According to columnist Robert Novak, House Majority Leader Tom DeLay (R., Tex.) is adamant about replacing the entire federal tax system — payroll and income taxes — with a 30 percent national retail sales tax (NRST) collected by the states, such as that in H.R. 25, sponsored by Rep. John Linder (R., Ga.). I have written many times before about what a dopy idea I think this is. Following is an effort to summarize the key arguments against it that appear over and over again in the scholarly literature. 1.
People will still have to keep records, file income-tax returns, and get audited as the states and some cities will continue to have income taxes. There is no reason whatsoever to think that the states will get rid of their income taxes if the federal income tax is abolished. Quite the contrary, they are likely to view the federal government as co-opting their traditional tax base — the general sales tax. Therefore, the states will just take over the tax base being given up by the federal government — the income tax — and abolish their state sales taxes, which would otherwise come on top of the NRST.
The only way this can be prevented is if the federal government prohibits the states from imposing income taxes at the same time it abolishes the federal income tax, which is probably impossible constitutionally. And if the states keep their sales taxes, the federal government will have to force them to conform to its tax base. Right now, no two states have exactly the same sales-tax systems and none come anywhere close to taxing sales as broadly as contemplated by the NRST.
2. There is a very severe problem of taxing business inputs under a sales tax. These must be exempt from tax in order to avoid cascading — taxes being levied on taxes — which creates serious economic distortions. To avoid this under a NRST, every business, no matter how small, would need some sort of exemption certificate, which would create unlimited opportunities for evasion, or businesses will have to be extensively audited in ways at least as onerous as under the income tax.
3. Services are by their nature much more difficult to tax than goods. For this reason, no state makes any effort to tax more than a few of them. Yet the NRST would tax 100 percent of services, including medical services and government services. Every time you go to the hospital you will have to pay 30 percent on top to the federal government. And local governments will also be taxed by the federal government on services they provide, which will sharply raise property taxes.
4. In order to offset the regressivity of the NRST, it would establish a massive new government entitlement program costing hundreds of billions of dollars that would send rebate checks to every American on a monthly basis. This system would be based on the poverty-level income established by the Census Bureau. People would get 23 percent of this amount annually in 12 monthly installments based on their family status. Quite apart from the massive complexity of this proposal, it would clearly require an enormous enforcement mechanism to avoid fraud and would undoubtedly be manipulated by politicians. It would be very tempting to change the formula to aid the poor and penalize the rich, just as the current tax code does.
5. Every serious analysis has concluded that a NRST would bring about massive evasion. Taxing the spending of drug dealers and others not currently paying income taxes will not come close to compensating for the new evasion opportunities that will be created. Since it is not in the interest of either retailers or consumers to pay the tax, and because all of the revenue is collected at the point of final sale, it will be too easy for tax-free deals to be made with producers and wholesalers.
Although evasion of state sales taxes is relatively small, this is only because the rates are low enough that it is not worth the trouble. However, where rates are high on things like tobacco, evasion is also high. A vast amount of foreign experience indicates that retail sales taxes cannot be collected much above 10 percent without breaking down.
Under our current tax system there is withholding of taxes on wages, which represents the vast bulk of the tax base. Under a value-added tax (VAT), something similar occurs because taxes are paid at each point of the production-distribution cycle. Thus, if the retailer fails to collect the tax, only a small portion of the total revenue is lost, whereas with a NRST all of it would be lost. Primarily for this reason, every single country that has ever contemplated something like a NRST has instead chosen a VAT, which the NRST people oppose.
– Bruce Bartlett is senior fellow for the National Center for Policy Analysis. Write to him here.