Arguments for and against the National Sales Tax - Essay Example

Arguments For and Against the National Sales Tax Introduction Since its creation in 1913, the income tax has been the of strident criticism.Many people see the income tax and other federal taxes as convoluted and unfair punishments for hard work. Some people have gone so far as to suggest a national sales tax (NST) to replace the current income tax system and related tax systems. One flat tax rate along with a rebate tied to the poverty line would replace the progressive system of taxation that businesses and individuals alike have to pay into. There are compelling arguments for and against the NST. The most compelling side is the side against the NST. Among other things, the NST is not high enough to replace current revenues. The NST should remain a fringe argument against the federal income tax. The Federal Income Tax The NST would replace a number of taxes levied by the federal government. Principal among them is the income tax. The income tax sprung into being with the adoption of the 16th Amendment in 1913 (McNulty and Daniel 7). The tax taxes all income, however derived. The income that is taxed is subject to certain exemptions, deductions and credits depending on the class of person involved or the activity involved. For example, there is an additional standard deduction for the elderly and the blind (McNulty and Daniel 4). Additionally, there is a greater standard deduction for married people over single people (McNulty and Daniel 3-4). The government discerns among people and activities to encourage certain social behaviors. As McNulty and Daniel put on page 23: The income tax raises revenue, subsidizes some people or activities, encourages or discourages behavior, redistributes wealth, stimulates or stabilizes the economy, maintains federalism and tackles social problems like pollution and urban decay. The income tax is progressive - a defining feature of the system. People fall into different tax brackets based on their income. Higher income brackets are subject to higher marginal tax rates. The end result is that higher income individuals pay on average a higher proportion of their income as tax (McNulty and Daniel 18). Progressive taxation represents a federal policy of wealth distribution of money from the wealthy to services for the rest of the populace (Posin and Tobin 18). The income tax does not discourage work. People will be motivated to work so long as their federal, state and local tax rates don't exceed 100% (McNulty and Daniel 20). The federal income tax system is far reaching, pursues policy goals in addition to raising revenue and attempts to be fair among the classes. The National Sales Tax Defined The NST is a simple way to generate revenue. 45 states and the District of Columbia already take advantage of sales and use taxes. Several proposals for a national sales tax has floated in the last couple of years. This discussion reflects the national sales tax defined in H.R. 3039, sponsored by Reps. Dan Schaefer (R-Colo.) and Billy Tauzin (R-La.) (Burton and Mastromarco). The NST would replace the individual and corporate income tax, transfer taxes, and most non-trust-fund excise taxes with a single 15 percent flat-rate tax on tangible goods and services sold at the retail level (Burton and Mastromarco). The sales tax would be exempted from intermediate levels of production. The NST defined here does not replace the payroll taxes providing revenue for Social Security and Medicare. (Burton and Mastromarco). There are a slew of items that would be taxed in addition to goods and services. Housing, financial intermediation services and government goods and services that are sold to the public would be taxed. Rent and home purchases would be taxed. Imports would be taxed. (Burton and Mastromarco). The NST proposal attempts to deal with the otherwise regressive aspects of the tax. All people would receive a rebate of the tax equaling the tax rate times the poverty line, allowing poor people to avoid paying the tax and everyone else to afford the necessities of life tax free. The rebate would be included in every paycheck. The rebate would be based on family size. Burton and Mastromarco describe an example of how the rebate would work: For a family of four, the HHS poverty level for 1996 is $15,800, so the sales tax poverty level would be $18,588. The annualized rebate, which would be refundable for households with earnings below the poverty level, would therefore be $2,788. Assuming the head of household was paid 26 times per year, the rebate amount included in each paycheck would be $107.23 Families with no annual wages and salaries would apply directly to the Social Security Administration for a rebate check. The tax rate guarantees government spending at current levels. The 15% tax rate is arrived at by determining what percentage of total consumption would produce revenue equal to that currently being collected by the IRS. That amount is roughly 11%. Adding a rebate for