The Business Enterprise Income Tax

1
The Business Enterprise Income Tax
May 2005

• Presidents Advisory Panel on Federal Tax Reform
• Edward D. Kleinbard
• Cleary Gottlieb Steen Hamilton LLP

2
The Business Enterprise Income Tax

• The Business Enterprise Income Tax (BEIT) reforms
  the income tax rules that apply to operating or
  investing in a business.
• The BEITs tax base is income, not consumption.
• Current law would apply to activities not related
  to operating or investing in a business
  enterprise, such as employment income.
• The BEIT is designed to reduce greatly the role
  of tax considerations in business thinking.
• The BEIT does so by replacing current laws
  multiple elective tax regimes with a single set
  of tax rules for each stage of a business
  enterprises life cycle
• Choosing the form of a business enterprise
• Capitalizing the enterprise
• Selling or acquiring business assets or entire
  business enterprises.

3
Overview of BEIT

• The BEIT has four components
• 1. Taxation of all businesses at the entity
  level.
• Partnerships and even sole proprietorships are
  taxable entities.
• Similar in this one respect to Hall-Rabushka and
  1992 Treasury Comprehensive Business Income Tax
  (CBIT) proposals.
• 2. True consolidation principles for affiliated
  enterprises.
• Separate tax attributes of consolidated
  subsidiaries no longer are tracked.
• Instead, affiliated entities are treated as part
  of one single business enterprise.

4
Overview of BEIT (contd)

• 3. Repeal of all tax-free organization and
  reorganization rules.
• All transfers of business assets (or entry into a
  consolidated return) are taxable asset
  transactions.
• Tax rates on such sales are revised to be tax
  neutral.
• 4. A uniform cost of capital allowance (COCA) to
  measure a business enterprises tax deductions
  for any form of financial capital (e.g., debt,
  equity, options) that it issues to investors.
• Analogous income inclusion rules for holders of
  financial capital instruments.
• COCA replaces interest deductions. COCA does not
  replace depreciation deductions.
• Result is quasi-corporate integration.

5
One Tax System for All Business Enterprises

• All business enterprises are taxed at the entity
  level.
• Rules are similar to current taxation of
  corporations (other than acquisitions and the
  COCA regime).
• Recognizes that our largest pools of business
  capital (public corporations) already are taxed
  as entities.
• A sole proprietor thus is taxed both as an
  investor and as a separate business entity.
• Proprietorships today must segregate business
  from personal expenditures, so recordkeeping
  issues are not insurmountable.
• Taxing business entities rather than the owners
  of those entities reduces complexity and
  increases consistency.
• Different rules for collective investment
  vehicles (mutual funds).

6
True Consolidation Principles

• Current laws corporate consolidated return rules
  are stupefyingly complex.
• These rules do not consolidate companies in the
  everyday or accounting sense of the word.
• Instead, the rules track separate tax attributes
  of every affiliate.
• The BEIT provides a true consolidation regime.
• All business enterprises (whatever the form) held
  through a common chain of ownership are treated
  as part of a single business enterprise (like
  financial accounting).
• Minority investors in subsidiaries are treated as
  investors in the common enterprise.
• New ownership thresholds for consolidation look
  to all of an enterprises long-term capital, not
  just stock.

7
Tax-Neutral Acquisition Rules

• All tax-free organization or reorganization rules
  are repealed.
• The true consolidation model effectively requires
  the elimination of current laws stock/asset
  acquisition electivity.
• Any acquisition of a business asset or a
  controlling interest in a business enterprise is
  treated as a taxable asset sale/acquisition.
• Thresholds for business enterprise transfers are
  the same as the tax consolidation rules.
• Business assets comprise assets subject to
  depreciation, so inventory and financial
  instruments are taxed separately (as ordinary
  income and under the COCA regime, respectively).
• Gain/loss taxed at tax-neutral rates.
• Sellers tax rate PV of tax value of buyers
  asset basis step-up / step-down.
• So different rates apply for different
  depreciation classes.

