Eliminating the Income Tax
The global economic downturn has created the need to spur spending and investments. Despite central banks all around the world lowering interest rates to commercial banks to spur lending, we have not seen the kind of economic recovery that people expected, at least in the developed world. One of the reasons why the recovery has been particularly slow, especially on the jobs front, is because people are still generally cautious about spending and businesses are not investing nearly enough to create new jobs. I’m not a trained economist, but it doesn’t take an experienced one to know what is preventing more jobs from being created in the United States.
The Obama administration should be praised for taking the downturn to a stop. The Stimulus package clearly spurred an increase in productivity and brought job losses to a halt. With another year to go, it is expected that it will continue to at least keep the economy recovering at a reasonable pace. But as we see what’s happening with Obama’s agenda, from health care to climate change to financial reform, we know that people really would like to see a faster economic recovery. The question then would be if a faster economic recovery is possible. In the short-term, probably not. The government can choose to provide more stimulus, especially for local and state governments, but it can’t do anything innovative that can really create a big change in a short period of time.
Nevertheless, the government can secure faster economic growth over the long-term (say the next decade) if it did a few things. Surely, we need health care reform, financial reform, and a tax on carbon to spur innovation in clean energy. But we also need to reform a tax code that prevents jobs from being created and discourages saving and investing. After all, a lack of saving and too much overspending is what caused the economic crisis in the first place. It would therefore be prudent to encourage saving and investing, and discourage overspending to prevent future bubbles and secure steady, long-term economic growth.
So how do we do that? Robert Frank, a Cornell economics professor at the Johnson School, explains why eliminating the income tax would be a good thing. It would spur higher levels of consumer spending as incomes would be higher. This would have the effect of putting more dollars into the economy, which in turn would create more jobs. For those on the upper income brackets, it would lead to an increase in saving and investing as those with more money will have a higher amount left over after total consumption. This, too, would have the effect of creating more jobs.
Now, in a time like this we would like to have higher spending, but for the long-term, when economic growth is stable, it would not necessarily be too good to encourage overspending. This could lead to what we saw with the residential real estate market, where over-lending led to overbuying until the bubble burst. On top of that, eliminating the income tax without creating an additional source of government revenue would balloon the federal deficit, something that would be politically and fiscally unsustainable. So, in place of the income tax, professor Frank suggests implementing a “progressive consumption tax.” The idea here is pretty simple. You get a tax on how much you spend on goods and services annually, and the more you spend, the higher your tax bracket.
A progressive consumption tax would have the effect of increasing revenues for the government, especially from higher spenders. In effect, this would shift the tax burden away from the middle class and into the highest earners. While this may seem a bad thing for very wealthy people, in reality it may turn out to be good for them as well. Here’s why. A higher tax on big spenders would provide an incentive to spend less on luxury (reader: “what?” author: “wait, read on”) and invest more on things that provide actual returns, which would not only create more jobs, but also bring up wealthy people’s productive assets. When the financial markets crashed, a lot of people lost more than what they should’ve lost because they had not invested in productive assets. Instead, they had overspent on luxury, fueling others from lower income brackets to overspend as well and therefore fueling bubbles. So, in the end, it’s better to have an incentive to invest in productive assets than one to overspend on luxury. And this is what a progressive consumption tax would do.
In effect, these tax changes, coupled with new taxes on externalities to get rid of waste and harm, would create new and better jobs, increase federal revenues, lower unnecessary government spending, slash the federal debt and deficits, and create a more competitive environment in which society can prosper. Now, what are the chances of this being considered in the short term? Definitely closer to zero than to one hundred. The upcoming elections, the Obama agenda, and the public’s discontent with government will make something like this unlikely to come up soon, but talking about it consistently to give people an idea of what it would mean could increase its chances of becoming reality in the future.