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Three Views of Tax

Published online by Cambridge University Press:  20 July 2015

Edward J. McCaffery
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Virtually all liberal egalitarian advocates of redistributive taxation support an income tax, believing that consumption taxes fail to reach capital and its yield. But this is not true under progressive rates. There are two forms of consumption tax, prepaid and postpaid. A consistent progressive postpaid consumption tax reaches the yield to capital in just those cases in which ordinary moral intuitions want it to be reached: when savings are used to finance a “better,” more expensive, lifestyle. Such a tax stands between an income tax, which double taxes all savings, come what may, and a prepaid consumption tax, which never taxes savings. It is the last, best hope for some semblance of redistribution via tax on earth.

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Research Article
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Canadian Journal of Law & Jurisprudence , Volume 18 , Issue 1 , January 2005 , pp. 153 - 164
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Copyright © Canadian Journal of Law and Jurisprudence 2005

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References

Thanks to Alex Baskin and Greg Barchie for their excellent research assistance.

1. For some representative perspectives on point, see Pechman, Joseph A., ed., What Should be Taxed, Income or Expenditure? (Washington, D.C.: Brookings Institute Press, 1980).Google Scholar The income versus consumption debate has its historic roots in the writings of Thomas Hobbes, Adam Smith and, most importantly, perhaps, John Stuart Mill. The British economist Kaldor, Nicholas wrote an important volume, An Expenditure Tax, in 1955 (reprinted in the Routledge Library Editions—Economics, 91 (London: Routledge, 2003)).Google Scholar The American law professors William Andrews and Alvin Warren famously revived the debate in a series of law review articles beginning in 1974. It rages on to this day, as any basic tax policy book readly demonstrates See McCaffery, Edward J., “A New Understanding of Tax” Mich. L. Rev. [forthcoming, 2005]Google Scholar. This present essay is a shortened version of that much longer piece.

2. See Stark, Kirk J., “Enslaving the Beachcomber: Some Thoughts on the Liberty Objections to Endowment Taxation,” in this volume of CJLJ, for a discussion of the term “liberal egalitarian,” which, broadly speaking, characterizes the political philosophy of John Rawls, Ronald Dworkin and other contemporary liberal political theoristsGoogle Scholar.

3. For some representative criticisms of alternatives to the income tax along broadly liberal egalitarian lines, See Alstott, Anne L., “The Uneasy Liberal Case Against Income and Wealth Transfer Taxation: A Response to Professor McCaffery” (1996) 51 Tax L. Rev. 363 Google Scholar; Eric Rakowski, , “Can Wealth Taxes Be Justified?” (2000) 53 Tax L. Rev. 263 Google Scholar; Avi-Yonah, Reuven S., “Risks, Rents, and Regressivity: Why the United States Needs Both an Income Tax and a VAT” (December 20, 2004) 105 Tax Notes 1651.Google Scholar

4. For an overview of the basic analytics, see McCaffery, Edward J., Fair Not Flat: How to Make the Tax System Better and Simpler (Chicago, IL: University of Chicago Press, 2002).CrossRefGoogle Scholar

5. For an excellent statement of the popular understanding of tax policy, see Cassidy, John, “Tax Code” The New Yorker (6 September 2004) 70 Google Scholar (discussing inter alia President Bush’s below-the-radar efforts to shift to a flat tax).

6. I present a much extended version of this argument in “A New Understanding of Tax,” supra note 1.

7. See for some discussion of the historical support for progressivity, Hite, Peggy A. & Roberts, Michael L., “An Experimental Investigation of Taxpayer Judgments on Rate Structure in the Individual Income Tax System” (1991) 13 J. Am. Taxation Ass’n 47 Google Scholar; Baron, Jonathon & McCaffery, Edward J., “Masking Distribution (or Its Absence)” in McCaffery, Edward J. & Slemrod, Joel, eds., Behavioral Public Finance (New York: Russell Sage Press)Google Scholar [forthcoming]. Gene Steuerle considers some progressivity in tax to be essentially a requirement of natural law. Eugene Steuerle, C., Contemporary U.S. Tax Policy (Washington D.C.: Urban Institute Press 2004) at 11.Google Scholar

8. See below the discussion of Ant and Grasshopper, under constant tax rates, in section III “The Traditional View, and Beyond”.

