Part three of an exclusive three-part series of excerpts.
The flat tax is not the only solution that has been proposed to address the problem of our monstrous federal income tax code. Another proposal under discussion is the national retail sales tax (NRST). The NRST would be a consumption tax levied at the national level. One variation that has gained a lot of support in Congress is a 30 percent tax on most consumer purchases of goods and services.
The flat tax is a better idea than the NRST for a multiplicity of reasons we will get to shortly. But it should be stressed that supporters of a sales tax have their hearts in the right place — they rightfully believe that what we have today is an abomination, that we are overtaxed and that we are all subject to abuse from the IRS. A sales tax would be infinitely preferable to the current monstrosity. I believe, though, the flat tax is preferable, not least because it could more easily, readily be enacted than a national sales tax: Before a sales tax is put in place, we must first repeal the Sixteenth Amendment to the Constitution, which allows Washington to impose the income tax. Otherwise we will end up with the situation that exists in most states — and indeed in most other countries — and that is both an income tax and a sales tax (or in other countries the Value Added Tax).
First, a little background.
The national retail sales tax is intended to replace personal and corporate income taxes as well as payroll taxes, capital gains levies, and estate and gift taxes. It would be collected on the sale of new goods and services and exempt from all transactions of used items. Business-to-business purchases would also be exempt from taxation. Potential snags are immediately obvious: What is the definition of new? What constitutes a business? Let’s say you sell stuff on eBay; one can imagine people justifying a sales-tax exemption on a slew of items that may or may not really qualify.
The national sales tax plan calls for a refund from Washington for all taxpayers. This refund would be issued each month to offset the tax levied on necessities such as food, clothing, and shelter.
The official poverty level for a family of four is $18,850; the rebate — if this family included a married couple — would be $479 a month or $5,745 a year (see below).
Advocates of the plan say that it would be a progressive tax because it is based on how much a person actually spent. On the surface, a sales tax can look appealing. It employs some of the same principles that make the flat tax work. It does not create unnecessary and distorted incentives for certain segments of the economy. It treats savings and investment neutrally.
But, alas, the concept presents numerous challenges: A national retail sales tax will raise the price of many goods and services. The price of non-exempt goods and services purchased at retail would increase 30 percent. Partisans reply that such hikes would be overcome by people having higher take-home pay — no more deductions for incomes taxes or FICA taxes. They also insist that the sales tax would sufficiently lower the cost of most goods and services over the long term, so that the 30 percent surcharge would not be noticeable.
According to their reasoning, companies no longer liable for income and federal payroll taxes would have lower costs and could charge less. So they say, the sales tax would not mean massive price increases. Really? We have to admit we’re skeptical. Have you ever heard of a tax — one that’s, in effect, a surcharge — making a product less expensive? Even if sales tax advocates are right, such adjustments take time. Many people may find it hard to believe that employers will raise employee salaries after being freed from having to pay payroll taxes.
Competition may make some of it happen. But in the meantime, most people won’t believe such a thing will come to pass.
People may also express a similar uncertainty about some features of the flat tax, such as how it will enable taxpayers to come out ahead after losing various deductions. But the difference is that, under that plan, people will have a choice: stick with the old system or try the new.
Choice is not an option under a national sales tax system.
Steve Forbes is the author of “Flat Tax Revolution.” The excerpts are from that book.