The chairman of the Council of Economic Advisers said last night that the Reagan administration is considering "a very attractive approach to tax reform" with taxes based not on an individual's income but on consumption.
Martin Feldstein, the chairman, said in the prepared text of a speech to a tax policy seminar that "no decisions have been made. But many of us do think that taxing consumed income is a promising approach to tax reform, an approach that could guide decisions of a full-scale redesign of our tax system or of more modest piecemeal reform."
There have been reports that President Reagan might suggest in his State of the Union message next week that such revisions be undertaken in the next several years, but the reports have not been confirmed.
The purpose of shifting to a consumption-based tax would be to encourage saving, a substantial portion of the income from which is now taxed, so that more money would be available to finance business investment. More investment, in turn, would improve productivity growth and lead to a rising standard of living, the CEA chairman said.
Feldstein said the consumption tax he has in mind would not be a national sales tax or a value added tax (VAT), in which a tax is levied at each stage of production but with the ultimate consumer paying the entire tax.
"The fundamental feature of a consumption tax is that individuals would pay tax on the amount that they spend on personal consumption," Feldstein said. "More precisely, each individual would add up all of his cash receipts for the year and then subtract all of his savings, including additions to bank accounts, purchases of stocks or other assets, and repayment of loans.
"This difference between total receipts and total savings-investment outlays would be the amount on which he paid tax," he explained.
Feldstein said the entire proceeds from the sale of stock or other assets would be included as a receipt in the year they were sold. "At the same time, however, the individual could subtract any amount that is reinvested in new stocks and bonds or added to his bank balance."
Thus, capital gains would be taxed only if they were used to pay for consumption. If they were reinvested, there would be no tax.
Similarly, money borrowed to pay for consumption would be taxed while funds borrowed to make an investment would not be.
The CEA chairman said that the structure of rates applied to the level of consumption could be as progressive as is desired. "The progressivity of that rate schedule is a quite separate issue from the question of the appropriateness or desirability of basing individual tax liabilities on a measure of consumption rather than a measure of income received or accrued," he noted.
The rate schedule could be the same as it is now for the income tax, or quite different. But if it were the same, Feldstein added, "within each . . . income class those individuals who saved a larger than average proportion of their income would pay less tax than those who saved a smaller than average proportion of their income."
Feldstein also said deductions for state and local taxes could still be allowed, if desired, on the grounds that they represent money that the taxpayer cannot use for consumption. Deductions for charitable contributions could also be justified in similar fashion. Stolen property and casualty loss deductions and medical expense deductions could theoretically be justified, too, he said.
In a separate speech to the tax seminar, sponsored by the American Council for Capital Formation, former Treasury secretary John B. Connally called for elimination of the corporate income tax, adoption of a value-added tax, and reduction in what he termed the "excessive progressivity" of the personal income tax