Jason Harrison on the politics of taxes

Jason Harrison has a post that makes the case for a specific type of consumption tax:

At the heart of the blueprint was the Destination-Based Cash Flow Tax (DBCFT), a model born from years of academic work and championed by economists like David Bradford, Alan Auerbach, and Jim Hines. The DBCFT represents a synthesis of decades-long debates on optimal taxation, incorporating principles designed to raise substantial revenue to finance what the government deems worthy without throwing wrenches into business decisions.

It’s a fairly long post, but it provides one of the clearest explanations of the rationale for consumption taxes that I have encountered.  The Destination-Based Cash Flow Tax has some interesting features:

But unlike a VAT, the DBCFT provides relief for labor costs through a wage deduction, which effectively works like a subsidy to wages at the tax rate. This means that while a VAT taxes all consumption, the DBCFT only taxes consumption financed from non-wage sources—mainly existing wealth (wealth accumulated before the reform that has already faced the income tax) and above-normal returns to investment.

In the conclusion, he explains that a DBCFT is actually a wealth tax:

There’s a funny tidbit at the end of the last section, that you can view a cash flow tax as a tax on “existing wealth.” Turns out, when you dip into “consumption tax world”, you find these sort of weird equivalences and similarities. Well, they’re not as weird to me, since many become ‘obvious’ (like the payroll tax) when working through our precise definition of consumption. But what’s actually important to note is that, technically, everything is a consumption tax. On the infinite time horizon, everything must be consumed eventually, right? Wealth is just the present value of all future consumption—yours, your heirs’, or whoever you donate it to. So a consumption tax is effectively a one-time tax on wealth, measured at its present value. (Real-world wealth taxes, by contrast, impose recurring levies, making them fundamentally different in how they hit deferred versus immediate consumption.) 

In popular mythology a wealth tax is good because it “hits the rich”, and a consumption tax is bad because it falls more heavily on the poor.  But this is a wealth tax that is also a consumption tax.  Harrison points out that this means a DBCFT might have some appeal to both progressives and conservatives.

Harrison finds another appealing symmetry in the way a DBCFT treats border adjustments.  Imports are taxed while exports are exempt from taxes.  That sounds like a mercantilist’s dream, right?  Actually, that tax/subsidy combination is equivalent to completely free trade:

When import taxes and export rebates are applied together, they interact through the exchange rate. The import tax reduces demand for foreign currencies, while the export rebate increases demand for U.S. dollars. These forces reinforce each other, leading to a stronger dollar that neutralizes the effects of both adjustments. For example, if the export rebate lowers prices abroad by 20%, and the import tax raises prices domestically by 20%, the dollar’s appreciation cancels out these changes. As a result, trade flows, consumption patterns, and production decisions remain largely unaffected. 

It also eliminates many of the distortions under our current policy regime:

Under a border-adjusted system, manipulating export or import prices provides no tax advantage since the border adjustment would still apply to the transaction.

Furthermore, border adjustments eliminate the incentive to relocate production to low-tax jurisdictions. 

Cash flow taxes are very appealing because they eliminate many of the complexities of current tax law, such as depreciation schedules.  Of course no tax regime is perfect, but the DBCFT seems to have found a sweet spot that could appeal to progressives, conservatives, mercantilists, free traders, and fans of tax simplification.  Not many other proposals have the potential to gain such wide support. 

Read the whole thing.