8
Tax-Neutral Acquisition Rules (contd)

• Result economically is similar to making every
  acquisition a carryover basis asset-level
  transaction.
• But eliminates loss duplication trades.
• Eliminates exceptions to realization principles.
• Eliminates administrative issues of tracing basis
  back through former owners.

9
COCA Overview

• Replaces current laws differing treatment of
  interest and dividends with a uniform annual cost
  of capital allowance to issuers, and a
  correlative income inclusion for investors.
• Implements two different agendas
• A quasi-integration regime.
• One set of rules in place of current laws
  enormous and internally inconsistent
  infrastructure for taxing different financial
  instruments.
• Comprehensive in scope.
• Applies (with minor modifications) to derivatives
  cash investments.
• Revenue neutral, if so desired. Key drivers are
• Statutory formula for setting the annual
  allowance.
• Treatment of tax-exempt and foreign investors.

10
COCA Issuers Perspective

• A business enterprise (financial institutions
  excepted) deducts an annual allowance for the
  financial capital invested in it.
• Rate set by statute, e.g., at a fixed above
  1-year Treasuries.
• Rate is uniform, regardless of the form of
  capital raised by an enterprise (e.g., debt or
  equity).
• No further deduction (income) to issuer if actual
  payments to investors exceed (are below) the
  annual COCA rate.
• Similarly, no gain or loss to issuer on retiring
  a financial capital investment.
• COCA rate is applied to issuers total capital to
  determine the issuers annual COCA deduction.
• By definition, total capital total tax basis of
  assets.
• So total asset basis x COCA rate COCA
  deduction.
• COCA deduction is in addition to, not in place
  of, asset depreciation.
• COCA and depreciation are related, as
  depreciation reduces asset basis. COCA thus
  mitigates distortions from expensing/accelerated
  depreciation.

11
COCA Investors Perspective

• Minimum Inclusion taxed as ordinary income.
• Annual amount the investors tax basis in
  investments in business enterprises x COCA rate.
• Investor includes Minimum Inclusion as income
  each year, irrespective of cash distributions
  from issuer.
• Distributions from issuer then treated first as
  tax-free return of accrued Minimum Inclusions.
• Unpaid Minimum Inclusions added to investment
  basis (like zero coupon bonds today).
• Minimum Inclusion is not tied directly to
  issuers COCA deduction, so holders do not
  require any issuer-specific information
  reporting.
• Tax policy best would be served if all holders,
  including tax-exempts, included Minimum Inclusion
  amounts as taxable income.

12
COCA Investors Perspective (contd)

• Excess Distributions taxed at low rate
  (10-15).
• Amount gain on sale of financial capital
  instrument or issuer distributions in excess of
  prior accrued Minimum Inclusions.
• Excess Distributions would be tax-free to
  tax-exempts.
• Tax roughly compensates for any remaining
  issuer-level preferences, and is justifiable on
  traditional ability to pay grounds.
• Low rate not available for gains from
  collectibles, etc.
• Losses reverse prior income inclusions.
• First, deductible at Excess Distribution rates,
  to extent of prior Excess Distributions.
• Then, deductible at Minimum Inclusion rates, to
  extent of prior Minimum Inclusions (whether or
  not paid).
• Remaining principal loss deductible at Excess
  Distribution rates.
• Capital loss limitations can be replaced with
  rules to tax-effect the amount of Excess
  Distribution loss deductible vs. ordinary income.

13
COCA Impact

• For issuers, the COCA system removes tax
  considerations in choosing an optimal capital
  structure.
• An issuer obtains the same COCA deductions
  regardless of the form of financial capital
  instruments it issues.
• Current laws incentives to over-leverage and to
  package equity-based returns as debt thus are
  eliminated.
• Assuming that interest rates do not fully adjust
  for the new regime, immediate winners likely are
  companies with little or no debt (limited
  interest deductions today) and higher quality
  credits (whose cash costs for financial capital
  are low relative to a nationwide blended COCA
  rate).
• Immediate losers likely are highly leveraged
  companies and the weakest credits.
• Over time, capital structures will adapt, because
  current tax law distortions will have been
  eliminated.

