Taxing USA tomorrow.

• Author: Lokken, Lawrence
• Position: Unlimited Savings Allowance Tax

1. Introduction

Lawrence S. Seidman is an advocate of consumption taxation, in particular of progressive personal consumption taxes. In this book, he makes the case for such taxes, examining in particular the USA (Unlimited Savings Allowance) Tax, which was proposed by a bill introduced in the U.S. Senate in 1995 by Senator Pete Domenici (R-New Mexico), former Senator Sam Nunn (D-Georgia), and Senator Bob Kerrey (D-Nebraska) but which has not yet been seriously considered by either houses of Congress.(1) The USA Tax actually consists of two taxes - a personal tax on income, with an unlimited deduction for additions to savings, and a subtraction-method value-added tax. The former, which is the principal subject of the book, would be substituted for the present personal income tax and the latter for the corporate income tax. The book, although written by a professional economist, is easily accessible by a noneconomist, such as the writer of this review (a law-trained tax specialist). It is a stimulating starting point for a general evaluation of the USA Tax, as well as of Seidman's work, which this essay undertakes to provide.

Seidman notes that the idea of taxing consumption is an old one, having been advocated by Thomas Hobbes and later by John Stuart Mill and Alfred Marshall. However, he credits Irving Fisher with the insight that personal consumption can practicably be measured indirectly by summing up the funds available for consumption expenditure (including cash income, borrowings, and the proceeds of sales of investments) and subtracting all nonconsumption expenditures (including those for the purchase of investments). Although this practical insight was put forward in a 1937 article and developed in a 1942 book, concerted efforts to devise a personal consumption tax did not occur in the U.S. until the 1970s, with a U.S. Treasury study and several scholarly efforts (Andrews 1974; U.S. Treasury Department 1977; Graetz 1979). The USA Tax is the first personal consumption tax to be developed in the form of a bill introduced into the U.S. Congress.

2. Consumption Taxation and Savings

Seidman argues that substituting consumption taxes, such as the USA Taxes, for the present income taxes would increase savings rates and thereby promote growth in real incomes, although he does not attempt to quantify these effects.(2) He recounts rather startling statistics relating savings rates in the U.S. to those in other developed countries. For the decade of the 1980s, for example, the U.S. ranked 18th out of the 23 OECD countries in gross savings as a percentage of gross domestic product and last among the 5 largest OECD economies in net savings as a percentage of net national income, having a net savings rate (5.2%) less than one fourth of that of the leader (Japan, with 20.9%).

For a noneconomist, these statistics raise several questions not explored in the book. For example, given the increasing globalization of capital markets, does the savings rate in a particular country have the relevance to that country's prosperity that it had in the past, when economies were more closed? Seidman points to a correlation between low investment rates in the U.S. and low growth rates in productivity and hence in real wages, particularly for lower income employees. However, do the normal relationships between investment, productivity, and wages necessarily apply to the types of service jobs in which so many Americans with limited job skills are employed?

Moreover, what are the implications of savings statistics for tax policy? Among the five largest economies in the OECD, the country with the highest savings rate (Japan) and the savings laggard (the U.S.) have both relied primarily on income taxes, and in Japan, at least one type of tax on capital income, the corporate income tax, is imposed at higher rates than in the U.S. Among all OECD countries, Japan is the only country where consumption taxes are smaller as a percentage of gross domestic product than in the U.S.(3) In the other large OECD economies (France, Germany, and Italy), significant revenues are raised by value-added taxes, but these countries also have both personal and corporation income taxes.(4) Do the statistics show a correlation between the types of taxation employed by various countries and the countries' savings rates? If not, do statistics on savings rates advance the argument for consumption taxation?

