This book contains the proceedings of a May 5, 2006 conference held at the NYU Law School in honor of the late David F. Bradford. The book has seven chapters: Alan J. Auerbach writes on the choice between income and consumption taxation, David A. Weisbach on implementation of the two tax systems, Louis Kaplow on the transition to consumption taxation, Wallace E. Oates on fiscal federalism, Roger Gordon and Martin Dietz on dividend taxation, and Jerry Green and Laurence J. Kotlikoff on the "language" of fiscal policy. Each chapter is followed by comments by two discussants.
The book is exceptionally well suited to serve as a tribute to David Bradford. The authors and discussants address the questions that Bradford studied and they do so at the same broad and conceptual, but policy-relevant, level at which he addressed them.
The chapter by Oates on this topic is usefully organized around the Oates (1972) decentralization theorem, which concludes that, under stated assumptions, local decisions on the supply of a public good are at least as good as a centralized decision. The key assumptions are perfect decision making by local governments, no differences in the costs at which the two levels of government can provide the good, no spillovers across localities from the public good, and no ability of the central government to vary output levels across local areas. Because the assumptions are clearly restrictive, Oates focuses on surveying the robustness of the theorem.
Oates sensibly concludes with a general presumption in favor of decentralization, but aptly observes that "a delicate balancing act" between central and local governments is required. Harvey S. Rosen's comment provides additional support for the decentralization presumption, noting that centralized decisions can be flawed for various reasons and therefore need not improve on local decisions even when the Oates (1972) assumptions do not hold.
Of course, the merits of decentralization vary across policy issues, a point unintentionally reinforced by two examples of allegedly excessive centralization that Oates cites. He is on firm ground when he refers to an Environmental Protection Agency rule restricting arsenic in drinking water as "an especially dramatic case of welfare losses from centralization," noting that the rule imposes the same standards on all localities, even though the per-person costs of attaining the standard are hundreds of times larger in small localities than in large ones. But he is on weaker ground when he criticizes efforts to reduce cross-district variations in per-pupil public school spending within metropolitan areas. As he acknowledges, and as Bradford and Oates (1974) discuss at greater length, there may be valid arguments for equalization of spending across rich and poor districts, making this a dubious choice to showcase the drawbacks of centralization.
Oates devotes some attention to the problems that arise if localities face soft budget constraints due to transfers from the central government. But neither he nor the discussants address the related topic of countercyclical intergovernmental transfers. The February 2009 stimulus package gives states increased Medicaid matching funds, as the March 2002 stimulus package had done on a smaller scale. Because the additional funds are not targeted to states that have encountered financial problems, they do not raise the classic soft-budget-constraint problem. Because the grants are linked to Medicaid program size, though, their availability allows states to run larger programs while letting the federal government absorb the costs of preventing undesired cyclical variations. And, while the grants are conditioned on states not adding to their rainy-day funds during the recession (to avoid diluting the desired stimulative effect), they are not conditioned on states adding to, or even maintaining, their funds during economic expansions. More work remains to be done on the proper design of countercyclical intergovernmental transfers, a project that will require insights from both macroeconomics and public finance.
Gordon and Dietz tackle the perennial question of the proper model of dividend taxation. The authors provide a comparison of the "new" and "traditional" views of dividends. While they predictably and appropriately conclude that neither view fits all of the evidence, they find somewhat greater support for the traditional view. Their conclusions are sensitive, however, to their specifications of the two views. Like the discussants, William D. Andrews and George R. Zodrow, I think that the new view holds up somewhat better than Gordon and Dietz suggest.
The specification of the traditional view constructed by Gordon and Deitz is both sophisticated and restrictive. They posit a signaling model in which management has more information than shareholders about earnings prospects and in which dividends are a more effective signal of profitability than share repurchases precisely because they are more costly (due to their unfavorable tax treatment). The model includes a number of restrictive assumptions about such matters as the extent to which managers hold stock and the timetable on which they sell it and the extent of the information revealed by new share issuance. The resulting complexity necessitates a two-period, rather than infinite-horizon, formulation; even then, the presentation of the model is not fully transparent.
The Gordon and Dietz specification of the new view is restrictive in a quite different way; in its simplicity, it omits key features of more realistic versions of the new view. To begin, their version of the new view completely precludes share repurchases, leading them to treat the existence of repurchases as evidence against the new view. The argument is misplaced because broader versions of the new view incorporate share repurchases. As Sinn (1991) and Auerbach and Hassett (2003) demonstrate, the economic implications of the new view continue to hold so long as reductions in repurchases comprise the same fraction of investment financing as repurchases comprise of the distributions of returns.
