QandO

July 26, 2004

More on Taxation, complete with a shameless plug
Posted by Dale Franks

Reader John F. observes in the comments to my earlier post:

What you say makes a lot of sense, but the current tax structure still makes it a political playhouse with the deck stacked against the taxpayer. What do you think about the efficacy of either a flat tax or the so-called fair tax, a tax on retail sales, only? Both would seem to simplify the Orwellian tax structure, and would seem to offer a boone to businesses of all stripes.

As it happens, I addressed this in my book, Slackernomics: Basic Economics for People Who Think Economics is Boring:

Under the National Sales Tax (I’ll just call it the NST, because I’m lazy and it’s shorter.), the personal income tax would be totally eliminated. No more Federal Income Tax withheld from your paycheck. No more IRS at all. No more scrambling to the post office on April 15th. The government would no longer have any business at all asking you nosy personal questions like how much money you made, and what you did with it. On the other hand, the price of almost everything in the country would rise by 20%.

Obviously, under the NST, poor people would be hit hard, unless a provision was made to exclude staple items like food, clothing, and shelter from the tax. Poor people spend a much larger percentage of their incomes just acquiring these basics.

Taxes that burden lower income earners more than they burden high wage earners are called regressive taxes. Taxes that place a proportionally higher burden on the richer members of society are called progressive taxes.

Assuming that the NST would exempt staple items and become more progressive (The "Fair Tax" has many of these exemptions to increase its progressivity), it might be a very effective tax for several reasons.

First, under the income tax code, the rich tend to pay less than their nominal tax rate, because they have the ability to shelter income in ways that many poorer people do not. They also tend to buy many more things, because they have the money to do so. The NST, by taxing consumption instead of income, would not allow them to avoid taxes in the same way the income tax does.

Second, there is a small but significant portion of the population that makes its living in, well, shady ways. Their income is never taxed, because they do not report it. The transactions that are not reported to the government, and incomes derived from those transactions, are said to be the underground economy or black market. The current estimates are that the underground economy is generating income that could be worth hundreds of billions of dollars in revenues. Many of these underground transactions are made in cash, though, and are difficult to trace, so it’s hard to tell what the actual size of the black market is. But if we assume that the US has a $10 trillion economy, and 10% of that is hidden payments for cocaine and hookers—or doing plumbing or construction work “under the table”—that’s an extra $1 trillion floating around out there that would be good for $200 to $300 billion in government revenues.

I want to stress here that I certainly have no personal knowledge whatsoever about any black market dealings of any kind.

The people who work in the underground economy do not pay income tax, but they buy goods and services like the rest of us. Under the NST, those goods and services would be taxed, and revenues would be increased.

Additionally, there is a generally accepted economic rule that says if you tax something, you get less of it. The income tax—and the proposed Flat Tax—taxes production. The NST taxes consumption. If your goal is to reduce consumption and increase savings, while at the same time removing the burden on production, then the NST is probably the best way to do this.

Under the NST, people who get raises or who get new, higher paying jobs actually get to take home that extra money, instead of having it eaten away by being put into a higher income tax bracket. This increases the incentive to earn more by producing more. At the same time, higher prices tend to make people consume less, freeing up more money for savings, which, in turn, can be invested.

On the whole, I prefer an NST. Not only for economic reasons, which I find compelling, but also for philosophical ones that I find even more compelling.

The main problem with a personal income tax is that it allows the government too much power over the individual. It requires that I report, under penalty of law, the exact amount of my income from all sources. If I take anything other than the standard exemption, I must give the government an increasingly detailed view of my personal finances.

That, frankly, is none of the government's business.

Equally disturbing is that the income tax allows the government to pick and choose between favored groups or desired social outcomes by alterations of the tax code. Large businesses that are able to spend money on lobbyists can collect all sorts of tax breaks and loopholes through manipulation of the tax code.

Politicians seem completely unable to resist monkeying with the tax code to produce politically desired social or financial outcomes. As a result, the tax code is a compendium of special interest tax breaks, arcane finance rules, and an impentrable mass of regulations. Call the IRS two separate times asking the same question about the same tax problem, and the chances are, you'll get two different answers.

As a result, it is almost impossible to fill out a moderately complicated tax return without violating some arcane tax provision that government can use, if they desire to do so, to bring you to heel. In my view, the personal income tax is a potential tool of tyranny.

I am far more comfortable with the NST. It immediately liberates the citizenry from any personal financial oversight from the government, which automatically makes it more conducive to personal liberty. The need for citizens to obtain accountants, tax attorneys, or the services of H&R Block would be completely eliminated. More importantly, the temptation to call down audits upon unpopular government critics would be ended completely.

Moreover, it completely--or, at the very least, substatially--eliminates the government's ability to use the tax code to produce political or social results desirable to the government.

Needless to say, such a tax system would also substantially reduce the size of the IRS, hence, the size of the federal government as a whole.

So, count me as a big NST supporter.

UPDATE (McQ): There is a NST movement out there which can be found at this link (FairTax.org). If you're interested take a look. From the website:

Simply put, the FairTax replaces the way we're currently taxed - based on our annual income - with a tax on goods and services. The FairTax is a voluntary “consumption" tax: the more you buy, the more you pay in taxes, the less you buy, the less you pay in taxes.

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