Consumption Taxes and the Level and Composition of Saving Summary

Many proposals for tax reform would shift the base of taxation from income to consumption. Two arguments for a consumption tax are frequently made. One, a consumption tax is argued to encourage saving, at least more so than the current income tax. And two, a consumption tax is often considered a more efficient means of tax collection. In this paper, the merits of these arguments are analyzed. To accomplish this, the present income tax is compared to a generic consumption tax. By definition, a consumption tax does not include non-consumed accretions to wealth in the tax base. Hypothetically, each individual has a savings account where unspent income accumulates. Over the course of the year, all net gains to the account are deducted from wage earnings and net losses to the account added. The resulting total is the individual’s consumption and represents the taxable base. The appropriate tax rate is then applied to the derived annual consumption. All saving is in effect free from taxation. However, the added saving incentive (or lack of disincentive) implicit in a move to a consumption tax may not be as large or effective as anticipated; the current ta