Reason Magazine - Staff

The President's Rotten Record on Trade

info@reason.com (Bruce Bartlett) — Tue, 06 Jun 2006 00:00:00 EDT

Herbert Hoover is rightly reviled for having the worst record on international trade of any president. The Smoot-Hawley Tariff, which Hoover signed into law in 1930 after a Republican Congress passed it, was a significant factor in deepening the Great Depression. Since then, every president has embraced at least the rhetoric of free trade. But actions and rhetoric are different things, and George W. Bush in particular has preached free trade while advancing the agenda of a petty protectionist.

In so doing, he's returning his party to its roots. From Lincoln through Hoover, a high tariff on imported manufactured goods was the foundation of Republican trade policy. The Democrats, as the party of the workingman, backed free trade. They understood that tariffs raised the prices of goods, fattened the profits of politically connected businessmen, and acted like a tax on the poor.

After Smoot-Hawley led to a collapse of world trade and helped sow the seeds of World War II, a bipartisan anti-protectionist consensus emerged. Protection, it was understood, could lead to tit-for-tat retaliation by other countries that might explode into a trade war or even a shooting war. One of Franklin Roosevelt's first acts in office was to reverse Smoot-Hawley. He later insisted that freer trade be a key element of postwar planning, which led to the creation of the General Agreement on Tariffs and Trade. Harry Truman required nations receiving Marshall Plan aid to adopt free trade policies, a decision that probably did more to revive Europe's economies than the aid itself. Dwight Eisenhower supported creation of the Organization for Economic Cooperation and Development to help maintain free trade among major industrialized countries.

From then on every president had a hand in liberalizing world trade. John Kennedy initiated a round of multilateral trade negotiations, concluded under Lyndon Johnson, that eventually led to a reduction in world tariff levels by about a third. Under Richard Nixon, another round of trade negotiations began, known as the Tokyo Round, which Jimmy Carter finally pushed through an increasingly protectionist Democratic Congress in 1979.

Slowing Down Fast Track

By the 1980s, the parties had largely reversed their historical positions on trade. The Democrats, especially in Congress, had come to view protectionism as a way to protect jobs for working people rather than as a tax on them. And with American businesses becoming increasingly multinational, Republicans now saw free trade and access to foreign markets as central to their constituency. Ronald Reagan initiated talks with Canada and Mexico on establishing a North American free trade zone and inaugurated another multilateral trade negotiation known as the Uruguay Round. George H.W. Bush pushed forward negotiations on both the Uruguay Round and the North American Free Trade Agreement, known as NAFTA. Bill Clinton concluded the Uruguay Round and rammed NAFTA through Congress despite strong resistance from his own party.

George W. Bush came into office hoping to expand world trade by further breaking down barriers, which increasingly take the form of subsidies that distort prices and create an unlevel playing field. His first U.S. trade representative, Bob Zoellick, was widely known for his commitment to open markets and was anxious to start a new round of trade negotiations.

But before negotiations can begin, Congress has to give the president negotiating authority, sometimes called fast-track authority. The president could negotiate whatever he wants and then submit it to Congress for approval.

But without negotiating authority in advance, such an effort likely would succumb to the inevitable amendments and filibusters. Fast-track authority gets Congress to bind itself to granting an up-or-down vote on the package at the end of the process, with no further political gamesmanship.

In 2001 Congress was not in the mood to grant that authority. Democrats were against anything that would either expand trade (and thus, in their opinion, threaten American jobs) or help Bush, whose election many considered illegitimate. GOP control of Congress was very thin, and with the economy in recession many Republicans were skittish about voting to promote trade if it might be seen as threatening domestic jobs.

Republicans in the steel-producing districts of Pennsylvania, Ohio, and West Virginia were especially fearful of electoral retaliation. They demanded that Bush do something to help the steel industry as the price for their vote on trade-negotiating authority.

In June 2001, Bush initiated an investigation by the U.S. International Trade Commission into whether the steel industry was being injured by imports. It was virtually preordained that the commission would find such injury, because of the low legal threshold for such a determination. The commission did indeed find injury in December. Under the law, President Bush had until March to decide what actions he would take to protect the steel industry.

At the same time, Republicans from agricultural areas were complaining about low farm prices and demanding more subsidies, even though Bush had promised to move toward a more market-based agricultural system during the 2000 campaign. It was vital Bush do the right thing on the 2002 agriculture bill because the whole point of the trade negotiations, known as the Doha Round, was to remove subsidies for agriculture, which cost taxpayers in the industrialized countries dearly while making it impossible for farmers in the developing world to compete and better themselves.

In both cases, Bush made exactly the wrong decision.

George W. Bush, Man of Steel

Only one justification for trade protection has widespread support among economists: to preserve "infant" industries, those just getting started and competing against well-established rivals. So it is ironic that the American industry that has sought and received the most protection over the years is not a new one, such as electronics or software, but the quintessential old industry: steel. It is always just on the verge of being competitive, the industry swears, and only needs a little breathing space to invest and modernize. Then tariffs and quotas can be relaxed.

But that day never comes. Since 1969 the U.S. steel industry has received continuous protection in one form or another. These barriers have cost U.S. consumers between $104 billion and $175 billion more (in constant 2006 dollars) for products made with steel, such as automobiles and appliances.

Many academic studies have concluded that steel industry protection has done nothing to improve its competitiveness. The higher prices simply raise industry profits or reduce its losses—and reduce incentives to innovate. Despite that, many analysts who usually support free trade have made an exception for steel on national security grounds, arguing that we need adequate domestic manufacturing capability to build ships and tanks in the event of war. But today's weaponry depends much more on high-tech composite materials than on ordinary steel. According to an October 2001 Commerce Department study, no weapons system is dependent on imported steel; there will be more than sufficient domestic capacity for all Defense Department needs for the foreseeable future; and there are far cheaper ways of ensuring the Pentagon's needs than through trade protection.

In late 2001 the Doha Round officially started. But well into 2002, the U.S. could not meaningfully participate because Congress had yet to pass fast-track authority. Steel and agriculture were the hang-ups.

On March 5, 2002, Bush sought to assuage those concerned about steel by imposing a 30 percent tariff on steel imports. In an amazing example of doublespeak, Trade Representative Zoellick explained that this was a major step toward free trade. The tariffs, he said, would compensate for government subsidies often given to foreign steel producers. Most observers saw Bush's action as nothing but buying a few votes in politically important swing states.

The Europeans and Japanese immediately drew up lists of American goods they'd subject to retaliatory tariffs. On a trip to Beijing in April, hoping to open the Chinese market to more U.S. exports, Zoellick found Chinese officials unresponsive. Why should they open their market, they asked, when the United States was in the process of closing its own?

