Indeed, the flat tax and a national sales tax (such as the Fair Tax) are basically different sides of the same coin.
The only big difference is the collection point. A flat tax takes a piece of your income as you earn it while a national sales tax grabs a piece of your income as you spend it.
Using the jargon of public-finance economists, both the flat tax and national sales tax are “consumption base” systems.
But that does not mean a tax that is collected at the cash register. Instead, it simply means a system where there is no double taxation of saving and investment (i.e., a system where all saving and investment receives IRA/401(k)-type protection).
But just because two tax plans are economically similar does not mean that they have the same political appeal.
Over the past few decades, I’ve explained to many politicians the best arguments for both the flat tax and national sales tax. I’ve also warned them about the most likely attacks and how to respond.
Suffice to say that it’s much easier to sell the flat tax and defend it from demagoguery (usually revolving around class warfare or itemized deductions).
Which is why some pro-tax reform folks are trying to discourage House Republicans from supporting the Fair Tax.
Here are excerpts from a Wall Street Journaleditorial.
House Republicans may be…set to vote on a national sales tax that won’t become law but will give Democrats a potent campaign issue. The plan is called the Fair Tax and its premise is simple: Replace every existing federal tax with a new national tax on sales. …the true rate would be about 30%. The Fair Tax rate would be on top of state sales taxes. …It would also eliminate the Internal Revenue Service, but…replace it with a new Sales Tax Bureau and Excise Tax Bureau. …The Fair Tax is based on the reasonable theory that levies on consumption distort the economy less than our current taxes on work and investment. Killing the income tax also sounds good until you realize that a future Congress could restore it if the Constitution’s 16th Amendment isn’t repealed. …The point is that a consumption tax might make sense if Congress were writing the tax code from scratch. But it isn’t, and we could end up with both a national income and sales tax, the later of which could evolve over time into a value-added tax. …the Fair Tax has hurt GOP candidates before. When tea party Republicans ran on the idea in 2010, Democratic groups ran ads that blasted the sales tax… Few voters listen to a second sentence after they hear about a 30% tax on everything they buy.
Opining for National Review, Ramesh Ponnuru is even more critical.
Any House Republican who backs this bill can accurately be accused of voting for the following things: raising the price of everything by a huge amount at a time when inflation is already high; shifting more of the tax burden to the middle class; instituting a large new wealth tax on senior citizens; increasing federal spending by a massive amount; increasing the deficit; and creating large black markets. …FairTax supporters have answers for most of these charges. They are not…persuasive answers. But even if they were right, Republicans who vote for the bill would be taking on a formidable amount of defensive work. Those in competitive seats, especially, should know what they are getting themselves into.
Last but not least, Grover Norquist of Americans for Tax Reform argues against the Fair Tax in an article for the Atlantic.
The bill proposes to abolish the Internal Revenue Service and eliminate the federal income tax. So far, so good. Unfortunately, the bill would replace the income tax with a 30 percent national sales tax on all goods and services and establish a giant new entitlement program. …Under the bill’s plan, all households would receive a monthly check from the federal government regardless of earned income. …In all but name, in fact, the Fair Tax’s “prebate” system would establish a universal basic income, one of the left’s favorite policies. …Fair Tax proponents make two good points. They understand the need to end the double taxation of savings and investment in the present system, and they want to depoliticize the IRS workforce… None of this has stopped Democrats from seizing the opportunity to claim that Republicans now want to raise taxes on the poor and middle class. …the Fair Tax Act has a long record of proving politically toxic.
P.S. While I recognize that a national sales tax has political vulnerabilities, I actually think its biggest problem is the risk that politicians would not actually get rid of the income tax. Or, maybe they would get rid of the income tax, but then reinstate that awful levy after a few years. This is why, in this video, I explain that a national sales tax only should be considered after the 16th Amendment is repealed and replaced with something that unambiguously prohibits the income tax from ever again plaguing the nation.
I’m a long-time proponent of tax reform and I mostly focus on the flat tax, but as I wrote last month, a national sales tax also is a good option.
Here’s some of what I said on the topic back in 2007.
The key thing to understand is that the flat tax and sales tax are different sides of the same coin.
What differs is the collection point. A flat tax takes a slice of your income when you earn it while a sales tax gets a slice of your income when you spend it.
Those are the main economic arguments, though it’s also worth noting that either version of tax reform would allow a dramatic downsizing of the IRS.
I don’t know whether that should be a victory over bureaucracy or a victory for civil liberties, but it would be a good outcome.
In a column for today’s Wall Street Journal, Professor John Cochrane of the Hoover Institution makes the economic case for reform. Here are some excerpts.
…t“Fair Tax” bill…eliminates the personal and corporate income tax, estate and gift tax, payroll (Social Security and Medicare) tax and the Internal Revenue Service. It replaces them with a single national sales tax. Business investment is exempt, so it is effectively a consumption tax. Each household would get a check each month, so that purchases up to the poverty line are effectively not taxed. …our income and estate tax system is broken. It has high statutory rates with a Swiss cheese of exemptions, immense cost, unfairness and distortion. …A consumption tax, with none of the absurd complexity of our current taxes, is the answer. It funds the government with the least economic distortion. …A range of implicit subsidies will disappear. Good. Subsidies should be transparent. Money for electric cars, health insurance, housing, and so forth should be appropriated and sent as checks, not hidden as tax deductions or credits.
The bottom line is that we would have a much less destructive system with a national sales tax.
That being said, there is a very relevant debate about whether a sales tax is the politically smart way of trying to fix tax code.
In the video above, Bruce Bartlett argued that incremental reforms could solve almost all of the problems in the current system. That’s technically true, but tinkering with the tax code over the past 110 years is what’s produced the current mess.
So is it realistic to think that tinkering in the future will yield good results?
As I said in the video, it would be nice to toss the current tax code in the trash and replace it with something that collects revenue is a less-damaging and less-corrupt fashion.
Not because one is theoretically better than the other, but because of two political reasons.
As noted in the above clip, I’m very worried about giving untrustworthy politicians a new source of tax revenue without unambiguously and permanently getting rid of the income tax (so that we don’t repeat the European mistake of giving politicians a way of expanding government).
I also worry that a Fair Tax is vulnerable to demagoguery since lawmakers will get hit with election-year ads stating they want a big 30 percent tax on everything people buy (while overlooking that our paychecks will be much bigger once income taxes and payroll taxes are abolished).
