In this time of huge budget deficits and high unemployment, the attractiveness of the savings-exempt income tax is that it raises revenue with far less damage to the economy than the existing tax system.
This means that, over the years, we will see a faster growing economy. The benefits will be threefold: more people at work, lower federal outlays for unemployment payments, etc., and more income to the Treasury from growing tax base with no future change in tax rates.How do we achieve all these good things? Not by tinkering with the details of the Internal Revenue Code. We must overhaul the present income tax so that it exempts savings, which is the seedcorn for economic expansion. I do not advocate a new tax, such as a VAT, but a sea change in the existing income tax structure.
For the individual taxpayer, the proposal is straightforward. Continue reporting your income. But, on a new schedule, list all your savings during the year. Deduct savings from income and you pay tax only on the remainder. The result is a progressive-rate tax on income minus savings.
The idea is to tax income when it is spent instead of when it is received. You can also call it a consumed-income tax. But don't jump to the wrong conclusion. This is not a regressive sales tax. The rate structure can be as progressive as Congress wants to make it.
Exempting savings from the income tax encourages thrift and enterprise, which means a stronger economy. The money to invest in a more productive and competitive economy, with a higher rate of job formation, comes fundamentally from our saving.
The money we save doesn't sit idle. It works for us by being invested in stocks, bonds and bank accounts - which provide interest or dividends - and in homes that provide us shelter. In the process of saving and investing, we generate the forces that create more production of goods and services, more employment and a higher living standard. More capital formation will also enhance our competitiveness in an increasingly global marketplace.
A general consumption-oriented tax has not been adopted in the United States because the debate has focused on a very different kind of tax, a value-added tax or VAT, which is a sophisticated sales tax. The VAT is regressive. That regressivity can only be reduced by making it more complicated.
However, the savings-exempt income tax is not regressive at all. Like the existing income tax, each taxpayer faces a progressive rate table. Under a revenue-neutral shift from the traditional income tax, the average taxpayer experiences no change in tax burden. However, above-average savers pay less than they do now and below-average savers pay more.
A savings-exempt income tax will initially raise the same amount of revenue as the income tax system that it displaces. Over the years, however, it will generate more money for the Treasury because it encourages more saving to finance additional investments in a growing economy. This is one of the few pain-free ways of reducing the budget deficit!
On the positive side, a stronger economy will do more than generate more revenue. It will require fewer food stamps and less need for unemployment benefits. A stronger economy generates a double whammy: a lower budget deficit and a higher level of employment.