Tax systems can have multiple goals. For example, in addition to the common goal of raising revenue for the government, goals can also include redistributing income, stabilizing the economy, and achieving various other social and economic objectives through the use of preferences. Generally speaking, the greater the number of goals, the more complex is the tax system. Tax systems are commonly judged and compared according to four criteria: equity, economic efficiency, simplicity, and administrability. A tax system is generally considered better than alternatives that raise the same amount of revenue if it is more equitable, more economically efficient, simpler for taxpayers to comply with, and easier and less costly to administer. In this report, we focus on simplicity and administrability and do not analyze equity and efficiency. In deliberating on any changes to the current tax system, Congress would need to consider each of the four criteria. Designing a tax system that is superior on each of the four criteria is difficult because the criteria frequently conflict with one another and trade-offs must be made. For example, a tax system that provides credits to low-income individuals may be judged by some to be more equitable than a system without this feature. However, if including credits makes it necessary for more individuals to calculate their income and file tax returns, the tax system could become more complex for both taxpayers and tax administrators. The federal tax system raised about $1.4 trillion in fiscal year 1995 through individual and corporate income taxes, payroll taxes, various excise taxes on certain goods and services, and estate and gift taxes. Income taxes accounted for 62 percent of total federal tax revenue. The current income tax system includes an individual tax and a business tax. Wages, interest and dividend income, capital gains, and some types of business income, including that of sole proprietorships and partnerships, are taxed under the individual income tax. Individual income is taxed at graduated rates. Income earned by certain corporations is subject to a separate business income tax, also at different rates. The current system provides exemptions and different tax rates on savings and investment through a variety of special provisions, such as the preferential treatment of pensions, individual retirement accounts, life insurance, annuities, state and municipal bonds, and capital gains. The result is a hybrid income-consumption system of taxation that exempts some types of saving and investment from tax but taxes others. The current system includes numerous other tax preferences. Examples include the earned income credit; specific deductions for home mortgage interest, charitable contributions, and state and local taxes; and exclusions of employer contributions for health insurance. Requirements for filing returns and performing other tax-related functions vary. All individuals with gross income above certain thresholds based on personal allowances and a standard deduction must file returns. Businesses have certain responsibilities beyond filing returns, including withholding and remitting employee income and payroll taxes, such as Social Security, Medicare, and unemployment taxes. Further, many businesses must send information returns to the Internal Revenue Service (IRS) and to individuals detailing income paid as wages, interest, and dividends. For more detailed descriptions of the federal income tax system, as well as its complexity and burdens for both taxpayers and tax administration, see appendix II. In the last several years, proposals for making fundamental changes to the tax system have been discussed by policymakers and tax experts in government, academia, and the private sector. An overview of tax reform design issues appears in appendix III. The alternative tax systems we studied are briefly described below and are further detailed in appendixes IV through VIII. A national RST would generally be collected by businesses making retail sales to final customers, with sales to other businesses generally not taxed. VATs, now widely used internationally, are business-level taxes levied directly on the sales of goods and services. All types of businesses, not just retail businesses, are subject to the tax, and sales to both consumers and other businesses are taxable. With the credit method VAT, used by most industrialized countries, businesses claim a credit for tax paid on their purchases from other businesses, and with the subtraction method VAT, businesses deduct the amount of their purchases of goods and services from other businesses. Thus, under a VAT, businesses pay tax on the value they add to the goods and services they purchase. The flat tax discussed in this report would have both business and individual components. The business tax would be similar to the subtraction VAT, except that wages, salaries, and pensions would be deducted by businesses. Individuals would pay tax on wages, salaries, and pensions received above levels of allowances for themselves and their dependents. The same, single (flat) tax rate would apply to both individuals and businesses. A personal consumption tax would look much like the current individual income tax in that individuals would continue to pay tax on many kinds of income, such as wages, salaries, and interest and dividend payments received. It would differ in that borrowed funds would be included in the tax base, and funds that are saved or invested would be deducted. In most proposals, the personal