The Wall Street Journal worried that Bush's direction on steel was weakening his ability to influence other countries on a variety of issues. "The policy mattered less than the abandonment of principle," it editorialized. "It signaled to the world that Mr. Bush was not the president he had seemed after September 11; his moral and strategic clarity could be compromised for a price."

By summer, a wide variety of steel-using businesses in the U.S. were complaining about a cost squeeze. Their raw material cost had risen by 30 percent, but they were unable to raise their own prices to compensate. This was especially the case for businesses facing international competition, since finished goods made with steel were not subject to the tariffs. Hence the tariffs put U.S. manufacturers at a competitive disadvantage in both domestic and foreign markets.

Bush's steel policy probably did get him the last couple of votes he needed in the House to get trade promotion authority, so that the U.S. could finally participate meaningfully in the ongoing Doha Round. On July 27, 2002, 215 House members voted for the conference report on the trade bill, while 212 voted against it.

By January 2003, the steel tariffs had cost far more jobs in steel-using businesses than could possibly have been saved among steel producers. According to the economists Joseph Francois and Laura Baughman, 200,000 jobs had been lost among steel users. There were only 187,500 total jobs in the steel industry itself. Substantial numbers of manufacturers had been forced to move their production outside the U.S. to escape the tariffs. It is unlikely these outsourced jobs will return.

In a September 2003 study, the International Trade Commission concluded that the steel protection policy had been a net loss for the country, calculating that, on balance, the nation was worse off to the tune of $42 million. Furthermore, in May 2003 the World Trade Organization had ruled that the steel tariffs were illegal under world trade law. After a U.S. appeal was rejected, the European Union prepared to impose retaliatory tariffs on U.S. goods.

In December 2003, Bush finally bowed to reality and lifted the tariffs. But he continued to pay a heavy price in the Doha talks, as other countries repeatedly rejected American entreaties to lower their barriers to U.S. goods. As The Wall Street Journal put it, "When the world's main economic power indulges in protectionism, everyone else figures it's safe to do the same."

Dooming Doha

Congress traditionally produces a farm bill every five years. The 1996 law had eliminated a number of subsidies and regulations, but its 2001 successor was a return to the older, subsidy-heavy approach. The final bill, signed by Bush in May 2002, raised spending by almost $90 billion above the previous law; the Congressional Budget Office estimated that it cost $470 billion over five years.

The importance of the new agriculture subsidies went well beyond the burden on the budget or the impact on farmers. They basically doomed the Doha trade talks, which were primarily about reducing farm subsidies worldwide—especially in Europe, where farmers are even more politically powerful than they are here.

When pushing for the new trade round, the United States had enthusiastically endorsed farm subsidy reductions, believing they would increase U.S. exports. But the only hope of achieving meaningful cuts in agricultural subsidies lay in appealing to the basic principle that such payouts are wrong—that they are costly, inefficient, and a poorly targeted way to help farmers, with much of the money going to people who are already well-to-do. By working together with the few other countries that generally support free trade, such as Australia, it might have been possible to shame the Europeans into making some kind of deal. But when Bush signed a massive increase in U.S. subsidies right at the start of the trade talks, he lost all credibility.

It didn't help that the Bush administration also alienated Canada, another of the small band of free traders, by slapping a 29 percent tariff on Canadian lumber in March 2002. Not only did this raise the cost of homebuilding in the U.S.; it also led Canada to retaliate with a 71 percent tariff on U.S. tomato exports.

Another sad consequence of failing to curb agricultural subsidies is the further impoverishment of farmers in the less developed countries. By forcing down prices for agricultural products, subsidies drive many poor farmers out of business, making them dependent on food aid from the West.

The Bush trade mavens were willing to pick fights with anyone in the name of protection, including the supposedly dangerous superpower-in-training China. On November 18, 2003, the Bush administration announced a decision to impose new trade restrictions on imports of Chinese textiles. A petition from four textile industry groups, led by South Carolina Republican textile magnate Roger Milliken, got that ball rolling. It claimed Chinese imports "threatened to impede the orderly development of trade and caused market disruption in the U.S." No proof was offered to support this allegation.

To show just how absurd the situation was, one of the new restrictions applied to brassieres. Yet there is no domestic manufacturer of this product. Some components are produced in the United States, but all are exported to low-wage countries in Latin America for manufacture. This is done solely because of a law requiring a degree of domestic content to avoid trade barriers when the final product is imported. The reality is that 100 percent of brassieres are imported. There's no domestic industry to protect.

The day after the U.S. textiles decision, China canceled a trade mission to the United States that probably would have led to billions of dollars in orders for American goods. In previous weeks China had signaled a desire to increase its imports of planes from Boeing, jet engines from General Electric, and a variety of agricultural products as well as chemical and telecommunications equipment. Such purchases likely would have been greater than the value of the goods that were now restricted, creating vastly more jobs—and better-paying ones—than those protected in the textiles industry.

The Problem With Bilateralism

After the de facto collapse of the Doha Round, the Bush administration turned toward free trade agreements (FTAs) with individual countries or small groups of countries. Economists are dubious about the value of such agreements, which were often less about free trade than about pursuing new avenues for U.S. protectionism.

Before 2001 the U.S. had free trade agreements only with Israel, and with Canada and Mexico through NAFTA. In 2001 Bush signed an agreement with Jordan. In 2002 he initiated talks with Australia, Chile, Singapore, and five Central American countries (Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua). In 2003 his administration successfully concluded negotiations with Singapore and Chile and began new talks with Morocco, Bahrain, four Andean nations (Colombia, Peru, Ecuador, and Bolivia), and five Southern African ones (Botswana, Lesotho, Namibia, South Africa, and Swaziland). In 2004 the talks with the Central American countries (to which the Dominican Republic was added) and Australia were completed.

Although the amount of activity involved in pursuing FTAs was certainly impressive, economists had serious doubts about their value. "Nearly all scholars of international economics today are fiercely skeptical, even hostile, to such agreements," the Columbia University economists Jagdish Bhagwati and Arvind Panagariya argue in the Financial Times.

Key reasons for this hostility are that bilateral agreements—and smaller multilateral agreements, such as the Central American pact—divert attention and resources from multilateral agreements, which are vastly preferable. FTAs may divert trade flows rather than increase them and may lead trade blocs to impose restrictions on trade with those outside the bloc, thus raising the overall level of protection. Supporters of FTAs mostly argue that they are better than nothing and may provide building blocks for broader trade agreements. No one believes that FTAs are optimal trade policy.

