It’s Fix the Tax Code Friday!
This week, my post about a national sales tax on online sales was all in jest for April Fool’s Day. But it caught some folks off guard because it really could happen. Proponents say that a national sales tax would increase revenue by taxing consumption rather than income. Critics say that a sales tax is far too regressive and would disproportionately affect the poor.
I want to know what you think.
Today’s Fix the Tax Code Friday question is:
Should the US consider a national sales tax as an alternate method of raising revenue?
Theory aside, many other rich-world jurisdictions have implemented a VAT / GST regime of some sort and most of those have lower levels of inequality. For example, the EU has an aggregate Gini coefficient in the neighborhood of 30 whereas the US is closer to 45.
I had a client complain to me the other day about how the Obama administration is surely going to tax him to death. He has 5 kids, his wife doesn’t work, and he netted about 40k in schedule C work for ’08, so aside from state sales taxes, he paid roughly $1k total in tax last year, including SE. The state even pays for his family’s health insurance. I’m sure he’d be paying more taxes under a flat tax system, but as long as a Republican was in office when the change was made, he’d be happy about it.
There’s just no way that a flat tax wouldn’t help the rich and hurt the not-rich. Not being rich myself, I’m anti.
The national retail sales tax (NRST) as defined in HR 25 (The FairTax Act of 2009) would disproportionately afffect the poor, because they would NOT PAY THE TAX AT ALL! A “prebate” (rebate before the fact) would rebate all taxes due under the FairTax (in the amount of the tax on money up to the poverty level) before the taxes are paid. It is based on family size, so it is larger for larger families.
That doesn’t sound regressive to me. Almost all of the arguments I have heard against the NRST are from people either intentionally misrepresenting the tax as something is it not, or from people that want the existing system to continue because they have something to gain (mostly politicians and lobbyists).
Who wouldn’t want the income tax system (along with the IRS) to go away, except maybe the IRS?
By the way, the NRST is not a value added tax. It is applied only once, at the point of retail sale, on new goods only.
I say no, for the tried-and-true reason: any sales tax (or VAT, etc.) is extremely regressive. Most of the countries that implement a VAT have a much more economically homogeneous population that we do; they also impose income taxes that are very “progressive”; i.e.: the “wealthy” pay considerably higher income taxes than they would here. This has the effect of making their overall national tax structure much more “equitable”.
I feel the same about the so-called “flat tax”, an income tax where everyone pays the same rate. That, too, is extremely regressive, and would be even more so because one cannot realistically assume that passing a flat tax also would mean that all other types of “income” (capital gains, bonuses, stock options, stock, etc etc) would be subject to the same tax rate. Even if that did happen, it wouldn’t last long — witness the sort-of attempt to do that in 1986 with a teo-rate structure. The idea was that the loopholes would be closed; many never were and the capital-gains rate soon was reduced to much lower levels.
Speaking of capital gains; the lower cap gains rate applied to “long-term” investments, but the tax code defines long-term as only one year (last I heard, though I may now be wrong , the “long-term” for investiung in commodity futures was only six months.)
I suggest a slight change; after one year, for each additional month that one holds an investment, 1% of it becomes subject to the cap gains rate. Thus, it would take 9 1/3 years for all of an investment to become long-term gain. Noe THAT’s long-term!
Until July, 2007, my state (Arkansas) had one of the most regressive sales taxes in the nation; it was 6.125% and applied to everything (except bibles) including food and medicine. In 2007 the sales tak on food and medicine was reduced to 3.125%, and this year it will be reduced further to 2.125%. Still, we are one of the very few states that has any sales tax on such necessities.
How can a tax be regressive if the people with incomes at or below the poverty line PAY NO TAX AT ALL?
If you’re not rich, you will be paying more tax under the proposed “fair tax.” That’s why it’s regressive: people who make more will pay less, and people who make less will pay more. Theoretically, with the so-called “prebate,” the very lowest income people won’t pay tax (actually, they’d still pay tax, they just magically get it back in advance, which I guarantee would be a bureaucratic nightmare), but the next rung up the ladder would have to make up for it. It’s a pretty sweet deal for the rich.
