Does Canada need a progressive consumption tax?

Robert Frank argues that the US should replace its income tax with a progressive consumption tax:

By replacing federal income taxes with a steeply progressive consumption tax, the United States could erase the federal deficit, stimulate additional savings, pay for valuable public services and reduce overseas borrowing — all without requiring difficult sacrifices from taxpayers.

Translating the rest of Frank's argument into Canadian, this is how it would work:

Under such a tax, people would report not only their income but also their annual savings. A person would be taxed on income minus savings - just like people are taxed now on income minus  RRSP contributions. That amount would be "taxable consumption." Any dissaving - RRSP withdrawals, for example - would be included in taxable consumption and taxed. There would be a personal amount tax credit, like there is now. Rates would start low, as they do now. As taxable consumption rises, the tax rate on additional consumption would also rise.

So basically a progressive consumption tax is just like allowing everybody to make unlimited RRSP contributions.

Frank argues that such a tax would have economic benefits:

With a progressive income tax, marginal tax rates cannot rise beyond a certain threshold without threatening incentives to save and invest. Under a progressive consumption tax, however, higher marginal tax rates actually strengthen those incentives.

Unfortunately, there is a problem with Frank's argument, that can be represented diagrammatically by representing the tax design problem as a game:

Yes, exempting savings from tax would reduce inefficiencies associated with the taxation of savings. That whacks down one mole.  But in order to maintain tax revenues, some other tax would have to be raised.

In fact, there aren't a lot of choices.

Allowing people to make unlimited RRSP contributions, and taxing RRSP withdrawals, like Frank suggests, is equivalent to having a zero tax rate on investment income.  Here's an example. I used simple interest, so the total return on investments is 60% or 0.6 over a ten year time period (can't do compound interest in my head while standing in front of 70 people).

 

The after tax amounts in the "no tax on investment income" and the "RRSP" column are exactly the same, unless a person faces a lower or higher marginal tax rate when withdrawing RRSP funds (remember that the principal invested in an RRSP is subject to tax when it is withdrawn).

So a progressive consumption tax is like not taxing investment income.

It follows that a progressive consumption tax is equivalent to only taxing wage income.

[I'd recommend stopping now, getting yourself your beverage of choice, and just mulling that over for a while. But if you really care about such things, here's the math. Let w₁=wages in period 1, w₂=wages in period 2. Consumption in period 1 = wages in period 1 - savings, so c₁=w₁-s₁. Consumption in period 2 = wages in period 2 plus the return to savings, i.e. c₂=w₂+(1+r)s₁. The present discounted value of lifetime consumption = c₁+(1/1+r)c₂= (substituting for c₁ and c₂) w₁-s₁+ (1/1+r)(w₂+(1+r)s₁) =w₁+(1/1+r)w₂. Taxing lifetime consumption is the same as taxing lifetime wages]

[Correction: as a number of people have pointed out in the comments below, this proof ignores the possibility that people might inherit money or win the lottery. Also, switching from our current system to a consumption tax half way through people's lives isn't the same as having a consumption tax all along.]

Getting back to the whac-a-mole problem: if taxes on investment income are lowered (that's what a progressive consumption tax does), and the government wishes to maintain the same level of tax revenue, taxes on wage income must be raised.

The government could raise taxes on the income earned by the highest wage earners. There might be some margin for tax increases here, but not a lot: tax rates on this group are already fairly high (40%+). Taxes on wages create inefficiencies by distorting labour supply decisions, and the higher the tax rate, the bigger the distortions - we don't want people to stop saving, but we don't want doctors to stop working, either. Moreover, a large disrepancy between tax rates on wage income and tax rates on investment could give rise to tax avoidance opportunities: making wage income look like investment returns.

And it must be stressed: taxation of investment income is only an issue for upper-middle and high income earners. The RRSP contribution limit is 18% of earned income up to a maximum of $22,000 per year.  Tax Free Savings Accounts (TFSAs) provide another $5,000 per year of tax sheltered savings. Registered Education Savings Plans are, for parents and grandparents, yet another tax-preferred method of savings. Moreover, any returns on investment in your own home are also tax free.