Nevertheless, FTAs have become almost the sole Bush administration effort to open trade. Even while doing so, it has often used such agreements to pursue protectionist objectives. An especially egregious example of this is when the administration nearly scuttled the free trade agreement with Australia in order to maintain protection for the sugar industry, despite universal condemnation of the sugar program, which adds some $2 billion per year to consumer costs, mainly to enrich a few Florida producers.

According to the Financial Times, George W. Bush personally made the decision to exclude Australian sugar from the FTA. This became the first such agreement ever negotiated to exclude an individual product from its provisions. The New York Times spoke for many. "The agreement sends a chilling message to the rest of the world," it said. "Even when dealing with an allied nation with similar living standards, the administration…has opted to continue coddling the sugar lobby, rather than dropping the most indefensible form of protectionism. This will only embolden those around the world who argue that globalization is a rigged game."

In early 2005, the Bush administration put enormous pressure on Congress to approve the Central American Free Trade Agreement (CAFTA). Although the economic benefits from this agreement were quite modest, the administration had little choice but to press hard for its passage in order to salvage some semblance of a trade agenda. But the price for passage was very high, with Republicans demanding restrictions on Chinese imports in exchange for their votes. Consequently there was very little likelihood that its passage would lead to a net reduction in trade barriers.

CAFTA also proved costly to taxpayers, because the administration was forced to agree to many new pork barrel projects in order to buy the last couple of votes to squeak it through; CAFTA passed the House by a razor-thin margin of 217 to 215 on July 28, 2005. Free traders worry this precedent will encourage members of Congress to demand even more payoffs for future votes.

The Dumping Delusion

Although Bush and his team have shown contempt for overarching free trade principles pretty much every step of the way, the administration excuses a lot of the new trade protection on its watch by saying it's mandated by existing law, especially "anti-dumping" laws that require the imposition of tariffs and give the president no latitude. There is some truth to this defense. But in many cases the Bush administration has simply used anti-dumping statutes as backdoor protectionism that could have been resisted if it had chosen to do so.

The term dumping is commonly understood to mean selling foreign products at below cost, possibly because of subsidies from the producers' governments. But legally speaking, dumping exists simply when a product is sold in the U.S. for less than it is sold for in other markets. No evidence is needed that the product is being sold below cost or that any subsidy is involved.

Although dumping is assumed to be unfair when it involves international trade, a business might sell products at seemingly unprofitable prices for many reasons commonly accepted as reasonable in the domestic market. For example, when introducing a new product against established competition, a company may need to sell at a loss in order to gain a foothold in the market. It may need to dispose of inadvertent overstocks, or it may hope to make a profit through ancillary sales—think of Barbie dolls that are sold cheaply because the real profit is in the clothes.

U.S. businesses often use anti-dumping petitions as a tool to prevent foreign competitors from reducing prices and undercutting the domestic companies' profits and market share. Even when foreign firms are confident of winning a dumping case, they may not want to go through the effort and expense to defend themselves in what is rightly seen as a biased process. So they back off.

Though the idea that there is something inherently unfair or unjust about dumping has been entrenched in U.S. law for more than 100 years, the law was rarely enforced until the 1970s. At that time it was broadened to allow tariffs even in cases where no dumping was even alleged, as long as imports caused some injury to a domestic industry. Tariffs also could be imposed as retaliation for a foreign country's restrictions on U.S. exports.

Despite the Bush administration's claim that many of its tariff decisions are the result of obeying longstanding anti-dumping law, many of these investigations are instigated by the Commerce Department as a matter of policy and are rigged to guarantee that dumping will be found. Almost all of the tariffs imposed on Chinese furniture, Vietnamese shrimp, and other goods have taken place under the guise of anti-dumping enforcement when they are really policy actions. As a consequence, other countries increasingly are using their own anti-dumping laws against American goods. Like all protectionist moves, anti-dumping actions set in motion a domino effect of reactions and restrictions that clog up world markets and ultimately make us all poorer than we otherwise would be.

The New Herbert Hoover

Bush's overt protectionism may not be that great. But in overall policy, he's the most protectionist president since Hoover. All of Hoover's successors until Bush understood the fragility of free trade and the dangers of playing politics with it. They also understood that there is an inherent drift toward protectionism that needs to be vigorously resisted and offset by aggressive trade-opening measures. Bush has gone in the opposite direction, repeatedly using protectionism to buy short-term political support and sabotaging multilateral trade negotiations.

Bush also has treated the World Trade Organization with contempt. He has taken actions that he knew would be ruled illegal, such as the steel tariffs, and made little effort to redress illegal elements of U.S. law, such as the Foreign Sales Corporation tax break and the Byrd Amendment.

The former, which the WTO ruled to be a de facto subsidy, was finally repealed in 2004 with the White House and Treasury Department doing virtually nothing to aid the effort. The latter is a law enacted in 2000 that allows some anti-dumping duties to be paid directly to private businesses—making explicit what is already implicit in anti-dumping measures, which always help specific businesses at the nation's expense. (According to the Government Accountability Office, half the benefits of this legislation went to just five companies.) The WTO ruled the Byrd Amendment illegal as well.

Under Bush, free trade is probably in its weakest position since the 1920s. The ultimate consequence of Bush's abandonment of principle may not come on his watch. But thanks to him the dangers associated with protectionism are growing, and they will likely lead to future trade skirmishes and wars that will lower the standard of living of all Americans. Unfortunately, Bush seems comfortable with that legacy.

Rewriting the Code

Sat, 01 Jul 1995 00:00:00 EDT

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.

Moreover, in a study commissioned for the IRS itself a decade ago, Arthur D. Little Co. estimated that Americans spend some 5.4 billion hours of work a year just to comply with the tax code. Author James Payne puts the cost of those hours at about $250 billion per year, or about one-third of what the federal government hopes to reap from individual and corporate income taxes in 1995. In addition, Payne argues, the true cost of compliance should include the disincentives to savings and work and the costs of enforcement, litigation, and tax-distorted investments. All that could easily double the cost of this bizarre tax system to the American people.

Another benefit of switching from a high-compliance-cost system to a low-cost system is that it would free 120,000 tax bureaucrats and untold tens of thousands of bright lawyers and accountants in the private sector to engage in productive work that increases our standard of living--and would probably make them feel better about themselves, to boot. Flat-tax advocates' arguments that a sales tax would have high compliance costs are disingenuous; 45 states already collect sales tax.