Also, because Gordon and Dietz exclude the possibility of debt finance, their version of the new view predicts that dividends are a volatile residual equal to the difference between profits and new investment, leading them to cite the observed stability of dividends as evidence against the new view. In the presence of debt finance, however, firms can borrow to smooth dividends even when the new view holds. Like the presence of repurchases, this evidence against the new view vanishes when that view is specified in more general form.
Gordon and Dietz also cite the responsiveness of dividend payout rates to dividend tax rates as evidence against the new view. As Zodrow observes, it may be possible to reconcile such responsiveness with the new view, particularly if changes in the dividend tax rate are transitory. Still, this evidence probably favors the traditional view to some extent. On a more subtle note, Gordon and Dietz also cite evidence about cyclical variations in the market valuation of dividend payouts as supporting their signaling model over the new view.
As Gordon and Dietz ultimately conclude, neither view is fully satisfactory. Surprisingly, the participants devote little attention to firm heterogeneity. Auerbach and Hassett (2003) find that some mature dividend-paying firms behave in a new-view manner while others behave in a traditional-view manner. Further investigation of such heterogeneity may be the most promising direction for future research on dividend taxation.
The chapter by Green and Kotlikoff posits the general relativity of fiscal language, providing a mathematical demonstration that net taxes and transfers cannot be defined independently of the initial assignment of property rights. In his comment, Daniel N. Shaviro crisply summarizes their result in the following terms; a fiscal system in which a worker initially owns her lifetime earnings and pay taxes to the government equal to 30 percent of earnings can equally well be described as one in which the government initially owns the lifetime earnings and makes a net transfer payment to the worker with a present value of 70 percent of earnings.
Although Green and Kotlikoff's result is mathematically correct, Shaviro and Kent Smetters are right to emphasize its lack of practical implications in their comments. Noting that "little may turn" on the authors' result, Shaviro (p. 263) reasonably concludes, "I will continue using the term 'net taxes' until I become aware of problems with it that are not currently evident to me."
The chapter is most useful as a springboard for examining deeper questions about the role of economic terminology. There is broad recognition, for example, that the term "deficit" is problematic for reasons set forth in the generational accounting literature. While that literature often recommends that the term should be abandoned as meaningless, most economists continue to use the term. The persistence of deficit terminology reflects an appropriate understanding of the practical use of language.
It is true that two policies that feature identical deficits may have different impacts on agents' budget sets while two policies that have identical impacts on budget sets may feature different deficits; such outcomes readily arise, for example, if one policy features back-loaded IRAs and the other involves front-loaded IRAs. Clearly then, deficit terminology is not completely informative. But, it can still play a necessary role in an economically meaningful description. The most natural way for an economist to describe such policies includes both their effects on the deficit and the type of IRA involved, thereby providing substantial information about how the policies affect agents' budget sets. In such a description, the discussion of the deficit is meaningful because the impact on budget sets cannot be identified from the type of IRA alone.
Of course, the term "deficit" could be avoided if the economist instead stated the impact of each policy on the (state-contingent) budget sets of every living and future individual. In a world of information costs, however, it is clear that such a description would be difficult to state and impossible for the public or policymakers to fully assimilate. Comprehensible descriptions require the use of short-hand terminology. A policy's impact on the "deficit" may (or, depending upon the policy, may not) be useful short-hand that helps policymakers understand how the policy affects the budget sets of current and future generations.
The usefulness of a short-hand phrase such as "deficit" depends on whether it is correlated closely with the underlying impact on agents' budget sets, which in turn depends upon the policies being considered. Shaviro is probably right to note that "deficit" has been a reasonably meaningful term throughout much of U.S. history; for the policies that were adopted and considered during that period, the impact on the deficit and the impact on intergenerational distribution were probably closely correlated. He is also right to note that the term has become somewhat less meaningful in recent decades. With the expansion of pay-as-you-go social insurance programs, it is now more common for policy changes to impact the intergenerational distribution in ways that cannot be inferred from its impact on the deficit. That development has narrowed, but not eliminated, the usefulness of the term.
This conceptual framework readily resolves the immediate question of whether "net lifetime taxes" is a useful term. Few, if any, policy changes adopted or considered in the current political environment will alter the background principle that workers have the initial right to their lifetime earnings. Changes in lifetime net taxes therefore reflect changes in the intergenerational allocation of wealth and the "lifetime net taxes" terminology is indeed appropriate. There will be time enough to reconsider this terminology if and when proposals that alter the background wage entitlement become more common.
The comment by Edward J. McCaffery on the chapter by Weisbach also makes an important point about economic terminology. The same information costs that make it necessary to provide a short-hand description of policies also make it possible that the public and policymakers will form different perceptions of equivalent policies, depending upon the short-hand that is used to describe them. McCaffery notes that economists must give more consideration to how to describe good ideas in ways that make their policy advantages clear, particularly in the area of fundamental tax reform.
