FUNDAMENTALTAXREFORM:

TAXESONCONSUMPTIONANDWEALTH

Chapter21HowaValue-AddedTaxWorksProducerPurchasesSalesValueAddedVATat20PercentRateFarmer$

0$400$

400$

80Miller40070030060Baker70095025050Grocer9501,0005010

Total$2,050$3,050$1,000$20021-2EfficiencyandEquityofPersonalConsumptionTaxesEfficiencyissuesAnincometaxandsavingandlaborsupplydecisionsAconsumptiontaxandsavingandlaborsupplydecisions21-3EfficiencyandEquityofPersonalConsumptionTaxesEquityissuesProgressivenessAbilitytopayAnnualversusLifetimeEquityAnumericalexampleAformalmodel21-4AnnualversusLifetimeEquity–ANumericalExampleParameters

Incometaxrate=50%

Consumptiontaxrate=50%

Interestrate=10%Mr.GrasshopperMs.AntIncometaxConsumptiontaxIncometaxConsumptiontaxIncomeperiod0$1,000$1,000$1,000$1,000Consumptionperiod0$500$500$0$0Taxesperiod0$500$500$500$0Incomeperiod1$0$0$50$100Consumptionperiod1$0$0$525$550Taxesperiod1$0$0$25$550PresentValueoftaxespaid$500$500$523$50021-5AnnualversusLifetimeEquity–AFormalModelParameters

Incometaxrate=t

Consumptiontaxrate=tc

Interestrate=rIncomeTaxMr.GrasshopperMs.AntIncomeperiod0I0I0Consumptionperiod0c0Gc0ATaxesperiod0tI0tI0Incomeperiod1r(I0–c0G)r(I0–c0A)Taxesperiod1tr(I0–c0G)tr(I0–c0A)21-6AnnualversusLifetimeEquity–AFormalModelParameters

Incometaxrate=t

Consumptiontaxrate=tc

Interestrate=rConsumptionTaxMr.GrasshopperMs.AntPresentValueofLifetimeIncomeI0=c0G+c1G/(1+r)I0=c0A+c1A/(1+r)PresentValueofLifetimeTaxLiabilityRcG

=tcc0G+tcc1G/(1+r)=tcI0RcA=tcc0A+tcc1A/(1+r)=tcI021-7RetailSalesTaxGeneralsalestaxPercentofown-sourcerevenuefromsalestaxesState:34.7%Local:10.0%Selectivesalestax(excisetaxordifferentialcommoditytax)FormsofasalestaxUnittaxAdvaloremtax21-8RationalizationsforSalesTaxesEaseofadministrationDefiningthetaxbaseTaxevasion21-9EfficiencyandDistributionalImplicationsofStatesSalesTaxesDifferentialversusuniformtaxratesHowtosetratesEfficiencygoalonlyEquitygoalExternalitiesSalestaxesassubstitutesforuserfees“Sin”taxesInformationrequirementsfordifferentialtaxrates21-10ANationalRetailSalesTaxArgumentsinfavorSimplicityEaseofcomplianceArgumentsAgainst21-11Value-AddedTaxHowavalue-addedtaxworksVATasanalternativemethodforcollectingretailsalestax21-12ImplementationIssuesTreatmentofinvestmentassetsConsumption-typeVATCollectionprocedureInvoicemethodRatestructure21-13AVATfortheUnitedStates?DesirabilityofVATdependson…Whattax(ortaxes)itwillreplaceHowrevenueswillbespentPoliticalimplicationsofVAT’srevenueraisingprowessInternationalimplications21-14Hall-RabushkaFlatTaxBusinesstaxTaxbase=Sales–purchasesfromotherfirms–paymentstoworkersPayflattaxrateonfinalamountIndividualCompensationtaxTaxbase=PaymentsreceivedbyindividualfortheirlaborservicesNoadditionaldeductionsApplyselectedtaxscheduleWhyisH&Rtaxaconsumptiontax?21-15Cash-FlowTaxHowacash-flowtaxworksHowtocomputeannualconsumptionCash-flowbasisQualifiedaccounts21-16IncomeversusConsumptionTaxationNoneedtomeasurecapitalgainsanddepreciationFewerproblemswithinflationNoneedforseparatecorporationtaxAdministrativeproblemsTransitionalissuesGiftsandbequestsAdvantagesDisadvantages21-17ProblemswithBothSystemsDefiningconsumptionChoosingtheunitoftaxationChoosingtheratestructureValuingfringebenefitsDeterminingmethodforaveragingovertimeTaxinghomeproductionDiscouragingincentivetoparticipateinundergroundeconomyRealworldversusidealtaxsystems21-18WealthTaxesJustificationsfortaxingwealthLargeaccumulationsofwealthshouldbetaxedCorrectproblemswithadministrationofincometaxHigherwealthimplieshigherabilitytopayReducestheconcentrationofwealthPaymentforbenefitsreceivedfromgovernment21-19EstateandGiftTaxesRationalesPaymentforservicesReversionofpropertytosocietyIncentivesRecipientversusdonorbehaviorWorkSavingFormofbequestRelationtopersonalincometaxIncomedistribution21-20GrossEstateAlldecedent’sassetsattimeofdeath,includingrealproperty,stocks,bondsandinsurancepolicies,plusgiftsmadeduringdecedent’slifetimeTypicallyvaluedatmarketvalueatdateofdeath;valuationmaybeset6monthslaterifvalueofestatedeclinesCloselyheldbusinessesandfarmsarevaluedat“usevalue.”21-21ProvisionsoftheUnified

TransferTaxGrossEstateCharitableContributionsFuneralExpensesCostsofSettlingEstate(lawyer’sfees)OutstandingDebtsLifetimeExemptionQualifiedTransferstoSpouseAnnualGiftExclusionTaxableEstate*taxrateTax021-22Problems&PotentialReformsProblemswithEstateandGiftTaxesPolicyPerspective:DeathoftheDeathTax?JointlyheldpropertyClosely-heldbusinessesAvoidancestrategiesInsurancetrustGiftsofstockReformingEstateandGiftTaxesIntegratewithpersonalincometaxAccessionstax21-23Chapter21SummaryArgumentsforsubstitutingtheincometaxwithapersonalconsumptiontaxincludetheeliminationofdoubletaxation,promotiono