Greenspan Says Tax On Spending May Aid Growth

The Wall Street Journal 03/04/05
author: Rob Wells
author: David Wessel
(Copyright (c) 2005, Dow Jones & Company, Inc.)

Federal Reserve Chairman Alan Greenspan told President Bush's tax-reform commission that taxing consumption instead of income would help promote economic growth, but that such a switch "raises a challenging set of transition issues."

"Many economists believe that a consumption tax would be best from the perspective of promoting economic growth -- particularly if one were designing a tax system from scratch -- because a consumption tax is likely to encourage saving and capital formation," Mr. Greenspan said.

The federal government currently has a hybrid system that taxes wages, interest, dividends and other income, but it has inched toward a tax on spending, or a consumption tax, with breaks for savings and lower tax rates on capital gains and dividends. Consumption taxes come in many guises, including a national sales tax and a European-style value-added tax, but there also are proposals to convert the current income tax to a consumption tax by further lightening the tax bite on saving and investment returns, as Mr. Bush has proposed.

Mr. Greenspan described the U.S. tax system as "somewhat mixed" and said, "I would suspect that probably that may be the best route to go." He advised the nine-member Advisory Panel on Federal Tax Reform against trying to repeal the income tax and replace it with a consumption tax. "Don't try for purity," he said. The panel is to offer options for improving the tax code by July 31.

Critics of consumption taxes sometimes argue that they unfairly penalize the poor, who spend all their income just to survive, although advocates have devised consumption taxes that would tax the rich more than the poor. Consumption-tax advocates' chief argument is that taxing spending -- but not saving -- would lead Americans to save more, an objective Mr. Greenspan shares. "As the baby-boom generation begins to retire in a few years," he said yesterday, "it will become increasingly important for the nation to boost resources available in the future through greater national saving."

Earlier in the week, the Fed chairman urged Congress to increase national saving by restraining the federal budget deficit, even if that means higher taxes. (National saving is the combination of all private saving and government budget surpluses; a smaller deficit increases national saving.)

"Addressing the government's own imbalances will require scrutiny of both spending and taxes," Mr. Greenspan told the House Budget Committee, making clear his preference for restraining spending as the primary means. "Tax increases of sufficient dimension to deal with our looming fiscal problems arguably pose significant risks to economic growth and the revenue base."