Very interesting. I'm not certain I fully understand all of it and I'm even less sure I necessarily agree with all of it, but you've actually made a discourse on taxation interesting, accessible, and applicable. Thank you.
You mentioned that uncapping 401k savings would de facto convert the income tax to a progressive consumption tax, but missed a bit of bipartisan history: the Nunn-Domenici USA (Unlimited Savings Allowance) tax bill of 1995 would have done exactly this. I dimly remember thinking this was a great idea at the time but don't remember why it failed or what lessons that holds for the political feasibility of present day tax reform.
Great article! I broadly agree with this approach, but as a mom of a large family, I can't help but wonder: could this have the unintended effect of (effectively) taxing parents at a higher rate than non-parents? Those with kids are often forced to spend more of their money upfront (on education, gas, groceries, housing) and can't afford to save/invest as large a percentage of it. When we (and many of our friends) ceased to be DINKs and became parents, two immediate effects were:
1) Loss of gross income as one parent (typically mom) scaled back work hours or left her job to care for kids. This kicked many of us down to lower "income tax brackets";
2) More immediate, upfront "consumption spending" and less ability to save/invest. Those of us who had "saved aggressively" before kids could no longer sustain this, at all. This problem gets worse, not better, over time due to upfront costs of education, housing, transportation etc. that disproportionately affect larger families. I would consider this essential, rather than luxury consumption; most couples we knew, after having kids, were doing less luxury spending than before, but "consuming" more from their paychecks overall.
Even assuming no loss of income, this creates a situation where a couple might be penalized or stand to lose *relative* purchasing power if they chose to accept the upfront costs that come with children. I still think that consumption-based taxation is probably the best (and maybe inevitable) way forward, but I'd be curious about exemptions/mitigating incentives that could avoid further suppressing birthrate among the striver classes. Child tax credits, expanded childhood education savings accounts, school vouchers, housing/transportation tax relief for families, etc.
First broad point, for this proposal in specific, a cash flow tax would only tax 'consumption' financed out of non-wage income. We're still fundamentally taxing firms at the profit level, just allowing them to deduct their investment costs immediately.
More generally, there's an important distinction in how we interpret 'consumption'. If you have kids and need to spend more on goods, implementing a traditional VAT would indeed increase prices. We can and should mitigate this through transfer policy to address family costs, such as the child tax credit.... however
A key point about my post is that consumption is actually more broadly defined than it may seem. With a cash flow-consumption tax on firm profits that excludes wage income, we can tax wages via a progressive payroll tax. This structure looks remarkably similar to our current system—we're simply having the payroll tax to function a consumption tax so long as we remove any penalties for individual savings. A wage tax by itself is identical to a consumption tax even!
So rather than further reducing consumption power or targeting consumption power, this is about eliminating penalties on savings on existing taxes that already tax consumption power! In fact, this system implies only an increase in total consumption power, holding rates constant.
>This kicked many of us down to lower "income tax brackets";
Just to say more directly. We can still maintain the current progressive structure of our system, I contend that we should. You can simply modify the existing progressive income tax to a progressive consumption tax by, say, uncapping 401k contributions.
Won't the trade effects and FX adjustments make this unattractive to exporters in the economy? And financial transactions and investments become harder to assess in this regime. Regressiveness I guess we can handle with progressive rebates.
Regressiveness isn't an issue here. This is simply the same corporate tax set up we have except we allow capital to be fully deductible. As long as you exempt saving, you have a consumption tax.
On the trade side:
I'm a bit confused about your point here. The exchange rates adjust to leave real trade flows largely unchanged, so long as your import tax and export rebate are symmetric.
The DBCFT typically excludes financial flows from border adjustment. Financial companies tend to work a bit different. For instance, we also don't care for limiting interested deductibility for financial companies.
