A New Look at an Old Consumption Tax

By :: June 21st, 2012

Twenty-five years ago, Princeton economist David Bradford designed what he called the X Tax. The idea--a progressive consumption tax--generated lots of discussion among tax experts. Wonks loved it for its elegant simplicity though there were (and are) real questions about how the tax would work in an increasingly international economy and how it would treat financial services.

David’s idea never got much attention beyond the world of tax geeks.  But Bob Carroll and Alan Viard, in their new book Progressive Consumption Taxation: The X Tax Revisited (AEI Press 2012), are attempting to bring new attention to the design. Bradford, who was a senior Treasury official in the Ford Administration and a top economic advisor to President George H.W. Bush , died in 2005.

The X Tax is a consumption tax, essentially a European-style value added tax with a couple of key innovations.  Most important, unlike many consumption taxes, it is progressive. In effect, the X Tax divides consumption into two pieces—wages and business cash flow. Households are taxed on wages, but unlike a VAT, they pay at progressive rates rather than a single flat rate. Businesses pay one rate on their gross receipts, but get to deduct wages. The top individual rate is equal to the business rate.

Because it is fundamentally progressive, the X Tax addresses the most common criticism of consumption taxes—that they impose a greater burden on low-income households. This happens because people with lower incomes consume more of their money than the rich.

There are other ways to solve this problem. The VAT proposed by Mike Graetz, for instance, would give couples a tax exemption of $100,000 (and provide a rebate for those who owe no tax). Graetz, however, still retains both the individual and business income tax while the X Tax completely replaces the existing system.    

Economists will argue over which model makes more sense. But both are worth serious consideration when/if Congress really debates tax reform. Graetz can, and frequently does, speak for himself (with, among other things, great humor). Carroll and Viard deserve a lot of credit for being new voices for Bradford’s old idea.  

It is, btw, fascinating that so much of the debate over consumption taxes is among conservatives. These taxes are in extremely bad odor among most Republican politicians these days. Yet, House Budget Committee Chairman Paul Ryan (R-WI) and former GOP presidential hopeful Herman Cain (who could ever forget 9-9-9) both supported versions of such a levy. Bradford, of course, was an aide to GOP presidents. Graetz was a top Treasury official for the first President Bush. And Carroll and Viard are both known as conservative tax scholars.    

Bradford understood how controversial consumption taxes can be—that’s why he called his idea an X Tax. But whatever you want to label it, his design is worth consideration. There few new ideas in tax policy, so it never hurts to revisit one of the old ones. Thanks to Bob Carroll and Alan Viard for doing so.

11Comments

  1. Sam  ::  8:12 pm on June 21st, 2012:

    The only thing I don’t like about most of the proposed consumption taxes is that they are more rewarding to old capital than they are to those that are building capital in the transition. I’d like to combine this with an expansion of self directed tax-deferred investment accounts. I don’t like the idea of taxing my investment money as consumption even if it is mathematically the same on marginal rates.

  2. Sam  ::  8:18 pm on June 21st, 2012:

    Oh, and the hardest part is for conservatives to convince Conservatives that an efficient tax is better than a horrendously burdensome tax even if you hate government.

  3. Michael Bindner  ::  2:17 am on June 22nd, 2012:

    Lawrence B. Lindsey also has a proposal that would also replace all income tax filing through a Net Business Receipts Tax, which allows for both distributions to families like Graetz does (although Lindsey’s tax, as well as mine, both replace some or all of Social Security contibutions as well while Graetz uses credits offsetting FICA payments distributed with pay to channel his income). Where Lindsey may have it wrong is in not realizing the privacy concerns that a surtax paid with the NBRT would have, requiring investors to share income data or employees to share investment data to avoid some income falling through the cracks. It is much easier to have a separate high income surtax, as no one wants to employee a waiter with a trust fund if the taxes to be paid on his work are higher because of his income level.

  4. Tax Roundup, 6/22/2012: Whistleblowers, How computers will become hated, and accountants seeking dignified work « Roth & Company, P.C  ::  9:18 am on June 22nd, 2012:

    […] X-tax: A New Look at an Old Consumption Tax (TaxVox, Howard […]

  5. Ralph H  ::  12:15 pm on June 22nd, 2012:

    I doubt this will fly as an additive tax. I do not buy the “progressive” tagging of this. For one thing all sales will be marked up by the Business tax rate, so all people will have a higher cost of goods. The only way to sell a new tax would be to eliminate some other tax or to explicitly dedicate revenues to something needed — like Medicare or SSi.

  6. Mike Sax  ::  2:35 pm on June 25th, 2012:

    Howard my attitude about “consumption” taxes used to be the thing that would make me “reach for my gun” so to speak. I have read a little now which makes it sound like a consumption tax-if done right and the devil in this case is very much in the details-could work.

    I’m not a conservative-by the way mentioning it in the same breath of Cain’s 9-9-9 is the wrong approach for me as that’s a tax proposal I will indeed reach for my gun on. What could be more regressive than the Cain plan? Which called for a national sales tax which you do admit is regressive.

    As I’m not conservative I don’t have this hatred for the top individual tax rates and capital gains and coproprate taxes that they have. What does interest me, however, is the chance of cutting or eliminating the payroll tax-the most regressive tax in America.

    The thing I’m most skeptical is that this can truly be revenue neutral at least proposals that envision doing away with individual income and capital gains taxes. If we could eliminate the payroll tax I’d be interested to hear more about it but I’m skeptical about revenune neutrality. If it’s just a backdoor way of cutting Medicare and SS count me not interested!

  7. Mike Sax  ::  2:29 pm on June 27th, 2012:

    “The only way to sell a new tax would be to eliminate some other tax or to explicitly dedicate revenues to something needed — like Medicare or SSi.”

    Though I’m willing to be proved otherwise, Ralph I tend to suspect you’re right.

  8. John B. Paine III  ::  10:01 am on December 1st, 2012:

    The trouble with any national sales tax or VAT is compliance. How to get the gray (physical cash based) economy to comply. Until human nature changes, forget it. The only way to tax the gray economy would be indirect and rather draconian. Have paper money expire at the end of each year, to be replaced during a brief window of opportunity at 70 cents on the dollar. The 30 cent difference would be the indirect tax. Electronic money (bank accounts, etc.) would not be affected. To avoid an obvious loophole, it would be necessary to have a 30% withholding on any bank deposit of cash (conversion of physical to electronic money). The cost of printing new bills would be trivial relative to the 30% tax, and it is probable that the use of paper money would be drastically decreased anyway. Optimally, all other significant economies around the world would adopt a similar practice.

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