Valuing Personal Consumption: Cost Versus Value and the Impact of Insurance

Abstract

"An ideal income tax would perhaps differentiate among individuals according to their talents for using funds in consumption; but ... income taxes must [be based upon] measurable quantities! ... [c]onsumption, as an element of income, must be measured ... by outlays for consumption purposes."

Andy is excited. He has finally been able to get the money together for an expensive new car. After years of making do with a used car or cheaper models he is about to pick up a new $50,000 Mercedes sedan. But alas! Andy's dream of years of driving comfort are soon shattered. The car is a lemon. It is constantly in the shop for repairs wasting Andy's time and eventually costing him several thousand dollars. In the end, it never drives as well as expected.
Would an ideal tax system, as Simons suggests, take some account of Andy's misfortune? Should we, if we could, somehow determine what the car is really worth and allow Andy a deduction for the difference between that amount and his outlay of $50,000? Alternatively, should we ideally allow a deduction for the extraordinary cost of repairs, the amount spent  beyond what would normally be expected? Is our failure to take account of Andy's misfortune a concession to administerability rather than a matter of principle? This article explores the answer to that question as well as whether recoveries, from insurance or otherwise, should be taxable, if such losses are disallowed.
There are a number of reasons why there might be a great deal of difference between the amount of enjoyment derived from a consumer purchase and the cost to the individual on the market. Consumer surplus, circumstance of use, variation in quality, events subsequent to purchase, and changes in market price may explain the discrepancy between actual enjoyment and cost.