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In this inaugural episode of The Grumpy Economist Weekly Rant, John Cochrane explains how governments can efficiently raise revenue with minimal economic distortion. He shows that taxing individual goods leads people to substitute toward untaxed alternatives, reducing revenue. The solution, he argues, is broad-based, small taxes on all consumption to avoid distortions. He also extends the principle to consumption over time: taxing consumption evenly today and in the future. Further he advocates for no taxes on investment, as well as abolishing income, corporate, and estate taxes.
Transcript
John H. Cochrane: I’m John Cochrane, senior fellow here at the Hoover Institution. Welcome to The Grumpy Economist Weekly Rant. Let’s talk about taxes today and a little bit of tariffs. How does the government best raise revenue with minimum damage to the economy?
Well, let’s suppose we put a tax on strawberries. Maybe we’ll raise a lot of money that way.
But what happens? People look at the expensive strawberries and they say I’ll buy blueberries instead today. So, what do we get? Nobody buys strawberries. The government doesn’t raise a lot of revenue. What should we do? We better tax the blueberries, too. Well, now nobody buys strawberries or blueberries and goes off and buys meat instead. I guess we got a tax food, and we got to tax everything.
That’s right. The way you raise revenue for the government with minimum distortion to the economy is to tax everything just a little bit. For example, tariffs, tariffs have been sold as a sales tax which will raise revenue for the government. And it is. But it’s sort of like a tax on blueberries. What happens is people substitute away from imported goods to domestic goods, even when the imported ones are better or cheaper. And it’s better for the overall economy.
So, what should we do? The principle extends to consumption today versus consumption in the future. You don’t want to tax people’s consumption today and let it be free in the future. You don’t want to tax a lot of consumption in the future, and therefore people just eat it all today. So, we should have the same tax rate on consumption today versus consumption ten years from now.
That means that investment should be free. Tax consumption, not investment returns, so that you’re not telling people eat it all today or eat it all tomorrow.
So, the answer? Raise revenue for the government with minimum distortion to the economy in the most practical way. Throw out the income tax, throw out the corporate tax, throw out the estate tax, and just tax consumption, same rate for all goods.
If you want to tax rich people more, that’s easy too. They can pay a higher rate, or we can use the proceeds to send checks to other people. What about what about, what about? Well, there’s lots of, “what abouts.” But all of those “what abouts” mean you’re asking a different question. And so, if you have a different question, maybe there’s a different answer.
But to raise revenue for the government, that’s the answer.
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.