And there’s plenty of less-friendly opposition. In an article for the Bulwark, Jim Swift pours cold water on the idea.
…nobody has ever taken the Fair Tax seriously. Not in the years after the Tea Party wave… Not in 2011, when Texas Gov. Rick Perry briefly campaigned in support of the Fair Tax, only to quietly walk back his support and switch to a flat tax proposal.Not in 2017, when the Republican-controlled Congress passed the Tax Cuts and Jobs Act. …Do moderate House Republicans really want to be forced to vote on the Fair Tax? …In light of all this, why promise a vote on such a loser? Going straight to the floor poses risks, given the slim GOP majority. It’s a lose-lose situation: Vote yes, and the House Republican Conference looks frivolous, to say nothing of the messaging gift they would give Democratic speechwriters in 2024 (“Republicans want to instate a 30-plus percent federal sales tax!”). Vote no, and invite primaries by far-right candidates who will accuse you of siding with Democrats when given a chance to abolish the IRS. …It’s possible that McCarthy agreed to a floor vote expecting moderates to break ranks and the bill to fail by a spectacular margin. That would drive a stake through the heart of the Fair Tax. …What’s likelier is that McCarthy knew this was a promise he could break. He never said anything about when he would bring the bill to the floor.
While I do worry about the political blowback against a Fair Tax, I hope Speaker McCarthy keeps his promise and there is a floor vote.
Not because I’m deluded about something good getting through the Senate or surviving a sure-veto from Biden.
But if tax reform becomes a big issue this year, that may set the stage for a bigger debate in 2024 and maybe one of my fantasies will come true and we’ll get something good in 2025.
P.S. Here’s another video from the archives, in which I discuss the flat tax and national sales tax.
P.P.S. Speaking of archives, here are my brief thoughts from 2011 about the various proposals for tax reform.
P.P.P.S. And click here, here, here, or here if you want to peruse my arguments for the flat tax.
But maybe it is time to think about going on offense.
In a column for the New York Sun, John Childs makes the case for replacing the current mess with the national sales tax.
There is a better way — replace the entire income tax monstrosity with a national consumption tax, i.e. a national sales tax. Let Walmart and Amazon be the tax collectors. Odds are they will be vastly more efficient than the IRS, which at this point can’t even return the phone calls of bewildered taxpayers. All retailers already perform sales tax collection services for state governments. So it is hardly a leap of faith to ask them to do it for the Feds. …This would be bad news for tax lawyers and accountants. As some of the brightest minds in the country now devote themselves to crafting fiendishly clever tax avoidance schemes, though, imagine what an unexpected dividend would flow from redirecting all of that creativity to productive activities.
I agree that a national sales tax would be much better than the current system.
But always with the very big caveat that I mentioned in the video, which is that any sort of direct consumption tax (sales tax, Fair Tax, value-added tax) has to be a total replacement for the income tax.
However, that’s just one must-have requirement. Since politicians are untrustworthy, we also should not allow a direct consumption tax until and unless the 16th Amendment is repealed and replaced with a new amendment that unambiguously prohibits any future Congress from reinstating an income tax.
The bad news is that I don’t think either of these requirements will be met. And this is why I am more focused on supporting the flat tax.
After all, the worst thing that happens with a flat tax is that future politicians reinstate the current system.
But the worst thing that happens with a national sales tax is that future politicians have a new source of revenue to fuel bigger government (sort of what happened in Europe when value-added taxes financed a major expansion in the burden of government spending).
P.S. The same principles apply at the state level. Policymakers should use consumption taxes to help finance the repeal of income taxes.
P.P.S. A Fair Tax (or any form of national sales tax) will reduce the underground economy, but not by a greater amount than the flat tax.
I’ve repeatedly shared a flowchart to illustrate the pervasive double taxation in the current system (my example is for the United States, but many other nations make the same mistake).
And to help explain why this is economically misguided, I developed a (hopefully) compelling visual based on how to harvest apples.
But I’ve always wondered if I was presenting the information in an accessible and understandable manner. So for today’s presentation, I decided to experiment with some different visuals.
Here’s how I illustrated the current system.
As you can see, there are several additional layers of tax on people who save and invest their after-tax income.
And I explained to the crowd that this is very foolish since every economic theory agrees that saving and investment are key to long-run growth.
Even socialism. Even Marxism. (Socialists and Marxists are foolish to think government can be in charge of allocating capital, but at least they realize that future growth requires saving and investment.)
In other words, you don’t achieve good tax policy solely by having a low tax rate.
Yes, that’
s important, but genuine tax reform also means no bias against saving and investment.
Here’s another visual. This one shows the difference between the current system and the flat tax. As you can see, all the added layers of tax on saving and investment are jettisoned under true tax reform.
By the way, there are some people who prefer a national sales tax over a flat tax.
Why? Because it’s conceptually identical to the flat tax.
As you can see from this next visual, the difference between the two systems is that the flat tax grabs a bit of money when income is earned and the sales tax grabs a bit of money when income is spent (either today or in the future).
Remember, the goal is to eliminate the bias against saving and investing.
To economists who specialize in public finance, this is known as shifting to a “consumption base” system.
But I’ve never liked that language. What really happens under true tax reform is that we tax income, but using the right definition.
But this final visual shows that adding a VAT to the current system doesn’t solve the problem. All that happens is that politicians have a new source of revenue to expand the welfare state.
If a VAT was used to replace the current tax system, that might be a very worthwhile approach.
But that’s about as likely as me playing the outfield later this year for the New York Yankees.
P.S. The VAT visual is overly simplified and it sidesteps the logistical issue of whether politicians would go for a credit-invoice VAT or a subtraction-method VAT. But the visual is correct in terms of how a VAT would interact with the current system.
I warned just last week about the dangers of letting politicians impose a value-added tax.
Simply stated, unless the 16th Amendment is repealed and replaced with a new provision forever barring the re-imposition of any taxes on income, a VAT inevitably would be a new source of revenue and become a money machine to finance ever-larger government.
In some sense, it’s a version of the national sales tax, except the revenue is collected on the “value added” at each stage of the production process rather than in one fell swoop when consumers make their purchases.
