Is it better to tax incomes or purchases?
Should I have been collecting sales tax on these zucchini? How does the fact that we paid sales tax on the seeds factor in? What records do I have to keep to prove it? What happens when a seven-year-old fails to keep those records?
Every election season, tax simplification becomes popular. Once the election is over, it disappears.1 This year, some sort of federal sales tax is being promoted by a lot of people as a solution. Sales taxes, though, don’t seem to fulfill my own tax requirements of simple, obvious, and unobstructive when compared to income taxes.
The big problem I see with sales taxes is that they are paid for by consumers but not levied upon them. Like corporate taxes, sales taxes are not paid by businesses but by consumers and by employees. The title is bullshit, and meant to misdirect what sales taxes really are. Sales taxes are not sales taxes, they are purchase taxes. The seller is not taxed when they sell you something. You are taxed when you purchase something. It’s just that for political and logistical reasons governments prefer to rope the seller into collecting that tax.2
Sales taxes are also too complex to be levied against the person paying them. Unlike income taxes, which could be—in fact, theoretically are—levied against the employee who is paying it rather than the payer’s employer, the sales tax must be handled by the merchant, not by the person paying the tax. There is simply no reasonable way for taxpayers to track all of their thousands of inconsequential purchases. Even though they’re the ones paying the tax they are not the ones interacting with the taxing authority, and it’s hard to imagine a workable solution in which they are the ones talking to the taxing authority.
Sales taxes also bear inevitable confusion over who is a consumer and who is a seller. If all sales are taxed, regardless of whether the purchaser is an end consumer, then the sales tax becomes a hidden tax, multiplying invisibly with every sale in the supply chain.3 Such taxes are very prone to increase, because they are easily forgotten, until such time as the black market undercuts it so much that people start avoiding the legal market, instituting a death spiral for law.
If only end sales are taxed, then there has to be a definition of what an end sale is. This definition can and will be gamed, which will result in further punitive rules added to capture the inevitable gray-market sales. The more complex the rules, the more they will be gamed. When sales taxes reach twenty or thirty percent, as they will in some states if the federal government adds its own sales tax to existing sales taxes, the incentive to not pay them will be very strong.
People know what their income is. They don’t know what their sales are.
Grumpy economist John Cochrane, who is a lot more knowledgeable than I am on this issue, writes in favor of sales taxes over income taxes:
Second, the government should tax consumption, not wages, income or wealth. When the government taxes savings, investment income, wealth or inheritance, it reduces the incentive to save, invest and build companies rather than enjoy consumption immediately. Taxes on capital gains discourage people from moving or reallocating capital toward their most productive uses.
Recognizing the distortion, the federal government provides a complex web of shelters, including IRAs, Roth IRAs, 527(b), 401(k), health-savings accounts, life-insurance exemptions, and the panoply of trusts that wealthy individuals use to shelter their wealth and escape the estate tax. If investment isn’t taxed, these costly complexities can disappear.
This is true, but the problem is that the very same issue exists with sales taxes. For the same reason that taxing investments discourages investments, taxing purchases discourages purchases. “Recognizing the distortion,” polities that use sales taxes often exempt certain kinds of purchases that people should not be discouraged from, such as food, necessary medicine and other medical care or devices, clothing, things purchased for growing food, and some services.
The definition of these things becomes incredibly complex. Should potato chips be tax exempt because they’re food, or should they be taxed, and thus discouraged, because they’re junk food? Should aspirin be tax exempt for everyone, or only for people who buy it under a doctor’s orders? Is all clothing tax exempt or only clothing that isn’t too luxurious?
Then, combine these exemptions with what makes an end sale and what doesn’t, and you have a very complex system with a lot of leeway for prosecutors.
Further, the punitive possibilities of any kind of sales tax will be used to their fullest. In England, according to Irwin Stelzer, bras 34B and lower are untaxed, because they might be children’s clothing, while larger bras are taxed 20%, because they are probably for adults4. Foods are untaxed, unless they are on the list of snack foods, in which case they are taxed, unless the snack foods are hot food, in which case they go back to being untaxed, which encourages grocery stores to install microwave ovens. Imagine the possibilities for lobbyists and legislators, the kinds of milker bills that legislators will produce to milk campaign money from businesses, the kind of crony bills that national businesses will produce to target their smaller local competitors or to surreptitiously mandate the installation of their products!
