II. What is a consumption tax?
III. Periodicals
IV. Internet
b. Web sites
V. Books
VI. Other materials that might help
a. Current
b. Future
VII. Things to avoid
a. Materials
b. Terms
VIII. An opinion piece
I. What is a Pathfinder?
A pathfinder is a research guide to a particular topic. The topic must
be narrow enough to fully delve into the issue, yet broad enough to use
a wide array of materials. This pathfinder is a guide to potential federal
consumption tax plans.
II. What is a consumption tax?
A consumption tax can be either a sales tax or a periodic tax, like
an annual tax. A broad based consumption tax is a direct tax, which needs
to be apportioned among the states. For a consumption tax to be Constitutional,
it would have to tax poorer states higher than wealthy states. The 16th
Amendment allows for an income tax to avoid the apportionment clause of
the Constitution. But a consumption tax would not fit under the protection
of the 16th Amendment. However, high level officials have been calling
for a consumption tax to replace the income tax, and a consumption tax
may fit under the Supreme Court's definition of an excise tax.
The income tax is the result of "a societal judgment as to the appropriate distribution of social product or personal income." It is a tool for redistributing wealth. Graetz argues that a private property system means that an individual's consumption of that individual's resources does not affect any other person's consumption of resources, so that one person's consumption does not take from society's communal pool of resources. However, Graetz's argument assumes that resources are not limited.
The normative question of what type of tax is fair usually comes up whenever a tax system is discussed. An income tax is based on the idea that society deserves its share of what it produces. A consumption tax is based on what taxpayers take from the collective and is related to a taxpayer's standard of living. Consumption taxes tax people on what they take from society, while income taxes tax people on what they contribute to society.
Western tax systems are based on the premise that those who are most able to pay tax should be taxed the highest. An income tax is thought to be the best device to carry out the concept of "ability to pay." However, not all consumption indicates an ability to pay. Graetz uses the example of a cancer patient going through a divorce. While consumption is high, ability to pay is not. Thus, income may be a better measure of ability to pay.
A. Periodicals
1. LegalTrac
2. Lexis/Nexis
3. WestLaw
4. CLI
5. LRI
6. Index to Legal Periodicals
7. CCH Federal Tax Articles
8. Index to Federal Tax Articles
9. NYU Institute on Federal Taxation (Matthew Bender)
10. Tax Policy in the US: A Selective Bibliography with Annotations
11. Monthly Digest of Tax Articles (Newkirk Associates)
12. WG & L Tax Journal Digest (Warren, Gorham & Lamont)
a. Search engines
Search engines are indexing tools that look for a combination of search
terms and rank the relevant sites by how often the terms appear and by
where the terms are in relation to each other. Search engines vary in their
approach to ranking sites. The effectiveness of a search engine will vary
depending on such things as the researcher, the search terms, and the field
of research. The following search engines seemed to work best. They are
all accessible from the University of Arizona Library's home page.
1. The Best: Northern Light
This search engine gave a list of various articles and publications that were available on the internet or in book form. Some of the hits were also lists and directories. The related web sites were also very useful.
2. Second Best
These search engines were very similar to each other in format. They varied by content, but for the most part they were simply lists of relevant web sites.
A. AltaVista
B. WebCrawler
C. infoseek
D. excite
E. snap
3. The Worst
These search engines were very limited in their usefulness. One search engine's top hit was a web site that sells a "consumption tax" bumber sticker. Another engine's top hit was a site for economist jokes.
A. LYCOS
B. HotBot
C. galaxy
b. Web sites
Web sites are the best way to stay current on a current issue. However,
web sites can be maintained by anyone, so a researcher should take care
to make sure that a particular web site is reliable. The researcher can
generally rely on government sites, and to a lesser extent on those sites
which are familiar to the researcher as being reputable.
1. Congressional Universe: web.lexis-nexis.com/congcomp/
A. Bill Tracking
B. The National Journal
C. National Journal's Congress Daily
2. Congressional Budget Office - U.S. Congress
3. Bill Archer, Texas
Chairman of the House Ways and Means Committee
4. About the 10% Plan, Gephardt's 10% Tax Act (H.R. 3620)
www.house.gov/democrats/taxplan/about
5. Richard A. Gephardt Address to the Commonwealth Club of California, "Taxes: The Time to Reform is at Hand"
www.house.gov/democrats/speeches/taxreform
6. NewsHour Online, from PBS' News Hour
7. Tax Foundation: www.taxfoundation.org
V. Books
Books in general did not provide a very valuable resource for the topic
of consumption taxes. Because the topic is a current one that undergoes
changes everyday, books are not able to keep up with the rapid rate of
change. However, books can provide some background and history of taxes.
a. Sabio
Sabio is the University of Arizona's online card catalog system. Through
internet links, Sabio can be used to search the U of A libraries, as well
as other Arizona libraries such as Arizona State University, Northern Arizona
University, and Pima County Public Library.
b. WorldCat
WorldCat is similar to Sabio in that it is a catalog system for books.