Income and Consumption Taxes
Weisbach's insightful chapter isolates the differences in implementation between consumption and income taxes. Auerbach provides a highly valuable discussion of the broader similarities and differences between the two types of taxation.
Weisbach's chapter is organized around the fundamental precept that consumption and income taxes differ only with respect to their treatment of the safe rate of return (the "time value return"), which is taxed under income taxation but not under consumption taxation. As Weisbach observes, any inherent difference in implementation between the two tax bases must be related to how the time value return is taxed. Weisbach's analysis suggests that it is easier to exempt the time value return than to tax it. Accordingly, consumption taxation should generally be easier to implement than income taxation, holding other tax features constant. Of course, ease of implementation also depends upon the details of how the tax is imposed.
Consumption taxation probably has the smallest edge over income taxation when both taxes are imposed at the household level on a residence and "real-plus-financial" basis, that is, when an individual income tax is compared to a personal expenditure tax. Unlike the expenditure tax, the income tax, in order to tax the time value return, must distinguish between principal and interest and between investment and return on investment. As a result, the income tax must rely on the complicated and highly imperfect apparatus of basis accounting (or on accrual taxation) while the expenditure tax can employ simple cash-flow taxation. On the other hand, the expenditure tax faces the compliance (and political) problem of taxing borrowers on the proceeds of loans. In any event, both taxes are administratively feasible.
The most useful part of Weisbach's chapter is his comparison of firm-level income and consumption taxes. In a closed economy, consumption can be taxed at the firm level with a conventional consumption-type value-added tax (VAT) and income can be taxed at the firm level with an income-type VAT under which capital investment is depreciated rather than expensed. The use of depreciation schedules and basis accounting (required, again, to tax the time value return) make the income-type VAT significantly more complicated, but again both taxes are feasible.
Firm-level consumption taxation extends straightforwardly to the open economy. Domestic consumption can readily be taxed with a destination-based consumption-type VAT that taxes imports and exempts exports, as is now done in more than 150 countries. However, as Weisbach discusses, the extension of firm-level income taxation to the open economy is more problematic. An origin-based income-type VAT that exempts imports and taxes exports yields a tax base in which business income is taxed on a location basis (while income from financial holdings is taxed on a residence basis). Unfortunately, the location-based nature of the business tax tends to drive business investment out of the country, an effect that does not arise under residence-based individual income taxation. Weisbach demonstrates that things are little improved by switching to a destination-based income-type VAT that taxes imports and exempts exports. Under such a tax, the time value return on business investment is still taxed on a location basis, although super-normal returns and old business capital are taxed on a residence basis.
As Weisbach observes, the actual U.S. corporate income tax is far more complicated than an origin-based income-type VAT. In an attempt to mitigate the problems arising from location-based income taxation, tax is imposed (on a deferred basis and with a credit for foreign taxes paid) on the overseas income of firms with U.S. charters, which requires a number of complex rules. Because overseas income is not taxed when earned by firms with foreign charters (even when the savings are supplied by American residents), this "global" tax system seems ill-suited to address the fundamental limitations of location-based income taxation. It is unsurprising that VATs do not link a firm's tax liability to the irrelevant characteristic of where the firm's charter was issued. In contrast to the VAT, which is based only on real transactions, the corporate income tax also allows an interest expense deduction, which requires arbitrary rules to source interest expense between the United States and abroad. 
Although Weisbach pulls back from presenting any sweeping policy conclusions, his discussion suggests some clear policy prescriptions. Given the inherent complexity of taxing income rather than consumption, any income tax should be structured in a way that minimizes the associated implementation problems. That consideration points toward reliance on individual income taxation and away from the use of firm-level income taxes, particularly the current corporate income tax.
Of course, one can avoid these problems of income taxation altogether by moving to consumption taxation. Auerbach's chapter provides a clear exposition of the factors affecting the choice between the two tax systems; as in Weisbach's chapter, the key differences arise from the treatment of the time value return on saving. Auerbach rebuts a number of fallacies that purport to find other distinctions between the two taxes, such as those relating to border adjustments and the taxation of the underground economy.
Auerbach sensibly concludes that, regardless of whether the optimal tax on the time value return is exactly zero, consumption taxation is likely to be closer to the optimum than income taxation. Switching to consumption taxation is therefore likely to yield efficiency gains. As Auerbach emphasizes, the crucial uncertainty concerns the magnitude of the gains and how they should be weighed against the transition costs of the switch.