the poor brings the tax rate to 14%. Another 1% is added to deal with tax evasion, bringing the grand total to 15%. The NST is an expedient and simple solution to the problem presented by the current tax system. Arguments for Adopting the National Sales Taxes There are a potpourri of arguments supporting the adoption of the NST. Below are some of them. The NST Would Create Incentives to Work and Save The current tax system punishes work by taxing income at progressively higher rates. The tax system takes away income that can be saved and invested. The NST only taxes consumption. People will have more money in general because the marginal tax rate will be lower on a consumption based tax rate than an income based tax rate. The consumption base is larger than the income base (Limbeck). People are free to save and invest their income. The amount saved or invested would only be taxed when spent (Burton and Mastromarco). The individual or company could earn a great deal of compounding interest on the income before having to spend and be taxed on any of it. Workers would also have an incentive to invest broadly, since the tax does not punish certain types of investment over others. Individuals and companies would not have to hide behind tax shelters and other dodges. Overall, there would be an increase in economic growth with added incentives to work and save. (Burton and Mastromarco). Compliance Costs Will Go Down Another benefit of adopting the NST will be lowering the cost of compliance with the tax regime. Currently businesses and individuals spend $150 billion to comply with the federal income tax system. Individuals, businesses and non-profits spent an estimated 5.8 billion hours complying with the federal income tax code in 2002 (Limbeck). Compliance costs the nation between 20 to 50 percent of the total revenue generated. Compliance accounts for 1.9 to 4.1% GDP (Burton and Mastromarco). According to the Kemp Commission report, small firms especially bear the burden of compliance, paying 3.8 times the tax actually collected. Compliance costs would drop 90% be adopting an NST, which is equivalent to putting $1,000 to $2,500 into the pocket of every household in America (Burton and Mastromarco). That money is money that can be used to save and invest or to spend on the various goods and services offered by the nation. Compliance costs are stones around the country's neck that can be cast away with the NST. Tax collection can be done at little cost to the collectors. The federal government can pay the states a small fee to funnel the funds from businesses to the government. Most states already have sales taxes and can put their collection operation to work to collect the NST. Additionally, the federal government can pay businesses a small fee to collect the tax. Collection in general will be easier because there will be fewer points of collection from which to collect and later audit. The NST operation is lean and efficient. The Tax is Fair According to proponents, the NST is fair. It starts off by providing a rebate to all families to cover the tax on the necessities of life. The NST operating with a rebate is not regressive. People only pay more taxes if they spend more money, which would be the case for higher income individuals who have more money to spend. The NST taxes based on ability to pay (Limbeck). The NST also does not unfairly favor some groups of people over others like the federal income tax system does. The federal income tax gives breaks to some groups with its system of credits, exemptions and deductions (Fairtax.org). Government policy becomes more transparent with an NST as the system of favoritism is removed (Limbeck). The NST Stimulates Economic Growth Individuals and businesses will have more income to devote to spending, increasing activity in the economy. Capital is estimated to increase by at least 29% and potentially as high as 49%. The U.S. standard of living can go up be at least 7% and maybe even by as much as 14%. The GDP can rise 36.3% and private output can increase 48.4% (Burton and Mastromarco). Higher investment in the economy leads to increased productivity of employees and demand for workers. The NST creates a salutary cycle. Higher employment and economic growth leads to higher investment and consumption. The NST Encourages Charitable Giving It is true that the IRS provides a deduction for charitable giving. A taxpayer has to itemize their taxes, however, to realize the deduction and must earn marginally more than the deduction in order to get a certain quantity of deduction (Limbeck). The NST taxpayer does not have to worry about itemizing and deductions in order to give to charity. Most importantly, the contribution can be made using income taxed at a lower marginal rate than under the income tax. Lumbeck provided an example of how this works: The appropriate question to ask about charitable contributions is not "how much of a deduction is provided" but rather "what must a taxpayer earn in order to make that contribution" A