Seidman examines several ways in which increased reliance on consumption taxes, such as the USA Tax, might raise U.S. savings rates, all of which are likely familiar to readers of economics journals. The arguments, however, have an air of unreality because they compare the economic effects of a pure income tax, which we have never had in the U.S., and a conceptually pure consumption tax, which Congress would almost certainly never enact. For example, Seidman does not mention that large amounts of retirement savings are already treated as under a consumption tax. Qualified employer-sponsored retirement plans (including [section]401(k) plans) essentially provide consumption tax treatment because contributions to the plans are generally deductible, the plan trusts are tax-exempt, and the accumulated funds are taxed only on distribution to employees and their beneficiaries, which is usually near in time to when the funds are spent on consumption.(5) The benefits that can be expected from switching other savings to a consumption basis thus may be more modest than would be the case in a change from a more pure income tax to a consumption tax.

Moreover, tax-qualified plans have aspects of forced savings that might disappear if savings held outside these plans are taxed on a consumption basis (Bernheim 1996, p. 112; Engen and Gale 1996, pp. 103-08). Nondiscrimination rules preclude qualified plans from favoring highly compensated employees, either in prescribing plan coverage or in defining plan benefits. Thus, in order to meet the demands of older, high-income employees for pension coverage, employers must also cover younger and less highly paid employees who may have little inclination to save for retirement. Further, savings in qualified plans often are effectively locked in until retirement by severe penalties that attach to most preretirement withdrawals. Since employer-provided retirement savings would enjoy no preference in a consumption tax world, they might atrophy, or employer plans might be amended to eliminate forced savings aspects. Lesser savings through employer plans could conceivably more than offset any positive effects on savings rates otherwise flowing from the switch from income to consumption taxation.

Seidman states that there can be no guarantee that substitution of a consumption tax would increase savings (p. 31). Close examination of his arguments suggests that this caution is fully warranted.

3. Fairness of Consumption Taxation

Seidman believes in progressive taxation. He notes the wide and growing disparity in income distribution. In 1990, the most affluent 20% of American families received 51.4% of all pretax income, while the least affluent 20% received 3.7%. Federal taxes are a modest counterweight; in 1990, the effective tax rate was 25.5% for the highest quintile and 7% for the lowest quintile, and the highest and lowest quintiles bore 58.2% and 1.4% of the aggregate federal tax burden, respectively. Even so, taxes reduced the income share of the highest quintile only from 51.4% to 49.2%. For the top 1%, who were taxed in 1990 at an effective federal rate of 26.3% and bore 14.9% of the federal tax burden, federal taxes reduced the income share from only 12.8% to 11.3%. Seidman believes that this counterweight should not be lessened, although he does not explain the basis for his belief.

He therefore opposes any consumption tax that would shift a significant tax burden away from the most affluent to the less affluent. He describes studies showing that replacement of the personal and corporate income taxes with a retail sales tax or value-added tax (VAT) would increase taxes for the least affluent 80% of American families, reducing after-tax income for the lowest two quintiles by more than 10%, while the tax burden of the top quintile would be slashed, raising after-tax income for the top 5% by more than 10%. The Flat Tax advocated by Robert E. Hall and Alvin Rabushka is a modified VAT, with an element of progressivity (Hall and Rabushka 1995). Under the Flat Tax, businesses are allowed to deduct wages and a personal tax is imposed on wages, with a large personal and family exemption that effectively removes the basic living wage from the tax base. However, a U.S. Treasury study shows that, if imposed at a rate sufficient to replace the income taxes without loss of tax revenues, the Flat Tax would also increase taxes for the lowest four quintiles (by more than 80% for the lowest quintile) and would cut taxes for the highest quintile (by more than 35% for the top 1%) (Office of Tax Analysis 1996).(6)

Under a progressive personal consumption tax, rates can be set so that each income group bears the same tax share as under the income taxes, although, within each group, the tax burden would be shifted from those who save more to those who consume more. The USA Tax is designed to do just that. The personal component of the tax would be imposed at graduated rates, initially 0, 19, 27, and 40%, with the highest rate applying to taxable consumption in excess of $24,000.(7) The earned income tax credit of present law, which is essentially a negative income tax for the poorest families, would be preserved. Moreover, the employee share of the old-age, survivors, and disability insurance (social security) tax would be allowed as a credit against the consumed income tax.

As between a progressive income tax and a progressive consumption tax, the issue can thus be reduced to whether it is fairer to tax income or to tax consumption...