Mimsy Were the Borogoves

Editorials: Where I rant to the wall about politics. And sometimes the wall rants back.

What’s wrong with a national sales tax?

Jerry Stratton, October 25, 2011

A couple of years ago, the solution to our tax problems was the flat tax; today, the tax savior is the fair tax. The basic difference is that the flat tax is an income tax on all income (except possibly below a poverty threshold) and the fair tax is a national sales tax on all purchases (except possible necessities such as food, or, as in Herman Cain’s 9-9-9 plan, limited only to new purchases).

Is a sales tax better than an income tax? Any tax eventually gets used by the state to try and shape public action, whether to indulge in a bit of cronyism or progressivism. With income taxes, this shaping is limited: it’s very difficult to say that John Smith in Accounting should be taxed higher than Jane Doe the nurse, just because we like nurses more than accountants. We tend to limit our differentiation based on how much money people make, rather than on what job they have.

With a sales tax, however, it’s very easy to say we’re going to tax ice cream more than milk, because we want to discourage people from eating too much ice cream. We already do this all the time. Gasoline has historically had much higher sales taxes than other products in many, if not most, states.1 Cigarettes and liquor are also singled out for special taxes. And we actually have a national sales tax on those products: currently, $1.01 per pack of cigarettes and 18.4 cents per gallon of gas go to the federal government; the liquor tax is more complex. A national sales tax on all purchases will only make this worse: it will be easier to modify taxes for social engineering purposes once all products already have a federal sales tax and all merchants are required to collect a federal sales tax.

This is why I think the best tax is not a tax on individuals, but a tax on states; states will be able to experiment with the best tax regime for the people in their area. Every state can learn from the innovations of their neighbors.

That said, while all taxes have problems, income taxes are probably the fairest tax we can have. Business taxes are hidden taxes on consumers and on employees. Federal sales taxes will inevitably lead to social engineering.2

The income tax’s problem is it ends up being burdened with exemptions and deductions, but this is more obvious and more easily complained about than social shaping taxes, and it’s easier (though still very difficult) to reform income tax bloat than sales tax bloat.

The temptation for governments with the income tax is to add more line items and not call them a tax, but rather contributions; and to hide taxes by having employers pre-remove the tax from the employee’s paycheck without listing it, as they do with “their” part of social security taxes. I’d really like to get employers out of the business of collecting taxes on behalf of the government. That’s not the employer’s core expertise—it requires every business to spend resources on expertise in tax law in addition to their expertise in whatever it is they make; the requirement that employers siphon taxes from their employees to the government is a huge regulatory burden. It drains our economy of productivity and it drains our economy of jobs by making it less attractive to hire locally than to subcontract overseas.

It also makes it too easy for the government to add hidden taxes. Our social security tax is a good example of this: we have a social security deduction that is really just a tax. All of the money collected for social security goes into the general fund through a system of intra-governmental borrowing. It’s just a tax, but an insidious one because people think it’s more like a savings account. But worse, the full tax is hidden: employers are required to hide over half of the tax from their employees. The only people who see the whole thing are the self-employed, who are required to pay the “employer’s” share as well as the normal percentage everyone else sees.

But those issues remain with sales taxes, it’s just that the burden is shifted from employers to sellers. And I can’t see any way to remove merchants from the sales tax equation, as would be possible (though very difficult) to remove employers from income tax collection. Once we have a sales tax, the next push will be to turn it into a VAT that doesn’t get listed on the sales receipt. Further, sales taxes seem to me to be far more prone to cronyism than the income tax. With a national sales tax we’ll have businesses lobbying for all sorts of sin taxes that hurt their competitors or make it difficult for competitors to arise. The regulatory burden on the mom & pop corner store will be immense. Sin taxes will be used by established businesses to increase the price of new competitors.

The reason I don’t like Cain’s 9-9-9 plan is that it allows politicians to use the drawbacks of each tax type. There are benefits to multiple taxes, as long as all taxes are kept simple and equal: they ensure that everyone pays some tax. Even if you have no income because you’re living off of a trust fund, you still buy things occasionally and thus would pay sales tax. But this is only true if the 9-9-9 plan remains a simple plan. It would eventually become a 9-9-10 plan, or a 9(0/15/25)-9(10/11/12)-10(-5/+5/+2) plan, and so on. The problems outweigh the benefits, barring some seriously strong constitutional shackles. I’d be more inclined to support Cain’s plan if:

  1. It did not include a hidden tax (the corporate third).
  2. The two or three prongs were constitutionally required to always remain at the same percentage; that is, future politicians couldn’t raise income taxes without also raising sales taxes, and vice versa.
  3. Each of the three prongs were constitutionally required to be kept simple, so that future politicians couldn’t load them down with exemptions, deductions, and special add-ons tailored to their friends and contributors.

The third requirement is the most important. It isn’t the level of taxes that’s killing the economy the most today (although it doesn’t help). It’s the complexity of taxes that’s killing the economy. When every new employee or every new product or every new startup also increases the burden of just figuring out what your taxes will be, employers won’t hire as many employees as they otherwise would. Companies won’t expand into new industries that they otherwise would do well in and have to hire more employees for. And people won’t start up new, small startups that create completely new industries with completely new jobs, because doing so runs the risk of heavy fines and even jail time if they miss one codicil in the law.

Hiding taxes so that the average person doesn’t see them makes tax law more arbitrary, because even though people don’t see them they know they’re there, vague and unidentifiable; anything new they create runs the risk of tripping over an invisible tax, creating years of trouble with the IRS. So they don’t create anything new.

Kill the complexity and unhide hidden taxes, and even if the tax burden remains the same we’ll see strong economic improvement. We’ll see existing companies hiring more people—and hiring more people within the United States, since the regulatory burden applies mainly to domestic hires—and we’ll see more people risking new business ventures that also create more jobs.

Which is why I’m a little disappointed with Governor Perry’s new 20/20 plan. The basic idea—provide people with the opportunity to use either the current, complicated system or a new, simple system—is a good one. Unfortunately, it maintains several of the existing exemptions. The charitable exemption is the biggest issue for me, not because I dislike charitable contributions but because it’s going to continue to need policing. Without that one exemption, Perry’s plan would remove the need for most of the IRS. With that exemption, there are still going to be judgment calls, and that means a powerful IRS is still necessary to determine what is and is not a charity.

I’m also not a fan of exempting state and local taxes: it’s just one more incentive for states and cities to increase taxes.

That said, it’ll be interesting to see what Perry’s plan looks like. And I credit Cain for making sure that such plans need to be on the table this election cycle.

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.

  1. That isn’t true today because gasoline sales taxes are usually set as a tax per gallon rather than a tax per dollar, and gas prices have been rising.

  2. States have a tendency to do this, too—just look at gas and tobacco taxes—but they’re less likely to simply because it’s easy to evade a state that’s egregiously increasing taxes compared to their neighbors.

  1. <- No corporation pays taxes
  2. Hiding tax complexity ->