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Providers of Consumer Goods and Services
Financial and Tax-Related Services
This topic focuses on how various taxpayers may be affected by the tax reform proposals and how they may have to act in relation to the issues and results.
From a political perspective, consumption tax proponents will succeed only if they can
convince a substantial majority of taxpayers (both individuals and businesses) that the
taxpayers will be better off under a consumption tax system. If taxpayers do not feel that
they will be better off, they will strongly oppose the change. The concerns various
individuals and businesses may have about tax reform proposals reflect the political traps
ahead for Congress. Many of these concerns cut across income groups, industries, and
regions.
Proponents of a consumption tax believe that a shift from a system that supports
consumption to a system that does more to promote savings and investment benefits
everyone. Others believe that the adoption of a consumption tax is incompatible with the
American desire to be a leader in a world economy that is increasingly service-oriented
and dependent on increased consumption. It is clear that, given the budget constraints
Congress faces, any restructured tax system must raise about the same amount of revenue as
does the current system. As a result, unless the economy expands dramatically in response
to tax restructuring, generally for every individual or business that is a
"winner" there will be an offsetting "loser."
It is much too early for any individuals or businesses to conclude that fundamental tax
reform would be to their advantage or would hurt them. Until Congress fully debates all
possible alternative tax systems, it would be premature to put together a definitive list
of winners and losers.
Ultimately, who wins and who loses with any new consumption tax will depend on several
factors, including (1) the tax rate ultimately agreed to, (2) the precise levels of basic
and additional standard deductions, (3) the composition of a taxpayer's family (for
example, are there dependent children?), (4) the taxpayer's mix between investment and
wage income, and (5) the extent to which the proposal allows lower rates, exclusions, and
so forth for certain activities. In the rest of this chapter, we will identify several
categories of individuals and businesses that stand out as having a large stake in the
discussion of fundamental tax reform and the possible move to a consumption tax system and
will set out their concerns.
Taxpayers who are heavy consumers and regular borrowers, who are at a low savings point in their life cycle, or who are consuming previously amassed wealth may be losers. Both young families setting up new homes and elderly people living off of retirement assets, for example, might prefer to stay with an income tax rather than move to a consumption tax.
The roughly 17 percent of taxpayers with AGI between $50,000 and $200,000 claimed just over one half of all itemized deduction dollars in 1993, according to the Spring 1995 Internal Revenue Service Statistics of Income Bulletin. This group undoubtedly has the greatest anxiety about the elimination of any or all itemized deductions.
A particular concern of these individuals is the potential slide in their home values
should the home mortgage interest deduction be eliminated. Middle-class taxpayers
accounted for approximately $118 billion of the $203.9 billion in interest-paid deductions
in 1993. Similarly, middle-class taxpayers in states and localities with high tax rates
will be concerned about the loss of the ability to deduct state and local tax expenses. In
1993, this group accounted for $93 billion of the $175.4 billion in taxes-paid deductions.
Taxpayers who receive most or all of their income from going to the office every day may
ask whether it is fair that they are taxed on all or most of their income, while other
individuals whose only or major source of income is investing in the stock market are not
taxed at all.
In comparison, salaries and wages account for only 48 percent of the adjusted gross income
of high-income families with annual incomes above $200,000, compared to 82 percent of the
adjusted gross income of all other taxpayers. Capital gains, interest, and dividends
account for 26 percent of high-income taxpayers' AGI (all of which would be tax-free under
a consumption-based system) versus 7 percent of all other taxpayers' AGI.
If the top tax rate were as low as the 17 percent rate proposed by Armey, these
high-income individuals could be given a huge "tax break;" the subgroup of
highest-income taxpayers with incomes over $250,000 who now are in the 39.6 percent tax
bracket would be particularly favored. However, this high-income group, and all taxpayers,
might wonder whether fiscal conditions will allow rates to remain as low as they are in
the current proposals.
Providers of Consumer Goods and Services
Retailers, consumer credit companies, manufacturers of consumer goods, and other providers of consumer goods and services could be adversely affected. The announced purpose of a consumption tax is to tilt the balance away from consumption and toward savings. Businesses and individuals who are in the business of stimulating and meeting consumer demand will be concerned with the possibility of a consumption tax reducing demand for their products.
Businesses that are relatively labor-intensive and therefore are not now harmed by the capitalization of expenses could find that their tax burdens would increase in relation to those for capital-intensive firms that might benefit from the elimination of tax on capital income under a consumption tax.
Lower tax rates and a more comprehensive tax base could reduce the tax incentive for charitable contributions and lead to the imposition of tax (at least indirectly) on services charitable organizations buy or sell.
The life insurance industry and similar industries that essentially sell ways to take advantage of the current system could be fundamentally disrupted by adoption of a consumption tax. More subtly, industries such as the health care industry that operate in an essentially pre-tax environment in relation to their customers could find that advantage at risk.
The real estate sector already has begun a campaign to block elimination of the home mortgage interest deduction. It believes that such a move could lower the value of real estate and hurt the entire market. Armey and other flat-tax proponents reply that any adverse effect would be short-lived, because the imposition of a consumption-based system will lead to lower interest rates, which would benefit the housing industry.
The possible effect of tax reform on interest rates is critical to how the
various taxpayers view the reform proposals. Proponents believe that exempting investment
income from tax will lead directly to sharply lower interest rates. Many economists
question this. They observe that the United States is a net borrower in a world market and
that factors independent of U.S. tax rates determine interest rates.
Financial and Tax-Related Services
Some of the consumption tax proposals also would create problems for vendors of financial planning, tax, and accounting advice and services. The amounts and types of expertise currently provided to clients by tax advisors, financial planners, and investment advisors could be radically changed.
Brokers and bankers who deal in financial assets would seem to be big
winners in a consumption-based system that exempts capital investment. Under a consumption
tax, however, financial intermediaries might question whether it is fair for them to be
subject to a business tax at all. They may argue that their services should not be subject
to tax because imposing a consumption tax on these services is tantamount to taxing
savings. They may also question how the "value-added" component of financial
services as opposed to the purely financial gain would be measured.
Charges for financial services generally are blended with other elements of the
transaction. For example, banks may be compensated solely through the spread between
interest rates charged on loans and the interest rates paid to depositors. Many countries
using VAT systems exempt financial services for which there are no explicit fees. Because
financial services can be performed entirely outside the United States for a taxpayer
within the United States, it can be difficult to determine where the service took place.
Depending on the rules for border adjustability adopted in a new system, a consumption tax
on financial services could decrease compliance or discourage foreign use of U.S.
financial intermediaries.
State and local governments will be concerned with the federal government moving into their traditional tax base, a potential loss of the ability to effectively collect income taxes, and a change in their cost of borrowing. These concerns will become more acute as the federal government continues to discipline its budget by transferring responsibilities back to the states.
Some of the concerns discussed in this topic suggest that particular regions also may feel that they would be disproportionately affected by the adoption of a consumption tax. For example, retirement communities must worry about the purchasing power of retirees; they could face a substantial disruption if imposition of a VAT led older Americans to cut back on spending. Certain large cities that are centers for particular industries are concerned about possible effects on their industries; for example, both Chicago and New York have a strong interest in the health of the retail industry and the financial services sector. Smaller cities may be very concerned about the effects of certain proposals on major local employers; examples are Des Moines and Omaha, in which the life insurance industry is a substantial provider of high-paying jobs.
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