Yesterday, the Tax Foundation's Tax Policy Blog had a report on a CRS study, "Flat Tax Proposals and Fundamental Tax Reform: An Overview." Tax Policy Blog then presented what purported to be the summary of the CRS study as set forth in the study. However, the excerpt was not complete and was edited to make it appear that the CRS study agreed with the Tax Foundation's basic tax policy recommendations. That is not the case as the study itself states:
Should the tax base be income or consumption? Is one inherently superior to the other? How do they stack up in terms of simplicity, fairness, and efficiency —the three standards by which tax systems are generally assessed? There appears to be insufficient theoretical or empirical evidence to conclude that a consumption-based tax is inherently superior to an income-based tax or vice versa.(Footnote omitted, emphasis added.)
One issue associated with the choice of a tax base is equity — how the tax burden will be distributed across income classes and different types of taxpayers. For example, a tax is "progressive" if tax paid as a percentage of income increases as income rises. Although some types of consumption taxes can be designed to achieve any desired level of progressivity with respect to consumption alone, their progressivity with respect to income could only be approximated. Also, a consumption tax would involve a redistribution of the tax burden by age group, with the young and old generally bearing more of the total tax burden than those in their prime earning years. And the transition from an income-based tax to a consumption-based tax would have the potential for creating windfall gains for some taxpayers and losses for others.
A definitive assessment cannot be made of the effects of taxing consumption on either economic efficiency or the aggregate level of savings. Although the current tax system's distortions of the relative attractiveness of present and future consumption (saving) would be eliminated, to raise the same amount of tax revenue, a consumption-based tax would require an increase in marginal tax rates (since consumption is smaller than income). This action, in turn, would increase the current system's distortion between the attractiveness of market (e.g., purchased products) and nonmarket activities (e.g. leisure). The net effect on overall economic efficiency cannot be ascertained theoretically. In addition, economic theory indicates a consumption tax would not necessarily produce an increase in saving. The increase in after tax income might reduce saving, while the increase in the return to saving may increase it; the net result is uncertain.
A positive aspect of a consumption-based tax is the ease with which the individual and corporate tax systems could be integrated. In addition, the problems introduced by separate provisions for capital gains, attempts to distinguish between real and nominal income, and depreciation procedures would essentially be eliminated. It is doubtful, however, that a consumption-based tax would have much effect on the complexities introduced into the system to promote specific social and economic goals. Many of the same factors that influenced the design of the current income tax system would exert the same influences on the final design of a consumption tax.
Whether one prefers income or consumption, one tax rate or multiple tax rates, a critical point to remember is that the benefits to be derived from tax revision would result from defining the tax base more comprehensively than it is under current law. A tax with a base that is comprehensively defined would prove more equitable and efficient than a tax with a less comprehensively defined base.
In other words, the study concludes that the Tax Foundation's hobbyhorse can't run.