Rewriting the Code

A roundtable on tax reform

Bruce Bartlett, Edward H. Crane, Daniel J. Pilla & Grover Norquist from the July 1995 issue

(Page 9 of 9)

And indeed, income is the most basic element of the "articles of our own growth and manufacture."

Bruce Bartlett Responds

Dan Pilla and Ed Crane both favor a retail sales tax to replace the current federal tax system for one basic reason: It will cause the IRS to vanish. Unfortunately, it will not, for a number of reasons.

First, a federal sales tax will require too high a rate. Crane says a rate of up to 30 percent would do the job. My own calculations put the figure at a minimum of 32 percent. International and state-level experience indicates clearly that sales tax rates much above 10 percent cannot be collected due to massive evasion.

Second, to get the tax rate as low as 32 percent assumes that all services will be taxed. In other words, we are not just adding to the prices of goods at the checkout, but to every service we consume as well. These services include legal, medical, funeral, utilities, video rentals, racetrack wagers, airline tickets, movie tickets, plumbing, school tuition, telephones, rent, and many others too numerous to mention.

Again, experience at the state level and in foreign countries indicates that such comprehensive taxation of services with a retail sales tax--as opposed to a value-added tax (VAT)--is impractical. This is why almost all states exempt most services from sales taxes. Also, political resistance to taxing services tends to be strong. In fact, a recent effort to comprehensively tax services in Florida had to be repealed shortly after it took effect.

Third, there is a serious problem with intermediate goods and services--those resources used in production--under a sales tax. For a sales tax to work properly, intermediate goods and services must be exempted from the tax. Otherwise, you get what economists call "cascading," where taxes are levied on top of taxes. This is very inefficient and forces companies to vertically integrate in order to prevent it.

Fourth, eliminating federal income taxes will not relieve taxpayers of the necessity of keeping records, filing returns, or being audited. This is because 44 states have income taxes. Thus, most of us will still have to suffer all the invasions of privacy and other indignities that Crane and Pilla wish to save us from, but from our state governments rather than the federal government.

Fifth, simply eliminating the necessity to file income tax returns will not relieve all taxpayers of IRS-like audits. Every business, including all self-employed workers, will still be subject to audits to ensure that the necessary sales taxes have been paid on their production. This will affect upwards of 35 million Americans.

Sixth, someone will still have to collect the sales tax. Proponents of the sales tax, such as Sen. Richard Lugar, have said that the states will collect it for the federal government, since most already have sales taxes. Leaving aside the fact that this country tried that once during the Articles of Confederation and it didn't work, there are continuing problems with this idea:

[[perthousand]] It assumes that the states will do the collection willingly and not cheat the federal government.

[[perthousand]] It ignores the fact that states will need to be compensated for collecting these taxes. Studies suggest that this will require at least a 1 percent higher rate for this purpose.

[[perthousand]] It assumes that the states will keep their sales taxes. In fact, given the costs and burdens of facilitating a national sales tax, all would quickly abolish their sales taxes and increase their income taxes to replace the revenue, thus eliminating the sales tax collection machinery. States without income taxes would immediately adopt them.

[[perthousand]] It ignores the fact that no two states have the same sales tax base, nor is it likely that any state's tax base will be the same as the federal government's. This means that the cost of collecting the tax will be far higher than 1 percent.

Seventh, the problem of relieving the poor has not adequately been dealt with. While there may be some virtue in treating everyone the same--rich and poor alike--there is no possibility that the Congress would enact a sales tax without doing something to reduce the burden on the poor.

Historically, this has been done by exempting certain items, such as food and clothing, from the sales tax. However, exemptions greatly increase the complexity of the tax and the opportunities for evasion. Thus advocates of the sales tax have suggested a rebate mechanism instead. (Studies of the earned-income tax credit--a similar program--show error and fraud rates of up to 40 percent.) A rebate system would quickly turn into a major entitlement spending program running into the hundreds of billions of dollars. And it will also require a significantly higher tax rate.

While there are many other important problems with the sales tax, I will conclude by pointing out that every other major country with a national sales tax, with the exception of Australia, ultimately replaced it with a VAT. This is because a VAT is capable of dealing with the many administrative problems I have outlined. Therefore, I believe that the effort to enact a national sales tax will necessarily be corrupted into a VAT. And, as Ed Crane succinctly pointed out, a VAT would be a disaster.