But the best reason to support replacing the income tax with a retail sales tax is political. Today when someone mentions tax reform, Americans wisely grab their collective wallets. The politicians and bureaucrats of the New Class have down to a science the business of playing one tax-paying group off against another: farmers against manufacturers, rich against poor, old against young, workers against management, and on and on.

The tax system in America is so complex that it's virtually impossible to create a sense of taxpayer solidarity against taxes. Rather, each interest group spends its time lobbying to increase taxes on other groups in the (usually) futile hope that its own taxes can be reduced. That the complexity of the tax code is a key to the politicians' ability to continually increase taxes while constantly talking about decreasing them should be obvious.

The federal retail sales tax ends all that. Whether it's set at 20 percent, 25 percent, or 30 percent, Americans need only vote for the candidate who promises to lower it--the most. Suddenly we do have taxpayer solidarity. Suddenly, with no withholding or other hidden taxes, everyone is aware of the cost of government every time he or she buys a product. Lowering federal taxes suddenly becomes much easier.

The flat income tax was the cutting-edge initiative during the Reagan years, and many supply-siders such as Bruce Bartlett, Jack Kemp, and Grover Norquist still support it for that reason. But the mood of the American people is considerably more radical today. They want to abolish the income tax, and it would be a tragic error to allow old political allegiances to get in the way.

The energy behind abolishing the income tax and eliminating the IRS is the same energy behind the term-limits movement: No more kidding around. No more trusting the politicians to do what they say they'll do. After passing a statute, Congress should report out a constitutional amendment, replacing the 16th Amendment and limiting federal revenue to taxes on retail sales and services. The people want to take back control of government and then radically downsize it. That means cutting spending, which first requires cutting taxes, which is what the federal retail sales tax will make much more feasible.

When Sen. Richard Lugar (R-Ind.) campaigns for the presidency on a platform calling for the abolition of income taxes and Bill Archer (R-Tex.), the chairman of the powerful House Ways and Means Committee, says he favors scrapping income taxes and replacing them with a sales tax, you know this is no longer an idea confined to the political fringes.

If mainstream politicians like Archer and Lugar feel that intensity of public support for this idea, the time has come for all advocates of a free society to lend a hand. This is an enormous opportunity to role back the power of government in our lives. It is an opportunity to tell your federal bureaucrat, "Look, I appreciate your interest, but please get out of my face--you'll get yours when I buy something."

Edward H. Crane is president of the Cato Institute.

Killing the IRS

By Daniel J. Pilla

Are you fed up with the annual ritual of gathering bags of receipts, poring through pages of convoluted tax forms, and working into the night on the mind-numbing task of preparing your income tax return? Does the idea of filing your tax return on a postcard appeal to you? Does the thought of an IRS audit terrify you?

If so, you are among the millions ready for a radical change to our tax system. A driving force behind the push is the frustration of dealing with the Internal Revenue Service.

The IRS wields awesome powers. It can execute wage and bank levies, seize property, and obtain your most personal records, all without a court order. Even worse, you are presumed guilty in virtually all your dealings with the IRS; unlike the common criminal, you must prove your innocence. Since our tax law consists of 17,000 pages of regulations, compliance is often an impossible task.

And while the IRS holds the average citizen to inexorably high standards of compliance, the IRS itself doesn't meet the mark. In 1993, the General Accounting Office issued the results of its first audit of the IRS. In testimony to Congress, Comptroller General Charles Bowsher explained that the IRS was unable to account for 64 percent of its $6.7-billion 1992 appropriation. Despite repeated promises to reform, a 1995 GAO report explained that the IRS's own internal audits revealed that its financial statements are "still not accurate, reliable or consistent."

The IRS's inability to manage itself is visited upon the public in a big way. In 1995, the IRS will assess between 32 million and 34 million penalties against individuals and businesses. However, its own annual reports indicate such penalties are wrong about 40 percent of the time. Further, the IRS will issue over 10 million computer-generated correction notices, claiming citizens have made errors in their returns. Numerous GAO reports show those notices are incorrect about 50 percent of the time.

In 1993, the IRS announced a plan to increase its face-to-face audit coverage by 500 percent. This year alone, the number is expected to grow by 100 percent. This explosion is based on the agency's belief that citizens underreport their incomes. Yet its own audit results are wrong about 50 percent of the time.

The average face-to-face audit nets about $5,000 in increased tax and penalties. Thus, the agency's inability to perform its administrative tasks correctly leads to billions of dollars in improper assessments.

As if the ineptitude is not bad enough, IRS invasiveness into private lives of all Americans has reached new heights. Driven by the belief that citizens underreport their income, the IRS announced plans in December 1994 to begin two very troubling programs. The first involves a system of recordkeeping designed to give the agency "on-line access" to records held in all public and private databases.

The agency plans to link its computers with "commercial sources, state and local agencies, construction contract information, license information from state and local agencies...and information on significant financial transactions from reviews of periodicals and newspapers and other media sources." IRS computers will be able to track every financial move of every citizen.

The second program, announced last year, is an audit endeavor known as the District Office Research and Analysis program. DORA audits have little to do with tax returns. Rather, they involve "lifestyle audits." Citizens will be targeted for DORA audits on a random basis, and audit results will be used to develop statistical formulas to be applied on a broader scale. To ascertain whether someone is living beyond his means and therefore more likely to have understated income, an IRS training manual titled Components of Economic Reality instructs agents to evaluate a target's home and neighborhood, furniture and fixtures, educational and personal background, cultural and family background, toys and hobbies, vacations and gifts, clothing and jewelry, and on and on.

Expect auditors to interview one's friends and neighbors, family members and children, business associates and co-workers. The information will then be codified into personal dossiers. The idea is to use the information to catch people in the act of underreporting income.

No doubt such a program will have a serious effect on privacy rights. Without factual justification or probable cause, these are the most deeply invasive investigations imaginable in
a free society. Given the IRS's track record of unreliability with its own affairs, these programs are outrageous, indefensible, and dangerous.

Personal freedom and privacy cannot survive in the face of such invasiveness. And a tax law of 17,000 pages is fertile ground for germinating IRS abuse of taxpayers' rights. It seems clear that if freedom is to survive, we must eliminate the IRS.

Alternative roads lead in two directions. First is the flat income tax, under which Americans would pay a flat rate on income without the current confusing myriad of loopholes. Proponents claim the flat tax could be so simple as to allow citizens to file their returns on a postcard. The second alternative is a national sales tax. This system promises to eliminate personal tax returns, as all tax is paid at the checkout counter. Which course should America pursue?

