Last fall, Independent American reported impressions of the FairTax plan, and came to the conclusion that it was not a good idea. The Presidential Tax Reform Advisory Panel agreed, rejecting the FairTax plan among many others. Three weeks ago, Leonard Burman of the Tax Policy Center gave Congressional Testimony in front of the Panel, and included his own assessment of the FairTax:
“[T]he NRST (National Retail Sales Tax) is uniquely flawed and unworkable.”
What follows is an excerpt of Mr. Burman’s Testimony.
Testimony on Tax Reform, National Retail Sales Taxes, and Small Businesses Leonard E. Burman February 1, 2006
National Retail Sales Tax
The Tax Reform Panel rejected a National Retail Sales Tax (NRST) as an option. A NRST, called the FairTax by its proponents, is a single flat tax rate applied to an extremely comprehensive base of final retail sales. To offset the regressivity of a sales tax (low-income people spend much more of their income on consumption than those with higher incomes do), every household would receive cash payments from the government equal to the sales tax owed on a poverty- level income. Advocates claim that all federal taxes could be replaced by a single 23 percent flat-rate NRST on a tax- inclusive basis (30 percent on the more conventional tax-exclusive basis against which other sales taxes are typically measured).2
However, this low tax rate implicitly assumes that all federal, state, and local government expenditures are in the tax base and that nominal government spending doesn’t change. In other words, the FairTax proponents’ math only works if real (after-tax) government purchases are cut by 23 percent across the board. William G. Gale has calculated that if state and local governments are exempt from the tax and federal government spending doesn’t change, the 23 percent NRST would increase the deficit by $268 billion in 2005 and almost $600 billion in 2010 compared with current law.3 Put differently, the revenue-neutral tax rate would be 31 percent on a tax- inclusive basis (44 percent if tax-exclusive), and that is under the implausibly optimistic assumptions of FairTax supporters: no avoidance, evasion, or erosion of the tax base.
In fact, even those high tax rates vastly understate the combined federal and state sales tax burdens, for numerous reasons. First, even if it were feasible to include purchases by state and local governments in the tax base (as assumed by FairTax advocates), doing so would require state governments to collect even higher taxes, so the combined state and federal tax rates would have to be much higher than assuming unchanging state tax rates. Moreover, as the report notes, taxing state and local government purchases would be problematic at best in our federal system of government.
Another problem for the states is that, if there were no federal income tax, it would be very difficult to maintain a state income tax. States benefit from the IRS’s information collection and auditing procedures, which would no longer exist. The compliance burden of state income taxes would be very high relative to the comparatively small amount of revenue collected by states, and taxpayers would pressure state lawmakers to eliminate their income taxes. (If they didn’t, many of the simplification gains from eliminating the federal income tax would evaporate since taxpayers would still have to deal with income tax complexity at the state level.) But without a state income tax, states would have to increase their own sales tax rates significantly.
The report assumes zero evasion, which is implausible. At the rates necessary to finance federal, state, and local governments, evasion would be rampant. This evasion would hurt compliant taxpayers and require still higher rates. It would also trickle down to the states, which would lose a significant portion of their tax bases. As a result, the required combined federal and state tax rates would be exorbitant. As a practical matter, government at all levels would have to be much smaller.
NRST advocates also assume that almost all forms of spending will be included in the federal retail sales tax base—including new homes, medical expenses, and financial services (which are notoriously hard to measure). Can policymakers really justify 40 to 80 percent tax rates on insulin? Would such a tax on new home sales be politically feasible? If it isn’t, the tax rates would have to be higher still.
The Tax Reform Panel concluded that NRST rates would have to be between 49 and 89 percent on a tax-exclusive basis, assuming a moderate amount of evasion, depending on how broad the tax base is. The Joint Committee on Taxation, as reported by Martin A. Sullivan, and William G. Gale reached similar conclusions.4 On top of those high federal rates, state sales tax rates would have to be 10 percent or more in many states.
The Panel report also shows that adopting the NRST would shift the tax burden significantly onto the middle class. Low-income people would pay lower taxes than under current law because of the cash subsidy, or “prebate,” and high-income people would pay much less because consumption is such a small share of their income. Thus, to raise the same amount of revenue, taxes would have to increase dramatically on the middle class. What’s more, the prebate would be “by far the largest [entitlement program] in American history.”5
There would also be problems in distinguishing final (taxable) from intermediate (nontaxable) sales (e.g., PCs). But taxing intermediate sales, as many states do, creates cascading rates (taxes applied on both inputs and outputs), which distorts investment decisions. And there could be problems in coordinating across states since state tax bases differ from each other and from the federal tax base.
Finally, the proposal would impose a disproportionate compliance burden on small businesses. The Tax Reform Panel cites a well regarded study of experience in Washington State, which found that compliance costs for small firms were 6.5 times as large as those for large firms.
The rampant evasion would hurt legitimate businesses, which would suffer relative to the growing underground economy. It would also undermine confidence in the fairness of the tax system (which would fuel more evasion).
Enormous transition problems can also be expected. If businesses can’t deduct unused depreciation, they would suffer an immediate and large capital loss. But if they are permitted to take those deductions, the NRST rate would have to be larger still to make up the lost revenue. Moreover, absent intervention by monetary authorities, prices would rise by the amount of the tax. Those higher prices would immediately erode the savings of elderly Americans. (Social Security benefits would be maintained in real terms because they are indexed to changes in the price level.) If instead prices were held fixed by monetary policy, then the tax would effectively be borne by stockholders (in the form of capital losses) and workers (in the form of lower wages). Again, retirees, whose stock portfolios would be devalued, would suffer disproportionately.
To be clear, many of these problems are unique to the NRST. Other forms of consumption tax, such as a VAT, flat tax, or X-tax, would likely be no more difficult to administer than the current income tax and would not undermine compliance with state sales taxes.6 But the NRST is uniquely flawed and unworkable. No wonder that no developed country has ever tried this radical experiment.
With your permission, I’d like to include an article Bill Gale and I wrote on the Tax Reform Panel report into the record as part of my written testimony. 7 Thank you. I would be happy to answer any questions.
2 As the Panel’s report points out, sales taxes can be represented on a tax-inclusive or tax-exclusive basis. Ordinarily, sales taxes are measured as a percentage of the pre-tax sale price of a good. Income taxes,however, are usually measured as a percentage of income including taxes. A 30 percent sales tax on a tax-exclusive basis would equal 23 percent of the after-tax price (0.30/1.30 = 0.23). The Panel report presents sales tax rates on a tax-exclusive basis to make them readily comparable with other sales taxes. 3 William G. Gale, “The National Retail Sales Tax: What Would the Rate Have to Be?” Tax Notes, May 16, 2005, pp. 889–911. 4 See Martin A. Sullivan, “The Rise and Fall of the National Sales Tax,” Tax Notes, November 15, 2004, pp. 916–21; and Gale, “The National Retail Sales Tax.” 5 The President’s Advisory Panel on Federal Tax Reform, Simple, Fair, and Pro-Growth (Washington, DC: U.S. Government Printing Office, 2005), p. 208. 6 They would share other drawbacks with a NRST. They would tend to shift the tax burden away from those most able to pay and would create similar transition problems. Moreover, a flat tax or X-tax may not be border tax–adjustable under WTO rules, as noted by the Tax Reform Panel in its discussion of the GIT (which is based on the X-tax). 7 Leonard E. Burman and William G. Gale, “A Preliminary Evaluation of the Tax Reform Panel’s Report,” Tax Notes, December 5, 2005, pp. 1349–68.
No comments:
Post a Comment