My question is even if we had a consumption tax only and got rid of the income tax co [Archive]

Dean

28th March 2011, 16:14

My question is even if we had a consumption tax only and got rid of the income tax could the Rich/Wealthy/Business Owners still find ways to not pay taxes would the Rich/Wealthy/Business Owners still have Tax Loopholes in what ways could they not pay taxes ?

A consumption tax might work if we had a more egalitarian system. However, it disproportionately targets the lower classes because they are the ones who spend a greater part of their income on consumption. So right off the bat, you are giving the wealthy a way to "not pay taxes."

This also makes it impossible to tax money that is leaving circulation (i.e., if I make $200,000 dollars and save 50% of it, I'm only taxed on 100,000 dollars - on the other hand, a $50,000/yr worker who uses 100% of his income on consumption would be taxed his whole income).

More on this here: http://thethinred.blogspot.com/2011/03/demand-101.html

Consumer spending for mass-production is driven by high quantity demanded of products which go through the same production process. When this is lowered (as in a shift in wealth from the mass-consuming working class), efficiency is lowered, prices go up.
Savings occurs at a rate proportional to the discretionary spending of a given household. This rate goes up as we climb the social ladder - so transferring wealth to the wealthiest causes demand to retract, by expanding the rate at which money is saved and taken out of circulation.

Demogorgon

28th March 2011, 16:21

My question is even if we had a consumption tax only and got rid of the income tax could the Rich/Wealthy/Business Owners still find ways to not pay taxes would the Rich/Wealthy/Business Owners still have Tax Loopholes in what ways could they not pay taxes ?
Yes, they could shop in jurisdictions with lower consumption taxes. If you have a situation where you shift tax away from income towards consumption you will find that those wealthy enough to achieve such an arrangement will have their income paid in your jurisdiction but do their shopping in a jurisdiction that still focuses on taxing income.

As an aside, it isn't necessarily inherent to an income tax system that the wealthy can easily dodge it. It is because of the complexity of many tax systems that they manage. Simply closing loopholes without changing tax rates at all would probably get more income.

Revolution starts with U

28th March 2011, 18:40

The earliest incarnation of the income tax was very hard to dodge (and far more righteous imo); 90% tax on the top 10%, no deductions... honestly we could drop that down to 1% or lower... but whatever
(I think. I may be mixing two incarnations of the income tax here.... but I think Im right)

ComradeMan

28th March 2011, 20:17

Taxes are just state organised theft.

Property Is Robbery

28th March 2011, 20:24

Taxes are just state organised theft.
Then why do you waste your time on this website?

ComradeMan

28th March 2011, 21:07

Then why do you waste your time on this website?

Eh?

inyourhouse

29th March 2011, 08:57

My question is even if we had a consumption tax only and got rid of the income tax could the Rich/Wealthy/Business Owners still find ways to not pay taxes

By "consumption tax", do you mean an indirect tax (e.g. VAT) or a direct consumption expenditure tax? Each can be avoided in different ways. Under a VAT, a percentage tax is applied to the value added on a good at whatever stage of production its at. Wikipedia has a good illustration (http://en.wikipedia.org/wiki/Value_added_tax#Example) of this. Although the legal incidence of a VAT is on firms, the economic incidence falls on consumers in the form of higher prices. If the VAT is a local tax then it can be quite easily avoided by shopping in another jurisdiction. However, a national level VAT is very difficult for the rich (or, indeed, any consumer) to avoid (ie. legally not pay) because the tax is already included in the price of goods and services they buy in that country and its also applied to imports from other countries. It is fairly easy to evade (ie. illegally not pay) VAT type taxes, though; primarily this is done by smuggling goods across countries with different VAT rates and by making unreported transactions with firms (of course, the firm has to be willing to be a party to this illegal transaction). In fiscal year 2005–06, an estimated £12.4 billion (14.5% of potential VAT revenues) was lost due to VAT evasion (www.ifs.org.uk/budgets/gb2007/07chap9.pdf) in the UK, so evidently this fraud can be quite significant.

The legal incidence of a direct consumption expenditure tax is different because it is paid by individuals rather than firms (the economic incidence is the same, of course: consumers bear the burden). It's essentially an income tax with savings and investments deducted from taxable income. Suppose a person earns $100,000 per year, of which he saves $20,000 and invests $10,000. Under a regular income tax (ignoring deductions for the sake of simplicity), the individual would be charged tax on that $100,000 income. Under a direct consumption expenditure tax, however, the individual would be charged tax on his consumption only, which is $100,000 - ($20,000 + $10,000) = $70,000. A person can only really avoid this tax by earning his income in another jurisdiction. A person can, of course, evade this tax by under-reporting income or over-reporting his savings and investments. Overall, though, I would say that it's harder to avoid and evade this tax compared with a VAT.

As for my personal opinion, I certainly think that replacing the current income tax with a progressive consumption tax would be a good move. The problem with income taxes is that they discourage saving, which means relatively higher interest rates, lower investment, less capital accumulation, and ultimately lower growth in output per capita. A consumption tax incentivizes saving and investment by lowering a person's tax burden if they choose to save or invest more. Of the two types of consumption taxes discussed, I think a direct consumption expenditure tax would be preferable because it's much easier to make progressive.

would the Rich/Wealthy/Business Owners still have Tax Loopholes in what ways could they not pay taxes ?

