OK, someone has to do it. There was a dreadful column on tax policy in today’s New York Times, and none of the usual suspects (Dean, where are you?) has jumped on it yet, so I guess it’s up to me.
The column tells us that shifting from an income to a consumption tax is something that “many economists in both parties applaud”. We learn that “Democratic economists, like their Republican counterparts, say taxing consumption encourages savings, investment and greater economic growth.” The only trick is to avoid making a national sales tax too regressive, so we’ll have to work on that.
Now tell me: exactly how is a consumption tax supposed to increase investment? Like, by what channel? Is there a dearth of savings that prevents business from being able to finance new projects? We have a savings glut. Will a flood of savings lower interest rates? Current rates on business borrowing are just about all risk premium at this point. And what’s the evidence that savings rates are so responsive to taxes anyway? Yes, I know that countries with VAT’s tend to save more, but there’s massive endogeneity there. Look at it this way: I live in Washington State, which finances itself with an 8% sales tax, while our next door neighbor, Oregon, has an income tax. Is there any evidence that savings are so much greater here than there?
So exactly what is the channel that’s supposed to lead from taxing consumption to greater business investment?
Incidentally, if you happen to be of a Keynesian persuasion, you believe savings are more a consequence of investment than a cause of it, and you would also expect that, at times of macroeconomic slack, consumption crowds in investment through rate of return effects. Just saying.