Should the U.S. Institute a National Sales Tax (or Similar Taxes Such as the "Value-Added Tax" or "Fair Tax") to Replace the Income Tax?
Overview/BackgroundIt is estimated that the cost to Americans of complying with our incredibly complex system is over $200 billion per year as well as over 7 billion hours of time (Source: The Tax Foundation ). Many complain that our tax system punishes hard work, investment, and success while encouraging consumption. With out-of-control government debt and deficits, one of the ideas currently being considered is a national sales tax, or " Fair Tax ". A similar tax called the " value-added tax " hits businesses at each stage of production, which ultimately hits the consumer through increased prices of goods and services. In other words, you would be able to keep your employment earnings but would have to pay an additional amount whenever you buy something (e.g. 15 or 20 percent tax). A compromise system would likely tax consumer items at different rates with complete exemptions for necessities such as food. This is a debate of the merits of a sales-tax system over an income tax system.
A national sales tax discourages consumption, leading to a conservation of resources.
One of the biggest complaints other countries around the world have about the U.S. is that we consume more than
25 percent of the world's resources despite comprising less than 4 percent of the population. Especially when it
comes to scarce, non-renewable resources such as oil, few people would argue that we need to cut wasteful
consumption. The basic economic law of supply & demand says that as prices go up for an item, demand will go
down. Thus, as a society, our national consumption should decrease with a national sales tax.
The removal of an income tax encourages saving and investing, which is the key to job growth.
The national savings rate is currently a putrid 4 percent of income. When Americans increase saving & investing,
interest rates go down and the economy expands since banks and corporations have more
invest in new projects, new stores, new businesses, etc. A national sales tax would encourage increased saving &
investing for two reasons: 1) Earnings from investments wouldn't be taxed; thus, the effective rate of return would
increase; 2) Americans are never taxed unless they spend money, which they would have to do on much more
expensive consumer goods; thus, they have extra incentive to refrain from frivolous
Individuals would have an extra incentive to work hard and earn income, leading to a far more productive nation.
Our tax system is completely backwards when you consider the fact that the majority of government revenues come
from tax on our earned income. National employment drives the productivity of the country. Since we tax personal
incomes, we are actually punishing people for working. What's worse is that we have a "progressive"
tax system, meaning rates go up as you make more. This in effect punishes the most successful and the hardest workers.
Corporations, which provide the greatest amount of national jobs, are even taxed twice: once at the corporate level
plus a second time when earnings are distributed to shareholders. If you take away the income tax, you give every
worker in America a raise (except those that don't pay an income tax),
which encourages citizens to work more hours. Think about it, if your take-home pay was
$20 per hour instead of $14 per hour, would you be willing to work more hours?
A sales tax would be a much simpler system, eliminating the need for individuals to comply with
complex tax reporting requirements and freeing up all the money & time lost on the income tax process.
Hundreds of billions of dollars are spent every year and billions of hours wasted complying with the incredibly
complex American income tax system. Replacing the income tax with a national sales tax would free up all the
resources necessary to fulfill those tax requirements. Only businesses that sell goods would be required to
file federal tax returns, and the system would be much simpler since they would only have to multiply each sale by the
specified rate. As a nation, we would no longer have to waste time & money figuring out depreciation recapture,
itemized deduction phase-outs, alternative minimum taxes, charitable deduction caps, and so on. Think about how
happy the environmentalists will be when they hear about all the trees that will be saved from the elimination
of all those tax forms & schedules!
Tax rates can be targeted to encourage or discourage the consumption of certain items.
A national sales tax doesn't mean one standard rate for every consumer good sold in the country. We can
customize the rates to help the poor provide for basic necessities as well as discourage or encourage
the consumption of certain items. For example, food and lower-priced clothing could be tax-free. Gasoline, cigarettes,
fast food, alcohol, and fuel-guzzling automobiles could face steep tax rates. Hydrogen & electric-powered cars,
equipment used in a business, and home improvement material could be given minimal tax rates. Get the picture?
Once again, the economic law of supply & demand will increase/decrease consumption of particular items.
Consumer prices of certain items would fall since labor and tax compliance costs would be cheaper to businesses.
Every cent that goes into producing a product or service is reflected in it's price. For example, if a law firm
pays a clerk $25 per hour to service a client, it must charge the client at least that much to avoid losing money.
Any business will usually add a certain markup to ensure an adequate profit for the effort and risk. Thus, if you
cut the underlying cost, you cut the final price charged to consumers. Elimination of the income tax means a
reduction in payroll taxes for businesses as well as the elimination of the need for much of the human resource &
payroll departments. Consequently, the cost of offering related products & services
It would allow a greater collection of tax money from those carrying out illegal transactions, since their income
is hid from the income tax system but will be taxed when they spend it in a sales tax.