14
COCA Impact (contd)

• For investors, the COCA system rationalizes the
  taxation of economic investment income and
  eliminates tax distortions.
• The COCA system distinguishes in a logical and
  consistent manner between ordinary (time value of
  money) returns (Minimum Inclusions) and
  extraordinary (capital gain) returns (Excess
  Distributions).
• Including a current time value return on all
  financial instruments reduces the opportunities
  for indefinite deferral and its distortive
  effects of understating income and locking-in
  investments.
• The replacement of capital loss limitations with
  (tax-effected) full utilization of losses
  eliminates a substantial economic distortion that
  today limits the attractiveness of risky
  investments.
• Investors benefit from quasi-integration for
  investments in profitable issuers, full
  integration is achieved to the extent of Minimum
  Inclusions.

15
BEIT Transition Issues

• For first three proposals (uniform entity-level
  tax, true consolidation principles, revised
  asset/business acquisition regime), new rules
  would apply immediately.
• These rules do not work under a phase-in model.
• Some consolidated groups would lose advantage of
  higher stock basis than asset basis for
  consolidated subsidiaries, but simplicity and
  efficiency of new regime compensate.
• For COCA, a phase-in rule is essential.
• Companies will need time to adapt their capital
  structures.
• 5 10 year period in which interest deduction
  scales down and COCA ramps up.

16
Appendix
17
COCA Additional Material
18
COCA Example

• Opening of Year 1 TaxBalance Sheet

• Assumptions
• COCA Rate 5
• No cash return on portfolio investment
• Operating business earns 130 EBITDA
• Cash payments to holders of all liabilities and
  equity 46
• Tax depreciation on machinery 50
• For simplicity, COCA calculations done once
  annually, using opening balance sheet

• Assets
• Cash 100Portfolio Investment 200Greasy
  Machinery 500Land 200 1,000

• Liabilities and Equity
• Short-term liabilities 100Long-term
  debt 200Funky contingent payment
  securities 200Preferred stock 100
• Common stock 400 1,000

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COCA Example (contd)

• Year 1 Results
• Income
• Net income from operations 130
• Deemed returns on portfolio investment 10
• Total Gross Income 140
• Deductions
• COCA deduction 50
• Depreciation 50
• Total deductions 100
• Taxable income 40
• Tax _at_ 35 14
• Cash Flow
• Net income from operations 130
• Less cash coupons on liabilities and equity
  (46)
• Less taxes (14)
• Net Cash Flow 70

Opening of Year 2 TaxBalance Sheet

• Assets
• Cash 170Portfolio Investment 210Greasy
  Machinery 450Land 200 1,030

Liabilities and Equity Short-term
liabilities 100Long-term debt 200Funky
contingent payment securities 200Preferred
stock 100 Common stock 430 1,030

• Notes
• Year 2 COCA 51.50
• Issuer does not need to accrete any amount to
  liabilities for prior years COCA expense,
  because no gain or loss on retirement of any
  liability or equity.

A-2
20
COCA Holder Example

• (Assume constant 5 COCA rate)
• Holder invests 1,000 in a security.
• First 3 years, no cash coupons, but Minimum
  Inclusion 158.
• Basis therefore 1,158
• End of Year 3, cash distribution of 500.
• 158 tax-free return of accrued but unpaid
  Minimum Inclusions (Basis gt 1,000)
• 342 Excess Distribution (taxable at reduced
  rates)
• Hold another 2 years, no cash coupons, but
  Minimum Inclusion 103
• Basis therefore 1,103
• a) Sell for 1,303 200 Excess Distribution.b)
  Sell for 1,000 (103) loss, deductible at
  Excess Distribution rates.c) Sell for 403
  (700) total loss. 342 at Excess
  Distribution rates 261 at Minimum Inclusion
  rates Remaining 97 at Excess Distribution
  rates