This tool was limited, however, by the limited usefullness of books in
general.
VI. Other materials that might help
1. U.S. Constitution
2. Committee Reports
A. CCH Standard Federal Tax Reporter: KF 6271 C64
B. RIA US Tax Reporter: KF 6285 U66
C. Internal Revenue Acts - Text and Legislative History
D. Tax Management Primary Sources (Hearings - Internal Revenue Acts of the US)
E. Seidman's Legislative History of Federal Income and Excess Profits Tax Laws: KF 6471 A58
F. Blue Book
3. Treatises: Mertens Law of Federal Income Taxation: KF 6365 M4
1. State Initiatives
2. White House
3. Accounting Firms or Tax Law Firms
a. Materials
Primary authority sources are currently of little use in the area of
consumption taxes. Because no laws are in place, no litigation has occured.
Thus, caselaw is non-existant. Likewise, a search of statutes will be fruitless,
as will a search of legislative histories.
State materials have not been useful. The only consumption taxes that any state has addressed seem to be sales taxes. However, if any state considers an annual consumption tax in the future, then that state's plan could be used as a model for a national consumption tax.
1. "Sales Tax"
One search term that occasionally comes up is "sales tax." Although
a sales tax is a consumption tax, this pathfinder has focused on annual
consumption taxes. While a sales tax would be easier to administer, an
annual tax has several advantages.
First, taxpayers would probably be required to file income statements anyway, because subsidies are based on income.
Second, a sales tax would not discriminate among taxpayers. Foreign visitors would pay huge taxes, which could deter tourism and investment. Many international trade treaties would need to be renegotiated.
Third, conversion to a consumption tax may be more attractive if one of the states tried it first. If a state were to have taxes considerably higher than those of neighboring states, buyers would travel to the lower tax state to purchase goods, thereby depriving the high tax state of revenues.
Fourth, a sales tax would not be progressive. Progressivity of a consumption tax could be accomplished by increasing the tax rate according to income, which would require an income statement.
Finally, to reach the current level of revenue from income tax, a retail sales tax would likely lead to a combined federal-state rate over 30%. So a consumption tax is best implemented with an income statement on an annual basis.
2. Foreign Tax Systems
Right now, Japan has some big consumption tax issues. A lot of the literature on consumption taxes is about Japan's taxes. To a lesser extent, other countries' tax policies will surface during a search on consumption tax. The researcher should be aware that foreign issues may arise during a search. Of course, if the researcher is looking for foriegn tax systems or for international and comparative issues, then this search term should be added.
Pros and Cons of a Consumption Tax
Stephen L. Tunney
INTRODUCTION
This paper will discuss the pros and cons of Professor Andrew's cash-flow consumption tax as opposed to an income tax. I begin by explaining how a cash-flow consumption tax works. This paper first assumes that no tax system is currently in place. So, starting from scratch, the paper will show that a consumption tax is more beneficial than an income tax.
This paper also assumes that any desirable tax system would be progressive. However, not all consumption indicates an ability to pay. For example, a cancer patient going through a divorce has a rate of consumption, but does not necessarily have a high ability to pay. Thus, income may be a better measure of ability to pay. I suggest that tax rates be progressive based on the taxpayer's income. Thus, while the tax base is dependent upon consumption, the tax rate would be based upon income.
The reader will note that a consumptive tax based partially on income
is more of a hybrid tax. This paper will demonstrate that any practical
tax system will actually be a hybrid of consumption and income taxes, resulting
in the conclusion that the consumption tax is only marginally superior
to an income tax. Finally, this paper concludes that the benefits of the
consumption tax do not outweigh the transition costs involved.
WHAT IS A CASH-FLOW CONSUMPTION TAX?
A cash-flow consumption tax is a tax that would tax people based on what they consume rather than on how much income they generate. Generally, people can either spend their money, or they can save it. The most basic design would use only the elements of income, consumption, and savings. The taxpayer would begin with income, then would deduct savings. The amount left would be the person's consumption for the year.
In practice, a few basic adjustments would be required. For instance, suppose the taxpayer started with income of $100,000. Suppose then that the taxpayer lived off of past savings and put the entire $100,000 into other savings accounts. The end result would be $100,000 income less $100,000 savings for a consumption of zero and thus, no tax. To stop this type of abuse, the taxpayer would begin with total savings from the beginning of the year, add income for the year, and deduct total savings at the end of the year to arrive at total consumption. Another avenue for abuse would be open if a taxpayer saved all income for the year and lived off of loans. Like the prior example, the taxpayer could put all income earned into a savings account. The taxpayer would live off of loans. Because a taxpayer who lived off of loans would have no consumption, loan proceeds would necessarily be included in income.