Yes, there are people - those with no mortgages and generous employer-provided pensions -- who are running up against the RRSP contribution limit. Perhaps a number of people reading this blog are in that position. But the majority of Canadians do not come close to exhausting their tax free investment opportunities.

Jonathan Kesselman has advocated raising the RRSP contribution limit above the current $22,000 level. The closer I get to exhausting my own RRSP room, the better this idea becomes.

Another change I would advocate: allowing people more flexibility in terms of withdrawing and re-contributing RRSP funds, so RRSPs can be used for income averaging. Sure, continue to tax withdrawals. But then add withdrawals to an individual's contribution room, so any withdrawal could be made up again later on.

So perhaps some tinkering with our current system is in order. But a move to unlimited RRSP contributions, like Frank proposes? Personally, I wouldn't favour it.

The somewhat ironic thing is that Robert Frank - who is a brilliant behavioural economist - doesn't realize that people's psychological quirks are a major problem with RRSP-type savings programs.

Taxes that people don't see - the European VAT, for example, or income taxes deducted at source, things that come out of your pay cheque before it ever arrives - hurt, but they don't hurt that much. It's like being caught unawares when you're given a shot - painful, but bearable.

But taxes that people see really hurt. You contribute money to your RRSP. You watch it grow. You care for your RRSP, tend it lovingly, daydream about all of the things you're going to do with those funds ("every summer we can rent a cottage on the Isle of Wight..."). Then it comes time to take money out of your RRSP - and it's TAXED! Taken from you!

Skeptical? Look at the enormous political pressures exerted on recent governments to minimize taxes on retirees through income splitting. Look at the recent debate about whether or not special withdrawals from RRIFS (what RRSPs become upon retirement) should be counted as income for the purposes of income support programs.

It's a looming political battle: will the government have the guts to stick with the current system? Or will the political clout of a booming generation of retirees carry the day?

This post is in response to a request from a WCI reader.

Comments

[Paul Friesen]

Could someone explain to me why so many economists seem to regard encouraging saving as desirable? Do they just believe that higher capital investment will lead to higher output? Do they think that savings are normally below optimum? If so, why?

I am pretty skeptical about the value of growth models, but even they predict that it would be possible to save too much, as I recall.

[Robert McClelland]

Could someone explain to me why so many economists seem to regard encouraging saving as desirable?

They don't. What so many economists do see as desirable is working to insure the wealthy keep as much wealth as they can. That's why they come up with all these silly tax schemes that invariably favour the wealthy and why you'd never see a progressive user fee system from any of them.

[Stephen Gordon]

Do they just believe that higher capital investment will lead to higher output?

Well, yes.

[Patrick]

My better half once suggested (half in jest) what I dub the Nightfall solution to cure tax derangement syndrome: once a generation, set all taxes to 0 and provide no services for one year - no medicare, no garbage collection, no snow removal, no police, no fire dept, no parks, no streetlights, no courts, no schools, no army, etc. If there was anything left of civilization at the end of that year, those remaining alive wouldn't complain too much about paying their taxes from then on.

[Rob]

I think there would be some major tax avoidance issues. Someone could theoretically transfer all income into savings and loan themselves money (to be used as disposable income). If they default on the loan (which they would), it would be absorbed as an investment loss. They would be living on credit that they do not need to repay, meanwhile paying no “consumption” tax.

[Paul Friesen]

But surely it would be possible to invest too much. After all the good investments are made, you are left only with investments that cost more than they produce. Why do many economists seem to believe that we are below the optimum and that more investment should be encouraged?

Also, why do they seem to think that more savings by Canadians, for example, will go to increasing Canadian capital and boosting Canadian output rather than seeking out the highest world returns and boosting output wherever that is?

