Accommodating the "Low-Income" in a Cash-Flow or Consumed Income Tax World

Abstract

I presented an outline of this paper to a meeting of the Tax Structure and Simplification Committee of the Tax Section of the American Bar Association in August, 1993, and a draft of the paper to a University of Virginia law school workshop.

Copyright © 1995 by George K. Yin. All rights reserved.

This article concerns a tax policy issue of keen current interest: the possible replacement of the income tax with a broad-based tax on consumption. The leadership of the new 104th Congress has promised early scrutiny of consumption tax proposals.
The weak link of most consumption tax plans relates to how they would distribute the tax burden across income classes. Critics charge that consumption taxes are regressive or at least not as progressive as the existing income tax. Many theorists believe, however, that one form of broad-based consumption tax, a cash-flow or consumed income tax, is immune to such criticism because it is an individualized consumption tax and could be implemented in a manner very similar to the income tax. Supporters of the cash-flow tax assert that it is flexible enough to attain any desired degree of progressivity.
In this article, I examine that proposition. Focusing on the impact of the cash-flow tax on low-income taxpayers, I conclude that it would be surprisingly difficult to fashion a cash-flow tax as redistributive at the lower end of the income scale as the current income tax system while still preserving the asserted advantages of the cash-flow tax. Although it may still be advisable to move towards a cash-flow tax system, it is important for policymakers to recognize the inherent limitations of such a system for achieving progressivity at the lower end of the income spectrum.