An old clich√?∆? ¬©: Everyone talks about the weather but nobody does anything about it. The same can usually be said for high taxes, but President Bush is determined to be the exception. On top of his first-term tax cuts, he’s appointed a commission to recommend simplification of the monster federal tax system. His panel may recommend reducing the sheer variety of taxes we pay, but income tax reform will be the greatest challenge. The committee will likely suggest either a flat tax for income or a national tax on sales. Despite some Congressional support for it, the sales tax concept is badly flawed.
The top benefit of a national sales tax would supposedly be reduced bureaucracy or even elimination of the IRS. Don’t bet on it. Forty-three states with income taxes rely heavily on federal enforcement to ensure compliance. With that enforcement gone, forty-three state bureaucracies would end up performing drastically more audits. And for a national sales tax to correlate with existing state collections, the five states without sales taxes would have to create brand new agencies. A mammoth federal bureaucracy would also have to remain in some form, as we shall see.
Suggestions that a federal sales tax of 20% would duplicate current revenue levels are uncertain. The GDP includes categories such as government purchases where taxing would be burdensome or impossible. Taxes on exports would be viewed as tariffs, inviting reciprocity. But the likely desire to exempt food, medicine and home purchases would necessitate a jump in the required rate. The resulting high percentage would depress sales, reduce revenue and harm the economy to boot.
If states become obliged to scrap income taxes and raise their sales tax, perhaps necessary in a system where income is no longer monitored, the total rate becomes even more onerous, probably exceeding 30% wherever other sales taxes currently exist. Businesses would be tempted to understate sales and pocket the tax. So the touted benefit of increased compliance is also questionable and while income records might not be required with a sales tax, sales and inventory records would still need scrupulous, even intrusive auditing by the IRS or similar agency to prevent fraud. This new monitoring system, a devil that we don’t know, may be as bad as the one we do.
Existing pensions, savings and various retiree nest eggs would face a substantial devaluation with a new sales tax, since that money was taxed when earned and now would be taxed again on sales. Although rebates are suggested for sustenance-level purchases, all expenditures above that would be heavily penalized.
A new sales tax would also produce an economic boom and bust. Purchases would accelerate prior to its inception, as buyers scramble to beat the tax, and would then drop abruptly. Initial revenues would thus be lower than expected.
When a luxury sales tax was once placed on items such as boats and expensive cars, many businesses were devastated as consumers bought used or lower priced products or did without the items entirely. Spending drives our economy and is the major factor in our unprecedented prosperity. Another tax on that consumption would be detrimental because almost everything you tax you’ll get less of — except income. The desire for earnings will overcome all but the highest rates.
The flat tax is thus the superior choice. It maximizes the urge to earn with rates that actually start at zero thanks to generous personal exemptions. Under one 20% flat tax scenario, a family of four would pay no income tax on $36,000 and would keep 80√?‚?? ¬Ę of each additional dollar. Only $4800 in income tax would be owed on $60,000 (an overall rate of just 8%) and only the highest incomes would pay 20%. With this incentive, commerce, investment and job creation would soar.
The flat tax would reduce tax evasion and the black market. Its low, competitive rates would encourage companies to locate or remain on our shores and the underground economy would shrink (as they’ve discovered in the former Soviet Union of all places) since much unreported income could be disclosed with little or no tax consequence. Once in the system, established filing patterns and reasonable rates would induce filers to stay. The perceived fairness of the system would be a major factor.
An enacted flat tax would likely retain charitable, medical and mortgage deductions, although with high personal and family exemptions, most taxpayers would fare well even without those write-offs. The case can also be made for a booming economy to produce an increase in charitable giving, as happened during the Reagan years. And Reagan himself once pointed out that even the Bible favors a flat tax. The scriptural levy was 10%, regardless of income.
It’s been said that Congress would be tempted to tinker with rates under the flat tax but the same argument holds true with any tax system. And one last problem of note with the sales tax is the need to repeal the 16th Amendment, which established the income tax. This complex endeavor is crucial if we’re to avoid ending up with both types of taxes and is unnecessary with the flat tax. Recent comments by Fed Chairman Alan Greenspan notwithstanding, having both levies would be a huge mistake.
Despite government shackles, our free market system is the closest thing to the mythical “golden goose.” A flat tax will remove some of those chains. Get out the hacksaws.