Experts Caution Panel on Consumption Tax

A poorly designed tax system overhaul to make the current income tax more like a consumption tax (search) would be "the worst of all worlds," experts told a presidential commission Wednesday.

Bob Greenstein, founder and executive director of the Center on Budget and Policy Priorities (search), told the President's Advisory Panel on Federal Tax Reform (search) not to add consumption tax features, such as large tax-free savings accounts, to the income tax.

"That approach, I think, is the worst of all worlds," he said. "It's sort of a 'what not to do.'"

William Beach, director of the data analysis center at The Heritage Foundation (search), agreed. "The motto is, tax all income once and at its source," he said.

The panel, formed by the president to recommend ways to make taxes simpler and fairer, reports its findings this summer. It has been studying changes to the income tax and the possibility of adding a consumption tax, such as a national sales tax or a European-style value-added tax.

Federal Reserve Chairman Alan Greenspan (search) has told the panel that some form of consumption tax could spur greater economic growth, but he cautioned that the government would face significant problems making the transition to such a system.

The panel's vice chairman, former Louisiana Sen. John Breaux, has said a hybrid between taxes on income and taxes on spending has merit and should be studied carefully.

Greenstein warned that one of the biggest advantages of a consumption tax — its potential to spur economic growth — would be lost in a poorly redesigned income tax. Such a change would be costly for the government.

Adding significant incentives for tax-free savings would also put more pressure on families that earn income through work and earn little from investments, and "you end up with a wage tax," he said.

Louisiana Treasurer John Kennedy said the panel should keep in mind that his state, and many others, already rely on sales taxes for a portion of their tax revenue.

"Adding a sales tax at the federal level on top of this will impact both business and consumers. That's just a fact," he said.

The tax experts were summoned to offer their thoughts on fairness in tax laws and how that concept should be measured.

Breaux said the tax system has long assumed that taxes should be levied according to a person's ability to pay, and that taxes should apply consistently to people of similar means.

"There is no consensus among tax experts, politicians or taxpayers on how to define fairness," Breaux said. "In fact, much of the complexity in the tax code is a result of numerous attempts to distribute tax benefits among taxpayers based on imprecise notions of fairness."

One feature added to the tax code to promote fairness is the earned income tax credit, known as EITC, which aims to pull low-income workers out of poverty. However, the credit is so complicated that 72 percent of its recipients pay a tax professional to prepare their returns, the panel was told.

Tax laws also include myriad incentives for education, health care, charitable giving and retirement savings.

David Marzahl, executive director at the Center for Economic Progress (search), said the tax code won't be entirely simple as long as lawmakers include items to promote fairness.

"It may beget complexity, but we feel that is not a bad thing," he said.

Breaux gave witnesses a glimpse of where the panel might be headed on questions of fairness, asking witnesses for more information about how the tax laws might help people buy health insurance and how to streamline the retirement savings incentives to help people use them.

Panel member Elizabeth Garrett — a public interest law, legal ethics and political science professor at the University of Southern California — said it's a question that can't be measured in the data but "ultimately it is a question of justice."