Hart, Albert Gailord

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Consumption Taxation as an Instrument of Economic Control

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CONSUMPTION TAXATION AS AN INSTRUMENTOF ECONOMIC CONTROLALBERT GAILORD HART*IThe proposition that taxation can and should be planned largely with a view toregulating economic activity is accepted, contrary to a sedulously cultivated populartradition, by most economists of all schools. In view of the high percentage ofnational income absorbed by taxation, the types of taxes levied and the rates fixedcannot fail to influence profoundly the size and composition of our national output,and the way in which that output is shared. In consequence there is no issue as towhether taxation is to be allowed to have regulatory effects. The issue is onlywhether these effects shall be recognized, measured, and taken explicitly into ac-count as a major element in framing tax policy, or whether they shall be publiclyignored and left to take the form of "riders" on measures ostensibly framed purelyfor revenue.The principal regulatory effects, intentional or unintentional, of consumptiontaxes' may be classified roughly as follows:(I) Effects on the relative consumption volume and prices of different sorts of goods.(2) Effects on the general direction of change of consumption volume and prices.(3) Effects on the distribution of the fruits of economic activity among persons andgroups.On the nature and extent of these effects, economists of all schools should be ableto approach agreement; though the approach cannot be very close, since there is* A.B., 193o, Harvard University; Ph.D., 1936, University of Chicago. Associate Professor of Economics,Iowa State College. Previously Instructor in Economics, University of Chicago; Economic Analyst, UnitedStates Treasury; Director of Research, Committee on Debt Adjustment, Twentieth Century Fund. Author,DEBTS AND RMCOVE.Y (1938); ANTICIPATIONS, UNCERTAINTY AND ECONOmIC PLANNING (940); co-authorof work on defense financing now in press.'By consumption taxes the writer means taxes proportioned either to the physical volume of sometype of goods or services passing to consumers for household use or else to consumers' money outlayon such a type of goods or services. In addition to excise taxes and sales taxes, levied on sellers toconsumers, this definition may be taken to include taxes levied on consumers directly (which foradministrative reasons we do not have), either on particular purchases or on total spendings. Incometaxes are clearly excluded by this definition; taxes on goods destined for consumers at the wholesaleor manufacturing levels, being approximately proportioned to consumption volume, lie close outsidethe boundary the definition draws, and are covered by most of the analysis of this paper even wherenot explicitly mentioned. Cf. Studenski, Characteristics, Developments and Present Status of ConsumptionTaxes, supra this issue.458 LAW AND CONTEMPORARY PROBLEMSroom for honest differences about various relevant questions of fact, and since itseems to be impossible to spell out the analytical procedure in enough detail abso-lutely to rule out illicit logical jumps.It is harder to set forth a generally acceptable list of regulatory goals for con-sumption taxes. But the writer proposes the following:(A) Justice in distributional effects. More concretely, this means in most contexts atendency to reduce rather than increase the inequality of income distribution; thoughthe writer can think of special cases where he feels just treatment would increaseinequality.(B) A high level of employment and production.(C) Charging to particular producers and consumers special benefits obtained fromgovernment.(D) Charging to particular producers and consumers costs which their operationsimpose upon others and which the market mechanism does not bring home to them.2(E) Representation of social interests in greater or less use of particular articles, eventhough these interests cannot be accurately valued in money-for example, the publicinterest in reducing whisky consumption, protecting health by stimulating use of vitamin-rich foods, or diverting .aluminum from kitchen uses to defense. This is very close inprinciple to goal (D), as is also goal (C).While goals (C), (D) and (E) can on the whole be reconciled, real conflicts existin some cases among goals (A), (B) and (C) and the principles of a desirablecompromise solution are difficult to state.IIIn view of growing professional and public interest in the monetary effects ofpublic finance, the body of this paper will be opened by considering possibilities ofusing consumption taxes as an auxiliary in a general program of stabilizing em-ployment and production at satisfactorily high levels.Consumption taxes immediately payable by sellers (as all actual