The Fair Income Tax

Abstract

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.