A Taxing Blog

Saturday, September 27, 2003
More on complexity of consumption tax  
Bill Mendus, a CPA, emails:

I vote with David Walser.

Unless uniform rules are imposed nationwide, a consumption tax would be vastly more complicated than the current income tax.

What are the odds that we could get uniform rules nationwide? Look at what is happening in the sales tax arena right now. Sales and use taxes are a total crazy quilt. The same transaction can be taxed differently within the distance of a few blocks. The states, counties, cities, school districts, and all the other various special taxing entities have a powerful incentive right now to regularize and simplify their rules because such action is a pre-requisite to taxing internet transactions. But there is very little progress on that front. The odds that we can get nationwide uniform rules for consumption taxes are just about zero.

Further, as the last remaining New Deal Democrat in the nation, I am troubled by the increasing reliance of state and local governmental units over the last number of years on sales taxes, which are regressive. I believe that any national consumption tax would also be regressive and I am simply not impressed by arguments to the contrary.

And I am also troubled by the increasing exemptions from income tax for savings and returns on savings. I assert that the only fair form of income taxation is one that taxes all forms of income the same. This means, for example, that income from capital gains should be taxed the same as income from labor. Right now, the sweat of one's brow is taxed much more heavily than returns on savings, unless the coupon clipping class breaks into a sweat clipping the coupons.

Valid points. On the last --- that income from the return to capital should be taxed the same as income from labor --- McCaffery makes a pretty good argument that a cash flow consumption tax probably does at least as good a job of this as our realization based income tax, and we might be better off devoting out political efforts towards a more progressive consumption tax rather than trying to fix our current quasi-income tax.

The Real Lucky Duckies not as lucky in '01  
David Cay Johnston of the NYT reports that Top 1% in '01 Lost Income, but Also Paid Lower Taxes.

Friday, September 26, 2003
Tax expenditures as a constraint on government  
One alleged advantage of the APT tax is that, as a uniform tax, it would eliminate tax expenditures; government would subsidize programs directly. So, for example, rather than giving homeowners a mortgage interest deduction, we just redistribute wealth from renters to owners if that's what Congress desires.

One objection is that this is simply unrealistic -- any tax written by Congress will, of course, be full of loopholes, favoritism, blah, blah, blah.

On a more substantive note, however, tax expenditures have the hidden advantage of allowing the private sector to determine where and how investments are made. The tax break may improve the after tax return of the investment vis-a-vis other, non tax subsidized investments. But the private sector still decides where the investments get made.

This has come up in my own research in looking at giving small businesses a capital gains tax break versus a direct grant from the federal government. The tax break method still requires that the founders of the company go to the private markets to seek funding, thus ensuring a screening mechanism that may be beneficial (and obviously less subject to political capture). Whether this is good or not probably depends on whether you want a venture capitalist or a city council member deciding what kind of technology is better.

APT tax  
Reader Scott Straupe pointed me to an interesting paper by Econprof Edgar Feige proposing an Automated Payment Transaction (APT) tax. Here's a summary of the paper:
"This paper examines the desirability and feasibility of replacing the present system of personal and corporate income, sales, excise, capital gains, import and export duties, gift and estate taxes with a single comprehensive revenue neutral Automated Payment Transaction (APT) tax. In its simplest form, the APT tax consists of a flat tax levied on all transactions. The tax is automatically assessed and collected when transactions are settled through the electronic technology of the banking/payments system. The APT tax introduces progressivity through the tax base since the volume of final payments includes exchanges of titles to property and is therefore more highly skewed than the conventional income or consumption tax base. The wealthy carry out a disproportionate share of total transactions and therefore bear a disproportionate burden of the tax despite its flat rate structure. The automated recording of all APT tax payments by firms and individuals creates a degree of transparency and perceived fairness that induces greater tax compliance. Also, the tax has lower administrative and compliance cost. Like all taxes, the APT tax creates new distortions whose costs must be weighted against the benefits obtained by replacing the current tax system."

The idea is interesting (and new to me) --- our current income tax in some ways resembles a tax on transactions (think about the realization requirement). And as our economy (and payment systems) become more and more digital, some type of tax like this might make sense. Obviously, noncompliance is an issue, but as more and more of the economy is based on credit cards, debit cards, Paypal, etc., all of which can be relatively easily policed, the cost of evading an APT tax would rise.

On the other hand, the design of the tax would be awfully tricky. People would obviously plan around the tax as much as possible, and it's hard to know how much distortive behavior this would cause, and how to measure the distortion or deadweight loss against the current income tax.

In any event, it's surely worth further study and consideration.

