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 10)

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 In fact, a recent effort to comprehensively tax services in Florida had to be repealed shortly after it took effect.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.

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