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COCA Issuers Perspective (Additional Material)

• Financial institutions are not taxed under COCA.
• Money is their stock-in-trade, and the rough
  justice of COCA would materially distort the
  income of such highly leveraged institutions.
• Optimal alternative for financial institutions is
  to mark to market all assets and liabilities
  second best is to preserve current law rules as a
  special carve-out to COCA.
• Special rules apply to financial derivatives, but
  the overall theme is the same.
• See below, this Appendix.
• Sole proprietor is both an issuer (a business
  enterprise) and an investor (the owner of that
  enterprise).
• Result effectively is the same as paying interest
  to oneself.
• Special small-business rule permits the
  consolidation of enterprise-level COCA deductions
  against investor-level income inclusion.

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COCA Issuers Perspective (Additional contd)

• Issuers that hold portfolio investments in other
  enterprises
• Are treated as investors in respect of that
  investment.
• But hold an asset (the portfolio investment) with
  a tax basis, which in turn gives rise to a COCA
  allowance.

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COCA Investors Perspective (Additional
Material)

• Mark-to-Market.
• Dealers in financial instruments taxed (at
  ordinary rates) on mark-to- market basis.
• Mark-to-market elections generally available to
  other holders (mitigates effect of excess Minimum
  Inclusions vs. cash receipts, at cost of
  accelerating Excess Distribution tax).
• Special rule for basis recovery from
  self-amortizing instruments.
• In all other cases, distributions are presumed to
  be income.
• Administrative Issues.
• No information required from issuer or prior
  holders (issuers COCA allowance does not drive
  investors Minimum Inclusions).
• Holders will need to track their own prior
  Minimum Inclusions and Excess Distributions to
  calculate future years income or loss.
• Financial intermediaries could be required to
  report that information for investors in public
  companies (like 1099s today).

A-6
24
COCA Derivatives

• First Priority Tax hedge accounting principles.
• Based on current law (e.g. Reg 1.1275-6).
• Presumption that financial derivatives of a
  business enterprise that is a non-dealer/non-profe
  ssional trader are balance sheet hedges, and as a
  result gain/loss is ignored (i.e., subsumed into
  general COCA regime, where cash coupons on
  financial capital instruments are ignored).
• Taxpayer may affirmatively elect out.
• Second Priority Mark-to-market.
• Generally, mandatory regime for
  dealers/professional traders.
• Dealers/traders may elect tax hedge accounting
  treatment for their liability hedges.

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25
COCA Derivatives (contd)

• Third Priority Asset/Liability Model.
• Treat all upfront, periodic and interim payments
  as (nondeductible) investments in the contract.
• Apply COCA Minimum Inclusion/Deduction rules to
  resulting net Derivative Asset or to increase
  in asset basis corresponding to Derivative
  Liability.
• Amount, and direction, of Derivative
  Asset/Liability fluctuates from year to year,
  with no consequence other than Minimum Inclusions
  on any net investment (and COCA deductions on
  assets).
• At maturity/termination, settle up by
  recognizing gain/loss.
• Maturity/termination gain taxed at Excess
  Distribution rates.
• Maturity/termination loss taxed identically to
  general COCA regime for holders (i.e., first
  deductible at Minimum Inclusion rates to extent
  of prior Minimum Inclusions, then Excess
  Distribution rates).
• Result is identical to general COCA rules for
  gain, or for loss on Derivative Assets, but
  different for Derivative Liabilities (because
  gain/loss recognized).
• Consequence is that a bright line test is still
  required to distinguish derivatives from
  financial capital investments.