Drug dealers, prostitutes, black market dealers, and bookies are examples of people who earn income illegally. Since
these and others engaging in illegal transactions obviously don't want the government to know about their
activities, the income generated won't be reported on income tax returns. Thus, none of that money is subject to
tax. However, with a sales tax, it doesn't matter how money is earned, since the tax is collected immediately
by the seller.
It's a tax system consistent with a free society; i.e. Americans have a choice regarding their taxes,
unlike our current confiscation system.
Our Founding Fathers went to war with England in large part to get
away from a stifling tax system like that which we currently face.
The U.S.A. is supposed to be a free country with little government interference. However, in our current tax system,
we must pay a significant portion of our earnings regardless if we use government services or not. Since our income
is taxed and we all have to generate earnings to survive, we don't have a choice. If we institute a national sales
tax, the amount of tax we pay is completely up to the individual. We aren't taxed a penny until we go out and spend.
Thus, a national sales tax is consistent with the very idea and foundation of America.
Many of the most intelligent people in the country have devoted their worklife to understanding a ridiculous tax system; those
accountants & other professionals could be redirected to cutting costs and improving planning, productivity, and profitability.
A Certified Public Accountant typically must go through 5+ years of college and pass a grueling exam. Enrolled Agents must go through
a similarly rigorous training program. You have to be both smart and hard-working to make it through such education. However, the
brilliant, hard-working people that make it through these programs have often tied up their worklife doing tax returns, trying to
make sense of a non-sensical, hodgepodge of laws & regulations. Wouldn't it be great for the productivity and competitiveness of
American companies if we could free them up to work on things that really matter, such as cutting costs, improving efficiency,
integrating technology, and so on? Improved productivity means a greater GDP, which leads to far more employment and profits for
Social Security, Medicare, Obamacare, and other government spending has put the federal budget on an unsustainable path, so
we have to try something new before America is totally bankrupt. If the U.S. can't pay its bills, the rest of the world will also be thrown into chaos.
The Federal government is running deficits over a trillion dollars per year; that's an annual increase in debt that's equal to
about half of what we take in for the full year! Think of what it'd be like if a family of four that brought in annual income of $100,000
was spending $150,000 every year and already had $700,000 in debt. How long do you think it'd be before that family could no longer pay
the bills? How long do you think it'd be before banks stopped extending credit to that family? The cost of all the bloated government
programs such as Medicare are simply unsustainable. Now we're adding a behemoth like Obamacare to the top of that. There never seems
to be political will in any of the major parties to cut discretionary spending. Much of the spending can't be reduced because
of contractual commitments. We have no choice but to try something new that will increase government revenues. More or less the
entire world economy is dependent on America. If our economy suffers, it cascades and hits all other countries of the world.
A sales tax is easier to see and track, whereas income & payroll taxes are usually divided among 24+ time periods and partially absorbed by the
employer; most people don't really look at the tax as part of their actual pay, so they take it for granted.
Every time you buy something, you can look at the receipt and know exactly how much you pay. If the sales tax is raised from 8 to 10 percent, you'll be able
to spot the difference immediately the first time you buy a high priced item. For example, if you spend $1000 on a laptop, the tax would be $100, and is
rarely ever listed in the published price. Income and payroll taxes are something most people have paid their entire lives. They barely consider it
part of their real salary since it's always been taken. Since people's annual salary often changes regularly, and since paychecks are normally bi-weekly
or twice per month, it's tough to spot a small change. Thus, government can stealthily increase taxes without most people noticing. Many people don't
realize that your employer pays social security tax & Medicare tax equal to what each employee pays every period. If the government raised the business side
of the tax, most people wouldn't consider it a tax on them. However, this goes into the total cost of employment and will effectively take away a bit
of your next raise.
Eliminating the income tax would lower employment costs for businesses, allowing them to hire more people or reduce prices. Thus,
the net effect of the lower costs + a sales tax would mean total prices are relatively the same as before the change.
When people tack a job, the only part of the pay that really matters to them is the take-home pay. Each person therefore has an acceptable take-home
salary for which they will perform the required services. Assume your actual pay is $50,000, but after taxes, it's $35,000. In other words, you've
agreed to work full-time for annual take-home pay of $35,000. If the income & payroll taxes are eliminated, the employer can now pay you $35,000 to achieve
the same end result. In fact, if they paid you $40,000, they'd save $10,000 and give you a $5000 raise, so both sides would improve!
Businesses can use that cost savings to hire additional people or drop the price of products in order to achieve the same acceptable rate of profit.
Taking the example above, assume you want to buy a sports car that costs $50,000 with the old tax system. After a change to a national sales tax,
the new price would be $35,000 (and if they don't drop prices, competition could eventually take all their business with lower prices). If the national
sales tax was, say, 10%, the tax would be $3,500. So the total cost would be $38,500, as opposed to $50,000 before the tax system change.