And it’s also conceptually similar to the flat tax. Both have one rate. Both have no double taxation. And both (at least in theory) have no special preferences and loopholes. The difference between a flat tax and the VAT is that the former taxes your income (only one time) when you earn it and the latter taxes your income (only one time) when you spend it.
In other words, the bottom line is that it is good (or, to be more accurate, less bad) to have a tax system with a low rate and no double taxation. And in the strange world of public finance economists, a system with no double taxation is called a “consumption-base tax.” And the flat tax, sales tax, and VAT all fit in that category.
So why, then, if supporters of limited government prefer a consumption-base tax over the internal revenue code, is there so much hostility to a VAT?
The answer is simple. We don’t trust politicians and we’re afraid that a VAT would be an add-on tax rather than a replacement tax.
Which explains why it’s better to simply turn the existing tax code into a consumption-base tax. After all, the worst thing that could happen is that you degenerate back to the current system.
But if you go with a VAT, the downside risk is that America becomes France.
There’s a story in today’s Wall Street Journal that illustrates why consumption-base taxation is both a threat and opportunity. Here are some introductory excerpts.
U.S. lawmakers on both sides of the aisle increasingly are finding appeal in an ambitious concept for overhauling the nation’s income-tax system: a tax based on consumption, a tool long used around the world. …As the name implies, consumption-style taxes hit the money taxpayers spend, rather than income they receive. One prominent feature of consumption systems is that they generally tax savings and investment lightly or not at all. That, in turn, encourages more investment and innovation, and ultimately more growth, many economists contend.
The reporter is wrong about consumption systems, by the way. Income that is saved and invested is taxed. It’s just not taxed over and over again, which can happen with the current system.
But he’s right that there is bipartisan interest. And he correctly points out that some politicians want an add-on tax while others want to fix the current system.
The tax-writing Senate Finance Committee is giving new consideration to the consumption-tax idea with the hope that its promised boost to economic growth would ease the way to a revamp. …Some of these proposals would have consumers pay another tax in addition to existing state and local sales taxes, while others would merely reshape the current system to tilt it more toward consumption. …Enactment of a broad-based federal consumption tax would align the U.S. with a global trend.
A Democratic Senator from Maryland wants to augment the current tax code by imposing the VAT.
Mr. Cardin introduced legislation last year to create a type of consumption tax known as a value-added tax and at the same time lower business taxes and scrap income taxes completely for lower-income Americans.
While some GOP Senators want to modify the current system to get rid of most double taxation.
Republicans on the working group also are interested in the concept, including a proposal put forward recently by GOP Sens. Marco Rubio of Florida and Mike Lee of Utah. That plan would make several changes to the tax code that would move the nation closer to a consumption-based system. …Many GOP members “believe that there are economic benefits to moving away from taxation of income and toward taxation of consumption,” a Senate aide said.
And the story also notes the objections on the left to consumption-base taxation, as well as objections on the right to the VAT.
Some liberals are concerned that consumption taxes affect poor people disproportionately, while unduly benefiting the rich, unless adjustments are made. For their part, conservatives fear that some types of consumption tax—particularly value-added taxes—would make it too easy to dial up government revenue collection.
So what’s the bottom line? Is it true, as the headline of the story says, that “Proposals for a consumption tax gain traction in both parties”?
Yes, that’s correct. But that’s not the same as saying that there is much chance of bipartisan consensus.
There’s a huge gap between those who want a VAT as an add-on tax and those who want to reform the current system to get rid of double taxation.
This doesn’t mean we shouldn’t worry about the prospect of an add-on VAT. As I warned last year, there are some otherwise sensible people who are sympathetic to this pernicious levy.
Which is why I repeatedly share this video about the downside risk of a VAT.
And you get the same message from these amusing VAT cartoons (here,here, andhere).
I’m a long-time proponent of the flat tax for three simple reasons.
1. It replaces the discriminatory “progressive” tax with a single tax rate at the lowest possible level, thus reducing the tax penalty on productive behavior.
2. It gets rid of all forms of double taxation, such as the death tax and capital gains tax, meaning economic activity is never taxed more than one time.
3. Other than a family-based allowance, it gets rid of all loopholes, deductions, credits, exemptions, exclusions, and preferences, meaning economic activity is taxed equally.
Some people say that these are also three reasons to favor a national sales tax.
My response is that they’re correct. In simple terms, a national sales tax (such as the Fair Tax) is like a flat tax but with a different collection point.
If you want more details, I often explain the two plans are different sides of the same coin. The only difference is that the flat tax takes of slice of your income as you earn it and the sales tax takes a slice of your income as you spend it. But neither plan has any double taxation of income that is saved and invested. And neither plan has loopholes to lure people into making economically irrational decisions.
So even though I’m mostly known for being an advocate of the flat tax, I have no objection to speaking in favor of a national sales tax, testifying in favor of a national sales tax, or debating in favor of a national sales tax.
With this bit of background, you can understand why it caught my attention that an economics professor at the University of Georgia (Go Dawgs!) wrote a column for Forbes with the provocative title of “I Will Support The Fair Tax When Its Backers Tell The Truth”.
Professor Dorfman writes that “such a consumption tax has much to recommend it from an economic point of view” but then warns that he “cannot support the Fair Tax as long as its backers continue to make implausible claims for their proposed reform.”
So what are the implausible claims? Let’s check them out and see if his friendly criticism is warranted.
He first expresses skepticism about the claim that take-home pay will rise to the level of gross pay under a Fair Tax, particularly given the assertion that prices won’t rise.
…the odds are that your gross pay will shrink over time under the Fair Tax. …employers can offer workers lower pay because of the lower cost of living (same prices, but higher take home pay). Because workers evaluate pay offers based on the purchasing power of that pay, the same competitive forces that will lower prices after the removal of business taxes, will lead to lower pay for employees in the long run as the labor market adjusts.
I suspect Professor Dorfman’s critique is correct, but I don’t think it matters. Workers understandably care first and foremost about the purchasing power of their paycheck, and that won’t be negatively impacted.
The Professor than looks at whether the Fair Tax gets taxes the underground economy.
…let’s tackle the claim that the Fair tax will do a better job of collecting taxes on criminals, the underground economy, and those who underreport their income. The idea is that people may hide some of their income or that drug dealers and others in the underground economy do not report their income, but that everyone spends money so the Fair Tax will tax everyone. Unfortunately, this claim is not true… Retailers are just as capable of underreporting revenue and not sending in the corresponding Fair Tax as people are of underreporting their income. …The incentive to avoid such consumption taxes will only increase when the rate is four or five times what it is now. If you don’t believe consumption taxes suffer from collection problems, go ask Greece.