I don't think this question makes sense. If the consumption tax had various loopholes, then yes, the rich would still have loopholes to avoid paying taxes. If the consumption tax didn't have loopholes, then no, they would not have loopholes to avoid paying taxes. That seems to be true by definition. In the case of a VAT, loopholes would be exempt goods and services. Usually exemptions are applied to goods that are considered necessities (e.g. vegetable), but the rich could lobby to have something they would like to purchase exempted (e.g. luxury sports cars). In the case of a direct consumption expenditure tax, the rich could lobby to have similar loopholes to the ones that currently exist in the income tax (e.g. deduction for mortgage interest payments).

A consumption tax might work if we had a more egalitarian system. However, it disproportionately targets the lower classes because they are the ones who spend a greater part of their income on consumption. So right off the bat, you are giving the wealthy a way to "not pay taxes."

Yes, that's definitely true, but it's easy to correct for in the case of a direct consumption expenditure tax by making rates and brackets more progressive than they are under the current income tax code. With these changes, it could be perfectly neutral with respect to income inequality. It's much harder to make a VAT progressive, though, which is why I've always wanted to see it abolished in the UK.

This also makes it impossible to tax money that is leaving circulation (i.e., if I make $200,000 dollars and save 50% of it, I'm only taxed on 100,000 dollars - on the other hand, a $50,000/yr worker who uses 100% of his income on consumption would be taxed his whole income).

More on this here: http://thethinred.blogspot.com/2011/03/demand-101.html

Saved money does not leave circulation. It simply results in an increase in the supply of loanable funds, which leads to a decrease in interest rates, and thus an increase in investment. So, overall, all that's changed is the distribution of spending between consumption and investment rather than the level of aggregate demand. The level of AD is determined by the central bank).

RGacky3

29th March 2011, 09:08

As for my personal opinion, I certainly think that replacing the current income tax with a progressive consumption tax would be a good move. The problem with income taxes is that they discourage saving, which means relatively higher interest rates, lower investment, less capital accumulation, and ultimately lower growth in output per capita. A consumption tax incentivizes saving and investment by lowering a person's tax burden if they choose to save or invest more. Of the two types of consumption taxes discussed, I think a direct consumption expenditure tax would be preferable because it's much easier to make progressive.

A consumption tax is not progressive, how can it be progressive?

How do income taxes discourage saving? Are you talking about personal savings?

A higher income tax actually will encourage re-investment rather than high executive compensation.

The fact is the people who have the luxury to choose saving vrs spending are those who are well enough to begin with.

Your opinion is based on the supply side theory, which is a terrible theory.

I don't think this question makes sense. If the consumption tax had various loopholes, then yes, the rich would still have loopholes to avoid paying taxes. If the consumption tax didn't have loopholes, then no, they would not have loopholes to avoid paying taxes. That seems to be true by definition. In the case of a VAT, loopholes would be exempt goods and services. Usually exemptions are applied to goods that are considered necessities (e.g. vegetable), but the rich could lobby to have something they would like to purchase exempted (e.g. luxury sports cars). In the case of a direct consumption expenditure tax, the rich could lobby to have similar loopholes to the ones that currently exist in the income tax (e.g. deduction for mortgage interest payments).

Most income tax loopholes are in place on purpose, they can be closed pretty easily.

Yes, that's definitely true, but it's easy to correct for in the case of a direct consumption expenditure tax by making rates and brackets more progressive than they are under the current income tax code. With these changes, it could be perfectly neutral with respect to income inequality. It's much harder to make a VAT progressive, though, which is why I've always wanted to see it abolished in the UK.

How could a direct consumption tax be more progressive?

Saved money does not leave circulation. It simply results in an increase in the supply of loanable funds, which leads to a decrease in interest rates, and thus an increase in investment. So, overall, all that's changed is the distribution of spending between consumption and investment rather than the level of aggregate demand. The level of AD is determined by the central bank).

loanable funds don't mean anything unless you have a strong enough market to make investment profitable. consumption comes before investment.

Kotze

29th March 2011, 12:52

The problem with income taxes is that they discourage saving, which means relatively higher interest rates, lower investment, less capital accumulation, and ultimately lower growth in output per capita. A consumption tax incentivizes saving and investment by lowering a person's tax burden if they choose to save or invest more.If shit doesn't get bought, what's my motivation to invest in production :P

The human chain of exchanges of a currency unit doesn't start with some human saving — if it did, money would have to come from non-humans — it starts with the unit being created and put into circulation by humans. Investment comes before savings, investment creates savings.
A consumption tax is not progressive, how can it be progressive?Don't imagine a tax that is put on the prices of goods, imagine an electronic system of payments and savings where the government tracks individual behaviour.

Dimentio

29th March 2011, 12:55

If shit doesn't get bought, what's my motivation to invest in production :P

The human chain of exchanges of a currency unit doesn't start with some human saving — if it did, money would have to come from non-humans — it starts with the unit being created and put into circulation by humans. Investment comes before savings, investment creates savings.Don't imagine a tax that is put on the prices of goods, imagine an electronic system of payments and savings where the government tracks individual behaviour.

Sounds like energy accounting utilised in a market system. Would probably still be used to repress the poor, since taxes in themselves demand a kind of private ownership of resources.

RGacky3

29th March 2011, 14:06

Don't imagine a tax that is put on the prices of goods, imagine an electronic system of payments and savings where the government tracks individual behaviour.

Almost impossible to impliment, and how would that be made to be progressive?

