Filed Under: Featured
Tags: corporate taxation • fair tax • flat tax • income tax • income tax compliance • IRS • John Linder • Ludwig von Mises • Neal Boortz • sales tax • tax reform • VAT
Sales, Flat, or Spherical, Tax Reform Isn’t the Answer
Lately there has been a flurry of interest in tax reform, typically aimed at making compliance less onerous, removing the incentive for special-interest lobbying, and reducing the size and intrusiveness of the tax-collection agency. While few people will reject those ends, that does not imply that the attempt to achieve them is the optimal use of the inevitably limited time and energy that citizens choose to devote to political activities. Of particular relevance to readers of this magazine is whether friends of liberty ought to focus on such reforms to forward the cause of freedom.
There are also schemes circulating for supplementing the current income tax with, for example, a sales tax or VAT (value-added tax), but such plans are unlikely to gain much support from libertarians, given that they pose the obvious danger of providing the government with an additional way to collect revenue. Since they threaten to merely increase the overall tax burden on society without offering, from a libertarian point of view, any compensating benefits, I will not address them in this article.
However, suggestions for replacing the income tax with a sales tax, or simplifying it by taxing everyone at a single rate and eliminating all deductions (a “flat” tax) have caught the fancy of some libertarians. The main attractions of these ideas are that substituting a sales tax or flat tax for the current income tax appears to ease the burden of tax compliance. A sales tax in particular does not seem to penalize savings and investment the way an income tax does, and the promoters of such policy changes contend that their new system of taxation will produce results closer to those that would come about on the unhampered market than does the existing apparatus.
One popular proposal along such lines has recently been described in The Fair Tax Book, coauthored by talk-show host Neal Boortz and Georgia congressman John Linder. Because of its prominence, I will use it as a paradigm for all plans of its kind. I believe that the problems it contains are endemic to other similar schemes; so my case against Boortz and Linder also applies more generally.
The authors under discussion present their alternative to our present system as a virtual cornucopia pouring forth blessings on the American people. Implementing their idea, they contend, will do away with the oft-reviled IRS, reduce the effort devoted to complying with the tax code to almost nil, greatly lift the living standards of the poorest Americans, reverse the trend of U.S. firms relocating overseas, and provide a tremendous boost to the nation’s economy. Clearly, if these promises are realistic, everyone should enthusiastically support their plan. However, a clear-sighted analysis of the proposal reveals that the case for predicting these benefits is constructed on a foundation riddled with wishful thinking and flawed logic.
For example, Boortz and Linder argue that their tax system will greatly boost the purchasing power of most Americans’ incomes, since it eliminates the portion of the cost of every good that currently stems from the seller’s tax burden. However, their argument relies on a ludicrous assumption as to where the incidence of present taxation actually falls: On the one hand, they claim that eliminating the income tax will reduce the price of what you buy roughly 20 or 30 percent because producers all pass the tax they pay on to you through higher prices. On the other hand, they also point out all the money you’ll save by no longer paying your own income tax. Apparently, unlike those involved in making everything you buy, you can’t just pass on that tax to others. It seems the incidence of the income tax falls entirely on one special segment of American society: the readers of The Fair Tax! The authors are guilty of counting the savings their readers will see from ending the income tax twice, once in the price of the things they buy and again in their own paychecks. In reality, getting rid of any tax will result in some combination of lower prices and higher incomes, the proportion depending on the particular circumstances of each case. But the total of the two effects will only sum to the gross reduction in taxation, and certainly not to double that figure!
Another supposed advantage of the Fair Tax is that, unlike the present situation where taxes are withheld from every paycheck, obscuring the share of one’s income that the government takes, the Fair Tax will be clearly visible, listed on every sales receipt. However, given that it would be a ubiquitous aspect of all one’s shopping, it is hard to see why its presence won’t fade from view just as readily as the income tax has through withholding. After all, workers today get a “receipt” with every paycheck that plainly shows how much of their salary went straight to Uncle Sam, but that has not solved the problem.
IRS Unnecessary?
Another curious claim on the part of the authors is that the Fair Tax will make the IRS unnecessary. Apparently, people will simply pay this sales tax with no need for an enforcement agency. No one will ever claim that what are really retail sales are wholesale, and no one will ever hide cash transactions from the government—all because we’ve changed how we collect a tax burden that remains just as large as it is today.