And he looks specifically at taxing criminal activity.
Another reason that the Fair Tax will not capture extra revenue from illegal activities is that it only switches which side of the transaction is missed by the tax system. Currently, while drug dealers may not report their income, the people who buy drugs are paying with after-tax income. Under the Fair Tax, the drug dealers will pay tax when they spend their drug profits. However, unless the drug dealer sends in the Fair Tax on their sales, the drug buyers will now avoid tax on their purchases. Under either tax system, one side of the underground transactions will be paying taxes and one will not.
I think Professor Dorfman is correct, particularly in his explanation that drug dealers and other criminals will not collect sales tax when they peddle their illicit goods.
And he’s also correct when he says that the Fair Tax won’t collect all taxes on legal products.
But that doesn’t mean the Fair Tax is somehow flawed. Indeed, it’s quite likely that the underground economy will shrink under a national sales tax since the incentive to evade tax (on legal products) is a function of the tax rate. So if we replace the punitive high-rate internal revenue code with a low-rate Fair Tax, there will be a higher level of compliance.
But not zero evasion, so Fair Tax supporters exaggerate if they make that claim.
The next point of contention is whether the IRS can be repealed under a Fair Tax.
…some agency needs to collect all the sales taxes, ensure retailers are sending in the full amount, and handle all the mechanics of the prebate. The prebate requires this federal agency to know everyone’s family size and have a bank account or other method of sending out the prebate each month. So while individuals will have less interaction with the federal tax agency, there will still be some. For retail businesses, their interactions with federal tax officials will be at least as much as now, if not more.
The Professor is right, though this may be a matter of semantics. Fair Tax people acknowledge there will be a tax collector (the legislation creates an incentive for states to be in charge of collecting the tax), but they say that the tax authority under their system will be completely different than the abusive IRS we have today.
Last but not least is the controversy over whether everyone benefits under a Fair Tax.
…while Fair Tax proponents often act like nobody loses under the Fair Tax that is simply not possible. If the Fair Tax is implemented in a revenue neutral manner (collecting the same amount of total revenue as all the taxes it replaces), and some people win then other people must lose. Poor people pay roughly no tax either way, so the Fair tax would be neutral for them. The very rich will assumedly pay less since they spend a lower percentage of their income and spend more overseas. Thus, the suspicion is that the middle class will be paying more. One other group pretty sure to pay more is the elderly. The elderly have paid income tax while earning income, and under the Fair Tax would suddenly pay high consumption taxes right when their income drops and their spending increases. In the long run, this is not a problem, but early in a Fair Tax regime, the elderly definitely are losers.
Once again, Professor Dorfman is making a good point (and others have made the same point about the flat tax).
My response, for what it’s worth, is that supporters of both the flat tax and national sales tax should not be bound by revenue neutrality. Especially if the revenue-estimating system is rigged to produce bad numbers. Instead, they should set the rate sufficiently low that the overwhelming majority of taxpayers are net winners.
And in the long run, everyone can be a net winner if the economy grows faster.
And that, as Professor Dorfman agrees, is the main reason for tax reform.
The Fair Tax really has much to recommend it. It is simpler than the current system. It causes fewer distortions in the daily economic decisions that people make. The main distortion it does introduce is positive: to encourage saving and discourage consumption which would make the country wealthier in the long run.
Though I would quibble with the wording of this last excerpt. I don’t think the Fair Tax creates a pro-savings distortion. Instead, it removes an anti-savings bias. Just like the flat tax.
Now let me add a friendly criticism that Professor Dorfman didn’t address.
Advocates of the Fair Tax correctly say that their proposal shouldn’t be implemented until and unless the income tax is fully repealed. But as I explain in this video, that may be an impossible undertaking.
P.S. Actually, what I really want is avery small federal government, which presumably could be financed without any broad-based tax. Our nation enjoyed strong growth before that dark day in 1913 when the income tax was imposed, so why concede that politicians today should have either a flat tax or Fair Tax? But that’s an issue for another day.
My modest contribution was to present “The Case for the Flat Tax,” and I was matched up – at least indirectly, since there were several hours between our presentations – against former Congressman John Linder, who gave “The Case for the Fair Tax.”
Elimination of all loopholes (other than mechanisms to protect the poor from tax) to promote efficiency and reduce corruption.
Dramatically downsize and neuter the IRS by replacing 72,000 pages of complexity with simple post-card sized tax forms.
For all intents and purposes the flat tax and sales tax are different sides of the same coin. The only real difference is the collection point. The flat tax takes a bite of your income as it is earned and the sales tax takes a bite of your income as it is spent.
That being said, I do have a couple of qualms about the Fair Tax and other national sales tax plans.
First, I don’t trust politicians. I can envision the crowd in Washington adopting a national sales tax (or VAT) while promising to phase out the income tax over a couple of years. But I’m afraid they’ll discover some “temporary” emergency reason to keep the income tax, followed by another “short-term” excuse. And when the dust settles, we’ll be stuck with both an income tax and a sales tax.
To be sure, there are downside risks to the flat tax. It’s quite possible, after all, that we could get a flat tax and then degenerate back to something resembling the current system (though that’s still better than being France!).
On dozens of occasions over the past 15-plus years, I’ve had to explain to reporters that why anti-sales tax demagoguery is wrong.
So I hope it’s clear that I’m not opposed to the concept. Heck, I’ve testified before Congress about the benefits of a national sales tax and I’ve debated on C-Span about how the national sales tax is far better than the current system.
Actually, what I want is a very small federal government, which presumably could be financed without any broad-based tax, but that’s an issue for another day.
Returning to the issue of tax reform, there’s no significant economic difference between the flat tax and the sales tax. What we’re really debating is how to replace the squalid internal revenue code with something worthy of a great nation.
And if there are two paths to the same destination and one involves crossing an alligator-infested swamp and the other requires a stroll through a meadow filled with kittens and butterflies, I know which one I’m going to choose. Okay, a slight exaggeration, but I think you get my point.
Never let it be said I back down from a fight, even when it’s the other team’s game, played by the other team’s rules, and for the benefit of the wrong person.