Dean

29th March 2011, 14:08

Yes, that's definitely true, but it's easy to correct for in the case of a direct consumption expenditure tax by making rates and brackets more progressive than they are under the current income tax code. With these changes, it could be perfectly neutral with respect to income inequality. It's much harder to make a VAT progressive, though, which is why I've always wanted to see it abolished in the UK.

This is why I said a "more egalitarian system" would have to be in place for the system to be feasible. A consumption tax has to be a function of the preservation of resources and public services for it to make sense. If we shifted to a consumption tax, influential parties would make it less progressive than our current income tax, which would only compound the damaging effect described above.

Saved money does not leave circulation. It simply results in an increase in the supply of loanable funds, which leads to a decrease in interest rates, and thus an increase in investment. So, overall, all that's changed is the distribution of spending between consumption and investment rather than the level of aggregate demand. The level of AD is determined by the central bank).
Are you saying that this distribution between investment and consumption doesn't matter? That an economy isn't weakened when less money goes through the process of production?

Bud Struggle

29th March 2011, 14:23

...imagine an electronic system of payments and savings where the government tracks individual behaviour.

That is down right frightening.

Kotze

29th March 2011, 16:12

Lol, what I meant is that the progressive consumption tax inyourhouse talked about tracks the amount of individual spending. It doesn't have to keep records which individual buys which goods. Probably the most prominent advocate of this progressive consumption tax is Robert H. Frank (wrote about that in the New York Times), and I ultimately disagree with most of his rationale (his outlook = bits of Thorstein Veblen + bleeding-heart liberalism + investment-from-savings fallacy + balanced-budget fallacy).

inyourhouse

29th March 2011, 17:29

A consumption tax is not progressive, how can it be progressive?

In the same way as with an income tax: by splitting consumption levels into different brackets and applying different rates. For example, suppose we had the following brackets and rates:

Consumption [] Rate
------------------------------------------
$0 - $10,000 [] 0%
$10,000 - $30,000 [] 30%
$30,000+ [] 60%

Further suppose that the consumption function showing how consumption relates to income (I) is C = 2000 + 0.5*I. Now, we can look at what different income levels would pay in taxes and work out the effective rate with respect to income:

Income [] Consumption [] Taxes [] Effective Rate
-----------------------------------------------------------------------------------
$0 [] $ 2,000 [] $ 0 [] 0%
$10,000 [] $ 7,000 [] $ 0 [] 0%
$20,000 [] $12,000 [] $ 600 [] 3%
$30,000 [] $17,000 [] $ 2,100 [] 7%
$40,000 [] $22,000 [] $ 3,600 [] 9%
$50,000 [] $27,000 [] $ 5,100 [] 10.2%
$60,000 [] $32,000 [] $ 7,200 [] 12%
$70,000 [] $37,000 [] $10,200 [] 14.6%
$80,000 [] $42,000 [] $13,200 [] 16.5%

As you can see, the effective rate with respect to income increases as income increases, which is the definition of a progressive tax. It's true that this particular example I constructed is not significantly progressive, but that can easily be changed by altering the brackets and tax rates. The principle is that a consumption tax can be progressive, and that there is some combination of rates and brackets that would make the effective rate at various income levels the same the same as under the current system. Here is a formal mathematical demonstration of the equivalence of consumption and income taxes, if you're interested: http://people.exeter.ac.uk/gdmyles/papers/pdfs/IncConEq.pdf

How do income taxes discourage saving? Are you talking about personal savings?

I'm talking about private saving (including personal saving). Income taxes discourage saving because the taxation of interest from savings effectively means that future consumption is being taxed at a higher rate than current consumption. As people have positive time preference (ie. they value a given amount of money now, rather than in the future), they will not reduce present consumption and increase saving by enough to result in the same equilibrium level of saving that would have resulted in the absence of the income tax. By contrast, present and future consumption are taxed at the same rate under a consumption tax. Here's a simple mathematical demonstration of this point: http://gregmankiw.blogspot.com/2006/06/consumption-vs-income-taxation.html

The empirical evidence supports this view, as the elasticity of savings with respect to the real after-tax return is estimated to be around 0.4 (http://www.nber.org/chapters/c11221.pdf). That implies that a 1% increase in aggregate real after-tax returns will increase aggregate savings by 0.4%.

A higher income tax actually will encourage re-investment rather than high executive compensation.

You're talking about the corporate income tax now, rather than the personal income tax. Regardless, I don't think that's correct. Investment will fall in response to a higher income tax for the same reasons that I argued saving will above. The empirical evidence (http://www.jstor.org/pss/40229546) seems quite clear on this this too.

Your opinion is based on the supply side theory, which is a terrible theory.

What part of my opinion is based on "the supply side theory" and in what way is it incorrect?

Most income tax loopholes are in place on purpose, they can be closed pretty easily.

I'm aware of that. A progressive consumption tax that is neutral with respect to revenues and income inequality is Pareto superior, though, because it increases growth.

loanable funds don't mean anything unless you have a strong enough market to make investment profitable. consumption comes before investment.

The market will always be able to support any level of investment as long as the central bank keeps nominal spending growth in line with expectations.

The human chain of exchanges of a currency unit doesn't start with some human saving — if it did, money would have to come from non-humans — it starts with the unit being created and put into circulation by humans. Investment comes before savings, investment creates savings.

So, what are you saying exactly? That a greater incentive to save will not increase investment?

Are you saying that this distribution between investment and consumption doesn't matter?