To illustrate the lack of realism on display, I’ll offer just one example of how the Fair Tax could be avoided (with a little imaginative effort the reader will probably be able to come up with many others): the tax is imposed only on final sales, meaning those to consumers, and not on purchases made by producers along the way to that end point. So let’s say some executive is tired of paying 23 percent extra—that’s the sales tax rate our authors envision—on everything he buys. The way around the tax is to have the firm pay for as much of his consumption as possible, by devising some way to portray buying the items as important business expenses rather than personal purchases.
Boortz and Linder will no doubt respond that such a practice will be illegal, but that’s not the point. To catch people at such a game requires an investigative body on the lookout for its taking place—the players are not going to turn themselves in, nor will those uninvolved easily spot the activity and report the participants to the authorities. Even with today’s comparatively low sales taxes imposed by state and local governments, it is common for small-business owners to offer a customer a discount for paying in cash, thereby splitting the savings from tax avoidance between the two parties. The Fair Tax rate, three or four times higher than its present counterparts, will promise a proportionally larger reward for successfully dodging it. Fair Tax advocates may not call the agency tasked with enforcing compliance with the new law the IRS, but they will surely require such an agency if they plan to maintain government revenue at anywhere near its current level, which is a crucial element in their sales pitch.
Moving Offshore
The contention that this kind of tax reform will stem the tide of American businesses relocating overseas relies on firms taking into account the tax impact of corporate decisions. If moving headquarters to some tax haven, such as Bermuda or the Cayman Islands , can significantly lower the firm’s tax costs, then the move is likely to get serious consideration. It is true, therefore, that eliminating corporate taxation, as Boortz and Linder propose to do, will be an attractive change in the eyes of multinational companies. However, executives do not consider only corporate taxes in deciding where to locate. The taxes they and their employees will personally have to pay, as well as the amount the local tax system adds to the cost of the products purchased within the country, are also relevant factors. Therefore, the best bet for a nation wishing to retain existing businesses and attract new ones is to have a low total tax burden, rather than to eliminate one form of taxation while seeking to completely offset the lost revenue by introducing a new method of collection.
To be fair to our authors, I will note that they also suggest their support for reducing the overall tax take, but they have decided to separate that issue from their tax proposal and focus on the latter, since they believe it would prove highly beneficial even without any tax cuts. This, I suggest, is a major error.
There is a subtle matter of economic theory, expounded by the great Austrian economist Ludwig von Mises, that is worth examining here since it has great bearing on the topic at hand. In his crowning work, Human Action, Mises points out that the actual burden of any tax is determined by the market process rather than by the taxing authority. The deep import of Mises’s contention can easily be overlooked because it seems at first glance to merely reiterate a standard lesson contained in introductory economics courses. It is commonplace for beginning students to encounter a demonstration of how the portion of a tax on, say, alcohol, that is paid by the buyer versus the portion borne by the seller is quite independent of the government’s decision as to which party is legally obligated to pay the tax. If, for example, there were only one supplier of alcohol, while drinkers’ demand for booze dropped very little in response to increased liquor prices, then the consumers would wind up bearing most of the burden of any new tax, even if officials assign the seller the responsibility for remitting it. Indeed, Boortz and Linder sometimes seem to grasp this idea, although they ignore it in contending, as I noted, that all the cost of the present income tax is passed on through higher prices.
But Mises’s insight goes well beyond the typical analysis. The mainstream textbooks analyze the market for the taxed good as if it were entirely self-contained, isolated from the rest of the economy. But in the real world the supply and demand for any good is deeply intertwined with the markets for all alternative goods and services that might be produced or consumed. That means that although legislators might be seeking to tax the alcohol industry, in reality it could turn out to be, say, truck drivers who are hardest hit, if liquor companies shift toward shipping by rail in response to their new cost. Or perhaps soft-drink manufacturers will be the group most affected, if consumers decide to forgo a few sodas a week to maintain their previous level of alcohol consumption at the now higher price.
One crucial ramification of understanding that the market determines the true incidence of a tax is that the particulars of how a government collects its revenues are of decidedly secondary importance. Of course, it is possible to design tax schemes so Byzantine that trying to comply with them is even more onerous than paying the taxes themselves. But in general the market process will distribute the true incidence of a nation’s tax system according to the cumulative dictates of individuals’ supply-and-demand decisions, thwarting policymakers’ dreams of directing the burden by top-down planning.
