And the deepest pain falls, as it so often does, on the poor and the jobless. High interest rates can shift the decisions richer people make about spending. If it’s a bad time to buy a house, even a multimillionaire might wait a few years. But higher interest rates won’t change how much child care they buy or whether they upgrade their phones or how much they spend on clothes. And it’s the spending of the better-off that drives the economy: In 2021, the top income quintile was responsible for almost 40 percent of total spending. The bottom income quintile accounted for less than 10 percent.
It would be nice to have policies that could work alongside interest rates so adjustments could be less severe. It would be particularly nice to have a policy that targeted the rich rather than the poor and did so in a way that didn’t hurt long-term investment. Such a policy exists.
For years, Robert Frank, an economist at Cornell, has argued for a progressive consumption tax on the ground that it would discourage the rich from spending on luxuries and give them more reason to save and invest. The way it works is simple: Instead of reporting your income to the I.R.S. and being taxed on that, you report your income minus your savings, and you’re taxed on that. That’s a consumption tax: Your taxable income is what you spend, not what you save. Congress can make it progressive by adding a hefty standard deduction and applying a much higher tax rate to people making much more money, just as we do now.
Frank wasn’t writing in a time of high inflation, so his argument centered elsewhere: He considers much of the spending among the rich to be harmful, not just wasteful. Take wedding spending: The rich compete with one another to throw ever more lavish weddings. That competition cascades to the near rich, who want to appear rich and so increase their spending, too. The pressure then shifts to the next group down the income ladder and the next group and so on, until everyone is spending more on weddings because the frame of reference on how much they “should” spend on a wedding has changed. You can find similar dynamics in spending on everything from homes to schools to cars and jewelry.
I’ve always liked Frank’s argument, but now I’m more interested in another feature of the progressive consumption tax: the ability to dial it up and down to respond to different economic conditions. In a time of recession, we could drop taxes on new spending, giving the rich and poor alike more reason to spend. In times of inflation, we could raise taxes on new spending, particularly among the wealthy, giving them a concrete reason to cut back immediately and to save and invest more at the same time.
Even better, we could make it automatic, as Posen suggested to me. Perhaps for every percentage point increase in unemployment above 5 percent, the tax rate would fall by three points, and for every percentage point increase in inflation above 3 percent, it would rise by four points. Other rules could apply for periods when unemployment and inflation moved together. The tax code would become responsive to the economy by default, rather than only through new acts of Congress.
Are we likely to create a progressive consumption tax right now? Of course not. Congress isn’t likely to do much of anything right now. But over the past two decades, we’ve seen a giant recession during which Congress passed far too little stimulus and now an inflationary crisis that Congress and the Federal Reserve were too slow to address. Maybe it’s time to think about policies that move at the speed of economies and psychology rather than the pace of institutions.
Additional research by Rollin Hu.
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