Simplifying Federal Taxes: The Advantages of Consumption‐​Based Taxation

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This year’s $1.35 trillion tax cut reduced incometax rates and modestly liberalized the tax rules forretirement saving plans. However, the new tax lawdid not slow the progression of the tax code towardincreasing levels of complexity. In fact, the law made441 changes to the tax code and created a complicatedseries of phase‐​in periods for tax changes.Meanwhile, the congressional Joint Committee onTaxation released a 1,300-page study cataloging theexcessive complexity of federal taxes but providingonly limited proposals for reform.

Minor simplification reforms will not beenough. The tax system is caught in a spiral ofcontinual change and nonstop growth in rules.Since the mid‐​1980s there have been 7,000 federaltax code changes and a 74 percent increase inthe number of pages of tax rules. Complyingwith federal tax requirements wastes 6 billionhours each year as families and businesses fillout tax forms, keep records, and learn tax rules.

The key factor that causes rising income taxcomplexity is that the tax base is inherently difficultto measure. The Haig‐​Simons measure ofincome favored by many academic theorists iseconomically damaging and too impractical touse in the real world. As a result, policymakershave fallen back on ad hoc and inconsistent rulesto define the income tax base. That intensifiescomplexity and creates instability as policymakersgyrate between different definitions of the taxbase. In addition, the lack of a consistentlydefined tax base increases the use of the tax codefor special‐​interest tax breaks, thus furtheradding to the system’s complexity.

The complexity and inefficiency of the individualand corporate income taxes have led togreat interest in replacing them with a consumption‐​based tax. The leading consumption‐​basedtax proposals, including the national retail salestax and the Hall‐​Rabushka flat tax, could dramaticallysimplify federal taxation. Those tax systemswould eliminate many of the most complexaspects of federal taxation, including depreciationaccounting and capital gains taxation.

Imposing the largest federal tax on incomewas a historic mistake: no simple, efficient, andstable measure of income has been found in ninedecades of the income tax. It is time to recognizethis mistake and replace the income tax with aconsumption‐​based alternative.

Chris Edwards

Chris Edwards is director of fiscal policy studies at the Cato Institute.