Consumption Taxes: Some Fundamental Transition Issues

A number of tax reform plans under discussion in the United States would replace the existing hybrid income-based system with a consumption-based system. In this paper I use uniform (single-rate) consumption and income taxes: (a) to explain how the problem of taxing "old savings" or "old capital" manifests itself in the shift from an income to a consumption base; (b) to indicate the tradeoffs that must be confronted in dealing with this phenomenon; (c) to show how price level changes that may or may not accompany a transition affect the distribution of gains and losses; (d) to sketch out how a transition might affect interest rates and asset prices (including owner-occupied housing); (e) to explore the case in equity for protecting the tax-free recovery of old savings; and (f) to enphasize the incentive problems that arise if savers and investors anticipate a change in the change in the tax rate in a consumption-based system.