[Frances Woolley]

Rob: "Someone could theoretically transfer all income into savings and loan themselves money" With a consumption tax, any negative saving, i.e. borrowing, is taxed. The greater issue, as I see it, is the tax treatment of small business/self-employment. E.g. what's to stop me from forming "Woolley Advice Inc" and, whenever I do consulting, from billing my clients from my company? And then when Woolley Advice makes a profit and pays me a dividend, is that wage income or investment income? This is particularly a problem when consumption taxes are implemented through Tax Free Savings Account-type arrangements, when investment returns just aren't taxed.

Paul Friesen, your point about the irrelevance of one country's savings rate in a global capital market is well taken. There is a well-documented "home country bias" i.e. Canadians tends to invest in Canadian companies but, yes, in the cosmic scheme of things, that shouldn't matter that much.

On your point about the desirability of savings - to some extent I share your skepticism. E.g. one of the Canada Pension Plan's largest investments a few years back was buying a shopping mall (or perhaps a chain of shopping malls, I don't remember the exact details). Well, the value of a shopping mall is basically land. More people investing in land might drive up the price of land. But it doesn't change the amount of land available - and it's the amount of productive capacity, rather than the dollar value of that productive capacity, that matters.

If the thinking is:
more money in Canada Pension Plan implies
more savings implies
more investment implies
increase in productivity implies
more output when the baby boomers are old and gray

somehow I'm thinking shopping malls aren't going to do it.

[brian]

Wouldn't the RRSP be equal to the no RRSP in your scenario after the money was withdrawn at a 33% tax rate? It doesn't work out like this in real life due to changing tax brackets and not having to pay tax every year on the interest.

brian

[Robert McClelland]

once a generation, set all taxes to 0 and provide no services for one year - no medicare, no garbage collection, no snow removal, no police, no fire dept, no parks, no streetlights, no courts, no schools, no army, etc.

Or simply implement a progressive user fee taxation system and avoid the ensuing armageddon. It's a lot more difficult to gripe about fees for what you use as opposed to fees for what you didn't use.

[Frances Woolley]

Brian,
No RRSP, investment income taxable: invest $10,000, get total investment income of $6,000, pay tax on the investment income of $2000 leaving you with $10,000 (principal) + $4,000 (after-tax investment income) at the end of the day.
RRSP: Invest $15,000, get total investment income of $9000. Withdraw money from your RRSP and pay tax on both ($5,000 on the principal, $3,000) on the interest. Have $10,000 (principal after withdrawing from RRSP) + $6,000 (after tax investment income) at the end of the day.
No RRSP, No tax on investment income (or a TFSA): invest $10,000, get total investment income of $6,000, end up with $10,000 + $6,000.

So the RRSP and the no RRSP + no tax on investment income are the same. But with No RRSP and investment income taxable you end up with less at the end of the day.

Changing tax brackets either help or hinder: anyone who is eligible for guaranteed income supplement will face a much higher effective marginal tax rate upon retirement than they do at present.

If you did it with compound interest rather than simple interest the numbers would be slightly different, but you'd still end up with the RRSP and TFSA (no RRSP, no tax on investment income) being equivalent.

RRSPs are a big business for the financial services industry, and there's a lot of people trying to sell them. No one who sells RRSPs has an interest in pointing out that nasty sting in the tail.

[Nick Rowe]

Paul: I should pay the same tax whether I spend my income on apples or bananas. Similarly, I should pay the same tax, whether I spend my income on apples this year, or on apples next year. That's why economists don't like taxing savings. It's equivalent to taxing bananas at a higher rate than apples.

[Patrick]

In general, I'd say anything that has to do with retiring boomers getting more and paying less is likely to be on the political radar. Old people tend to vote, and there are going to be lots more old people in the years to come. So I think it's safe to say we'll be spending way more all things related to old people and a lot less on everything else.

Robert: of course the suggestion was not to be taken literally. I think people's sense of grievance at paying taxes can never be balanced by receiving utility from Government provided goods and services. Change to a fee system, and people will just complain about the fees. Take garbage collection. People would want prices that reflect some immediate perception of utility relative to the next best option, like the cost of having to go to the dump yourself. They won't factor in the utility they derive from avoiding situations like the guy down the street whose next best option is to toss it in a rat infested heap in his backyard.