And that definitely went through my mind when U.S. News & World Report asked me to contribute to their “Debate Club” on the topic of “Should Mitt Romney pay higher taxes?”
But my job is to do the right thing and bring truth to the economic heathens, so I agreed to participate. And I’m glad I did, because it gave me a chance to try out a new argument that I hope will educate more people about the perverse impact of double taxation.
Let me know what you think of this approach, which asks people whether they would think it would be fair if they couldn’t take credit for withheld taxes when filling out their 1040 tax return.
Capital gains taxes and dividend taxes are both forms of double taxation. That income already is hit by the 35 percent corporate income tax. So the real tax rate for people like Mitt Romney is closer to 45 percent. And if you add the death tax to the equation, the effective tax rate begins to approach 60 percent. Here’s a simply analogy. Imagine you make $50,000 per year and your employer withholds $5,000 for personal income tax. How would you feel if the IRS then told you that your income was $45,000 and you had to pay full tax on that amount, and that you weren’t allowed to count the $5,000 withholding when you filled out your 1040 form? You would be outraged, correctly yelling and screaming that you should be allowed to count those withheld tax payments. Welcome to the world of double taxation.
By the way, if you like my argument, feel free to vote for my entry, which you can do on this page.
The bad part, as I explain here, is that Cain would let politicians impose a national sales tax at the same time as an income tax.
And the ugly part is that he also would let them impose a value-added tax as well, as I discuss here.
I pontificate on all these issues in the latest Coffee and Markets podcast, which you can listen to by clicking here.
In closing, I will admit that it’s been very frustrating to deal with Cain’s plan. Supporters of Cain accuse me of being too critical and opponents of Cain accuse me of being too nice.
Normally, I don’t like being in the middle of the road, but that seems to be the only logical place to be since 9-9-9 has some really good features and some really bad features.
I’m very enthusiastic – but also a little worried – about Herman Cain’s tax plan.
So when I got the opportunity to write a short column for the New York Times, I explained that his proposal was very good tax policy, in large part because it is based on the same principles as the flat tax.
The flat tax is desirable for a wide range of reasons, including simplicity, fairness and transparency. It also would end the widespread and corrupt process of inserting loopholes and preferences in the code in exchange for campaign cash and political support. But public finance economists generally like the flat tax for different reasons, most notably the pro-growth impact… For the same reasons, people should like Herman Cain’s 9-9-9 tax plan. …It is based on the idea that the tax rate should not penalize people for being productive, and even an ardent supply-side sympathizer like me can’t complain too much about a 9 percent rate. Another key principle is the repeal of most forms of double taxation… Cain also takes a chainsaw to the underbrush of credits, deductions, shelters, loopholes, exemptions, and other distortions in the tax code.
But I then expressed my concern that the 9-9-9 plan might morph into something we don’t want.
This doesn’t mean Cain’s tax plan is perfect. The biggest concern, at least from many on the right, is that he would allow the crowd in Washington to simultaneously impose a flat tax, a national sales tax and (apparently) a form of value-added tax. This might not be a problem if there was some way of guaranteeing that none of the rates could ever climb above 9 percent. Unfortunately, the European experience (especially with VATs) does not leave much room for optimism. Sooner or later, politicians who want bigger government can’t resist pushing tax rates higher. And when the dust settles, you become Greece. Which is why Cain should not have reinvented the wheel. If he wants a low rate, no double taxation and no loopholes, the flat tax has all the upsides and none of the downsides of the 9-9-9 plan.
My basic message is that 9-9-9 should be turned into a postcard because the flat tax is a safer way of achieving the same goals.
The worst thing that can happen with a flat tax, after all, is that politicians begin to re-install loopholes and re-impose discriminatory rates and we wind up with something that looks like the current system.
I like the overall approach of Herman Cain’s 9-9-9 tax plan. As I recently wrote, it focuses on lower tax rates, elimination of double taxation, and repeal of corrupt and inefficient loopholes.
After all, Europe’s welfare states began their march to fiscal collapse and economic stagnation after they added a version of a national sales tax on top of their pre-existing income taxes.
But it seems that I was too nice in my analysis of Mr. Cain’s plan. Josh Barro and Bruce Bartlett are both claiming that the business portion of Cain’s 9-9-9 is a value-added tax (VAT) rather than a corporate income tax.
In other words, instead of being a 9 percent flat tax-9 percent sales tax-9 percent corporate tax, Cain’s plan is a 9 percent flat tax-9 percent sales tax-9 percent VAT.
Let’s elaborate. The business portion of Cain’s plan apparently does not allow employers to deduct wages and salaries, which means – for all intents and purposes – that they would levy a 9 percent withholding tax on employee compensation. And that would be in addition to the 9 percent they presumably would withhold for the flat tax portion of Cain’s plan.
Employers use withholding in the current system, of course, but at least taxpayers are given credit for all that withheld tax when filling out their 1040 tax forms. Under Cain’s 9-9-9 plan, however, employees would only get credit for monies withheld for the flat tax.
In other words, there are two income taxes in Cain’s plan – the 9 percent flat tax and the hidden 9 percent income tax that is part of the VAT (this hidden income tax on wages and salaries, by the way, is a defining feature of a VAT).
This doesn’t make Cain’s plan bad from a theoretical perspective. The underlying principles are still sound – low tax rates, no double taxation, and no loopholes.
But if I was uneasy when I thought that the 9-9-9 plan added a sales tax on top of the income tax, then I am super-duper-double-secret-probation uneasy about adding a sales tax and a VAT on top of the income tax.
Here’s my video on the VAT, which will help you realize why this pernicious tax would be a big mistake.
Again, this doesn’t make Cain wrong if we’re grading based on economics or philosophy. My anxiety is a matter of real-world political analysis. I don’t trust politicians with new sources of revenue. Whether we give them big new sources of revenue or small new sources of revenue, they will always figure out ways of pushing up the tax rates so they can waste more money trying to buy votes.
The mini-documentary explains how needless complexity creates an added burden – sort of like a hidden tax that we pay for the supposed privilege of paying taxes.
Two things from the video are worth highlighting.