consumptiontaxes are) drive a wedge between the price of consumer goods as paid by the con-sumer and the price as realized (net of tax), by the seller. Accordingly, the effectof such taxes in themselves-that is, assuming government expenditures and othertax rates would be the same whether or not these taxes were levied-is to dis-courage production of consumer goods.3 For if prices to consumers rise, a given'For example, operations at one oil well increase the amount of pumping necessary to raise oil atother wells in the same field; and if opening the well will not repay enough above its costs to coverthe extra costs imposed on other wells, it is not socially desirable. If each well had to meet a taxrepresenting these extra costs, opening of superfluous wells would be discouraged. Note that thispresumption does not apply if the extra costs imposed elsewhere result merely from higher prices oflabor equipment or materials rather than from impairment of technical efficiency. As the chief authorsof this line of reasoning, Alfred Marshall and A. C. Pigou, have pointed out, it also indicates a claimto subsidy where operations produce benefits for which the producers are not able to collect-forinstance where electrification of a suburban railway would improve living conditions in the neighbor-hood. This is not surprising since a subsidy or bounty is merely a tax with a minus sign. Most ofthe arguments of this paper relating to taxes apply, with sign reversed, to bounties as well.'For an interesting discussion of the strongly analogous problem of payroll taxes see Kaldor, WageSubsidies as Remedy for Unemployment (1936) 44 J. POL. ECON. 721.ECONOMIC CONTROL THROUGH CONSUMPTION TAXATIONamount of consumers' money outlay will buy fewer goods. But if prices to consumersdo not rise, the prices realized by sellers will fall by the amount of tax, reducingincentives to produce. Prices to consumers can remain unchanged only if producersget costs reduced sufficiently to offset the tax; but this implies reducing wage ratesand farm prices and thus reducing spending power, so that even at unchangedprices consumers can buy less.Where proceeds of consumption taxes are applied to government spending whichwould otherwise be impossible, or to reduction of other taxes, this adverse effect onproduction will be attenuated, or in the most favorable case cancelled. If a by-productof the tax is to pour into consumption markets exactly as much money as the taxesdrain off, net proceeds of sellers after taxes will be unaffected. The price paid byconsumers will be increased, reducing the amount of goods the previous consumerscan buy; but the people who get the extra funds will be able to buy more goods.In practice, however, a complete offset cannot be expected. Even in the most favor-able case, that where the consumption taxes in question are levied by state or localgovernments which insist on balancing their budgets, not all the proceeds of thetax will take the form of consumer spending. If the proceeds go to additionalsalaries (even to additional relief payments), part will be saved by the recipients;and even more will be saved if the proceeds go to reduce income taxes or propertytaxes.4 Some adverse effect on consumer goods output must thus be expected; aminimum if proceeds all go to relief payments which would otherwise be impos-sible, a maximum if proceeds are net, other taxes and government expendituresbeing undisturbed, as is likely if federal taxes are being considered.It follows from this argument that consumption taxes can play a useful role ineconomic stabilization if (and only if) the stabilization program calls for reducingthe incentives to produce consumer goods. It is generally agreed that there is nouse discouraging consumer goods production in the trough of the business curve;the issue in regard to consumption taxes is, therefore, whether they can usefully belevied in peak years.At first glance, it is tempting to argue that the way to smooth the fluctuatingcurve of production and employment must be to level off the summits and fill inthe valleys. Admitting that it would be better to raise the valleys without loweringthe summits, stabilization at some sort of average level might have advantages overallowance of wild fluctuations. But it is by no means dear that flattening the peakswould raise the valleys. Even where full prosperity has not been attained, verysweeping business declines are possible; witness the United States in 1937-1938and Austria in 1929-1932, both starting from depression levels. To propose dis-couraging consumption output at the peak is dearly dangerous.In one rather important case, there is merit in reducing incentives for production.That is in the case where physical barriers make these incentives ineffective and' For indication of the purposes to which consumption tax revenues are put, see