Big tax reform gets another look

Sales tax simpler, but is it fairer?

Author: Amy Martinez

Published: August 22, 2004

Almost everyone can agree that replacing the federal income tax with a national sales tax, an idea recently proposed by House Speaker J. Dennis Hastert, a Republican from Illinois, would simplify things.

It would crumple up the IRS and deposit it in the wastebasket of history, along with tax filings, record keeping, audits and federal withholdings.

The complications come with the debate about whether the proposal is fair.

Conservatives are calling a national sales tax the most intriguing idea since the flat tax, which publisher Steve Forbes centered his presidential campaign on four years ago. President Bush has said it's "the kind of interesting idea that we ought to explore seriously."

Democrats, including presidential contender Sen. John Kerry, say it would hurt low- and middle-income Americans by making them pay the same rate as rich people.

A national sales tax would be on top of state and local sales taxes, so North Carolinians could find themselves paying an extra 30 percent or more for goods and services. But with the IRS no longer taking a chunk of their earnings, they would also get bigger paychecks.

"What they make is what they take home," said Tom Wright, executive director of FairTax, a Houston organization that seeks congressional approval for the sales tax. Founded seven years ago, FairTax is backed by businesses and private donors such as billionaire Bob McNair, owner of the National Football League's Houston Texans.

"They'll decide how much tax they pay by what kind of lifestyle they choose," said Wright, who also works for a Florida investment fund.

Supporters like the sales tax because it penalizes short-term spending while rewarding savings and long-term investments. They argue that the sales tax could be written in a way that prevents poor people from paying more in taxes, by offering rebates, for example, or lowering the rate for groceries and other necessities.

William R. Gale, a senior fellow at the Brookings Institution, a Washington think tank, estimates that eliminating the income tax -- without cutting government spending over the next 10 years -- would require a sales tax rate of more than 26 percent. Replacing all federal taxes, Gale said, would require a rate of about 60 percent. Those estimates are based on the assumption that a fifth of the base would be eroded by tax evaders and loopholes.

People living from paycheck to paycheck are potentially the biggest losers, said Richard Schmalbeck, a Duke University law professor. Although they may like the idea of saving more, they'd still spend almost everything they earn on food, clothing, car payments and housing.

But wealthier people may decide they don't really need that new SUV or sofa. They can drive their Expedition a little longer and put more of their money in stocks and bonds, thus lowering their tax burden.

"People with more than $200,000 in annual income would surely pay less," said Schmalbeck, who served in the Office of Management and Budget under President Ford. Schmalbeck said Americans would balk at a sales tax rate above 20 percent and demand less federal spending or accept an even bigger budget deficit. "It would raise less revenue and be more regressive," he said.

Bush will have an opportunity to lay out his tax proposals during the Republican National Convention in New York. Some economists speculate that by introducing the idea, Bush supporters intend only to galvanize the flat-tax crowd of the Republican Party and are not seriously interested in overhauling the system.

In a recent op-ed piece in The Wall Street Journal, Forbes, the former presidential aspirant, urged Bush to stir the "electoral pot" by following Hastert's advice and replacing the current tax code with either a sales tax or a flat tax. But Forbes cautioned that Americans could end up with both a sales tax and an income tax unless Congress does away with the 16th Amendment, which allows the income tax. He said the flat tax would require no constitutional changes.

Under Forbes' plan, a family of four would pay no federal income tax on the first $36,000 of income and 17 percent on any earnings above that, he wrote. There'd be no tax on interest, dividends or capital gains. "The economy would then roar ahead -- and so would Washington's revenues," Forbes wrote.

Another possibility is a European-style tax on consumption at every stage of business production. Hastert has said a value-added tax, similar to a national sales tax, would more efficiently collect money than the income tax and could be devised to ensure low-income people don't pay more than they do now. But critics say it would result in higher prices for consumers.

FORUM

Should the federal government replace the current tax code with a national sales tax? Discuss online at www.newsobserver.com/business.

WHAT WOULD IT MEAN?

Republican House Speaker J. Dennis Hastert of Illinois has resurrected an idea introduced in 1990 to replace the federal income tax with a national sales tax. How that would affect taxpayers is difficult to know because the devil, as they say, is in the details.

Hastert and other backers have not said what the sales tax rate should be, or if some goods and services ought to be exempt. But here's what you might expect if lawmakers do away with the income tax and adopt a sales tax:

PROS

- Your paycheck would come to you with no federal withholdings.

- You'd no longer have to file annual returns with the Internal Revenue Service.

- You'd no longer have to keep records or fear being audited by the IRS.

- Your bank no longer would have to perform surveillance functions for the IRS.

CONS

- You would still have to pay North Carolina's income tax.

- The national sales tax would be on top of state and local sales taxes.

- You would likely pay more to the government if you typically spend most of what you make.

- Without tax deductions for charitable contributions, charities could suffer.

TOM WRIGHT OF FAIRTAX, RICHARD SCHMALBECK OF DUKE UNIVERSITY

KERRY'S TAX SUGGESTIONS

Some of the tax proposals from Democratic presidential candidate Sen. John Kerry:

- Repeal the Bush tax cuts for households with incomes over $200,000; make permanent the middle-class tax cuts.

- Implement a new refundable tax credit for higher education expenses.

- Reduce the corporate tax rate 5 percent, or 1.75 percentage points. This would be paid for by increasing the tax on U.S. corporations that produce goods and services overseas and by the elimination of tax loopholes, says Kerry.

- Provide a discounted corporate tax rate for businesses that repatriate foreign earnings.

- Give small businesses a tax credit worth up to 50 percent of the health insurance premiums they pay for employees.

- Introduce a 20 percent tax credit for the purchase of energy-efficient building equipment.

BUSH'S TAX SUGGESTIONS

President Bush is expected to lay out his tax plan at the Republican National Convention in New York. His campaign has not released many details about his agenda for a second term, but this has been reported:

- Make permanent all individual tax cuts.

- Make permanent estate and gift tax cuts.

- Has said a national sales tax is worth exploring but has stopped short of backing the proposal.

URBAN INSTITUTE, BROOKINGS INSTITUTION