Paul L. Caron

Tuesday, September 7, 2004

Winners and Losers Under a National Sales Tax

Tuesday, September 7, 2004

The Institute on Taxation and Economic Policy has issued an 18-page report, The Effects of Replacing Most Federal Taxes with a National Sales Tax: A State-by-State Distributional Analysis. The report concludes that replacing existing federal taxes with a national sales tax would shift the tax burden from well-off individuals and states to middle- and lower-income individuals and states:

• In virtually every state, the bottom 80% of taxpayers would face much higher taxes (a $3,200 per year average tax increase).
• The 80% of middle- and lower-income taxpayers would pay 51% more in taxes.
• The wealthiest 1% of taxpayers would save $225,000 in taxes each year.
• 13 states (and D.C.) would pay less, while the remaining 37 states would pay more.
• Of the total amount shifted among states, 50% would go to California and New York (even though most Californians and New Yorkers would nevertheless pay considerably higher taxes.)
Here are the leading state winners and losers under a national sales tax:
District of Columbia..........Rhode Island
New Jersey.........................Mississippi
New York.............................Montana
New Hampshire.................Kentucky
Massachusetts...................New Mexico
Illinois...................................West Virginia

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My understanding of the proposed national sales tax suggests that while those who spend an amount equal to the official poverty level - or less - would pay no tax, this tax would be regressive for the working class, esp those earning (roughly) between $15K and $30K (depending on certain conditions, e.g. kids or no kids (and how many), rent or own). For one thing, the tax credits important to the working class would be eliminated.

I have not seen anyone yet note that it's particularly regressive for those above the poverty level who cannot buy homes and must therefore rent - their rent would be taxed, while purchase of an existing home would not be taxed.

So consider two identical $100K homes. One is owner-occupied, the other is rented for $1000/mo. Homeowner H pays no NST, renter R pays through the nose, month after month. Toss in $200/mo in property taxes, paid directly by the homeowner and indirectly by the renter. (More on this in a bit.) A new underclass of working renters, unable to buy homes and paying higher taxes indefinitely, would be created. Note also that renters would suffer from tax cascading, as the $200 they pay indirectly in property tax would now be taxed again. Since they live in identical homes, it's unlikely that R's housing consumption exceeds H's - while it might be called a consumption tax, it's not exactly consumption that's being taxed here. Note also that H would be able to spend more on housing and also more on other things than R spends, while paying less tax. How is this fair to R?

Posted by: Frank Lessa | Nov 12, 2004 4:16:14 PM

A few missed points in the PDF- revenue would now be garnered from all that make money "under the table", from all that have tax shelters and dodges and then the very rich may well buy more and still pay more taxes.

Posted by: John E. Carte | Nov 10, 2004 3:56:50 PM

I think the first real step to changing the tax code in any direction is to agree on the rationales, which it seems to me might include:

- reducing inefficient market activity that occurs in response to a convoluted tax structure

- reducing/eliminating tax abatements that are now unintentionally being given to people and/or companies who are gaming the system or who do not need/deserve them

- reducing the government's cost of collecting taxes

- reducing citizens' costs of complying with the tax code and calculating taxes owed

- to provide government with a more consistent, predictable revenue source -- and to provide government with a fairer, easier tool to predictably raise and lower tax rates to provide stimulus or meet revenue needs in times of crisis (e.g. war), collection drops, surplus, and during recessions, as well as to meet increasing debt obligations


- to maintain overall equity in the system insofar as it correlates to American ideals: which I think tend to mean: that those benefiting the most from the opportunities America creates can give a little more back; that we encourage/reward the working poor to keep working; that we enable government to meet its obligations without sticking our children with the debt; and that we still encourage entrepreneurialism, investment and savings

One of the biggest tax issues in my mind is the current emphasis on only taxing individuals' earned income. Efforts to reduce dividend, capital gains and estate taxes to me are misguided. I think most double taxation arguments are bogus. Individuals earn income by investing their time and/or property/money. Some have more of one thing than the other. Either way, I think you should pay tax on the returns (until income tax is eliminated). Similarly, I'm against an estate tax, but I'm all for a tax on inheritance (particularly when coupled with a sizable exemption). Someone who inherits money from their father or mother should have no greater benefit than someone who earns a salary while working for the family business. To me, this gets to the core of the American dream -- we are for opportunity and mobility, not the plodding aggregation of all wealth in the hands of a few, who come by it through dint of blood relation and then don't even pay taxes on the dividends or equity investment returns.

Posted by: Parker | Sep 8, 2004 1:33:14 PM

"You can't move tax collection later in the earn-and-spend cycle without hitting savings twice. So retirees would be against it."

It's conceivable that we could move to a new dollar with an exchange rate that compensated for the new taxes. It would sure be an ugly process, however.

Posted by: McGroarty | Sep 7, 2004 7:02:17 PM

It instantly confiscates 25% of your savings, if you happen to have some, say savings outside an IRA for retirement.