[RSJ]

"That's why economists don't like taxing savings."

Who is talking about taxing savings? The issue is about taxing income, not expenditures. In this case, it is capital income that is being taxed more or less than wage income.

But I agree that if you tax both income and expenditures, then this is double taxation. In that case, unless you tax every expenditure in the same way, and here you would need to tax savings -- then you are incentivizing one expenditure over another.

But if you only tax income, then it is up to the person to decide what to do with that income, whether to purchase an apple or a bond, and you are not distorting his choice. We should be only taxing income.

[Andrew]

Just as an outside-observer here… I guess some casual readers of economics saw something like a “progressive consumption tax” as a way of reorienting the incentive structure away from the competitive acquisition of goods, which some have argued causes more grief than good for overall happiness.

One of the positive upshots of a potential reform of the incentive structure, for social-democrats at least, would be the prospect that people would be less tense about investing in public goods and services. But from the discussion here, and from what I’ve seen on the PEF regarding a progressive consumption tax, it would seem that this kind of tax system (if it’s in fact what we have in Canada) doesn’t do much at all to lead us in such a direction.

A second point of interest with this kind of system is that it might offer new tools for taxing the rich (i.e. whenever they actually buy something). But it would seem that, if anything, it provides more opportunity for them to accumulate wealth over the long run.

[Frances Woolley]

Patrick: "In general, I'd say anything that has to do with retiring boomers getting more and paying less is likely to be on the political radar."

I'm not sure if this comment means that you support a Frank-type progressive consumption tax, oppose the consumption taxes, or agree with me that taxes on RRSP withdrawals will be a hot issue in the next few years.

Just to clarify:

Under a consumption tax like Frank suggests, retiring boomers pay *more* in taxes because they're dis-saving, taking the money they set aside for retirement and using it for current consumption.

If you put your money under your mattress, you don't pay tax on it when you spend it. If you put money in an RRSP, you pay tax when you take it out again.

[Frances Woolley]

Andrew: "I guess some casual readers of economics saw something like a “progressive consumption tax” as a way of reorienting the incentive structure away from the competitive acquisition of goods, which some have argued causes more grief than good for overall happiness."

I'm really glad you made this point - indeed, reducing the misery caused by excess consumption is one of Frank's key arguments for a progressive consumption tax.

Remember, however, that for savings, income and substitution effects may be offsetting.

When investment income is taxed, saving is more expensive, so people tend to substitute (cheap) present consumption for (more expensive) future consumption - that's the substitution effect.

But suppose you figure you need $X per year to avoid misery and destitution in old age. If savings are taxed, you will need to set aside *more* income now to achieve that desired $X level of savings. It's what economists call an income effect. When savings are taxed, people *can't afford* to spend so much now.

Just on the basis of theory alone, it is not possible to predict whether taxing investment income increases or decreases the amount that an individual saves (before taxes).

[RSJ]

"Do they just believe that higher capital investment will lead to higher output?

Well, yes."

LOL.

Jokes aside, will it lead to more steady state consumption? Investment isn't free, it takes up resources that could be used for consumption. If you are doing that in every period, why do you think steady state consumption would be higher?

Before rushing out to tip the scales so that it cheaper to purchase capital goods rather than consumption goods, it would be good to find out what imbalance you are trying to address. Are Canadians too impatient, so that with a uniform tax on all expenditures (or equivalently, a uniform tax on all income), they would make the wrong choices?

[Patrick]

Frances: Really just stating the obvious. I agree that taxes on RRSP/RIF derived income will be a big deal in the future, and I suspect that whatever the aging boomers want, the aging boomers will get.

[Frances Woolley]

Patrick, so you see massive erosion of the tax base as special breaks are given for RRSP withdrawals, while younger workers get stuck with high taxes to pay for my ever-increasing medical expenses? Any solutions?

Actually I was looking through old posts earlier today (have to do something for the Globe on the best policy idea of the year) and found a comment from you where you'd written that you found my posts depressing.

