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The consumption tax - to be or not to be.

The Consumption Tax - To Be or Not to Be

With the unification of East and West Germany, 1992 establishment of the European Economic Community (EC) and emergence of the Pacific Rim countries, America as a nation must quickly position itself to secure trade opportunities, financial security and competitiveness within changing world markets. Saddled with a looming budget deficit, recessionary pressures, floundering financial institutions and growing domestic demands, such positioning appears easier to discuss than to actually accomplish.

No longer are the traditional "quick fix" measures of reduced congressional spending and income tax rate increases viable or effective solutions. Confronted with the nation's desire for tax fairness and the contradicting need for additional revenues, congressional leaders have been forced to tinker and adjust practically every revenue raising alternative, no matter how small.

Late last year, Congress passed the Omnibus Budget Reconciliation Act of 1990 (OBRA), the eighth tax reform bill since 1980. In an effort to alleviate and rectify our nation's deteriorating financial health, congressional leaders did everything short of significantly raising the income tax rate. In enacting the 1990 budget, legislators increased the nine cent per gallon gasoline tax to 14 cents per gallon, imposed a 10% tax on the retail price of certain luxury goods, raised the per pack tax on cigarettes to 20 cents in '91 and 24 cents in '93, doubled the tax on beer to 32 cents per six pack, raised the rate on distilled spirits by $1 per proof gallon and the rate on table wine by 18 cents per bottle. They permanently extended an expiring 3% excise tax on telephones, adjusted personal exemptions, eliminated the tax "bubble" and increased the top rate to 31%, increased the alternative minimum tax for individuals and even raised the tax on airline tickets. Despite these extensive efforts, the deficit has again exceeded budgeted considerations and appears to require additional offsetting.

Today, accountants, business owners and taxpayers alike wonder where the 102nd Congress will turn for additional federal funding. Throughout the coming months, congressional leaders will seek to finance the nation's domestic programs and activities, negotiate tax treaties and trade agreements (with old and new world markets), finance necessary military initiatives and contain if not reduce a growing deficit. Where will the revenue come from?

Whispers within the corridors of the Capitol indicate that many congressional representatives candidly believe a value-added-tax (VAT) or consumption tax is an inevitable solution. VAT is a tax imposed on the value added at each stage in the production and distribution of goods and services. While few congressional leaders are presently willing to stand before their counterparts and argue the merits of a VAT, many have said that it is just a matter of time before the state of the nation dictates a responsive course of action.

Simple in concept, a consumption tax is a method of obtaining revenue without taxing savings twice. The income tax taxes savings twice, once when it is included in an income tax base and once as the yield on accumulated savings. Under this theory, a person should be taxed on what he or she uses (consumes) rather than what he or she does not use (saves). Proponents contend that a consumption tax would increase savings, leading to the greater availability of funds for financial investment, faster growing capital stock and ultimately economic growth.

Opponents, on the other hand, argue that as the consumption tax taxes consumption, lower income earners will be taxed higher, as typically lower income earners spend proportionally larger percentages of their incomes on goods and services. Therefore, critics conclude, the tax is regressive and unfair.

A consumption tax of some form appears to be the most alluring prospect for many congressional leaders. Consumption tax options include: the retail sales tax, the European style invoice and credit value-added tax and the deduction method value-added-tax, a business transfer tax promoted by Senator William Roth (R-DE).

While these methods differ in collection technique and technical application, they offer large amounts of revenue which would ultimately come from the consumer. Estimates provided by Joseph Cordes, congressional budget office assistant director for tax analysis, indicate that a modest national VAT would raise approximately $150 billion annually.(1)

Several alternatives for VAT implementation exist. For example, the value added tax (VAT) could be an indirect supplement to the already existing personal income and corporate tax structure, which would tax the value added onto an item during each individual stage of production. Proponents believe that the improvement in savings and welfare from enacting a consumption tax as an add-on or partial replacement of the current system would be fairly modest and would tend to get smaller as the needs ease.

Other consumption tax policy alternatives which U.S. legislators continue to quietly discuss and consider include a consumption income tax in lieu of a replacement for the present income tax system, a type of sales or excise tax to supplement the present income tax system and a national tax such as a sales or value-added tax to replace the present income tax system.

Regardless of the breadth or scope of the applied tax system, to be truly effective the system must meet a number of fundamental objectives. It should provide sufficient revenues to finance government programs, be appropriate for the economic structure of the nation, reflect the basic values of the society and maintain the respect of the taxpaying public. Most importantly, the corporate and personal tax systems must also be internationally competitive and the total tax system must neither impede export performance not accord any favor or penalty on imports.(2) In light of the scheduled introduction in 1992 of the European community, the ongoing unification of East and West Germany, increased competition with Japan, recognized growth in the Pacific Rim and the recent free trade agreement with Canada, legislators must locate additional revenues without hindering or limiting U.S. entry into and competitiveness within complex foreign markets.

Risks surround every tax system alternative, the current structure included. Accountants, business owners and taxpayers must remain informed on tax policy issues to ensure the development of a sound and effective system which promotes U.S. competitiveness and market entry while minimizing local business and taxpayer burdens.

