The World Affairs Discussion Group Message Board › Effect of tax regime on investment
|John Van P.||
At our meeting about taxation the question arose whether exchanging the income tax for a consumption tax would change the rates at which people consume and invest. Having pondered this a bit I believe it depends on your assumption about how a person on a salary invests.
Assumption 1: A person on a salary invests enough money each year so that they will have enough to live comfortably upon retirement. Under this assumption workers invest the same amount regardless of how they are taxed.
Assumption 2: A person on a salary invests a fixed proportion of their paycheck. Changing from an income tax to a consumption tax would boost people's paychecks, so under this assumption you would get a higher rate of investment.
I claim Assumption 1 is consistent with good retirement planning; workers should invest enough each year so that they can retire comfortably, regardless of the tax regime. However, it is an open question how people would actually behave under different tax systems. Behavioral economists might be able to study this problem in the lab.
Another way to study this question would be to examine the rates of investment in countries that have a flat tax (such as Russia and Bulgaria) and in countries that rely heavily on a consumption tax (I believe this includes most countries in Western Europe). Of course, there are confounding factors, i.e., that countries have different levels of prosperity, different old age social safety nets, and so on.