Taxing consumption only: identifying the issues.

• Author: McDaniel, Paul R.

Editor's Note: The signs are unmistakable that substantial attention will be devoted in the coming months and years to whether the federal tax system in the United States should be fundamentally restructured. In the January-february 1994 issue of The Tax Executive, former Commissioner of Internal Revenue Shirley D. Peterson set forth the case for such a fundamental review in "Restructuring the Tax System." (Mrs. Peterson, who now serves on the National Commission on Economic Growth and Tax Reform -- the so-called Kemp Commission -- also presented her views at Tax Executives Institute's 1995 Annual Conference in Nashville.) In the following article, Professor Paul McDaniel identifies the major issues that need to be considered as the United States contemplates whether to move from an income tax system to a tax regime that taxes consumption only. In the coming months, The Tax Executive will publish articles on various alternatives to the current system, and invites TEI members and other readers to submit their views for publication.

For a number of years, the issue whether the United States should adopt some form of consumption tax has been analyzed by academics, including those serving in the Office of Tax Policy in the U.S. Treasury Department. Until recently, however, the issue was not one with which politicians were prepared to deal. That situation has now changed and various proposals have been put forth in Congress to replace the current income tax (sometimes the personal income tax only; sometimes the corporate income tax, too) with some variant of a consumption tax.

Let me state my position at the outset: I oppose replacing our income tax with a tax on consumption only. Nonetheless, I think it is healthy for our country that the supporters of the two positions engage each other in debate on the merits of each system of taxation. Ultimately, either a pure consumption tax or a pure income tax rests on value judgments that we make as a society. The present debate requires that we reexamine the values that caused us to choose an income tax in 1916 and continue to use it to the present. But for the debate to be fully engaged, it is equally necessary that the values underlying a tax on consumption only also be identified clearly so that the electorate can assess which set of values it subscribes to.

We should be clear what the debate is not about. It is not about taxing something -- consumption -- that we do not tax currently. We already tax consumption in our income tax system. This fact can be demonstrated by reference to the Haig-Simons definition of income: personal income equals a taxpayer's increase in net worth plus consumption, each measured between two points in time. The middle income taxpayer can see the point just by looking at his or her tax returns. The tax paid is based largely on the cost of personal consumption during the year and, if the individual has savings, on the income derived from that saving. Using simple algebra, the Haig-simons income definition can be converted to a consumption definition: consumption equals personal income minus any increase in net worth.

Thus, the income tax-consumption tax debate is not about whether to...