The quadrennial alignment of the tax preparation and
presidential primary seasons can he relied on to produce stinging
criticism of the federal income tax. Regardless of how much a
candidate may personally have had to do with writing the current
tax code, each wants nevertheless to convey that he feels the pain
of the voters as they confront their Form 1040s. Routine as this
is, the stakes seem much higher this year.
We're not hearing about three-martini lunches anymore; we're
hearing that the entire income tax should be replaced. It seems
reasonable to ask: With what? Most of the options suggested involve
some type of consumption tax, with the so-called "flat tax"
appearing to have the lead as we file our returns. Let's look
briefly at consumption taxes in general, all then at the "flat tax"
Consumption taxes have two great attractions. First, by
removing tax burdens from income that is not consumed, they could
be expected to stimulate private savings. The appropriate measure
of national savings is subject to debate, but all analysts agree
that the United States has one of the lowest savings rates among
developed nations, and nearly all analysts think that this is a
The second, related attraction of consumption taxes has to do
with the moral qualities associated with thrift, and
correspondingly with a tax system that encourages that virtue.
Whatever we tax we tend to discourage. Income represents the return
on productive deployment of labor and capital; why would we want to
Consumption, in contrast, is a necessary but essentially
destructive activity. It quite literally consumes resources, making
them unavailable for the future use of current taxpayers, or for
future generations. Burdening that activity as a means of
simultaneously financing the government and sending the right
signals to taxpayers has considerable appeal.
What's wrong with consumption taxes? In a word, they tend to be
regressive, taking a higher percentage of income from lower-income
taxpayers than from higher ones. This is so simply because
lower-income taxpayers, on average, spend more of their income and
save less of it than higher-income taxpayers do.
The tendency toward regressivity can be mitigated by, for
example, exempting some categories of consumption, such as food.
Generally, however, the mitigation mechanisms are rather crude,
providing too much relief in some places and not enough in others.
And they inevitably complicate a tax system whose simplicity is
supposed to be one of its primary virtues.
The flat tax attempts to preserve the atttractive incentives of
a consumption tax while incorporating a novel (those who like ii
would say ingenious) method of mitigating regressivity. The flat
tax begins with a tax on business that resembles a value-added tax.
A value-added tax assesses a flat rate - 17 percent is frequently
mentioned - against the revenues of a business, minus its
purchases. However, the usual value-added tax doesn't recognize
wages paid to employees as "purchases." But the flat tax does,
effectively removing wages from the base of the business part of
the flat tax. …