Thursday, September 25, 2003
Simplification advantage of consumption tax?  
David Walser emails a skeptical view of the simplification advantage of consumption taxes:

I keep hearing this argument, but it just does not jive with my real world experience. I've defended clients in income tax, sales tax, and VAT audits. By far, the sales tax and VAT have been the most difficult. In theory, a consumption tax need not be any more complicated than an income tax, but that's not what I've seen in practice. Here in Arizona, the state, county, city, and other government entities (such as the airport authority) may each tax the exact same transaction differently. For example, suppose I've client who owns a hanger and rents use of the hanger (along with access to mechanics, etc.) to airplane owners. For liability purposes, the hanger is held inside one LLC which rents it for $1x to the other LLC (which makes it available to the public, hires the mechanics, etc.) The state and county do not tax the $1x rental payment since it is a rental for release to the public. The city does tax the $1x rental. The airport authority has determined the $1x rental is not at fair market value, so it taxes the rental at its "true value" -- say $5x. How they came up with the number, I've no idea. That's just the sales tax issues associated with the building. The state, county, city, and airport authority take conflicting positions on the equipment used inside the building. Unless a national consumption tax would require each state and local taxing authority to use the federal rules for defining the tax base, I think you'd have an unworkable mess.

I think the reason the myth of the ease of administering the consumption tax is because the burden of compliance is borne almost entirely by business. People don't understand how many sales tax returns a business might be required to file -- the returns may be filed monthly, weekly, or even daily, depending on volume. Some states require each location to file its own return. Yes, most of the returns are now automated, making it easy to file the returns. But most of the returns are wrong. My brother-in-law makes a good living as a sales tax consultant. He files amended returns for businesses and is paid a percentage of the refund he generates.

Walser is right that we cannot take simplification as a given; rather, it will depend on the details.

The specifics are way beyond my expertise; my hunch is that a sales-type consumption tax would be considerably simpler for individuals and about the same (certainly no worse) for businesses. The complexity that Walser notes is already present in the current system -- replacing the income tax at the federal level with a VAT doesn't necessarily simplify things, but neither does it necessarily complicate them. For his hypothetical, even under current law we have to figure out whose income it is and how much.

In any event, I take Walser's point that consumption taxes are NOT self-evidently simple, but beyond that I'll defer to the experts.

One final note --- perhaps the simplest transition to a "consumption" tax would not involve a sales or VAT tax at all.
Rather, we would keep the current income tax and give everyone an unlimited deduction for savings. (We are moving in this direction in any event.) Becuase the current income tax would be retained, simplification gains would be small, but we could do away with various deductions like college savings plans, retirement plans, etc. and put it all under one savings umbrella.

(It's still a "consumption" tax because, by definition, Income - Savings = Consumption.)

Wednesday, September 24, 2003
Replacing the Income Tax With a Progressive Consumption Tax  
Dan Shaviro has also posted Replacing the Income Tax With a Progressive Consumption Tax --- I haven't had a chance to read it, but after reading Ed McCaffery's paper, "The Fair Timing of Tax," I suspect that I'll agree with most or all of what Shaviro has to say. Here's the abstract:

Shifting from an income tax to a consumption tax would offer major simplification advantages. Even if Congress created as many preferences and other special rules to what it has under the existing income tax, the massive set of complications that relate to realization and to the taxation of financial transactions would largely be eliminated. The main (though not the only possible) reason for opposing such a shift is the concern that it would require reducing progressivity. However, the capacity of a consumption tax to achieve progressivity comparable to that of an income tax is widely misunderstood, for two main reasons.

First, a consumption tax purportedly exempts "capital income," seemingly raising the specter of its exempting the likes of Bill Gates and Warrant Buffett. As recent tax policy literature has shown, however, the only difference in theory between an income tax and a consumption tax pertains to the risk-free return to waiting, which historically has averaged less than one percent per year. The point made by this literature is by now familiar and well-accepted in some circles, but in others it remains unfamiliar or has been unduly dismissed. This article aims to win it wider acceptance.

Second, many believe that wealthy people escape the burden of a consumption tax by deferring their consumption, and that advocates of such a tax ignore the effects of unconsumed wealth on one's security, political power, and social standing. The argument overlooks the fact that what makes wealth valuable is the real purchasing power that it commands. Otherwise, real money would be no different than Monopoly money. A consumption tax affects the purchasing power even of unspent wealth, and the burden it imposes generally is not reduced by deferring one's consumption.

The article also discusses the choice between use of the origin basis and the destination basis in taxing cross-border transactions. A consumption tax can use either method, but an income tax is practically compelled to use the origin basis. Use of the destination basis would eliminate transfer pricing issues, although in their place it would create various problems that an origin basis tax avoids, such as the need for border adjustments (e.g., tax rebates for exports).

