care. I don't see that happening. That means we need new tax revenue. 

Saying we should reject a new tax because it might increase government spending that's coming anyway is like a Gulf Coast city saying, "Let's not buy shutters this fall, because they tend to correlate with hurricane weather." To Holz-Eakin, VAT is like the warm Gulf waters churning up a storm. To me, VAT is the shutters.

Nobody is calling for a value-added tax (in Washington, you could probably end the sentence right there.) that wouldn't be offset by reductions in other taxes. The reason I gravitate toward a consumption tax in theory is that it's a tax with good incentives whose revenue can offset taxes with bad incentives.

Think about the way we collect money in 2010. We tax workers. We tax income. We tax capital gains and dividends and business profits. Those are all good things that we tax because we need money. If we moved more of the tax code away from earning money and toward spending money, we could encourage more work, more business and more saving. After our consumption-fueled binge, we should be thinking about ways to incentivize savings.

In a column for Politico, the authors defend their findings and call for what's sounds like a consumption tax (surprise!) on the difference between income and savings, with the first $30,000 of compensation exempted to spare low-income workers. It's an interesting idea, and it would be easy to administer. We know total wages. We can calculate the money we've saved in 401(k)s and IRAs. The difference -- what we've spent -- would be taxed. I'd be shocked if I saw the deficit commission propose this, or any consumption tax, but it's nice to have VAT-blasters concede that there are good reasons to tax what we spend rather than earn.