"Despite its allure of eliminating the current tax bias against saving, a true consumption tax runs into fervent opposition from some (mostly liberal) economists. The one objection to a consumption tax that is based on pure economics is that it would require a higher tax rate in order to raise the same revenue as the income tax. That is because saved income is gone from the tax base. For this reason a consumption tax would be less neutral between work and leisure than an income tax. Advocates of a consumption tax maintain that the gains from additional saving and investment would outweigh the losses from less work effort. It is, however, impossible to know with certainty whether that is correct.
The practical objection to a consumption tax used to be that it is too complicated to monitor the amounts that people save or dissave each year. But that actually can be done quite easily, as we have learned with more than a decade of experience with IRAs. Moving to a complete consumption-tax system for the individual tax code would entail little more than allowing universal, unlimited IRAs and doing away with penalties for early withdrawals. That is, everyone would be able to contribute any amount he or she liked to an IRA or similar saving account and deduct the contribution from taxable income. Investment income would accumulate tax-free in the account, but all withdrawals, including principal, would be added to taxable income. People would not have to pay a penalty if they withdrew funds before waiting until age fifty-nine and a half, as they do now.
Another objection to a consumption tax is that it would be regressive (i.e., it would fall most heavily on those with the lowest incomes). The fear is that the tax burden would be shifted to labor because returns to saving and investments—which constitute a much larger share of income in the upper brackets—would not be taxed. That is partly true. IRAs, for example, have precisely the effect of making returns to saving tax-free. The objection, however, ignores two facts: income from existing capital would be tax exempt only if it was saved, and labor income that was saved would get the same exemption. "
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