"It is a great comfort to have you so rich" - Jane Austen, Pride and Prejudice.
Stripped down to the barest essentials, taxation works like this:
taxes owing = tax rate * tax base + lump sum taxes - income guarantees and tax credits.
The appropriate tax base, rate and income guarantee are the three fundamental issues in tax design.
Many economists believe that consumption is the best possible tax base (see this post, and the comments). Consumption is the best measure of what a person takes, consumes, and enjoys; consumption measures her welfare, how well off she is. It is thus the fairest basis for taxation. Moreover, these economists argue, taxing consumption has desirable incentive effects: it encourages saving; it discourages excessive, wasteful, environmentally destructive spending.
Consumption taxation could be achieved by allowing individuals to make unfettered contributions to registered retirement savings plans (RRSPs in Canada, IRAs in the US) and taxing all withdrawals from those accounts. Or relying more on sales taxes like the GST and HST.
There are well-known limitations to our ability to tax all consumption. What is produced and consumed in the home, for example, falls outside the tax system - something which is a problem for income taxes also. It can be hard to distinguish between business expenses, such as home offices or travel, and personal consumption.
Less often observed is that wealth itself generates consumption benefits, even if one never spends a dime of it.
I own a 12 year old Toyota Matrix. The front fender has collided with one too many snow banks, and is now held together with string. The exhaust system has seen better days. It breaks down occasionally. But overall it's very cheap to run.
If I was poor, it would be tough having an old, unreliable car. The unexpected, yet inevitable, major repairs would be a financial nightmare. $750 to repair the clutch. $200 to fix the axel seal. If the car broke broke down, and I couldn't get to work, I might lose my job.
But because I'm financially secure, I can afford a cheap car. I can self-insure against financial risks: unexpected repair costs, taxi fares, rental cars, and so on. I can afford to get my car towed. If it was beyond repair, I could get another car tomorrow.
The real value of having $10,000 in the bank isn't $200 in interest income, or the stuff $200 in interest income might buy. $10,000 in the bank creates a little bit of room to take risks. One could call it the "implicit value of self-insurance generated by own capital." It's the comfort of being rich (or having rich relatives). It's real. It's valuable. But it wouldn't be taxed if Canada had a consumption tax.
Admittedly, the insurance value of having wealth isn't taxed under an income tax either. But at least under an income tax some of the return on wealth is taxed, so there is, at least potentially, some shifting of the tax burden onto those with wealth.
The greatest freedom money offers is the freedom to walk away. Your bank doesn't offer you unlimited everything with no monthly fees? Walk away. There's always someone else who wants your money. Your phone plan is too expensive? Walk away (o.k., that may not be the best example).
People with money have alternatives, which makes their demand for goods and services elastic. Food may or may not cost more in poor areas. But a rich person can shop at Value Village if he chooses. A poor person may not be able to afford expensive purchases which save money in the long run, like bread machines or high efficiency appliances or pressure cookers. Consumption taxes aim to tax the amount of stuff people actually consume. But if poor people pay a higher price for their stuff than rich people, is a system that taxes only consumption spending, without taking into account the ability to command consumption wealth conveys, fair?
There is a more subtle benefit to having wealth: the power it gives in social interactions. Becker's Rotten Kid Theorem explains how those how have wealth can control the behaviour of others by giving or withholding transfers. Shakespeare's King Lear is a vivid example. As long as King Lear has wealth, his two eldest daughters flatter him and treat him with loyalty and devotion - because they hope their obsequious behaviour will, in time, be rewarded. Once King Lear gives over his kingdom to them, Regan and Goneril cast him out.
Some might argue that taxing consumption taxes capital - once that capital is spent. But wealth generates benefits for the holder even if the holder never spends a cent. Canada has relatively low taxes on capital - we do not have an inheritance tax, do not tax capital gains on principal residences, provide dividend tax credits to offset corporate tax paid, and provide room for tax-free savings within pension plans and tax free savings accounts.
The noted economist Tony Atkinson has recently made the case for introducing an annual tax on wealth. His argument is that taxing wealth would reduce inequality.
Even those who find Atkinson's argument for wealth taxation on purely distributive grounds unconvincing, and believe that consumption is the most equitable basis for taxation, should still be open to the idea of wealth taxes - because such a tax would recognize the comforts of being comfortably off.