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To provide transfers and services, governments must tax. In affluent countries the principal sources of government revenue are taxes on income (individual and corporate), payroll, and consumption. What is the optimal mix among these three types of taxes? The comparative empirical record suggests the following: Income taxes are the most progressive of the three. But taxation tends to have relatively little direct impact on the income distribution; transfers and services are far more important. Consumption and payroll taxes have not been the key to expansion of tax revenues in recent decades. The nations that have increased revenues (as a share of GDP) have done so as much via income taxes. Countries relying more heavily on income taxes have not suffered slower economic growth. Nations that rely more heavily on payroll taxes do appear to have had slower employment growth over the past few decades. For policy makers seeking an optimal tax mix, these findings suggest that countries have a good bit of leeway to choose.

This introductory chapter discusses the purpose of this book and its content. The main purpose of this book is to study consumption tax policy and the taxation of capital. Several reasons are presented why it is interesting to study different literature on consumption tax policy. First, consumption tax has the potential of generating significant amount of revenue and it can be a possible alternative to income tax as the main source of government income. Second, knowledge learned from studying consumption tax provides a good tool for help with future decisions regarding government policy. Third, studying consumption tax policy provides a good example of the way in which economics as a science evolves and of how policy debates evolve.

This chapter talks about the simple life cycle model. There are several models which are concerning with bequeathing and the results of policy analysis depend on the motive for bequeathing. In a situation where the giving parent cares about the size of the bequest, the bequest acts like parental consumption and should be taxed under a consumption tax policy. On the contrary, if the giving parent cares about the full income of the offspring, then the bequest is more like an asset and should not be taxed under a consumption tax. This could maintain neutrality. However, if the population is made up of different people with different motives for bequeathing, it will be impossible to impose a consumption tax. Therefore, a proportional consumption tax will not be completely neutral with respect to decision-making in the existence of bequest.

This chapter presents a discussion of the early literature on the consumption tax proposal. Early writers were concerned that people pay tax on what they get out of society in consumption rather than on what they put into society in labor and capital investment. The primary argument against general income tax was that such a tax taxes savings twice — once when the income is earned and a second time when the saving generates income. Some of the early proponents of the consumption tax include John Stuart Mill, Alfred Marshall, A. C. Pigou, John Maynard Keynes, and Irving Fisher. Later on, analysts focused their attention on the efficiency aspects of taxing capital income.

This chapter focuses on the relationship between money and taxation. Several models of money generate different results concerning the patterns of distortions of different tax systems. Income tax will affect the consumption decision. If cash balances are taxed under the consumption tax, consumers prefer the accumulation of capital and people will hold less cash when the tax is implemented. It is difficult to assume that a consumption tax is perfectly neutral because money plays two roles: as liquidity and as a store of value. In this chapter the case where cash reserves are being taxed under a consumption tax is presented. It is predicted that cash balance decisions will be distorted by the consumption tax. In general, the impact of different tax systems on the economy will depend on the model of money one uses, and consumption and income tax are distorting.

Assesses the overall performance of past tax reforms thathas developed in three stages; the Nakasone and Takeshita reform packages from the mid‐1980s, and recent tax reform in the 1990s. From an academic point of view, as the final conclusion, Japan's tax reforms have been far from satisfactory, and further steps are required to improve with regard to equity, neutrality, and simplicity.

This chapter focuses on the relationship between taxation and several privately produced public goods. Charity and private contributions play an important role in the economy especially for a large portion of the population. This is modeled as a ‘subscription game’, where donors give contributions to a public good — the charity. There are different motives for donating to charity. One is where the donor cares about the actual amount donated and the other is where the donor cares about the optimal recipient's consumption. Motive for donating affects the tax policy of a country. Also, many governments, especially small developing countries, attempt to reduce their fiscal deficit by reducing their spending and foreign debt levels. It is shown that consumption tax makes it more difficult to solve the budget crisis, and reducing spending is a better way of solving the budgetary problem.

Examines indirect tax reform movements in the late 1980s before the introduction of a broad‐based consumption tax: VAT. Needless to say, the adoption of VAT had a close bearing upon the changes in existing excise taxes, such as alcoholic beverages, tabacco, petrol, and commodity taxes.

This chapter discusses literature concerning optimal taxation, based on versions of the Ramsey growth model. Several economists showed that it is sub-optimal to tax capital income in the long run. This is true in the endogenous growth model studied by Lucas because a tax on income will permanently lower the growth rate of the economy and consequently welfare. However, there are several limitations to this result. These limitations are: government spending is proportional to output; precautionary saving from incomplete insurance markets exists; productive public spending that enhances private investment is present; there are liquidity constraints; and negative externalities associated with production exist. Voters in a democratic country, as discussed by Krusell, Quadrini, and Rios-Rull (1996), prefer a general income tax system over consumption tax since it tends to reduce the level of redistributive taxation.

This chapter places the defined contribution paradigm in the context of contemporary tax policy debates about consumption taxation and tax expenditures. It concludes that, under the most likely scenarios, the individual accounts of the defined contribution paradigm will persist as central features of federal tax law. A cash flow consumption tax would represent the ultimate extension, indeed the triumph, of the defined contribution paradigm since all savings would occur through individual accounts. The most likely future of the Code is the continuation of the status quo, whether that status quo is considered a proto-consumption tax or an imperfect income tax laden with tax preferences. It is unlikely that Congress will upset that status quo by jettisoning the individual accounts of the defined contribution paradigm as this would defeat the expectations and raise the taxes of Congress's middle and upper-middle class constituents.