To answer this question, we must first address the threshold question: Under which system will Americans be free of the invasive, capricious, and error-prone behavior of the IRS? This question must guide our debate, and it leads to one inexorable conclusion: Freedom and an income tax cannot co-exist in the same society. One must necessarily drive out the other.

It is inarguable that a flat tax is simpler to report than our current income tax. Preparing a return will be less exasperating if it can be filed on a postcard. But the flat tax still requires the IRS. It requires the filing of tax returns, which can and will be audited. And it requires elaborate recordkeeping by citizens and allows invasive investigations.

Any system which requires IRS administration must necessarily fall under deep suspicion. It is simply unreasonable to ask Americans to submit to the arbitrary whim of an agency which itself cannot perform the tasks it demands of the public.

Because it requires a tax return, the flat-tax system cannot eliminate IRS abuse. Though there may be no deductions to audit, the IRS will nevertheless insist on auditing one's income. This is the reasoning behind the outrageously invasive DORA audits. Nothing in a flat-tax system can or will stamp out such abuse.

Because lifestyle audits are so broad, we can expect recordkeeping requirements to increase, not decrease, under a flat tax. Any income tax system is dependent on massive reporting to the government of income information. At present, this is accomplished through the annual filing of some 1.3 billion information returns, such as IRS Forms 1099 and W-2. Since enforcement of a flat tax is dependent upon income information, look for the number to triple as IRS traces every nickel you earn.

There is little about a flat-tax system that will trim the staggering cost of tax law compliance. At present, this burden is estimated at $700 billion annually. Much of the cost is associated with recordkeeping and tax law enforcement, neither of which is reduced by a flat tax. A flat tax certainly involves a simpler tax return, but return preparation is the smallest component of tax law compliance.

The solution to our tax problem is to adopt a national retail sales tax in place of the personal and corporate income tax. Only a sales tax can eliminate the invasiveness of the IRS, since one's income and lifestyle are irrelevant. When one spends money, the tax is simultaneously assessed and collected. That is why only a sales tax can reach the underground economy. The IRS's chief compliance problem is the alleged failure of citizens to report their income. A flat tax will not capture this income because to do so it must be voluntarily reported.

Best of all, a sales tax can eliminate the IRS. The 50 states could collect it in concert with their own sales tax. The federal government would bear the costs but they would be minimal as all but a few states already have a sales tax. For the same reason, virtually all businesses are equipped to pay it. Those businesses which do not now collect a sales tax would still see a reduction in compliance costs because of the elimination of the complex federal income tax laws.

The states would in turn pay the tax to the federal government. This reduces the federal tax collection points from 200-plus million (the number of tax returns filed annually) to just 50.

Only a sales tax eliminates the need for individual audits, recordkeeping, and enforced tax collection, and it can eliminate the staggering $700-billion annual compliance cost. In short, the national sales tax is the only way to get the federal government out of your life.

Daniel J. Pilla is a tax litigation consultant in St. Paul, Minnesota, and the author, most recently, of How to Fire the IRS (Winning Publications).

Flat-Out Better

By Bruce Bartlett

The best tax reform that could be enacted by Congress would be to adopt the Hall-Rabushka flat-rate tax proposal. Named for economists Robert Hall and Alvin Rabushka of Stanford's Hoover Institution, the Hall-Rabushka proposal was first put forward in a Wall Street Journal article on December 10, 1981, and has since been elaborated in three editions of their book, The Flat Tax. The most recent edition has just been published by the Hoover Institution Press. Versions of the Hall-Rabushka plan have been sponsored by Rep. Dick Armey (R-Tex.) and Sens. Richard Shelby (R-Ala.), Larry Craig (R-Idaho), and Arlen Specter (R-Penn.).

In brief, the Hall-Rabushka plan would establish a single tax rate of 19 percent on all personal and business income. Businesses would be taxed on their gross revenue less cash wages, salaries, and pensions paid (but not benefits); purchases of goods, services, and materials used in business; and all capital equipment, structures, and land. Individuals would be taxed on their wages, salaries, and pensions received, less a large family allowance. A family of four would have to earn $25,500 per year before it paid any income tax. Note that individuals would pay no tax whatsoever on interest, dividends, or capital gains received. Moreover, the system is so simple that businesses and individuals alike would be able to file their tax returns on a form the size of a postcard.

Although they have always referred to their proposal as a flat tax, I prefer to think of it as a single-rate tax plan. This is because the central element of the Hall-Rabushka plan is to tax all income only once. And it is not truly a flat tax because those with higher incomes will pay higher effective tax rates, although the marginal rate will be the same for all.

The importance of this distinction gets at what I believe is the major problem with our current tax system, which is that some forms of income are taxed two, three, or more times while others are not taxed at all. Thus we have close to confiscatory rates on some forms of capital income, while a considerable portion of labor income--in the form of fringe benefits--is entirely free of tax.

In the aggregate, we tax less than half of all personal income. In 1992, personal income as defined by the Commerce Department came to $5.2 trillion, yet taxable income as defined by the IRS came to just $2.4 trillion. This means that in theory a 9.2-percent tax rate on all personal income would raise the same revenue that the individual income tax raises today at an effective rate of 19.2 percent, with marginal rates between 15 percent and 39.6 percent.

However, the effective tax rate on capital income can go far higher than 39.6 percent. Consider a dollar of increased corporate profit. Looking only at federal taxes, we first take off 35 percent corporate income tax. Then whatever is paid out to the corporation's owners--the shareholders--is taxed again up to a 39.6-percent rate. This adds up to better than a 60-percent tax on the original dollar of profit. But we aren't finished yet, because if the higher profit leads to a higher stock price, we tax that profit again when the stockholder sells his shares, even though the stock price merely reflects the discounted present value of the future profits that are already going to be taxed twice. The capital gains tax, therefore, in effect is a third layer of taxation, going up to 28 percent, on the same dollar of profit. If we factor in state and local taxes and inflation, it is not at all difficult to get tax rates on capital up over 100 percent.

This excessively heavy taxation of capital, combined with widely different tax rates on different forms of income, has created enormous inefficiency and is, I believe, at the root of our economic malaise. We are collecting less revenue for the government at a far higher cost than necessary. The compliance cost of the income tax runs into the tens of billions of dollars a year.

However, the compliance cost is only a small part of the cost we pay for our current tax system. A much larger cost is what economists call the "excess burden" of the tax system. The excess burden is the cost to the economy of reduced work, saving, and investment that is over and above the amount of tax collected. Estimates of the excess burden run into the hundreds of billions of dollars per year.

