The Pursuit of Happiness

Before opining on taxes, I’d like to say how gratifying it is to see names I haven’t heard from in years show up in my email as new subscribers. I can’t say I blame people for abandoning the comment section over at TheMoneyIllusion, and with your help I hope to make this comment section both friendlier and more thoughtful.

The issue du jour seems to be whether to tax at least some unrealized capital gains. Cowen and Tabarrok have done a better job than I could have in pointing to all of the real world complications that make that approach problematic. Here I’d like to take a broader view; what is the problem with our tax system that makes people look for such unwieldy solutions?

In my view, the original sin of tax policy was the decision to focus on income, not consumption. Once we started down that road, we created a system where closing one loophole would inevitably create a couple more. Yes, if income really is the thing that should be taxed, then it makes logical sense to tax unrealized gains. But income is not the right base for our tax system; consumption is what matters.

You can think of a consumption tax as a system that taxes current and future consumption at the same rate. As always in economics, it’s possible to dream up theories where this is not optimal. But ask yourself the following question. If a neutral attitude toward saving is the baseline assumption, how likely is it that the optimal tax regime in a more realistic model would tax saved income at a higher rate than currently consumed income?

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