One solution that a number of people have been working on is called the "Fair Tax." [1]
The general idea (and I'm probably missing some of the significant points, but this is a rough outline) is that there would be no income tax at all — all taxes would be on consumption. Rather than trying to regulate what is taxed and what isn't, everything would be taxed at the same rate.
To fight any regressiveness involved in that, everyone would get a set amount of money every year, which is equal to the consumption tax you'd be paying on the first, say, $30K of purchases a year. So if the consumption tax rate is 25%, you'd be given $7,500 a year. (The term they use is "prebate.") That way, everyone's first $30K of expenses is a wash. After that point, you're only taxed on the money you spend beyond it. The more you buy, the more tax you pay.
A number of Republicans have been in favor of the Fair Tax, and it was one of the planks of Gary Johnson's presidential campaign last year. But it gets support from Democrats as well, and was one of the main components of Mike Gravel's campaign in 2008.
I'm sure others will point out downsides to it, but one that I know of is that current retirees, who have already paid income tax on some of their savings, would have much less purchasing power under the new plan. That is, they'd be double-taxed on the money used to buy goods under a Fair Tax plan. I believe there's also been skepticism from opponents that the numbers actually work out well enough that a Fair Tax system would bring in enough money (as compared with current tax revenues). [Edit: the double-taxation wouldn't be limited to retirees; they're just the group that's often mentioned as being significantly affected.]
(I'm not an apologist for a Fair Tax approach; just wanted to mention it as one theory for introducing a consumption-based tax in the US, in case you're interested / want to learn more.)
One seemingly obvious problem to this (at least the way you describe it, maybe not the way it's actually proposed - I didn't read it) is that this would disincentivize spending, and incentivize saving. So it would seem[1] that this would cause the economy to take a big hit.
I just remember a few years back when the economy was at the worst we've seen in a while, the government seemed to really push spending and investing in stocks over saving. So if there was no penalty for earning money, only spending it, we'd be back in the same boat.
[1] Disclaimer: I'm certainly not an expert in economics.
The US economy is in such dire straights because of consumption, not due to the lack of it. The Keynesian economics fraud of the last few decades (see: Japan, half of Europe, the US), which has been pushed 24/7 at every level of government and media, is massively to blame.
Ask yourself one simple question: how does higher consumer spending help the US economy when all that money flows back to eg China? Right now the US is merely a middleman, with service workers that take a small cut for distribution.
China as you'll have noticed is getting wildly rich, at breakneck speed, without the need to constantly push over consumption (their savings rate is doing just fine).
America needs a lot more savings, capital investment, and production, and a lot less spending. We had this algorithm decades ago, and we were extraordinarily rich accordingly, and were far better off with a lot less consumer spending as a ratio of our economy.
To paraphrase Warren Buffett: you get rich producing things, and you get poor buying things.
China figured out how it works. Their economy more closely resembles the US economy of the early 20th century, in terms of production vs consumption. The arguments being made for China to consume more, are arguments in favor of China handicapping itself to allow others to compete more easily.
The planet money podcast recently talked about this. One of the reasons:
If you're "poor" and you spend 90% of your income on goods, you're getting taxed on 90% of your income.
If you're "rich", you spend 10% of your income on goods and just put the rest in other investments. This means that only 10% of your income gets taxed.
The general idea (and I'm probably missing some of the significant points, but this is a rough outline) is that there would be no income tax at all — all taxes would be on consumption. Rather than trying to regulate what is taxed and what isn't, everything would be taxed at the same rate.
To fight any regressiveness involved in that, everyone would get a set amount of money every year, which is equal to the consumption tax you'd be paying on the first, say, $30K of purchases a year. So if the consumption tax rate is 25%, you'd be given $7,500 a year. (The term they use is "prebate.") That way, everyone's first $30K of expenses is a wash. After that point, you're only taxed on the money you spend beyond it. The more you buy, the more tax you pay.
A number of Republicans have been in favor of the Fair Tax, and it was one of the planks of Gary Johnson's presidential campaign last year. But it gets support from Democrats as well, and was one of the main components of Mike Gravel's campaign in 2008.
I'm sure others will point out downsides to it, but one that I know of is that current retirees, who have already paid income tax on some of their savings, would have much less purchasing power under the new plan. That is, they'd be double-taxed on the money used to buy goods under a Fair Tax plan. I believe there's also been skepticism from opponents that the numbers actually work out well enough that a Fair Tax system would bring in enough money (as compared with current tax revenues). [Edit: the double-taxation wouldn't be limited to retirees; they're just the group that's often mentioned as being significantly affected.]
(I'm not an apologist for a Fair Tax approach; just wanted to mention it as one theory for introducing a consumption-based tax in the US, in case you're interested / want to learn more.)
1. http://www.fairtax.org/