Basically, if it sounds too good to be true, it usually is.
I really don’t think it sounds too good to be true. A 23% tax rate does not sound good to me, but it sounds better that what I’m paying now. Owning my own business, I pay not only the marginal tax rate (which puts much of my income at 25%), I pay 7.65% self employment tax as well. How that translates to more than 23% of what I spend on NEW goods is something I don’t understand, since the largest expenses I have are for my mortgage payment (not taxable under FairTax) and car payments (also not taxable under FairTax).
I stand by my previous statement: “Almost all of the arguments I have heard against the NRST are from people either intentionally misrepresenting the tax as something is it not, or from people that want the existing system to continue because they have something to gain (mostly politicians and lobbyists).”
Neither of those was my argument, actually. My main argument is that if you level out the taxes, the people on the lower end pay more and the people on the upper end pay less. I for one don’t want to pay less, and I tend to think that those who make more should shoulder more of the burden.
Also, the 23% figure you cite is flat out wrong. It’s confusing, but basically the 23% is before tax. When we say that we have a 7% (eg) sales tax, that’s after tax. IE the 23% is including tax on the tax. The real number is closer to 30%, and Bush the Great himself thought it’d actually be much higher. In my state, that would mean a +40% tax at the till.
Okay, if you apply what amounts to a national sales tax (value-added-tax, whatever), lower and middle-income households would pay proportionately more of their incomes in tax than upper-income. That’s because they spend proportionately much more of their incomes on taxable goods than wealthy people do. You’d have to have a lot of exemptions to a NRST; for example, if the tax applied to housing and rent, the results would be disastrous. If it applied to automobiles, same thing.
Giving lower-income households a “prebate” to offset some of the tax (so that it’s less regressive) would be a Rube Goldberg nightmare, and would require the IRS to stay in business just to check up on everyone claiming that particular exemption — all of whom would have to file a tax return that would be much more complicated than the 1040-EZ, or possibly even the 1040 itself — because they’d have to keep track of how much NRST they paid during the year so the gov’t would know how much to pay them back.
When would this “subsidy” be applied? With each paycheck? As a huge refund at the end of the year?
A “flat” income tax generates its own can of worms, unless we allow much much larger $ exemptions and standard deductions — so as to make the “flat” tax genuinely progressive.
And none of this discussion takes into account the social security tax (FICA) which is the most regressive tax of all. First, it comes off the top; there’s very little of earned income that’s exempt, EXCEPT for income over about $100,000. That’s because FICA applies only to the first $100,000 or so of earned income (income subject to the medicare tax is unlimited). Your typical working stiff pays 6.25% off the top; someone who makes, say, $500,000 a year pays about 1.25% off the top. And much of the income that really high-income people make (stock, stock options, etc etc) isn’t subject to ordinary income tax at all; it’s structured so, at the most, one might pay long-term capital gain tax at some point in the future.
If we had a “flat” income tax that applied to ALL forms of compensation, combined with much larger exemptions and standard deductions, then we might have something that approaches some sort of fairness. Except that it would expose much more income of the wealthy to taxation and, so, could never be enacted.
Mr. Hickman
You wrote “I for one don’t want to pay less…” If you truly don’t want to pay less, you are free at any time to voluntarily send as much money as you desire to the treasury. Please don’t attempt to impose your preferences on the rest of us.
You wrote “Also, the 23% figure you cite is flat out wrong.” The 23% rate was used because is the calculated on the same basis (inclusive vs. exclusive) as the current income tax. To require on to be calculated as inclusive and the other as exclusive is comparing apples to oranges. What Bush the great thought is irrelevant because he did not spend the time, nor have the expertise to make that judgement.
You wrote “In my state, that would mean a +40% tax at the till.” Please do not add the state sales tax into this discussion. It remains regardless of the federal taxing system, and it thus irrelevant.
JBruce
You wrote “That’s because they (lower and middle-income households) spend proportionately much more of their incomes on taxable goods than wealthy people do.”