Another fundamental error common to tax-reform schemes like the Fair Tax is that their proponents evaluate the attractiveness of their favored plan in an ideal world where powerful and wealthy special interests won’t greatly influence its realization. They then compare that fantasy scenario with the messy reality of the tax code we have today. But any method of taxation that attempts to divert as much of the output of society’s productive activities into the coffers of the state as does the current one will inevitably prompt intense efforts by a multitude of parties to tailor the actual details of the system to their liking. I see no reason to imagine that their lobbying would not complicate any “reformed” tax code until it is as convoluted as what we have today. The only reform that is likely to avoid that fate is a dramatic reduction in the total tax take, thereby greatly decreasing the potential payoff of successfully tilting the system in one’s favor.
I don’t mean to rule out the possibility that one or another tax reform might represent a genuine improvement over the present situation. But the key question is whether such proposals deserve any significant portion of the necessarily limited attention that libertarians can devote to policy issues. A small reduction in the penalties currently imposed for drug crimes would no doubt be a step forward, but I suggest that focusing on such a goal would be a distraction from the real libertarian aim of repealing all laws violating individuals’ freedom to decide on their own what to eat, drink, and smoke.
Similarly, while the hope of achieving any large decrease in the level of taxation may appear remote today, that hope will only recede further into the distance if we dissipate our energy in marginal battles that, even if won, would leave the core of the problem untouched.
Those who desire to relieve the crippling effect that today’s massive states have on their citizens ought to focus on reducing the share of private wealth that governments are able to claim as their due. To instead concentrate on tinkering with the means by which that claim is effected is like a doctor treating a person for athlete’s foot even while the patient is suffering a heart attack.
Comment by Robert L. Hall on 27 May 2009:
Mr. Callahan you are way off base here on tax reform, if you would read the fair tax plan you will see that it is the best thing this Country could do to bring about a tax reform. It would create more jobs; it would get Uncle Sam’s hands out of our back pocket. It would allow me to keep more of my hard earned money instead of sending it to Washington DC for those idiots to spend on their pork barrel projects in order to keep getting reelected.
Tax reform is exactly what this country needs to get this economy humming again, tax reform would give more people an opportunity to build their own business, and Tax reform would give people an incentive to make more money and to invest more money which in turn would create more jobs. So Mr. Callahan I encourage you to go back and do your home work or don’t write on subjects that you know nothing about. I would like to hear from you on this subject.
Thank you for your time.
Sincerely,
Robert L. Hall
Alexandria, AL
Comment by Philip Hasty on 27 May 2009:
Like so many who have offered objections to the “Fair Tax”, Mr Callahan either distorts or takes out of context the ideas of Congressman Linder and his co-author Neal Boortz. The Fair Tax doesn’t offer double savings as Mr. Callahan argues. It offers to accumulate the same income from the government, but from different sources. Linder and Boortz never claim what Mr. Callhan says they claim. His argument that the Fair Tax won’t do away with an agency charged with collection and enforcement seems rather petty. Everyone with any common sense knows there would be such an agency, then difference being of course that the common man who doesn’t try to scheme his way around the system would never have any interaction with such an agency. He wouldn’t be called upon to make his weekly or quarterly payments, nor would he have to wonder each April 15 whether some part time auditor at the IRS would come knocking on his door about some deduction he listed on his 1040.
Mr. Callahan also complains that the Fair Tax plan wouldn’t be enacted in its current form because of special interests and lobbyists. It seems ironic to me that while claiming to be a libertarian, he doesn’t support a plan that hopes to remove power from politicians and the government over our personal lives.
Comment by David Ralston on 27 May 2009:
As a CPA that has worked with small businesses and prepared tax returns for over 30 years, I strongly support a national sales tax and elimination of the income tax and the IRS as it is today for the following simple reasons:
1. The income tax is unevenly distributed amoung the American people. It has turned into a welfare program that makes it more of income distribtution system, which is characteristic of a socialist government. 20% of the population has more than 80% of the tax burden. As a result, they don\’t have a real voice in our government.
2. Due to the fact that every state has a effective sales tax collection system thru their infrastructure, which the federal government could piggyback on. This would eliminate the need for the federal government to set up a large and costly presence in each state. The feds would only need a small office to oversee the collections and they could pay a small percentage of federal taxes collected to each state to cover their expenses.
3. Also this would eliminate the heavy cost of tax preparation and planning, and the non-productive time spent on those areas by individuals and businesses. This would be huge boost to the economy alone.
