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An Income Tax, Not A Wage Tax:Comments on “A Fair and Simple

Tax System for Our Future”

Peter R. Orszag

Co-Director, Tax Policy Center

January 31, 2005

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Moving back to an income tax

• Tax changes over past several years have been moving toward taxing only labor income, not capital income

• This proposal would move the system back toward a true income tax– 1986 reform also moved in this direction, by

reducing capital income preferences

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Wage tax vs. consumption tax• Consumption tax: Tax break only for new

saving, not for existing capital – Imposes tax on existing assets and future wages

(two sources of financing for consumption)

• Bulk of economic benefit from consumption tax derives from tax on existing assets

• Without tax on existing assets, result is simply a wage tax– All the regressivity of a consumption tax, little or

none of the economic benefits

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Using broad tax reform to boost saving: A flawed approach

• Aim of consumption/wage taxes: Boost new saving by reducing tax burden imposed on it

• Flaw: Especially at top of income distribution where bulk of tax benefit is provided, tax preferences generate little new saving – Asset shifting, not new saving– Regressive without significant beneficial impact on

saving

• This proposal correctly moves in opposite direction

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A better approach: Two key steps

• Make it easier to save– Evidence showing significant effects from automatic

enrollment and automatic escalation (automatic 401k)

• Level the playing field for tax-preferred saving– Evidence that contributions made by lower-income

workers more likely to be net addition to saving– Yet current system provides larger incentives to

higher-income workers– Universal credit to level the playing field

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Level the playing field$100 deposited by:

Immediate tax saving under

current system

Immediate tax saving under CAP proposal

High-income family

$35 $25

Middle-income family

$15 $25

Low-income family

$0 $25

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Conclusions

• Among its many features, proposal highlights need to fundamentally re-think how we encourage private saving

• Represents very useful contribution to tax reform and retirement security debates