The Need For The X-Tax

We at Rekonomics all agree the current U.S. tax code is a mess. The tax code is messy, frequently double taxes earnings, and hampers economic growth. Flat taxes are often attacked as being unfair to the poor whereas progressive income taxes reduce economic efficiency and harm economic growth.  The X-Tax, a progressive consumption tax, is both pro-growth and economically “fair.”

There are two parts of the X-Tax: the personal side and the business side. On the personal side, households would pay taxes on their wages—they would not pay taxes on investment income, savings, or anything else. These taxes would levied in a progressive manner, with wealthier people being taxed at higher rates and poorer people being taxed at lower rates. The rates could be adjusted by policy makers to make it as progressive or flat as they wanted. On the business side, businesses would pay a flat tax rate on their cash flow equal to the highest rate paid by workers, and then would immediately deduct their investment income. The X-Tax would tax money people had taken out of the economy, but would leave what people put back into the economy untouched. This would eliminate double taxation and encourage people to save and invest more than they do today, prompting long-term economic growth.

A few empirical studies have looked at the X-Tax, and the results are resoundingly positive. A study reviewing the effects of multiple tax reforms—including flat taxes and VAT taxes—calculated that replacing the current tax code with an X-Tax would increase economic growth by 6.4% over the long-run, and by 1.8% and 3.1% over the short- and medium-run time periods, respectively. A flat VAT tax would increase growth the most over the long term, at 9.4%, but VAT taxes are regressive and harm the middle- and lower-classes. The X-Tax, on the other hand, increases the wellbeing of all income groups. Flat taxes were found to have only modest growth impacts.[1]

The X-Tax would reduce tax complexity, which has been estimated to cost the economy $431.1 billion each year,[2] and it would eliminate capital taxation, which is extremely bad for the economy.[3]

The X-Tax is the closest thing to a free lunch in economic policymaking, and we should all hope policy makers begin to closely look at such reforms.

[1] Auerbach, David Altig, Lawrence Kotlikoff, Kent Smetters and Jan Walliser, “Simulating Fundamental Tax Reform in the United States,” American Economic Review 91 (2001): 587.

[2] Arthur B. Laffer, Wayne H. Winegarden, and John Childs, “The Economic Burden Caused by Tax Code Complexity” (The Laffer Center, 2011), 4.

[3] Jason Clemens, Charles Lammam, and Matthew Lo, “The Economic Costs of Capital Gains Taxes in Canada” (Fraser Institute, 2014), 3.

 

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2 thoughts on “The Need For The X-Tax

    • Under the current system, both capital income and labor income is taxed. Many economists have favored abolishing capital taxation in order to create a consumption tax. Income taxes take away what people put into the economy, whereas a consumption tax take away what people take out. The United States currently taxes both, through personal income taxes (wages and salaries) and capital income taxes (capital gains). Personal income taxes are what people take away and capital income taxes are what people put in.

      An X-Tax, which eliminates capital taxation, would eliminate double taxation, which increases the incentive to invest.

      A second reason is because eliminating taxes on capital income would cause something called “temporal neutrality.” A neutral tax does not alter the economic behavior of an economic agent; in other words, a person will act the same paying the tax as they would if there were no taxes at all. No tax is truly neutral because taxes will always increase the costs of doing certain actions, but a consumption tax would reduce something called a “tax wedge,” and get us closer to neutrality. A tax wedge is simply the difference between someone’s pretax income and their post-tax income. The tax wedge caused by capital taxation is deleterious to long-term economic health and causes serious damage. Taxing capital income punishes savers, who are instrumental to long-term growth. The result of the current tax code, then, is to reduce the number of savers that would exist in a tax-free universe. So an X tax would increase investment and saving compared to the current universe, which is necessary for long-term growth.

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