9. See Vickrey, William, Agenda for Progressive Taxation (New York: The Ronald Press, 1947).Google Scholar

10. See the discussion below on corporate taxes.

11. See, e.g., Cunningham, Noël B., “The Taxation of Capital Income and the Choice of Tax Base” (1996) 52 Tax L. Rev. 17 Google Scholar (“Both bases include consumption; the difference is that an income tax also includes changes in wealth, or savings. Whether or not it is appropriate or desirable to tax savings has been at the core of the debate.” (footnote omitted)); Fried, Barbara H., “Fairness and the Consumption Tax” (1992) 44 Stan. L. Rev. 961 CrossRefGoogle Scholar (“Under a plausible set of assumptions, the two forms of consumption tax—a tax on consumption only and a tax on wages only—impose an equivalent tax burden in present value terms” (footnote omitted)); Murphy, Liam & Nagel, Thomas, The Myth of Ownership: Taxes and Justice (Oxford: Oxford University Press, 2002) at 101 CrossRefGoogle Scholar (“This equivalence allows us to say, furthermore, that any consumption tax scheme, in taxing not accretions to wealth as such, but rather only consumption, exempts from taxation the normal returns to investment.”). See also Slemrod, Joel & Bakija, Jon, Taxing Ourselves: A Citizen’s Guide to the Great Debate Over Tax Reform, 3rd ed. (Cambridge, MA: MIT Press, 2004).Google Scholar

12. See Simons, Henry C., Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy (Chicago, IL: University of Chicago Press, 1980 (1938)) at 50 Google Scholar; Haig, Robert M., “The Concept of Income—Economic and Legal Aspects” in Haig, Robert M., ed., The Federal Income Tax (New York: Columbia University Press, 1921) at 7 Google Scholar; McCaffery, supra note 4 at 11-12.

13. See Mc Caffery, supra note 4 at 11-13.

14. See, for example, the sources cited in supra note 11.

15. See Mc Caffery, supra note 4 at 15.

16. Andrews, William D., “A Consumption-Type or Cash Flow Personal Income Tax” (1974) 87 Harv. L. Rev. 1113 at 1167-68 [hereinafter Andrews 74].CrossRefGoogle Scholar (“Neutrality with respect to consumption is important not only because it promotes efficiency in the allocation of income, but because it keeps the tax from bearing more heavily on one person than another on account of differences in need or taste for particular goods or services, now or in the future.”). Warren, Alvin C. Jr., “Fairness and a Consumption-Type or Cash Flow Personal Income Tax” (1975) 88 Harv. L. Rev. 931 CrossRefGoogle Scholar.

17. For the idea that it is the initial distribution of material resources, and not their “redistribution,” that is at stake—that, in other words, the pretax distribution of material resources is not a nor-matively compelling baseline—see e.g., Murphy & Nagel, supra note 11. See also, Andrei Marmor in this Taxation issue of CJLJ.

18. Mill, John Stuart, Principles of Political Economy (orig. 1848), ed. by Ashley, W.J. (Logmans, Green & Co., 1909) Book V., ch. II, § 4 at 814Google Scholar.

19. This is before bringing transaction costs into the story, which push the income tax to an income-with-realization tax, and generate other types of “hybrid” taxes. Mc Caffery, Edward J., “Tax Policy Under a Hybrid Income-Consumption Tax” (1992) 70 Tex. L. Rev. 1149 Google Scholar.

20. Internal Revenue Code (“I.R.C.”), 26 U.S.C. § 408A.

21. Ibid. § 408.

22. 110.25/1.21, that is, the future value divided by 1 plus the discount rate, squared.