Income has its own definitional issues, of course, but what makes an income is relatively simple compared to what makes a sale. If we were to stop hiding taxes by pretending we can tax businesses, income becomes even simpler to define. And we are at least talking about “income” taxes rather than “employment” taxes, avoiding the verbal virtuosity that we employ for turning purchase taxes into sales taxes.
The complexities of defining what gets taxed and when is a big part of why I am most in favor of no federal taxes except on states. This would let the states experiment with the best means of taxing their citizens. But if this is politically impossible, an income tax—compared with a sales tax, at least—combines, I think, the most transparency with the least friction, meaning lower taxes overall.
In response to Simple, obvious, and unobstructive: minimize the value-minus of taxes: There is no value-added in taxes, but we can minimize the loss of value.
One of the reasons I supported Carly Fiorina is that she recognizes and articulates this problem.
↑Just as they prefer to rope the employer into collecting income taxes. They also have a tendency to call new income taxes something else, such as the social security tax; and when possible, they like to pretend that the tax isn’t even on the employee, as when they forbid the employer from listing the full social security tax on the employee’s paycheck, under the fiction that half of the tax is paid by the employer. Employers don’t pay taxes. Employers have expenses, and those expenses reduce their employees’ paychecks or add to the prices they charge consumers—unless the expenses force the employer out of business, in which case nothing is taken from employee paychecks because there aren’t any paychecks, and nothing is charged to consumers because there’s nothing to sell.
↑This is basically what a VAT, or value-added tax, is. It hides the sales tax throughout the supply chain, though it technically attempts to keep the tax from multiplying by only taxing the “added value”.
↑Is the theory that clothing for children is essential, and should be exempt from taxes, but clothing for adults is optional, and so should be taxed? Is England trying to become one giant nudist colony?
↑
- Five Million Times Easier!
- I’ve got a way to make the IRS’ job five million times easier. And your tax forms half as difficult.
- Sales taxes in the United States at Wikipedia
- “The definition of retail sales and what goods and services are taxable vary among the states. Nearly all jurisdictions provide numerous categories of goods and services that are exempt from sales tax, or taxed at reduced rates. The purchase of goods for further manufacture or for resale is uniformly exempt from sales tax. Most jurisdictions exempt food sold in grocery stores, prescription medications, and many agricultural supplies.”
- Tax Oped—full version: John H. Cochrane at The Grumpy Economist
- “Second, the government should tax consumption, not wages, income or wealth. When the government taxes savings, investment income, wealth or inheritance, it reduces the incentive to save, invest and build companies rather than enjoy consumption immediately. Taxes on capital gains discourage people from moving or reallocating capital toward their most productive uses.”
- A tax that mainly adds complexity: Irwin M. Stelzer at The Weekly Standard
- “Researchers at the Urban-Brookings Tax Policy Center estimate that a 5 percent consumption tax in its most common form, a broad-based, value-added tax, levied on the value added at each stage of the production process, could raise about $160 billion per year. That’s real money, and it could be much more, especially if the internationally common 20 percent rate were applied. But even then, it would not be enough to replace all income taxes.”
- Throw Them All Out
- IPO nowadays stands for Invest in Politicians Often. Investing in politicians brings huge returns.
More income tax
- Consumption vs. Income vs. Sales
- I would love to be convinced that consumption taxes are a better idea than income taxes. But I just don’t see how politicians wouldn’t find it easier to muck up a consumption tax worse than they’ve mucked up income taxes. Is convincing Americans to switch from an income tax to a sales tax an effective use of resources?
- Income tax vs. national sales tax
- There is no such thing as a fair tax. All we can do is try for the simplest, most unobstructive tax we can find.
More purchase tax
- Consumption vs. Income vs. Sales
- I would love to be convinced that consumption taxes are a better idea than income taxes. But I just don’t see how politicians wouldn’t find it easier to muck up a consumption tax worse than they’ve mucked up income taxes. Is convincing Americans to switch from an income tax to a sales tax an effective use of resources?
- Income tax vs. national sales tax
- There is no such thing as a fair tax. All we can do is try for the simplest, most unobstructive tax we can find.
- What’s wrong with a national sales tax?
- When considering a new tax, consider how easily that tax is abused by the state and by the state’s good intentions.
- Regulations cost money
- Regulations cost money. Do politicians really not understand this?
- San Diego’s proposition D: tax first, reform afterward
- San Diego’s proposition D is an attempt to raise taxes and then reform—which is, of course, an attempt to raise taxes and not reform anything at all.