"This equivalence reveals something I find beautiful about the DBCFT. It can be thought of as a value-added tax (VAT) combined with a deduction for wages–or equivalently, a VAT plus a wage subsidy at the same rate. Consider how a VAT works: it taxes domestic consumption by taxing all domestic sales and imports while ‘zero-rating’ exports–meaning exporters not only pay no tax on their export sales but also get refunds for VAT they paid on their inputs. But unlike a VAT, the DBCFT provides relief for labor costs through a wage deduction, which effectively works like a subsidy to wages at the tax rate. This means that while a VAT taxes all consumption, the DBCFT only taxes consumption financed from non-wage sources—mainly existing wealth (wealth accumulated before the reform that has already faced the income tax) and above-normal returns to investment."
Nice article. It would be great to develop more how the "border adjustment" part is better than a typical tariff (and how do you deal with classical complains about tariffs). I suppose this tax is less harmful because importers who need cheap inputs from other countries can deduce them?
I touch on this in the piece, but I could have been more explicit. Exchange rates adjust to make the import tax trade neutral—this is why we have an export subsidy.
On the import side, border taxes reduce demand for imports, which decreases the demand for foreign currency needed for these purchases, leading to domestic currency appreciation.
On the export side, rebates incentivize exporters to convert more of their foreign currency earnings back into domestic currency, causing further appreciation.
Together, you have less demand for foreign currency from importers and more conversion to domestic currency by exporters and drive up the domestic exchange rate until it appreciates enough to offset the border adjustment's impact, while foreign currencies correspondingly depreciate.
This appreciation makes imports cheaper in dollar terms, offsetting the import tax, while making exports more expensive in foreign currency terms, offsetting the export rebate. The net result leaves real trade flows largely unchanged .A 20% tax and rebate paired with a 20% dollar appreciation leaves relative prices and incentives where they started. The insight here is that symmetry is the key, the rates on both sides need to be equal.
How does this interact with intermediate goods that may cross the border back and forth multiple times?
And does it make a difference if there are symmetric tax regimes on both sides?
Take the US-Canada auto sector as an example, where components are embedded in sub assemblies, and into larger ones, all the way to finished products with the individual components crossing back and forth multiple times.
Land taxes are economically efficient. In theory, the most efficient tax. There's a few concerns, some a put more weight on than others, and it's mainly a political economy point (but I have some critiques of the inelastic POV, (that I largely agree with and I know Geologists have addressed)) .
I was going to type out a reply, but now that I'm writing, perhaps I should simply turn it into a short post. I'll notify you when I do!
Obviously a lot I disagree with or don't care about here, but I wanting to focus on your discussion of saving. You say "When individuals save rather than consume immediately, these savings don't simply disappear from the economy". But when individuals consume immediately, savings also don't disappear from the economy, they just move to someone else. You talk about saving that can fund actual investments in machinery or people, all well and good. But the money has to come from somewhere. If you want to increase financial savings of both businesses and households, the only possible domestic source is an increase in the deficit.
I suppose your discussion of relative returns is supposed to get around this (the idea being that shifting to a consumption tax will cause people to shift to more productive investments). But this is not clear. Increasing consumption also increases the returns on investment (more demand to verify the investment). Also, increasing consumption has a more broad-based effect: a lot of investment (especially at mature firms) is financed internally, so it's not clear why the individual income tax rate would matter (you not distinguishing much between corporate and income taxes in this portion of the article also muddies things here).
So in conclusion, I'm curious for a better explanation of why you think shifting to taxing consumption of individuals would actually increase productive investment in theory.
This is why people, Rightly, don’t trust academic arguments about taxation or much else. Lots of overly complex arguments with the proviso that the average person isn’t quite sophisticated to follow it. Or quite sophist enough to follow it. You don’t need a phd to figure out consumption tax both makes the cost of everything more expensive, which decreases demand which is of course not conducive to growth. And people who pay little or no tax will now be paying tax every time they spend. For many living on SS and a little pension that extra money is felt. It also promotes the lie that cutting taxes increases jobs. Not true. Increased money for the wealthy does not lead to more jobs, just more investment and inflated asset values. Income inequality just increases (how much more money do the wealthy really need?) and there is nothing about that that is fair. So talk of fairness in this context is just sell rhetoric.
“does not lead to more jobs, just more investment”
Blue collar jobs are lost when investment in domestic production capacity does not keep pace with that of other countries.
Investment in domestic production capacity is necessary to create and sustain good blue collar jobs.