This time you're depressing me.

[Patrick]

Quid pro quo?

Yeah, that's basically what I see. Solutions? I suppose the problem is ultimately self correcting: the boomers will die off.

[Kien]

Hi, Frances. Thank you for posting about the merits of a progressive consumption tax.

I have a query about what "savings" means. Would it cover expenditure on education? Or is that consumption? If the latter, wouldn't that discourage investment in human capital? More generally, does "savings" include all forms of investment, in both physical capital and human capital? What about investment in "cultural capital"? Would buying works of art be a form of saving too?

If progressive consumption tax exempts income from physical investment, shouldn't it also exempt income from human capital investment and cultural capital investment? If not, wouldn't it distort investment decisions in favour of physical capital?

[Bob Smith]

Frances, Rob,

The RRSP system already has mechanisms in place to prevent people from extracting money from their RRSPs on a tax-free basis (and a handful of programs that allow people to borrow from their RRSPs for very limited purposes). Generally the type of investments you can make through an RRSP are limited "qualified investments". The list of qualified investments are pretty broad (pretty much any publicly traded security, mutual fund, public company debt, etc.) but are generally limited to real arm's length investments and would exclude the sort of schemes that Rob proposes (loans to self or related parties). Similarly, the TFSA regime shares the qualified investment regime of the RRSP system but also has a "prohibited investment" concept.

There were a number of schemes set up in the early 1980s to try to get around this, involving reciprocal loans (I lend to you, you lend to me), but those were shot down pretty quickly by the courts. Similarly, there were a number of schemes that popped up last year to try to transfer income from RRSPs to TFSAs (often involving option schemes), but Finance shut them down with extreme prejudice.

There are also special rules dealing with small businesses. It's been a while since I've looked at them, but they are restrictive. In any event, the existing RRSP system has shown the ingenuity of the legislative drafters at Finance is every bit a match as that of taxpayers and their advisers.

[Frances Woolley]

Kien: "I have a query about what "savings" means. Would it cover expenditure on education? Or is that consumption?" Excellent question. Which means that I don't know the answer. Basically if education is treated as savings, then the current tuition amount tax credits would need to be changed to deductions - which wouldn't make any difference to a lot of students. (More generally, why is it "investment" if a restaurant buys a new stove, but consumption if I buy a new stove?)

Bob: however if the RRSP system was expanded to cover essentially all savings, would Finance be able to keep these kinds of restrictions in place

[Determinant]

Robert Frank's proposal has little merit and I can prove it.

The United Kingdom equivalent of an RRSP is called a Personal Pension. Like Canada, the UK's retirement saving system is consolidated. The rules are even more generous than Canada: retirement savings are 100% deductible from income tax and there is no contribution limit, you may contribute up to 100% of your income. The only cap is that your pension savings may not exceed 1.6 million pounds (both employer and employee funds). Anything over that is penalized.

Furthermore, 80% of a person's pension savings must be converted into a life annuity on retirement. 20% can be taken as a "lump sum".

The British retirement tax system very closely approximates a system where only expenditures are taxed. The results have been nowhere near what Robert Frank predicts for his proposal. The British still have income taxes, a large deficit and growing debt, certainly not the panacea he predicts.

[Patrick]

Determinant: Not sure it says anything about Frank's proposal. The state of public finances in the UK of late seems to be pretty well explained by the cost of bailing out banks (850 billion to 1.5 trillion depending on the source) and big increases in social assistance transfers due to a severe recession.

[Michael Smart]

"It follows that a progressive consumption tax is equivalent to only taxing wage income."

That is not correct. A consumption tax is equivalent to a tax on wage income plus a tax on the existing capital stock. That's a big difference. IIRC, in Auerbach and Kotlikoff's still-relevant simulations, the lion's share of the welfare gains from consumption taxation came from this feature, not from exempting future capital income.

[Nick Rowe]

Michael: but if the gains come from taxing the pre-determined existing capital stock, but excluding future capital, doesn't that create a time-inconsistency problem?

