To MMM: Please Pass the Ultra-Mustachian Policy of a Consumption Tax

[DoubleDown]

Dear MMM -- Your site and advice are great, keep up the great work!

Now, I would like to ask you to wield your substantial geopolitical influence to get the USA to abolish our 10-trillion page income tax code and replace it with a one-page Consumption Tax Code. This is the most badass of badass Mustachian public policies there could ever be.  All federal income taxes would be completely abolished. Everyone would bring home 100% of their paychecks (minus employer deductions like insurance, retirement contributions, etc.). No one would ever have to file an income tax return. The IRS could be downsized by 90-95% since there would be no tax returns to process or audit.

Instead, all non-mandatory consumption would be taxed at some FLAT national level for everyone -- say, 15%, or whatever rate makes sense to replace the revenue that used to come from taxing income. This is ultra fair, since everyone gets to decide how much they are taxed by their own spending. It encourages saving instead of spending, since saving is not taxed. It encourages earning more money, because you don't pay more taxes on your higher earnings. It discourages consumption (i.e., encourages badassity), and particularly discourages excess consumption on big-ticket items like Cadillac Escalades, boats, private jets, gas, etc.

You could exempt a few basic necessities, perhaps -- food, prescription medicines, and maybe a few other things. Otherwise, all consumption is taxed. The government can also continue to add heavier "sin" taxes to certain purchases if they want: for example, taxing cigarettes extra to pay for health care, taxing gasoline to pay for infrastructure, roads, public transportation. But that part is no different than it is now.

Merchants will collect the national consumption tax and pass it on to the federal government, just like they do for (most) state sales taxes today. The remaining 5-10% of the IRS that is left can be devoted to hardcore enforcement to go after any scofflaws who might try to engage in black market sales activities without collecting taxes.

Everyone can get on board with this -- conservatives/republicans should like it since everyone is taxed at the same rate, and there is no perceived penalty for earning more. Money can be passed from generation to generation, tax-free. It is only taxed when it is spent.

Progressives/democrats can get on board since everyone is paying only for what they consume, with spendy, rich people paying more. The poor are not hit hard or even at all if they are mostly mostly buying the things we've said are absolute necessities that are exempt from taxation. And individuals on welfare will quickly see their benefits disappear in taxes if they are spent on booze and cigarettes.

I realize special interests will not like it since they currently benefit from the 10 billion loopholes in our current, convoluted tax code (like mortgage interest deductions on vacation homes, favored by the real estate industry). But too bad for them, this Mustachian Policy's time has come.

Would you please see to it that Congress passes this legislation next week (you advocate thinking big, so I'll give it a try!)? Do other Mustachians agree with this?

[tooqk4u22]

I like the concept, but this will disproportianately affect the low and middle classes as they are the ones that spend most of their money as people with high incomes (earned or otherwise) have a much greater amount of discretionary income (i.e. they don't need to spend it). The wealthy pay most of the income taxes currently and their spending would never approach the levels needed to offset it.

The system needs to be fair.....its funny that I am saying this because when it comes to tax discussions I am typically arguing why the wealthy shouldn't pay more.  Again needs to be fair.

[lauren_knows]

I'm no economist, but this economy (as most are, if not all) is based on consumption running it.  Discouraging consumption is technically bad for the economy as a whole. 

I'm not sure if this would ever eventually right itself in such a scenario, but it's something to think about. If EVERYONE was Mustachian, a lot of businesses would go under.  The way people lived their lives would fundamentally change (maybe for the better, but it would be chaotic at best).

[kolorado]

Are you including the Payroll tax in your proposal?
I think the US spent about $4 trillion in 2011. As far as I can tell from pie charts(http://www.businessinsider.com/the-only-chart-you-need-to-see-to-understand-why-the-us-is-screwed-2011-2), 80% of the revenue was from income taxes and payroll taxes. So we the people need to replace roughly $3.2 trillion in revenue.
There are approximately 250 million adults in the US. Figuring that at least a third are retired(from age), disabled or imprisoned, leaves 165 million people to shoulder the tax burden. That's a yearly tax burden of $19.5K for every able bodied adult in the USA. At that level of needed revenue, the tax rate on a median wage earner would be 50%. My own one income family would need to pay all our income to the government to pay our fair share.
The only fair thing to do is to reduce government to a level we can actually afford.