You can't move tax collection later in the earn-and-spend cycle without hitting savings twice. So retirees would be against it.

Then there's the ugly matter of what the Fed does about prices - does it allow deflation that tanks the economy, or in effect is there in addition a real inflation that will be accommodated? Neither is a good choice.

So what you get is gigantic wealth transfers, and random winners and losers, from the point of view of incentiv

Posted by: Ron Hardin | Sep 7, 2004 6:15:57 PM

This analysis ignores indirect taxation. Ronald Reagan said it best - "Businesses don't pay taxes; they collect them!". When taxes are nominally applied to incomes, they really fall on the transactions that generate those incomes.

When someone shops at Wal-Mart, does it really matter whether the tax is called a 'sales tax' added on top where he can see it, or an 'income tax', nominally paid by the Walton family, Earl the greeter and Lurleen at Register 10? The fact is that people who don't write a check to the IRS are already paying federal income tax every time they buy any goods or services. The problem is that most of them don't realize it.

Posted by: The Monster | Sep 7, 2004 3:33:05 PM

The information is interesting, but I don't think it matters who the "winners" and "losers" are under a national sales tax. National sales tax or a flat tax is imminently fair. That's what's important.

The fact that there are winners or losers at all is not an indictment of a national sales tax, but rather underscores inequality of our current system.

Posted by: Ron Rapp | Sep 7, 2004 3:00:33 PM

Neal Boortz has an interesting article at concerning a national sales tax:

Posted by: merc | Sep 7, 2004 2:56:13 PM

Repealiung the 16th amendment would have no effect on state income taxes.

Posted by: Mr. Davis | Sep 7, 2004 2:55:05 PM

While a national sales tax would be preferable to the current monstrousity of a tax code we have, I still prefer a flat tax. As long as the 16th Amendment is on the books, it's a near certainty that within a few years, we'd end up with both a sales and an income tax. All it would take to get an income tax would be for the country to go into a recession and Congress to pass a "temporary" tax like the one they passed to pay for the Spanish-American War that remained in effect for over 100 years. There are few things more permanent in life than a temporary tax.

With over 40 states having their own income tax, I see the chances of repealing the 16th Amendment as virtually zero.

Posted by: Larry J | Sep 7, 2004 2:49:30 PM

Was this intutively obvious ?
Sales taxes are (almost) always regressive, at least when compared to a progressive tax system like we have now.
Of course, the current system, with the top 1% paying so much, has the government trying to make the top 1% wealthier so as to reap taxes at the highest rate.

Death ans Taxes. Both are a nasty business.

Posted by: _Crater | Sep 7, 2004 2:49:21 PM

Hey Dave,

You may like, but they do not answer reasonable questions. I asked about Roth Ira's. I got no response. I never got any response from these "fair" tax folk. The only responses that I get from people who support them are frankly stupid. They just say that I am wrong without any reasonable argument. I distrust people with an agenda, but with no ability to make an argument. My experience is that is a farce.

Posted by: Mike | Sep 7, 2004 2:45:16 PM

"And don't forget the impact on the underground economy from a national sales tax. All those sources of tax-free income, i.e., unreported tips, working off the books, drug profits, etc. would become taxed as the money was spent."

"not if the sales are off the books too."

Actually, this is something positive, I think. A poor McDonald's employee who WAS paying income tax, and not being taxed when buying drugs on the black-market, while actually be benefitted by the sales tax, since they now get to keep more of their income.

On the other hand, the drug dealer who paid no taxes on their income (since it was received on the black market) will now be taxed by the National Sales tax when they buy their yacht (or food).

So we apply taxes to the drug dealers (the *real* scum), and we easy the burden on the economically poor person who has become addicted to drugs.

IMHO that's a positive change.

Posted by: JC Cleaver | Sep 7, 2004 2:40:32 PM

Retired people would get hurt badly if a national sales tax became a substitute for the income tax. First, they've already paid income taxes for all those years then when they retire and have far less to pay in income taxes--they would suddenly have everything that they bought taxed. Doesn't seem as if this is the right way to do it. Perhaps a flat tax would be more fair.

Posted by: Dot Clark | Sep 7, 2004 2:39:01 PM

not if the sales are off the books too.

Posted by: Mr. K | Sep 7, 2004 2:30:41 PM

"One of the saddest things about American society today is that we don't all share the burden - the only sadder thing is the belief that we do."

No, the saddest thing is the nearly universal acceptance of the idea that government ought to be a financial burden on the population that gives it its existance.

Posted by: Jay Kominek | Sep 7, 2004 2:26:29 PM

And don't forget the impact on the underground economy from a national sales tax. All those sources of tax-free income, i.e., unreported tips, working off the books, drug profits, etc. would become taxed as the money was spent.

