Scott Sumner  

The art of the possible

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Two Public Choice Questions... Coercive Priors...

This is from an excellent John Cochrane essay on tax reform:

Second, the government should tax consumption, not wages, income or wealth. When the government taxes savings, investment income, wealth or inheritance, it reduces the incentive to save, invest and build companies rather than enjoy consumption immediately. Taxes on capital gains discourage people from moving or reallocating capital toward their most productive uses. . . .

All the various deductions, credits and exclusions should be eliminated--even the holy trinity of tax breaks for mortgage interest, charitable donations and employer-provided health insurance. The extra revenue, over a trillion dollars annually, could finance a large reduction in marginal rates. This step would also simplify the code and make it fairer.

Imagine that Congress proposed to send an annual check to each homeowner. People with high incomes, who buy expensive houses, borrow lots of money or refinance often, would get bigger checks than people with low incomes, who buy smaller houses, save up more for down payments or pay down their mortgages. There would be rioting in the streets. Yet that is exactly what the mortgage-interest deduction accomplishes.

Similarly, suppose Congress proposed to match private charitable donations. But rich people would get a 40% match, middle class people only 10%, and poor people nothing. This is exactly what the charitable deduction accomplishes.

Zeroing out deductions, credits, and corporate and investment taxes matters--for permanence, for predictability and for simplicity. If the corporate rate is drastically reduced, or if deductions are capped, it seems that the economic distortions go away. But the thousands of pages of tax code are still in place, the army of lawyers and accountants and lobbyists is still in place, and the next administration will itch to raise the caps, and the rate.

Why is tax reform paralyzed? Because political debate mixes the goal of efficiently raising revenue with so many other objectives. Some want more progressivity or more revenue. Others defend subsidies and transfers for specific activities, groups or businesses. They hold reform hostage.

Wise politicians often bundle dissimilar goals to attract a majority. But when bundling leads to paralysis, progress comes by separating the issues. Thus, we should agree to first reform the structure of the tax code, leaving the rates blank. We will then separately debate rates, and the consequent overall revenue and progressivity.

Consumption-based taxes can be progressive. A simplified income tax, excluding investment income and allowing a full deduction for savings, could tax high-income earners' consumption at a higher rate. Low-income people can receive transfers and credits. I think smaller government and less progressivity are wiser. But we can agree on an efficient, simple and fair tax, and debate revenues and progressivity separately.

We should also agree to separate the tax code from the subsidy code. We agree to debate subsidies for mortgage-interest payments, electric cars and the like--transparent and on-budget--but separately from tax reform.

Negotiating such an agreement will be hard. But the ability to achieve grand bargains is the most important characteristic of great political leaders.


Some people claim that it's pointless to call for tax reform, because it will never happen. I don't agree with that view. We'll never have a perfect system, but it's useful to first figure out which direction we want to go, and then see what's possible. Because the current system is so inefficient, there are potential compromises that benefit a wide range of income levels.

I see two big roadblocks to achieving Cochrane's vision, both of which may call for a bit more compromise that he would prefer:

1. How to disentangle labor and capital income.
2. Cognitive illusions in tax incidence and inequality.

If we eliminate all taxes on capital income, as most sensible reformers advocate, then we need to make sure that labor income is not disguised as capital income. One compromise is to have the IRS err on the side of treating entangled income as labor income. Examples:

If a contractor buys an old house, fixes it up, and sells it without using it as his primary residence for at least X years, treat the gain in property value as labor income. If a hedge fund manager receives any income from managing a hedge fund, treat it as labor income, even if it is structured to look like capital income. Treat all meals as consumption, without exception. Even business lunches. If "consuming" meals isn't consumption, what is? Cap business travel deductions at the coach class rate.

I believe that advocates of a clean consumption tax have to show good faith, by showing a willingness to aggressively go after tax shelters, especially shelters that re-label labor income as capital income.

As far as cognitive illusions, the current tax system looks far more progressive than it actually is. Eliminating taxes on capital won't make it all that much more regressive, but it will look far more regressive to the average progressive economist. So we need to be willing to compromise on progressivity, to make a grand deal feasible.

Fortunately, the benefits of true tax reform would be so great that even with some compromises, it would be a win-win situation for both libertarians and progressives. Pity about the people in the tax preparation industry.

Seriously, if Cochrane's plan were actually implemented, the loss of jobs in health care would be at least 10 times greater than in the tax preparation industry. That's the biggest political hurdle to clear. And the biggest benefit from reform.