[velocistar237]

A consumption tax is one of the platform elements of NPR Planet Money's Fake Presidential Candidate. The show got together economists from all over the spectrum to build a consensus platform based on economic ideas, and they agreed on abolishing income, payroll, and corporate taxes and moving to a consumption tax.

You can make the tax progressive, with whatever tax brackets. There could be a withholding system. It would still be a lot simpler than the current system.

Read this section and the section following on Wikipedia, on practical considerations and impact on economic growth.

[jpo]

The biggest glaring negative I see about instituting this is that I'll be taxed twice when I spend my current assets (first as I accumulated them, then again when I spend them).

[DoubleDown]

Great questions/insights, thanks for responding! My take at some answers:

I like the concept, but this will disproportianately affect the low and middle classes as they are the ones that spend most of their money as people with high incomes (earned or otherwise) have a much greater amount of discretionary income (i.e. they don't need to spend it). The wealthy pay most of the income taxes currently and their spending would never approach the levels needed to offset it.

I do not see any unfairness or extra burden on the low or middle class (and funny, I'm usually the one arguing to tax the rich a little more!). To use MMM's examples, say you earn $1 million with your family of four, but live on a Mustachian annual budget of $25,000. Meanwhile, I earn $30,000 and also live on an annual budget of $25,000 for my family of four. We would both pay the same amount in taxes, assuming our expenditures were roughly the same. My expenditures, of course, would be a much higher percentage of my income than yours, and you would have far more discretionary income to spend. But what is unfair about that? Wouldn't it make sense that you get to decide what to do with your substantially higher earnings (save it, or spend it and get taxed 15% on your purchases)?

Most people with higher incomes are going to spend more, particularly when they aren't getting hammered in income taxes. I believe the "Millionaire Next Door" authors found that as incomes rise, spending usually rises too (to the detriment of saving).

I'm no economist, but this economy (as most are, if not all) is based on consumption running it.  Discouraging consumption is technically bad for the economy as a whole. 

I'm not sure if this would ever eventually right itself in such a scenario, but it's something to think about. If EVERYONE was Mustachian, a lot of businesses would go under.  The way people lived their lives would fundamentally change (maybe for the better, but it would be chaotic at best).

Yes, it should right itself. Our country is in no danger of under-consuming, and our current levels of consumption are excessive and unsustainable. It would be appropriate for our levels of consumption, at the macro level, to decrease to a sustainable level, although I suspect there would still be plenty of consumption to go around. Remember, everyone would now have 100% of their income to spend. We're used to only having 80%, 70%, 60% available to spend. If your paycheck suddenly was 30% bigger, we might not be wary of some healthy levels of spending.

The only fair thing to do is to reduce government to a level we can actually afford.

I would argue that the very legitimate discussion over how much government we can afford is separate from the "how we pay for it" discussion. That is, whether we decide government should spend $3.2 trillion or $1 trillion, we should pay for it with a tax on consumption instead of income. And yes, I am currently only talking about payroll/income taxes, not the other taxes currently collected (social security, medicare, etc.). I'm not sure if/how those should get factored in, but I'm intentionally ignoring those areas for the moment.

[TLV]

Fair Tax, the system the Libertarian party is advocating, is similar to this. It includes a tax "prebate" (i.e. the government pays everyone at the beginning of every month) of the amount of tax that "poverty-level" spending would pay, so households spending less than the federal poverty-level would have a net negative tax. Tthe tax rate would need to be about 30% (as sales taxes are calculated; 23% if compared to income tax) to be revenue-neutral.

