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National Retail Sales Tax: What would and would not be taxed?

Under a pure national retail sales tax, all consumption expenditures by individuals and by federal, state, and local government agencies would be subject to the tax. (Purchases by businesses are, by definition, not retail sales and so would not be subject to tax.) However, no sales tax in history has come close to such an ideal tax base. Some items, such as imputed financial services, are quite difficult to tax. Other items might not be taxed for reasons of social policy, such as child care, rent, food, housing, and health care. Powerful political influences also often successfully lobby for exemptions from the sales tax, just as they do from the income tax. As a result, very few of the state sales taxes currently in existence tax many of the items listed above, and none tax all of them. Hence there is no precedent for a broad-based national retail sales tax that would include all consumption expenditures by individuals and government.

Exempting selected sectors, however, would cause serious problems for a national retail sales tax. The broader the tax base, the lower the tax rate can be and still raise the same amount of revenue. As discussed elsewhere, the required tax rate under a national retail sales tax would have to be very high to replace existing federal taxes, even with a broad tax base. But health, food, and housing make up about half of all personal consumption, so that exempting even one of these sectors would cut deeply into the sales tax base, forcing the required rate even higher.

  • Even with extreme political discipline in avoiding subsidies, it would be difficult to tax more than 80 percent of personal consumption. Retaining some of the major preferences in the income tax could reduce the private consumption base to about 60 percent of personal consumption.
  • A national retail sales tax would need to tax all consumption and investment purchases made by state and local governments. Leaving these transactions out of the tax base would reduce the base substantially, which would in turn raise the required tax rate for a given amount of revenue. Taxation of government transactions would also be necessary to ensure that private industry is not placed at a disadvantage when competing with public suppliers of goods and services. Taxing government transactions would likely add complexity to a system that its advocates laud for its simplicity.
  • Although the details of the various national retail sales tax proposals vary, they generally maintain several similar tax base characteristics. Exemptions would be provided for business purchases and education, both of which are considered investment. Domestic purchases by foreigners would be taxed; foreign purchases by U.S. residents would not.
  • Employer-provided health insurance would be taxed. Economists Jonathan Gruber and James Poterba have calculated that this tax change would boost the price of health insurance by an average of 21 percent. They estimate that this price increase would reduce both the number of people insured (by between 6 million and 14 million) and the amount of insurance that each remaining insured person would choose to carry.
  • The existing deductions for mortgage interest and property taxes would disappear with the income tax. This would reduce the value of all residential housing. Newly constructed houses sold to occupants would be subject to the sales tax. But already existing houses would generally not, because sales of a house from one household to another would be exempt since they do not represent a retail sale (i.e. a sale from a business to a household). This would boost the cost of buying a new house relative to existing houses.
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