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Dump the income tax? Don't bet on it
Bush, GOP float national sales tax proposal but the trial balloon is likely to sink, experts say.
August 11, 2004: 3:50 PM EDT
By Mark Gongloff, CNN/Money senior writer

NEW YORK (CNN/Money) - President Bush and other Republican leaders have been talking about abolishing the IRS and replacing the income tax with a national sales tax.

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If that sounds like your idea of a dream world, keep dreaming -- it probably won't happen any time soon, analysts said Wednesday.

Bush, answering questions at a campaign stop in Florida on Tuesday, said the idea of replacing the income tax with a national sales tax had some merit.

"You know, I'm not exactly sure how big the national sales tax is going to have to be, but it's the kind of interesting idea that we ought to explore seriously," Bush said, according to a Reuters report.

With that, he echoed recent calls by conservative lawmakers, including House Speaker Dennis Hastert of Illinois, to abolish the Internal Revenue Service and replace the national income tax with a flat tax, a tax on retail sales or a tax on all sales, called a value-added tax (VAT).

Rep. John Linder, R-Ga., has introduced a bill -- with 54 House co-sponsors -- to replace the income tax with a 23 percent sales tax on all purchases. The goal would be to take a flame-thrower to the Byzantine tax code and encourage investment, job growth and wealth accumulation by making investment and savings totally tax-free.

The issue has special salience in an election year, in which Bush is looking for a big idea -- the vision thing, if you will -- that will please his conservative base and help carry him to re-election.

“ "Trying to eliminate the IRS by adopting a national retail sales tax is a very dumb idea." ”
Bruce Bartlett
economist, columnist, National Review Online

Still, while few would disagree that a world without an IRS would be a wonderful world indeed, the issue is a little more complicated than that. It's a lot more complicated, in fact, which is why Bush will probably not try to make this a campaign issue this year.

"There was a lot of speculation around [Washington] a week ago that something big could come, that the White House needed to trot out something bold ahead of the convention," said Greg Valliere, political economist at Schwab Washington Research Group. "I've talked to several people who've come away from this thinking it's unlikely."

"The feeling is that Bush might call for a study, a commission, a blue ribbon panel on tax change, but that, if you start talking about radical tax reform, it becomes a big, fat target for criticism."

Conservative economist Bruce Bartlett, an adviser to President Reagan and author of the 1981 book Reaganomics: Supply-Side Economics in Action, illustrated this quite bluntly in a recent column for the conservative Web site National Review Online.

"With all due respect to Speaker Hastert, trying to eliminate the IRS by adopting a national retail sales tax is a very dumb idea," Bartlett wrote.

One of the biggest roadblocks to such a proposal is that it could entail doing away with tax deductions precious to many Americans, including the home mortgage deduction.

After all, buying a house is, technically, consumption. Same thing with buying diapers and food for the kids -- say goodbye to the child tax credit. If you get sick, you'll be paying that 23 percent tax on your doctor and prescription bills, too.

You could make such purchases tax-exempt, but that would push the tax rate on other goods even higher. In fact, that 23 percent rate is probably not what the rate would actually be, anyway. Bartlett said in the real world, it would be closer to 30 percent.

Economist Robert McIntyre, director of Citizens for Tax Justice, a liberal think tank, said other estimates of the tax rate necessary to run the government have been even higher than that.

"Imagine a 40-to-50 percent sales tax -- that would cheer everybody up," McIntyre said.

What's more, a simple sales tax would punish people at the lower end of the income scale, who tend to consume almost all of their income in order to stay afloat. That means they'd be taxed at the 30-percent rate on their full income, while the wealthy would be taxed only on whatever part of their income they spend.

If somebody making $500,000 spends $250,000, for example, they'd be taxed 30 percent of what they spend, or $75,000, which amounts to just 15 percent of their total income. That's called a "regressive" tax -- the higher your income, the less tax you pay -- and it is not a politically popular idea.

What's more, McIntyre and some other economists believe, it will hurt the economy. If people are taxed heavily on their consumption, they'll be inclined to consume less, according to this theory, which will force businesses to produce less.

"If people don't buy stuff, why would anybody invest in machinery to make stuff?" McIntyre said.

Supporters: sales tax would boost economy, cut prices

Supporters of a national sales tax, however, say such concerns are misguided. For one thing, they argue that encouraging investment and spending will improve the economy, making everybody -- rich and poor -- better off.

They also suggest that eliminating corporate taxes will cut the base costs for most goods and services. In other words, consumers won't be paying $130 for a $100 DVD player. Instead, the price of the DVD player could be cut to, say, $80. The 30 percent tax on that would take the final price to just $104 -- a negligible price increase, which could be followed later by price declines.

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"We will have more investment and business growth, which leads to lower prices, because more people will be coming to the marketplace with similar products," said Stephen Slivinski, director of fiscal studies at the Cato Institute, a libertarian think tank.

What's more, they believe that people will be encouraged to work harder and earn more if they know Uncle Sam won't be taking some of their extra money.

Liberal economists respond that the world isn't that simple -- do a Google search for "backward-bending labor supply curve" one day, if you have absolutely nothing better to do -- but the idea could have some political resonance.

Slivinski also said the regressiveness of a sales tax could be eased by, for example, helping lower-income workers open up tax-free retirement accounts.

Rep. Linder's proposal would also give every family a partial tax refund at the start of each month, based on the poverty line. Others have proposed similar refunds of basic living expenses -- which would, however, potentially drive up taxes on other items.

Still, Slivinski agreed that scrapping the income tax and replacing it with a national sales tax was probably a tall order, politically.

But he suggested Republicans could find a way to back into a consumption tax in a more nuanced, politically palatable way -- for example, by allowing unlimited contributions to 401(k)s. This would help cut taxes on investment and saving, leaving only disposable income to be taxed.

In fact, the "ownership society" theme Bush has been trumpeting on the campaign trail recently could, in the long run, have a similar effect as a national sales tax. That theme encompasses several policies, including Social Security privatization and health savings accounts, which would ostensibly cut the cost of investment and saving, just as a national sales tax would.

"Going in the direction of an ownership society gets you to the consumption tax in a different way," Slivinski said.  Top of page




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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.