The distribution between investment and consumption matters for long run growth (the higher the share devoted to investment, the high long run growth is). You seem to be suggesting, however, that current growth will be lower if consumption spending falls and investment spending increases. That's simply not true.

That an economy isn't weakened when less money goes through the process of production?

If nominal spending is lower than expected, then economic growth will be lower. Saving does not lower the amount of spending in the economy, though. It just shifts it away from consumption and towards investment.

RGacky3

30th March 2011, 12:33

In the same way as with an income tax: by splitting consumption levels into different brackets and applying different rates. For example, suppose we had the following brackets and rates:

Consumption [] Rate
------------------------------------------
$0 - $10,000 [] 0%
$10,000 - $30,000 [] 30%
$30,000+ [] 60%

Further suppose that the consumption function showing how consumption relates to income (I) is C = 2000 + 0.5*I. Now, we can look at what different income levels would pay in taxes and work out the effective rate with respect to income:

Income [] Consumption [] Taxes [] Effective Rate
-----------------------------------------------------------------------------------
$0 [] $ 2,000 [] $ 0 [] 0%
$10,000 [] $ 7,000 [] $ 0 [] 0%
$20,000 [] $12,000 [] $ 600 [] 3%
$30,000 [] $17,000 [] $ 2,100 [] 7%
$40,000 [] $22,000 [] $ 3,600 [] 9%
$50,000 [] $27,000 [] $ 5,100 [] 10.2%
$60,000 [] $32,000 [] $ 7,200 [] 12%
$70,000 [] $37,000 [] $10,200 [] 14.6%
$80,000 [] $42,000 [] $13,200 [] 16.5%

As you can see, the effective rate with respect to income increases as income increases, which is the definition of a progressive tax. It's true that this particular example I constructed is not significantly progressive, but that can easily be changed by altering the brackets and tax rates. The principle is that a consumption tax can be progressive, and that there is some combination of rates and brackets that would make the effective rate at various income levels the same the same as under the current system. Here is a formal mathematical demonstration of the equivalence of consumption and income taxes, if you're interested: http://people.exeter.ac.uk/gdmyles/p...s/IncConEq.pdf (http://people.exeter.ac.uk/gdmyles/papers/pdfs/IncConEq.pdf)

So they would track your consumption? how?

Its not a sales tax, or something, so how exactly does it work?

I'm talking about private saving (including personal saving). Income taxes discourage saving because the taxation of interest from savings effectively means that future consumption is being taxed at a higher rate than current consumption. As people have positive time preference (ie. they value a given amount of money now, rather than in the future), they will not reduce present consumption and increase saving by enough to result in the same equilibrium level of saving that would have resulted in the absence of the income tax. By contrast, present and future consumption are taxed at the same rate under a consumption tax. Here's a simple mathematical demonstration of this point: http://gregmankiw.blogspot.com/2006/...-taxation.html (http://gregmankiw.blogspot.com/2006/06/consumption-vs-income-taxation.html)

The empirical evidence supports this view, as the elasticity of savings with respect to the real after-tax return is estimated to be around 0.4 (http://www.nber.org/chapters/c11221.pdf). That implies that a 1% increase in aggregate real after-tax returns will increase aggregate savings by 0.4%.

Except taxes, as opposed to savings, can be used in investments that benefit all of society, private investment is not as good as public investment.

You're talking about the corporate income tax now, rather than the personal income tax. Regardless, I don't think that's correct. Investment will fall in response to a higher income tax for the same reasons that I argued saving will above. The empirical evidence (http://www.jstor.org/pss/40229546) seems quite clear on this this too.

No I'm talking about PERSONAL income tax, if personal income tax is high compensation for executives will be loewr because its taxed more.

Of coarse ALL OTHER THINGS BEING EQUAL, taxes will slightly lower investment, but what will lower investment more is lower consumption, which lessens demand, which makes investment not profitable.

A coonsumption tax huts an economy way more than an income tax.

Also public investment is superior since its democratic in nature.

What part of my opinion is based on "the supply side theory" and in what way is it incorrect?

Your opinion is based on the theory that investment comes first, you give more money to the investors and it will be more positive than money to the consumers.

I'm aware of that. A progressive consumption tax that is neutral with respect to revenues and income inequality is Pareto superior, though, because it increases growth.

I need to know exactly how a progressive consumption would work, a VAT? a sales tax? What other type are you talking about.

The market will always be able to support any level of investment as long as the central bank keeps nominal spending growth in line with expectations.

i.e. inflation going way out of control. That does'nt do anything to help the real economy, at that point your just handing out money to banks.

You gotta think more than one step ahead.

inyourhouse

30th March 2011, 13:22

So they would track your consumption? how?

Its not a sales tax, or something, so how exactly does it work?

A direct consumption expenditure tax is administered in the same way as an income tax. At the end of the fiscal year, a person would simply fill in a tax return noting their income and savings. The former minus the latter would give their consumption, and their tax liability could then be calculated based on whatever the brackets and rates are. Of course, in practice some sort of withholding system would need to be implemented in order to ensure that tax payments are spread over the course of the year.

Except taxes, as opposed to savings, can be used in investments that benefit all of society, private investment is not as good as public investment.

I'm not sure what you're arguing here. Tax revenue wouldn't be any lower with a consumption tax, so the government would free to spend as much as it currently does on public investment. The only difference would be an increase in private saving (and, in consequence, private investment) relative to private consumption.