4. Also it would make it harder for our government(congress) to pass on sales tax increases and enlarge our government unnecessarily, because then 100% of the population would be affected and then they as a group would have a more powerful effect on fighting those increases.
5. Not sure what the author meant by business expenses be non-taxable. Business expenses would be taxed the same. Unless he is talking about \"Cost Of Goods Sold\", which is products used directly in the manufacturing goods to be sold.
6. A value added tax is a subterfuge to hide taxes, where a sales tax placed on the goods is a direct and open tax.
7. The elimination of the IRS would be a huge savings to the American people and the govenment. Also,the IRS is the economic equivalent of what the KGB was to the USSR. Politicans have used it to intimidate their opponents, and people have a great fear of it, and are often bullied into paying taxes that they don\’t owe. It is a drain on the economy and the psychic of the American people.
8. Businesses would increase and the economy would grow more prosperous than ever before.
Thank You,
David Ralston
Comment by Robert L. Hall on 27 May 2009:
I whole heartily support the statements made by Philip Hasty and David Ralston on the fair tax. Mr. Callahan needs to read the Fair Tax plan again so he can get all of the information he needs before he writes on tax reform again.
Also the one big thing that needs to be done to make any tax system fair is to repeal the 16th amendment.
The Sixteenth Amendment (Amendment XVI) to the United States Constitution allows the Congress to levy an income tax without apportioning it among the states or basing it on Census results. This amendment overruled Pollock v. Farmers’ Loan & Trust Co. (1895), which greatly limited the Congress’ authority to levy an income tax.
It was ratified on February 3, 1913.
Robert L. Hall
Alexandria, AL
Comment by Ed Holden on 27 May 2009:
Certainly a more efficient method of collecting taxes can be devised. Was it not Milton Friedman who devised the very effective witholding system? It seems to me that spending time and effort on the best method of tax collection is akin to rearranging the deck chairs on the Titanic. Perhaps if I were being executed by the state, I could advise them on the the method that would be the least painful to me. Gene Callahan correctly identifies the problem as the level of taxation and not the method.
Comment by Robert Kinnett on 27 May 2009:
Left out of this discussion is the important issue of state soveriegnty. The appeal of states has always been that people would have a national government limited in power, and could migrate if their State became too oppressive.
Since 1913 and 1937, Washington has taken enormous power away from the states. Moving to a ‘joint’ system of sales tax collection would quickly be taken over by the feds, with states getting the short end of that stick.
The only solution is for voters to be educated enough to support a reduction in the powers of Washington. No one argues that the founders or the Constitution envisioned a federal government that could vote dollars any direction it wanted… Or print dollars for that matter.
Comment by Sheldon Richman on 31 May 2009:
"The Sixteenth Amendment (Amendment XVI) to the United States Constitution allows the Congress to levy an income tax without apportioning it among the states or basing it on Census results. This amendment overruled Pollock v. Farmers’ Loan & Trust Co. (1895), which greatly limited the Congress’ authority to levy an income tax."
This is misleading. The Pollock case did not declare the tax on wages and salaries unconstitutional. Nor did it hold that such a tax must be apportioned among the states by population. On the contrary, it affirmed (alas) that Congress has the unquestioned authority to tax wages and salaries, regarding it as an indirect tax that does not require apportionment. What the court struck down was the tax on the income from real and personal property. Such a tax, the court said, is identical to a tax on the property itself, which (in the court’s view) is a direct tax requiring apportionment.
The court proceeded to strike down the entire tax bill, including the wage-and-salary tax, but only because not to have done so would have put the entire tax burden on wage and salary earners, contrary to Congress’s intent. To repeat: the court did not declare the tax on wages and salaries unconstitutional.
The 16th Amendment was intended to permit a tax on property income without apportionment. The key words in the amendment are "from whatever source derived."
Thus if the 16th Amendment were to be repealed, Congress could still tax wages and salaries legally (though not morally in my view). See my article here.
Comment by Gene Callahan on 1 June 2009:
Mr. Hasty: “Linder and Boortz never claim what Mr. Callahan says they claim.”
You seem to be saying I’m lying! Everything I wrote about their claims I took directly from their book. If you care to point to a specific claim you think I got wrong, I will find you the specific page and quote where they say exactly what I wrote that they say.
