A National Sales Tax Plus an Income Tax

About a year ago, I commented on the proposal for the "Fair Tax" as an alternative to the income tax, and indicated that I would prefer a national sales tax to the income tax (in spite of its many problems). But -- I also indicated that it would be nearly impossible to repeal the income tax amendment and that it was likely we could end up with both an income tax and a national sales tax. This would put us in a position similar to most of the European countries and many others around the world.

Last January, at the World Economic Summit in the Bahamas, Marshall Langer predicted that Obama would turn to the value added tax (VAT) as a way to pay for his national health care. Now, it seems that various members of his administration are running up trial balloons to gauge whether a VAT is politically feasible. According to the Washington Post (5/27/09)

At a White House conference earlier this year on the government's budget problems, a roomful of tax experts pleaded with Treasury Secretary Timothy F. Geithner to consider a VAT. A recent flurry of books and papers on the subject is attracting genuine, if furtive, interest in Congress. And last month, after wrestling with the White House over the massive deficits projected under Obama's policies, the chairman of the Senate Budget Committee declared that a VAT should be part of the debate.

The VAT and the sales tax are similar in that the tax is added to the cost of the goods and services that we buy, rather than being based on a nebulous concept like income. But the method of collection differs. With a sales tax, the entire tax is added to the price of a product or service by the vendor (or service provider) who then remits that amount to the government. But a sales tax is often buried in the price of goods or services that are bought for resale or further production, which results in sales taxes on top of sales taxes. Some businesses would be granted an exemption for purchases of goods for resale (as is done in most of the states), but that isn't a complete solution.

With a VAT, the tax paid by a lower tier supplier is deducted from the tax computed by a higher tier supplier or vendor. Each producer or vendor only pays the VAT applicable to the value added by that vendor. Thus, no matter how many levels of production are involved, there is only one VAT. (For more see Wikipedia.)

Proponents of a national sales tax may support a value added tax, thinking that it would replace the income tax. But most other countries that have a VAT also have an income tax and their combined impact is much higher than the U.S. income tax alone. Proponents of bigger government are likely to be ambivalent about the VAT because while it would raise more tax revenues, the burden would fall more heavily on the poor and those who are retired. However, such Liberals are more likely to support the VAT if they believe it is partly offset by reduced income taxes for the lower income taxpayers. But when you consider that the lowest 40% of the population (based on income) don't pay any income taxes now, the VAT would cause them to pay more tax.

Whatever your position, the subject is now "in play" and we can expect to hear a constant stream of commentary from the talking heads, along with endless editorials in the print media. If you have a serious interest in the relative advantages and disadvantages of various tax reform methods (including a national sales tax and various forms of the VAT), the American Institute of CPAs has produced a guide to alternative methods of taxation. Although written in 2005, the basic issues are the same today. For a free market perspective, see "Beware the Value Added Tax" by Dan Mitchell of the Heritage Foundation. For a more liberal perspective, see this Washington Post article.

Reprinted from the International Wealth Protection Monitor