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COCA Derivatives Example

• (Assume COCA rate 5)
• X pays 50 to Y for 3-year option on SP 500.
• X has Minimum Inclusions over 3-year life 8
  (rounded).
• So Xs basis at maturity 58.
• Y receives COCA deductions on cash proceeds
  i.e., on assets, not directly on Derivative
  Liability.
• At maturity, contract pays either
• 88 X recognizes 30 in Excess Distribution
  gain Y recognizes 38 (not 30) in loss
  deductible at Excess Distribution rates.
• 0 X recognizes 8 loss deductible at Minimum
  Inclusion rates, 50 loss deductible at Excess
  Distribution rates Y recognizes 50 gain(not
  58), taxable at Excess Distribution rates.

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Tax-Exempt Investors International Applications
28
COCA Tax-Exempt Holders

• Exempting tax-exempts from tax on Minimum
  Inclusion amounts effectively makes a portion of
  business income tax-exempt.
• Tax-exempts cannot directly engage in unrelated
  businesses, so why should they be able to do so
  indirectly (by holding financial capital
  instruments)?
• Issue compounded by consideration of foreign
  portfolio investors (below) answers for one
  naturally drive the other.
• Compromises are possible as a technical matter,
  even if undesirable as a policy matter.
• Tax at reduced rates?
• Distinguish among different classes of
  tax-exempts?
• Pension plans, etc. are primarily investment
  vehicles in ways that charities arguably are not.

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29
COCA Foreign Portfolio Investors in U.S.
Securities

• Unavoidable tension between COCA system (which
  can tax income before distributions) and
  withholding tax collection mechanisms (which rely
  on cash distributions).
• Problem exists today for original issue discount
  (in cases where portfolio interest exception
  does not apply).
• Catch-up withholding on cash distributions is
  easier than withholding on secondary market
  sales.
• Proposal General withholding tax with extensive
  tax treaty relief.
• Require broker reporting and withholding on
  proceeds as general case.
• Provide extensive relief for residents of tax
  treaty partners, where income in fact is taxed
  locally.
• Consider limitations on treaty relief where at
  risk holding period is not satisfied (to limit
  gaming through Delta 1 OTC derivatives).

A-11
30
COCA U.S. Portfolio Investors in Foreign
Securities

• General rule COCA applies.
• COCA regime should apply here as it does to
  investments in domestic business enterprises.
• Foreign tax credit rules will require tweaking to
  match withholding tax credits with
  prior/subsequent income inclusions.
• Use tax treaty relief for treaty partner
  residents as negotiating tool to obtain broader
  relief from treaty partner withholding taxes.

A-12
31
BEIT Foreign Direct Investment

• Current law is schizophrenic.
• Ultimate protection from double taxation is the
  foreign tax credit, but interest allocations,
  etc. continue to limit its utility (although 2004
  Act obviously helps).
• Subpart F 'anti-deferral (a/k/a acceleration)
  regime is enormously complex, and in a state of
  complete disarray.
• Deferral vastly complicates IRS compliance task
  in transfer pricing.
• Why is deferral important to taxpayers?
• Financial accounting Permanently reinvested
  earnings taxed at lower foreign rates reduce
  reported financial accounting tax costs, and
  therefore are highly valued.
• Master blender Tax Director functions as a
  master distiller, rectifying foreign tax credit
  problems by artfully blending reserve stocks of
  high-taxed and low-taxed deferred foreign
  earnings to produce a perfect 35 tax-rate blend
  of includible foreign income.
• If financial accounting rules were different,
  basic U.S. business entity tax rates reasonably
  low, and foreign tax credit rules less onerous,
  the deferral debate would become irrelevant.

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32
BEIT Foreign Direct Investment (contd)

• Proposal (against the background of lower overall
  business enterprise tax rates)
• Full inclusion of foreign subsidiaries income
  (via consolidation).
• Full consolidation of foreign subsidiaries (so
  foreign loss offsets domestic income).
• Repeal interest allocation (now, COCA
  allocation) and similar rules.
• Consider steps to harmonize FTC limitation with
  foreign measures of income.
• Results
• Vastly simpler system.
• Substantial reduction in importance of transfer
  pricing issues to IRS.
• Fair system that respects international norm that
  source country should have priority in taxing
  income.
• Ultimate protection of U.S. fisc against
  taxpayers using foreign taxes as credits against
  domestic income should be lower U.S. tax rate on
  business enterprise income (compared to major
  trading partners).

