MIT Press • 1997 • 160 pages • $20.00
Hot dogs, baseball, apple pie, and the USA Tax: What is the relationship among these pieces of Americana? The fourth-listed one imposes a tax on the other three. USA stands for Unlimited Savings Allowance. Taxes are to be imposed only on consumption, as set out in the 1995 USA Tax bill sponsored by Senators Domenici, Nunn, and Kerry. Professor Laurence Seidman of the University of Delaware has written a book to argue the case for this progressive consumption tax and to defend his relatively pure version of it against the version in the actual legislation. The 1995 bill involves a few needless complexities and inequities, but these legislative quirks do not unduly distract Seidman or his readers from the more fundamental issues.
Although the transition from an income tax to a consumption tax would involve radical change, the proposed tax system would be the same as the existing one in several important respects. The total tax burden would be the same, the distribution of that burden across the different income classes (or consumption classes) would be about the same, and the computation of the tax liability for each individual and for each firm would be complex—though maybe not as complex as it currently is. Most importantly, some of the distinctive features of the proposed system are in serious conflict with the basic principles of liberty. For one example, taxes themselves would be treated as consumption (public rather than private) and thus would be subject to further taxing. For another, all deposits and withdrawals of cash, the key determinants of consumption-tax liabilities, would be reported to the government by financial institutions.
The supposed appeal of the USA Tax lies in its favorable treatment of saving and investment and in its “fairness.” The favorable treatment of saving and investment is achieved simply by excluding these activities from the tax base; the “fairness” (so judged on the basis of survey results believed to reflect the majority opinion among Americans) is achieved by the progressivity of the marginal tax rates. In comparison with the USA Tax, our current income tax is found inferior because it taxes both consumed income and (with some exceptions) saved income. A national sales tax and the Hall-Rabushka Flat Tax are found inferior because they do not allow for enough progressivity.
The two main features of the USA Tax (pro-saving and progressivity) are presented separately in Seidman’s book. Weighing strongly against this tax scheme, however, is the conflict between these features—a conflict that Seidman does not notice (or, at least, does not mention). The steeply progressive tax schedule may well discourage saving and/or encourage borrowing. A simple example can make use of the tax schedule to be applicable for the year 2000 and beyond, together with an assumed interest rate of 10 percent. The marginal tax rates for the four consumption brackets are 0 percent, 8 percent, 19 percent, and 40 percent, the top rate applying to consumption levels of $24,000 and higher. Suppose our taxpayer is in a position to consume $24,000 worth annually. He could, instead, spend only $23,000 this year so as to be able to spend $25,000 (plus some interest) next year. This year’s $1,000 reduction in consumption allows our taxpayer to take advantage of the tax-free status of savings. He would pay $190 less in taxes this year (19 percent of $1,000). Next year, after collecting $100 in interest, he can spend $25,100. But the taxes he owes on that last $1,100 worth of consumption is $440 (40 percent of $1,100). For the two-year period, his initial saving has allowed consumption to go up by $100, but his corresponding tax liability goes up by $250! In this example (and in others where consumption levels are close to the bracket breaks) the anti-saving effect of the “fairness” feature swamps the direct effect of the pro-saving feature. This net anti-saving bias is even stronger when incomes (and levels of consumption) are increasing over time—as they generally are. A temporal smoothing of consumption to avoid high marginal rates requires borrowing—dis-saving—in the lean years.
If considerations of fairness keep people from saving this year in order to consume next, maybe the more farsighted among us can take advantage of tax-exempt saving by waiting until retirement to consume. But this is the one component of saving that is exempt even under the existing system. Further, retirement years are low-income years, not necessarily low-consumption years. Many people in their 60s and 70s travel extensively as they never could before. They consume. Many in their 80s and 90s pay dearly for their daily keep in a retirement center. Should these people pay even more dearly on April 15? Our hapless taxpayer may once again be foiled by fairness.
In comparing income and consumption as alternative tax bases, there seems to be no clinching argument that allows for an unambiguous preference. Each is deficient when judged by the standard set by the other. If we take consumption as the appropriate base, we see that an income tax is applied to some of it twice. If we take income as the appropriate base, we see that a consumption tax lets some of it go untaxed. Ultimately, Seidman’s case for the pro-saving feature of the USA Tax is itself based on considerations of fairness: “[I]t seems fairer to tax a person according to what that person subtracts from, rather than adds to, the economic pie.” It is true—and seems eminently fair—that when we “subtract from the economic pie,” we pay, and when we “add to the economic pie,” we get paid. But this truth, which reflects the ordinary working of the market system, leaves unanswered—and unasked—the question about how much each of us should pay for government and about how much government we should have. The holistic notion of the “economic pie” provides little or no scope for claims about fairness. The size of the pie is a consequence of the various preferences of market participants—for enjoying leisure rather than supplying labor and for consuming now rather than consuming later. What seems fair is that each of us should make his or her own choices in this regard. The notion of fairness, however, provides no clear link between changes in the size of the pie and obligations to pay for government.
Opponents of the current tax system who base their criticism on the tenets of classical liberalism will be equally critical, if not more so, of the USA Tax. For the classical liberal, meaningful reform is better aimed at reducing taxes and, more generally, in reducing government.