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CATEGORIES: Tax Reform




COMMENTS (28 to date)
Jeff writes:

Getting rid of the corporate income tax altogether is a good idea, but unless you also tax all income the same, it will be perceived as unfair. That means treat things like carried interest and capital gains as ordinary income.

Now you may object that capital income should be lightly taxed, or not at all, or you may point out that if capital gains are not indexed to inflation, you're actually taxing capital itself, not just the income from it.

The solution to all of these problems is to tax consumption only, rather than any kind of income.

David writes:

Yeah, I thought the proposal to tax consumption only implies that all income, including labor income would not be taxed.

Which I agree with, it is a dramatic simplification, and the VAT model is well proven in EU.

However, a flat consumption tax is regressive, low incomes spend much more on necessary consumption than higher incomes. This is easily and neatly fixed with a basic income scheme, which kills the majority of the complicated welfare system as well. Now we are dreaming eh?

Mike W writes:

If "consuming" meals isn't consumption, what is?

It's a special interest tax break...and that is the real "roadblock" to tax reform.

Floccina writes:

Wouldn't it work if all income could be put in a tax sheltered account and you would be taxed on all money that you receive that is not put into the tax sheltered account plus any withdrawals from the tax sheltered account? So you would want to buy an investment house in the sheltered account and sell it in the sheltered account and you would be taxed when you withdraw the money.

Tom DeMeo writes:

I would say there are two larger reasons than the ones cited why tax reform is so difficult:

1. Politicians derive power from complications in the tax code. You are asking them to let go of that power.

2. An actual good reason - these types of changes in the code would create a massive refactoring of value propositions throughout the economy, and they would occur all at once. I have no idea whether the net effect would be tolerable or not, but my guess is it would be very rough going for a few years.

ThomasH writes:

I very much agree with consumption not income taxation. I'd prefer charitable contributions were only partially counted as consumption, but I'd compromise that for high marginal rates on high consumption. I agree about removing the wage tax but still think we'd need an EITC (ECTC?) and a high zero rate consumption level (high enough to cover health insurance).

I think the problem with tax reform is that folks who claim to be wanting to increase efficiency often propose taxes that in practice shift the burden to low-consumption people.

Problems: What is "consumption?"

Does education count as consumption?
Are bequests consumption of the deceased?
Is the enjoyment of possessing great wealth consumption?
The leisure of not having to work?

Conscience of a Citizen writes:

There is no logical or even economic difference between "capital income" and "human capital income," but you call the second "labor income" and want to tax it more harshly. Why?

Why should a rickshaw-puller's lunch be taxable consumption when a bucket of oats for a donkey-driver's beast (his "capital asset") is a deductible cost of production?

Problems with "pure consumption" taxes include not just distinguishing consumption from investment, but the fact one can "consume" a lot of wealth without generating taxable transactions. For example, a rich person borrows at a lower rate because the lender has more security for repayment.

ThomasH writes:

I think politicians representing high income people are mainly interested in the total tax liabilities of their clients who probably would rather stick with their current dodges that risk a clean progressive consumption tax. High income/consumption people know that most voters think low and middle income people (for them the difference between income and income is not much) pay too much tax and want to shift the tax burden upward. Stirring the pot would be too risky. The kind of politician that could lead a consumption tax revolution Clinton 1 or Bush 1, are particularly unpopular with one of our major parties.

BorrowedUsername writes:

Are houses consumption? With VAT seems like they should be, but that's a lot of sticker shock. Also how does financing work in that world (actually trying to figure it out, not trying to refute anything). So a house is "worth" $100, VAT is 25%, will someone give you a loan for the $100 (with $25 down) or only $80.

There are probably a lot of ideas that need to get disentangled. What about sticky prices? Will people raise / lower prices fast enough or will there be a huge distortion period during the transition?

What about resource extraction? Is that value creating or consumption? Like if I spend $20 to get $40 worth of oil from the ground, it's a little weird to say I've created $20 in value. What if I'm not even the cheapest marginal extractor, maybe I've destroyed value.

Da5id writes:

@BorrowedUsername: Of course houses are consumption. And no, it won't really be sticker shock, here is why: If you work a w2 job for 10 years to earn the cash to buy the house, then you have paid the 15-25+% tax of your effective income tax rate on the cash to buy the house. Or a 1099 int job, same thing + plus your share of the payroll tax. Or Sced C self employed. All of these you have already paid tax. So when you get to buy the house in the theoretical income untaxed, consumption taxed world, you will have 15-25+% more in your pocket, ready to pay the "higher price" including consumption tax. Or in simple terms, everyone (with mid income) gets a 20% raise, as at the same time all (mid priced) house prices increase by 20%, for example.

