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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.

Suggested Citation

  • David F. Bradford, 1998. "Transition to and Tax Rate Flexibility in a Cash-Flow Type Tax," NBER Working Papers 6465, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:6465
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    References listed on IDEAS

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    9. 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.
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    Cited by:

    1. Mr. Howell H Zee, 2006. "A Superior Hybrid Cash-Flow Taxon Corporations," IMF Working Papers 2006/117, International Monetary Fund.
    2. Alan J. Auerbach, 2006. "The Future of Capital Income Taxation," Fiscal Studies, Institute for Fiscal Studies, vol. 27(4), pages 399-420, December.
    3. David F. Bradford, 2003. "The X Tax in the World Economy," Working Papers 109, Princeton University, Department of Economics, Center for Economic Policy Studies..
    4. Auerbach, Alan J., 2006. "The Choice between Income and Consumption Taxes: A Primer," Department of Economics, Working Paper Series qt9q85f6qz, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    5. Hans-Werner Sinn, 1999. "Inflation and Welfare: Comment on Robert Lucas," NBER Working Papers 6979, National Bureau of Economic Research, Inc.
    6. David F. Bradford, 2003. "The X Tax in the World Economy," Working Papers 109, Princeton University, Department of Economics, Center for Economic Policy Studies..
    7. Bradford, David F, 2003. "Addressing the Transfer-Pricing Problem in an Origin-Basis X Tax," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 10(5), pages 591-610, September.
    8. Ethan Yale, 2008. "Taxing Cap-and-Trade Environmental Regulation," The Journal of Legal Studies, University of Chicago Press, vol. 37(2), pages 535-550, June.
    9. 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.
    10. Louis Kaplow, 2006. "Capital Levies and Transition to a Consumption Tax," NBER Working Papers 12259, National Bureau of Economic Research, Inc.
    11. Fehr, Hans, 1999. "Welfare Effects of Dynamic Tax Reforms," Beiträge zur Finanzwissenschaft, Mohr Siebeck, Tübingen, edition 1, volume 5, number urn:isbn:9783161470165, September.
    12. repec:pri:cepsud:93bradford is not listed on IDEAS
    13. Peter Wilson, 2002. "An Analysis of a Cash Flow Tax for Small Business," Treasury Working Paper Series 02/27, New Zealand Treasury.

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