In recent political debates the idea of a “fair tax” has become popular among independent voters as well as members of both political parties. Why has this form of taxation gained favor and why is it referred to as a “consumption tax?” And is it “fair” or “grossly unfair.”
Several months ago, before the present political campaigns began, the President’s Advisory Panel was held and the infamous Alan Greenspan, the former Federal Reserve Chairman, presented the idea of a consumption tax to replace all or part of the current income tax system.
What is a Consumption Tax?
First, what is a consumption tax?
With a consumption tax, money is taxed when it is spent (similar to a sales tax), instead of when it is earn (such as a net income tax.) Greenspan argues that “many economists believe that a consumption tax would be best from the perspective of promoting economic growth…because it is likely to encourage saving and capital formation.”
For a moment, let us logically analyze this form of tax. Assume we have a proposed 23% national sales tax (this is a consumption tax on gross purchases as it has been proposed in Congress (H.R.25). This would be in addition our local regular 8% sales tax, resulting in a total tax of 31%.
This federal 23% national sales rate will be applied on items presently charged a sales tax in addition to services, homes purchases, prescription drugs and health care, and eventually everything else. Obviously, with the number of lobbyists in Washington, there probably will be some exceptions to this tax and some items would be probably excluded.
The benefits projected are the following:
1) There will be no income tax, corporate tax, estate tax, gift tax, and payroll tax. And of course, the poor people who fall below the poverty level will be getting some kind of a rebate from this national tax paid, similar to our present earned income tax credit.
2) It is easy to implement and collect the money.
3) We eliminate the dreaded Internal Revenue Service.
Now this all sounds great in theory, except there are several logical reasons why the “fair or consumption” tax would have problems and one gigantic reason why a disaster could result. It was amazing to me that Greenspan never mentioned these negative aspects at the hearing.
What are the Problems with the Fair (Consumption) Tax?
Naturally, you should ask the question what are the potential problems with a consumption tax for it may not be very fair at all.
First, you don’t need to be a rocket scientist to understand that 31% tax on gross consumption is huge in anyone’s books.
It is interesting to note that 90% of all taxpayers in the United States pay none or very little in income tax. That is, 10% of individuals pay 90% of the income tax generated by individuals. Corporations, other entities and governmental fees collected pay the rest.
To illustrate, let’s put some figures to the theory. If you are a family of three making $50,000 and are spending $45,000 on the necessities of life, liberty and the pursuit of happiness, you will probably have paid $14,000 in sales taxes under the consumption tax program.
In comparison, under our present complicated income tax system, you would have paid: $3,825 in payroll taxes, $3,000 in income taxes after deducting itemized deductions and personal exemptions, and another $2,000 to $3,000 on sales and other types of taxes. That amounts to an estimate of $9,825. However, if you were a client of Waite and Associates, Certified Public Accountants, we probably would have reduced this amount down to $6,000 because of deductions you missed.
Now, with this new fairer consumption tax, your overall tax burden has been increased by $4,175 ($14,000-$9,825) or even greater. That should make your life less complicated because the IRS would not be around to bother you any more and you would have probably saved $350 on your tax preparation bill.
Second, you should always know that any gross tax is regressive economically. What does this mean? It works against what you want to accomplish?
For example, the inequities that exist among people and businesses are vast. For example, the grocery store, if it is well managed, makes about a net profit of 1%, whereas the Microsoft and IBM companies of the world make 20% to 35% net profits on gross sales. If you tax the low margin companies based upon their gross sales, you will have destroyed their bottom line—that is, the net profits are not large enough to even cover the consumption tax let alone returning any profits to it stockholders. Under the consumption tax program and in order to stay in business, all companies would have to increase the prices of their goods and services. And what do you think that impact would have on our economy. That is right--it would send prices through the roof.
