The Debate over Replacing the Present Income Tax with an Alternative Tax Structure

By Hymson, Edward B. | Southern Law Journal, Fall 2013 | Go to article overview

The Debate over Replacing the Present Income Tax with an Alternative Tax Structure


Hymson, Edward B., Southern Law Journal


I. Introduction

There is an ongoing debate about whether the United States should switch from its present progressive income tax structure to a consumption tax or a hybrid income tax, and whether the tax structure chosen should be a flat tax (all taxpayers pay the same percentage) or a progressive tax. The debate turns on disputes over the economic efficiency of the alternative structures, social welfare, and transition problems inherent in any attempt to change the present tax structure. The following discussion identifies mainstream proposals to replace or modify the present income tax structure as well as identifying the theoretical and practical reasons for and against proposing changes.

Whether a pure income tax, a pure consumption tax, or a hybrid tax structure is preferable depends largely on whether it is desirable to always, sometimes, or never tax the return to earnings from savings and investments (income invested in savings accounts, stocks and bonds, real property, or a business).1 Consumption tax supporters argue that their preferred structure maintains the parity of present value between consumption and savings decisions, prevents over consumption and under-saving, and moves toward a more efficient tax structure.2 Hybrid income tax supporters argue that their structure can achieve most of the benefits of converting to a consumption tax without having to deal with the major problems associated with managing the transition.3

Both income tax and consumption tax structures can be designed to be either flat (a constant tax rate regardless of the level of income or consumption), or progressive (a tax rate that increases as income or consumption increases). Whether a flat tax rate or a progressive tax rate is preferable depends on both the effect of progressive taxes on work and investment incentives and on differing definitions of social welfare posited by the advocates of the two alternatives.

II. Definition of Income, Consumption, and Hybrid Taxes

A. Income and Consumption

The Haig-Simons definition of income is "the algebraic sum of (1) the market value of rights exercised in consumption and (2) the change in the value of the store of property rights between the beginning and end of the period in question."4 Consumption is the using up of goods and services5 and a consumption tax is imposed on the portion of income that is consumed either immediately (for example by eating food or going to a movie) or over time (for example by purchasing a consumer durable good that wears out over time such as a personal residence, washing machine, or automobile).6

B. Income Tax, Consumption Tax, and Hybrid Tax

An income tax is a tax imposed during the year as either a flat percentage of income or as a percentage that progressively increases as annual income increases, less whatever exemptions from taxable income (tax expenditures) are mandated by statute. A pure income tax taxes all income earned from any source.

A consumption tax is a tax on the market value of all goods and services consumed during the year imposed as either a flat percentage of consumption or as a percentage that progressively increases as annual consumption increases, less whatever tax expenditures are mandated by statute.7 It is imposed on consumption financed from income, funds removed from saving/investment (as either income or principal), as well as funds that are borrowed. A consumption tax does not tax income used to repay prior borrowings. It can be imposed on either the increase in the value of goods and services at each stage of production, a value added tax (VAT), as a tax on the value of the final sale of goods and services, a retail sales tax, or as a flat or progressive tax on each individual's annual aggregate consumption. VAT and retail sales tax are usually a flat tax ultimately paid by the consumer on all goods and services consumed.8

A hybrid income tax has some characteristics of an income tax and some of a consumption tax. …

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