The voices of Tax Policy Center's researchers and staff
Would you be willing to swap a new, broad-based consumption tax for your employer’s share of the Social Security and Medicare payroll tax? According to a new paper by my colleagues Jim Nunns and Joe Rosenberg, it would be a good trade for all but the highest income taxpayers. Not only that, but the change would be more economically efficient, unlikely to drive up prices, and relatively easy to administer. If it were set at a rate of 4.1 percent, the new consumption tax would raise the same amount of money as the employer share of the payroll tax.
Consumption taxes are in the air—House Speaker Paul Ryan and his GOP caucus proposed a variant (called a business cash flow tax) last month. Three GOP presidential hopefuls—senators Ted Cruz and Marco Rubio and former governor Jeb Bush—made a business-side consumption tax a key piece of their tax reform plans. And economists of all political stripes are exploring such levies.
But what should Congress do with the money a consumption tax would generate? There are almost as many choices as there are versions of the consumption tax itself. For instance, the new revenue could be used to buy down corporate tax rates, cut the individual income tax, or a combination of both.
In their new paper, Jim and Joe look at yet another option: First, they propose a broad-based consumption tax. Then, instead of using the new revenue to fund a cut in the personal or corporate income tax, they’d eliminate the employer portion of the Social Security and Medicare payroll tax. And the results look promising.
Jim and Joe propose a credit invoice Value-Added Tax, a form of consumption tax widely used around the world. Businesses collect the tax on all of their sales, but receive a credit for the tax that is built into the cost of what they purchase from other firms. Imports are taxed but exports are not. In countries such as Canada and New Zealand, the tax is known as a goods and services tax, or a GST--the name Jim and Joe adopt for their plan.
Like the employer payroll tax, their proposed consumption tax is built on a very broad base. All goods and services sold to households and most of what is sold to the government would be subject to the tax. No exceptions for education, health care, or food. That base ($12.7 trillion in 2015) allows for a relatively low tax rate and simplifies tax administration.
Jim and Joe look at this model with two rates: The first, 7.65 percent, tracks the employer’s payroll tax rate on wages below the Social Security cap ($118,500 this year) and would raise about $287 billion in new revenue in 2015. They also looked at a GST rate of 4.1 percent, which would raise the same amount of revenue as the employer share of the payroll tax.
Remember, economists believe that payroll taxes are ultimately borne by workers even though employers remit the tax to the government. In other words, if your employer didn’t have to pay its share of your payroll tax, you’d get the money in wages.
How would such a swap work out? First, it would be very progressive. At the 4.1 percent GST rate, the average tax rate would be unchanged, but the bottom 90 percent of taxpayers would get a small tax cut, on average.
Households making less than about $26,000 would get an average tax cut of 0.8 percent of income. Middle-income households making between about $51,000 and $88,000 would get a tax cut of 0.4 percent of income. By contrast, those in the top 1 percent, who make about $850,000 or more, would see their average tax bill rise by 1.1 percent of their income. In effect, the GST would uncap the payroll tax and tax fringe benefits.
Because the plan would preserve the worker share of the payroll tax, it would be easy to maintain the current Medicare and Social Security systems. The Social Security Administration could maintain wage histories and benefit records and any necessary revenues could be transferred from the GST to those accounts.
The GST has other benefits as well. Because the base and design of the GST and employer payroll tax are similar, there is less chance of unanticipated economic consequences from the switch. It would reduce opportunities to game the system by, say, choosing to establish a firm as a partnership rather than a corporation, or by working as an independent contractor instead of an employee. Finally, since the tax would be collected by business, there would be no new administrative burden on households.
Like any consumption tax, this one won’t be an easy political sell. But, when you see the potential benefits for most taxpayers, perhaps it should be.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.
This photo taken June 1, 2009 shows the snow-capped Aoraki, also known as Mount Cook, is reflected in the still waters of Lake Matheson, New Zealand. Aoraki, part of the Southern Alps, is the highest peak in the Southern Hemisphere. (AP Photo/Kathy Matheson)