Grover Norquist Responds

Reading the arguments of Ed Crane and Daniel Pilla, I am reminded why all taxpayers find the present income tax system a threat to American civil liberties and the American economy. The wonderful aspect of this debate on reforming the tax system is that Bill Clinton and those who practice the politics of hate and envy are so isolated from the view of most Americans and are alone in their support of the present system.

So, among friends of liberty and serious critics of the present tax code--with its intrusiveness and economic deadweight--let us revisit the argument for a flat tax on consumed income versus a national sales tax or a VAT.

First, I reiterate that any sales tax of 20 percent or 30 percent will become a value-added tax. Only a VAT would be enforceable. On large ticket items or personal service, the retail sales tax would be easily avoided. There is a reason that every European nation with a significant consumption tax has it in the form of a VAT rather than a retail sales tax. And it is for the convenience of the tax collectors, not the citizenry.

Second, the idea that a shift to a national sales tax/VAT would free "us" from the burden of paperwork, intrusive government oversight, and forced labor to calculate the amount of tribute sent to Washington, D, assumes that none of "us" run businesses or are self-employed. If all service producers and all sellers of goods must calculate their value added or their sales prices and collect and remit taxes, this requirement would hit well over 20 million American small-business owners.

I have always looked forward to the day when most Americans would be "self-employed" and contract for their own services rather than serving as paid staff to a company. The self-employed would be more numerous today if not for archaic and doomed laws written for the benefit of labor union organizers. It isn't good news to a self-employed American, the owner of a small business, an independent contractor, or a home-worker to be told that "you" will do all the federal government's tax collecting from now on, rather than you and wage earners.

Karen Kerrigan, the president of the Small Business Survival Committee, reminds us that "small businessmen and taxpayers are allies in fighting against big government and big government intrusion. Why would some work so hard to saddle small businessmen with all the burdens of ripping resources out of the real economy and sending them to Washington, D?"

Third, the sales tax fails the test of making the total tax burden clear. Pop quiz: How much, gentle reader, did you pay in your state sales taxes last year? How much in federal excise taxes on your phone bill, tires, cigarettes, liquor, etc.? Yet I bet you could look up your federal income tax burden within minutes.

Fourth, the sales tax fails the test of making the tax painful to pay and painful to raise. On small purchases, the sales tax would be hidden in the price of the good or service. On large purchases, the sales tax would be avoided--which is why the government would do what every other nation in the world has done: turn the sales tax into a VAT. For example, if a car is only taxed at the "retail" level, clever people would figure out how to buy at wholesale. Only by taking at all levels of production--i.e., a VAT--can the tax collector be sure that taxpayers don't go around retail outlets to do their purchasing tax free.

Fifth, the advantage of the flat tax of uniting all taxpayers in opposition to tax hikes and in support of tax reduction would be lost by a sales tax/VAT. Today's national sales taxes or excise taxes on cigarettes, liquor, tires, gasoline, guns, aviation fuel, and phone bills already are all set at different rates. At the state level, some items are exempt from state sales taxes, others included.

In Europe, the VAT discriminates among product categories. Some are exempt. Some are taxed as necessities. Some are taxed as luxuries and all at different rates. Wait until the environmentalists get to tax recyclable and non-recyclable materials at different rates. All "social costs" can be "internalized" in an industry by setting different rates. Packaged-goods manufacturers can pay for landfills and recycling programs. Guns and ammo taxes can pay for hospital costs for gang members. Snack foods can pay for health care. Cigarettes can pay for anti-smoking ads (as they already do through a special sales tax in California). Target an industry. Come up with a "worthy" spending program. And you're off to the races.

Such differential rates are a gold mine for politicians. Every year some industry would be threatened with an upgrade from necessity to luxury. If campaign contributions are sufficiently forthcoming, no change. If not, zap. And some industries and products would be offered lower rates in return for--yes, you got it--campaign contributions. The income tax has no such ease of targeting whole industries or portions of production.

Lastly, the greatest danger of moving to a consumption tax of any kind--whether a national sales tax or a VAT--is that it risks saddling the American taxpayers with what our European brethren have sadly suffered: both an income tax and a national sales tax/VAT. No imagined benefit of the sales tax is worth this risk.