Friday, April 16, 2010

National Sales Tax is No Panacea

Imagine America without an income tax; it’s easy if you try. No more payroll tax; no more tax brackets; no more audits too. What you earn is what you get whether it comes from wages, net profits, or investment income and April 15 means nothing to us anymore.

Sounds like Utopia and that is what the national sales tax proponents want you to believe. Presidential candidate Mike Huckebee supports a national sales tax to replace the Federal Income Tax. So do the Americans for Fair Taxation. Even Republican rising star and candidate for the US Senate in Florida, Marco Rubio, endorses it. They all envision a much more simple, and in their view, a more fair tax structure. They believe it would eliminate the need for the Internal Revenue Service, stimulate the economy, and even resolve our illegal immigration problems.

There is an old saying, “If it sounds too good to be true, then it probably is.”

The national sales tax proponents estimate it would require a 23% sales tax rate to generate enough revenue to replace the Federal Income Tax. But, here in lies the first problem with the national sales tax proposal. You have heard of hidden costs, right? Well, here is a whopper for you. If I asked how much tax you would pay on a $100 purchase with a 23% sales tax, most everyone would say $23. But, that is not the kind of math the national sales tax proponents use. They say, you would pay $30 in tax and $30 divided by $130 equals a 23% tax rate. Talk about smoke and mirrors. Every state in the country that has a sales tax divides the tax collected by the price of the good or service to calculate the excise tax rate. $30 divided by $100 equals a 30% tax rate.

Let’s address the fairness issue. I do not believe it is the government’s responsibility to redistribute income to make things more “equal.” However, there is a certain sense of fairness that suggests that those who have higher income can better afford to pay higher taxes. That is this core principle behind America’s progressive income tax structure wherein those with higher income levels may find themselves paying a higher percentage tax rate. Indeed, America’s income tax structure is so progressive that in 2007, the top 10% of income earners paid 71% of the income tax collected. But, it is also common knowledge among economists that sales taxes are the most regressive form of taxation. The reason is that people with lower income levels spend a much higher proportion of their income on sales taxable goods and services. While it is true that wealthy people buy more expensive products, in the end, they spend a much lower percentage of their income on sales taxable items. Wealthier people save a much higher percentage of their income and investments and savings are not sales taxable items.

A national sales tax may mean the end of the Internal Revenue Service, but can anybody really be gullible enough to believe that there will not have to be something like a Bureau of National Sale Tax to develop a reporting system, account for the sales tax revenues, and enforce the collection from consumers and payment to the Federal government of a national sales tax. And, if you think people use the barter system to avoid income tax now, just wait until they can save 30% on the cost of a car by trading straight across. I do not believe anybody has really studied or measured the amount of barter trade that occurs in America today, but we all know it happens every day. People all over the country are providing goods and services in exchange for other goods and services they need and thus avoiding income tax and Social Security and Medicare taxes. A 30% sales tax will drive even more of our economy underground, and to deter barter trade, the Federal government would have to create an onerous and invasive tax bureau that would make the IRS look like a pussy cat.

The national sales tax proponents argue that by eliminating payroll taxes, consumer’s pay checks would increase and thus they would spend more and stimulate the economy. What the proponents fail to consider is that any tax diverts money from the private sector to the government sector. If a national sales tax collects the same amount of revenue for the Federal government as the income tax does now, then the amount of money diverted from the private sector remains the same. A national sales tax that effectively replaces the income tax cannot stimulate the economy because it does not result in any more money being available for private sector economic activity. Moreover, what happens to the housing market when mortgage interest paid is no longer deductible for income tax purposes? What happens to car sales or large appliance sales when their costs effectively increase by 30%? How many fewer dinners will your family buy at restaurants when the cost of a meal goes up 30%?

I fail to see how a national sales tax would resolve our illegal immigration problems. People who are in this country illegally are even less likely to conform to our laws and regulations. They already have well developed systems of barter trade and underground activities to avoid detection. It would be easy to adjust such a system to help them avoid a national sales tax as well. And, the incentive for citizens and legal residents to pay cash for services provided by illegal immigrants would go up because the services these immigrants provide would be sales taxable services under a national sales tax.

Historically, economists and tax policy wonks have always maintained that the most fair and stable way to fund government operations is through a system that includes a mix of property taxes, sales taxes, and income taxes. All of us would like a more simple and fair tax system. The Internal Revenue Code is the largest piece of legislation in this country. Even, the IRS cannot answer every question about the income tax. Certainly, current Treasury Secretary, Timothy Geithner, and other government officials have had their problems figuring out their income taxes.

Ronald Reagan proposed income tax reform in the late 1980’s. He wanted a simple and much lower flat rate tax for all taxpayers. To keep it revenue neutral, increase equity, and insure everyone pays some taxes, Reagan’s tax reform would have eliminated all tax deductions. At its surface, this sounds like a good idea. But the facts are that Congress has used the tax code over the years to create incentives for certain activities such as home ownership, charitable contributions, saving for retirement, investment capital for business, and even historic preservation. While the wisdom and need of those incentives could be questioned, the reality is that billions upon billions of dollars have been invested on the basis of the current rules of the game. Many people would argue that changing those rules in the middle of the game is grossly unfair and would cause economic havoc.