Ok, how about resource extraction? I think you are confused. Resource extraction is the creation of value, and that will not be taxed. The only tax you as a producer pay is on the goods and services necessary for you to do your work. This is incorporated into your cost of doing business, and you will price your output to maintain your desired profit margin. There is no value destroyed here, your services and goods providers are being paid for their work, and the government is taking their cut of this consumption. The people buying your goods and services are paying for your work, and paying the government for the cut of (the now higher) value of their consumption. (This can be complicated some by a VAT scheme where the government only takes a cut of the last transaction in the chain, but effectively, its all the same idea).

[nick changed to Da5id for clarity, with commenter's permission--Econlib Ed.]

Floccina writes:

Because some commenters expressed transition problems:
I think that you can slowly migrate to a progressive consumption tax by raising the amount of money that can be put in an IRA each year.

Don Geddis writes:

The single most brilliant idea in that piece -- that I hadn't even heard of before -- is to separate the decision about the structure of the tax code, from the rates. And from the subsidies!

That is genius. We shouldn't even be debating the actual best tax structure. The current system is in place, because of poor incentives on the part of the taxing authorities. All we need to do, is have one entity charged with creating the tax structure (in the most economically efficient way), and a completely separate entity deciding how much revenue they wish to raise. And yet a third, again separate, entity (probably just Congress) deciding what subsidies to offer. Don't push for a specific tax structure; have a meta-fight instead: push for a decision process that will lead to a good tax structure.

One of the early universal health care plans (in Oregon?) worked like this. One set of doctors merely made an ordered list: if you have to choose between covering condition X, or condition Y, choose coverage for condition X first. Completely separately, the fiscal authorities decided how much money to fund into the system. And then whenever the money ran out, that was the cutoff between what was covered, and what wasn't. The beauty is that there is no single responsible person (or organization), for why some pet condition (e.g. liver transplant for an alcoholic) was, or wasn't covered. No one to approach for political appeals. The doctors making the ordered list merely say: do you have evidence that your condition is more important (or cost effective) than these others higher on the list? The fiscal authorities say: we're already spending X% of GDP on health care; even if we go up a bit, we still won't reach your pet condition. You just voluntarily eliminate the ability to carve a specific special interest exception, outside of the overall structure.

The same could work with taxes, tax rates, and subsidies. Just make them completely separate decision-making processes, unrelated to each other.

Of course it will never pass. Cochrane says "We agree to debate subsidies ... transparent and on-budget--but separately from tax reform." That would be better for society, but runs afoul of the political power of politicians. In the current system, they get lots of opportunities to cause low levels of distributed pain (small taxes) in exchange for highly concentrated benefits for a highly visible subpopulation. Many of these exchanges are a net negative for society, and so transparency would eliminate them and be better (on net) for society. But not for the politicians who you need to convince (since they have the voting power). Their incentives in this matter are not aligned with society's benefits. Instead, they get enormous political capital out of highlighting and publicizing the anecdotes of how government has "helped" specific cases.

They don't want transparency in the tax code. It's hurting all of us ... except the politicians and special interests that know how to play the political game. They actually win, with the current structure ... at the expense of overall society.

Creating a new nation from scratch would be one thing. From our current situation, however, I don't see a realistic path to overcome the (structurally-induced) selfish interests of the political elite.

Scott Sumner writes:

A few comments:

A labor tax is the same as a consumption tax.

Income from human capital should not be taxed if education is taxable. But in the US, education typically is not taxed, so there's not much distortion from taxing income from human capital.

Houses are not consumption, the flow of services from housing is consumption. In the US that flow is taxed (property taxes), so that's not the big issue. The bigger problem is that interest on home loans is tax deductible, even for owner occupied units where no tax is paid on implicit rents. This means renters face higher tax rates than homeowners.

BC writes:

Isn't it a cognitive illusion to call the charitable deduction a "tax break"? Suppose one volunteers labor at a soup kitchen. The market value of that labor is not taxed. Now, if one instead volunteers labor at one's regular job by diverting the corresponding wages to the soup kitchen, i.e., one donates part of one's wages to the soup kitchen, then one has done the same thing, so why should one be taxed on the wages that one never received (nor consumed)? The so-called charitable "deduction" is merely an adjustment to misreported, unreceived (and unconsumed) income to avoid inadvertently taxing charitable donations.

