vol. 46, no. 12 (December), 1996, pp. 839-40.
Dan Mitchell's challenging remarks, particularly his reference to a "glaring error" concerning the tax status of saved income, provides an opportunity for dealing with a common point of confusion. I take Hall and Rabushka's Flat Tax (2nd ed.: Hoover Institution Press, 1995) to be ground zero for the modern resurgence of interest in simplifying our tax system. Hall and Rabushka (p. 55) leave little doubt about the status of saving in their proposed system:
Given the ex post macroeconomic identity between saving and investment, Hall and Rabushka could hardly fail to recognize the nature of their proposal: "Our proposal is based squarely on the principle of consumption taxation. Saving is untaxed..." (p. 54). Yet, Hall and Rabushka themselves are at least partly responsible for the current confusion. At critical points, they misleadingly write "income" instead of "consumption," and sometimes they write as if there were no difference between these two magnitudes. Although there are many such instances, I will cite just two. "The business tax...is carefully designed to tax every bit of income outside wages but to tax it only once" (p. 61). In fact, it is actually designed, as Hall and Rabushka had already stipulated, to tax only income net of investment, effectively converting the income tax to a tax on consumption. And virtually guaranteeing confusion, Hall and Rabushka explicitly affirm their "goal of taxing all income once at a common, low rate and achieving a broad consumption tax" (p. 63). This compound goal is simply at war with itself. Consumption and income are not the same thing; they differ precisely by the amount of income saved.
The confusion that has its roots in the original Hall and Rabushka proposal has caused Mr. Mitchell and undoubtedly others to see my exposition as involving a "glaring error." Some supply-siders leverage the confusion by insisting that "consumed income" is, in fact, what "income" actually means. Others offer the all-to-facile claim (not supported by Hall and Rabushka's basic logic) that saved income (or, alternatively, the yield on saved income) has already been taxed. These and other confusing claims stem from their using the rhetoric about taxing income once and only once in defense of a consumption tax. It is consumption, not income, that (beyond the generous personal exemptions) is taxed once and only once.
Several other points of disagreement raised by Mr. Mitchell are resolved once the tax status of investment (and hence saving) is established. For instance, there undoubtedly would be efforts in the private sector to disguise part of the (taxable) net income as (nontaxable) investment as well as efforts by the government to counter such attempts at tax avoidance.
Mr. Mitchell points to the vulnerability of our current system to the "divide-and-conquer tactics" of politicians trying to raise tax rates but fails to acknowledge that Hall and Rabushka's generous personal exemption, which converts flatness into progressivity, would seriously weaken taxpayer solidarity and expose their proposed system to those same divide-and-conquer tactics.
Remaining differences between Mr. Mitchell's views and my own are matters of perspective and judgment. Yes, some-maybe most-supply-siders would prefer tax reductions, but their willingness-even eagerness-to propose revenue-neutral or revenue-enhancing reform suggests their priorities lie elsewhere. And yes, given the complexities of the current system, there is plenty of room for reform in the direction of tax simplification. TANSTAAFL does not deny that some lunches are cheaper than others; TANSTAABST (There ain't no such thing as a big simple tax.) should be interpreted analogously. My arguments do suggest that a tax system involving (1) post-card-size tax forms and (2) the transferring of hundreds of billions of dollars from the private sector to the public sector is (not-so-unhappily) outside the realm of possibility.
Roger W. Garrison