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Choosing Between Income and Consumption Taxes

1 min readBy: Andrew Chamberlain

In recent years, the basic taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy question facing federal lawmakers has been whether to repair the federal income tax, or abandon it and move toward one of the consumption-style tax systems favored by most economists.

Economist Alan Auerbach of the University of California at Berkeley has posted a useful primer on the choice between consumption and income taxes to the NBER website. From the abstract:

It has now been nearly three decades since the publication of two important volumes that laid out many of the details of how one might implement a progressive consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. . Over the years since, many contributions have analyzed the mechanics of the different variants of consumption taxation, the potential efficiency and distributional effects of their adoption, the issues of administration and transition from the current tax system, and the problems relating to certain types of transactions. But much of what we “know” is not part of the general policy discussion and there are important issues that the literature has recognized but still not resolved.

The aim of this paper is to lay out the key economic issues involved in deciding whether and how to adopt a consumption tax and to discuss what theory and evidence have told us and could tell us about these issues.

Download the full paper here.