23. For fuller discussion, see McCaffery, supra note 1 at Part II.

24. See further discussion of “neutrality” as a norm in section IV below.

25. Like many elements in the traditional view, Andrews was among the first best spokespersons for this idea. See Andrews 74, supra note 16. See also Slemrod & Bakija, supra note 11; Bradford, David E. & US Treasury Tax Policy Staff Blueprints for Basic Tax Reform, 2nd rev. ed. (Arlington, VA: Tax Analysts, 1984)Google Scholar.

26. See Andrews, William D., “Fairness and the Personal Income Tax: A Reply to Professor Warren” (1975) 88 Harv. L. Rev. 947 [hereinafter Andrews 75]CrossRefGoogle Scholar.

27. For more detail on how tax rates work, see Mc Caffery, supra note 4 at ch. 5.

28. My simple example ignores interest, which I discuss at greater length in Mc Caffery, supra note 1.

29. Andrews 74, supra note 16.

30. See Andrews 75, supra note 26.

31. See McCaffery, Edward J., “A Voluntary Tax? Revisited” (2001) Nat’l Tax J. 268. 93rd Annual National Tax Association ProceedingsGoogle Scholar.

32. Ibid.

33. The highly influential Grover Norquist, for example, notes of the four tax cuts in President George W. Bush’s first term that “[p]eople looked at those and thought they were just catch as catch can. But every one of those tax cuts moved us toward a single-rate tax system that taxes income just one time.” Stephen Moore, president of the powerful Club for Growth, foresees not “a big grandiose plan, but rather incremental steps.” Moore regards the flat tax as the “Garden of Eden [that requires] that every change we make with tax policy is moving us in that direction.” Reported in Veith, Warren, “U.S. Tax Code May Be Facing a Full Rewrite” L.A. Times (7 November 2004) A27 Google Scholar.

34. For more discussion of debt, see McCaffery, supra note 4 at 19-20, 132-34. This inclusion of debt-financed consumption, plus the repeal of any special preference of capital gains under a consistent postpaid consumption tax model, happen to be two base-broadening features of such a plan, compared to the status quo. It is not simply true that rates will have to rise in any conversion from the status quo to a consistent postpaid consumption tax; the base broadening features must be set against the base-constriction of allowing additional deductions for savings, bearing in mind that the current tax has many such features already. These are, of course, empirical questions to be studied. See McCaffery, Edward J., “Ten Facts about Fundamental Tax Reform” (22 December 2003) Tax Notes 1463 Google Scholar.

35. Michael J. Graetz, on his proposal to reform the current American tax system with a value added tax plus a continued income tax for the wealthy, uses a $100,000 cut off. See Graetz, Michael J., “100 Million Unnecessary Returns: A Fresh Start for the U.S. Tax System” (2002) 112 Yale L. J. 261 CrossRefGoogle Scholar; “To the Point of No Returns” New York Times (15 November 2004) A23. I compare and contrast Graetz’s plan to my preferred one in McCaffery, supra note 4 at 102-03.

36. McCaffery, supra note 4 at 100-02.

37. See Pollan, Stephen M. & Levine, Mark, Die Broke (New York: Harper-Collins, 1997)Google Scholar. For my own thoughts on estate or wealth transfer taxation, See McCaffery, Edward J., “The Uneasy Case for Wealth Transfer Taxes ” (1994) 104 Yale L. J. 283 CrossRefGoogle Scholar; McCaffery, Edward J., “The Political Liberal Case against the Estate Tax” (1994) 23 Phil. & Pub. Affairs 281 CrossRefGoogle Scholar; McCaffery, supra note 4 at ch. 4, 62-77.

38. I.R.C. § 1011 (basis); I define ‘basis’ in McCaffery, supra note 4 at 161, as after-tax dollars.

39. Income Tax Act, R.S.C. 1985 (5th Supp.), c1, s. 70(5), (5.1).