Taxes

Why does income tax penalize savers but consumption tax would not?

Consumption tax differs from income tax in that it allows taxpayers to deduct any savings they may have from their overall income prior to calculating their taxes (p.644). This type of taxation has become increasingly advocated due to widespread low savings among people in the United States and long-term negative effects this may have on the economy (p.644). With a consumption tax, both savers and non-savers are taxed based on the figures associated with their labor income alone (p.649). However, with the consumption tax, those who have saved money are not required to pay any sort of tax on income earned from accrued interest in their accounts, which is different from requirements with regard to income tax (p.649). This illustrates how savers are penalized with income tax because they are taxed on interest accrued. Overall, the consumption tax has more favorable results for those who save and has greater likelihood of demonstrating no loss in efficiency with regard to the allocation of resources between consumption in the present and that in the future (p.653)

In what sense can spending be regarded as a better index of ability to pay taxes than income?

Consumption may be considered a better index with regard to ability to pay tax based on the premise that by not spending money and instead saving, the tax payer will effectively lower their taxable income since savings are excluded from the tax base (p.644), and the tax is based on labor alone (p.649). Taxation of income, on the other hand, includes savings and investments in the tax base, which results in high efficiency losses that are avoided with consumption-based tax (p.644). Furthermore, consumption taxes have more favorable outcomes with regard to incentives associated with investment and savings in comparison to income tax.