Tax code changes like these are necessary but not sufficient for boosting domestic production capacity.
Regulatory risks are incredibly important to that. Why invest a gazillion dollars in a new factory subject to the whims of politically-connected regulators armed with myriad indecipherable subjective regulations and approval powers? There are so many opportunities to receive good $ returns without taking on the risks associated with US regulators.
I have been interested in the DBCFT and understand the border adjustments, but I don't think it fully captures consumption by high net worth people who purchase a lot of goods overseas.
How would you account for personal purchases made in a foreign country, for example if a billionaire went on a spending spree in St Tropez and purchased a $50 million private yacht or a collection of luxury watches?
DBCFT is better compare only to what we have now. Compared to either a flat tax on income net of savings, or a flat national retail sales tax levied on only personal income, DBCFT is a super loser that continues to tax household saving. The FairTax offers substantial advantage to any other tax system I've ever heard of or imagined.
The FairTax does not tax income; it's national retails sales tax that would replace ALL taxation levied on income. You can read about it on ny Substack, Economics and Freedom. It's absolutely, hands down the winner of any tax policy I've ever studied. I teach public finance, UVA Wise.
Very interesting. I'm not certain I fully understand all of it and I'm even less sure I necessarily agree with all of it, but you've actually made a discourse on taxation interesting, accessible, and applicable. Thank you.
You mentioned that uncapping 401k savings would de facto convert the income tax to a progressive consumption tax, but missed a bit of bipartisan history: the Nunn-Domenici USA (Unlimited Savings Allowance) tax bill of 1995 would have done exactly this. I dimly remember thinking this was a great idea at the time but don't remember why it failed or what lessons that holds for the political feasibility of present day tax reform.
Great article! I broadly agree with this approach, but as a mom of a large family, I can't help but wonder: could this have the unintended effect of (effectively) taxing parents at a higher rate than non-parents? Those with kids are often forced to spend more of their money upfront (on education, gas, groceries, housing) and can't afford to save/invest as large a percentage of it. When we (and many of our friends) ceased to be DINKs and became parents, two immediate effects were:
1) Loss of gross income as one parent (typically mom) scaled back work hours or left her job to care for kids. This kicked many of us down to lower "income tax brackets";
2) More immediate, upfront "consumption spending" and less ability to save/invest. Those of us who had "saved aggressively" before kids could no longer sustain this, at all. This problem gets worse, not better, over time due to upfront costs of education, housing, transportation etc. that disproportionately affect larger families. I would consider this essential, rather than luxury consumption; most couples we knew, after having kids, were doing less luxury spending than before, but "consuming" more from their paychecks overall.
Even assuming no loss of income, this creates a situation where a couple might be penalized or stand to lose *relative* purchasing power if they chose to accept the upfront costs that come with children. I still think that consumption-based taxation is probably the best (and maybe inevitable) way forward, but I'd be curious about exemptions/mitigating incentives that could avoid further suppressing birthrate among the striver classes. Child tax credits, expanded childhood education savings accounts, school vouchers, housing/transportation tax relief for families, etc.
Ah, thought I replied to this!
First broad point, for this proposal in specific, a cash flow tax would only tax 'consumption' financed out of non-wage income. We're still fundamentally taxing firms at the profit level, just allowing them to deduct their investment costs immediately.
More generally, there's an important distinction in how we interpret 'consumption'. If you have kids and need to spend more on goods, implementing a traditional VAT would indeed increase prices. We can and should mitigate this through transfer policy to address family costs, such as the child tax credit.... however
A key point about my post is that consumption is actually more broadly defined than it may seem. With a cash flow-consumption tax on firm profits that excludes wage income, we can tax wages via a progressive payroll tax. This structure looks remarkably similar to our current system—we're simply having the payroll tax to function a consumption tax so long as we remove any penalties for individual savings. A wage tax by itself is identical to a consumption tax even!
So rather than further reducing consumption power or targeting consumption power, this is about eliminating penalties on savings on existing taxes that already tax consumption power! In fact, this system implies only an increase in total consumption power, holding rates constant.
