- The Washington Times - Tuesday, May 3, 2005

Columnist Robert Novak says House Majority Leader Tom DeLay, Texas Republican, is adamant about replacing the entire federal tax system — payroll and income taxes — with a 30 percent national retail sales tax (NRST). The tax would be collected by the states, and would be similar to that proposed by H.R. 25, sponsored by Rep. John Linder, Georgia Republican.

I have written many times before about what a dopy idea I think this is. The following is an effort at summarizing the key arguments against it that appear over and over again in the scholarly literature.

(1) People will still have to keep records, file income tax returns and get audited because the states and some cities will still have income taxes. There is no reason to think the states will get rid of their income taxes if the federal income tax is abolished. Quite the contrary, they are likely to view the federal government as co-opting their traditional tax base — the general sales tax. Therefore, the states will just take over the tax base given up by the federal government — the income tax — and abolish their state sales taxes, which would otherwise come on top of the NRST.

The only way to prevent this is for the federal government to prohibit state income taxes at the same time it abolishes the federal income tax, which is probably impossible constitutionally. And if the states keep their sales taxes, the federal government will have to force them to conform to its tax base. At present, no two states have exactly the same sales tax systems and none come anywhere close to taxing sales as broadly as contemplated by the NRST.

(2) There is a very severe problem of taxing business inputs under a sales tax. These must be exempt from tax to avoid cascading — taxes being levied on taxes — which creates serious economic distortions. To avoid this under a NRST, every business, no matter how small, would need some sort of exemption certificate, which would create unlimited opportunities for evasion, or they will have to be extensively audited in ways at least as onerous as under the income tax.

(3) Services are by their nature much more difficult to tax than goods. For this reason, no state makes any effort to tax more than a few. Yet the NRST would tax 100 percent of services, including medical services and government services. Every time you go to the hospital, you will have to pay 30 percent on top to the federal government. And local governments will also be taxed by the federal government on services they provide, which will sharply raise property taxes.

(4) To offset the regressivity of the NRST, it would establish a massive new government entitlement program costing hundreds of billions of dollars that would send monthly rebate checks to every American. This system would be based on the poverty level income set by the Census Bureau. People would get 23 percent of this amount annually in 12 monthly installments based on their family status.

Quite apart from its massive complexity, this proposal would clearly require an enormous enforcement mechanism to avoid fraud and would undoubtedly be manipulated by politicians. It would be very tempting to change the formula to aid the poor and penalize the rich, as the tax code now does.

(5) Every serious analysis has concluded a NRST would result in massive evasion. Taxing the spending of drug dealers and others not now paying income taxes will not nearly compensate for the new evasion opportunities created. Since it is not in the interest of either retailers or consumers to pay the tax, and because all revenue is collected at the final sale point, tax-free deals with producers and wholesalers will be too easily made.

Although evasion of state sales taxes is relatively small, that is only because, given the low rates, it is not worth the trouble. However, where rates are high on items like tobacco, evasion is also high. A vast amount of foreign experience indicates retail sales taxes cannot be collected much above 10 percent without breaking down.

Under our current tax system taxes are withheld on wages, which is the vast bulk of the tax base. Under a value-added tax (VAT), something similar occurs because taxes are paid at each point of the production-distribution system. Thus, if the retailer fails to collect the tax, only a small part of the total revenue is lost, whereas a NRST would lose it all. Primarily for this reason, every country that ever contemplated something like a NRST has instead chosen a VAT, which the NRST people oppose.

Bruce Bartlett is senior fellow with the National Center for Policy Analysis and a nationally syndicated columnist.

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