Tax talk

Ready for an 82 percent sales tax?

Author: Howard Gordon

Published: June 1, 2005

The thought of doing away with our income tax is appealing to many people. Many think that replacing our income tax with a national sales tax would save millions of hours filing income tax returns and, perhaps, eliminate the need for the Internal Revenue Service.

A bill (HR25) was recently proposed in Congress that would replace all of our federal taxes with a sales tax.  The proposal would do away with our income tax, corporate taxes, payroll taxes, and estate and gift taxes by imposing a 23 percent sales tax.

A study of this proposal, which was reported in Tax Notes and done by William G. Gale, indicates one of the problems with a national sales tax is the fact that the 23 percent tax is very optimistic.

There are two ways to state a rate for a sales tax. One is called the "tax inclusive rate" and the other is called the "tax exclusive rate."  When we pay sales tax now (approximately 8 percent) it would be considered a tax exclusive rate because we add the tax to the amount we pay.

A tax inclusive rate would be a tax that is included in the total sales price.

In the legislation being proposed, the 23 percent rate is a tax inclusive rate, which would really be a 30 percent tax exclusive rate.  Most of us think about sales tax as if something were selling for $100 then a 30 percent addition would be made to it so that it sold for a total of $130.

If you were to compute the tax based on a total sales price of $130, paying a $30 tax, the tax inclusive rate would only be 23 percent.  As confusing as this sounds, the bottom line is that the additional sales tax rate proposed under HR25 would really be 30 percent added on to every sale.  This does not count any additional sales tax that might be required by the state to cover not only the state's sales tax but, perhaps, an additional amount because the state would have no way of collecting an income tax which had, in the past, been based on the federal income tax.  The combined taxes would be around 50 percent, tax exclusive.

In Gale's study, he also determined that the 30 percent tax rate in the bill would have a revenue loss that would exceed more than $7 trillion over the next 10 years compared to our current law.  In other words, assuming that we have to raise the same amount of money that we are currently raising, the proposed 30 percent rate wouldn't do it.  It would be short over $7 trillion.  In order to raise the exact same amount of money over 10 years, it would require a 44 percent national sales tax.

The assumptions used under HR25, which was sponsored by Rep. John Linder, R-Ga., and co-sponsored by 54 other members, assumes that there would be no tax avoidance and no tax evasion.  This is a highly unlikely scenario, since realistically a tax rate in excess of 30 percent would cause some evasion.

Also, as proposed, the sales tax would cover interest payments and credit card payments.  By eliminating interest payments and allowing for some tax avoidance, we would probably be looking at a tax exclusive rate closer to 65 percent.  If we were to eliminate the tax on purchases by state and local governments and keep the tax revenue neutral, then the tax exclusive rate would increase to 82 percent.

Can you imagine adding 82 percent to every item or personal service that you buy? Add the state tax and our sales tax would be over 100 percent.

A national sales tax has incredible appeal, by virtue of the fact that we would no longer have to fill out income tax returns.  The other side, however, is the high rate of the sales tax applied to both purchases of material goods and to services would have a stinging effect.

Consider the stifling effect of even a 30 percent to 40 percent sales tax on hotel rentals, restaurant meals and airplane tickets would have on our local economy, where we rely so much on tourism.

Retired individuals that have already paid tax on their savings would now be required to pay a second tax when they start spending their savings during their retirement years, to say nothing of the regressive nature of the sales tax.

There is no doubt that our entire income tax system has become convoluted, but a national sales tax is not the way to correct the problem.