Arnold Kling at TCS Daily looks at the Fair Tax, which proposes to replace the Federal Income tax with a consumption based national sales tax. Kling has proposed a similar idea himself in the past, but has some issues with the proposal as it stands today. One thing proponents like to tout is that you get your entire paycheck with no taxes taken out, which sounds like a good deal until you dig into a bit further.
First, the advatanges of such a plan, as Kling sees it:
"Potential advantages include reduced complexity, weaker incentives to lobby for tax breaks, and stronger incentives to save. Potential drawbacks include difficulty raising revenue and major shifts in the tax burden relative to the current system."
The Fair Tax proposal is to tax all purchases, even those made by government agencies, at a rate the proponents claim is 23%* (see Kling's note below), with the exception of educational costs. There is also a exception for repurchased goods, even big ticket items such as houses and cars, so only newly produced items and services would be subject to the tax. The tax would replace all Federal taxes, including the payroll taxes for Social Security and Medicare. The personal tax exemption would be $2352 for adults and $732 for children. One thing he doesn't examine is that the plan calls for the government would send a check to those making under a certain income figure (or maybe it was everyone) to defray living costs - but I haven't seen how that would be implemented.
"(*The FairTaxers quote a 23 percent rate. If a boombox costs $100 and I pay a $30 sales tax, then to me that is a 30 percent tax. What the FairTaxers are saying is that if I have to lay out $130 for the boombox and $30 of that is taxes, then I am paying $30/$130 = 23 percent in taxes. This is consistent with the way we think of income taxes--if you earn $130 in income and pay $30 in taxes, then you think of your tax rate as 23 percent. However, it is not the way we typically think of sales taxes.)"
Kling compares the Fair Tax with his own proposal and finds it wanting in several regards, but suffice it to say that it is lacking - for example, the exemptions from his own plan for a family of four would be $20,000 versus $6288 under the Fair Tax, and he also believes proponents are ignoring the transistion costs, which might puts the real rate as high as 45%. But one biggie he points out is that the vast majority of the current income tax revenues come from the upper end of the income distribution; the top 10% of income earners, those making over $104,000 a year, contribute 70% of the income tax revenues. As he puts it:
"The problem with a consumption tax is that the top 5 percent of earners do not consume at the same rate that they earn income. As a result, the government cannot abolish the income tax without sacrificing hundreds of billions in revenue from the subset of high earners who also are high savers. To make up for this loss, the middle class has to be socked with either higher taxes or fewer entitlements."
A while back the Skeptical Optimist looked at the proposal and pointed out another huge issue: if I have money in my savings account that I've already been taxed on from the current income tax regime, why should I pay another tax when I spend it after the Fair Tax is implemented? I've seen no good answer from the Fair Tax proponents on this one.
Kling goes on to make a more practical middle proposal, one in which you flatten the income tax to three rates: zero for those earning under $100,000, 10% for those between $100-150,000, and 35% over that figure, abolishing the payroll tax and institute a national sales tax at a rate of around 20%, with all future tax adjustments being address on the sales poriton only. This would certainly make tax payers sensitve to the cost of new govenrment programs (as well as the politicians elected by the taxpayers).
Interesting discussion, but I'm still not sold - either way, both systems are fairly complicated, and the transition is likely to be messy. I'm still drawn to a much more appealing proposal that has been empirically shown to work to unleash the engine of economic growth - the Flat Tax.