University of Southern California

The Last Best Hope for Progressivity in Tax

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Article by Edward J. McCaffery & James R. Hines Jr.
From Volume 83, Number 5 (July, 2010)

We argue that a spending tax, as opposed to an income or wage tax, is the last best hope for a return to significantly more progressive marginal tax rates than obtain today. The simple explanation for this central claim looks to incentive effects, especially for rich people. High marginal tax rates under an income tax fall on and hence deter the productive activities of work and saving. High marginal rates under a wage tax fall on and hence deter the productive activity of work alone. But high marginal rates under a spending tax fall on and hence deter high-end spending, which is arguably a social bad, and do not necessarily deter the social goods of work and saving; indeed, a progressive spending tax may increase saving. The idea is that because one can escape or defer paying taxes under a progressive spending tax by saving, an activity with positive social externalities, the efficiency costs of high marginal rates under a spending tax can be mitigated. A spending tax can bear more steeply progressive rates with less cost in efficiency or social wealth than an income or wage tax. A progressive spending tax also holds out the possibility of sorting the rich or high-ability into two groups, elastic savers and inelastic spenders: separating the two types of taxpayers could yield welfare gains unavailable under income or wage taxes, which under current technologies can only sort the high-ability into workers and nonworkers. Progressive spending taxes also fall on consumption financed by windfall gains, doing so with diminished adverse incentive effects.

Most of the Article sets out analytic possibilities. In the final part, we add a sketch of both a welfarist and a fairness-based argument for progressive spending taxes and conclude with a call for a major new research agenda.

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