nondepreciable investments, such as those in inventories, land, and working capital. It thereby penalizes firms and industries that make relatively heavy use of highly taxed assets. Furthermore, Kemp-Kasten continues to allow full deductibility of interest on funds used to finance investments that can be expensed. Such inconsistent treatment of borrowing and investing not only would greatly enlarge the benefits to depreciable capital, but also would allow many individual taxpayers to completely shelter income from taxation.
No annual income tax can avoid the tension between taxing income comprehensively and providing saving and investment opportunities that are unencumbered by the income tax. Reduction of the extra burdens placed on saving and investment inevitably leads to opportunities for tax avoidance by asset shifting or borrowing. All three plans illustrate the dilemma and the tradeoffs.
The income tax is currently in such sad shape that major improvements can be made simply by removing its existing abnormalities and excesses. By pruning deductions, credits, exclusions, and allowances that have narrowed the tax base, it is possible to simplify the returns of millions of taxpayers, lower marginal rates, and curb incentives that reduce economic efficiency. The Treasury proposal for accomplishing such base- broadening while also measuring real economic income would represent a milestone in tax reform. Although it is more modest in scope, the Bradley-Gephardt proposal also qualifies as a major step forward. The Kemp-Kasten proposal requires more extensive surgery regarding the treatment of capital income. Elements of each plan could be selected for a compromise proposal. Any such plan, however, that remained within the framework of an annual tax on realized income would be unable to correct important flaws in our current tax system. But these problems can be solved if we take an approach to taxation along the lines described in the next chapter.