Pay Up, Big Spenders

By Charles P. Alexander

Growing calls for a consumption tax that would spur saving

In the law that every Boy Scout must learn, the word "thrifty" comes right before "brave, clean and reverent." Yet when a Scout grows up and runs into the U.S. tax code, he finds that a different law is in effect. Uncle Sam rewards big spenders much more than those who save. If a person earns $1,000 and spends it, that income is taxed only once. But if he saves the $1,000, he generally pays additional taxes on the interest the money earns. The combined impact of taxes and inflation can make saving a money-losing proposition. Borrowing, in contrast, is a savvy strategy because interest payments on debt are usually tax deductible.

Many economists argue that the tax burden should be rearranged so that it weighs more heavily on the spendthrift than on the thrifty. That change, they say, would stimulate the savings and investment the U.S. needs to revitalize its economy. Congress took a step in that direction in 1981 by allowing all income earners to set aside a limited amount of money in tax-deferred Individual Retirement Accounts. Now momentum is beginning to build in favor of a more sweeping change: a new tax on consumption that would gradually replace part or all of the present income tax system.

More and more prominent economists, mostly conservatives, are endorsing a consumption tax. They include Princeton's David Bradford, James McKie of the University of Texas, Stanford's Michael Boskin, and Alan Greenspan, who was chief economic adviser to President Gerald Ford. The idea is also bubbling within the Administration. Martin Feldstein, chairman of the Council of Economic Advisers, calls the consumption tax "appealing." Says Treasury Secretary Donald Regan: "In the long run, we have to have fewer taxes on savings. A move toward consumption taxes will probably be an absolute necessity if the U.S. is to remain competitive with other industrial nations."

A big impetus behind the consumption-tax movement is this year's projected federal budget deficit of $210 billion, which could distort and cripple the economic recovery by forcing up interest rates. Since serious spending reductions do not seem possible in the present political climate, the only alternative is the collection of more tax revenues. Economists, though, are afraid that higher income taxes would discourage savings and investment even more. Says Mark Bloomfield, executive director of the American Council for Capital Formation, a Washington tax-lobbying group: "The income tax has reached its limit in raising revenue productively. It's impossible both politically and economically to ride it any further."

Several ways of taxing consumption are being discussed. One option is the value-added tax (VAT), which is used in most West European countries. The VAT is similar to a national sales tax, except that it is paid at every link in the production and distribution chain as more value is added to a product. A furniture store, for example, pays a tax on the sofas that it buys from a manufacturer, and consumers pay the tax when they purchase the couches in the store. The VAT is also levied on services such as hairdressing, home repairs and car rentals.

A major drawback of the VAT is that it can boost inflation. After Prime Minister Margaret Thatcher raised Britain's VAT from 8% to 15% in June 1979, the British inflation rate, fueled in part by the higher tax, surged from 11.4% to a peak of 21.9% in May 1980. VAT opponents have argued that it is unfair to the poor, who must spend a larger part of their income than the rich. To moderate this regressive effect, some European countries charge 30% or more on such luxury items as television sets and cosmetics but levy no tax on basic foods and medicine. The VAT has become an important source of revenue for European nations, but no evidence has been found that it has significantly raised investment levels.

Feldstein, among others, has outlined another approach to taxing consumption that would revamp the present system of income tax filing. A taxpayer would add up all receipts for a year, including wages, interest, dividends, loans and proceeds from the sale of assets like stocks. Before determining his taxable income, however, he would subtract all money put into savings or investments. Anything taken out of savings and not reinvested would be added to income. In short, an individual would be taxed only on what he spent and not on what he saved.

The public would be less than enthusiastic about a new tax, even if it were billed as a replacement for existing taxes. Observes Edgar Fiedler, a vice president of the Conference Board, a nonprofit business-research organization in New York City: "No matter how carefully it was explained, there would be ten taxpayers whose intuition told them their taxes were going to be higher for every one who calculated that his would be lower."

Partly because of the political risks, few members of Congress have openly championed a consumption tax. Lawmakers remember that twelve-term Democratic Congressman Al Ullman of Oregon called for a VAT in 1978 and lost the next election after his opponent made the new tax a campaign issue. On Capitol Hill, the VAT is sometimes referred to as the "Al Ullman Memorial Tax." President Reagan is intrigued by the consumption-tax concept but is said to feel that it would be too complicated to explain to the voters, at least before 1984.

Democratic Presidential Candidates Walter Mondale and Gary Hart are supporting an alternative plan proposed by Senator Bill Bradley of New Jersey and Congressman Richard Gephardt of Missouri that would bring down the highest tax rates but boost Government receipts by curbing tax deductions for middle-and upper-income people. Like the consumption tax, the Bradley-Gephardt plan will have rough going in Congress.

Supporters of the consumption tax are confident that it is an idea whose time will eventually come. They argue that when future Administrations or congressional budget committees start looking for new revenue sources, they will be forced to come back to a consumption tax. Says former Treasury Secretary John Connally, who has put together many political deals: "A consumption tax can be sold. It all depends on who's behind it and how it's packaged."

--By Charles P. Alexander. Reported by David Beckwith/Washington and Cristina Garcia/New York

With reporting by David Beckwith, Cristina Garcia This file is automatically generated by a robot program, so viewer discretion is required.