First, we should make sure to put most of the blame on Congress. The IRS is in the unenviable position of trying to enforce Byzantine tax laws. Yes, there are examples of grotesque IRS abuse, but even the most angelic group of bureaucrats would have a hard time overseeing 70,000-plus pages of laws and regulations (by contrast, the Hong Kong flat tax, which has been in place for more than 60 years, requires less than 200 pages).
Second, we should remember that compliance costs are just the tip of the iceberg. The video also briefly mentions three other costs.
2. The budgetary burden of the IRS, which is a staggering $12.5 billion. This is the money we spend to employ an army of tax bureaucrats that is larger than the CIA and FBI combined.
If you go to the IRS website, there are about one thousand forms (and accompanying material such as instruction documents) that you can download.
Fortunately, most of us only have to worry about a small fraction of what’s on that list, but it’s still a nightmare – and one that gets worse every year because politicians have an endless appetite for manipulating our lives and auctioning off new loopholes for campaign cash.
Just a quick caveat for my friends who prefer the national sales tax. Yes, that system also would be a vast improvement. But since the Fair Tax or something like that would require a constitutional amendment to ensure that politicians couldn’t impose both a sales tax and income tax, that’s more of a long-term project.
This was an opportunity for some narcissistic reminiscing, beginning with my first appearance in 1990 (which I shared with a friend, who laughed at my “Justin Bieber haircut”).
I spoke at the Tea Party Patriots convention earlier today. Great people, great crowd.
My job was to debate on the side of the flat tax over the fair tax. Several people asked for more information, and I promised to put this video on the blog. Long-time readers probably will have seen it before, but it’s always good to be reminded why we need tax reform – and also reminded why we can’t trust politicians with a new source of revenue.
In the past 15 years, I’ve debated in favor of a national sales tax, testified before Congress on the merits of a national sales tax, gone on TV to advocate for the national sales tax, and spoken with dozens of reporters to explain why the national sales tax is a good idea. Even though I prefer the flat tax, I’ve been an ardent defender of sales tax proposals such as the FAIR tax because it would be a great idea to replace the current system with any low-rate system that gets rid of the tax bias against saving and investment. I even narrated this video explaining that a national sales tax and flat tax are different sides of the same coin – and therefore either tax reform proposal would significantly improve prosperity and competitiveness.
I will continue to defend the FAIR tax and other national sales tax proposals that replace the income tax, but I wonder whether this is a losing battle. Every election cycle, candidates that endorse (or even say nice things about) the FAIR tax wind up getting attacked and put on the defensive. Their opponents are being dishonest, and their TV ads are grossly misleading, but they are using this approach because the anti-FAIR tax message is politically effective. Many pro-tax reform candidates have lost elections in favorable states and districts, largely because their opponents were able to successfully demagogue against a national sales tax.
The Wall Street Journal reaches the same conclusion, opining this morning about the false – but effective – campaign against candidates who support a national sales tax.
In 16 House and three Senate races so far, Democrats have blasted GOP candidates for at one point or another voicing an interest in the FAIR tax. …FAIR tax proponents are right to say these Democratic attacks are unfair and don’t mention the tax-cutting side of the proposal, but the attacks do seem to work. Mr. Paul’s lead in Kentucky fell after the assault, and the issue has hurt GOP candidate Ken Buck in a close Colorado Senate race. In a special House election earlier this year in Pennsylvania, Democrat Mark Critz used the FAIR tax cudgel on Republican opponent Tim Burns. In a district that John McCain carried in 2008, Mr. Critz beat the Republican by eight points and is using the issue again in their rematch. This is a political reality that FAIR taxers need to face. …in theory a consumption tax like the FAIR tax is preferable to an income tax because it doesn’t punish the savings and investment that drive economic growth. If we were designing a tax code from scratch, the FAIR tax would be one consumption tax option worth debating. But…voters rightly suspect that any new sales tax scheme will merely be piled on the current code.
We won’t know until next Tuesday what is going to happen in Kentucky and Colorado, and we won’t know until then what will happen in the other campaigns where the FAIR tax is an issue. But if there are two tax reform plans that achieve the same objective, why pick the approach that faces greater political obstacles?
FAIR tax proponents presumably could defuse some of the attacks by refocusing their efforts so that repealing the income tax is the top priority. This would not require any heavy lifting since all honest proponents of a national sales tax want to get rid of the 16th Amendment and replace it with something that unambiguously prohibits any direct tax on income. So why not lead with that initiative, and have the national sales tax as a secondary proposal? This is what I propose in the video, and I think it would be much harder for demagogues to imply that a FAIR tax would mean a new tax on top of the corrupt system that already exists.
After my recent post on “bashing the IRS,” I got several emails and comments asking whether a national sales tax might be a better idea than the flat tax. I’m a big fan of proposals such as the Fair Tax. I’ve debated in favor of the national sales tax, done media interviews in favor of the national sales tax, written in favor of the national sales tax, and even defended the national sales tax in congressional testimony. As far as I’m concerned, we should junk the IRS for some type of single-rate, consumption-base (meaning no double taxation), loophole-free system. The flat tax is the most well-know approach for achieving these goals, but the national sales tax also would work. Indeed, the two plans are different sides of the same coin. A sales tax takes a piece of your income (but only one time and at one low rate) when it is spent, and a flat tax grabs a slice of your income (but only one time and at one low rate) when it is earned.
So why, then, do I devote most of my energies to a sales flat tax? The answer is that I don’t trust politicians. I fear that they will pull a bait-and-switch, and implement something like a Fair Tax but never complete the deal by getting rid of the income tax. The European experience certainly serves as a warning. Nations across Europe began implementing their version of a national sales tax (the value-added tax) in the late 1960s. Voters often were told that other taxes would be eliminated or reduced. But all the evidence shows that VATs simply led to a much higher tax burden and a much bigger burden of government.
By the way, some fans of the Fair Tax say the solution to this problem is an amendment to the Constitution. I fully agree, but then I point out that there are not even enough votes to approve a watered-down balanced budget amendment, so that seems an unlikely path to success. That being said, if we ever reach this point, and are able to repeal the 16th Amendment and replace it with something that unambiguously would stop the politicians from ever burdening America with an income tax, I will gladly offer my support and push a national sales tax
I have a question for my friends who support a national sales tax. First, some background. Beginning with the defeat of Woody Jenkins in his Louisiana Senate race back in the 1990s, various versions of the national sales tax have caused political headaches for GOP candidates. Even candidates from conservative states, such as Sen. DeMint in South Carolina, have been put on the defensive because they said good things about the FairTax. The latest example comes from the Pennsylvania special election for Rep. Murtha’s seat. As this Wall Street Journal column points out, the winning Democratic candidate hammered the Republican because of his support for the FairTax. So even though I have said very nice things about a national sales tax, testified about the virtues of the national sales tax, and debated in favor of a national sales tax over the current system, I am increasingly convinced that the flat tax is the only plan that is sufficiently immune to demagoguery. Can anyone give me a persuasive argument about the political viability of the FairTax?