No I'm talking about PERSONAL income tax, if personal income tax is high compensation for executives will be loewr because its taxed more.

Well, of course, if you tax income at a higher rate, people will have less income. I'm not sure why that means it's being "re-invested", though. In any case, this is besides the point because a consumption tax with high enough rates could lower after-tax income by the same amount.

Of coarse ALL OTHER THINGS BEING EQUAL, taxes will slightly lower investment, but what will lower investment more is lower consumption, which lessens demand, which makes investment not profitable.

Aggregate demand is not simply consumption; it is consumption plus investment plus government purchases plus net exports. The level of aggregate demand is a function of monetary policy; all that the tax system can do is change the distribution of spending between those components. A consumption tax would, of course, lower consumption, but it would increase savings and thus investment by an equivalent amount. The positive effects of a consumption tax show up on the supply side, because a shift away from consumption and towards investment means more capital accumulation and thus higher real growth.

A coonsumption tax huts an economy way more than an income tax.

A consumption tax will lead to higher levels of saving, which means more capital accumulation, and thus higher growth. This is a standard part of growth theory.

Your opinion is based on the theory that investment comes first, you give more money to the investors and it will be more positive than money to the consumers.

I suppose you could describe it like that.

I need to know exactly how a progressive consumption would work, a VAT? a sales tax? What other type are you talking about.

I stated in my first post that I was talking about a direct consumption expenditure tax. I even explicitly contrasted it with a VAT.

i.e. inflation going way out of control. That does'nt do anything to help the real economy, at that point your just handing out money to banks.

No, by keeping nominal spending growth in line with expectations I mean that the central bank should hit some fixed target (implicit or explicit) each year. In the long run, that means an inflation rate approximately equal to growth in nominal spending minus the long run growth rate of output. So, if the target was 5% growth in nominal GDP and long run real GDP growth was 3%, then long run inflation would be approximately 2%.

You gotta think more than one step ahead.

I will try to do that.

RGacky3

30th March 2011, 13:42

The former minus the latter would give their consumption, and their tax liability could then be calculated based on whatever the brackets and rates are. Of course, in practice some sort of withholding system would need to be implemented in order to ensure that tax payments are spread over the course of the year.

So would that include investments? Buying securities?

I'm not sure what you're arguing here. Tax revenue wouldn't be any lower with a consumption tax, so the government would free to spend as much as it currently does on public investment. The only difference would be an increase in private saving (and, in consequence, private investment) relative to private consumption.

At the exepense of demand, which would actually destroy private investment.

Well, of course, if you tax income at a higher rate, people will have less income. I'm not sure why that means it's being "re-invested", though. In any case, this is besides the point because a consumption tax with high enough rates could lower after-tax income by the same amount.

I was'nt being clear enough, I'm talking about executives, people who decide where the money goes in a firm, their compensation would drop because it would be taxed more, and it would be more profitable to put it back in the company.

Aggregate demand is not simply consumption; it is consumption plus investment plus government purchases plus net exports. The level of aggregate demand is a function of monetary policy; all that the tax system can do is change the distribution of spending between those components. A consumption tax would, of course, lower consumption, but it would increase savings and thus investment by an equivalent amount. The positive effects of a consumption tax show up on the supply side, because a shift away from consumption and towards investment means more capital accumulation and thus higher real growth.

Monetary policy is the central bank right? I.e. buying bonds from banks and increasing the money supply, thats just inflation.

if consumption is lowered, less profit is made, meaning there is LESS OF AN INCENTIVE TO INVEST. investment only makes sense if your getting a return.

Investment only happens if demand is high enough to make it worth its while.

A consumption tax will lead to higher levels of saving, which means more capital accumulation, and thus higher growth. This is a standard part of growth theory.
¨

Or it will lower demand, which means lower returns, which means the economy slows down, which means people get laid off.

I suppose you could describe it like that.

Which is supply side economics which is aboslutely proven to be majorly flawed.

I stated in my first post that I was talking about a direct consumption expenditure tax. I even explicitly contrasted it with a VAT.

I get it now, but there are major problems with implimenting that, is purchesing property an investment?

No, by keeping nominal spending growth in line with expectations I mean that the central bank should hit some fixed target (implicit or explicit) each year. In the long run, that means an inflation rate approximately equal to growth in nominal spending minus the long run growth rate of output. So, if the target was 5% growth in nominal GDP and long run real GDP growth was 3%, then long run inflation would be approximately 2%.

My point was that when oyu lower demand but want to increase investment, you have to make that up somehow, which means the lower the demand goes, the more money you need to just put out which means the inflation would essencially be the same as the investment returns beyond the normal demand returns.

You lower demand, investment WILL have less returns, to make up for that by changing the monitary policy won't do much.

The whole point of investment is to take resources not being used and put them to use in the economy.

Dean

30th March 2011, 16:54

The distribution between investment and consumption matters for long run growth (the higher the share devoted to investment, the high long run growth is). You seem to be suggesting, however, that current growth will be lower if consumption spending falls and investment spending increases. That's simply not true.

If nominal spending is lower than expected, then economic growth will be lower. Saving does not lower the amount of spending in the economy, though. It just shifts it away from consumption and towards investment.

Shifting towards non-production investment lowers aggregate demand. Regardless, I'd break from Keynes here and say further that consumer demand and capital investment are two competing forces - one provides the basis for consumer spending, the other provides the products consumers demand. If 100% of Keynes' agg. demand was in investment, products would have to be completely free to maintain the process of production exchange - in which case there would be no incentive for production. On the other hand, a consumer-heavy model would provide a massive incentive for the production process to expand.

