Sorting through a shift toward a consumption tax

Conservatives are rejoicing. They see the United States already on a path of fundamental tax changes that will accelerate economic growth.

"Stealth tax reform," it has been called. That's because relatively few voters are aware of the significance of the changes in the system proposed by President Bush and incorporated in the three tax-cutting measures passed by a Republican-led Congress since he took office.

"George W. Bush is the first president to actively understand and embrace the fundamental core principles of tax reform," says Ernest Christian, a founder of the Center for Strategic Tax Reform in Washington.

The ultimate tax-reform goal varies somewhat among conservatives.

In general, these reformers see their proposals and the recent tax-cut changes as shifting the system toward taxing consumption, that is, money used by people and companies to buy goods and services, and leaving individual savings and much of corporate profits facing less income taxation. This, their rationale goes, will encourage extra savings and investment, thereby speeding up growth in productivity.

For instance, Grover Norquist, head of Americans for Tax Reform in Washington, would like to see a single-rate tax - a "flat tax" - that taxes income only once. Corporate dividends, for example, would be taxed at either the corporate or individual level, but not both.

"It's a huge political winner today because 70 percent of voters [those actually voting] own corporate shares," he maintains. "So we will keep taking baby steps" in that tax-reform direction.

Michael Graetz, a Yale Law School professor and Treasury tax-policy official under the first President Bush, last fall called for a 10-to-15 percent federal value-added tax, like that in some 120 other nations. This type of sales tax would raise enough revenues to allow families with $100,000 of annual income or less - almost 90 percent of all current filers - to pay no income tax, or even need to file. Those with incomes above that would be taxed at a flat 25 percent rate.

But Mr. Graetz's VAT plan is widely seen as a nonflier in Washington.

"It is not going to happen," says Stan Collender, a budget expert with Fleishman-Hillard Inc. It may be "right academically," but is "incredibly wrong politically." It would be opposed by retailers, as well as by the states and cities that regard sales taxes as their turf.

Even L. Glenn Hubbard, chairman of the Council of Economic Advisers (CEA) under Bush before leaving earlier this year for Columbia University, "doubts very much" that Congress would approve a value-added tax.

Mr. Hubbard devoted a 36-page chapter in the CEA's annual report last winter to a pitch for a consumption tax. And he expects the Bush administration to introduce more "reform" in the months ahead, but won't spell out what.

The tax changes so far include these:

• Marginal income-tax rates have been cut - from 38.6 to 35 percent for the rich, a smaller cut for those with less income.

• The tax on corporate dividends was not eliminated, as proposed by Bush, but slashed to 15 percent along with the tax rate on capital gains.

• The amount that business can write off their taxes in the first year on purchases of plant and equipment has been raised to 50 percent for bigger companies, and by as much as 100 percent for small businesses.

Mr. Christian would like 100 percent depreciation in the first year. He also wants to excuse from taxation export and other foreign-trade income of US multinationals, as many other nations do.

The next likely "baby step" is the revival of the Lifetime Savings Account proposed by Bush last January, and later dropped for fear it would distract from the White House goal of selling its main tax package. The radical measure would allow taxpayers to contribute up to $7,500 a year of after-tax income into an investment account where it could grow untaxed and be withdrawn tax-free later for retirement, education, or other purposes.

"That is coming back," says Chris Edwards, a fiscal expert at the Cato Institute in Washington. He sees it as having political appeal in an election year. And its revenue loss is small in the 10-year window used by Congress in looking at tax bills.

The measure would also move toward a consumption tax by easing the tax burden on money not spent, that is, savings.

Critics of the Bush step-by-step moves are bothered that they tend to benefit mostly the well-to-do who can afford to save more than the middle class or poor.

William Gale, a Brookings Institution tax expert, says the nation is headed toward "a wage tax" system that puts the tax burden on employees, and ignores some dividends, interest, capital gains, and other "nonearned" income. The tax system will be less progressive and worse than either today's system or a more pure consumption-tax system, he argues.

Robert Reischaurer, president of the Urban Institute, complains the developing system will "worsen" an after-tax distribution of income that already is slanted to the top, and especially help "old capital."

An academically "pure" consumption-tax system would tax inheritances. But it is unlikely Bush would push for that, notes Joel Slemrod, a University of Michigan Business School tax expert in Ann Arbor.

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