The fair tax website argues that consumption wouldn't be discouraged, because disposable income would rise (no income/payroll tax, plus the prebate) and pre-tax prices would drop (no corporate tax). I'm not sure I buy that argument, but there it is.

[tooqk4u22]

I do not see any unfairness or extra burden on the low or middle class (and funny, I'm usually the one arguing to tax the rich a little more!). To use MMM's examples, say you earn $1 million with your family of four, but live on a Mustachian annual budget of $25,000. Meanwhile, I earn $30,000 and also live on an annual budget of $25,000 for my family of four. We would both pay the same amount in taxes, assuming our expenditures were roughly the same. My expenditures, of course, would be a much higher percentage of my income than yours, and you would have far more discretionary income to spend. But what is unfair about that? Wouldn't it make sense that you get to decide what to do with your substantially higher earnings (save it, or spend it and get taxed 15% on your purchases)?

Yes people would pay the same tax based on spending and while spending increase with income (the more you make the more you spend) it slows down considerably at some point - a person who makes $25k will spend everything because of need, those who make $100K to $1mil will increase their spending (assuming not MMM), but those who make more than that do not spend significantly more so anybody that is making more than that and paying income taxes (even if the effective rate is only 15%) would be paying anything on those amounts or spending and they would just reinvest and make more and more and more.  And because they are not spending and getting taxed on it the $4trillion would have to be made up on higher tax rates on the low-middle income spending.

So you are right that it is technically fair (and I am all for that) but from social contract perspective it is completely unfair - again I can't believe I am saying this because I think the current system is fair. I am so confused, who am I. 

[BuildingFrugalHabits]

A consumption tax is one of the platform elements of NPR Planet Money's Fake Presidential Candidate.

I was going to mention this as well.  I love this idea.  But how would we get around the fact that we've already paid taxes on income earned?  I would hate to have to pay it twice.

[TwoWheels]

I'm a big fan of this idea because it puts the disincentive of taxation in the right place - on consumption rather than on additional productive effort. Yes, our self-image and definition of success as a nation revolves almost entirely around maximizing consumption, but this can't go on forever. Such a tax system (or a tax system based on the concept) would be a very painful adjustment, but it would leave everyone much better off in the long run, IMO.

[JJ]

We have the GST (goods and services tax) here in Oz.  Plus a 10-trillion page tax code.  Sigh.  Plus a top marginal tax rate of 46.5% for high earners. Sigh again.  I guess we're a big country which is sparsely populated so if we want roads, hospitals and phones which work in the middle of nowhere then we have to pay a bit more. 
One good thing about the GST is necessities are not taxed - e.g. residential rent, fresh produce, basics like flour, rice and pasta - but processed foods (chocolate, soft drinks etc) are.  If you eat well you don't pay so in theory a low income earner could more or less avoid it if they tried (as could a high earner).  It also doesn't apply to second hand goods bought and sold privately.  Rent + food + most "stuff" you could ever want can be GST free.

[marty998]

Quick mental calc...to replace all taxes collected through income and corporate tax in Australia would require raising the GST from 10% to 60%.

Can you imagine a GST of 60%? I haven't finished typing but I can already hear Gerry Harvey complaining.

[JJ]

That would give him a real excuse to charge twice as much as the rest of the planet for electronics.

[DoubleDown]

The biggest glaring negative I see about instituting this is that I'll be taxed twice when I spend my current assets (first as I accumulated them, then again when I spend them).

That is a dilemma, I wonder if there's any reasonable way around that?

again I can't believe I am saying this because I think the current system is fair. I am so confused, who am I. 

That literally made me LOL, thanks!

One thing I like about the consumption tax approach is it seems to give incentives to the right behaviors, whether or not people agree it is "fair." I used the word "fair" in my description of it, but really that was lazy and I should admit that the idea of what's fair is probably HIGHLY subjective. What I deem to be fair, and what you or someone else thinks is fair could be very different things. I happen to think progressive taxes on increasing wealth is fair, but I get that others do not. At least with a consumption tax, it would put control in everyone's hands to decide (at least to a large degree) how much tax they are willing to pay based on how much they choose to consume, and it is not progressive unless spenders make it that way.  And people wouldn't have to be bothered about the government putting their hands in their pockets on their (higher) earnings.