This chapter discusses the general principles of direct taxation when the economy is open to capital flows. Two basic principles of direct taxation are the residence principle and the source principle. The resident principle states that the government taxes the income of its residents regardless of source. The source principle tells that the government taxes income generated within the country. Also, this chapter studies the effects of opening up the economy to international capital flows. Opening up the economy allows capital to be mobile but it does not necessarily mean consumption tax is preferred to income tax. Governments will most likely find it optimal to tax capital, to impose a tax on it, or to sign tax treaties enabling them to impose a tax on it.

This chapter studies the time consistency problem as it affects tax policy. One example of the time consistency problem is the capital levy. Current governments cannot force future governments to continue their tax policy and the usual scenario in most countries is that there is a ongoing change in tax policies as governments change. This time consistency problem tends to favor income tax over a consumption tax because of the temptation to tax fixed factors like capital at a high rate. However, tax evasion can reverse this scenario. Since it is easier to evade taxes on capital income than taxes on labor income, then it may be optimal to tax labor income at a higher rate than capital income.

This concluding chapter gives a summary of the results and conclusions based on the arguments presented in this book on consumption tax. First, consumption tax greatly affects the economy. Its effect differs depending on the product upon which the tax is imposed and the way consumers use money. The government plays a big role in restricting these behaviors. Governments limit the types of financial instruments the private sector can issue, impose change control, restricts ownership of foreign assets, and price control. Generally, taxing consumption is a very complicated issue. Finding its optimality is difficult due to its varied effects on different situations. Studies on taxing consumption have a long way to go due to its complexity.

Proponents of consumption taxation claim that one of its major advantages is simplification. They argue that a consumption tax would be considerably less complicated technically than the present income tax and that it would lead to a drastic reduction in the resources devoted to tax planning, compliance, and administration. This chapter considers whether the idealized proposals for consumption tax reform in the United States could survive the political process. It discusses numerous ways in which the pure proposals might be modified and concludes that such highly plausible political adjustments would reduce or eliminate the gains that otherwise might be realized from fundamental tax reform. In analyzing the possible politics of consumption-based tax reform, the chapter discusses two plausible scenarios: bipartisan consumption tax reform and consumption tax reform led by the Republican Party. It also looks at the significance of the fiscal gap for consumption-based reform and important political interests that might affect the end product of consumption-based reform (for example, homeownership, charities, state and local governments, health insurance and healthcare). Finally, it considers the politics underlying the X-tax.

This chapter examines the strengths and weaknesses of the case for taxation based on consumption rather than income. It proposes a simple macroeconomic model for analyzing a wide range of issues raised by the different tax reform proposals, including those relating to income tax and consumption tax. After discussing the choice between income and consumption taxation, the chapter looks at tax-related issues concerning capital income as well as bequests and inheritances. It then turns to distortions in the treatment of assets and liabilities, attributes of consumption taxes (government purchases, consumption base), the timing of tax payments, individual versus business taxation, and tax progressivity.

This epilogue discusses two issues and how to deal with them: the indiscriminate use of income for personal consumption and the use of wealth for maintaining a class structure. Robert Frank suggests that the way to deal with indiscriminate use of income for personal consumption is to institute a progressive consumption tax. A progressive consumption tax has been supported by both the Right and the Left. Even Milton Friedman suggested in a 1943 article that a progressive consumption tax is the best way to reduce conspicuous consumption and encourage investment. With respect to the use of wealth to maintain a class structure, the epilogue explains why we need an estate tax. It argues that the estate tax is important for sustaining philanthropy, which has been wedded to promoting opportunity creation and innovation throughout American history.

This chapter explains the methods by which a consumption tax could be achieved at the individual level. These methods are the consumed income tax and yield exemption, that is, the exclusion from tax of investment earnings. These systems look deceptively similar to the current personal income tax, Form 1040 and all. As a result, the psychological transition to either of them would be quite easy. In addition, because the tax is imposed on individuals under both of these alternatives, both can readily be made progressive, which has been an important feature in our tax system. The chapter uses a numerical example to demonstrate how each of the alternative methods operates, which allows for easy comparison between alternatives. The chapter compiles the results of the example into one table for easy reference.

This chapter observes and explains that the current income tax, as a result of many special provisions (e.g., for retirement savings, capital gains preference, homeowner tax benefits), has already evolved toward an eclectic consumption tax. The chapter points to specific tax provisions, both consumed income type and yield exemption type, in the tax code that cause many individuals to be taxed in the same way under the current income tax as they would be under a consumption tax. The chapter, after recognizing the existing hybrid nature of the income/consumption tax system, explains why it would not be wise to allow the current system to continue to evolve into an eclectic consumption tax, noting the failings of such an eclectic system. The chapter argues for the adoption of a single consumption tax replacement as a superior alternative.

This chapter investigates the optimal taxation treatment of the return to capital in a small open economy using the marginal cost of public funds concept. It uses a simple two-period life cycle model to examine one of the most hotly contested tax policy issues: whether governments should levy income taxes or consumption taxes. The optimal tax rule from the Corlett and Hague model—tax at a higher rate the good that is most complementary with leisure—implies that there should be a tax on the return on savings if future consumption is more complementary with leisure than current consumption. This insight, stemming from the work of Feldstein (1978) and Atkinson and Sandmo (1980), provides an alternative intuitive explanation of the optimal tax treatment of savings.