Commentary: Beyond Bush: A Simple Plan to Tax Consumption

By Peter Coy

President George W. Bush's top economic adviser, R. Glenn Hubbard, has singled out David F. Bradford for his work in "fundamental tax reform." For good reason. The 64-year-old Princeton University and New York University School of Law professor is a 30-year advocate of taxing consumption and not savings, a policy promoted by the Administration. In the mid-1970s, he served as deputy assistant secretary for tax policy in Gerald Ford's Treasury Dept. He led a study, Blueprints for Basic Tax Reform, that inspired Ronald Reagan's sweeping tax reform in 1986. And he returned to Washington in 1991 for a stint on the Council of Economic Advisers during the first Bush Administration.

Yet Bradford, of all people, is surprisingly lukewarm about the Bush tax plan, which would accelerate income-tax cuts, end the double taxation of dividends, and expand tax-advantaged savings plans. First, he's concerned that it will cut government revenues too drastically. ("I'm a deficit hawk," he says.) Second, Bush's plan goes only halfway toward being a consumption tax, he argues, making the tax code even more complex and easier to evade without encouraging saving. Says Bradford: "We should go for the whole shebang."

The Princeton prof agrees with the White House that today's tax code hinders growth. The reason: It taxes savers twice. They pay tax on their original income, and then again when the money they have saved produces income such as dividends and interest. In contrast, spenders pay tax only on the original income.

Bradford has a solution. Since the 1970s, he has argued that the government should exempt from taxation all dividends, interest, and other income from savings. That way, people will be treated equally by the tax system, whether they choose to spend now or save to increase their future spending power.

One system that does exactly what Bradford advocates is the flat tax, introduced in the early 1980s by Stanford University economist Robert E. Hall and Hoover Institution political scientist Alvin Rabushka. Although their flat tax is best known for its single "flat" tax rate for all income brackets, its most important feature is that it eliminates taxes on income earned through savings. And since interest earned on savings isn't taxable, then interest paid on borrowing isn't deductible.

Democrats complain that a flat tax would tax the rich and poor at the same rate. So Bradford came up with the X tax, a variation that keeps the savings treatment of the flat tax but adds a graduated rate schedule: People with higher incomes pay higher rates. In other words, it's a "flat tax" that isn't flat. But Bradford wasn't interested in flatness in the first place.

As he and University of Michigan economist Joel B. Slemrod observed in a 1996 guide: "[F]lat is not always a good thing. Just think of beer, musical notes, or tires."

Bush's plan is messier than Bradford's. It adds the tax breaks of a flat tax or X tax system while keeping the tax breaks of today's system. Notably, Bush wants to preserve the deductibility of interest payments such as home mortgage interest. That's politically sensible, but it means that taxpayers could continue to load up on debt and put money into new tax-advantaged assets. That would cut government revenue without increasing net savings.

Politically, it doesn't matter that one economist is demurring from the Bush plan. Bradford has stayed quiet about his views, at least until BusinessWeek questioned him. And he's the first to agree that his X tax is a long shot. But at least his proposal has intellectual coherence--something that's lacking in the Bush plan.

Coy is Economics Editor.

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