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In this week’s Grumpy Economist Weekly Rant, John Cochrane argues that debates over progressive taxation often blur two different questions: how government should raise revenue and how it should support lower-income households. Rather than asking the tax code to do both, he argues for looking at taxes, spending, transfers, and social programs together.
Cochrane argues that even a simple consumption tax can be made progressive, while support for lower-income households can be delivered more transparently through direct spending and social programs. But those policies still involve trade-offs: higher marginal tax rates and benefit phaseouts can reduce incentives to earn more. His broader proposal is a simpler tax system that raises revenue efficiently while making those costs more visible.
Transcript
Hi. I’m John Cochrane, senior fellow here at the Hoover Institution, and welcome to my Grumpy Economist Weekly Rant. Today, I’m gonna rant some more about taxes.
I advocated eliminating the income, corporate, estate, and other taxes in favor of a simple consumption tax, of which I prefer a value-added tax. Now, what about progressivity, you might ask? Shouldn’t the rich pay a larger share? Aren’t consumption taxes notoriously regressive?
I say, wait a minute. You changed the question. We started by asking, how should the government raise revenue without long-term economic distortion? Now you’re asking me how the government should redistribute resources. Policy debates always get confused because we too easily discuss the answers and then shift the questions around. Once you define the question, answers get a lot easier.
So, in fact, the tax code does try to do three things: raise revenue for general spending, transfer income, and subsidize a whole range of activities and people.
So last week, I advocated that Congress subsidize whatever it wants to with on-budget, authorized, and visible spending rather than hide it in the tax code. Let’s think in the same way about redistribution.
Now remember, even a flat tax redistributes. If we each pay a 30% share of our consumption, the high consumer chips in more than you and I do, but people typically want more redistribution than that.
Also, a consumption tax can be more effective than an income tax. Some people claim that the rich avoid income taxes. Well, if they were patient, they’d get them down at the Porsche dealer with the consumption tax.
And all of us should think clearly about whether pure forced redistribution is a government goal rather than ensuring opportunity and prosperity for all Americans.
Now, I emphasized also that we should think about the effect of all taxes taken together. In the same way, if you want redistribution, it only makes sense to think of the redistributive effect of the government as a whole, uniting taxing, spending, transfers, social programs, and services rather than each one in isolation.
If a flat tax efficiently raises lots of revenue that Congress hands out to needy people, then the government as a whole redistributes a lot of resources, even though the flat tax system doesn’t. If the flat tax and consequent economic growth raise even more resources, the poor can get even more even if they get a lower share.
Do you really want redistribution or do you care about prosperity? Do you really care about shares or about everyone’s level?
So you can’t meaningfully separate tax redistribution from social program reform, and that is badly needed. The chaotic smorgasbord of social programs wastes a lot of money, and it often implies 100% marginal tax rates. Yeah, earn a dollar and lose a dollar of benefits.
Putting all that support in one place, including the support now offered through a progressive income tax and its smorgasbord of credits, and sending it as appropriate spending would produce a lot more efficient support.
But still, if you must, it’s easy enough to make a consumption tax progressive all on its own. You can make a VAT or a sales tax progressive by simply exempting the first, I don’t know, $20,000 of purchases or whatever number you want.
Give people a credit card, as cash benefits do, that pays for those taxes. You can also make high consumers pay more by retaining the income tax enforcement mechanism. Then have a separate redistribution code walled off from the tax code.
I’d rather not, as it risks keeping all the rot of the current code, but at least it’s possible.
Bottom line: The right answer is a clean, simple tax code that raises revenue without economic distortion, a separate messy subsidy code, but via on-budget, authorized, visible spending, and an integrated set of social programs that provide support for the needy while controlling their disincentives.
But there’s an inescapable bottom line: redistribution shrinks the pie.
If the first, say, $100,000 of consumption isn’t taxed, then higher consumption has to face a higher marginal rate and a higher disincentive. If people get benefits so long as their income is less than $50,000, there has to be a disincentive to earning $60,000.
Now, right now, these marginal rates are hard to see because the taxes are so spread out and there are so many interacting social programs. I think actually hiding the disincentives is part of the point.
So, in the long meantime, until my clean and transparent taxing and spending takes over, let me offer one last idea: the alternative maximum tax.
No American shall face a marginal tax rate of—oh, well, pick your number—but let’s say half. If anyone can show that he or she faces a marginal tax rate, including social program phase-outs, greater than that number, say half, they get their money back.
We’ll at least learn where all those hidden disincentives really are.
Well, thanks for listening, and if you enjoyed this Weekly Rant, please click to subscribe.
John H. Cochrane is the Rose-Marie and Jack Anderson Senior Fellow of the Hoover Institution at Stanford University. An economist specializing in financial economics and macroeconomics, he is the author of The Fiscal Theory of the Price Level. He also authors a popular Substack called The Grumpy Economist.