Introduction

Surprisingly little is written about progressive consumption taxes in Australia. Even when stuff is written, it often assumes the need for a new, elaborate method of implementation.

I outline how to do a progressive consumption tax in Australia with no new taxes. All you have to do is expand eligibility to existing schemes and dial some tax rates up and down.

If you're wondering what the gist is, Scott Sumner gives the game away here:

The other approach is to tax income minus saving. Under this system, you would start with money inflows from wages, interest, dividends, rent, asset sales and borrowing, and then subtract outflows that went to savings vehicles such as stocks, bonds, commercial property and bank accounts.

Consumption = Income - Savings

There's a neat accounting identity:

Consumption = Income - Savings

The ATO already observes Income, and applies a progressive tax to it.

To get a progressive income tax, we can just create a savings vehicle, where contributions to the vehicle are tax-deductible, and withdrawals from the vehicle get added back to your assessable income.

Then, the existing progressive income tax gets transformed into a progressive consumption tax. The tax base shifts from "Income" to "Income - Savings", which is of course consumption.

A savings vehicle where contributions are deductible and withdrawals are added back to income

Happily, this already exists. They're called Farm Management Deposits (FMD).

At present, they're reserved for primary produces (read: farmers). We have this because farmers are always getting tax breaks to allow farmers to smooth their income due to volatility in farm returns. It's also great for farmers because smoothing income under progressive income taxes lowers their income tax bill.

But you could just as easily expand the scheme to include everyone.

A few more steps

If you think it can't be that easy, you're wrong. But in the interests of full disclosure you'd need to make some amendments:

• Start small: You can introduce this quickly and then expand the scheme over time (kinda like superannuation)
• Expand over time: If you started this way, all of the savings in FMDs would be bank intermediated. Over time you might expand offerings so that other institutions like brokerages could also offer FMD compliant products. In the end you'd recreate something like SMSFs for FMDs (kinda like superannuation)
• No taxes on income from FMDs (Optional): The effect of this is to automatically assume that income from FMDs are re-invested. But it's optional because people could just manually recontribute their income from FMDs within the FY and achieve the same impact.

The implications

If you expanded FMDs to everyone, you'd expect that a lot of people would start saving in them. Income taxes would effectively only touch what people were spending in a given year.

Some neat consequences:

• Unobserved expenditure: A neat feature of this is that the ATO doesn't have to observe the consumption to tax it. This type of income tax captures the expenditure of an Australian on holiday in Bali, or money spent on Cocaine. Another way of thinking about it is that the tax base of the GST is "All consumption occurring in Australia" and the tax base for this would be "All consumption by Australian taxpayers"
• Strong incentives for self-reporting: By providing a deduction for savings, you incentivise people to self-report their saving. This minimises enforcement cost and would make most savings/investment observable in the economy.