Transition to Consumption Taxation
The chapter by Kaplow further examines the transition from income taxation to consumption taxation, particularly the longstanding question of how existing capital should be treated. Without transition relief, the adoption of a consumption tax or an increase in its rate reduces the value of existing capital because existing capital does not receive the expensing treatment that new capital receives. If the introduction of the consumption tax is accompanied by the repeal of an income tax, the loss to existing capital is mitigated by the forgiveness of any deferred income tax liabilities that arose from accelerated depreciation or investment credits.
Some economists cite the "opportunity" to impose this levy on existing capital as an advantage of moving to consumption taxation. They argue that this capital levy offers a better equity-efficiency tradeoff than other taxes; its burden falls on (generally wealthy) stockholders, but is nondistortionary because it applies to past savings decisions that can no longer be changed.
Drawing on his past work and on Shaviro (2000), Kaplow persuasively argues that this is not the right way to think about the transition. Because capital levies can be imposed at any time, the switch to consumption taxation offers no new opportunity to impose a levy. Given that Congress can unexpectedly cancel depreciation allowances for existing capital at any time (while promising never to do so again), why should it wait for the introduction of a consumption tax?
One answer is that the promise not to repeat the levy is more credible if the levy is imposed during a switch to consumption taxation, because nobody expects such a switch to happen again. But, that answer is incomplete. If Congress announced that it was canceling depreciation allowances "because" of a contemporaneous and unique astronomical phenomenon, its promise to never repeat the levy would not become credible merely because the astronomical phenomenon would never recur. Firms would know that the levy was an opportunistic policy that had nothing to do with astronomy and they would expect its repetition.
The real argument, then, is that imposing the capital levy during the switch to consumption taxation camouflages its opportunistic nature because firms accept the levy as an unavoidable part of the reform. As Kaplow notes, this camouflage is unlikely to work. Far from accepting the absence of transition relief as an inevitable part of the reform, firms are likely to view transition rules as a necessary feature of reform. Any counter-argument that relies on the desirability of capital levies merely removes the camouflage.
If anything, Kaplow understates the pernicious nature of the traditional argument for capital levies. Taken literally, the argument recommends a policy of imposing a levy on any past productive activity whenever the nature of the levy can be concealed. Of course, the existence of this general policy must itself be concealed, contrary to the precept of Rawls (1971) that the principles of justice be publicly known. The capital levy is truly the policy that dares not speak its name.
The quest for capital levies is fundamentally antithetical to the rule of law on which market interaction depends. Would economic welfare really be maximized under a government that continually searched for excuses to invalidate prior patents while persuading today's innovators that their patents will be honored? Or would welfare be higher under a government that steadfastly honors patents as a matter of principle and abhors any suggestions to deviate "just this once"? Empirical evidence from Barro (1997) and others confirms that economic growth is enhanced by respect for property rights and the rule of law. The norms against capital levies should be strengthened rather than weakened, to attain the advantages of precommitment as identified in the time-consistency literature. On this issue, the public seems to have better intuition than many economists.
The transition to consumption taxation, therefore, should not be used as an excuse to opportunistically place unexpected burdens on existing capital. Still, it is not entirely clear that transition policy must maintain the value of existing capital, as Kaplow recommends. The move to consumption taxation will increase the after-tax rate of return earned by the owners of existing capital, arguably compensating for some decline in value. Kaplow rejects the compensation argument on the grounds that the benefits of the higher rate of return depend on the remaining consumption horizon of the capital owner. His response does not seem entirely conclusive, as it would be possible to tailor transition relief to the owner's age.
The details of the proper transition policy remain uncertain, but should be set based on announced principles that will apply to all policy changes, including those that lower after-tax rates of return. In any case, policy makers should heed Kaplow's and Shaviro's warning against using reform as an excuse for opportunistic capital levies.
This book should be of interest to economists studying any of the topics that it covers, particularly to those interested in fundamental tax reform. It is a fitting tribute to David Bradford and should serve as an inspiration to those seeking to carry on his work.
Alan D. Viard is a resident scholar at AEI.
 In principle, as shown by Auerbach and Bradford (2004), the income tax can also use cash-flow taxation, but the tax rates must change in a counter-intuitive manner as the taxpayer ages.
 The other major way in which the corporate income tax differs from an income-type VAT is more innocuous. The corporate income tax allows firms to deduct wages, which are then taxed to workers under the individual income tax.
 Kaplow points out that the levy could not, in any event, be imposed on all capital in place on the date the consumption tax is introduced unless the reform was immediate and unexpected. To avoid deterring investment during the consideration and enactment of the reform, it would be necessary to provide transition relief for investments made during that period. That interval might be lengthy; the process that culminated in the Tax Reform Act of 1986, a significantly more modest change, took more than two years.
 As Kaplow observes, the argument can be
challenged on its own terms by noting that firms might expect the rate of the
newly introduced consumption tax to rise over time. Each rate increase poses a similar transition
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