The tax reform revolution: "the four approaches to tax reform—flat, USA, national sales, and value-added—all are variations on the same theme. All would shift the base of Federal taxation from income to consumption while simplifying the process of complying with tax law."

USA Today (Society for the Advancement of Education), Jan, 2005 by Murray Weidenbaum

The flat tax would be much simpler than the current income tax. A key reason is the absence of "transition" rules. For example, with the substitution of a flat tax for the current income tax, the holders of municipal bonds (on which the interest is exempt from Federal income tax) would experience a substantial reduction in the market value of their portfolios. That is likely because investors buy these low-yielding "munis" for their unique tax-exempt feature--but all interest would be tax-exempt for individuals under the flat tax. Thus, the loss of this special characteristic would reduce the value of municipal bonds substantially.

Unlike the other variations of consumption taxation, the flat tax on business covers all domestic operations, including sales and exports. Likewise, all purchases (including capital equipment) are deducted from taxable revenue, including imports.

The Savings-Exempt Income Tax. The proposed USA tax (or consumed income tax, as technicians often refer to the concept) would be collected much as income taxes are now. The annual taxpayer return would continue to comprise the heart of the collection system, and a rate table accompanying the return could ensure as progressive a tax structure as Congress desires. However, one major change would be instituted. The portion of income that is saved would be exempt from taxation--until it is spent.

The difficult bookkeeping requirement to tally all consumption outlays can be finessed quite simply. Based on the notion that income equals consumption plus savings, consumption readily can be estimated, indirectly but accurately, merely by deducting savings from income.

A companion shift to the adoption of a top-down consumption tax would be the conversion of the corporate income tax to a cash-flow tax on business. A major change--and one that would encourage investment--would be to expense, or write off, all capital investments, such as purchases of production equipment and factories in the year in which they are acquired. At present, these outlays are deductible on the income tax over the useful life of the asset, which is a period of several years or even decades.

In many ways, such a business version of the consumption tax would be simpler than the existing corporate tax. For example, by focusing on cash flows, it would avoid the complicated transfer pricing arrangements under which domestic subsidiaries of foreign corporations minimize their U.S. tax payments.

Although these changes may sound quite technical, a top-down consumption tax would be a move toward simplification. In effect, the major substantive change for the individual taxpayer would be to convert the complicated Individual Retirement Accounts (IRAs) to an unrestricted savings mechanism. The individual taxpayer would decide how much to save and in what form and over what time period. Taxation based on income is by its nature more complicated than extracting revenues from consumption. Income taxation is inherently complex for many reasons. Complicated timing rules are necessary, such as depreciation allowances, capitalization of expenses, and inventory accounting. Inflation distorts the tax base by eroding the value of depreciation allowances and overstating the real value of capital gains. Being based instead on cash flow, taxation of consumption automatically avoids these difficulties.