At this point, Professor Andrew's cash-flow model is easy to conceive.
The taxpayer begins with total savings at the beginning of the year, adds
in all cash in-flows (which include loans), and deducts all cash out-flows
to arrive at taxable consumption. When consumption is finally determined,
it would then be multiplied by the applicable tax rate to calculate the
taxpayer's liability. The tax rate could be progressive, based on the taxpayer's
income. The taxpayer would likely have deductions similar to the ones available
under the current system, but this paper is only concerned with the basic
cash-flow consumption tax.
THE PROS OF THE CASH-FLOW CONSUMPTION TAX
The consumption tax has many pros. Probably the most obvious is that it encourages saving. Because people are only taxed on what they spend, people would be inclined to spend less. The basic model shown above means that whatever is not spent is saved. Thus, the tax would encourage people to save. While the proposition that increasing savings is beneficial to both the individual and society, it is beyond the scope of this paper. I will simply assume that increasing savings is in fact desirable.
The consumption tax would also be more fair than an income tax. An income tax taxes people on what they contribute to society. The consumption tax, by contrast, taxes people on what they take from society. Thus, under an income tax, those who contribute more will pay more. Under a consumption tax, those who consume are taxed more heavily. Because the consumption tax encourages production and discourages consumption, society benefits more.
Another effect of the consumption tax is that people would make a direct connection between spending and tax liability, causing people to consume less. Because the consumption tax focuses on what the taxpayer takes from society, people would see that only a finite amount of resources are available, which would encourage smaller families. Because families would be smaller and would consume less, the problem of overpopulation would be reduced somewhat.
But the biggest benefit from the consumption tax is the simplification that it provides. Because income is not taxed, the type of income does not matter. The taxpayer would no longer be concerned about a good number of things. For example:
1) The characterization of income as ordinary or capital would no longer be an issue. Income is treated the same regardless of how it was earned, so characterization is not important.
2) The holding period of a security as long term or short term would likewise be unimportant.
3) The alternative minimum tax (AMT) would not be necessary anymore, because it was designed to prevent taxpayers from using too many deductions in the code.
4) Whether an expenditure should be capitalized or expensed would no longer be a concern. A cash out-flow is treated as a cash out-flow, regardless of why the expenditure was made.
5) Depreciation or amortization would similarly be unnecessary, because the expenditure would be taken when the transaction occurred.
6) The effects from inflation would be neutralized. Even though the taxpayer can delay paying taxes until she consumes something, she does not get any real benefit because she would have to spend more in the future than she would have to spend today to acquire the same goods. Because the taxpayer would pay more, she would also be taxed more.
7) Realization issues would be negated, because cash basis is used. Any increase in wealth would not be recognized until the taxpayer has a cash in-flow. Similarly, the taxpayer can avoid tax by simply re-investing the cash.
8) The taxpayer would not carry over losses from year to year because
only cash out-flows would matter.
THE CONS OF A CASH-FLOW CONSUMPTION TAX
The cash-flow consumption tax has some inherent disadvantages, too.
1) The consumption tax is regressive, because low income taxpayers usually spend all of their income and would not benefit from a system that encourages saving.
2) A rate that is progressive based on income would cause taxpayers who receive a lump sum, such as a gift, to be put in a higher bracket. Thus, an individual with no change in consumption patterns would have different tax liabilities because of the transfer.
3) The consumption tax spreads out the lifetime tax burden on the taxpayer, instead of condensing the burden in the income producing years. Young people and old people who previously did not have to file would be required to do so.
4) The current system has a stabilizing effect on the economy. Suppose
that a company has a bad year economically. The company may not be able
to afford any extra expenditures, particularly if the company would be
taxed on the purchase. The consumption tax discourages companies from spending
during economically weak years, which would deprive the economy of a much
needed boost.
DO THE PROS REALLY OUTWEIGH THE CONS?
Looking at the number of pros attributable to the consumption tax, one would think that the consumption tax is clearly superior to an income tax. However, many of the pros could be achieved by amending the income tax. For instance, problems of characterization of income and holding period could be eliminated by treating all income the same. Alternatively, such gains could simply be non-taxed. Capitalization could be done away with by simply allowing everything to be expensed, as could depreciation. Losses could net with all gains and income, which would minimize the need to carry over losses. Realization issues could still be a problem under the consumption tax, because the taxpayer still has to determine income and amendments to the consumption tax could muddy the waters. Likewise, amendments to the system could require something similar to the AMT. Congress could also encourage saving under an income tax. Thus, the only truly inherent benefits to the consumption tax are the neutralization of inflation and the potential to ease the overpopulation problem.