taxpayer needs to earn only $100 in order to contribute $100 under the FairTax, but even an itemizing taxpayer today must earn at least $108 to contribute $100. A non-itemizing taxpayer (two-thirds of all taxpayers) in the 28-percent bracket must earn $155 to make a $100 contribution to charity today. The NST Discourages Tax Evasion The NST can decrease tax evasion. Consumers have to pay taxes every time they make a purchase and can't hide their income by underreporting their income or by not filing at all. Currently 18 million wage-earning Americans have dropped out of the tax system by not filing for taxes at all. Consumers would not be able to escape the NST (Limbeck). Businesses would have a harder time evading taxes because they represent fewer loci of tax filers for the government to supervise. (Burton and Mastromarco). More than 85 percent of the sales tax would be collected by less than 15 percent of the retailers. Overall, cheating is discouraged because the marginal tax rate is lower. There is less reason to evade a tax when one has to pay less money (Limbeck). Arguments Against Adopting the National Sales Taxes There are a number of arguments which militate against having an NST. The NST Won't Fully Replace Federal Revenue 15% is too low a number to cover the revenue generated by the income tax. One estimation is that a 30% tax would be needed to replace income and payroll taxes. Brookings Institution economist William Gale has estimated that the NST rate would have to be as high as 44% (Ponnuru).These estimations assume that no one would evade the tax or that the government would not carve out exemptions for specific groups or activities. A level of taxation as high as 30 or 40% is simply untenable (Ponnuru). The NST is Unfair to Certain Groups Several groups of people suffer with the NST. Retired people are penalized by the tax. They are living on income that has already been taxed during their lives. An NST taxes their income again. The value of their accumulated savings would drop as they spent it. The middle class is squeezed by the NST as well. Poor people will have their taxes subsidized by the rebate. Rich people will see their tax rates drop as well. They consume proportionately less than other classes by putting more income into nontaxed investments (Ponnuru). In order to maintain the same level of revenue realized by the income tax now, the middle class will have to see their tax rates rise. This effect will be regressive and discourage consumption and work by the largest segment of the population. It will take a long time for the estimated rise in economic growth to mitigate the effect on the middle class (Ponnuru). Wages Will Fall Currently there are taxes embedded throughout the levels of production and consequently labor. Taking away taxes from the intermediate levels will lead to a reduction in wages as businesses adjust their business models. Unemployment will rise if wages do not fall. Prices will rise if the Federal Reserve increases the money supply to account for lost wages. The effect of the NST on wages is not healthy. Enforcement Will Be Difficult No state or nation in the world has an NST as high as 15%. Most nations that have sales taxes divide up the burden by taxing items at every level of production in what is known as value added taxing (Ponnuru). Businesses and consumers alike will flinch at the thought of having to pay 15% on everything they buy right off the bat. Federal authorities will have less places to look for tax evaders (businesses that collect taxes), but there are still enough businesses out there that tax evasion would remain a viable and profitable course of action. Consumers can also evade taxes by buying items on the black market from outside of the United States. Tax evasion will remain a challenge for the government. The NST Discourages Consumption The NST will discourage consumption. Everything will cost more. Consumers and businesses alike will be less inclined to spend that extra dollar on a good or service when 15% of that dollar is siphoned out for taxes. The incentive with the NST will be towards savings and investment, which is not taxed until they are withdrawn and spent in the future (Balancedpolitics.org). This effect will harm the economy. The economy runs on consumption. Less consumption will lead to less production of goods and services. Less production of goods and services will mean less demand for workers. Fewer people with jobs means fewer people will have the income to consume things and pay taxes. The government will generate fewer revenues and have less money to provide needed resources to the country. The NST can engender a negative economic cycle. The NST Will Eliminate Government Incentives for Positive Behavior The NST will destroy the incentives for socially beneficial behavior that the income tax currently creates (Balancedpolitics.org). For example, the income tax encourages home ownership by providing a substantial deduction for mortgage interest incurred. The government