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33
Tax Policy Considerations
34
BEIT Overview of Goals

• The BEIT has three objectives
• 1. To simplify the income tax rules applied to
  operating or investing in a business.
• Do not confuse ease of recordkeeping with true
  simplicity. Recordkeeping is a nuisance, but it
  is not difficult. True simplicity requires
  consistent conceptual clarity, to reduce
  ambiguity in applying the law.
• 2. To increase consistency of tax results by
  rooting out deeply embedded structural flaws in
  our current system for taxing business operations
  and investments. These structural flaws distort
  economic behavior.
• 3. To reduce tax avoidance/gaming opportunities.

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BEIT Goals Simplifying Current Law

• Current law Multiple elective tax regimes for
  economically similar, but formally different,
  types of
• Business organizations.
• Acquisitions.
• Investments.
• The BEIT Promotes simplicity by adopting one
  set of rules that applies to all forms of
• Business enterprises (corporation, partnership,
  proprietorship).
• Acquisitions of businesses or business assets
  (incorporation, merger, sale) through one or more
  companies (true consolidation).
• Financial investments in business enterprises,
  however denominated (debt, equity, derivatives).
• The BEIT Is comprehensive and unambiguous in
  application.

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BEIT Goals Eliminating Structural Flaws

• Current law Riddled with tax-induced
  distortions in economic behavior
• Over-reliance on the realization principle
  leads to understatement of economic income, and
  to lock-in of inefficient investments.
• Inconsistent rules for taxing different forms of
  financial capital lead to arbitrage
  transactions based on ordinary income vs. capital
  gain, or debt vs. equity.
• The BEIT Roots out these structural flaws
• Eliminates deferral from tax-free reorganizations
  and similar transactions.
• Requires an easily-measured and universal current
  return to all financial investments.
• Clearly distinguishes between time value and
  risky returns, and applies consistent rules to
  each, however denominated.
• Applies one set of rules to all financial
  instruments, regardless of legal labels.

A-17
37
BEIT Goals Reducing Tax Avoidance

• Current law Multiple elective tax regimes for
  business entities and investments lead to complex
  optimization (at best) or abusive (at worst)
  behavior.
• Of 31 IRS listed abusive transactions, 13 are
  the direct result of manipulation of the
  carryover basis or consolidated return rules, or
  inconsistencies in the rules applicable to
  different types of entities.
• The BEIT Eliminates electivity based on form,
  and imposes instead a single uniform system
• Imposes entity level tax on all forms of business
  organization.
• Replaces consolidated return rules with true
  consolidation principles.
• Replaces competing forms of taxable and
  tax-free acquisitions with a single new
  tax-neutral taxable acquisition model.

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COCA Constitutional Issues

• Current academic consensus is that realization
  requirement is a rule of convenience, not a
  constitutional imperative.
• COCA (through loss deductions and mark-to-market
  election) in fact reaches a taxpayers net income
  over time.
• Courts regularly have rejected constitutional
  challenges to tax provisions that diverged from
  realization precepts
• Accrual taxation generally.
• Estimated taxes.
• Personal holding company/subpart F deemed
  inclusion regimes.
• Mark-to-market.
• Original issue discount.

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COCA vs. CBIT

• CBIT (proposed by 1992 Treasury) proposed a
  uniform COCA-like system, with a COCA rate set
  permanently at zero i.e., interest
  disallowance.
• Distributions to investors (interest or
  dividends) generally would not be taxed.
• To ensure that distributed amounts bore tax at
  the entity level, CBIT contemplated that issuers
  would maintain an Excludable Distributions
  Account (rejected in 2003 debate on dividend tax
  rates for complexity reasons), or a similar
  mechanism.
• Disadvantages of CBIT.
• Apparently preserved all of current laws bias in
  favor of expensing over capitalizing.
• Example Enterprise X spends 100 on a perpetual
  machine that earns 10/year Enterprise Y spends
  100 on deductible RD to develop a perpetual
  intangible that earns 10/year.
• COCA (but not CBIT) mitigates the difference by
  giving a deduction in the former case, but not
  the latter.