Mr. Hall says I need to read the book again. Yet he doesn’t cite anything I misunderstood about it. So what would the point of this be?
Mr. Ralston: “Not sure what the author meant by business expenses be non-taxable. Business expenses would be taxed the same. Unless he is talking about \”Cost Of Goods Sold\”,”
The tax as proposed is only levied on final sales, not on sales for business expenses. That is quite explicit in the plan. Perhaps Mr. Ralston needs to read the book again.
Comment by Rocket Man on 2 June 2009:
While Libertarians have a few good points they tend to harp on causes that can never come to fruition. Most on this thread could likely agree with the premise that we need a much much smaller and less intrusive government, especially at the federal level. But, short of a revolt and revolution, does anyone honestly believe that the Libertarians could ever make Joe Public understand? I once believed it possible but no longer have the confidence in my fellow citizens. Case in point, look at who the masses elected to run the show in both the Executive and Legislative branches. Those who think correctly are at a definite disadvantage. With out decrepit educational system and a leftist news and print media, and a soon-to-be regulated radio and internet (via Fairness\’esq Doctrines) how do you propose we educate Joe? The best method I\’ve yet seen is to make incremental advances. We need to be on the same team Libertarians! I\’m a college-educated business major who has run a business for many years and the \"Fair Tax\" is the best tax proposal/idea I\’ve seen in my 46 years. It AINT PERFECT, OK! But it is a step in the right direction and, most importantly, it is teachable to Joe Public and is, therefore, implementable. Pie-in-the-sky libertarian rhetoric is not.
RM
Comment by John Anello on 2 June 2009:
One of my major apprehensions about the flat tax is that the actual rate of taxation would be purely arbitrary and subject to same rapacious politicians and bureaucrats as our current tax system. What would be a “fair” rate? 6 percent? 10 percent? Who knows? But who would decide, some Washington czar no doubt. Hayek said that what is needed in a tax system is “a principle that will limit the maximum rate of direct taxation in some relation to the total burden of taxation.”
Comment by Jeff Smith on 21 April 2010:
Nice analysis. Correct or not, I can’t answer – I just don’t know enough. However, on the surface any plan that does away the multi-thousand page, Byzantine system with special exemptions for single companies we have now has, I say HAS, to be better than the current system, imperfect as the new system may be.
But what really irritates me about articles like this is they are great at picking at someone else’s idea, but they don’t propose a better one. Just saying lower overall taxes isn’t a plan. Not even close.
Try again, maybe you’ll do better…
Comment by Erich Lamontagne on 21 April 2010:
@Rocket Man
“Pie-in-the-sky libertarian rhetoric” lol- really? Pie-in-the-sky? I think you need to sit down, watch a Disney movie, and get a little hope, padre. Libertarianism is incredibly simple. We just have so many people with state-educated doubt mental blocks, for example
@Robert L. Hall
says (in my own words) “wahh the Government is not stealing from us the best way.” Come on, how complicated is the idea that government “experimenting” with people is immoral- you “lets tax ourselves better,” people, just want to be the experimenters.
If you’re like @Rocket man and have lost your “confidence in my fellow citizens” that sounds like a personal problem. What do you think the government thinks? That we can take care of ourselves? Ha.
@Jeff Smith
If you’re not educated enough to appreciate a critique, don’t whine about it. Go read some low-bar propaganda like @Rocket Man
“It would create more jobs; it would get Uncle Sam’s hands out of our back pocket… …those idiots to spend on their pork barrel projects in order to keep getting reelected.”
Can you believe this guy? Who says this kind of stuff? He’s practically a propaganda robot, no mind of his own, just repeating some crap he read somewhere. Don’t be a troll!
Comment by Michael Johnson on 26 April 2010:
Mr. Smith needs a plan? How about simply repealing Amendment 16 and eliminating the income tax …. replacing it with NOTHING? The Feds were able to ‘live’ without it from 1789 until 1913, they can certainly do so again.
Not that Mr. Callahan needs assistance, but Laurence Vance has two rather detailed critiques of Boortz’s books that even the kool aid drinkers might grasp. At the very least they complement Mr. Callahan’s efforts.
There is No Such Thing as a Fair Tax
Monday, December 12, 2005 by Laurence M. Vance
http://mises.org/daily/1975
There Is Still No Such Thing As a Fair Tax
Thursday, May 15, 2008 by Laurence M. Vance
http://mises.org/daily/2961