ELSEVIER Journal of Public Economics 58 (1995) 257-265 JOURNALOF PUBLIC ECONOMICS Taxation, uncertainty and the choice of a consumption tax base George R. Zodrow Economics Department, Rice University, Houston, TX 77251-1892, USA Received February 1993; revised version received May 1994 Abstract Several observers have concluded that the equivalence between the cash flow and wage tax approaches to direct consumption taxation breaks down in the presence of uncertainty, as individuals with extraordinarily large gains are treated too generously under the latter approach. In particular, Ahsan (Journal of Public Economics, 1989, 40, 99-134; Canadian Journal of Economics, 1990, 23, 408-433) contends that equivalence obtains only if returns in excess of a safe rate of return are included in the wage tax base. This paper constructs an alternative and arguably more plausible model under which full equivalence between the two approaches obtains even inthe presence of uncertainty. It also derives Ahsan's result in a more general context, and demonstrates that the divergence between the two analyses is attributable to different assumptions regarding the cost to the government of an uncertain revenue stream. Keywords: Consumption tax equivalence results; Taxation and saving; Tax with uncertainty JEL classification: H2; D8 I. Introduction The question of whether income or consumption is the preferable base for direct taxation has sparked extended debate. 1 The issue is complicated by the existence of two alternative methods of implementing a consumption For example, see the papers in Pechman (1980) and Rose (1990). 0047-2727/95/$09.50 © 1995 Elsevier Science B.V. All rights reserved SSDI 0047-2727(94)01470-1