At first glance, it appears that there is no way the Hall-Rabushka tax system could possibly raise the same $740 billion that the federal government expects to raise in individual and corporate income taxes in 1995. It also appears to be an enormous giveaway to the rich, who now pay rates as high as 39.6 percent on all of their income except capital gains, which are taxed at a maximum of 28 percent.

In fact, the numbers in the Hall-Rabushka plan do add up. And it is not quite the giveaway to the rich that it appears. In return for gaining the ability to expense capital investment, businesses would lose the ability to deduct the cost of fringe benefits and interest. Hall-Rabushka would also sweep away a long list of business tax incentives currently in law. On the individual side, taxpayers would lose the ability to deduct mortgage interest, charitable contributions, and state and local taxes, among other things. Also, keep in mind that while interest and capital gains are not taxable for individuals under the plan, they are taxable at the business level.

The result of all this is to roughly triple current federal revenue from taxing businesses, while halving individual income tax revenue. Since business income largely accrues to the wealthy, the effect of the Hall-Rabushka plan is to raise the actual amount of taxes paid by rich people even as their tax rate falls. And this result does not in any way depend on any "supply-side" effects on economic behavior, although it is clear that there will be a significant impact on saving, investment, and work effort. Economist Dale Jorgenson of Harvard, for example, recently estimated that if something like the Hall-Rabushka plan were enacted by Congress it would lead to an immediate $1-trillion increase in national wealth, which was $19 trillion in 1993 (the most recent year for which data are available).

Unlike the Tax Reform Act of 1986, however, the Hall-Rabushka plan is not a simple trade-off between higher corporate taxes and lower individual taxes. Rather, Hall-Rabushka must be viewed as a fully integrated tax system, of which the business tax and the wage tax are simply two sides of the same coin.

And Hall-Rabushka is by definition a pure consumption tax, because capital investment is fully expensed and because individuals pay no taxes on their investment income. Thus it is unnecessary to institute any sort of specialized saving incentive, such as that proposed by Sens. Sam Nunn (D-Ga.) and Pete Domenici (R-N.M.). Their plan, in effect, would force people
to save before they received any tax benefit, whereas Hall-Rabushka simply abolishes taxes on saving altogether.

As noted earlier, the Hall-Rabushka plan is not the pure flat- rate tax it appears to be. That would require a single rate on gross income, with no deductions at all. The effect of a large personal and family allowance is to create effective progressivity. Under Hall-Rabushka the effective tax rate on wage, salary, and pension income would rise from zero on low-income families, to a rate between 3 percent and 12 percent on moderate-income families, to 16 percent on a family earning $200,000. Rates continue to rise as income rises, although no one would ever pay more than 19 percent.

While there are many other comprehensive reform ideas out there--such as the Cato Institute's sales tax proposal--I believe that the Hall-Rabushka plan is the best one that has been put forward in terms of fairness and simplicity. And it is not a new proposal, but one that has been around for almost 15 years.

It has been the subject of previous hearings in the Senate Finance Committee, the House Ways and Means Committee, and the Joint Economic Committee, and has been discussed in numerous studies and articles. Consequently, it is a plan that is familiar and well vetted. Thus, rather than reinvent the wheel and try to come up with an entirely new reform proposal, I recommend that the Congress simply adopt the Hall-Rabushka plan.

Bruce Bartlett is a senior fellow with the National Center for Policy Analysis. He was previously deputy assistant secretary of the Treasury for economic policy. As deputy director of the Joint Economic Committee, he organized the first congressional hearing on the flat tax in 1982.

Taxes We Can See

By Grover Norquist

It spoke volumes about the revolutionary expectations of the American people and the Republican Congress that only days after the Republicans won a majority in the House and Senate on November 8, public debate shot past the already ambitious Contract with America to plans for radically restructuring the federal income tax.

Public cynicism might well have dwelled on the difficulty of moving a balanced budget amendment, line-item veto, tort reform, and term limits through the House, much less the U.S. Senate. Yet as unlikely a Jacobin as Texas's Bill Archer, slated to head the newly Republican House Ways and Means Committee, fast forwarded the political agenda by announcing his desire to abolish the federal income tax, root out the Internal Revenue Service, and replace the present tax structure with a national consumption tax: a sales or value-added tax. Archer's fellow Texan, House Majority leader Dick Armey, has weighed in with his own reform agenda: a flat tax of 20 percent on personal and corporate income for 2 years, to be reduced to 17 percent thereafter.

When facing such obvious injustices as France's ancien régime, Russian czarism, or our own 1040 form, men and women of restrained temperament have an understandable urge toward random and immediate violence--and the presumption that the destruction of the present unsatisfactory oppression could only be followed by something better. But the French and Russian revolutions remind us that it is indeed possible to move from bad to worse.

Should friends of liberty in America rush to embrace radical reform of the federal corporate and individual income tax? And if so, which plan is better, Archer's or Armey's? Armey would tax "consumed income," exempting savings and investment, capital gains, and interest and dividend income. Unlike the present tax structure, all income would be taxed once and only once. Inheritance taxes would be abolished: You already paid taxes on that money, so it's yours. Armey contends a flat tax of 17 percent that exempts savings would do less damage to the economy, spur job creation, and be seen as fairer and less intrusive.

Archer, however, argues for a national sales tax and gives four imperatives that guide his thinking: First, the new system must not tax savings and investment. Second, the IRS must be abolished. Third, the new tax system must capture the underground economy. And fourth, the tax must be border adjustable (i.e., the tax must be removed from American exports and added onto imported goods and services to American citizens). This, as Pete DuPont has observed, describes not a national sales tax, but a European-style value-added tax. Any sales tax large enough to replace the income, Social Security, inheritance, and gift taxes (all enforced through the condemned IRS) would immediately become a value-added tax since avoidance at the retail level would force tax collectors to move to the wholesale level and backwards through manufacturing, as has happened in every European nation.

In comparing Dick Armey's flat consumed-income tax and Bill Archer's national sales tax/VAT, it is important to begin by outlining just what criteria determine the "best" or least destructive tax.

The most important aspect of any tax is that it be difficult to increase. This means a tax should be visible, painful, and applied equally to all taxpayers. Politicians love invisible taxes. How many times have we heard Ted Kennedy and Dick Gephardt urge that corporations pay more in taxes? Of course, the only way that General Motors gets any money to pay its corporate income taxes--or property taxes and wage taxes, for that matter--is to include the taxes in the price of cars it sells to the public.

Bill Clinton's 1993 tax hike "on the richest 1 percent" actually raised two-thirds of its revenue from small businesses filing as subchapter S corporations. Thus all Americans pay this "millionaires' tax" when they shop at the grocery store or go to the dry cleaners. Yet Clinton says--and may actually believe--that people don't pay his tax, businesses do.

