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Government officials examine consumption tax proposals.

Leslie B. Samuels, assistant secretary for tax policy in the U.S. Treasury Department, told CPAs attending the American Institute of CPAs spring tax division meeting that he believed the United States would retain a progressive income tax, "but it would need to do a much better job in its design."

The Treasury official was responding to the growing number of proposals by lawmakers and presidential hopefuls who are leading a revolt against the income tax. House majority leader Richard Armey (R-Tex.) and Senator Arlen Specter (R-Pa.) have introduced flat-tax bills that call for a flat rate of 20%. Senators Sam Nunn (D-Ga.) and Pete Domenici (R-N.M.) have proposed a "USA tax" that would tax what people consume but would allow businesses and individuals to deduct income saved or invested.

"All of the proposals under discussion are consumption taxes," said Samuels. "When considering radical changes to the tax system we must carefully evaluate each proposal's ability to achieve the fundamental objectives of the tax system--fairness, efficiency and simplicity. I want to emphasize that a consumption tax does not inherently simplify the tax system."

Samuels agreed that the complexity of the tax laws had increased dramatically over the last 20 years and that this complexity had fueled taxpayer discontent. "We strongly support simplification of the tax system," he said. A consumption tax in its purest form would be simple, but "the ideal is not what will be enacted. Consumption tax proposals that come out of a conference committee would be as complex as our existing system and in some cases even more so," added Samuels.

Do consumption taxes help savings?

Samuels said he doubted consumption taxes would improve savings rates and capital formation. He said past declines in savings did not appear to have been caused by changes in tax policy. "Marginal rates in the 1980s were substantially reduced, but the rate of private savings still fell," said Samuels. He also noted the savings rates of U.S. trading partners had declined since the 1960s, "yet all of these countries, except Japan, more heavily rely on consumption taxes for revenues. Japan depends the least on consumption taxes," said Samuels, "and it had the highest savings rate in the 1980s."

Samuels also warned that a consumption tax would be less equitable than the current income tax system. "The change from the current progressive income tax system to a broad-based consumption tax would shift the tax burden from high-income families to middle- and low-income families," said Samuels. The Armey flat tax, he continued, would require a tax rate of 22.9% to collect the same amount generated under the current tax system. "At that rate, families earning up to $100,000 would pay up to 17% more in federal taxes than under the current system, while families earning more than $200,000 would see their federal tax liability reduced," said Samuels.

How likely is change?

Kenneth J. Kies, chief of staff of the Joint Committee on Taxation, told the meeting that the prospects for a fundamental change in the way the federal government raises revenues were far greater today than they had been since the origin of the income tax. But he said there was little chance there would be action on this issue before the 1996 presidential election.

Kies said there was a new attitude in Congress--a desire to revisit every aspect of the federal government--and key members of Congress were backing consumption tax proposals. He said this level of enthusiasm was partly due to a feeling outside Washington that the current tax system was too complex. "There is strong interest in moving sooner rather than later on this issue," said Kies.

But Kies said there were important positive factors of the current system that would complicate the debate. "The current system raises $1.2 trillion to $1.3 trillion annually on a largely voluntary basis, and it is a fair, progressive tax system." Kies also pointed out that a move to a consumption-type tax system would create a significant generational inequity for older taxpayers.

The Tax Foundation has calculated a specially selected Tennessee family's tax burden to illustrate the different tax rules and effects for individuals under the alternative plans discussed in this article. (The "Jones" family's name was changed to ensure privacy).

Tax Consequences of Current Law for the Jones Family
Wage-salary $47,066
Interest 67
Capital gains (1,960)
Dividends 303
Gross income $45,476
Standard deduction $6,350
Exemptions 7,350
Taxable income: $31,776
Tax (15% bracket) 4,766
Childcare credit 480
Tax liability $4,286

Source: The Tax Foundation

Tax Consequences of Armey Flat Tax for the Jones Family
Wage-salary $47,066
Personal allowances 26,200
Dependent exemption 5,300
Taxable income: $15,566
Tax liability $3,113
(20% rate)

Source: The Tax Foundation

Tax Consequences of USA Tax System for the Jones Family
Wage-salary $47,066
Interest 67
Capital gains (*)
Dividends 303
Gross income $47,436
Family allowance $7,400
Exemptions 7,650
Previously taxed savings(*) 653
Mortgage interest 4,250
Charity 240
Savings allowance 3,600
Taxable income: $23,643
Tax (19% on first $5,400;
27% on the difference) $5,952
Refundable credit
for payroll tax(**) $3,630
Tax liability $2,322

(*)Under the USA tax transition rules, most taxpayers will be able to amortize over a three-year period previously taxed basis-of-savings assets acquired before the USA tax. The $653 (one-third of $1,960) amortization deduction assumes that the Jones family had previously taxed savings basis of $1,960--the value of their capital losses for 1994. Since the Jones family has a history of saving, its deduction for previously taxed savings is probably understated in this example.

(**)Both the Social Security and the Medicare portion of the payroll tax are included in the tax credit for wages up to the Social Security wage cap. No credit is available on the payroll taxes levied on wages above this cap.

Source: The Tax Foundation

Tax Consequences of a National Sales Tax for the Jones Family
Wage-salary $47,066
Interest 67
Capital gains (1,960)
Dividends 303
Gross income $45,476
Payroll taxes $3,630
Property taxes 698
Mortgage interest 4,250
Charity 240
Savings 3,600
Other government fees 150
Estimated nontaxable
expenditures $12,568
Estimated taxable
expenditures(*) $32,908
Tax liability $5,594
(17% rate of taxable

(*)Assumes the broadest possible tax base. No goods and services are excluded.

Source: The Tax Foundation
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Publication:Journal of Accountancy
Date:Aug 1, 1995
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