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

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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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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6465.

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Date of creation: Mar 1998
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Publication status: published as David F. Bradford. "Transition to and Tax-Rate Flexibility in a Cash-Flow-Type Tax," in James M. Poterba, editor, "Tax Policy and the Economy, Volume 12" MIT Press (1998)
Handle: RePEc:nbr:nberwo:6465

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  1. Howitt, Peter & Sinn, Hans-Werner, 1989. "Gradual Reforms of Capital Income Taxation," American Economic Review, American Economic Association, vol. 79(1), pages 106-24, March.
  2. 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.
  3. Alan J. Auerbach & James R. Hines, Jr., 1987. "Anticipated Tax Changes and the Timing of Investment," NBER Chapters, in: The Effects of Taxation on Capital Accumulation, pages 163-200 National Bureau of Economic Research, Inc.
  4. Hall, Robert E, 1997. "Potential Disruption from the Move to a Consumption Tax," American Economic Review, American Economic Association, vol. 87(2), pages 147-50, May.
  5. David Bradford, . "Consumption Taxes: Some Fundamental Transition Issues," EPRU Working Paper Series 95-15, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  6. Bradford, D.F., 1989. "Market Value Us. Financial Accounting Measures Of National Saving," Papers 34, Princeton, Woodrow Wilson School - Discussion Paper.
  7. Robin Boadway & Neil Bruce, 1982. "A General Proposition on the Design of a Neutral Business Tax," Working Papers 461, Queen's University, Department of Economics.
  8. Hall, Robert E, 1971. "The Dynamic Effects of Fiscal Policy in an Economy With Foresight," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 229-44, April.
  9. Zodrow, George R., 1985. "Optimal tax reform in the presence of adjustment costs," Journal of Public Economics, Elsevier, vol. 27(2), pages 211-230, July.
  10. 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.
  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. Zodrow, George R. & McLure, Charles E. Jr., 1988. "Implementing direct consumption taxes in developing countries," Policy Research Working Paper Series 131, The World Bank.
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Cited by:
  1. Auerbach, Alan J., 2006. "The Choice between Income and Consumption Taxes: A Primer," Berkeley Olin Program in Law & Economics, Working Paper Series qt9q85f6qz, Berkeley Olin Program in Law & Economics.
  2. David Bradford, 2004. "The X Tax in the World Economy," CESifo Working Paper Series 1264, CESifo Group Munich.
  3. Howell H. Zee, 2006. "A Superior Hybrid Cash-Flow Tax on Corporations," IMF Working Papers 06/117, International Monetary Fund.
  4. David Bradford, 2003. "Addressing the Transfer-Pricing Problem in an Origin-Basis X Tax," CESifo Working Paper Series 997, CESifo Group Munich.
  5. Auerbach, Alan J., 2006. "The Future of Capital Income Taxation," Berkeley Olin Program in Law & Economics, Working Paper Series qt90v90406, Berkeley Olin Program in Law & Economics.
  6. Peter Wilson, 2002. "An Analysis of a Cash Flow Tax for Small Business," Treasury Working Paper Series 02/27, New Zealand Treasury.
  7. Auerbach, Alan J., 2006. "Tax Reform in the 21st Century," Berkeley Olin Program in Law & Economics, Working Paper Series qt444479wh, Berkeley Olin Program in Law & Economics.
  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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