Sunday, November 20, 2011

Can a Consumption Tax Really Save America’s Economy?

By Rui Li

In Robert J. Barro’s New York Times article “How to Really Save the Economy” (, he argues that the U.S government should impose a consumption tax to increase tax revenues. According to Barro, government deficit has reached an intolerable level and will harm the country’s long-term sustainable development.

While this idea sounds appealing, the downside includes a loss of economic activity due to the tax, and an overall welfare loss to the whole society. The fundamentals of supply and demand suggest that any tax raises the cost of transaction for someone, whether it is the seller or purchaser. In raising the cost, either the demand is reduced (demand curve shifts leftward), or the supply is reduced (supply curve shifts leftward). The two are functionally equivalent. Consequently, the quantity of goods purchased decreases and the price increases. Many mutually beneficial transactions will not take place due to this price change. Overall, society experiences a revenue loss. This is known as a deadweight loss which can make society worse off.

A consumption tax also places greater burden on the poor as compared to wealthier individuals. Lower-income individuals spend a higher portion of their income on necessities and thus shoulder disproportionate costs. In light of the current economic recession, a slight increase in commodity price will cause a relatively larger decrease in the quantity of commodities demanded of the commodity. In other words, more mutual beneficial transactions are lost. Any society experiencing economic decay will find this situation unfavorable. When consumers do not want to buy goods, producers cannot sell all their products and earn less profit. Small firms have to shut down and fire their employers. People lose their jobs and in turn have to cut down their spending. This vicious cycle will be a detriment to our economy.

In sum, a consumption tax cannot really save the American economy. The whole society will be worse off because of the deadweight loss. During this period of economic downturn, consumers are more responsive to a price change of necessities and deadweight loss may be even greater than usual. This situation will make it more difficult for the economy to recover and prosper. Therefore, although Barro’s proposal may help to increase the government’s tax revenue and reduce the deficit in the long run, the efficiency of imposing such a tax at this time is remains dubious. 

Rui Li

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