GST as a neutral tax?
Posted July 30, 2007on:
I was reading a quick little post on Econlog. In it they say that you should not tax income, you should tax consumption. Ergo we should remove income taxes and replace them with a higher rate of GST.
The main criticism I often hear about this is that GST is regressive. Now I used to spout that line as well, after all poor people have a lower marginal propensity to save then wealthy people, as a result they spend more of their income, and so more is taxed.
However, then I was told to think about it a different way. Over our lifecycle we should spend all our money, so that we are on the boundary of our budget constraint. As everyone spends all their income over their lifetime, GST must be a flat tax.
Now you could make GST a progressive tax by having a higher rate of tax on luxury items (although that distorts the market by changing the relative price of goods). As a result, changing from income taxes to GST seems to make sense, if you think it is more efficient.
In the above article they said that income=consumption+savings+charity. They said that savings and charity should not be taxed, and that is why we need a GST tax. Now, as we have said that savings become consumption over time, that doesn’t hold, and you can get tax rebates on charity. As a result, the only reason I can see to switch to an only GST tax will be if it is easier and cheaper to administer, and I seriously doubt that setting up a progressive GST schedule will be easy or cheap to administer.
Note: The labour market distortion still exists with a GST tax, since even though your disposable income is higher, the cost of everything is also high, so the real return for an hour worked is the same.