[Miep]

Progressive consumption taxes are great, as an addition to progressive taxes on all income, labour and capital. As standalone replacement for progressive taxes on income, they are just a horrible bad disgusised right wing attack on mixed economies, if not on democracy itsself. The rich could just acumulate more and more power, without anyone ever disturbing them. With all that power, they will find their ways to avoid paying those progressive consumption taxes much easier than they already do today with capital gains taxes.

[Paul Friesen]

Nick,

That's why economists don't like taxing savings. It's equivalent to taxing bananas at a higher rate than apples.

I don't get it. Suppose I earn $100 and want to invest it. The government taxes it 10%, so I have $90 and invest it. After some time, it doubles to $180 through interest and I collect it tax-free because I already paid tax. Now, suppose it is not taxed when saved, so I invest the whole $100. After the same time, it doubles to $200. When I want to collect it, it is taxed 10%, and I get $180, exactly the same.

The advantage I see to RRSP's is that when I go to collect my RRSP, my tax bracket may be lower than when I was working, so the tax rate may be less. But then that's equivalent to taxing future apples at a lower rate than current ones, isn't it?

[Bob Smith]

"If the RRSP system was expanded to cover essentially all savings, would Finance be able to keep these kinds of restrictions in place"

Why wouldn't they be able to maintain those restrictions? As I noted earlier, the universe of available investments that are "qualified investments" (and not "prohibited investments" for TFSAs) is enormous.

Also, I'm not sure it's correct to say that a progressive consumption tax system is equivalent to not taxing investment income and would result in a higher level of tax on wage income. The equivalence you noted above, for example, wouldn't hold if someone was investing funds our of a non-taxable source of funds such as an inheritance (or, in Canada, lottery winnings). I'd think a system which is equivalent to not taxing the investment income of working stiffs, but taxing the investment income of trust fund kids would be highly desirable (at least on equitable grounds). So its only correct to say that a progressive consumption tax system is equivalent to not taxing investment income derived from savings out of taxable income - which is, I think, the point of the exercise.

Also, while you're right that, assuming a positive savings rate, a tax on consumption would require a higher tax rate than a tax on income (though note, in recent years, when people were consuming more than their incomes that wouldn't be the case - indeed, in that context, a tax on consumption rather than income would be higher desirable for discouraging excess consumer borrowing). Of course, the savings rates in most western countries (even after their recent increases) is sufficiently small (what was it, 3.3% in Canada last quarter?) that there likely wouldn't be a huge difference in the size of the tax base. Granted, we'd hope that in a consumption tax regime that savings rate would increase (decreasing the size of the consumption tax base relative to the income tax base), but then again, presumably the increase in savings would also increase the size of both tax bases in the long-run.

Finally, I don't understand the statement that a extended RRSP system would create avoidance opportunities from shifting wage income into investment income. The obvious point is that the tax rate on all forms of income in a consumption tax regime is the same, zero, income isn't being taxed. So there's no avoidance opportunity in converting wage income into investment income since, if you use that income to consume (regardless of its source), it's all going to be taxed at the same rate.

[Frances Woolley]

Michael, yes, you're right, if the consumption tax is imposed at the start of period 2, it's not equivalent to a tax only on wage income. I'll amend the post to clarify that point. Their simulations, available here reinforce the conclusions discussed here: high income people gain a consumption tax. As soon as the tax is made more progressive so that the gains don't all go to the highest income earners, a large part of the efficiency gains disappear.

Paul, good example.

[Nick Rowe]

Paul:

I'm pleased to see someone actually thinking this through.

Your example is a perfect illustration of the difference between a TSFA and an RSP. There is no difference (unless your tax bracket changes over time, so your marginal tax rate changes). You get to spend $180 either way.

But now suppose you do that saving outside an RSP or TSFA.

You have $100, pay $10 tax, so save $90. It doubles to $180. $90 principal, plus $90 interest. You pay an additional $9 tax on the $90 interest. So you get $171 left over to spend.

[Frances Woolley]

The hyperlink to Auberbach and Kotlikoff doesn't seem to have worked, this is it here: http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.23.3141&rep=rep1&type=pdf.