Smart and Hart, TheDistribution of Revenues from State-Collected Consumer Taxes, infra this issue.LAW AND CONTEMPORARY PROBLEMScreate a danger of their running off into needless increases of prices and profits.Where a rise in consumers' outlay cannot bring about a rise in output of consumergoods, tax diversion of outlays is in order to avoid inflation. This is likely to bethe case in every wartime boom, and may sometimes be the case in peacetime.To admit a possible use for taxes to constrict consumers' money outlay, however,is not yet'to justify use of consumption taxes for the purpose. Such taxes as weknow them have the very great demerit of being regressive, in conflict with goal(A). A set of excise taxes or sales taxes designed to avoid this demerit would haveto be confined to goods on which the rich spend a larger percentage of their incomethan do the poor, which would very sharply limit the tax base. The monetary pur-pose in view could be served without conflict with goal (A) by levying direct taxes onindividuals with exemptions for minimum needs, and with progressive rates. Con-ceivably these taxes might be on consumption outlays as such (a new form ofconsumption tax); but both equity and administrative convenience suggest use ofthe income tax. Consumption taxes could be justified for this purpose only if in-come taxes were unavailable and the inequities of inflation were considered worsethan those of levying the consumption taxes proposed.,The idea of cyclical use of consumption taxes has one very important residue,however; depression can be mitigated by getting rid of consumption taxes andintensified by creating new ones. The epidemic of sales and excise taxes in 1932-1935 probably had serious adverse effects on business activity, not to mention itseffects on the fairness of the distribution of tax burdens. The next time we sufferthe misfortune of a major depression, we should make it the occasion for a con-certed move against indirect taxes.IIISince consumption taxes are in their administrative nature taxes which applyby special prescription to individual commodities,6 their natural field of usefulnessis where differential treatment of commodities is warranted. The nature of thisfield was indicated in the introduction to this paper; but it needs futher examination.Applying a tax to a particular consumption good (or removing such a tax) hastwo types of effects to be watched:(i) It discourages (or encourages) use of the commodity by its previous buyers,reducing consumption volume.(2) It reduces (or raises) the incomes which arise from the production of thecommodity.Sometimes one of these effects is to be desired and the other is to be regarded asan unfortunate by-product; sometimes both are desired.An example of emphasis on the effect on consumption is liquor taxation. A'The argument for this position, in a context of inflation dangers arising from defense, is set forthbriefly in the writer's pamphlet, Economic Policy for Rearmament (University of Chicago Press, Nov.1940) 22-27, and in more detail in the forthcoming volume cited supra note *.'Even sales taxes in practice must proceed by enumeration of things taxable.EcONOMIC CONTROL THROUGH CONSUMPTION TAXATIONgood deal of sentiment in the country favors limitation of liquor consumption;and taxation is welcomed largely on this ground. But the growth of the industrysince Repeal has been so rapid that nobody has been much concerned about restrict-ing the income of those connected with it. Vested interests in such income havenot been recognized, and revenue and sumptuary considerations have ruled theroost.At the other exteme is the problem of taxing increases in house and apartmentrents which may result from housing scarcities under the defense program. Suchtaxation could be justified as a sort of excess profits tax, catching windfalls tolandlords who merely happen to be fortunately placed. This justification wouldbe purely on income grounds; the very reason for the windfall is that the supplyof housing cannot quickly respond to higher rents, so that consumption, i. e. useof housing, would not be affected one way or the other.The problems of defense also offer a convenient example of an intermediate casein which both consumption and income distribution considerations point the sameway. Before defense develops much beyond the present stage, it is likely to requireresources now used for automobile production; private plirchases of new cars musttherefore be restricted. If the number sold is reduced, higher prices can be charged.But there is no special reason why automobile manufacturers and dealers should beallowed to pocket the increase. Levying a substantial excise on new cars is likelyto commend itself as a system for curtailing purchases by raising prices withoutunjustly enriching the sellers.Aside from political and administrative