is encouraging people to try home ownership. Outside of saving for retirement, buying a home for most people is the most important and most expensive investment that they can make. Government aid in the income tax system helps to make home ownership a reality. The income tax encourages other behaviors that the NST would not. The income tax encourages people to create businesses by providing numerous and substantial business deductions. The NST on the other hand, discourages people from creating businesses. Their products will become 15% more expensive than they otherwise would be without the tax. Taken everything together, the NST would make it harder for people to achieve certain things that society wants them to have. The NST cannot create exemptions for classes of people or activities without reducing the tax base and necessitating a tax increase on everything else. The NST Tax Penalizes Renters Every month of rent would constitute the purchase of a service - the privilege to live in a specific dwelling. Every payment of rent would have a 15% tax tacked onto it. Compare this to the homeowner who has a house paid off. They don't have to pay taxes on anything. The NST is regressive in housing (Youdebate.com). The poor disproportionately rent and the wealthy own property. The NST also makes it hard to transition to owning a home. Renters would have to pay money for the tax on their rent instead of save the money for buying a home. The NST is distinctively unfair when it comes to housing. The NST is Not Indexed For Inflation The income tax brackets are indexed for inflation to protect taxpayers from the effects of runaway inflation and to preserve taxpayer income. The NST is not indexed in this way (Karlonia.com). Taxpayers pay more taxes the higher in price goods and services become. This is harmful in inflationary times - the tax burden becomes a real hardship for people and businesses. It will take more effort by the government and in the business cycle to correct inflation. The NST Makes it Easy to Tax Certain Activities The government can tax certain activities just by increasing the tax on their production. The government can, for example, tax cigarettes, firearms, and alcohol at higher rates to discourage their use. Unequal taxation can become the wave of the future with the NST because of how easy it will be to tax different kinds of goods and services. This possibility goes against the concept of the NST as a fair tax (Karlonia.com). The Rebate Creates a Welfare State Instead of poor people receiving government benefits, everyone will receive government benefits in the form of the rebate everyone will enjoy. The rebate discourages work. People will want to avoid as much taxation as possible and will want to hew as closely as possible to the free lunch they get with the rebate (Karlonia.com). Any amount of money taxed after the rebate has been spent will be wasted money. People will gravitate towards black markets to avoid paying taxes above the rebate amount. Conclusion: Keep the Income Tax This essay evaluated the income tax and NST and presented arguments for and against the adoption of the NST. While there are some compelling arguments for the NST, such having lower compliance costs, the arguments against the NST outweigh the arguments for the NST. Especially persuasive is the argument that the NST tax rate is not high enough to replace current revenue. It would be a nightmare to institute an NST and then see revenue plummet as taxpayers limited their consumption of goods and services. The nation needs the government services that the income tax currently funds. Instituting an NST that cannot meet revenue needs is playing with fire. The country cannot go without revenue or raise the NST to 30%, as some economists have proposed would need to happen. The NST is too good to be true. References Burton, David R. and Dan R. Mastromarco. "Emancipating America from the Income Tax: How a National Sales Tax Would Work." Cato Policy Analysis No. 272, 15 Apr. 1997. Web. 29 Mar. 2010. "The Fair Tax Act of 2007 - HR 25/S 1025: plain English summary." Fairtax.org. Web. 29 Mar. 2010. "Fair Tax Pros and Cons." Karlonia.com. 16 Apr. 2007. Web. 30 Mar. 2010. "Is the National Sales Tax the Fairest Plan" Youdebate.com Web. 30 Mar. 2010. Limbeck, Jr., Leo "Submission of Americans For Fair Taxation on the FairTax Comprehensive Tax Reform Proposal toThe President's Advisory Panel on Federal Tax Reform." Fairtax.org. 29 Apr. 2005. Web. 29 Mar. 2010. McNulty, John K. and Daniel J. Lathrope. Federal Income Taxation of Individuals. 7th ed. St. Paul: Thomson West, 2004. Print. Ponnuru, Ramesh. "A Misleading Sales Pitch For a Misguided Sales Tax." National Review. 22 Mar. 2010. Web. 30 Mar. 2010. Posin, Daniel Q. and Donald T. Tobin. Principles of Federal Income Taxation. 7th ed. St. Paul: Thomson West, 2005. Print "Should the U.S. Institute a National Sales Tax (or the "Fair Tax") to Replace the Income Tax" Balancedpolitics.org. 18 Feb. 2010. Web. 30 Mar. 2010. Read More