Human Capital under an Ideal Income Tax

Abstract

*Professor of Law, Harvard Law School, and Research Associate, National Bureau of Economic Research. I am grateful for comments from Josh Rosenberg, Jeff Strnad, Al Warren, and participants in 1993 Seminar on Current Research in Taxation sponsored by Harvard Law School; research assistance from David Elsberg; and financial support from John M. Olin Foundation. 1 Henry Simons defined personal as the algebraic sum of (1) market value of rights exercised in consumption and (2) change in value of store of property rights between beginning and end of period in question. Henry C. Simons, Personal Income Taxation 50 (1938). Robert Haig defined it as the money value of net accretion to one's economic power between two points of time. Robert M. Haig, The Concept of Income-Economic and Legal Aspects, in The Federal Income Tax 1, 7 (Robert M. Haig ed., 1921) (emphasis omitted). Although it is common to rely on Haig-Simons definition of income in defining an ideal income tax base, this Article avoids such reliance because conceptual ideal usually invoked in contemporary discussions may differ from actual intent of Haig and Simons or be inconsistent with some of their phrasings. For example, Simons emphasized market valuations, motivated by need for administrability, see, e.g., Simons, supra, at 110-24 (discussing appropriate treatment of income in kind), whereas conceptual discussions often treat things of value as income regardless of whether they are traded. Thus, it is commonly suggested that, in principle, an ideal income tax would include all gains as they accrue, rather than await a realization event (typically a sale). The realization requirement of existing income tax is viewed as a departure from an ideal tax on income, which might or might not be justified as a concession to practicality. See, e.g., Alan J. Auerbach, Retrospective Capital Gains Taxation, 81 Am. Econ. Rev. 167 (1991); Noel B. Cunningham & Deborah H. Schenk, Taxation Without Realization: A Revolutionary Approach to Ownership, 47 Tax L. Rev. 725 (1992); Mary L. Fellows, A Comprehensive Attack on Tax Deferral, 88 Mich. L. Rev. 722 (1990); David J. Shakow, Taxation Without Realization: A Proposal for Accrual Taxation, 134 U. Pa. L. Rev. 1111 (1986); David Slawson, Taxing as Ordinary Income Appreciation of Publicly Held Stock, 76 Yale L.J. 623 (1967); William Vickrey, Averaging of Income for Income Tax Purposes, 47 J. Pol. Econ. 379, 383-84, 395-96 & n.7 (1939). Indeed, Simons adopted this general perspective in principle, although not in practice: When does income accrue? One reason question presents difficulties is that it has been badly phrased.... The question is better stated simply as a problem in valuation: When should value changes be recognized? We do best, in general, to regard income not as something accruing or flowing with time-for such language is