A sales tax would be a regressive tax; i.e. low-income individuals would pay a much higher
share of their incomes than wealthy individuals.
Food, housing, clothing, medical attention, and other basic necessities eat up a portion of every American's income.
However, with lower-income individuals, these basic necessities already use up almost all of that income. For
upper-income individuals, they use up only a small percentage of their income. In other words, all of the discretionary
spending of the poor is going to be hit by a national sales tax, but only a small portion is affected for the rich.
Thus, a sales tax would be regressive, meaning the percentage of your income that's eventually taxed is at a much
higher rate for lower-income individuals, who have much less ability to pay, and the rate decreases as your
Our current income tax system forces you to pay a certain percentage of your earnings, and this percentage increases
as you earn more. One of the main benefits of a national sales tax is that the increase in sales tax paid is offset by
a decrease in the income tax paid. However, tens of millions of the working poor currently pay zero income tax
(Remember that the standard deduction, personal exemptions, tax credits, etc. prevent many Americans from
paying anything for federal taxes). In other words, eliminating the income tax provides no benefit at all to those
low-income citizens. Thus, a national sales tax would amount to a net increase in total taxes on the poor.
A national sales tax is a risky system that may not raise near enough money to support all our needs in
defense, education, health care, etc. According to the Congressional Budget Office, our current tax system
brings in over 2 trillion dollars in
revenue per year. On top of that, we're already running a trillion dollar deficit. There is no way to accurately
predict how much revenue a sales tax will generate. There is no way to accurately predict what sales tax rate will
generate the most revenue. What happens if we only generate 500 billion dollars of revenue in the first year? Does
that mean we tolerate 3 trillion dollar annual deficits while we wait for the system to work? Does that mean we
cut vital funding for education, social security, the military, homeland security, etc.? The value of the U.S.
dollar has already plummeted in the last few years. What would happen to it if our economic viability is put in
question? Think about how high interest rates will rise if we're running
3 trillion dollar deficits, along with the
stifling effect it has on our economy. In the middle of a war, with the U.S. economy just beginning to recover, this is
not a good time to be taking such a risky action.
Consumer spending, which drives a thriving economy, would likely drop as people save and invest
more rather than spend.
Would you spend $3000 for a big-screen TV with DVD and surround sound? Maybe, maybe not. How about if the same TV
cost $4000? How about if it cost $5000? It's possible that you may buy the TV even if it's $5000, but there's no
doubt that you are less likely to buy if the price is $5000 than if it's $3000. That's basic economic supply & demand.
Elimination of the income tax would mean that Americans could invest all their money tax-free. Why should they
go out and spend money on unnecessary items when they can accumulate unrestrained wealth by saving? While saving
& investing are definitely a good thing, consumer spending is also necessary to drive economic growth.
For example, if you buy
a car, the automaker makes money, as well as the raw material companies that sell tires, radios, car batteries, etc.
The shareholders of the auto company can then spend their earnings on other items like computers, furniture,
home improvement projects, etc. Consumer spending has a positive chain reaction effect on the economy. A national
sales tax may stifle that. In Japan, the national savings rate is about 25 percent of earnings, yet it has been
in an economic funk for over a decade. This is largely due to the fact it doesn't have potent consumer spending
to add some juice to its economy.
Many incentives built into our tax system (such as education, home ownership, charity, etc.) would be eliminated.
There are numerous incentives in our current tax system that benefit the individual as well as society as a whole.
Education credits provide an incentive for continuing education, leading to a highly-trained population, which is
vital in the technological environment of today. Home ownership, which is rewarded in our tax code, leads to stability,
stronger families, and better maintained property. The list goes on and on. Businesses are given credits for using
renewable energy, for hiring disabled or low-income individuals, and for investing in new equipment. Individuals
are rewarded for giving money to charity, for holding investments long-term, and for setting aside money in
retirement accounts. All those incentives would instantly go down the drain with the elimination of the income tax.
Tens of thousands of attorneys, accountants, and human resource workers would likely lose their jobs due
to the simpler tax system.
Thousands of Americans have trained and devoted their work lives to implementing our current tax system. A national
sales tax would mean all those citizens would likely be out of work
or have to start all over, and their years of training would be wasted.
Real estate values would likely plummet since the tax advantages to ownership would vanish.
The value of any investment is basically determined by two things: 1) its risk, and 2) its rate of return. In fact,
any real estate appraiser or investment analyst will factor these two items into a model that determines the
value. If you eliminate the tax deductions of real estate, you reduce the
annual return produced by the investment. Thus,
the price of all real estate will drop. Think of it this way: if you rent a 3-bedroom house, you may have to pay
$700 per month in rent. However, if you buy that house, the mortgage payment & property taxes would likely
lead to a monthly cost of $1200 or more. So why would people spend that extra money? By far the biggest reason is
that they get to deduct the mortgage interest and property taxes against other income.
