So also, the taxpayer who borrows money may use the funds so borrowed either to exercise a right of consumption or to increase his/her store of property rights. In either case, SHS might provide that taxpayer has realized income. However, an obligation to repay accompanies any loan. This obligation counts as a decrease in taxpayer’s store of property rights. Hence, the addition to income is precisely offset by this decrease in the value of taxpayer’s store of property rights. Incidentally, the Code nowhere states that loan proceeds are not included in a taxpayer’s gross income.
AND: taxpayer may use loan proceeds to purchase an item for which s/he is credited with basis, just as if s/he had paid tax on the income used to make the purchase. Doesn’t this seem to violate the first principle of income taxation noted above? No. Taxpayer will repay the loan from future income that will be subject to tax. Taxpayer actually pays for his/her basis with money to be earned and taxed in the future. Repayment of loan principal is never deductible. Sometimes the cost of borrowing, i.e., interest, is deductible.
Building a Stronger Economy
Not taxing loan proceeds but permitting a taxpayer to use loan proceeds to acquire basis has tremendous implications for economic growth, long ago taken for granted. However, countries where credit is scarce have low growth rates. Not taxing loan proceeds until the time of repayment decreases the cost of borrowing. Basic rule of economics: When the cost of something goes down, people buy more. When the cost of borrowing money goes down, they borrow more; they invest what they borrow (or use it to make purchases for consumption); the economy grows.
In the pages ahead, we examine various topics concerning income tax. In all cases, keep in mind how they fit into the principles described in this chapter. Hopefully, the text will provide enough reminders to make this a relatively easy task.