[UPDATE: This whole “disagreement” with Rothbard may have been a figment of my bad memory; see this post.]
Some people are asking me about Robert Wenzel’s take on Peter Schiff/Herman Cain on tax theory. I would have to sit and think through Rothbard’s argument about a consumption tax getting shifted back onto the incomes of land, labor, and capital (goods).
In the meantime, though, let me say that there really is a legitimate sense in which taxing income is more distortionary than taxing consumption. The reason I stress this is that I used to think this was a neoclassical myth. But I realized I was wrong when I was working on a tax reform paper for PRI. None of this is an endorsement of Cain’s 9-9-9 plan, of course, but anyway this is what I can quickly add to the discussion for what it’s worth. From a post a while ago:
When it comes to people arguing for a consumption tax instead of an income tax, a typical argument is, “The income tax discourages savings.”
Now for a long time, I agreed with Murray Rothbard’s take on this. I thought it was a dumb argument, because there’s nothing magical about saving more; it would clearly be terrible if the government said, “Save 99% of your income or else you get executed.” And the whole point of saving is to consume in the future, so why wouldn’t a consumption tax discourage saving just as much?
Well, when working on my PRI Flat Tax pamphlet [.pdf], I realized Rothbard and I were wrong. An income tax really does distort the consumption/saving decision, moving it away from the margin that the consumer would have chosen in the absence of taxes. In other words, the consumption tax makes the consumer poorer, to be sure, but at least the consumer gets to decide in which time period to distribute the blow. But an income tax is a double whammy–it takes away from your overall budget, but then puts on extra penalty on your decision to carry income forward. (This is because interest income or dividends is hit afresh with the income tax in the next period.)
To repeat, I am not here saying that Wenzel is wrong and Schiff/Cain are right. I’m just firing off a quick point that might move the ball forward for some of you.