Democrats turned the table and ran against Mr. Burns on taxes. The GOP businessman had flirted in the past with supporting the FAIR tax, a version of a national sales tax that supporters want to replace the income tax. Mr. Critz’s ads blasted Mr. Burns for supporting a 23% sales tax increase without mentioning the income tax elimination, and the GOP seems to have been caught flat-footed. Republicans can rightly complain that this is unfair and that Mr. Critz will vote to raise taxes when Mrs. Pelosi gives the order. But they need a real-time campaign answer to the tax-hike charge. Whatever the merits of the FAIR tax in theory, we’ve long thought it is a political loser because voters figure they’ll get the sales tax without losing the income tax. At a minimum, FAIR tax supporters shouldn’t have left Mr. Burns defenseless on the subject. By the way, this is also a political warning to Republicans inclined to fall for the Democratic trap of agreeing to a new value-added tax in return for lower income-tax rates.
I only vaguely remember this debate that took place at Furman University, and I never saw this recording until it arrived in my inbox today. I invite fans of both the flat tax and FairTax to watch this debate and let me know your thoughts.
Many of my arguments, by the way, also apply to the debate on the value-added tax. Simply stated, I don’t trust politicians when they claim a VAT won’t be used to increase the overall burden of government.
Gloominess and despair are not uncommon traits among supporters of limited government – and with good reason. Government has grown rapidly in recent years and it is expected to get much bigger in the future. To make matters worse, it seems that the deck is stacked against reforms to restrain government. One problem is that 47 percent of Americans are exempt from paying income taxes, which presumably means they no longer have any incentive to resist big government. Mark Steyn recently wrote a very depressing column for National Review Online about this phenomenon, noting that, “By 2012, America could be holding the first federal election in which a majority of the population will be able to vote themselves more government lollipops paid for by the ever shrinking minority of the population still dumb enough to be net contributors to the federal treasury.” Walter Williams, meanwhile, has a new column speculating on whether this cripples the battle for freedom:
According to the Tax Policy Center, a Washington, D.C., research organization, nearly half of U.S. households will pay no federal income taxes for 2009…because their incomes are too low or they have higher income but credits, deductions and exemptions that relieve them of tax liability. This lack of income tax liability stands in stark contrast to the top 10 percent of earners, those households earning an average of $366,400 in 2006, who paid about 73 percent of federal income taxes. …Let’s not dwell on the fairness of such an arrangement for financing the activities of the federal government. Instead, let’s ask what kind of incentives and results such an arrangement produces and ask ourselves whether these results are good for our country. …Having 121 million Americans completely outside the federal income tax system, it’s like throwing chum to political sharks. These Americans become a natural spending constituency for big-spending politicians. After all, if you have no income tax liability, how much do you care about deficits, how much Congress spends and the level of taxation?
Steyn and Williams are right to worry, but the situation is not as grim as it seems for the simple reason that a good portion of the American people know the difference between right and wrong. Consider some of the recent polling data from Rasmussen, which found that “Sixty-six percent (66%) believe that America is overtaxed. Only 25% disagree. Lower income voters are more likely than others to believe the nation is overtaxed” and “75% of voters nationwide say the average American should pay no more than 20% of their income in taxes.” These numbers contradict the hypothesis that 47 percent of Americans (those that don’t pay income tax) are automatic supporters of class-warfare policy.
So why are the supposed free-riders not signing on to the Obama-Reid-Pelosi agenda? There are probably several reasons, including the fact that many Americans believe in upward mobility, so even if their incomes currently are too low to pay income tax, they aspire to earn more in the future and don’t want higher tax rates on the rich to serve as a barrier. I’m not a polling expert, but I also suspect there’s a moral component to these numbers. There’s no way to prove this assertion, but I am quite sure that the vast majority of hard-working Americans with modest incomes would never even contemplate breaking into a rich neighbor’s house and stealing the family jewelry. So it is perfectly logical that they wouldn’t support using the IRS as a middleman to do the same thing.
A few final tax observations:
The hostility to taxation also represents opposition to big government (at least in theory). Rasumssen also recently found that, “Just 23% of U.S. voters say they prefer a more active government with more services and higher taxes over one with fewer services and lower taxes. …Two-thirds (66%) of voters prefer a government with fewer services and lower taxes.”
There is a giant divide between the political elite and ordinary Americans. Rasmussen’s polling revealed that, “Eighty-one percent (81%) of Mainstream American voters believe the nation is overtaxed, while 74% of those in the Political Class disagree.”
Voters do not want a value-added tax or any other form of national sales tax. They are not against the idea as a theoretical concept, but they wisely recognize the politicians are greedy and untrustworthy. Rasumussen found that “just 26% of all voters think that it is even somewhat likely the government would cut income taxes after implementing a sales tax. Sixty-six percent (66%) believe it’s unlikely to happen.”
Fiscal restraint is a necessary precondition for any pro-growth tax reform. If given a choice between a flat tax, national sales tax, value-added tax, or the current system, many Americans want reform, but it is very difficult to have a good tax system if the burden of government spending is rising. Likewise, it would be very easy to have a good tax system if we had a federal government that was limited to the duties outlined in Article I, Section VIII, of the Constitution.
Republicans should never acquiesce to higher taxes. All these good numbers and optimistic findings are dependent on voters facing a clear choice between higher taxes and bigger government vs lower taxes and limited government. If Republicans inside the beltway get seduced into a “budget summit” where taxes are “on the table,” that creates a very unhealthy dynamic where voters instinctively try to protect themselves by supporting taxes on somebody else – and the so-called rich are the easiest target.
Last but not least, I can’t resist pointing out that I am part of a debate for U.S. News & World Report on the flat tax vs. the current system. For those of you who have an opinion on this matter, don’t hesitate to cast a vote.
