I’ve just been thinking about it again. And I think I got too excited with the interest rate in the previous comment.

If income taxes fall and consumption taxes rise (making your true real income now the same) you will have to save “more money” in order to buy the same number of goods in the future.

Prices in the future will be higher, and as a result even if the interest rate does stay the same, the amount of real goods you can buy won’t be any different.

For example, you make $100 net of tax and spend $50 now and $55 in the future (with a 10% interest rate) your intertemporal budget constraint is satisfied. If we increase income by 20% but increase prices by 20% you now make $120, but the cost of consuming the same bundle now is $60 the same bundle we would have purchased earlier is $66 (again consistent with a 10% interest rate). As a result, the change in tax structure does not provide you with a greater net income – as any nominal lift is canceled out by higher future prices.

Ultimately, the tax structure change does not change the budget constraint, regardless of the interest rate as we have had an equivalent income and intertemporal price shift in opposite directions. Given that the indifference curve (the intemporal preference) is no different, the fact that our budget constraint is the same ensures that the consumer will make the same choice in real terms – as a result there should be no change in savings or borrowing behaviour from a position where the person is neither a borrower or a lender.

If you are ALREADY a net saver you suffer- as your savings are worth less. If you are ALREADY a net borrower you suffer, as you are made better off – as you brought before the lift in the price level. This is a distributional issue associated with the change in tax structure – however, it does not remove the long-run equivalence between the two.

Do you agree – or am I still on crack 😉

Starting at the same interest rate, then if you are a net saver yes. If you are a net borrower it is the opposite. At any point in time these groups cancel out don’t they. This implies that the interest rate adjusts to set them equal.

If the interest rate is adjusting to set these groups equal, then any “gain” in real income will net out, thereby making GST and income taxes equivalent again. I guess that will influence the distribution of the tax burden though wouldn’t it.

Does that sound right?

By not paying the tax now you can invest that money and earn interest leaving you with greater real income in the future.

I’ve only just purchased my second coffee of the day so you’ll have to excuse me if I’m missing something obvious;)

No, because the value is derived from the final product with is consumed in the further in either case. Fundamentally, your level of real savings (and the therefore the amount you buy with savings) is the same in either case – so the individual will not prefer either situation.

As long as the consumption tax still exists in the future, then consumption taxes are also on “savings” – given that savings is deferred consumption. In the end, it all gets taxed.

From an individual’s perspective wouldn’t you prefer a tax on consumption then? This is becasue with an income tax you pay the tax now where as with a consumption tax you defer paying the tax till later? Thus all other things being equal, the present value your liftime tax liability would be lower.

Haven’t thought this through much, interested in your thoughts.