I am well aware that, for instance, extant capital and further investments thereof expand the potential value and lower the potential cost of products. However, none of these functions can overcome the need for a large base of consumer spending to maintain its processes.

inyourhouse

31st March 2011, 03:48

So would that include investments? Buying securities?

Neither investments nor savings would be taxed until they are used for consumption. So, for example, if I bought $100 worth of gold now and sold it in 50 years for $1100, I would only be taxed on the amount I used for consumption. In other words, if I saved $300 and spent $800 of that $1100 on consumption, I would only be taxed on that $800. Of course, when I got around to spending that saved $300 on consumption, I would then be taxed on that as well.

At the exepense of demand, which would actually destroy private investment.

Aggregate demand is an exogenous variable controlled by monetary policy. All that we need to analyze is the effect of changing the tax structure on aggregate supply growth.

I was'nt being clear enough, I'm talking about executives, people who decide where the money goes in a firm, their compensation would drop because it would be taxed more, and it would be more profitable to put it back in the company.

I don't think that's correct, but regardless, a consumption tax could result in the same level of after-tax income, so this effect (if it exists) would still occur.

Monetary policy is the central bank right? I.e. buying bonds from banks and increasing the money supply, thats just inflation.

Monetary policy is carried out by the central bank, yes. Recall from the equation of exchanges (growth rates form) that %M + %V = %P + %Y. That means that the percentage change in aggregate demand (%P + %Y) will equal the percentage change in the money supply plus the percentage change in velocity (%M + %V). The extent to which that increase in aggregate demand causes inflation (%P) and the extent to which it causes real growth (%Y) is determined by aggregate supply growth. This diagram illustrates this point quite well:

http://themoneyillusion.com/wp-content/uploads/2009/11/New-Image.JPG

Note that monetary policy does not simply cause inflation, but also an increase in real growth. This is because prices are "sticky" in the short run (ie. they cannot perfectly adjust to change in AD). If prices were perfectly flexible (as they are in the long run), an increase in AD growth would simply cause inflation, of course.

if consumption is lowered, less profit is made, meaning there is LESS OF AN INCENTIVE TO INVEST. investment only makes sense if your getting a return.

Lower consumption only means less profit for businesses selling consumption goods. Higher investment means more profit for businesses selling capital goods.

Investment only happens if demand is high enough to make it worth its while.

Or it will lower demand, which means lower returns, which means the economy slows down, which means people get laid off.

Again, aggregate demand is exogenous; it's controlled by the central bank. What we need to look at is aggregate supply. Investment has positive effects on aggregate supply because it increases the capital stock, which means higher output per worker.

I get it now, but there are major problems with implimenting that, is purchesing property an investment?

It could be. The simplest way to control for problems like this is to treat it as though it's a consumption good, but then return the tax paid in a rebate if the house is later sold.

My point was that when oyu lower demand but want to increase investment, you have to make that up somehow, which means the lower the demand goes, the more money you need to just put out which means the inflation would essencially be the same as the investment returns beyond the normal demand returns.

Aggregate demand is aggregate demand. It doesn't matter whether it's coming from more units of money being spent the same amount of time (ie. an increase in %M with a fixed %V) or whether it's coming from the same units of money being spent more (ie. a fixed %M with an increase in %V). It can't, by itself, determine inflation or real output growth. That is determined by its equilibrium with aggregate supply growth. I think this will be clearer if you look at the diagram above.

Shifting towards non-production investment lowers aggregate demand.

How are you defining aggregate demand? The standard way of defining aggregate demand is total spending on all final goods and services, which is simply consumption plus investment plus government purchases plus net exports. A shift away from consumption and towards investment therefore has no effect on aggregate demand.

If 100% of Keynes' agg. demand was in investment, products would have to be completely free to maintain the process of production exchange

Of course, in reality, consumption cannot fall below the amount necessary for sustenance. We are not talking about extreme shifts to 0% consumption, however. A consumption tax would not cause that unless all consumption was taxed at 100%.

Geiseric

31st March 2011, 03:54

maybe if we paid based on consumption need, that would work. However thats socialism...

Taxing based on consumption won't really work because most rich people have a few billion they'll never spend, they have so much money. Somebody can only really consume so much, and the rate of consumption between rich people and regular people is different, but people with 40 million will be taxed the same as people with 20 billion. That is what i'm trying to say.

RGacky3

31st March 2011, 09:04

I wrote a long detailed reply but it got lost (DAMN IT)

But here are my main problems.

1. A central bank CANNOT control aggregate demand, it can try and curb a trend, but it cannot force banks to lend, it cannot force people to buy, it cannot force anything, and yeah prices are sticky, but thats short term and will end up hurting the economy if its a long term policy, government spending is another option. All economies are ultimately based on consumer demand.

2. INVESTMENT AND CONSUMPTION ARE TIED, investment is always tied to consumption, people don't invest in industries that do not make a profit, and profit is made buy people buying stuff, thats the basis of an economy, you can't have an investment based conomy without an equivilant consumption base, try invest in walkman production, it won't work, because people don't buy walkmans.

Aggregate demand will drop, because consumption will drop, and because consumption drops investment will be less profitable.

Supply side economics is a total disaster.

Demogorgon

31st March 2011, 09:48

The notion of a progressive consumption tax does have its attractions, but there are problems with it that make me doubt it.

