Federal Reserve Chairman Alan Greenspan (search) on Thursday gave his support to an overhaul of the U.S. tax code and said some form of a consumption tax — such as a national sales tax — could help the economy, but he cautioned that the government would face significant problems making such a transition.
The central bank chief made his comments in prepared remarks to the President's Advisory Panel on Federal Tax Reform. Revamping the complex tax code is an important goal of the Bush administration.
Greenspan pointed out the merits of a "consumption" tax, as well as the challenges of setting up such a tax. Consumption taxes can take the form of national retail sales taxes (search) or a value-added tax, imposed on the increased value of a good or service at each stage of manufacture and distribution and ultimately passed on to the consumer.
"As you know, many economists believe that a consumption tax would be best from the perspective of promoting economic growth — particularly if one were designing a tax system from scratch — because a consumption tax is likely to encourage saving and capital formation," Greenspan said.
"However, getting from the current tax system to a consumption tax raises a challenging set of transition issues," he added.
Bush's advisers have spoken favorably of the economic benefits that could be achieved by moving from a system that taxes income to one that taxes consumption. However, Democratic critics contend such a consumption tax would hit low-income Americans the hardest.
Bush's aides have pointed out that the current tax system is actually a combination of a system that taxes income and one that taxes consumption. They note the creation of individual retirement accounts and other tax-deferred savings accounts allows taxpayers to shelter some investment earnings from tax.
The tax panel is responsible for coming up with recommendations to make taxes fairer and simpler. In addition to revamping Social Security (search), Bush wants to overhaul the nation's tax system — two centerpieces of his second-term economic agenda.
In his remarks, Greenspan also backed the goal of simplifying the tax code and said previous overhauls, including the most recent revamp in 1986, could provide guidance on how to proceed.
"Since the exemplary 1986 reform, the tax code has drifted back to be overly complicated and burdened by higher marginal rates and by many special provisions that have undesirably narrowed the tax base," the Fed chief said.
"A defining feature of the 1986 reform was the broadening of the tax base and the lowering of tax rates, and it is widely believed that these changes enhanced economic efficiency," he added.
Greenspan didn't offer a specific approach for policy-makers to follow as they consider an overhaul of the tax code.
But he did say that changes should be aimed at making the tax code easier for Americans to navigate, be fair and should contain an element of predictability so that businesses and consumers alike can look into the future and have a good idea what their tax obligations are — allowing them to plan ahead.
"A simpler tax code would reduce the considerable resources devoted to complying with current tax laws, and the freed up resources could be used for more productive purposes," Greenspan said.
Reuters and the Associated Press contributed to this report.