An argument for consumption taxes

Australia’s Treasury has recently kicked off a fundamental review of the tax and transfer system, with publication of a discussion paper and creation of a review panel.

It’s got a pretty immense scope. On the tax side, Australia’s three big taxes are - like most OECD countries - income tax, corporation tax and consumption tax (in that order). Together these make up about 85% of total revenue, with a further 122 taxes making up the rest.

For my part I’ve long thought the left needs to get over its fear of consumption taxes and shift this up the revenue hierarchy. Why?

Here’s a quick list of 10 for starters…

1. Easy to administer: unlike many other taxes a consumption tax doesn’t need such a level of bureaucracy and administration to run.
   


2. Hard for the rich to avoid: let’s face it – it’s pretty easy to avoid many taxes if you’re wealthy enough to pay for a decent accountant or smart enough to know how to shift money into different forms or between different countries. Consumption – paid at source – is almost impossible to avoid.
   


3. Consumption is a better tracker of long-term income: while incomes used to be relatively stable over the life course, today many people’s incomes will fluctuate considerably (e.g. as people take career breaks or move between different sectors). Taxing consumption is actually a lot fairer way to pay your share over the long term.
   


4. Earned income less correlated with wealth than consumption: again, while in the past earned income formed a sizable proportion of total wealth, today unearned income (like from share investment) rising and difficult to tax. So income tax becoming relatively unfairly burdenous on middle and low-middle income earners. Consumption more closely linked to total income.
   


5. Income and corporation taxes are not the tax bases that they once were: Income tax is less useful these days as unearned income rises in proportion of wealth. In any case income taxes always a drag on productivity through their labour supply effect. And there’s strong downward pressure on corporation taxes in a global economy. Meanwhile the revenue side needs to come from somewhere.
   


6. Link between consumption and happiness weak: the line from classical economists has always been that people know best how to spend their money. I’d broadly agree but at the margins the evidence looking clearer that that marginal DVD really doesn’t matter that much to us anymore.
   


7. We need to save more anyway: Anglo-Saxon economies have long been over-consuming and under-saving. Indeed I’d argue that’s one of the causal factors driving the current downturn. A marginal shift to consumption taxes will raise the savings rate.
   


8. Possible to exempt goods for social objectives: the left always been afraid of effect of consumption taxes on the poor. But easy to exempt for things like babies clothes (which we do already).
   


9. And vice versa on ‘sins’: good evidence that price (as part of a wider package of behaviour drivers) can reduce unhealthy smoking and drinking.
   


10. There are other economic benefits to consumption taxes like their neutrality on differential investments (unlike corporation and income taxes).