I previously said:
>
>>The investment income might or might not exceed
>>the initial tax liability, depending on rates
>>of return and the time involved, but this income
>>itself is taxed if it is spent, so under a
>>consumption tax there is no payoff to deferring
>>taxable spending.
>
which didn't stop Bro. Gaspar from replying:
>But as I explained in my last post on this topic, the fact that income will
be taxed in future years when it is finally spent, doesn't even things out,
because in the meantime the wealthy accrue investment income on the deferred
taxes (not to mention investment returns on their other income).>
He then tries to motivate this with an example:
>Suppose that Moneybags has an annual income of $1m and that, as a result of
being able to defer spending, he pays only 6% of this in state and local
taxes for the current year. Meanwhile, the poor (most of whom are compelled
to spend their entire income) pay 11% of their income in state and local
taxes. Let's assume that if Moneybags had spent his entire income, he would
have paid tax at the same rate as the poor (it doesn't matter if he would
have paid a higher rate--you can do the numbers for yourself). So as a
result of deferring spending, Moneybags has deferred $50,000 in taxes.>>
This doesn't quite work. The implication of this example is that the consumption tax rate is 11 percent. Note that if you start with a million, you can't spend it all on consumption because you won't have anything left for the tax. Your consumption plus 11 percent of it must be less than the million, or X plus 11 percent of X. X can be no more than $901K. Therefore you can't pay $60K in tax and 'save' $50K. You can only have saved $41K. If you paid $60K in tax, your consumption must have been $545K ( of which $60K is ten per cent). So you spent $545 and paid 60, leaving $395K of the million.
So Mr. M has deferred $395K of consumption, gross of tax, and $354K (395-41) net of tax. Pressing on:
>Let's assume he is a cautious investor, and gets only a modest return of
10% per year on this. After 10 years, he will have made about $80,000.>>
If you want to gross up $50K to $80K, it is consistent to say that the $395K (what's left of the million after tax and consumption) grows to $632K. Capital gains is irrelevant because we're talking about a consumption tax where how you finance consumption has no bearing on tax liability.
Ten years later, if Mr. M wants to blow his $632K on taxable consumption, note that he must pay his tax out of the $632K. So he can only consume an amount such that 111% (under an assumption of an 11 percent tax) of it equals $632K. This is about $569K, with a tax of about $63K.
So the tax savings of $41K was offset by a subsequent tax of $62K. If $50K grows to $80K, than $41K grows close to $62K. The present value of the eventual tax equals the initial tax saving.
Bro. Gaspar confines his 'deferred tax' to the tax savings, whereas the entirety of deferred consumption (which subsumes tax savings) is taxable when consumption takes place. In addition, his initial tax savings number is inconsistent with his implied 11 percent tax rate.
>> Take off say 20% in capital gains tax and he still has $64,000
left--money he never would have had if he had paid tax at the same rate as
the poor in the first place. Now he spends the original income, pays the
deferred $50,000 in tax out of the investment income (thus effectively
paying nothing) and still has an extra $14,000 in the bank.>
As noted, spending the 'original' income as well as the returns incurs tax.
If we did the rates of return more rigorously, we could show that the tax savings from deferring consumption is the precise present value of the future tax liability resulting from subsequent spending of principal and interest on consumption.
Try a simpler number. You earn $11. There is a ten percent consumption tax. You save the $11. You have escaped a dollar in tax. You can only spend $10 because you need the 11th dollar to pay the tax. In one year, with a ten percent ROR, the $11 is $12.10. The next year it is $13.31. You spend $12.10 and pay $1.21 in tax.
Under the same ROR, the dollar in tax you saved is worth $1.21 two years later. Ergo under a consumption tax, with some simplifying assumptions, you profited nothing by saving.
Anybody still here?
Cheers,
MBS