By contrast, property taxes have the virtue of being paid in lump sum installments--not dribbled out as in a sales tax or withheld like the income tax. It's no accident that the first success of the contemporary tax revolt--California's passage of the Jarvis-Gann Proposition 13 in 1978--was a measure to roll back property taxes. Subsequent efforts to cut income taxes and sales taxes have been less successful, in part because those taxes are less obvious to taxpayers.

Dick Armey's flat tax would abolish withholding and require that all Americans send a check to Washington each month, just as we pay our rent, phone, or utility bill. Now this is creating truly revolutionary conditions. Monthly checks to the feds will be painful reminders of the cost of government. By contrast, the sales tax or VAT will hide the true cost of government. Sen. Dick Lugar (R-Ind.), speaking at the Cato Institute in favor of a national sales tax, was asked how much he paid in local sales taxes last year and he didn't know. Every citizen will know exactly how much he or she is paying with Dick Armey's flat tax. A tax bill hidden in a VAT will mask the deadweight cost of the state.

After visibility and painfulness, taxes should apply equally to all taxpayers--and perhaps as important--be seen to do so. Armey's bill would unify taxpayers by having all taxpayers pay one rate and by eliminating almost all deductions. With its many complicated deductions, one of the problems of the present tax code is that some taxpayers think that they are benefiting from deductions and are "getting away with something," despite their heavy tax burden. A flat tax not only puts all taxpayers in the same miserable relationship with the state but also lets taxpayers feel confident they are all in the same situation.

To the political class, the greatest virtue of the graduated or progressive income tax is that it allows politicians to divide taxpayers into discrete groups that tax increasers can target and mug one at a time, rather than having to take them all on at once. Bill Clinton worked hard at this, telling Americans, "Pay no attention to my little tax hike, I'm only going after the top 1 percent." The taxman's strategy is to divide and conquer, a little bit at a time.

Such a ploy works extremely well. The business community remains quiet when the personal income tax is raised or inflation shrinks the value of personal and dependent exemptions. Then individual taxpayers remain inert when business taxes are raised. Politicians such as Clinton and Gephardt even play to class envy, urging one group of income earners to hold the politicians' coats as they expropriate another.

In Massachusetts, the establishment left has tried five times through the constitutional initiative process to repeal the present requirement that the state income tax have one rate. Those who want higher taxes and more government know they cannot raise the income tax as high as they would like if they must face all taxpayers at once. Offered the chance to see "average taxpayers' taxes fall while the rich pay more," Bay Staters have rejected the siren call of envy. Dick Armey, in fact, may want to take a cue from Massachusetts and codify single-rate language in the Constitution.

When it comes to treating everyone equally, Archer's sales tax/VAT has no advantage over the present income tax. Every VAT in Europe has multiple rates. Politicians extort campaign funds from cowed industries that fear having their products taxed more or that want their product exempted from the VAT. Products are labeled "necessities" or "luxuries," and taxed at politically determined rates. In America, we already have politically driven multiple rates on sales of goods and services such as tobacco, alcohol, and hotel rooms. Sen. Daniel Moynihan (D-N.Y.) has suggested a 10,000-percent tax on gun ammunition. A national sales tax would politicize the "virtue" and "sinfulness" of every product and service in America.

The progressive or graduated income tax divides Americans by income class and treats them differently, just as racial preferences--whether old-style Jim Crow laws or new-style affirmative action--divide Americans by race. And for the same reason: so we can be divided against each other by the state. It is no coincidence that the graduated income tax and racial preferences are collapsing at the same time. Americans wish to be treated equally before the law. This is neither South Africa nor East Germany, despite the best efforts of Clinton and Gephardt to divide us against each other, first by race and then class.

There's another reason to be wary of a sales tax or VAT: Canada, Japan, and every European nation have a national sales tax or VAT and a personal income tax and a corporate income tax and wage taxes. In fact, it has long been a goal of the Democrat party to add a VAT to our present tax burdens. I remind readers that Hillary Clinton has three times argued for a VAT to pay for her German-style government-run health care plan. As further proof, remember that Bill Clinton has three times denied such plans for a VAT.

It is inauspicious that both Bill Archer and Dick Lugar have refused to insist that the 16th Amendment, which allows the federal income tax, be repealed before any national sales tax or VAT is introduced. To implement any consumption tax without first repealing the 16th Amendment is a guaranteed recipe for disaster. Honest supporters of a VAT as a replacement to the present tax must insist both on repeal of the 16th Amendment as the prerequisite for any new tax and on a constitutional prohibition to the return of any income tax. Given the present courts, I despair that even this would save us from Europe's experience, where politicians in every case have used tax reform impulses to saddle their citizens with both taxes.

Tax reform should not blind us to the true battle: the total size, scope, and power of the state. The total tax burden, not simply how it is carved out of our lives, is the target. Perhaps the most important tax reform measure is the Barton Amendment urged by freshmen Reps. John Shadegg (R-Ariz.) and Linda Smith (R-Wash.) to require a three-fifths vote of both houses to raise or introduce any tax. Speaker Gingrich has promised a vote on this amendment on April 15, 1996, and if it doesn't pass then another vote will be held on April 15, 1997--conveniently after the 1996 elections.

All tax reformers should support this amendment--or preferably one that requires a two-thirds supermajority to raise taxes, as is the case now in Arizona, California, and the state of Washington, and may soon be true for Ohio, Florida, and Nevada.

Strategically, friends of liberty should support the Republican efforts to cut taxes and spending at the same time. Linking budget cuts with the $500-per-child tax credit and cuts in the capital gains tax and inheritance tax builds public support for both budget cuts and tax cuts. Let's ratchet down the state, cutting back spending and handing the savings back to Americans in tax savings.

In this process of reducing government, every tax cut is a good tax cut. Mae West made a similar observation about sex. Let's work together to reduce the total tax burden, to protect Americans against a political class that would divide us to better loot us, recognizing that there is no good way to rip 20 to 25 percent of the economy away from those who earned it to be distributed by the political class to those who vote for it.

Asking Americans to choose the best way to be taxed--rather than focusing on reducing total taxes--is too reminiscent of the "choice" the state of Utah offered Gary Gilmore: hanging or shooting?

Grover Norquist is the president of Americans for Tax Reform.

Edward H. Crane Responds

I t's important to keep in mind that the flat income tax being proposed by Dick Armey, based on the research of Hall and Rabushka, is actually a consumption tax. Neither Grover Norquist nor Bruce Bartlett dispute this fact. Thus, the economic impact of both the flat tax and the federal retail sales tax would be the same. That impact, of course, would be enormously positive when compared to our present tax system. So, as I mention in my essay, the issue isn't economics. It is politics and tactics.

