Presidential candidates from both parties, and others, have proposed a national sales tax be enacted to replace the current income tax. They say a national sales tax would be much simpler than the current system, increase tax fairness and permit a shutdown of the IRS as it now exists.

However, all is not so green in the other pasture. A report by the Joint Economic Committee (JEC) of Congress says a national sales tax may be a fatally flawed proposal and just as bad as the system it’s designed to replace.

Let’s look at what these sales tax advocates want to do. They claim a tax of 16 to 18 percent could raise all of the revenue now collected by the IRS.

And the rate will have to be higher than that if the tax provides for exemptions. For example, investment outlays, exports and government purchases are almost certain to be exempt.

With these items excluded, a national sales tax becomes, in effect, a tax on personal consumption expenditures. Using this as a base would require a tax rate of at least 32 percent to replace current revenues. And, of course, this does not include any sales taxes that states impose.

What about being taxed on services, which are exempt from most states’ sales taxes? If they enact this national tax, every time the plumber or electrician visits, a tax will have to be paid. The same is true for other services, such as doctor’s visits, haircuts, taxi rides and funeral services.

The government report makes some strong arguments about why this type of tax would be bad, maybe even worse than the current IRS system. It says a national sales tax of 19 percent on everything sold would be required to equal current income tax revenues. Historically, it has proven difficult to impose a sales tax on services at the state level. Imagine trying to collect such a tax at the federal level.

No one making these kinds of proposals has answered: Who is going to collect this sales tax if there is no IRS?

Sales tax advocates suggest the federal tax can be piggybacked onto state sales tax collections. Bad idea. First of all, five states have no sales tax. They would have to put in place sales tax collection procedures they don’t have. The rest of the states would have to add a whole new bureaucracy to collect and remit this federal sales tax.

It’s estimated the extra cost of collecting federal sales taxes will create a new financial burden on states of at least $12 billion.

Some states would exempt items taxed at the federal level and vice versa. In some states, food is exempt. In others, medicine is tax-free. And so on.

Think about the issues of business versus individual taxation. Would businesses get exemptions on the tax if they were to resell the goods? To avoid this double tax, producers, wholesalers and service providers will have to be given tax registration numbers allowing them to avoid paying the sales tax on inputs used in their businesses.

But this creates complications for retailers, as well as easy opportunities for evasion.

And what is to stop people from engaging in sham businesses simply to obtain a tax exemption? According to the JEC report, there will have to be a vast auditing procedure that could make today’s IRS methods tame by comparison.

A national sales tax would give people an enormous incentive to consume as much as possible before the tax takes effect, drawing down savings and even going into debt to buy everything they could possibly need in the future.

Having done so, consumption after the tax takes effect will collapse, at least for a time. This could cause a recession.

What about payroll taxes? If the Social Security payroll tax is not eliminated along with the income tax, the IRS would still be required to collect it. If the payroll tax is eliminated, a drastic revision of the Social Security benefits system would be required, since benefits are currently linked to taxes paid, which, in turn, are linked to earnings.

Everyone agrees our current tax system stinks. Other possibilities, like a national sales tax, might be even worse.

Troy Neff is managing director of Advanced Retirement Solutions. He also hosts “The Troy Neff Show” each weekday 6 to 9 a.m. on WCWA 1230 AM. He may be contacted by e-mail at Troy@TroyNeff.com.

This entry was posted on Friday, February 23rd, 2007 at 12:00 am and is filed under TFP Version 1.
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