It is basically an income tax with savings being tax deductible. Presumably it would have to replace income tax as well as VAT and sales taxes as it would make little sense for people to be paying two different income taxes with different rules. That already gives an advantage for those able to save more.

Apart from that it runs into practical problems around what happens with money once it is saved. Is the same tax rate paid on withdrawals from saving accounts? That isn't going to be easy to enforce and at any rate it will make saving less attractive. On the other hand if it is not taxed it makes placing money in a savings account and then withdrawing it a great tax dodge. of course you could get around that by making it harder to withdraw from the accepted savings accounts. You could have Singapore style accounts that you could only use under certain circumstances prior to retirement. Such a scheme would certainly have its attractions but it would still give an unfair advantage to those able to save more.

There is also a problem about whether you tax money moving from one account to another. Particularly when the new account is in a new tax jurisdiction. Suffice to say the system leaves me with my doubts.

inyourhouse

31st March 2011, 10:54

1. A central bank CANNOT control aggregate demand,

You already implicitly accepted that a central bank can control aggregate demand when you accepted that it can cause inflation. For a given amount aggregate supply growth, an increase in inflation can only come about through an increase in aggregate demand. To look at this from another angle, suppose that tomorrow the Fed reduced the monetary base right down to $1. Wouldn't that cause a massive decrease in AD? I think it's reasonable to say that it would. On the flip side, suppose that tomorrow the Fed increased to monetary base by 1 million percent. Wouldn't that cause a massive increase in AD? Again, I think it's reasonable to say that it would. It follows that central banks have the ability to manipulate AD. Of course, they may not be very good at it (ie. they may undershoot or overshoot their target), but they nevertheless have the power to do it.

2. INVESTMENT AND CONSUMPTION ARE TIED, investment is always tied to consumption, people don't invest in industries that do not make a profit, and profit is made buy people buying stuff, thats the basis of an economy, you can't have an investment based conomy without an equivilant consumption base, try invest in walkman production, it won't work, because people don't buy walkmans.

Aggregate demand will drop, because consumption will drop, and because consumption drops investment will be less profitable.

Supply side economics is a total disaster.

Okay, I can see that we're coming at this from two completely different theoretical paradigms. Perhaps it would be better to go right to the empirical evidence. If what I'm saying is correct, then a higher investment share of GDP should be associated with higher real GDP growth. If what you're saying is correct, then a higher investment share of GDP should be associated with lower real GDP growth. Is this a fair summary of our respective positions? Well, my view of the literature is that it supports my position. In particular, Ross Levine & David Renelt's 1992 AER article (http://www.jstor.org/pss/2117352) (the most extensive review article I know of) analyzed a very large number of cross-country regressions and found "a positive and robust correlation between average growth rates and the average share of investment in GDP" (p. 959). How do you account for this?

That already gives an advantage for those able to save more.

That's the idea. Nevertheless, the rates and brackets could be such that the average person on any given income is no better/worse off than they are under the current income tax system. It's just that for two people with any given level of income, the burden would shift towards the person with higher consumption.

Apart from that it runs into practical problems around what happens with money once it is saved. Is the same tax rate paid on withdrawals from saving accounts?

Yes.

That isn't going to be easy to enforce and at any rate it will make saving less attractive.

I'm not sure why that would be the case.

There is also a problem about whether you tax money moving from one account to another.

Only consumption should be taxed, so I see no reason to tax transfers between accounts belonging to the same person. You may want to have a separate gift and/or inheritance tax to stop transfers between different individuals, though.

RGacky3

31st March 2011, 11:30

You already implicitly accepted that a central bank can control aggregate demand when you accepted that it can cause inflation. For a given amount aggregate supply growth, an increase in inflation can only come about through an increase in aggregate demand. To look at this from another angle, suppose that tomorrow the Fed reduced the monetary base right down to $1. Wouldn't that cause a massive decrease in AD? I think it's reasonable to say that it would. On the flip side, suppose that tomorrow the Fed increased to monetary base by 1 million percent. Wouldn't that cause a massive increase in AD? Again, I think it's reasonable to say that it would. It follows that central banks have the ability to manipulate AD. Of course, they may not be very good at it (ie. they may undershoot or overshoot their target), but they nevertheless have the power to do it.

Of coarse they can influence inflation, by increasing the money supply, but that does not mean they can control demand. your example is flawed because increasing inflation will only increase nominal demand, its not like more products are being bought it just means they cost more.

If the Fed increased monetary base 1 million percent it would have major inflationary consequences but people would not neccessarily perchase more things (perhaps initially due to prices being sticky, but not in the long run).

Okay, I can see that we're coming at this from two completely different theoretical paradigms. Perhaps it would be better to go right to the empirical evidence. If what I'm saying is correct, then a higher investment share of GDP should be associated with higher real GDP growth. If what you're saying is correct, then a higher investment share of GDP should be associated with lower real GDP growth. Is this a fair summary of our respective positions? Well, my view of the literature is that it supports my position. In particular, Ross Levine & David Renelt's 1992 AER article (http://www.jstor.org/pss/2117352) (the most extensive review article I know of) analyzed a very large number of cross-country regressions and found "a positive and robust correlation between average growth rates and the average share of investment in GDP" (p. 959). How do you account for this?

I account for this by saying that higher investment and higher GDP growth goes along with a high consumption, it may also be the case that the country is an export economy, in which case the exports can be seen as consumption.