Bob: "The equivalence you noted above, for example, wouldn't hold if someone was investing funds our of a non-taxable source of funds such as an inheritance (or, in Canada, lottery winnings)." This is basically the point Michael Smart is making also (who knows a lot about taxation).

"Why wouldn't they be able to maintain those restrictions?" Bob, you're the tax lawyer so know more about the details of this than I do. Looking through the CRA web page, there are some things that don't qualify as RRSP investments, for example, "real property." (http://www.cra-arc.gc.ca/E/pub/tp/it320r3/it320r3-e.html#P226_38586) If people want to make investments in real property, and those are going to be tax exempt (as they would have to be under a progressive consumption tax), wouldn't the RRSP rules have to change?

"when people were consuming more than their incomes that wouldn't be the case" good point.

[Michael Smart]

Nick: A move from income to consumption taxation is equivalent to exemption of capital income plus a one-time capital levy at the given consumption tax rate. So yes that capital levy is time inconsistent - you'd like to impose it again in the next period. But there's no time inconsistency I can see in the choice of income and consumption base - once you make the move there is no incentive to move back. (Of course there is a big political problem in making the reform - akin to the reasons the US will probably never succeed in eliminating home mortgage deductibility.)

[Nick Rowe]

Michael. Thanks. Got it.

[Determinant]

"On your point about the desirability of savings - to some extent I share your skepticism. E.g. one of the Canada Pension Plan's largest investments a few years back was buying a shopping mall (or perhaps a chain of shopping malls, I don't remember the exact details). Well, the value of a shopping mall is basically land. More people investing in land might drive up the price of land. But it doesn't change the amount of land available - and it's the amount of productive capacity, rather than the dollar value of that productive capacity, that matters.

If the thinking is:
more money in Canada Pension Plan implies
more savings implies
more investment implies
increase in productivity implies
more output when the baby boomers are old and gray

somehow I'm thinking shopping malls aren't going to do it. "

Frances, I'm perplexed you would contend that the value of a shopping mall is in the land value. Nope. Shopping malls are rented out by the owner to the shops. The value is in the commercial rents. There is the assumption that uncontrolled commerical rents can stay ahead of inflation.

A pension plan buys a shopping mall for the income. CPP wanted an inflation-indexed perpetuity.

[Patrick]

" There is the assumption that uncontrolled commerical rents can stay ahead of inflation."

In the long run, that seems to me to be a crazy assumption. Shops pay rent out of income from selling stuff. The price of stuff rises at the rate of inflation. How can rents possibly rise faster than inflation without the shop owners either eventually going bankrupt or deciding to do something else more profitable?

[K]

Shopping mall profits are about the best example of Ricardian land rent that I can think of.

[Frances Woolley]

(By the way, I wrote this reply before seeing that K had made exactly the same point)

Determinant: "Shopping malls are rented out by the owner to the shops. The value is in the commercial rents. There is the assumption that uncontrolled commerical rents can stay ahead of inflation."

What is there to stop Mall B coming along, opening up beside Mall A, and luring away all of Mall A's tenants by charging slightly less?

The cost to Mall B of doing so is the cost of buying the land + pouring some concrete and building a few stores.

New malls will open until the present discounted values of the rents that can be earned are greater than or equal to to the cost of the land + the cost of the buildings.

Since building shopping malls - especially big box stores - is relatively inexpensive, and the facilities depreciate also, the major determinant of the value of shopping malls is the price of land.

[Determinant]

Sorry Frances, that's not a realistic assessment.

First, zoning laws prevent that sort of behaviour. Second, stores don't move location that easily. In my experience malls don't spring up that easily.

Third, Cadillac Fairview can't be wrong, can it? If your contention is correct, how does this company continue to make operating profits?

[Paul Friesen]

Nick:

Thought I must be missing something. I can see now that an RRSP essentially allows you to avoid tax on the interest income.