considerations, it will be noticed, neces-sary restrictions of consumption could be taken care of by rationing, and preventionof windfalls in such situations by price-fixing. The combination of a higher priceto consumers and an excise tax upon producers is a make-shift substitute which isplainly inferior to ideal and costless rationing and price-fixing. But it is not neces-sarily or even probably inferior to actually practicable rationing and price-fixing.The controls which would be necessary to take care merely of liquor, housing andautomobiles would absorb a large part of the administrative resources of govern-ment, and even so would have to act either by crude rules giving very unfair al-locations or with a degree of discretionary authority which would be highly dan-gerous. The fact that taxation can restrict consumption and catch windfalls withoutcreating a necessity for planning the consumption of every household makes itpossible to save bother and to avoid moving too far toward a government of men.In a democracy, rationing and price-fixing must remain emergency devices forlimited application; and working substitutes have a high value.Cases do arise where consumption and income effects conflict. At the presenttime, for example, tobacco is considered by most of us a very harmless enjoyment;and a reduction of cigarette taxes and prices to permit more consumption wouldbe very welcome to smokers, especially in the lower income brackets. But the cig-arette taxes have largely embedded themselves in the values of factories and lands462 LAW AND CONTEMPORARY PROBLMSused for tobacco production. To repeal them would give windfalls to the interestswhich now own this property. Cigarette taxes are thus covered in part by thetraditional rule that "an old tax is a good tax," a rule which applies, of course, onlyto taxes affecting values of durable goods.Fortunately, discriminatory income effects among producer groups resulting fromchanges in consumption taxes can be expected to iron themselves out in a fewyears, if they do not take hold on land values or on very specialized human skills.For moderate long-range adjustments aimed to give fair assessments of benefits fromgovernment services or to bring home social costs to nuisance-mongers, as by taxinguse of soft coal without smoke arresters, such income effects may legitimately bedisregarded. They are important chiefly for sudden and large adjustments such asare likely to be involved in the defense program.IVDown to this point, only the regulatory aspect of consumption taxes has beenconsidered, to the exclusion of revenue and collection costs. This exclusion, althoughimmediately dictated by the scope suggested for this paper, conforms, the writerfeels very strongly, to the basic principles of public policy on which taxation shouldrest. The closing paragraphs will be devoted to arguing the proposition that revenueand collection cost should be given only secondary weight in considering con-sumption taxes.7If revenue from these taxes were essential to the functioning of government,their revenue aspect would of course be central. But while this has been true inthe past, it is not true at present either for our Federal Government or for any exceptthe most completely rural state governments. The income tax is well developed inthe federal system and has proved its adaptability to the uses of state governmentswhere the states are fairly industrialized and urbanized. There is an old and well-founded rule in economics to the effect that any revenue that could be raised byindirect taxes, can be raised more equitably by direct taxes on incomes and in-heritances; the only first-order corrections to this rule are for ill effects which canbe obviated by permitting averaging of tax liability over a few years and by properinterpretation of taxes to the public.The ease of collection of neatly designed indirect taxes is a standing temptationto the legislator. But such taxes are no longer so "painless" as they used to be;gasoline taxes, sales taxes, tobacco taxes, and liquor taxes in particular, are broughtforcefully to the attention of the consumer. This development should make itpossible to exclude the use of consumption taxes as sources of general revenue.Needless to say, if such taxes are used where regulatory considerations call for them,the total revenue they produce will be substantial, though probably a good deal lessthan at present. But the rule of policy should be to regard revenue as the by-productand regulation as the main product in looking at all indirect taxes, relying forrevenue upon income taxes.' Contrast the views of Pierce, The Place of Consumers' Excises in the Tax System, supra this issue,

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Consumption Taxation as an Instrument of Economic Control

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