CHAPTER

21

Fundamental Tax Reform: Taxes on

Consumption and Wealth

McGraw-Hill/Irwin Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
 Pendahuluan
• Pajak pendapatan dan pajak perusahaan
menimbulkan ketidakpuasan
• Kedua pajak mempengaruhi keputusan
ekonomi : keputusan investasi yang tidak
bijak, disinsentif untuk bekerja, tabungan
kurang dan meminjam lebih banyak.
• Tax reform : pajak pada konsumsi (bukan
pendapatan)

21-2
 Efficiency and Equity of Personal
Consumption Taxes
• Efficiency issues
– An income tax and saving and labor supply
decisions
– A consumption tax and saving and labor supply
decisions

21-3
 Efficiency and Equity of Personal
Consumption Taxes
• Equity issues
– Progressiveness
– Ability to pay
– Annual versus Lifetime Equity
• A numerical example
• A formal model

21-4
 Retail Sales Tax
• General sales tax
• Selective sales tax (excise tax or differential
commodity tax)
• Forms of a sales tax
– Unit tax
– Ad valorem tax

21-5
 State and Local Sales Tax Revenues by
Source ($ billions)

Source: US Bureau of the Census. [2008c]

21-6
 Rationalizations
• Ease of administration
• Defining the tax base
• Tax evasion

21-7
 Efficiency and Distributional
Implications of States Sales Taxes
• Differential versus uniform tax rates
• How to set rates
– Efficiency goal only
– Equity goal
• Externalities
• Sales taxes as substitutes for user fees
• “Sin” taxes
• Information requirements for differential tax rates

21-8
 A National Retail Sales Tax
• Arguments in favor
– Simplicity
– Ease of compliance
• Arguments Against

21-9
 Value-Added Tax
• How a value-added tax works
• VAT as an alternative method for collecting
retail sales tax

21-10
 Implementation Issues
• Treatment of investment assets
– Consumption-type VAT
• Collection procedure
– Invoice method
• Rate structure

21-11
 A VAT for the United States?
• Desirability of VAT depends on…
– What tax (or taxes) it will replace
– How revenues will be spent
• Political implications of VAT’s revenue
raising prowess
• International implications

21-12
 Hall-Rabushka Flat Tax
• Business tax
– Tax base = Sales – purchases from other firms – payments
to workers
– Pay flat tax rate on final amount
• Individual Compensation tax
– Tax base = Payments received by individual for their labor
services
– No additional deductions
– Apply selected tax schedule
• Why is H&R tax a consumption tax?

21-13
 Cash-Flow Tax
• How a cash-flow tax works
• How to compute annual consumption
– Cash-flow basis
– Qualified accounts

21-14
 Consumption Taxation

Advantages Disadvantages
• No need to measure • Administrative
capital gains and problems
depreciation • Transitional issues
• Fewer problems with • Gifts and bequests
inflation
• No need for separate
corporation tax

21-15
 Problems with Both Systems
• Defining consumption
• Choosing the unit of taxation
• Choosing the rate structure
• Valuing fringe benefits
• Determining method for averaging over time
• Taxing home production
• Discouraging incentive to participate in underground economy
• Real world versus ideal tax systems
• Policy Perspective: President’s Advisory Panel on Federal Tax
Reform

21-16
 Wealth Taxes
• Justifications for taxing wealth
– Large accumulations of wealth should be taxed
– Correct problems with administration of income
tax
– Higher wealth implies higher ability to pay
– Reduces the concentration of wealth
– Payment for benefits received from government

21-17
 Estate and Gift Taxes
• Rationales
– Payment for services
– Reversion of property to society
– Incentives
• Recipient versus donor behavior
• Work
• Saving
• Form of bequest
– Relation to personal income tax
– Income distribution

21-18
 Provisions of the Unified
Transfer Tax
Gross Estate
- Charitable Contributions
- Funeral Expenses
- Costs of Settling Estate (lawyer’s fees)
- Outstanding Debts
- Lifetime Exemption
- Qualified Transfers to Spouse
- Annual Gift Exclusion
Taxable Estate
* tax rate
Tax
21-19
 Special Problems
• Policy Perspective: Death of the Death Tax?
• Jointly held property
• Closely-held businesses
• Avoidance strategies
– Insurance trust
– Gifts of stock

21-20
 Reforming Estate and Gift Taxes
• Integrate with personal income tax
• Accessions tax

21-21
 Prospects for Fundamental
Tax Reform
• Broad versus piecemeal changes

21-22
 Gross Estate
• All decedent’s assets at time of death, including real
property, stocks, bonds and insurance policies, plus
gifts made during decedent’s lifetime
• Typically valued at market value at date of death;
valuation may be set 6 months later if value of estate
declines
• Closely held businesses and farms are valued at “use
value;” this can reduce estate value by up to $770,000

21-23
Annual versus Lifetime Equity – A Numerical Example

Parameters
Mr. Grasshopper Ms. Ant
Income tax rate = 50% Income Consumption Income Consumption
Consumption tax rate = 50% tax tax tax tax
Interest rate = 10%
Income period 0 $1,000 $1,000 $1,000 $1,000
Consumption period 0 $500 $500 $0 $0
Taxes period 0 $500 $500 $500 $0
Income period 1 $0 $0 $50 $100
Consumption period 1 $0 $0 $525 $550
Taxes period 1 $0 $0 $25 $550
Present Value of taxes $500 $500 $523 $500
paid

21-24
Annual versus Lifetime Equity – A Formal Model

Parameters
Income tax rate = t Income Tax
Consumption tax rate = tc Mr. Ms. Ant
Interest rate = r
Grasshopper
Income period 0 I0 I0
Consumption period 0 c0G c0A
Taxes period 0 tI0 tI0
Income period 1 r(I0 – c0G) r(I0 – c0A)
Taxes period 1 tr(I0 – c0G) tr(I0 – c0A)

21-25
 Annual versus Lifetime Equity – A Formal Model

Parameters
Consumption Tax
Income tax rate = t
Mr. Grasshopper Ms. Ant
Consumption tax rate = tc

Interest rate = r
Present Value of I0 = c0G + c1G/(1 + r) I0 = c0A + c1A/(1 + r)
Lifetime Income
Present Value of RcG = tcc0G + tcc1G/(1 + r) = RcA = tcc0A + tcc1A/(1 + r) =
Lifetime Tax
Liability tcI0 tcI0

21-26
How a Value-Added Tax Works

VAT at 20
Value Percent
Producer Purchases Sales Added Rate
Farmer $ 0 $400 $ 400 $ 80
Miller 400 700 300 60
Baker 700 950 250 50
Grocer 950 1,000 50 10

Total $2,050 $3,050 $1,000 $200

21-27
 Policy Perspective: President’s Advisory Panel
on Federal Tax Reform
• Simplified Income Tax (SIT)
• Growth and Investment Tax (GIT)

21-28
 Policy Perspective: President’s Advisory Panel
on Federal Tax Reform
• Common features
– Eliminate individual and corporate alternative minimum tax
– Replace standard deduction, personal exemption, earned income tax credit, and
child tax credit with “Family Credit” and “Work Credit”
– Replace mortgage interest deduction with mortgage tax credit
– Reduce tax preference for employer-sponsored health insurance
– eliminate deductibility of state and local taxes
– Reduce number of tax brackets
– Reduce maximum tax rate to 33% under SIT and 30% under GIT
– Create savings plans (Save at Work, Save for Retirement, Save for Family)
• GIT allows business to expense investments, lowers tax rates
on business, and imposes single, low tax rate on dividends,
interest and capital gains

21-29