Now, if one was really hard-headed (hard-hearted?) one could argue that the charity's recipients (e.g., people eating at soup kitchen) should be taxed on their consumption of charity and that taxing the donor is equivalent to taxing the recipient. However, donors are often in higher tax brackets than recipients so removing the charitable deduction would effectively tax charity recipients at higher than appropriate tax rates. In any event, I would think there would be even less political support for taxing recipients of charity than for eliminating the charitable tax "deduction", even though they would seem to be equivalent.

The point here is that the charitable tax "deduction" is actually a tax break for charity recipients, not for donors.

Tim Ozenne writes:

I'll likely be dead long before there are any major revisions to taxes, but... Most of our family savings are in IRA accounts. It's not clear that shifting to a consumption-only tax would be "fair" to someone like me vs. someone taking the same amounts from an after-tax account. Windfall?

Hans writes:

[Comment removed pending confirmation of email address. Email the webmaster@econlib.org to request restoring this comment. A valid email address is required to post comments on EconLog and EconTalk.--Econlib Ed.]

ThaomasH writes:

@ David/Da5id
"Yeah, I thought the proposal to tax consumption only implies that all income, including labor income would not be taxed."

There is some confusion between taxing different kinds of income and taxing different uses of income. Taxing only labor income and taxing only consumption are the same only if all "labor" income is "consumed."

First an aside: the most important benefit from taxing consumption rather than income would be the elimination of taxes on "business" income. This would mean no scope (or less) for special tax breaks for income generated by different kinds of business models, technologies, locations, etc. [Yes we would still still need oversight of business accounting so that some kinds of consumption was not hidden as business costs.]

As a first approximation a progressive consumption tax is just a progressive income tax with a 100% deduction for net increases in enumerated IRA-type assets. Unrealized capital gain? Zeros out. Realized capital gain or dividend income that's 100% reinvested? Zeros out. Since consumption is less than income, the rates will have to be higher than rates on income, but there is no reason they should not be progressive with zero rates for the first x thousand of consumption, a subsidy for low levels of consumption and possibly a subsidy for asset accumulation by people with low levels of consumption.

Should there be preferred types of consumption (charitable contributions? medical insurance premiums? mortgage interest on residences? State and local taxes?) That's a separate question which of course affects revenue and therefore required rates.

Consumption of/investment in "education" will be difficult to deal with. ["Studying" archaeology by visiting different sites and staying in luxury accommodation could be quite attractive to someone in the 75% consumption bracket and we may expect as much entrepreneurial ingenuity going into muddying that distinction as that between "labor" and "capital" income.]

[David's nick changed to Da5id for clarity, with his permission. His nick in this comment has been edited to match.--Econlib Ed.]

Conscience of a Citizen writes:
Scott Sumner writes:

A labor tax is the same as a consumption tax.

One suspects you have elided a massive simplifying assumption there.

Income from human capital should not be taxed if education is taxable. But in the US, education typically is not taxed, so there's not much distortion from taxing income from human capital.

Oh. I never understood before that human capital was the same thing as education. That explains why college dropout Bill Gates has so little human capital. I'm not so clear on the tax-free character of education, though. I have to pay for my continuing education with after-tax dollars and the for-profit school I attend has to pay tax on its profits, so which part of that is not taxed? And what about experience, is that untaxed too, despite all those 1040's filed along the way?

da5id writes:

@ThaomasH and Scott Sumner
Ah, yes, I see what you mean about a tax on labor income and consumption spending being equivalent, in impact at least, though the mechanism of implementation is different.

In my mind taxing at the point of *spending* the income is much easier, because it removes the need to differentiate between labor and non labor income. Though making a sales tax or VAT progressive is challenging, if you desire a more finely grained ramp than my preferred option of a flat tax sales tax and a basic income, which is effectively just two brackets.

Plucky writes:

There is a big problem when dealing with mortgage interest in those three line-items, and it is a real problem and not a interest-group problem.

