Rewriting the Code

A roundtable on tax reform

For the first time since the Great Depression, congressional leaders are seriously considering sweeping alternatives to the Internal Revenue code. Two Texans in the House of Representatives are leading the calls for drastic change. house Majority Leader Dick Armey wants to replace the current income tax with a single-rate tax with no deductions other than a generous personal exemption. Ways and Means Committee Chairman Bill Archer would instead scrap the Internal Revenue Code entirely and replace it with a flat-rate national sales tax.

Would either proposal enhance civil liberties and raise enough money to operate the federal government? REASON assembled four knowledgeable advocates to discuss the possibilities.

No More Kidding Around

By Edward H. Crane

At the end of a brilliant section on taxation from his book Power & Market, the late Murray N. Rothbard writes, "Our conclusions are twofold: (1) that economics cannot assume any principle of just taxation, and that no one has successfully established any such principles; and (2) that the neutral tax, which seems to many a valid ideal turns out to be conceptually impossible to achieve."

I cite Rothbard's conclusion--which he persuasively develops in the book--by way of disclaimer. I do not favor a federal retail sales tax. I support replacing the current Byzantine system of financing the federal government with a federal retail sales tax. I do so for the simple reason that it will make it easier for Americans to reduce their overall tax burden.

We can replace the personal income tax, corporate income tax, inheritance tax, gift tax, and the Social Security payroll tax with a simple federal tax on retail sales and services of between 25 percent to 30 percent. There are economic, civil libertarian, and political advantages to doing so.

Before discussing those advantages, it's worth emphasizing two more disclaimers. First, what we are talking about here is a complete replacement of the existing federal tax system. Critics of a federal retail sales tax who point to the danger of politicians simply adopting the retail sales tax on top of reduced rates for the present system have a very legitimate concern. The last thing we should want would be a sales tax in addition to the taxes we already have. The movement for the sales tax must reject any deal that allows the income tax to survive even at one-half of 1 percent.

Second, it must be made clear that we are not talking about a value-added tax. The European experience with the VAT makes it clear how easy that tax is to increase, primarily because it is hidden at the various levels of production. It is true that there will be some problems involved in defining "retail sales," but they are not insurmountable problems. The point is that the retail sales tax will be much more visible than a VAT and, hence, much harder to increase.

A theoretical case for the preferability of a retail sales tax can be made on the basis of the fact that consumption is the purpose of an economy. It is not investment, saving, or even employment. It is consumption. Government lives off of the economy. Let, then, the burden of government fall precisely where the economy is headed: on consumption. Such a tax, while unquestionably damaging to the economy and our standard of living, nevertheless will act to reduce the damage done to the economy compared to other taxation schemes.

A study done for the Cato Institute by Boston University economist Laurence J. Kotlikoff found that replacing the income taxes with a retail sales tax would more than double the savings rate (after all, the whole world outside consumption becomes an IRA), increase the capital stock by a third, and boost national output by nearly a half trillion dollars. One need not accept Kotlikoff's econometric model as an instrument of precision (or even crude accuracy) to see that by eliminating the income and inheritance taxes, including the tax on saving, there is bound to be a huge boost in output and productivity. Entrepreneurial incentives could not be more enhanced within the revenue constraints currently imposed by the federal government.

Thus, on the economic front the retail sales tax is an enormous improvement on the current system. So is Rep. Dick Armey's proposed flat income tax. It has been carefully constructed and, if left alone by politicians, would have virtually the same economic impact as the sales tax.

The problem is--and this is where the civil libertarian aspect comes in--that the flat tax remains a tax on income and keeps in place the Internal Revenue Service. The retail sales tax abolishes both. As the readers of REASON are well aware, there is no more intrusive and abusive agency of the federal government than the IRS. With a staff of more than 120,000 agents and auditors, the very mention of the IRS strikes fear in the hearts of Americans who, in theory, live in the land of the free.

The list of IRS intimidations, civil liberties abuses, snooping, and general ineptitude continues to grow. And for 1995 and 1996 we are promised particularly harsh audits, supposedly necessitated by the estimated $150-$200 billion in annually uncollected taxes.

Civil liberties abuses under the income tax regime are blatant and well documented. We are, for instance, assumed guilty and must prove our innocence when charged with violating the Internal Revenue Code, a code so complex and illogical that the IRS itself only pretends to understand it. The IRS regularly undertakes "civil forfeiture" proceedings that deny Americans their constitutionally guaranteed right to due process of law by confiscating property to pay for alleged (but not proven) tax deficiencies.

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