>This kicked many of us down to lower "income tax brackets";
Just to say more directly. We can still maintain the current progressive structure of our system, I contend that we should. You can simply modify the existing progressive income tax to a progressive consumption tax by, say, uncapping 401k contributions.
great piece! as economist who's always favored consumption over income taxes, i really hope it plays out this way
Very timely and well-written post!
Won't the trade effects and FX adjustments make this unattractive to exporters in the economy? And financial transactions and investments become harder to assess in this regime. Regressiveness I guess we can handle with progressive rebates.
Regressiveness isn't an issue here. This is simply the same corporate tax set up we have except we allow capital to be fully deductible. As long as you exempt saving, you have a consumption tax.
On the trade side:
I'm a bit confused about your point here. The exchange rates adjust to leave real trade flows largely unchanged, so long as your import tax and export rebate are symmetric.
The DBCFT typically excludes financial flows from border adjustment. Financial companies tend to work a bit different. For instance, we also don't care for limiting interested deductibility for financial companies.
What's the advantage of DBCFT over a VAT?
"This equivalence reveals something I find beautiful about the DBCFT. It can be thought of as a value-added tax (VAT) combined with a deduction for wages–or equivalently, a VAT plus a wage subsidy at the same rate. Consider how a VAT works: it taxes domestic consumption by taxing all domestic sales and imports while ‘zero-rating’ exports–meaning exporters not only pay no tax on their export sales but also get refunds for VAT they paid on their inputs. But unlike a VAT, the DBCFT provides relief for labor costs through a wage deduction, which effectively works like a subsidy to wages at the tax rate. This means that while a VAT taxes all consumption, the DBCFT only taxes consumption financed from non-wage sources—mainly existing wealth (wealth accumulated before the reform that has already faced the income tax) and above-normal returns to investment."
Nice article. It would be great to develop more how the "border adjustment" part is better than a typical tariff (and how do you deal with classical complains about tariffs). I suppose this tax is less harmful because importers who need cheap inputs from other countries can deduce them?
I touch on this in the piece, but I could have been more explicit. Exchange rates adjust to make the import tax trade neutral—this is why we have an export subsidy.
On the import side, border taxes reduce demand for imports, which decreases the demand for foreign currency needed for these purchases, leading to domestic currency appreciation.
On the export side, rebates incentivize exporters to convert more of their foreign currency earnings back into domestic currency, causing further appreciation.
Together, you have less demand for foreign currency from importers and more conversion to domestic currency by exporters and drive up the domestic exchange rate until it appreciates enough to offset the border adjustment's impact, while foreign currencies correspondingly depreciate.
This appreciation makes imports cheaper in dollar terms, offsetting the import tax, while making exports more expensive in foreign currency terms, offsetting the export rebate. The net result leaves real trade flows largely unchanged .A 20% tax and rebate paired with a 20% dollar appreciation leaves relative prices and incentives where they started. The insight here is that symmetry is the key, the rates on both sides need to be equal.
How does this interact with intermediate goods that may cross the border back and forth multiple times?
And does it make a difference if there are symmetric tax regimes on both sides?
Take the US-Canada auto sector as an example, where components are embedded in sub assemblies, and into larger ones, all the way to finished products with the individual components crossing back and forth multiple times.
These are a much better set of tax proposals: https://zerocontradictions.net/civilization/georgism-crash-course, https://thewaywardaxolotl.blogspot.com/2023/07/natural-resource-taxation.html
Land taxes are economically efficient. In theory, the most efficient tax. There's a few concerns, some a put more weight on than others, and it's mainly a political economy point (but I have some critiques of the inelastic POV, (that I largely agree with and I know Geologists have addressed)) .
I was going to type out a reply, but now that I'm writing, perhaps I should simply turn it into a short post. I'll notify you when I do!
Okay, I'll read your post when you publish it. I personally prefer the term "natural resources tax" over "land value tax".
I also don't propose that they should be the only tax in society, since there are a couple other taxes that have beneficial effects. https://zerocontradictions.net/civilization/political-philosophy#government-revenue
There a lot of detail here, but I feel like it is missing an introduction.
Which federal tax are proposing be reformed?
Personal income tax? Corporate income tax? Payroll tax?
Some combination of the above?