In his recent article addressing this topic, Representative Rostenkowski wrote, "I don't doubt that a good stiff VAT would take care of our deficit. I am not a schooled economist able to predict the side effects that would emerge. But, I am enough of a politician to predict that, at best, a true VAT proposal would emerge from Congress looking like a lace doily. If you think today's relatively progressive tax system is full of holes and inequities, imagine the alterations awaiting a national sales tax."(3)

Each of the 12 countries uniting to form the 1992 European Community currently imposes some type of a VAT, ranging anywhere from 6 to 33%. The question to U.S. congressional leaders and business individuals is whether the European Commission will effectively harmonize tax rates and switch from a destination tax to an origin-based tax. And how will the implemented tax structure affect entry and pricing competition for U.S. business? The VAT is a substantial revenue source, and European member states worry that an origin tax would prompt people to make purchases elsewhere. France, Italy, the Netherlands, Sweden, the United Kingdom and the Federal Republic of Germany have in place VATs combined with other elements of a tax system. Even Japan recently imposed a 3% consumption tax on the sale of goods, services and imports to finance lower income tax rates. In fact, the United States is the only major country (save for the USSR) that has yet to impose some form of VAT.

Three vocal advocates of the VAT are Representatives E. Clay Shaw, Jr. (R-15-FL), Richard T. Schulze (R-5-PA) and Bill Gradison (R-2-OH), members of the House Ways and Means Committee. Shaw upholds that it is time for the House Ways and Means Committee to seriously consider a national value-added-tax, asserting that such a national VAT is crucial to U.S. competition.(4) Congressman Schulze believes that a "well-designed tax on consumption would increase the national savings rate, reduce the budget deficit and improve our standing in the global economy." Representative Gradison supports a supplemental VAT, that is, a VAT that adds on to the current system enabling a diversified tax structure and a diversified tax base.(5)

While supporting the need for a value added tax, many VAT proponents have expressed concern for potential incidences of abuse that such a tax may allow. Problems experienced by other VAT enforcing countries and current problems in enforcing already standing simple excise taxes indicate that cases for complexity and abuse effectively burden both tax systems. Like many of his colleagues, Ways and Means Committee member Robert Matsui (D-3-CA) cautiously supports a supplemental consumption tax of sorts, yet believes that public education and support is necessary prior to implementation.(6)

One of the most forceful, active and influential opponents of the VAT argument is House Ways and Means Committee Chairman Dan Rostenkowski (D-8-IL). In a recently authored statement, the esteemed committee chairman emphatically stated his opposition to a broad-based federal consumption tax, arguing that "there are better ways, if not faster ways, to form capital, raise revenues and promote competitiveness." While he acknowledges that the nation will need a tax increase to reduce the deficit, Chairman Rostenkowski firmly believes that such a revenue increase should come from higher progressive rates on income, not by a low, regressive tax on need. He maintains that "any consumption tax is the tax of last resort".(7)

In spite of the debate and continued deliberations, many congressional leaders have already taken steps toward introduction of a value-added-tax. The 1990 Omnibus Budget Reconciliation Act effectively imposes a tax on certain luxury goods, a form of single stage VAT. More recently, Representative John D. Dingell, (D-MI), chairman of the House Energy and Oversight Committee, has introduced H.R. 16 which would impose a 5% VAT on goods and services at all levels of production and distribution to fund a national health insurance program. Under the proposal, food, clothing and medical care would be exempted from a VAT tax.

On the Senate side, Senator Max Baucus (D-MT), a member of the Senate Finance and Small Business committees, has indicated that to benefit international competitiveness and ease current deficit concerns, "a VAT may be a preferable alternative which deserves further study".(8)

Economists and theorists generally support the need for some type of value-added tax. Opponents, on the other hand, argue that a VAT, with its potential for consistently raising large amounts of revenue, would have little likelihood of "easing" or of repeal once it is in place. Further, opponents consider it a regressive tax which could stifle the poor, hinder small business, reduce consumer spending, preempt state and local tax bases and spiral the economy into an inflationary situation.

For accountants, businesses (large and small) and taxpayers, the question remains the same. Where will this Congress turn for additional revenue? Beware. Though congressional leaders are not referring to them as "consumption" or "value-added" taxes, the nation's incentive plans (IRAs, Keoghs, 401 (k) plans) and new luxury tax have introduced elements of a consumption-based tax.

A national consumption tax would impact accountants, businesses and taxpayers alike. Accountants ultimately become responsible for the smooth implementation of a system - ultimately ensuring client education and compliance while simultaneously accepting many of the administrative and compliance burdens of businesses. Businesses (large and small) would encounter compliance costs and extensive recordkeeping burdens. This may be proportionately greater for small businesses, as many large business entities already have the necessary employees, facilities and equipment, ensuring an easy and fairly inexpensive compliance transition. Taxpayers, the ultimate target, will have to pay a significantly higher price on goods and services. While the alternatives are not easy - the problems are alarmingly-real. In order to be a part of the tax policy system, accountants, businesses and taxpayers must be aware and stay informed on this issue. While a national consumption or value-added tax seems unlikely for the moment, smaller supplemental consumption-based alternatives, often patterned after a VAT or a sales tax, appear to be likely.


(1) BNA Daily Tax Report, The Bureau of National Affairs, Inc., 11-14-90, G-4.

(2) "The Consumption Tax: A Better Alternative?", The American Council for Capital Formation Center for Policy Research, 1987. pg 44.

(3) Op Cit. pg 27.

(4) Tax Notes, Tax Analysts, December 17, 1990, pg 1283.

(5) "The Consumption Tax: A Better Alternative?", The American Council for Capital Formation Center for Policy Research; 1987. pgs 241, 264.

(6) Op. Cit. pg 336.

(7) Op Cit. pg 27.

(8) Op Cit. pg 223.
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Author:Barr, Dorothea
Publication:The National Public Accountant
Article Type:column
Date:Mar 1, 1991
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