But that then brings us back to the original point. Why would that be less distortionary? You've just introduced a source of income that is not taxed at all. That encourages people to save more than they would if all sources of income were taxed equally. Why do economists think that is beneficial?

[Paul Friesen]

Nick:

Sorry. Scratch that last post. I see now that interest is taxed in an RRSP but that it gets taxed extra if interest income is taxed outside an RRSP.

[Frances Woolley]

Paul "You've just introduced a source of income that is not taxed at all. That encourages people to save more than they would if all sources of income were taxed equally. Why do economists think that is beneficial?"

No, you were right to begin with. Interest is not taxed in an RRSP - the bottom line is the same in the "no tax on interest income" column and the "RRSP" column.

You make a very good point - Stephen Gordon makes the same point in the more recent post on "radical tax ideas."

The supply of capital is generally thought to be more elastic than the supply of labour, which is a good reason to tax it less. But taxing it less very different from not taxing it at all.

I'm really not at all convinced by the whole progressive consumption tax idea. Especially since, as Michael Smart points out, a lot of the gains in some policy simulations arise because the government is able (in these hypothetical scenarios) to impose the consumption tax on the pre-existing capital stock - I just can't imagine that ever being acceptable politically.

[Paul Friesen]

Frances:

I seem to be in the weird position of arguing against my own idea.

But the interest does get taxed in an RRSP. To take my original example, you earn $100 and invest it under an RRSP and it grows to $200. When you take it out, you will pay tax on the whole $200, right? You are getting taxed on both the principal and the interest.

If you invested outside an RRSP you wind up paying more total as Nick says because you are paying tax on the interest when the principal was already reduced by tax.

[Frances Woolley]

Paul - the fact that you get interest on your *before tax* earnings exactly cancels out the fact that the interest is taxed at the end of the day. So an RRSP is exactly equivalent (assuming no change in marginal tax rates) to having investing *after tax* earnings and paying no tax on investment income.

[Mark_dowling]

"Taxes that people don't see - the European VAT ... hurt, but they don't hurt that much."

Except that also makes them easier to raise because the consumer isn't reminded on every receipt how much is being taken. Some people would think there would be a revolution if Canadians saw $23 in taxes levied on a $100 purchase (given how much hay the Tories made about reducing fed GST to 5%) and yet that is what is going to be hidden on Irish purchase receipts from 2014 (currently 21.5pc and 22pc from January 1 2013)

[Frances Woolley]

Mark - true enough.

So it comes down to whether or not you think what government does is good (e.g. build infrastructure that's needed, help the poor) or bad (e.g. fat expense accounts).

If you think that what government does is mostly bad, then visible taxes are good to the extent that people are more likely to resist paying them.

If you think that what government does is mostly good, then there's something to be said for hidden taxes - if people aren't as aware of the taxes they're paying, one could argue that they're less likely to adjust their labour supply etc in response to taxes (I said "one could argue" rather than "people will" because this is really armchair economics speculation).

[Jack]

I thought the main issue with consumption taxation was the underground economy. Shouldn't the problem partly be framed in terms of whether there is a greater move to the underground economy when income is taxed vs. when consumption is taxed?

[Michael Nuwer]

I alerted Robert Frank to this post and he replied with the following:

Many thanks for your thoughtful response to my proposal. In return I offer a few quick thoughts:

You're right that to make my proposed tax revenue neutral, it would be necessary to raise the top marginal rates on consumption substantially. You worry about efficiency losses if we do that. My claim is that we would instead reap efficiency gains. Consider a marginal tax rate of 100 percent on expenditures over $2 million a year. People considering big additions to their mansions would then have strong incentives to build smaller ones. And since relative house size is what counts beyond some point, no utility would be sacrificed if that happened. The tax revenue levied on the smaller additions could be put to good uses and the additional savings and investment would also be welcome in an economy that currently saves and invests too little.

There are many other activities that cause harm to others--CO2 emissions and congestion, to name two--that we should be also taxing. These taxes, together with a steeply progressive consumption tax, would generate plenty of revenue to pay for everything.

Again, I appreciate your thoughtful comments.

All best,

Bob