I do think it would be worthwhile to shift to a pure consumption-based tax system. I would do it by exempting all saving from taxation. This could be done by consolidating all existing tax deferred savings accounts--IRA's, Keoghs, 401k's, etc.--into one savings vehicle. All contributions would be tax-deductible, all withdrawals would be fully taxed at ordinary income tax rates. Money inside the account compounds tax-free until withdrawn.  There would be no limit on contributions, no limit on withdrawals; no age restrictions and so on. Since there are only two things that can be done with income--either save or spend it--all taxation would necessarily fall on consumption if such accounts existed.

The VAT and the so-called fair tax would arrive at this goal by taxing consumption directly. The VAT would essentially tax producers and the tax would be embedded in the prices of goods and services, the fair tax would impose a national retail sales tax and tax final sales. It's a grave mistake, however, to lump all of these types of consumption taxes together as economically the same.  There are critical differences in distribution and administration between them that cannot be glossed over.

For example, under my preferred system, you could still have progressive tax rates.  You really can't with a VAT or retail sales tax. Regressivity would have to be offset with some sort of rebate mechanism that would quickly become the biggest entitlement program of all time. Furthermore, a sales tax large enough to replace all federal taxes would have to be around 60 percent, according to Bill Gale of the Brookings Institution. In large part, this is because there would be massive incentives for evasion and very easy opportunities to avoid the tax.

Basically, the fair tax is a totally crackpot idea in the view of virtually every serious tax expert. The sole exceptions are a couple that the fair tax people have bought off. To make it work, you would have to convert it into a VAT, which solves all of the administrative problems inherent in the sales tax. But for some reason, the fair tax kooks won't buy this and insist on their plan or nothing.

In any case, there is zero chance that this country will ever replace the entire tax system with a sales tax, a VAT or anything like it. Any changes, no matter how large, will be incremental in nature. In my opinion, the most likely option is some sort of add-on tax, which is what the Europeans have done. A low--I emphasize low--retail sales tax might be viable in this regard, but will probably run into insurmountable opposition from state and local governments, which view the general sales tax as theirs exclusively. Therefore, a VAT is much more likely.

One point that has helped VAT efforts in other countries is that it applies to imports, but is rebated on exports. Although this looks like a trick to reduce imports and subsidize exports, it really isn't. Nevertheless, there are a lot of businessmen who think this is the case and support a VAT for this reason. Thus there is a built in constituency for a VAT in the business community, especially if they think the alternative is higher corporate taxes.

As I said earlier, my premise is that this will not become an issue until there is a fiscal crunch. There is zero chance of a VAT until and unless there is a budget crisis that demands a large increase in taxation. Until then, all of this discussion is merely theoretical. But it could be important in shaping how policymakers perceive their options when some action-forcing event comes along.

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