WASHINGTON _Federal Reserve Board Chairman Alan Greenspan said Thursday that the nation should create a "hybrid" tax system that taxes not only income but also personal consumption, as in a national sales tax.
Testifying before President Bush's Advisory Panel on Federal Tax Reform, Greenspan heartily endorsed Bush's call to simplify the tax code. He said the coming retirement of the baby boom generation and the strain that will place on the federal budget make changing the tax system an urgent priority.
"Many economists believe that a consumption tax would be best from the perspective of promoting economic growth—particularly if you were designing a tax system from scratch—because a consumption tax is likely to encourage saving and capital formation," Greenspan said.
Neither Greenspan nor members of the advisory panel discussed specific taxes on consumption. But one long-studied option would be a national sales tax on retail purchases, which could be levied on everything from food, drink and movie-theater tickets to cars.
Another option is a so-called Value-Added Tax (VAT) to replace the corporate income tax. Instead of taxing gross profits, as the income tax does, a VAT is an indirect sales tax paid by businesses on each stage of production or distribution from raw material to final sale. Businesses would then pass the tax along to consumers in their products' final prices.
Economists generally like consumption taxes because they are simple to collect and hard to duck. However, many Democrats oppose them because they hit poor and middle-income Americans disproportionately hard. Poor people spend virtually all their income on consumption rather than putting it into savings and investments.
Greenspan suggested a compromise "hybrid" system that would tax both income and consumption because, he said, Congress and the country probably aren't ready to shift entirely from one system to another.
"I would suspect that probably that may be the best route to go. In other words, don't try for purity," he said. The nation's central bank chief also said that a consumption tax could be constructed to shield some purchases from its bite, especially items (such as food) that claim a large share of poor people's money.
Asked later by reporters what he thought of Greenspan's comments on a possible consumption tax, Bush declined to offer an opinion.
"I think that I'm going to wait until the tax commission I put together ... comes forward with some ideas," Bush said.
Commission members listened carefully to Greenspan.
"I interpret what the chairman said as being very significant. ... I think what he said today is it doesn't have to be either/or, that you could have some combination made to work," said John Breaux, vice chairman of the advisory panel and a former Democratic senator from Louisiana.
The last time the federal tax code was revamped was in 1986. Former Treasury Secretary James A. Baker III presided over those changes and cautioned the panel Thursday that its work "is a political exercise every bit as much as it is an economic exercise."
Speaking to reporters later, Breaux wondered whether Congress is capable of making major tax-code changes while it's consumed by a national debate on transforming Social Security.
"Anybody who has been around here more than a few days can understand that those two challenges are not likely to occur in the same Congress," Breaux said.
(c) 2005, Knight Ridder/Tribune Information Services.
PHOTO (from KRT Photo Service, 202-383-6099): Alan Greenspan
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