The Deceptively Disparate Treatment of Business and Investment Interest Expense Under a Cash-Flow Consumption Tax and a Schanz-Haig-Simons Income Tax
J. Clifton Fleming Jr., 𝘛𝘩𝘦 𝘋𝘦𝘤𝘦𝘱𝘵𝘪𝘷𝘦𝘭𝘺 𝘋𝘪𝘴𝘱𝘢𝘳𝘢𝘵𝘦 𝘛𝘳𝘦𝘢𝘵𝘮𝘦𝘯𝘵 𝘰𝘧 𝘉𝘶𝘴𝘪𝘯𝘦𝘴𝘴 𝘢𝘯𝘥 𝘐𝘯𝘷𝘦𝘴𝘵𝘮𝘦𝘯𝘵 𝘐𝘯𝘵𝘦𝘳𝘦𝘴𝘵 𝘌𝘹𝘱𝘦𝘯𝘴𝘦 𝘜𝘯𝘥𝘦𝘳 𝘢 𝘊𝘢𝘴𝘩-𝘍𝘭𝘰𝘸 𝘊𝘰𝘯𝘴𝘶𝘮𝘱𝘵𝘪𝘰𝘯 𝘛𝘢𝘹 𝘢𝘯𝘥 𝘢 𝘚𝘤𝘩𝘢𝘯𝘻-𝘏𝘢𝘪𝘨-𝘚𝘪𝘮𝘰𝘯𝘴 𝘐𝘯𝘤𝘰𝘮𝘦 𝘛𝘢𝘹, 3 Fʟᴀ. Tᴀx Rᴇᴠ. 544, (1997).
In spite of their differences, both a cash-flow consumption tax and a Schanz-Haig-Simons income tax require that dollars paid out as business or investment expenses be eliminated from the base. This is necessary under a cash-flow consumption tax because business and investment expenses are not consumption and it is necessary under an SHS tax because these expenditures are neither consumption nor additions to savings. Since business and investment outlays have no place in the base of either tax, intuition suggests that business and investment interest expenses would be treated identically under a cash-flow consumption tax and an SHS tax. But they are not. The cash-flow regime allows a deduction for such interest only if the related debt is included in the tax base whereas business and investment interest is always deductible under an SHS tax even though the related debt is never part of the base (unless the debt is bogus or is ultimately canceled). The apparent conflict is, however, deceptive because the interest expense deduction serves different functions in these two different taxing regimes. In the cash-flow system, business and investment capital income is wholly excluded from the tax base with the result that a deduction for related interest expense is not required to arrive at a net taxable amount. Instead, the cash-flow consumption tax employs an interest expense deduction as part of an adjustment mechanism that removes previously included borrowings from the tax base. Thus, an interest deduction is not appropriate under a cash-flow regime unless the related debt was part of the base at an earlier time. By contrast, an SHS tax always excludes borrowed amounts from its base so that no interest expense deduction is necessary to assist in canceling the prior inclusion of borrowed sums. But an SHS regime invariably includes business and investment income in the base. Consequently, and SHS deduction for business and investment interest expense is required to reduce related gross income to a net amount even though the debt which generated the interest outlay was not a previously included item. This illustrates the point that the propriety of an interest expense deduction depends on the role which is assigned to the deduction in the particular tax system.
3 Fla. Tax Rev.
Florida Tax Review