What would be the economic impact of eliminating the federal income tax system and replacing it with consumption tax?

Ask an Economist
Question: 

What would be the economic impact of eliminating the federal income tax system and replacing it with a national consumption tax such as the FairTax?

Answer: 

This policy change would redistribute income from lower to higher income households because the current income tax is progressive while the flat tax would not be as progressive, if at all.

The change would also lead to the double taxation of older households. Intuitively, these households already paid income taxes on taxable income that they saved. Now when they withdraw the money to consume it, they will be taxed again by the consumption tax. On the other hand, the new tax on the consumption of older households would raise tax revenue, permitting a consumption tax rate that is lower than the current average income tax rate. This decrease in tax rates would benefit younger households.

There would also be an increase in efficiency and national income as a result of the decrease in marginal tax rates. In addition, the abolition of taxes on capital income would raise social welfare and stimulate savings and growth.

In conclusion, there would be an increase in efficiency and higher national income. However, the policy change would shift of the tax burden from the young to the old and from high earners to low earners.

Last updated on April 29, 2016