National Retail Sales Tax: Why wouldn’t the rate be 23 percent?
Advocates of a national retail sales tax have suggested that such a tax at a 23 percent rate would be sufficient to replace the entire federal tax system. This estimate is misleadingly low for a variety of reasons, in part because it assumes that there will be no evasion or avoidance of the tax and no exclusion of hard-to-tax items from the tax base. Furthermore, the 23 percent rate they cite is a "tax-inclusive" rate, which corresponds to a 30 percent tax-exclusive rate. Besides all this, the 23 percent rate advocates cite is based on a mathematical error in the way they compute the changes in consumer and producer prices that would occur under the proposed tax. For all these reasons, the 23 percent tax rate can be considered unrealistic given plausible and accurate assumptions about how a national retail sales tax would be implemented.
- The 23 percent tax rate cited by advocates of the NRST is a tax-inclusive rate; the mark-up at the cash register under a 23 percent tax-inclusive rate would be 30 percent.
- Proponents assume that there will be no evasion, no avoidance, no erosion of the statutory base due to political pressure to exempt certain goods and services, and no exceptions for hard-to-tax items. This makes the effective tax base in their calculations much larger than it would be likely to be in a real-world implementation; hence the required tax rate in their calculations is much lower than it would be in a real-world setting.
- Advocates also made a mathematical mistake in calculating their required tax rate. An analysis of the required rate in a sales tax requires a consistent set of assumptions about what how consumer and producer prices will change relative to the current system. Producer prices could either remain constant in nominal terms, fall by the entire amount of the previously embedded taxes, or fall by an amount somewhere in between. Consumer prices are just producer prices plus the sales tax. (So, for example, if producer prices remained constant in nominal terms after the transition to a sales tax, consumer prices would rise by the full amount of the sales tax.) In calculating their required rate, advocates assumed that producer prices would remain constant when they calculated the revenue the government would obtain from the tax, but they then assumed that producer prices would fall when calculating the amount of spending the government would have to do to maintain current programs. These assumptions are obviously inconsistent, and they either understate government spending needs, overstate the likely revenue, or both. Making a consistent assumption about producer prices-whichever of the three above options one chooses-leads to a significantly higher rate than advocates assumed.