What if we taxed what people spend, not what they earn?

When people talk about tax fairness, the focus is almost always on income. How much the rich earn, how heavily that income should be taxed, and how to make sure lower earners are protected. But there is an older idea that is quietly starting to get attention again. What if taxes were based not on what people earn, but on what they spend?

This is more than a technical tweak. A progressive consumption tax^[1] – where people who spend more face higher effective rates – can behave very differently from a progressive income tax. And according to economic research^[2] I co-authored with fellow researcher Carlos da Costa based on life-cycle behaviour, the consequences may be surprisingly large.

At first glance, taxing income and taxing consumption might look similar. If you earn £40,000 and spend £30,000, you could imagine taxing either amount and raising similar revenue. But people do not live one year at a time. They earn very unevenly over their lives – lower wages early in their career, higher wages later – and they tend to save in good years to stabilise their spending in leaner ones.

This basic feature of real life makes the choice between taxing income or taxing consumption much more important than it seems.

Progressive income taxes increase the marginal tax rate (the percentage applied within someone’s highest tax bracket) as earnings rise. This is designed to redistribute income towards lower earners. But it also creates an unintended effect: people are discouraged from working more in the years when they are most productive because those extra earnings are heavily taxed.

Over a lifetime, this discouragement flattens people’s earning patterns and reduces saving. When lots of people make these choices at once, the whole economy ends up with less investment, lower productivity and slower wage growth. These long-run effects are invisible in year-to-year statistics, but they matter greatly for overall prosperity.

A progressive consumption tax takes a different approach. It doesn’t penalise earning more in a particular year. Instead, it taxes people according to how much they spend overall. Someone who earns £70,000 but saves £25,000 would face a lower tax bill than someone who earns £50,000 and spends it all.

This creates an incentive to save in high-earning years. While higher saving might sound like it would slow the economy, in the long run it does the opposite. Saving provides the funds that businesses use to invest in new equipment, technology and expansion.

Over time, this raises productivity and – crucially – pushes wages up. This mechanism is particularly important for lower-income households, who depend almost entirely on their earnings rather than capital income (from things like property) or investment returns.

Our analysis^[3] suggests that switching from progressive income taxation to progressive consumption taxation could make households noticeably better off. This could be roughly equivalent to a permanent 10% increase in living standards as a result of rising wages and families being better protected when their incomes fluctuate.

A policy reform that both strengthens the economy and improves financial security is rare. From our analysis, it looks like this approach could do both.

A common concern is that consumption taxes are regressive. A flat tax on spending would indeed fall more heavily on low-income households who spend all or almost all of the money they have coming in. But progressivity can be built into a consumption-based system.

In fact, our work shows that a progressive consumption tax can redistribute as much as a progressive income tax, but with fewer of the distortions that slow growth.

Put simply, it is possible to design a consumption-based system that is both fair and efficient. And it wouldn’t necessarily require radical reform. It may sound like a major overhaul, but many of the benefits could be achieved with practical, incremental reforms.