"ownership society" philosophy would go right down the tubes with the elimination of the income tax. There would also
be far less incentive for businesses to build more malls, apartment buildings, etc., leading to a further
depressive effect on the economy.
Mortgage and other consumer debt would likely explode since consumers would be forced to finance the taxes also.
It's common knowledge that Americans aren't very disciplined when controlling their spending; the vast majority of citizens
have some kind of debt outstanding. This debt will likely increase since every purchase will reflect a cost for the item
itself plus the additional taxes. For example, if you buy a house for $200,000 and assume a 15 percent tax rate, you'd
have to pay an additional $30,000, which most people would simply have to mortgage. Over a 30 year loan you might end
up paying $60,000 for the taxes after you factor in the interest. The situation is much worse when credit cards come
into the equation since interest rates can be as high as 20 percent.
We would have to come up with another way to raise or set aside funds for social security.
The amount of social security tax collected for each individual is determined by his or her income. If we eliminate
the income tax, how are we supposed to collect the funds for social security? If we continue to require businesses
to collect the tax, we partly eliminate one of the advantages of a national sales tax; that is, reduced complexity.
The transition costs of such a change would be extremely expensive.
Here are some of the changes required with a national sales tax replacement of income tax: the entire
Internal Revenue System would have to be eliminated or reorganized; tax software would have to be re-written; accounting
packages such as QuickBooks & Peachtree would have to be redesigned; accountants, lawyers, payroll clerks, and
human resource workers would have to be retrained or find new employment; a new tax collection auditing system
would have to be created; new tax forms & instructions would have to be created and distributed. I could go on, but
you get the idea. Our current tax system has had almost 100 years to become entrenched. It won't be easy to make
such a drastic change.
Tax evasion and instances of black market purchasing would likely increase.
With our current system, it's relatively easy to track down most individuals who don't pay their taxes. If you
work for an employer, your income is reported to the government. If you invest money with a bank or stock broker,
your income is reported to the government. If you earn large amounts of cash without reporting it, an IRS agent
can audit your bank statements and ask you to explain every deposit. However, for businesses, the process isn't
so easy. Small businesses and independent contractors have by far the highest rate of audit precisely because
it is so easy to hide their income. For example, consider a small bar & grill business. Such a business is almost
entirely cash-based. Assume they take in $4000 for one night of sales. What's to stop that business owner from
pocketing $1000 of the money and telling the government he took in sales of $3000? If you institute a national sales
tax, the entire tax compliance burden shifts to businesses, which are in the best position to cheat. In fact,
a sales tax would add even more incentive to cheat than already exists since the tax is on revenue, not profit. You're also
going to increase the instances of black market purchasing. For example, assume the cost to produce a certain box
of cigars is $1.00 per box, but the tax per box is $9. If you legitimately sell the item at $12 per box, you make
a $2 profit. If you illegally sell the cigars at $6 per box, you make a
$5 per box profit. The incentive
exists to sell illegally since you make more money, plus the incentive also exists to buy illegally since you
only have to pay half the cost. Consequently, an "underground" economy develops. Examples of this type will only
increase with the implementation of a national sales tax.
Consumer prices of many items would go up by a much greater rate than the sales tax rate since raw materials
would also be taxed.
If you put a 10 percent national sales tax on automobiles and one you want normally costs $10,000, it's logical to
assume that the total price including tax will be $11,000. However, it's not that simple. What about the sales
taxes the carmaker must pay on the raw materials that make up the automobile? Is there a tax on the tires?
How about the battery, windshield wipers, glass, spark plugs, CD player, and so on? If there's a tax on each of those
items the cost of the entire car is likely to go up proportionately. Assume the total price of that car now goes
up to $14,000. Now imagine a business like Hertz Rent-a-Car. The cost of its inventory now goes up and consequently,
their rental rates go up. Now all business travelers must pay a higher rental car rate, which will be passed on as
higher prices to the customers they serve. The chain reaction continues. This is only one example. Virtually every
business will be forced to raise prices to cover increased costs. A national sales tax will in effect change the
whole pricing structure of the economy.
Retirees and others who have earned the majority of their life income have already had their money hit with
income tax; thus, they will pay extra sales tax with money already subjected to income tax.
While the reduction or elimination of an income tax will help Americans pay the extra sales tax, it's not going to
help older Americans who have earned the majority of their lifetime income. Many retirees are living on a fixed
income or funds drawn from savings. A decrease in income tax is going to increase the disposable income of
those that are still working, but it won't help those who've already had their income taxed. Consequently, older
Americans will bear an incredibly high burden of the new tax load.
Related LinksReader Comments
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Tax Information Center: National Sales Tax Links
Written by: Joe Messerli
Page Last Updated: 11/04/2011
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