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Transition to and Tax-Rate Flexibility in a Cash-Flow-Type Tax

In: Tax Policy and the Economy, Volume 12

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  • David F. Bradford

Abstract

The difficulty of making a transition from an income-type to a consumption-type tax is often cited as an obstacle to such a change in policy. The problem is the double taxation of 'old savings' or 'old capital.' A person who has accumulated wealth under an income tax will be hit with an extra tax on the consumption financed by that accumulation with a shift to a consumption tax. Such a transition effect raises issues of equity, political feasibility and efficiency. In the typical implementation of a consumption tax, the same sorts of transition phenomena associated with a shift from an income tax come from any change in the rate of tax. Introduction of a consumption tax is the same as raising the rate of consumption tax from zero to whatever positive rate is envisioned for the new system. Consequently, the problem of transition to a consumption tax generalizes to the problem of changing the rate of consumption tax. In this paper I consider the design of rules that render consumption taxes in the family of business cash-flow taxes immune to the incentive and incidence effects of changes in rate of tax. I show that two relatively simple approaches are available to deal with it: grandfathering the tax rate applicable to a given period's investment or substituting depreciation allowances for the usual expending of investment, coupled with a credit for the equivalent of interest on the undepreciated investment stock. A cost of this approach is its requirement to identify tru depreciation and, in the second case, the real rate of interest.

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This chapter was published in:

  • James Poterba, 1998. "Tax Policy and the Economy, Volume 12," NBER Books, National Bureau of Economic Research, Inc, number pote98-1.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 10916.

    Handle: RePEc:nbr:nberch:10916

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    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Robert E. Hall, 1996. "The Effects of Tax Reform on Prices and Asset Values," NBER Chapters, in: Tax Policy and the Economy, Volume 10, pages 71-88 National Bureau of Economic Research, Inc.
    2. David F. Bradford, 1995. "Consumption Taxes: Some Fundamental Transition Issues," NBER Working Papers 5290, National Bureau of Economic Research, Inc.
    3. Zodrow, George R., 1985. "Optimal tax reform in the presence of adjustment costs," Journal of Public Economics, Elsevier, Elsevier, vol. 27(2), pages 211-230, July.
    4. Alan J. Auerbach & James R. Hines, Jr., 1987. "Anticipated Tax Changes and the Timing of Investment," NBER Chapters, in: Taxes and Capital Formation, pages 85-92 National Bureau of Economic Research, Inc.
    5. Howitt, Peter & Sinn, Hans-Werner, 1989. "Gradual Reforms of Capital Income Taxation," American Economic Review, American Economic Association, American Economic Association, vol. 79(1), pages 106-24, March.
    6. Bradford, D.F., 1989. "Market Value Us. Financial Accounting Measures Of National Saving," Papers, Princeton, Woodrow Wilson School - Discussion Paper 34, Princeton, Woodrow Wilson School - Discussion Paper.
    7. Zodrow, George R. & McLure, Charles E. Jr., 1988. "Implementing direct consumption taxes in developing countries," Policy Research Working Paper Series 131, The World Bank.
    8. Boadway, Robin & Bruce, Neil, 1984. "A general proposition on the design of a neutral business tax," Journal of Public Economics, Elsevier, Elsevier, vol. 24(2), pages 231-239, July.
    9. Hall, Robert E, 1971. "The Dynamic Effects of Fiscal Policy in an Economy With Foresight," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 38(114), pages 229-44, April.
    10. Hall, Robert E, 1997. "Potential Disruption from the Move to a Consumption Tax," American Economic Review, American Economic Association, American Economic Association, vol. 87(2), pages 147-50, May.
    11. David F. Bradford, 1991. "Market Value versus Financial Accounting Measures of National Saving," NBER Chapters, in: National Saving and Economic Performance, pages 15-48 National Bureau of Economic Research, Inc.
    12. John B. Shoven & Jeremy I. Bulow, 1975. "Inflation Accounting and Nonfinancial Corporate Profits: Physical Assets," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(3), pages 557-612.
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    Cited by:
    1. David Bradford, 2004. "The X Tax in the World Economy," CESifo Working Paper Series 1264, CESifo Group Munich.
    2. Howell H. Zee, 2006. "A Superior Hybrid Cash-Flow Taxon Corporations," IMF Working Papers 06/117, International Monetary Fund.
    3. Peter Wilson, 2002. "An Analysis of a Cash Flow Tax for Small Business," Treasury Working Paper Series 02/27, New Zealand Treasury.
    4. Alan J. Auerbach, 2006. "The Choice Between Income and Consumption Taxes: A Primer," NBER Working Papers 12307, National Bureau of Economic Research, Inc.
    5. Bradford, David F, 2003. "Addressing the Transfer-Pricing Problem in an Origin-Basis X Tax," International Tax and Public Finance, Springer, Springer, vol. 10(5), pages 591-610, September.
    6. Auerbach, Alan J., 2006. "Tax Reform in the 21st Century," Berkeley Olin Program in Law & Economics, Working Paper Series, Berkeley Olin Program in Law & Economics qt444479wh, Berkeley Olin Program in Law & Economics.
    7. Alan J. Auerbach, 2006. "The Future of Capital Income Taxation," Fiscal Studies, Institute for Fiscal Studies, Institute for Fiscal Studies, vol. 27(4), pages 399-420, December.
    8. Louis Kaplow, 2006. "Capital Levies and Transition to a Consumption Tax," NBER Working Papers 12259, National Bureau of Economic Research, Inc.

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