The current tax system, with its graduated tax on individual incomes, its separate tax on corporate profits, its gift and estate taxes on the transfer of wealth, and its separate wage tax to fund the Social Security and Medicare systems, has many critics. It is said to cost the country in lost time, economic efficiency, trade, and contentment. Reform proposals have proliferated, ranging from a broader-based, flatter-rate income tax to scrapping the system altogether in favor of a national sales tax or some other form of national consumption tax. This report surveys some of the issues to be considered in debating such drastic tax changes, considering not only a broader based income tax but also three basic forms of consumption taxes: the Hall-Rabushka "flat tax," the value-added tax (VAT), and the national retail sales tax. After a brief overview of some of the current proposals, the sections that follow discuss economic efficiency issues, foreign trade issues, effects on different economic sectors, short-run adjustment costs, compliance and administration, and revenue and distributional implications. The idea of replacing our current income tax system has been a topic of perennial congressional interest. Although many recent proposals are referred to as "flat taxes," most actually go much further than merely adopting a flat-rate tax structure and would change the tax base from income to consumption. More recently, the President has indicated some interest in such fundamental tax reform, and his advisory commission has proposed a modified flat tax. Theoretically, one could construct a tax system using one or a combination of three main tax bases: income, wages, or consumption. Income-and wage-based taxes are familiar and relatively easy to understand. Under a comprehensive income tax, all income, whether from labor or capital, would be included in the tax base. A wage-based tax would be levied only on income from labor; income from capital would be excluded from the base. Obviously, wages provide a smaller tax base than income and would therefore require higher tax rates to raise the same revenue as a tax based on all income. With the exception of sales taxes, the American people are not very familiar with other forms of broad-based consumption taxes and so there is some confusion about how they might be measured and levied. The easiest way to understand the basis of consumption taxes is to first define and understand the economic concept of income. In its broadest sense, income is a measure of the command of resources that an individual acquires during a given time period. Conceptually, an individual has two options with respect to his income; he can consume it or save it. This relationship means that by definition income must equal consumption plus saving. This relationship helps in understanding how a comprehensive consumption-based tax might be levied at the individual level. An individual would add up all his income as he does under the current tax system but would then subtract out his net saving (saving minus borrowing) or add net borrowing. The result would produce a tax based on consumption at the individual level. A consumption tax could also be collected at the retail level as a retail sales tax on final consumption. (A retail sales tax exempts, in theory, the sale of intermediate goods including capital goods to be used in a business). Or it could be collected at each stage of the production process in the form of a value-added-tax (VAT). With the VAT, firms face a tax on gross receipts less purchases of materials, goods for resale and capital to be used in the business. A VAT can be implemented using either a credit-invoice method or a subtraction method. Another way of collecting the tax, the Hall-Rabushka flat tax, would split the VAT base between firms and individuals. Firms would deduct wages from their tax base and individuals would pay a tax directly on their wages. Although the point of collection differs (individual level, retail level, or firm level), when defined comprehensively, the tax base is the same: consumption. Regardless of the point or form of collection, however, a consumption tax is ultimately paid by the individual consumer. Because consumption is smaller than income, a comprehensive consumption tax would require higher tax rates than a comprehensive income tax to raise the same revenue, although with a low savings rate, the bases (and thus tax rates) are very close. Other developed nations have VATs (of the credit-invoice type), but also have income taxes. Their VATs do not replace income taxes, but rather finance a higher level of government spending. Most of these nations do not have a retail sales tax, which is an important subnational tax in the United States. There is currently no serious proposal to shift the entire tax system to a wage-based tax as such. The current proposals are almost all based on a switch to some form of consumption taxation, either a national sales tax or some form of value-added tax. They differ principally in their point of collection rather than their tax base. These proposals include several versions of the value-added tax widely used in Europe, a national sales tax such as those used in the states, and more exotic variations, such as the "Flat Tax" devised by economists Robert Hall and Alvin Rabushka and the Unlimited Savings Account or "USA" tax originally introduced in the 104 th Congress by Senators Dominici and Nunn. There is also some interest (and at least one serious proposal) in a broader-based, flatter rate income tax. No bill for this type of fundamental tax reform has had sufficient detail to be operational, and no such bill has ever received a floor vote. The President indicated that fundamental tax reform would be a major priority of his second term, although the shape of that reform is uncertain at this point. His advisory commission has included a modified flat tax (which included a tax on financial income) as one of the recommended options along with an income tax reform. Many of the issues discussed in this paper, especially sectoral effects on currently favored industries would also apply to a broader based income tax. Probably the most often repeated argument in favor of switching to a flat-rate consumption tax is that it will make the economy more efficient and will increase private savings. When evaluating this argument, however, comparisons should not be made between the current income tax system and an ideal consumption tax. Compared to a theoretically ideal tax (whether the base is consumption or income), the existing tax system will always appear flawed. For policy evaluation, therefore, a more appropriate comparison is between a theoretically pure consumption tax and a theoretically pure income-based tax. The economic efficiency or inefficiency of a tax system may be judged by its effects on behavior. To the degree that the tax system distorts economic behavior (from what it would be in the absence of the tax), it is economically inefficient. The distortion prevents the efficient allocation of resources. Basically, with the exception of lump-sum or head taxes, all taxes, regardless of whether they are based on income or consumption, distort behavior and affect the allocation of resources. Both an income and a consumption tax distort the choice between labor and leisure. For example, under either tax, the price of leisure is reduced relative to the consumption an individual could finance with an extra hour of labor. An income tax also distorts the choice between present and future consumption (saving). Under an income tax, the return to savings is subject to tax. This reduces the resources an individual will have available for consumption in the future, and hence raises the price of future consumption relative to the price of present consumption. In contrast, a tax on consumption is neutral with respect to the choice between present and future consumption. The relative price of future consumption in terms of present consumption is the same as if there were no taxes. In theory, adopting a consumption tax may or may not increase overall economic efficiency. Under a consumption tax which yielded revenue equal to an income tax, the tax rates would have to be higher than the tax rates on the income tax base because consumption is smaller than income. The higher tax rates under a consumption tax would increase the distortion between work and leisure choices. The efficiency gain from removing the present/future consumption distortions, therefore, might be offset by the efficiency loss inherent in the larger distortion between work and leisure decisions. Many economists have argued, however, that a consumption tax is superior in achieving economic efficiency (i.e., in leading individuals to consume and work in a more optimal fashion) because of the elimination of the distortion between present and future consumption. They base this argument on the simulated outcomes of inter-temporal models, which virtually always predict a gain in efficiency from the shift from flat rate income to flat rate consumption taxes. One reason for this predicted efficiency gain—which often does not occur with a shift from an income to a wage tax base—is that a consumption tax is the equivalent of a tax on wages and a lump sum tax on existing wealth. The lump sum tax allows tax rates to be much lower with a consumption base than with a wage base, even though neither tax the return to new investment. In fact, when an economy's saving rate is very low, the consumption tax base is quite close to the income tax base. (There are distributional consequences to this feature that will be discussed subsequently). Thus, even though tax rates may be higher under a consumption tax than under an income tax and increase the distortion between work and leisure, this increase is a relatively small effect—the lump sum tax on old wealth has made this efficiency gain possible. The existence, and even the magnitude, of this efficiency gain, however, is not entirely clear under a less abstract modeling of the tax. First, under current law the income tax imposes higher marginal tax rates on capital income than on labor income (primarily because of the corporate income tax). To replace both corporate and individual revenues by a flat consumption tax would require a higher consumption tax rate and the tradeoff between the labor leisure distortion and the present and future consumption distortion is less clear.