Sales-Tax Scam

Author: Matthew Yglesias

Published: December 1, 2004

BASKING IN THE GLOW OF his first actual presidential victory, President Bush held a November 4 press conference in which he claimed a broad mandate for big-time "tax reform," the details -- or even broad outlines -- of which he spelled out neither on the campaign trail nor at the post-election media event. House Speaker Dennis Hastert, however, has spoken of his fondness for the idea of replacing the income tax with a single national sales tax. Vice President Dick Cheney, according to press reports, also likes the idea.

The closest thing to a concrete proposal for such a tax that we have on the table is HR 25, co-sponsored by several House Republicans, which aims to finance the federal government on the basis of what it calls a "23-percent sales tax." This is not, however, a 23-percent sales tax as the term is generally understood; this is adding a $ 23 tax to an item that costs $ 100 before tax. Instead, the item would cost $ 130, with the 23-percent figure arrived at by the unorthodox method of dividing $ 30 (the amount of tax) by $ 130 (the after-tax price) and getting 23 percent. So 23 percent means 30 percent.

Even that rate is arrived at only by assuming that the tax base would be extraordinarily broad, with no exemptions for the purchase of any sort of goods. Of course, the current income tax could be lower were it not for the political pressure to exempt mortgage costs and health care, along with a whole raft of special-interest loopholes that have popped up in the legislative process. Why shifting to a sales tax would eliminate such pressures is something on which its advocates remain studiously mute. If a sales tax did get rid of these kind of exemptions, though, eliminating the one for health-care costs would cause an estimated 6 million to 14 million individuals to lose their health insurance. Families with children that currently receive significant help -- child credits, education credits, dependent deductions, and so forth -- would lose all that and likely find themselves overburdened.

Worse, the 23-percent "estimate" takes no account of the fact that some taxation would doubtless be evaded. Under the current system, income-tax evasion stands at around 15 percent. But as the Brookings Institution's William G. Gale points out, this breaks down into a 5-percent rate for income that is withheld and reported by employers, and a 50-percent rate for non-withholding employers. Under the sales-tax system, merchants could evade the tax by not reporting the sale -- so all revenue would resemble non-withheld income and possibly be subject to a correspondingly high rate of evasion. In fact, governments around the world have historically found that rates higher than 12 percent produce so much evasion as to be useless and unenforceable.

On the other hand, the very wealthy people who currently suffer the indignities of progressive taxation would not only be freed from that burden but would also see any money they plow into investments go untaxed. Thus, absent a major market crash, wealth would beget more wealth with even less impediment than under the current system. Problems aside, that may give the president all the reason he needs to learn to love the sales tax.