Would it be revenue neutral?
Obviously a lot I disagree with or don't care about here, but I wanting to focus on your discussion of saving. You say "When individuals save rather than consume immediately, these savings don't simply disappear from the economy". But when individuals consume immediately, savings also don't disappear from the economy, they just move to someone else. You talk about saving that can fund actual investments in machinery or people, all well and good. But the money has to come from somewhere. If you want to increase financial savings of both businesses and households, the only possible domestic source is an increase in the deficit.
I suppose your discussion of relative returns is supposed to get around this (the idea being that shifting to a consumption tax will cause people to shift to more productive investments). But this is not clear. Increasing consumption also increases the returns on investment (more demand to verify the investment). Also, increasing consumption has a more broad-based effect: a lot of investment (especially at mature firms) is financed internally, so it's not clear why the individual income tax rate would matter (you not distinguishing much between corporate and income taxes in this portion of the article also muddies things here).
So in conclusion, I'm curious for a better explanation of why you think shifting to taxing consumption of individuals would actually increase productive investment in theory.
This is why people, Rightly, don’t trust academic arguments about taxation or much else. Lots of overly complex arguments with the proviso that the average person isn’t quite sophisticated to follow it. Or quite sophist enough to follow it. You don’t need a phd to figure out consumption tax both makes the cost of everything more expensive, which decreases demand which is of course not conducive to growth. And people who pay little or no tax will now be paying tax every time they spend. For many living on SS and a little pension that extra money is felt. It also promotes the lie that cutting taxes increases jobs. Not true. Increased money for the wealthy does not lead to more jobs, just more investment and inflated asset values. Income inequality just increases (how much more money do the wealthy really need?) and there is nothing about that that is fair. So talk of fairness in this context is just sell rhetoric.
“does not lead to more jobs, just more investment”
Blue collar jobs are lost when investment in domestic production capacity does not keep pace with that of other countries.
Investment in domestic production capacity is necessary to create and sustain good blue collar jobs.
Tax code changes like these are necessary but not sufficient for boosting domestic production capacity.
Regulatory risks are incredibly important to that. Why invest a gazillion dollars in a new factory subject to the whims of politically-connected regulators armed with myriad indecipherable subjective regulations and approval powers? There are so many opportunities to receive good $ returns without taking on the risks associated with US regulators.
Interesting idea with some appeal re simplifying the tax code.
Border effects mught get tricky when affluent people shift their spending abroad by...
... travelling esp to lower cost countries. Consumption - mostly of services - is not taxed at home.
... emigrating eg at retirement, ditto.
... personal importing of goods
I also not that any money spent on illegal stuff eg drugs would go untaxed... this could be a huge boost for the profit margins in organised crime...
I have been interested in the DBCFT and understand the border adjustments, but I don't think it fully captures consumption by high net worth people who purchase a lot of goods overseas.
How would you account for personal purchases made in a foreign country, for example if a billionaire went on a spending spree in St Tropez and purchased a $50 million private yacht or a collection of luxury watches?
Ten potentially fatal flaws of DBCFT versus a Unitary Tax with Formula Apportionment are discussed here https://taxjustice.net/2019/03/19/ten-reasons-why-the-destination-based-cash-flow-tax-is-a-terrible-idea/ . Has something fundamental changed since 2019 that invalidates this analysis?
This feels like reading about the impact of poor land use policy and NIMBY vs YIMBY a decade ago. Trillion dollar bills sitting on the sidewalk
I hope the Trump administration picks them up
DBCFT is better compare only to what we have now. Compared to either a flat tax on income net of savings, or a flat national retail sales tax levied on only personal income, DBCFT is a super loser that continues to tax household saving. The FairTax offers substantial advantage to any other tax system I've ever heard of or imagined.
Not true. You are missing the most important points, which are about corporate taxation and eliminating import/export distortion
(or do flat tax proposals really set corp tax to 0%?)
The FairTax does not tax income; it's national retails sales tax that would replace ALL taxation levied on income. You can read about it on ny Substack, Economics and Freedom. It's absolutely, hands down the winner of any tax policy I've ever studied. I teach public finance, UVA Wise.