Thoughtful consideration of the choice between the origin and destination basis upon shifting to a consumption tax requires dismissing a popular canard, which is that the destination basis, because it exempts exports, offers an "export subsidy" that would favor countries using it in international trade competition. Economists universally agree that well-functioning origin and destination basis systems have equivalent incentive effects on international trade once in place. This suggests that a destination basis consumption tax should neither be favored politically as a tool of trade war, nor subject to successful legal challenge under the GATT.

I should note that Shaviro, unlike McCaffery, does not seem to take a position on whether a prepaid or postpaid (cash flow) consumption tax is desirable.

Shaviro on the Bush Tax Cuts  
Taxprof Dan Shaviro posts The Bush Administration's Huge Tax Cuts: Steps Towards Bigger Government? on SSRN. Here's the abstract:

The 2001 through 2003 tax cuts, to the extent that they involved a principled, long-term policy view, seem to have been aimed at shrinking the size of government. The idea apparently was to force eventual spending discipline, even (or perhaps especially) with respect to Social Security and Medicare, by turning reduced tax revenues into a political fact on the ground that would be difficult to reverse. In fact, however, the idea that the tax cuts would make the government smaller seems to have rested on spending illusion, or confusion between the actual size of government, in terms of its allocative and distributional effects, and the observed dollar flows that are denominated "taxes" and "spending."

Given the long-term budget constraint, which holds that government inflows and outlays must ultimately be equal in present value, and the huge preexisting fiscal imbalance, the tax cuts are likely to be paid for, in the main, through some combination of future tax increases and cuts to Social Security and Medicare. (Other government spending cuts, relative to the case where the tax cuts were not enacted, are likely as well, but cannot contribute nearly enough.) To the extent that the 2001 through 2003 tax cuts lead to future tax increases, the combined effect is likely to make the government bigger both allocatively and distributionally. To the extent that Social Security and Medicare spending bear the brunt, the government still gets larger in the sense of increasing redistribution from younger to older generations, although Medicare cuts might decrease the size of government allocatively.

It's counterintuitive, but surely Shaviro is right that the tax cuts increase the intergenerational redistribution effect of government.

Tuesday, September 23, 2003
Business Associations  
When I was at Columbia, my second year course was called "Corporations." At many schools, coverage is expanded to include the basics of partnerships and LLCs, and the course is called "Business Organizations," or Biz Orgs for short. Here at UCLA it's called "Business Associations." This is a bad idea. Why?

It's called "Biz Ass." As in, "No, Professor Fleischer, we didn't learn that in Biz Ass."

Wow -- 9th Circuit Panel Reversed Quickly  
OK, there's not much of a direct tax nexus to this blog post, but I was surprised to see the 9th Circuit en banc court reverse the panel in a per curiam opinion less than 24 hours after argument, suggesting that they may have drafted and circulated the opinion prior to argument. I agree with the en banc decision, but it sure is a slap in the panel's face, and I doubt it would have happened if Reinhardt weren't recused.

(Per Curiam opinions are most commonly used when the case is an easy one with a clear answer, although sometimes also used when it is considered important that the Court speak with one voice to the public.)

Monday, September 22, 2003
Coase Theorem  
Blogger extraordinaire Larry Solum has a useful post explaining the Coase Theorem --- especially useful for students and practitioners who haven't been bombarded by the law and economics literature. At Columbia, students learn the Coase Theorem several times -- in first year torts and two other first year courses, "Perspectives on Legal Thought" and "Foundations of the Regulatory State." Most students also get it a couple more times in upper year courses. I assumed that most law schools shared this emphasis on law and economics literature, but I'm discovering that -- for better or worse -- most law schools do not teach much law & econ, at least in the foundation curriculum.

My friend and current tax court clerk Adam Chodorow has a paper analyzing the tax jurisprudence of Judge Posner (one of the leading law & econ scholars). I'll post a link when the paper goes up on SSRN.

Company Stock in the 401k  
Taxprof Maureen Cavanuagh posts Tax as Gatekeeper: Why Company Stock is Not Worth the Money.

What caused Proposition 13?  
Econprof William Fischel posts Did John Serrano Vote for Proposition 13? A Reply to Stark and Zasloff's 'Tiebout and Tax Revolts: Did Serrano Really Cause Proposition 13?'. Of interest not only to California tax wonks, but also those interested in the political economy of state taxes and tax revolts.

Speaking of wacky California, I just watched the last 25 minutes or so of the 9th Circuit en banc oral argument in the recall case. At the very end, the ACLU atty inadvertently (or Freudian slippingly) referred to the 9th Circuit as "This circus" instead of "This circuit" --- a truly funny moment.

Personally I'm against the recall but I also think the panel decision is a terrible precedent. I was predicting something like a 7-4 reversal of the panel (i.e. "Game On" for the recall), and I'll stick with that prediction, but after watching the oral argument I'm less confident in the prediction.

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