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Comments on John B. Shoven and John Whalley, "Irving Fisher's spendings tax in retrospect"
American Journal of Economics and Sociology, The, Jan, 2005 by Michael J. Graetz
John Shoven and John Whalley are certainly correct in their two basic observations concerning Irving Fisher's contribution to the tax policy debate nearly six decades ago. First, Fisher was far ahead of his time substantively. His detailed treatment in his 1942 book Constructive Income Taxation of what we now call a personalized progressive consumption tax could have served as the blueprint for the "USA" ("unlimited savings allowance") tax (a progressive consumption tax) introduced in 1995 by Senators Sam Nunn (D-GA) and Pete Domenici (R-NM). Indeed, that tax would have avoided much complexity and many pitfalls had it simply followed Irving Fisher's recommendations of how to treat borrowing (Ginsburg 1995; Warren 1995).
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Second, Shoven and Whalley properly remind us that Irving Fisher's contribution in detailing how to implement a progressive tax on consumption has largely been lost. The intellectual history of this subject usually goes back only as far as Nicholas Kaldor's 1955 book The L3cpenditure Tax, even though, as Shoven and Whalley point out, Kaldor himself made extensive references to Fisher's work. In fact, neither William Andrews's influential work nor my own detailed article on implementing a progressive consumption tax refer to Fisher's contribution (Andrews 1974; Graetz 1979), although we all agree about the proper resolution of many of the issues Fisher discussed.
I
Taxing Consumption Rather Than Income
IN THE POLITICAL ARENA, Irving Fisher was not the only member of the Yale economics department to play a key role in advocating a tax on consumption. Thomas Sewall Adams apparently was responsible for Congressman Ogden Mills's proposal for a "spendings" tax in 1921. (Mills, then a congressman from New York, later served as Herbert Hoover's Secretary of the Treasury.) Unlike Fisher, Adams played a key role in the tax legislative process during the early decades of the income tax. Not surprisingly, one finds in Adams's writings considerably greater sensitivity to the political difficulties of writing a tax law, to the pushes and pulls of tax politics (e.g., Adams 1928).
During the 1921 debate, Chester Jordan, a public accountant from Portland, Maine, told the Senate Finance Committee that he could reduce the size of his accounting firm from eight to three members if Congress only would substitute a tax on "spendings" for the income tax (1,2) (Reams, Jr. 1979). After Congress refused to go along, the demand for Chester Jordan's services grew, he changed his name to Price Waterhouse, and the rest is history. (I made that last part up, of course, but it should have happened that way.)
So even in the 1920s, taxing consumption rather than income was not a new idea. As Fisher emphasized, John Stuart Mill had favored taxing consumption. Alexander Hamilton also had only praise for consumption taxes. Hamilton claimed that with consumption taxes people could choose how much to pay; as he put it, "the rich may be extravagant, the poor may be frugal."
In 1942, the same year that Fisher's book Constructive Income Taxation was published, Franklin Roosevelt's Treasury secretary Henry Morgenthou advanced a progressive-rate tax on spendings as the way to finance World War II, but Congress once again rejected a consumption tax. (3) Instead, the Revenue Act of 1942 began the conversion of the income tax, which had applied only to high-income people, into a tax on the masses. Had this episode turned out differently, the income tax might have remained narrowly targeted to high-income people, and a consumption tax might have become the federal government's mainstay revenue producer. Although Fisher's goal of taxing consumption rather than income has been kept alive in the economics and legal literature, only recently has the idea of substituting a tax on consumption for the income tax reentered the national political debate.
Shoven and Whalley make the important--and surely true--point that there is great opportunity for more neutral taxation of income from capital by moving either in the direction of a consumption tax, as Fisher urged, or by revising the income tax. Shoven and Whalley illustrate distortions in the taxation of capital income within the current income tax, emphasizing the disparity between the overtaxation of corporate investment and the undertaxation of housing.
The comprehensive business income tax (CBIT) proposal, described in Shoven-Whalley, was developed by the Treasury Department while I served as Deputy Assistant Secretary (Tax Policy). In my view, CBIT is feasible and would be an important move in the right direction. It would simplify individual taxes by moving much of the tax collection of capital income taxes to the business level, thereby replicating one of the main advantages of sales and value-added taxes. As Shoven and Whalley point out, adjusting depreciation allowances within CBIT, or allowing for expensing of capital income taxes, would turn this tax into a consumption tax, which would impose no burden on new capital investments. Indeed, if under CBIT an immediate deduction for purchases of capital assets were allowed, the tax would essentially become a subtraction-method VAT.