If you get rid of the deductibility of mortgage interest but keep interest deductibility in corporate tax law, then there is an obvious dodge: rather than take out a mortgage personally, form a sole-proprietor LLC (or even better a personal REIT), buy the property in the name of the LLC, personally guarantee the mortgage to keep the lenders happy, and then rent yourself the property at a rate such that the LLC reports $1 in annual profit. As a property-management company, the LLC would also be able to stuff all kinds of other "business" expenses onto its income statement, including all home repair, maintenance, and utility costs, and then adjust the "rent" appropriately. Thus, not only would people effectively regain the mortgage interest deduction, they would also effectively get to invent a yardwork, utility bill, and A/C repair deduction to boot. The only disincentive to adopting this strategy would be your state's franchise tax.

Naturally, the government would try to figure out a way to "close" that "loophole", the most obvious solution to which would be to administratively order the FHA to not guarantee a mortgage for which title is held by an LLC and declare as fraud and after-closing paper shuffling to achieve that end. That would work fine for the conforming-loan range, but that would do nothing to anyone in non-conforming territory, i.e. people in the >450k house market, i.e. the exact people from whom you wish to take away the deduction.

The mortgage interest deduction cannot be effectively undone without simultaneously removing interest expense as deductible in corporate tax law. That would in the grand scheme of things probably also be a rational thing to do (so long as it was matched by reclassifying interest income as capital gains), but it greatly expands the political difficulty of accomplishing tax reform, because it means personal and corporate tax have to be reformed simultaneuously rather than piecemeal.

Scott Sumner writes:

Thomas, You said:

"There is some confusion between taxing different kinds of income and taxing different uses of income. Taxing only labor income and taxing only consumption are the same only if all "labor" income is "consumed.""

I don't agree. The long run effects are identical even if a part of labor income is saved, to be consumed later.

Conscience, I never said it is all education. Some is on the job training, but that's also tax free under our current regime, as it's a business expense. A portion of his ability may be innate, but obviously that's not something created through investment in human capital. Does a labor tax cause too little investment in human capital? Perhaps, but I'd have to be convinced of that, I see little evidence to support that claim.

Plucky, The simplest solution is to abolish the corporate income tax. But I agree that any tax scheme runs into problems. Nonetheless, ours has far too many unnecessary problems.

Capt. J Parker writes:
"Consumption-based taxes can be progressive. A simplified income tax, excluding investment income and allowing a full deduction for savings, could tax high-income earners' consumption at a higher rate."

The tax scheme described above by Cochrane is not a tax on consumption, It's a tax on wages with "wages" crossed out and "consumption" written in in crayon.

Thomas B writes:

Massive transition problem for those who have already worked most (or all) of their likely careers, whose life savings are from already-taxed income: a consumption tax would now tax those savings again, as if the workers had never been taxed in the first place.

For fairness, after-tax accounts would all have to be converted into "tax recovery" accounts: taxpayers would receive tax reimbursements on funds drawn from these accounts (regardless of where the money goes, since it was or will be taxed when spent).

Weirdly, "tax-deferred" accounts like 401(k)s would simply become ordinary investment accounts like any other, with no tax advantage; while existing after-tax accounts would become tax recovery accounts with special tax treatment.

Nathan W writes:

It all makes too much sense. Definitely worth working for, even though the forces against are well organized, well funded, and presumably quite intent on maintaining their advantages. It would take true leadership indeed to make progress on turning these ideas into political reality.

Of the issues mentioned, the one that bothers me the most is that some people get to write off a five star lifestyle as business expenses. Not only does it bother me that they get to write off expenses that I cannot afford to incur in the first place, but also such practices are a significant structural barrier to social mobility in that potential risers cannot give potential clients the treatment they have become accustomed to. Eliminating business lunches from deductibles and capping travel deductions at the coach rate won't eliminate the issue, since deep pockets can still afford to splash out for clients, but at least it removes the offensive subsidies which exacerbate this barrier to social mobility.

Also worth noting: taxing all consumption instead of income is a massive competitive advantage in trading with any country that continues to tax income and not consumption. Total taxation on any imports would be their domestic income taxes + the American consumption tax, whereas American products would only face the consumption tax.

Zeke5123 writes:

Plucky:

I think you'd run into a host of business purporse, economic substsnce, tax avoidance (IRC 269) problems that would sink this arrangement. Also, the person paying the LLC (taxed either as a partnership or C Corp) would need to pay an arm's length rent payment. If this payment exceeds the LLCs expense, then the home owner is creating taxable income out of thin air.

Scott Sumner writes:

Captain, No, labor and consumption taxes are essentially identical.

