1 An Income Tax, Not A Wage Tax: Comments on “A Fair and Simple Tax System for Our Future” Peter R. Orszag Co-Director, Tax Policy Center January 31, 2005

2 Moving back to an income tax Tax changes over past several years have been moving toward taxing only labor income, not capital income This proposal would move the system back toward a true income tax –1986 reform also moved in this direction, by reducing capital income preferences

3 Wage tax vs. consumption tax Consumption tax: Tax break only for new saving, not for existing capital –Imposes tax on existing assets and future wages (two sources of financing for consumption) Bulk of economic benefit from consumption tax derives from tax on existing assets Without tax on existing assets, result is simply a wage tax –All the regressivity of a consumption tax, little or none of the economic benefits

4 Using broad tax reform to boost saving: A flawed approach Aim of consumption/wage taxes: Boost new saving by reducing tax burden imposed on it Flaw: Especially at top of income distribution where bulk of tax benefit is provided, tax preferences generate little new saving –Asset shifting, not new saving –Regressive without significant beneficial impact on saving This proposal correctly moves in opposite direction

5 A better approach: Two key steps Make it easier to save –Evidence showing significant effects from automatic enrollment and automatic escalation (automatic 401k) Level the playing field for tax-preferred saving –Evidence that contributions made by lower-income workers more likely to be net addition to saving –Yet current system provides larger incentives to higher-income workers –Universal credit to level the playing field

6 Level the playing field $100 deposited by: Immediate tax saving under current system Immediate tax saving under CAP proposal High-income family $35$25 Middle-income family $15$25 Low-income family $0$25

7 Conclusions Among its many features, proposal highlights need to fundamentally re-think how we encourage private saving Represents very useful contribution to tax reform and retirement security debates