When it comes to tax policy and tax reform, a couple of principles come to mind. Be careful what you ask for and Caveat Emptor (buyer beware). Although I hate to say it, maybe in the case of the income tax versus a national sales tax the old adage is true, “Better is the devil you know than the devil you don’t know.”

Friday, April 2, 2010

A Really Big Deal

After decades in public service and several gaffs to his credit, you would think Vice President Biden would know that the microphones are always on. But, I guess he just cannot help himself. During the Health Care Reform legislation signing ceremony, he leaned over to the President and said, “This is a really big [expletive deleted] deal!”

F-Bomb aside, the VEEP is absolutely right; this new Health Care Reform Law is a really big deal. As Nancy Pelosi said the night the bill passed the House, this is the biggest and most significant piece of legislation since Social Security and Medicare were passed. That says a lot. Social Security and Medicare are two well regarded federal programs, but they are not financially sustainable as currently configured. Social Security recently passed a significant and dubious milestone; for the first time ever, payments going to Americans exceed payments by Americans into Social Security. Notwithstanding any of the arguments that Congress has raided the Social Security Fund, most experts agree that without significant structural changes the Social Security System will be insolvent some time soon after 2030. Medicare is said to be going broke even faster. Now, we have added to these two significant challenges, a new federal entitlement that may be just as unsustainable in the long term. A World War II F-Bomb comes to mind—SNAFU.

Perhaps the really big deal about Health Care Reform is not whether it is good or bad policy. There are plenty of arguments for and against health care reform and there seems to be no end to the disparate facts cited in support of either side. While politicians are quick to claim “the people” are on their side, Americans can best be described as divided on the issue. Although most polls say more people believe the recently passed plan is a bad idea, I believe even more Americans are frustrated by the way this “really big deal” went down. I cannot remember when more partisan politics have prevailed. It seems that public ire has been fueled more by the unscrupulous abuses of power than the merits of the policy.

The Republicans, labeled the “Party of No” by Health Care Reform supporters, did advance a detailed and comprehensive set of alternatives in their own health care reform bill. However, there was little or no consideration given to any alternatives to the recently passed bill. And while the Republican alternative was publicly mashed in series of legislative slams, the Health Care Reform bill of choice was crafted in a back room by a selected handful of legislators.

When the Democrats lost their super-majority in the Senate after the surprising election of Scott Brown in Massachusetts, many pundits thought Health Care Reform was dead. There appeared to be no consensus on how to reconcile the House and Senate bills and the Senate leadership feared a filibuster could not be overcome. But, the bill was revived when the majority party opted to use the Senate Reconciliation Rule to resolve differences with the House bill and circumvent the filibuster process. Oh, to be sure, the Reconciliation Rule has been used in the past by both parties to enact legislation that was substantially non-budget. The difference is that in those cases there was strong bi-partisan support for the legislation. For Health Care Reform, the only demonstrated bi-partisanship was when a number of Democrats joined Republicans in opposing it.

Americans were also frustrated by the fact that when the House passed their Health Care Reform bill, many in Congress had not even read the 2,000 page proposal. More to the point, it was only made available to Members of Congress and the public hours before the vote. It occurred to many Americans that the promise of transparency in government was a fleeting notion at best, lip service at worst.

Then along came the Senate version of Health Care Reform, and when several Democrats said they could not support the bill on principle, the Senate leader went to work. Americans have been truly outraged at the sweetheart deals made to “buy” votes in what appears to be one of the most overt forms of legislative chicanery. I have heard many Americans suggest that Article II, Section 4 of the Constitution, which provides for removing the President from office for “bribery,” should be applied to Members of Congress.

In a twist of irony that really makes a person’s head spin, Congress has once again exempted themselves and the President from the very law that they fought so hard to pass. Truly, one has to wonder if Health Care Reform is so good for America (the goose), why is it not good for Congress and the President (the gander). Apparently, Members of Congress and the President have what they call Cadillac plans. So while most Americans will likely pay more for health care and health care insurance, Congress and the President have adopted a double standard because the new law does not apply to them.

The Health Care Reform debate energized Americans and this is a good thing. People who had grown apathetic got involved, and most of this energy has been positive, it also has resulted in frustration for some. On numerous occasions the telephone systems at the Capitol were overwhelmed by callers. People calling district offices were relegated to answering machines and all too often the voice mail boxes were full. As the health care debate developed, Americans struggled to learn about the bill being considered. Because of the size of the bill, complexity, and legalese, it was unintelligible even for many Members of Congress. As time went on, more light was shed on what this legislation would do and would not do. Those opposing the bill even included many reform supporters who felt it did not go far enough when the public option was dropped. As the ground swell of opposition grew, many people felt they were not being heard, or worse yet, they were being ignored.

After the Health Care Bill was passed by the House of Representatives late on a Sunday night, many people vandalized offices and made threats to members of Congress on both sides of the aisle. This was not appropriate and I do not support this kind of activity in any way, shape, or form. But, we would do well to better understand what causes otherwise law-abiding citizens to resort to civil disobedience or even violence. For many of us who have been politically active or engaged in trying to change government policies for many years, we are used to defeat and even humiliation.

The current health care debate is over. Those of us who opposed this particular brand of reform have lost this round. To those Americans who feel disenfranchised by the process or who were abhorred by their first exposure to the making of sausage and legislation, I say do not lose heart and stay involved. Our democracy is not perfect, but it is the best form of government out there. It is not whether we win or lose; it is about how we engage in the process.