Thomas, The transition problem would depend on the type of consumption tax enacted. The fewest problems would occur with a consumption tax that consisted of an income tax, plus unlimited 401k privileges.

Conscience of a Citizen writes:
Scott Sumner writes:

Labor and consumption taxes are essentially identical.

You keep writing that as if anyone who does not concur must be a dolt. I urge you to consider the matter more carefully.

I am fairly confident you are restating the famous results of Chamley and Judd, that given the heroic assumption of a single-generation of infinite-life actors with the same propensity to work, labor and consumption taxes are equivalent in terms of long-run overall consumption (basically because capital accumulation drives productivity).

In real life, though, the economy is a species of iterated game. In fact, simply allowing for two generations instead of one and letting the government-debt to capital-stock ratio vary reveals the non-equivalence of taxes on consumption, labor (wages), and (all-)income.

For people who don't want to read econ papers, let me present a very simple model to illustrate why consumption and labor taxes are not the same.

Consider two actors Larry and Carl. Each commands wages of 1/6 pumpkin per hour. Each has an inelastic appetite for 1 pumpkin per day. Carl (only) is endowed with land (capital) that rents for 1 pumpkin per day.

If there are no taxes, Larry satisfies his appetite by working 6 hours each day. Carl doesn't work for food; he lives off his endowment.

But to support an herd of useless bureaucrats, the government decides to levy a tax.

In scenario A, the government imposes a 16.7% consumption (sales) tax. To purchase their pumpkins Larry and Carl both have to work 1 additional hour per day (Larry works 7 hours, Carl works 1).

In scenario B, the government imposes a 25% labor tax (i.e., a tax on wages). Larry has to work 8 hours to purchase his pumpkin. However, Carl does not have to work at all. He can live off his untaxed rents.

The cost of government remains the same, you understand, and Carl still enjoys an equal share of government output. Naturally, in scenario B Larry resents Carl's free-riding.

Now, you could offer a long complicated argument that taxing Larry's wages should eventually drive up prices to Carl and depending on their various cross-elasticities of supply and demand, etc, etc, in the long run somehow Carl would have to pay for his share of government. However, that would be a load of hooey.

You could try another tack: "Subsistence," you might argue, "which necessarily includes government, demands 8 hours of daily work from everyone, like Larry, who lacks an endowment. However, Carl or one of his ancestors (must have) worked overtime in the past to build up his endowment and emancipate him from labor, so it would be immoral now to impose a sales tax instead of a wage tax because that would force Carl to work." That is also hooey, because we are discussing a new tax (or a tax increase-- there is no difference analytically) and worrying about tax incidence. Since the tax is new, the question is whether it should burden both actors or only Larry. Remember, Carl was only endowed with a certain stream of rent, not a government guarantee that he would eat one pumpkin daily in perfect leisure even if the government expanded (say, to fight a war).

Would imposing a consumption tax instead of a wage tax harm productivity by reducing capital accumulation? Not in the given model, obviously, since Larry and Carl only work for their daily subsistence pumpkin, not to generate savings. But not in a more complex model either!

Suppose Larry and Carl are both willing to work 8 hours daily and save all income above one pumpkin each. Assume that the total cost of government is fixed (for a period) and the tax rate adjusted to collect just that much. The government can get by on 1/3 of a pumpkin per day. With a consumption tax (scenario A) Larry saves 1/6 pumpkin daily and Carl saves 7/6 for a total of 8/6 pumpkin daily. With a wage tax (scenario B), Larry saves nothing and Carl saves 8/6 pumpkin daily. Total taxes and savings are the same under either tax. That remains true even if you vary the cost of government. The big difference is, with a wage tax Carl gets wealthier over time but Larry does not. With a consumption tax, both get richer over time, though Carl gains faster than Larry. In scenario B Larry pays for Carl's share of government, so taxing wages instead of consumption basically transfers Larry's surplus to Carl!

What about a new scenario C in which labor (wages) and capital income (Carl's rents) are taxed identically? That makes income and consumption taxes equivalent: Larry works 7 hours daily for his pumpkin and Carl works 1 hour, just as in scenario A. (Savings remain unchanged.)

Now it should be more clear why wealthy people favor taxing only wages. (Seidman, author of the third paper linked above, calls Carl the "lazy heir.")

Larry writes:

Dump the corporate income tax. Lump investment income with other income. Treat net investment as savings. Tax consumption progressively with negative rates for minimal consumption. See the economy surge. Keep hope alive!

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