You wrote “You’d have to have a lot of exemptions to a NRST; for example, if the tax applied to housing and rent, the results would be disastrous. If it applied to automobiles, same thing.” Pre-owned housing and automobiles are exempted, as are educational expenses. Only new houses and automobiles are subject to the tax.
You wrote “Giving lower-income households a “prebate” to offset some of the tax (so that it’s less regressive) would be a Rube Goldberg nightmare…” The Social Security Administration currently sends a monthly payment to millions of persons, with very few glitches.
You wrote “all of whom would have to file a tax return that would be much more complicated than the 1040-EZ, or possibly even the 1040 itself — because they’d have to keep track of how much NRST they paid during the year so the gov’t would know how much to pay them back.” The NRST prebate is not based on how much tax you paid, but rather on the number of persons in your household. There is no requirement to file a “tax return”, only a statement (including names and SSNs) of how many people live in your household. Hardly more complicated than even the 1040EZ, much less the 1040.
You wrote “When would this “subsidy” be applied?” This question is inflammatory and argumentative. The prebate is no more a subsidy that the refund you get under the current income tax structure.
You wrote “With each paycheck? As a huge refund at the end of the year?” For those with a bank account, the prebate would be in the form of a monthly direct deposit. For those without a bank account, and those opposed to a direct deposit, it would come in the form of a credit to a check card account, or a printed check.
You wrote “A “flat” income tax…” any reference to a flat income tax is not relevant to the discussion at hand and requires no response.
You wrote “none of this discussion takes into account the social security tax (FICA)…) The NRST replaces all federal payroll taxes (among others) and therefore addresses the FICA issue. It gives solvency to the SSI system by depositing and withdrawing directly from the general treasury.
I stand by my original statement that “Almost all of the arguments I have heard against the NRST are from people either intentionally misrepresenting the tax as something is it not, or from people that want the existing system to continue because they have something to gain (mostly politicians and lobbyists).” with the following consideration. Many arguments are from people who have been exposed to arguments from the groups above and have not availed themselves of the information from that developed the plan. I refer to these as the “ignorant masses”. I do so not as an insult, but as a description of their state of education on the topic. These people simply regurgitate the mis-information generated by the first two groups without verification of the facts. I believe you fit firmly into this category, and could benifit by taking the time to study the information presented by those that developed the plan.
Heh. I just noticed my mistake above. Multitasking doesn’t really work, does it?
Doug – I think it’s misleading to say that it’s a 23% rate, because most people would compare that to their own state’s sales taxes and get the impression that the rate is lower than it is. At the very least, both numbers should be cited.
And you can’t leave out state sales tax from the discussion. It is very relevant to the people in my state – and others like it – that the sales tax rate would be at least 40% under the so-called fair tax system.
For purposes of this discussion, you must leave out the state sales tax. The state taxes are not affected one way or the other by the federal tax collection method. You still pay the same state taxes what ever method is used. While state taxes are definatly a topic that should be examined and discussed, they are not relevant to the worth of the NRST.
I guess we’ll have to agree to disagree. I don’t think you can honestly do an examination of a national sales tax without discussing the combination of the national with local sales taxes, which would be quite burdensome. It’s very relevant to a lot of people that a national sales tax would add to a local sales tax. And honestly, I think it’s also relevant because one big possibility of a massive tax at the till would be a big increase in barter, and that’s even more likely if I am suddenly paying half again for a product because of a sales tax approaching 50%.
Well, I did a little research on the NRST.
(1) The tax is 23% of the TOTAL PAYMENT made for whatever you buy. In other words, if you buy something and pay $100 for it, $23 of that goes to the tax. Which means that the seller gets $77 and the government gets $23. Which means, as far as the seller is concerned, you bought something “worth” $77, and then paid a tax of $23. $23 is 29.9% of $77, so this “23%” tax is really a 30% tax.
Or, put another way, let’s say I sell coats in my store. I sell them, for $100 each. Now, along comes the NRST at a supposed 23%. How much must I inrease my price so as to still get $100 for the coat? The answer is I must raise my price 30% to $130; 23% of $130 is $29.90, which leaves me with $100.10.