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COCA vs. CBIT (contd)

• Disadvantages of CBIT (contd).
• An issuer-level compensatory tax as part of the
  EDA mechanism would materially have affected
  issuer payout policies.
• Did not address derivatives at all.
• Did not propose rules distinguishing time value
  from risky returns generally and did not
  resolve capital gains taxation.
• Presumably would have been inefficient to the
  extent interest rates did not fully adjust for
  new tax regime (like municipal bonds today).
• Advantages of CBIT.
• Indirectly imposed tax on tax-exempt
  institutions.

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In Praise of the Income Tax

• Income, Wealth and Consumption.
• Imagine normative income and consumption taxes,
  in which gifts or bequests are realization
  events/consumption to the donor/decedent.
• Annual income beginning wealth
  consumption - ending wealth. So income tax
  taxing lifetime wealth (other than gifts/bequests
  received) once only once.
• If gifts/bequests are treated as consumption to
  donor/decedent, then a consumption tax is
  identical to an income tax in its tax base over a
  lifetime, but for time value of money
  considerations. Taxes are deferred on lifetime
  savings, but are imposed on a higher lifetime
  base.
• Effective and nominal tax rates diverge under the
  two systems, however. A consumption tax must
  always have higher (and steeper) nominal rates
  than an otherwise identical income tax to achieve
  the same progressivity and revenues (because in
  an income tax model the fisc can invest earlier
  tax payments at a pre-tax rate of return).
• A periodic wealth tax and an income tax are
  conceptually identical, but administratively very
  different. A consumption tax differs only in
  that it exempts the time value return to savings.

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In Praise of the Income Tax (contd)

• Our income tax system reflects 90 years of
  invested intellectual capital.
• A vast number of issues and applications have
  been fully mapped out.
• By contrast, most consumption tax proposals in
  the U.S. remain abstractions if implemented,
  those systems also will be complex, and require
  many line-drawing exercises, but without decades
  of law to guide taxpayers and policymakers.
• Taxpayers have intuitive understanding of broad
  contours of current system.
• Principal acknowledged defects (e.g. inconsistent
  treatment of financial capital) can be addressed
  through BEIT, or similar proposals.
• The income taxs lower nominal tax rates (for
  comparable revenues and progressivity) reduce
  evasion incentives.
• Politically-driven exceptions to a consumption
  tax will create greater distortions of economic
  behavior, and encourage more creative avoidance
  tactics, as nominal rates increase.
• Efficient transitional tax as part of switch to
  consumption tax system is a sneak attack on
  existing wealth.
• This efficient double taxation contained in
  some proposals is a large percentage of estimated
  economic benefits of switching.

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In Praise of the Income Tax (contd)

• Tax the Rich!
• (Paraphrasing Schenk, Saving the Income Tax With
  a Wealth Tax) Why should deferring consumption be
  privileged over deferring leisure? I can work
  less and save for the future purchase of a plasma
  TV, or I can work overtime now (deferring
  leisure) and buy the TV sooner. Why is one
  tax-deferred and the other currently taxed?
• Current participation in funding government is a
  hallmark of a democratic society permitting the
  wealthy temporarily to scale back their
  participation strains the social fabric and
  exposes the system to the risk of tax
  hemorrhaging from future temporary rate cuts or
  exceptions.
• Neither wealth nor income is a perfect measure of
  virtue, aptitude, industry or thrift Luck still
  determines a great deal of lifes outcomes. But
  wealth (and its surrogate, income) is a very good
  measure of ability to pay.

A-24