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The Concept of Income Revisited: An Investigation into the Double Taxation of Saving

2 min readBy: Arthur P. Hall, Ph.D.

Download Background Paper No. 17

Background Paper No. 17

Executive Summary We find, in the statutes, very few attempts to define income. Rather do they assume the meaning of tha term, so puzzling in economic literature, to be self-evident. Consequently the meaning of the statutes themselves is always vague and varying. The growing precision and progress toward a truer concept consists chiefly in the gradual disentangling of income from capital.—Irving Fisher

Little has changed since economist Irving Fisher made that statement about the federal income taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. in 1927, except that progress toward the gradual disentangling of income from capital stopped. The economic essence of the modern tax reform debate centers on regenerating this progress. The unsatisfactory distinction between income and capital in the current income tax laws manifests itself as two driving forces behind the tax-overhaul debate—the quest for both administrative simplification and greater economic growth potential through the elimination of the tax bias against saving and investment.

Many people think that this quest should result in the replacement of the traditional income tax with a consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. . Proponents of consumption tax systems argue that such systems can simplify the process of complying with the tax laws for the same reason that they can increase economic growth opportunities—they eliminate (or substantially reduce) the taxation of capital accumulation and capital mobility. Eliminating the required income tax accounting for capital can reduce administrative complexity and, therefore, administrative expense. Eliminating the taxation of capital accumulation and capital mobility would remove the current tax bias against two key ingredients of the economic growth process.

The debate in the postwar era over the relative merits of consumption taxation versus income taxation is a carryover of a long-running, almost ancient, debate over the proper definitions of capital and income. The debate drew many international participants from both the economic and legal professions. The key figures in America were economists Irving Fisher, Robert M. Haig, and Henry C. Simons . The debate, on its surface, may appear as an esoteric argument over labels. But it was a debate over profound economic substance. Labels like “capital ” and “income” matter because they guide thinking and create focal points for administrative and legal issues. Contrasting and comparing Fisher’s views with those of Haig and Simons illuminates the modern debate—in the context of economic fundamentals—over the relative merits of consumption taxes as opposed to the traditional income tax.