I don't necessarily agree that low and middle class people will bear the burden under the theory that really rich people can only spend so much. Rates can be set so that the same overall tax burden is attained. And, lower and middle class people can strive to earn more without any concern of it being taxed, giving them (equal) opportunities to save and better their lives!

[kisserofsinners]

It is my understanding that it's not a reasonable option due to the fact that changing our tax code in this way would damage our viability globally. The rest of the world does income taxes where applicable. The proposed option would kill us in reduced exports.

[Matte]

Is this not the tax that some states And counties put on goods.

[DoubleDown]

It is my understanding that it's not a reasonable option due to the fact that changing our tax code in this way would damage our viability globally. The rest of the world does income taxes where applicable. The proposed option would kill us in reduced exports.

Could you please explain this a little further? I'm thinking (maybe naively) that what we export wouldn't matter at all. This would be strictly a domestic taxation thing, flipping our taxes collected from our citizens and residents from income to the sale of goods. But am I missing something?

[Matte]

Bc Canada is big on these, we call them "sin" taxes, pretty much they tax things that the govt sees as unnecessary.  Alcohol, tobacco are taxed over 100 percent, gasoline has over .25/l $1 gallon tax, there are levies on your power and has bills.  Auto insurance is public and gives millions in hidden tax to the govt.  Now they are adding tolls to bridges, i know that on the surface it sounds very mustachian, but it has effects much more wide spread then you would think.  All these taxes are paid by businesses as well so then they add them to the consumer cost as well.  Even if you consume very little it tends to cost you much more.  Everyone needs to eat, everyone needs heat, many need cars, if all these prices are so inflated just so that you can get a slight income tax break the amount where your better off with consumption tax i would think is well over 100k.

[skyrefuge]

Everyone would bring home 100% of their paychecks (minus employer deductions like insurance, retirement contributions, etc.).

If there is no income tax, then there are also likely to be no "retirement contributions", since at the moment it's only the existence of income tax that differentiates "retirement contributions" from regular old "money".

You could exempt a few basic necessities, perhaps -- food, prescription medicines, and maybe a few other things.

Your one-page tax code is getting longer already!

The government can also continue to add heavier "sin" taxes to certain purchases if they want: for example, taxing cigarettes extra to pay for health care, taxing gasoline to pay for infrastructure, roads, public transportation.

Oops, longer again!

In general, I think a consumption tax is a good idea.  So does nearly every other country in the world, which have Value Added Taxes, leaving the US as a rare exception.  The problem with your particular plan (which, yes, is essentially the FairTax plan) is that the US Federal government currently requires too much tax revenue, so in order to replace the income tax entirely with a consumption tax, the rate on the consumption tax would have to be so high as to make it impractical.  Most (all?) other countries with consumption taxes use them together with income taxes.

For a well-written, detailed look at the issues with FairTax, see http://taxprof.typepad.com/taxprof_blog/files/bartlett_fair_tax.pdf

and it is not progressive unless spenders make it that way.

It is really not progressive under any conditions.  In general use, "progressive" doesn't mean "tax payment goes up as income goes up", it means "tax rate goes up as income goes up".  Under your proposal, the tax rate remains flat regardless of income, with the exemptions for "necessities" being the only thing that gives the plan a slight progressive curve at the low end.  Maybe that's fine, but it's quite a different curve from our current progressive system where high-earners pay substantially higher rates on income.

It is my understanding that it's not a reasonable option due to the fact that changing our tax code in this way would damage our viability globally. The rest of the world does income taxes where applicable.

Almost every other country in the world has both national income and national consumption taxes.

http://en.wikipedia.org/wiki/Value_added_tax