A Consumption Tax Is An Income Tax
Why do "free market" supporters advocate this garbage? First, as I've mentioned earlier today, I have no interest in selling out like the so-called free-market economist Uncle Milty and helping the government "streamline" its tax system. Who cares about increasing government revenue? Bring on the loopholes! Good try guys, let's promote liberty by making it easier for government to figure out how to take our money! Hooray!
More importantly, in stricly economic terms, I must attack the idea that the consumption tax is better than an income tax. This is a serious error in economic understanding being pushed as a free-market idea.
A "consumption tax" is a general sales tax on final goods and services (consumption goods). Of course, firms cannot merely "pass the tax forward" to the consumer by raising the price of a good. Firms are already maximizing profits by selling at the price which maximizes net revenues. Therefore, the tax can only be shifted "backward," eating away at the profits of the firm in the short run.
Reduced profits by the firm means lower returns to the factors of production (land and capital). Ultimately, this "consumption tax" is shifted back to the owners of the land, capital and, by extension, labor. With the anticipation of lower profits, resources are shifted to uses promising higher returns, reducing the supply of final goods and services, raising prices and therefore reducing the standard of living, in the long run! Wages (the discounted marginal productivity of labor) are also necessarily reduced! Ultimately, this is an income tax!
Now, while a tax on a partcular industry--cigars, for example--will push resources out of the production of cigars, if ALL final goods and services are taxed there is relatively less room for the shifting of resources. The real distortion of production in this new consumption tax society will depend on the use of the tax revenues by the State. For instance, if the market purchases mostly clothing and the government spends mostly on arms, a fall in the price of clothing and a rise in the price of arms will occur, with the nonspecific factors tending to shift from clothing production to arms production. In short, a redistribution of resources away from the demands of consumers. So, some factors of production will lose, some will lose less, and some will even gain by shifting into the arms industry.
As Rothbard concludes: "The general sales tax is therefore an income tax, albeit a rather haphazard one. Many 'right-wing' economists have advocated general sales taxation as opposed to income taxation, on the grounds that the former taxes consumption but not savings-investment; many 'left-wing' economists have opposed sales taxation for the same reason. Both are mistaken; the sales tax is an income tax, though of a more haphazard and uncertain incidence. The major effect of the general sales tax will be that of the income tax--to reduce the consumption and the saving-investment of the taxpayers. In fact, since, as we have seen, the income tax by its nature falls more heavily on savings-investment than on consumption, we reach the paradoxical and important conclusion that a tax on consumption will faill more heavily on savings-investment that on consumption in its ultimate incidence." (Rothbard, Man, Economy and State 812-813)
Down with the evil consumption tax!