Posted by: Rex | Sep 7, 2004 2:25:26 PM

Just yesterday a friend told me that he has paid no taxes for several years. He has so many deductions for things like his airplane that he manages to reduce his business and personal income to zero every year.

But, he still buys stuff. He and his business would be paying if there were a sales tax. I wonder how many people like my friend are out there, and whether it wouldn't make sense to use a sales tax to close those loopholes. Similarly, people who make their money illegally and thus without tax (like, say, drug dealers), would still be taxed because they would buy stuff.

Posted by: samuelv | Sep 7, 2004 2:05:31 PM

We don't have to rely on guess-work studies to figure out what effect a national sales tax in place of income tax would have. We've already done the experiment.

Many states have no income tax and state government is largely supported by sales tax. Somehow, these states stay solvent without taxing the poor and middle classes into starvation.

Posted by: Shannon Love | Sep 7, 2004 1:55:15 PM

"The analysis in the PDF seems questionable. It claims a 50 percent rate would be needed to collect the same revenues that are collected under the current system. I find that hard to believe."

Consider what percentage of your purchases would be tax-exempt. My two biggest expenditures each month are rent and food -- I pay no tax on my rent, and virtually no tax on my food.

Would these apply with a national sales tax as well?

Posted by: McGroarty | Sep 7, 2004 1:55:09 PM

I haven't had time to read the report, but I did glance at it long enough to see that it appears to consider the economy to be a "zero-sum game". In suggesting that a 54% (!!) tax would be required to break even, that much became clear to me.

Any study that doesn't account for the factors that cause an economy to grow is bound to be flawed, as this one certainly is.

For real studies, go to

Posted by: Dave | Sep 7, 2004 1:50:43 PM

There is no meaningful way to take current private expenditures and assume they'll remain static, class by class, after eliminating income tax and instituting a flat sales tax. This analysis is flawed.

Posted by: 6Gun | Sep 7, 2004 1:50:33 PM

I don't trust the messenger to be terribly impartial in their outcome by looking at the board of directors of ITEP.

I also don't trust their numbers too much, I think they're cherry picking to make their point.

At 30%, they show that the average burden goes up some $3000. Wouldn't this mean that $3000*(#tax payers) more be collected per year, essentially that the tax is too high?

Posted by: RussSchultz | Sep 7, 2004 1:50:32 PM

The reasons for this are fairly simple: most lower income families people don't pay ANY income taxes now, so trading income taxes for sales taxes would NECESSARILY cause the burden to be borne disporportionately on those who pay nothing.

One of the saddest things about American society today is that we don't all share the burden - the only sadder thing is the belief that we do.

Posted by: slim | Sep 7, 2004 1:50:07 PM

Wouldn't companies have to adjust their compensation to employees if a flat tax was adopted? I mean, my concern is my net pay, not my gross pay. If high earners were getting a big break, wouldn't companies give those earners a zero raise, and big raises to the low wage earners to make up the difference?

Posted by: David Pinto | Sep 7, 2004 1:46:25 PM

oops...didn't mean to list "water" twice!

big house = big water and electricity, while things like telephone will depend more on family size and work pattern instead of income.

Posted by: Ursus | Sep 7, 2004 1:40:51 PM

The analysis in the PDF seems questionable. It claims a 50 percent rate would be needed to collect the same revenues that are collected under the current system. I find that hard to believe.

Posted by: John Doe | Sep 7, 2004 1:40:49 PM

I like the idea of a national sales tax as an ongoing idea. As soon as every new spending program becomes *everybody's* concern, there will be more public pressure to cut government waste.

I see two problems in the transition, however. I wrote about them here ( ) but I'll summarize the two points.

First, I've already paid taxes on the savings I have now. Ditto for people with huge non-IRA retirement accounts, equity in houses, etc. Moving taxes to the back end means one hell of a lot of double taxation.

Second, many existing tax breaks are designed to encourage certain behaviors. In Chicago, one can invest in housing projects with a small but tax-free return, for example. With a flat national tax, these incentives go away.

Posted by: McGroarty | Sep 7, 2004 1:38:59 PM

It will be interesting to see how far this goes as all the winners look like they're sending their electoral votes to Kerry. Only Maryland is missing.

Posted by: Mr. Davis | Sep 7, 2004 1:38:02 PM

I haven't read the study yet, but it's important to point out that you can reach almost any conclusion you pre-ordain with this kind of stuff.

Certain kinds of flat taxes are prone to increasing the burden on the poor. Specifically, usage fees for services like water and phones will flatten out since most families use those things the same. But usage fees on water and electricity are much higher for people with big houses. Usage fees on roads are much higher for companies that ship stuff than for the poor, etc.

There is also the point that you have to give waivers to the poor in order to make these things work out right. No survey that does not include exemptions and waivers and refunds can possibly make any sense.

Posted by: Ursus | Sep 7, 2004 1:35:56 PM