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Taxing Income Is Taxing Consumption Plus Increments to the Power to Consume

29 July, 2015 - 17:31

Three Principles to Guide Us Through Every Question of Income Tax

There are three principles (which are less than rules but close enough):

  1. We tax income of a particular taxpayer once and only once.
  2. There are exceptions to Principle #1, but we usually must find those exceptions explicitly defined in the Code itself.
  3. If there is an exception to Principle #1, we treat the untaxed income as if it had been taxed and we accomplish this by making appropriate adjustments to “basis.”

Know these principles.

Focus for now only on additions to “the store of property rights” that a taxpayer may accumulate during a relevant period and not on the consumption element of the SHS definition. By taxing increments to savings and investment, we actually tax a taxpayer’s additions to his/her unexercised power to consume. Taxation of income is therefore the taxation of consumption and additional increments to the power to consume.

The Unit of Measurement of Income, Consump-tion, and Savings – USD

Inflation in the United States or elsewhere affects the relative value of savings held in different currencies. We measure taxable income by the currency of the United States, i.e., dollars. Similarly, we measure basis in assets by dollars. We assume that the value of a dollar does not change because of inflation. (We might alter the ranges of income subject to particular tax rates – i.e., to index – but we do not alter the number of dollars subject to income tax.) We do not adjust the amount of income subject to tax because the value of a dollar fluctuates against other of the world’s currencies. Instead, we require that transactions carried out in other currencies be valued in terms of dollars at the time of the relevant income-determinant events, i.e., purchase and sale.

People save money only if they value future consumption more than current consumption and believe that they can spend their savings on future consumption. Imagine living in a country where inflation is so high that a single unit of the local currency now buys virtually nothing. Would you expect the savings rate in such a country to be very high? Why not? Discuss this for awhile, but ultimately your answer will be that such savings will not buy anything for consumption in the future.

The citizens of a country may manifest their lack of confidence in the future spending power of their savings by biasing their spending decisions towards current consumption or by choosing to hold their wealth in more stable but perhaps illiquid forms. After the fall of the Soviet Union, Russian citizens did not save very much money in banks but chose instead to consume (e.g., trips abroad) or to purchase items such as Sony television sets whose consumption could be spread over many years. Purchase of a Sony television set had elements of both consumption and saving. The property in which the spending power of savings was most stable after the demise of the Soviet Union was the flats that former Soviet citizens received.