America’s biggest fiscal challenge is excessive government spending. The public sector is far too large today and it is projected to get much bigger in coming decades. But the corrupt and punitive internal revenue code is second on the list of fiscal problems. This new video, narrated by yours truly and produced by the Center for Freedom and Prosperity, explains how a flat tax would work and why it would promote growth and fairness.
There are two big hurdles that must be overcome to achieve tax reform. The first obstacle is that the class-warfare crowd wants the tax code to penalize success with high tax rates. That issue is addressed in the video in a couple of ways. I explain that fairness should be defined as treating all people equally, and I also point out that upper-income taxpayers are far more likely to benefit from all the deductions, credits, exemptions, preferences, and other loopholes in the tax code. The second obstacle, which is more of an inside-the-beltway issue, is that the current tax system is very rewarding for the iron triangle of lobbyists, politicians, and bureaucrats (or maybe iron rectangle if we include the tax preparation industry). There are tens of thousands of people who make very generous salaries precisely because the tax code is a playground for corrupt deal making. A flat tax for these folks would be like kryptonite for Superman. But more than two dozen nations around the world have implemented a flat tax, so hope springs eternal.
Here are a few stories to bring holiday cheer for taxpayers. First, we have an Associated Press report that several hundred thousand federal bureaucrats have serious tax delinquencies. The Department of Housing and Urban Development always ranks high on the list of government entities that should be abolished, so it’s interesting to see that HUD bureaucrats are most likely to be dodging their taxes:
More than 276,000 federal employees and retirees owed back income taxes as of Sept. 30, 2008, according to data from the Internal Revenue Service. The $3.04 billion owed was up from $2.7 billion owed by federal employees and retirees in 2007. Among cabinet agencies, the Department of Housing and Urban Development had the highest delinquency rate, at just over 4 percent.
This rampant nonpayment is especially outrageous since federal bureaucrats “earn” twice as much compensation, on average, as those of us laboring in the productive sector of the economy. One might think they would go out of their way to comply since their bloated salaries come from tax collections. Speaking of outrage, the internal watchdogs at the Treasury have just published a report showing that it is almost impossible to verify eligibility for the special interest tax breaks in the so-called stimulus. As Investor’s Business Daily opines, this is an invitation to fraud:
A new report from the Treasury Department’s Inspector General for Tax Administration counts 56 tax provisions in the bill having a potential cost of $325 billion. Of those, 20 are tax breaks for individuals and 36 are for businesses. The problem, the Inspector General says, is the IRS can’t verify taxpayer eligibility “for the majority of Recovery Act tax benefits and credits.” For individual taxpayers, 13 of the 20 benefits and credits can’t be verified; for businesses, it’s 26 of 36. …To suggest, as Treasury does, that the biggest chunk of the $325 billion in stimulus package tax breaks can’t be adequately followed violates the pledges of openness and fairness made when the stimulus was passed last February. As the government-stimulus-oversight Web site, recovery.gov, notes, last year’s package “requires that taxpayer dollars spent under the Act be subject to unprecedented accountability.” We wouldn’t call being unable to verify upwards of two-thirds of the $325 billion handed out as “unprecedented accountability.” Sounds more like an invitation to fraud, all at the expense of the taxpayers.
To be fair, even a competent government agency might have trouble making a bad law work, and the $787 boondoggle was rushed through the legislative process with very little – if any – attention paid to anything other than funneling other people’s money to special interest groups. That being said, the IRS has trouble even with routine tasks. According to another IG report, the agency has a staggering 70 percent error rate in its processing of taxpayer identification numbers for individual taxpayers:
The Treasury Inspector General for Tax Administration (TIGTA) today publicly released its review of the IRS’s processing of applications for Individual Taxpayer Identification Numbers (ITINs). TIGTA reviewed a sample of ITIN applications and found that almost 70% contained significant errors and/or raised concerns that should have prevented the issuance of an ITIN. The IRS estimates that it has issued more than 14 million ITINs as of December 2008. ITINs are intended to provide tax identification numbers to resident and nonresident alien individuals who may have U.S. tax reporting or filing obligations but do not qualify for Social Security Numbers, which generally are only issued to U.S. citizens and individuals legally admitted to the U.S. …”The number of individual income tax returns filed using ITINs and reporting wage income has increased by 247 percent from 2001 to 2008,” commented J. Russell George, the Treasury Inspector General for Tax Administration. “If the IRS continues to issue ITINs without proper verification, the risk of fraudulently filed returns – along with fraudulently claimed refunds – will continue to rise,” added Inspector General George.
Just think how much fun it will be when the IRS is in charge of determining those of us who should get fined or jailed for noncompliance with government-run healthcare! No wonder so many taxpayers put a flat tax or national sales tax on their Christmas lists.
Using the jargon of public-finance economists, both the flat tax and national sales tax are “consumption base” systems.…The Fair Tax is based on the reasonable theory that levies on consumption distort the economy less than our current taxes on work and investment. Killing the income tax also sounds good until you realize that a future Congress could restore it if the Constitution’s 16th Amendment isn’t repealed. …The point is that a consumption tax might make sense if Congress were writing the tax code from scratch. But it isn’t, and we could end up with both a national income and sales tax, the later of which could evolve over time into a value-added tax. …the Fair Tax has hurt GOP candidates before. When tea party Republicans ran on the idea in 2010, Democratic groups ran ads that blasted the sales tax… Few voters listen to a second sentence after they hear about a 30% tax on everything they buy.
instituting a large new wealth tax on senior citizens; increasing federal spending by a massive amount; increasing the deficit; and creating large black markets. …FairTax supporters have answers for most of these charges. They are not…persuasive answers. But even if they were right, Republicans who vote for the bill would be taking on a formidable amount of defensive work. Those in competitive seats, especially, should know what they are getting themselves into.
…Under the bill’s plan, all households would receive a monthly check from the federal government regardless of earned income. …In all but name, in fact, the Fair Tax’s “prebate” system would establish a universal basic income, one of the left’s favorite policies. …Fair Tax proponents make two good points. They understand the need to end the double taxation of savings and investment in the present system, and they want to depoliticize the IRS workforce… None of this has stopped Democrats from seizing the opportunity to claim that Republicans now want to raise taxes on the poor and middle class. …the Fair Tax Act has a long record of proving politically toxic.
International Liberty 