(2) the NRST would raise the price of everything, not just new goods. Example: a middling Toyota Camry now costs about $25,000. A one-year old Camry is worth about $20,000. However, with the NRST, the price of the new Camry goes up to $32,468. (So that, after 23% of that ($7,468) is taken in tax, the dealer still has his $25,000 left.) So, would a one-year old Camry still command only $20,000 — i.e., would the owner of a one-year old Camry now be willing to take a $12,468 bath to sell his one-year old car? That’s depreciation of over 38%, compared to the 25% depreciation, and practically nobody would be willing to undergo that. No, they’d ask a higher price than $20,000 for it, and, after some bargaining and give and take, the market would arrive at a price considerably higher than $20,000. Keep in mind that a lot of people seeing a price tag of almost $32,500 for the car would say, well, let’s get a used one. Demand for the used car would rise, and up goes the market price.
It would be the same for housing. The pre-NRST $250,000 house would cost $325,000 after the NRST. Sellers of existing homes would ask higher prices for their homes, since the alternative (a new one) had now become much more expensive.
This same sort of effect would exist in markets for most used items.
So, one effect of the NRST would be to raise the price of everything, new or used. It also would provide a one-time windfall profit for sellers of used items. The Camruy I paid $25,000 for a year ago might now bring even more than I npaid for it, when a post NRST new Camry now costs $32,500.
If you don’t get this, just think about it. Or take my word for it: I have a PhD in economics and a 40-year career as a Professor of finance.
The real elephant in the room in this discussion is the inherent power attached to formulating tax policy. I don’t see either party of Congress being willing to give up the power to use income tax as a force for directing public policy, or granting favors, or fomenting social change.
What I suspect we would more likely wind up with is some sort of hybrid, or perhaps even two full taxes (income and national sales tax) at the federal level.
JBruce
There are at least two flaws in your missive.
1. Again, I do not disagree that the tax can be quoted as 30%. If you do so, then to be consistent you must quote the income tax rate using the same basis. This method then increases the 25% tax bracket to something approaching 35%. If you quote the NRST using the same basis as the income tax, it is 23%. You choose, I don’t care. (see http://www.fairtax.org/site/News2?news_iv_ctrl=1541&page=NewsArticle&id=8248 for a more indepth discussion)
2. You neglect to account for the decrease in the price of goods due to the decreased cost of doing business. Studies indicate that at least a 22% of the cost of goods is currently due to corporate income tax that is passed down through the manufacturing/distribution chain. If these costs are eliminated, the quest for increased market share will cause those involved in the chain to lower prices, or lose market share, thus lose profit. Once you figure this into the equation, and then add the NRST, the cost at the register (or dealer, or title company) is essentially the same.
Congratulation on your academic achievements and your long and what I am sure is a very prosperous career, although I’m not sure what bearing this has on the facts of the matter. The information I have was generated over the course of many years, at considerable cost (more than 20 million dollars) bysome of the most prestigious institutions in the country. If you disagree with what I say, then you should take it up with those that developed the information.
Because you’re not going to be doing any thinking for yourself?
Vinny
You are correct in believing that the “powers that be” are unwilling to turn loose of the control available through the income tax system. They are even more unwilling to lose the job when they get voted out of office. This is truly a grassroots effort. Only when enought people are willing to vote for the candidate that supports the FairTax Act will the change occur.
As to the “dual tax”issue, language in HB25 repeals the portions of the income tax code that provide for collection of payroll taxes (income taxes, FICA, and others). Another provision sunsets the NRST if the 16th ammendment (authorizes direct, or income, taxes) is not repealed.
Because greater minds than mine (and I suspect yours) did the hard work.
The real danger of adding a new mode of taxation is that it will not replace the existing modes, but instead will simply create a new pathway for government to collect additional money from the people. The only rational way to implement a national sales tax would be to abolish, completely and utterly, the income tax. And that will never happen.
Rainer;
One of the stipulations in the Fair Tax Act is that it only goes into effect on Janurary 1 after the 16th ammendment is repealed, thus depriving the congress of the power to levy direct taxes, of which the income tax is one.