Joseph M. Dodge

Deconstructing the Haig-Simons Income Tax and Reconstructing It as Objective Ability-to-Pay 'Cash Income' Tax

This article argues that the classic Haig-Simons formulation of personal income, namely, an individual’s consumption plus net increases in wealth for the taxable year, was not actually embraced by Simons himself, is contrary to fundamental political values, and (unnecessarily) raises intractable problems. Contrary to what adherents to the Haig-Simons concept assume, consumption is not an independent category of income, but only a deduction-disallowance principle of limited use. Likewise, the “accretion” notion of “changes in wealth” – referring to changes in asset values – cannot be maintained in the face of the realization principle – embraced by Simons – which (on the income side) is widely understood to refer to the receipt of cash or its deemed equivalent. On the deduction side, the notion of realization has erred by following accrual principles. Accordingly, not only should accrual taxation be abandoned, but the tax treatment of borrowing should be completely revamped, and depreciation would be eliminated. The problems attending the Haig-Simons income concept, as well as Simons’ goal of designing a tax compatible with a redistributive government, are resolved under an objective ability-to-pay personal income concept. Such a tax embraces the realization concept as a matter of principle. “Income” would refer to the flow of cash through an individual. Cash would be deemed to “flow out” not when it is spent on the purchase of an asset but rather when any asset purchased with cash is finally disposed of. Accordingly, the tax (called a “cash income tax”) would be a true income tax, as opposed to being a cash-flow consumption tax. The larger claim is that tax fairness should take a place at the tax policy table along with economic efficiency and welfarism. The contrary claims that tax fairness is a vague, subjective, and/or indeterminate notion are rejected. The notion of objective ability to pay is an internal-to-tax tax fairness norm that is constructed from the ground up by considering the role of taxation (in a liberal society) to raise cash revenue in an annual budget cycle. It is also shown that the concept dictates the content of a fair income tax with remarkable specificity, and in a way that is comprehensible and user-friendly. Numerous issues frequently disputed (or taken for granted) by tax commentators are covered, including those of income tax vs. consumption tax, imputed income, in-kind income, basis indexing, the personal deductions, the taxable unit, entity taxation, and even international taxation.

Income Tax Accounting Consistency: Eliminate Accrual and Depreciation, and Revamp the Tax Treatment of Borrowing

The thesis is that inconsistent tax accounting rules undermine the individual income tax, and the best available move for improving it – given the unassailability of the realization principle - is to eliminate its accrual (and quasi-accrual) features. Specifically, the agenda is to eliminate tax accrual accounting in the conventional sense, revamp the tax treatment of borrowing to (inter alia) abolish the Crane doctrine, and eliminate depreciation deductions for indivisible productive assets. The end result would be a consistent cash realization system for (at least) individual taxpayers. The proposals made herein would upset long-standing features of the income tax, and therefore are highly controversial. Nevertheless, these features create structural asymmetries that are systematically exploited to the advantage of taxpayers. Part I explains why tax reform should focus on the current realization income tax, rather than ideal systems (such as an accretion income tax or personal consumption tax). Included is a defense of the realization principle on the merits. Part II considers what realization really means in a general sort of way. Part III argues that the accrual method should be abolished. Proposals for revamping the tax treatment of borrowing, including abolition of the Crane doctrine, are the subject of Part IV. The case for abolishing depreciation (with exceptions) is made in Part V, where the Samuelson model of depreciation is shown to be irrelevant to a realization income tax. Collateral changes would include, inter alia, liberalizing the repair doctrine and expensing of indirect production costs. Part VII considers the feasibility of limiting the proposed changes to the individual income tax, and Part VII is the conclusion.

The Fair Income Tax

This article argues that the classic “accretion�? Haig-Simons formulation of personal income, namely, an individual’s consumption plus net increases in wealth for the taxable year, not only was not actually advocated by Simons himself, but also is (in part) contrary to fundamental political values and raises unnecessary practical problems. Contrary to what is commonly supposed, consumption is best seen not an independent category of income, but only a deduction-disallowance principle. Likewise, the “accretion�? notion of “changes in wealth�? - requiring the annual valuation of asset values - is (mostly) impractical, psychologically unacceptable, and contrary to political values. The realization principle - embraced by Simons - is not only convenient but considered to be fundamentally fair. The problems attending the Haig-Simons income concept, as well as Simons’ goal of designing a tax that serves as the platform for top-down redistribution of material resources, are resolved under an objective ability-to-pay personal income concept. This concept is an internal-to-tax substantive fairness norm derived from the function of taxation as an institution. Because fairness is the driving norm, the tax base must be keyed to the personal economic attributes of individual taxpayers. “Objective ability to pay�? refers to material resources (as opposed to satisfactions, utility, or well-being) under the control of the taxpayer that the (federal) government can legitimately tax, considering fundamental political values and institutions. The fair tax based on the objective ability-to-pay concept is not derivative of any meta-theory of social justice or political ideology, but is not incompatible with welfarist and economic efficiency norms, and is perfectly posed to serve as the fulcrum for redistribution (or the absence thereof). Since taxation involves the exaction of cash for government to spend in annual budget cycles, the tax base of individuals must be conceived of as a flow of economic outcomes, as opposed to wealth or endowment. The fair tax is an income tax. Contrary to the charge of vagueness, the concept of an objective-ability-to-pay personal income dictates the content of a fair income tax with remarkable specificity, and in a way that is comprehensible and user-friendly. Numerous issues frequently disputed (or taken for granted) by tax commentators are covered, including those of imputed income, in-kind income, the personal deductions, the taxable unit, entity taxation, and even international taxation. The fair tax closely resembles existing income taxes, except that the U.S. income tax has misapplied the realization principle when it comes to certain deductions and offsets. Specifically, a fair income tax would abandon accrual accounting, revamp the tax treatment of borrowing, and eliminate depreciation. The larger aim of this article is legitimize tax fairness as an academic enterprise that should be taken seriously in discussions of tax system design.