The cons of the consumption tax are equally misleading. The consumption
tax could easily be made progressive, by basing the tax rate on income.
Putting recipients of lump sum transfers into a higher bracket also goes
along with progressivity. The tendency to place the tax burden more on
the younger and the older taxpayers could be alleviated with amendments
and deductions. Amendments could also require corporations to depreciate
expenditures. So, the cons are not really inherent in the consumption tax
at all. The benefits of the consumption tax are actually quite minimal.
TRANSITION COSTS OF SWITCHING TO THE CONSUMPTION TAX
While the benefits of the consumption tax are small, the costs of switching to the consumption tax are large. First, those taxpayers who have already paid tax on their savings would pay again on their spending. This is called the "generational gap," because one generation would have to pass before the double taxation effect would be gone. However, the generational gap could be avoided through a system of credits. The gap would at least be minimized by the progressive tax rate based on income. For instance, those individuals who rely solely on savings would have no tax liability, because their tax rate would be zero. The real concern would be middle-aged taxpayers with substantial savings. The actual numbers and proposals for mitigation are beyond the scope of this paper.
Transfer taxes might also require some modifications. The consumption tax encourages saving, so the transfer taxes would need to counteract the tendency to amass fortunes. Transfer taxes is an entirely distinct area that is also beyond the scope of this paper.
Any overhaul of the tax system would have international effects. The government would at least need to re-negotiate treaties. The effect on the global economy would need to be considered, such as the effect on other countries and the effect on multinational corporations. Since income would not be taxed, U.S. corporations may favor domestic sites. However, the consumption tax would not necessarily apply to corporations. Again, international effects are beyond the scope of this paper.
The biggest reason to not switch to the consumption tax is the potential for Congress to enact amendments that they would not otherwise be able to enact. The smoke and mirrors of tax reform could hide all sorts of special interests. Two recent proposals point out why the public should not believe that any tax labeled as a consumption tax is inherently beneficial. Those proposals are the Armey flat-rate tax and the Nunn-Domenici unlimited savings allowance (USA).
The Armey flat tax would tax corporations at 17% and would tax individuals at 20% for two years and at 17% thereafter. The flat tax would allow deductions for compensation, would allow losses to be carried forward indefinitely, and seems to contemplate cash basis accounting. The flat tax does have a wider tax base than the current system. However, the treasury has estimated that a flat tax would have to be about 23% to raise the same amount of revenue. If the current deductions in the income tax system are kept, the flat tax rate would have to be about 31% in order to replace the current levels of tax revenue from income and corporate returns.
Companies with high levels of investment would gain the most under the flat tax, while exporters will tend to pay more. The flat tax would also eliminate the current research credit, thereby discouraging Research and Development (R & D).
The Nunn-Domenici USA tax would be a consumption tax with progressive rates up to 40% on individuals and a rate of 11% on corporations. The USA tax would not allow for deductions for employee compensation and benefits, interest payments, and taxes. The main benefactors under the USA tax would be exporters, because exports would not be taxed. The losers would be companies with high levels of compensation, fringe benefits, and interest expense.
The flat tax and the retail sales tax would lead to huge tax savings
for high income taxpayers, while the USA tax would be almost neutral across
income classes. Another difference between the two proposals is that the
USA tax would tax imported goods and exempt exported goods, while the flat
tax would exempt imported goods and tax exported goods. Thus, the USA tax
encourages exports while the flat tax encourages consumption of imports.
The flat tax seems to favor big business, not only because bigger businesses
tend to have over seas divisions, but because they also enjoy the largest
tax cuts.
CONCLUSION
The basic cash-flow consumption tax has many advantages over an income tax system. The consumption tax is more simple, more fair, and promotes the socially desirable goals of saving and moderate consumption. The income tax, by contrast, is antiquated and does not efficiently promote any social goals. Most of the advantages of the consumption tax, however, can be realized under the current income system. Conversely, the advantages to the consumption tax could be minimized by amendments. So, while the consumption tax system does have a small edge on the income tax system, the transitional costs would outweigh those benefits.
Any tax system will almost necessarily be a hybrid of consumption tax
and income tax systems. Whether the basic system is one or the other is
not very important. Instead, the amendments to whichever system is implemented
are important. In the recent past, Congress has not shown the ability to
leave the tax system alone for even one year. Conversion to a consumption
tax should not lead one to believe that Congress would be able to leave
the new system alone, either.