There's a little dissembling going on when Grover Norquist consistently uses the VAT and a federal retail sales tax interchangeably. They ain't the same thing, and Grover knows it.

Of course, you could argue (and Norquist does) that a retail sales tax will inevitably become a VAT. But there's less reason to expect that to happen than to expect a flat tax--Bartlett points out that it's not really a flat tax even at the outset--to be twisted and molded into something that looks a lot like what we have today. In either case, it would be best to eventually back up a statute with a constitutional amendment.

One other point. Norquist had better dust off his copy of Power & Market if he actually thinks business income taxes are paid by consumers. They are paid by the owners of the business. The notion that prices are determined by costs, which are easily passed on to consumers, is nonsense. Supply and demand determine prices. Consumers couldn't care less how much it costs for a business to produce a product or how much in the way of taxes it pays.

Back to the issue of politics. As Dan Pilla points out, getting rid of the IRS is an appealing aspect of the sales tax. This is not an agency that spends a lot of time reminding its employees of the Bill of Rights. If we can fund the federal government without it, by all means, let's do it. Flat-tax advocates posture that the retail sales tax will necessitate hordes of revenuers swarming over the landscape to keep shopkeepers from breaking the law. That 95 percent of retailers willingly comply with state retail sales tax requirements already is apparently inconsequential.

But even if there was some problem with collections--and with taxes as high as they are, we could expect some--it's unlikely that missing taxes under a national sales tax would exceed the $150 billion that annually escapes the feds now. Besides, whatever sales tax enforcement agency would be created, it would not be going into your home to discuss every aspect of your personal and business life. How much money you make and how you make it would then be no business of the federal government. Actually, since the vast majority of states that have
an income tax depend on the IRS to enforce compliance at the state level, most, if not all, would switch to a sales tax or increase their current one. Income taxes would be abolished throughout the land.

Moreover, politics in America would forever be changed. The psychological impact of living in a society where it was none of the government's business how much money you made--where your paycheck reflected exactly what you earned--would be huge. It would change people's attitudes on all public policy issues to remove the intimidating and paternalistic Internal Revenue Service from people's lives.

Finally, public support for abolishing the income taxes is at an all-time high. When columnist Jack Anderson asked readers of Parade magazine to write in and tell him if they would like to replace income taxes with a federal retail sales tax, some 40,000 did. And 97 percent of them favored the retail sales tax.

Daniel J. Pilla Responds

The chief opposition to the sales tax is the claim that due to evasion, it will quickly degenerate into a European-style value-added tax (VAT). All agree VATs are inefficient, hidden, and to be avoided.

The argument that a sales tax will mutate is simply not supported by the American experience. Forty-five states now have a sales tax. In no case has it transmogrified into a VAT. Moreover, the present system creates an incentive for a merchant to engage in sales tax evasion with a customer. When a product is purchased "off the books," the customer evades the sales tax, and the merchant evades the income tax. If there is no income tax, the merchant loses his primary incentive to aid in sales tax evasion. He is not as likely to abet evasion when the risks are his but the rewards are not.

Please note: Evasion is greatly reduced when the public perceives the tax rate is reasonable, and the system itself is fair and simple. Hence, as the overall tax burden falls, evasion falls. This is precisely why it is critical to eliminate existing federal taxes in favor of a single national sales tax.

The average American family today pays 15-percent income taxes. Social Security tax, not including the employer's matching share, is 7.65 percent. Thus, to purchase a $10,000 automobile, the average family must earn $12,265 (not counting state taxes). Now, consider that business taxes and compliance costs amount to 15 percent of a car's purchase price. Get rid of those costs and the car costs $8,500. By eliminating other federal taxes and going to a 25-percent retail sales tax, the average family would have to earn $10,625 to purchase the same auto--a $1,640 savings.

The Armey plan also seeks to eliminate wage withholding. It would require us to send a check to Washington each month. Grover Norquist suggests payments will "be painful reminders of the true cost of government." True, but they will also remind us of the continuing presence of the IRS. And, in fact, IRS records show about 3.5 million citizens annually cannot pay what they owe, regardless of how simple it is to file a return. To collect, IRS executes 3 million to 4 million wage and bank levies, and files about the same number of tax liens.

A flat tax coupled with no withholding creates a compliance problem unheard of in any sales tax environment. It turns loose tens of thousands of IRS collectors on the public. A system designed to remind us that taxation is painful will become a collection nightmare for millions.

Norquist suggests that a flat tax puts "all taxpayers in the same miserable relationship with the state." I fear this is true, as the IRS is preparing for draconian enforcement measures even now. Overreaching IRS procedures will flourish under a flat tax. Our challenge, however, is not to put all citizens on equally miserable footing. Our challenge is to free all citizens from the misery inflicted in the name of taxation.

The biggest single advantage of the sales tax, apart from eliminating the IRS, is simplicity. This is lost with the flat tax. Advocates claim both businesses and individuals will be able to file flat tax returns on a postcard. However, Bruce Bartlett's remarks betray this claim.

He acknowledges that businesses retain substantial deductions, including, "wages, salaries, and pensions paid (but not benefits); purchases of goods, services, and materials used in business; and all capital equipment, structures, and land." It is no easy matter to account for these expenses. It is even more difficult to persuade error-prone IRS examiners that one's own calculations are accurate.

Also consider that withholding of income tax ceases under the flat tax, but withholding of Social Security taxes does not. Consequently, every business with employees must continue to withhold, make regular deposits of the tax, and file five employment tax returns annually.

According to the IRS's 1993 Annual Report, nearly 29 million such returns were filed, at tremendous cost. The IRS assessed nearly 11.5 million penalties in connection with those returns, at a direct cost of over $3.5 billion. Nothing in the flat tax proposal eliminates this albatross.

In sum, the claimed benefits of a flat tax are non-existent. Only a national sales tax provides the kind of relief needed. We all recognize a reduction in government is a key element in the tax reform debate. A sales tax provides a unique advantage in this regard. If funded through a sales tax, government has a vested interest in keeping its hands off the economy and out of people's pockets. As the economy grows, government's share of the pie grows.

Conversely, the flat tax is still an income tax and carries with it the unarguable reality that it penalizes growth. That is precisely why our founders used consumption taxes as the primary means of funding government. Alexander Hamilton rejected taxing "the articles of our own growth and manufacture" as they are "more prejudicial" to the economy than consumption taxes.

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.