The laws of market supply and demand are the same as gravity as to their effectiveness. If your demand for goods and services are reduced because of the cost of taxes are increased, then the supply has to be reduced to equalize and balance the demand. If the supplies are reduced, jobs need to be reduced. If jobs are reduced, there is less income in the system to buy the goods in the first place, and if there is less income then companies make less and the downward cycle continues.
The National Retail Federation (NRF) estimated that the implementation of a national sales tax would result in a three-year slump in the economy, a four-your decline in employment, and an eight-year decline in consumer spending. (I would think these figures are overly conservative.) Steve Pfister, the NRF’s senior vice president for government relations, logically stated,
“Consumers would simply stop spending on anything but the barest necessities for a prolonged period of time,”
Bartering would take over and the tendency to cheat would be great.
Also the tendency to increase taxes from a government standpoint would be great when we are only dealing with one type of tax. Michael J. Boskin, a senior fellow at the Hoover Institution think tank and a professor of economics at Stanford, (who is in favor of a consumption tax), agrees that a national sales tax would be used as a tool for expanding spending rather than replacing the income tax.
That’s what we need in America, a built-in incentive for governments on the federal and state levels vying to increase taxes collected so that more government programs can be implemented. Is this smart?
But Why Would the Consumption Tax Be a Disaster?
Mr. Boskin continues his sales pitch for the consumption tax by saying:
“If it could completely replace the corporate and personal income tax, a national retail sales tax probably in the end would be the simplest to administer and do the best job at getting at the underground economy.”
The “underground economy” is where the consumption tax would create a disaster.
Again, think logically with me for a moment. What do you think organized crime will do when their retail operations get an additional 23% of trillions of dollars in there hands? Would there be ways to mask that income so that it would not be paid to the government? All they would have to do is keep every sixth cash transaction in their pocket and billions will be made? What about the little guy who is not apart of the organized crime scene, and he keeps every ninth transaction for his pocket to pay his bills? This is an easy non-traceable crime to commit. How much money would be lost?
In a recent news article, it was estimated that one quarter of a trillion dollars is lost in one year to theft in Europe’s national sales tax program. That is billions that are lost. In United States, such a program would probably lose a couple of trillion because of theft. Why?
Do you know how difficult it is to audit the cash transactions not reported in a retail store? There are thousands of state auditors that are already over loaded with audits and they are lucky to find a tenth of the missing sales tax receipts. Magnify this by a billion fold, and you have a classic case for disaster. And how many more auditors do you need to audit the mess? Probably, that number would be the same number of IRS auditors you just fired under the old system of taxation.
Why Fight For the Existing Tax System?
I am not fighting for the existing tax system. I believe as you do, the system is too complex and too compulsive, and very unfair in so many areas. The poor pay nothing, the rich pay everything and the system is geared to reward welfare thinking. Sadly, it is the best we have at the present time, but it sure beats the alternatives that are on the plate.
Perhaps our tax system does need to be blown up and then start all over again. Unfortunately, if we were to do that, we would have the same system in a few years because we have the same political system that caused it in the first place. When you place hundreds of newly elected representatives in Congress ever few years, they need to justify why they are there. Since there are equities in our society, there will be equities in our taxation system. Our taxation system is too often used to promote social change, not economic balance. And therein lays the inequities and complexities.
We Certified Public Accountants (CPA) have been accused of wanting to keep this present system of taxation to protect our jobs. Any successful CPA in America will agree with me that the tax system is too complex and difficult to stay current with new laws. Most CPAs in America make their money by being financial and business advisors to clients and maintaining their accounting systems, not just tax preparation.
In Summary:
Any way you cut it, the consumption tax is dangerous. Its implementation would take years to complete or you would have a major depression on your hands. Most proponents of the consumption tax admit that it must either be implemented immediately or it will not work.
The alternative of our present tax system is not good either, but it does work without destroying the economy. A fairer tax as to simplicity would be a simple flat tax, but Congress would still want to tinker with it to make it more pliable to their constituents. And there lays the same old complexity.
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