Also a high investment means that there is a lot of disposible income and an actual market to invest it (that makes profit).

Show me a market economy that does better with lower consumption and lower exports.

inyourhouse

31st March 2011, 11:49

Of coarse they can influence inflation, by increasing the money supply, but that does not mean they can control demand. your example is flawed because increasing inflation will only increase nominal demand, its not like more products are being bought it just means they cost more.

Aggregate demand is, by definition, nominal spending. You can't increase aggregate demand without increasing inflation as well. Look at that graph I posted earlier. Any increase in aggregate demand (ie. an outward shift in the blue curve) will raise both inflation and output in the short run (although only inflation in the long run). The crucial point is that it doesn't matter if that increase in aggregate demand is caused by an increase in the money supply or by an increase in the velocity of money (e.g. caused by a government fiscal policy): both will have identical effects. You seem to be suggesting that increasing the money supply will increase inflation, whereas increasing consumption spending will increase output. That's simply not possible.

I account for this by saying that higher investment and higher GDP growth goes along with a high consumption,

The study isn't looking at the level of investment, it's looking at the share of investment (ie. the percentage of total spending that goes towards investment). A higher investment share necessarily means a lower consumption share. Let me state my position as clearly as I can:

* my view is that higher investment shares lead to higher real GDP growth
* the evidence cited shows "a positive and robust correlation between average growth rates and the average share of investment in GDP"
* therefore, the evidence seems to support my view
* do you agree with my view?

it may also be the case that the country is an export economy, in which case the exports can be seen as consumption.

The study controlled for trade, so that doesn't explain the result.

RGacky3

31st March 2011, 13:15

The study isn't looking at the level of investment, it's looking at the share of investment (ie. the percentage of total spending that goes towards investment). A higher investment share necessarily means a lower consumption share. Let me state my position as clearly as I can:

* my view is that higher investment shares lead to higher real GDP growth
* the evidence cited shows "a positive and robust correlation between average growth rates and the average share of investment in GDP"
* therefore, the evidence seems to support my view
* do you agree with my view?

The study controlled for trade, so that doesn't explain the result.

I don't have access to the actual study (you have to pay for it), so I'd have to check it out first.

Heres an explination, after a certain amount of consumption it won't grow that much more, which means that the excess wealth will automatically go to investment, I think thats more a sign of a healthy economy with already high consumption rather than the investment causing the healthy economy.

Aggregate demand is, by definition, nominal spending. You can't increase aggregate demand without increasing inflation as well. Look at that graph I posted earlier. Any increase in aggregate demand (ie. an outward shift in the blue curve) will raise both inflation and output in the short run (although only inflation in the long run). The crucial point is that it doesn't matter if that increase in aggregate demand is caused by an increase in the money supply or by an increase in the velocity of money (e.g. caused by a government fiscal policy): both will have identical effects. You seem to be suggesting that increasing the money supply will increase inflation, whereas increasing consumption spending will increase output. That's simply not possible.

If aggregate demand goes up AND supply goes up inflation does not go up, it does matter where the increase comes from, a healthy increase would come from actual consumer purchaces, i.e. a real market.

The velocity of the money will have a different effect, because it will stimulate production, increasing the money supply, not neccessarily, increasing the velocity which is created by increasing consumer demand (or government spending) requires production, it requires jobs, it requires capital and investment, when you just throw money in the system, perhaps more money is spend, but the actual productoin, capital and investment does'nt nessesarily have to go up.

Demogorgon

31st March 2011, 13:42

That's the idea. Nevertheless, the rates and brackets could be such that the average person on any given income is no better/worse off than they are under the current income tax system. It's just that for two people with any given level of income, the burden would shift towards the person with higher consumption.

Well in the first instance there are reasons why people might have to consume more-having children for instance. Secondly the higher your income, the lower your propensity to consume. This means the wealthy will be paying proportionately less in tax than under a conventional income tax without deductions for saving.

I'm not sure why that would be the case.
Difficulty collecting or saving being discouraged?

For the first, unless you apply the tax as the withdrawal happens it is difficult to see how the tax authorities can detect all withdrawals. If it is taxed at the point of deduction, it is difficult to know what rate it should be taxed at unless the record of how much you consume is being update in real time.

As for why it would discourage saving. Well if you are going to pay quite heavy taxes on each withdrawal you are going to wonder what the point of it is. It effectively means that the amount being paid into your account will exceed the amount that can be withdrawn and much of the contents effectively only exist on paper.

Placing the money in the account will seem not to involve shielding it from taxes but simply deferring the taxes paid on it. Why bother?

Only consumption should be taxed, so I see no reason to tax transfers between accounts belonging to the same person. You may want to have a separate gift and/or inheritance tax to stop transfers between different individuals, though.
The key question is whether transfers abroad are taxed. That is to say I earn my money in a country with then progressive consumption tax saving as much as possible, then transfer it to a country with a conventional income tax and spend it there hence dodging taxes in both countries.

Don't get me wrong, my objections are not ideological, I am just not sure how this would work. I could see variations of it working however. For instance in the United Kingdom there are effectively two taxes on income. Income Tax and National Insurance contributions. You could for instance raise national insurance but make any income transferred to special savings accounts exempt from the tax (while still being subject to income tax). These accounts could only be withdrawn from upon retirement or under other special circumstances (if you fall under hardship for instance) and withdrawals under these circumstances would not be taxed. I think setting the system up like that would more effectively encourage saving than the system you propose.