consumption tax has been supplemented by a business tax designed to ensure that business purchases of goods and services for consumption, such as nonpension fringe benefits, would be taxed. Income tax reform options that would replace the current income tax with a more broadly based income tax have been discussed by the Department of the Treasury and others over the years. Instead of being replaced by a consumption tax system, the current tax system could be changed to a broad-based income tax system by, for example, eliminating preferences on certain types of income. Some proposals for reforming the income tax would also change the collection point, or level, of tax. Options we studied include levying taxes on businesses only, on businesses combined with a relatively simple individual tax, and primarily on individuals. Table 1 lists four basic design features of the tax systems we studied: (1) the basis for taxation (income or consumption); (2) whether individuals, businesses, or both would be subject to tax; (3) whether tax preferences could exist for certain individuals, businesses, or goods and services; and (4) the rate structure for individuals (single or multiple rates). One major difference in the design of alternative tax systems is whether the tax base is income or consumption. An income tax system generally does not allow deductions for savings and requires that earnings on savings be measured and taxed as they are earned. Also, it generally requires that businesses depreciate their purchases of assets, that is, deduct the cost of assets over time rather than at the time they are purchased. Consumption-based tax systems differ from income-based tax systems in that they generally exempt from tax income from savings and investment. The national RST, VAT, flat tax, and personal consumption tax would achieve this exemption in different ways. Under a national RST, businesses would generally not pay tax on goods and services they buy. Under the VAT and the flat tax, businesses could immediately deduct purchases of goods and services, including purchases of plant and equipment, that they made from other businesses. Under a personal consumption tax, funds that are saved or invested would be deducted by individuals. Another major design difference among alternative tax systems is who would be subject to tax. Consumption and income taxes could be levied on individuals, businesses, or both. By levying tax directly on individuals, a tax system can make distinctions among individuals or households to account for varying individual circumstances by, for example, allowing deductions and multiple rates. Alternatively, a tax system could focus only on businesses and thus require fewer taxpayers. The alternative consumption tax systems we considered differ from one another according to who would be taxed. The national RST and the VAT generally would only tax businesses. All types of businesses, including corporations, as well as partnerships and sole proprietorships, could be subject to tax. A national RST would differ from a VAT in that only businesses making retail sales would be subject to a national RST, while retail and wholesale businesses could be VAT taxpayers. The flat tax would collect much of the tax base from businesses but also would include a relatively simple individual tax. The personal consumption tax would continue to tax individuals. In conjunction with this tax, businesses could be subject to a supplemental tax. Similar to the national RST, VAT, or flat tax, an income tax could be designed to collect taxes from businesses rather than from individuals. Such an income tax could, for example, disallow business deductions for wages and free individuals from filing returns. It would collect tax on all or part of individuals’ incomes where the incomes were generated and before they were paid. Other income tax options would, like the current income tax system and the personal consumption tax system, tax most types of income at the individual level. Each of the various alternatives could include tax preferences, although the types of preferences provided would differ among alternatives. These preferences could include special deductions, exemptions, and/or credits, as well as various tax rates on different types of income or goods and services. The types of taxpayers in a tax system would influence the type of preferences that could be allowed. Alternatives that tax individuals directly could include preferences designed to target specific groups of individuals. It would be more difficult for a tax system, such as a national RST or a VAT, that applied only to businesses to provide preferences for groups of individuals because businesses can apply different tax rates to goods and services but cannot distinguish among individuals. Preferences under business-level taxes could also include exemptions of specific types of businesses or activities. The fourth design difference is the rate structure for individual-level income or consumption tax systems. The alternatives that we considered that include an individual-level tax—the flat tax, the personal consumption tax, and several income tax options—could tax different individuals at different rates. All these options could include what is, in effect, a zero tax rate by providing a standard deduction or personal allowances. For example, under the flat tax, individuals with wage income under the personal allowance amount would not owe any individual tax; wage income above the deduction or allowance amounts would be taxed at a single rate.