Editore"s Note
Tilting at Windmills

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August 2, 2004
By: Kevin Drum

ABOLISH THE IRS!....I see that House Speaker Dennis Hastert has written a book boldly suggesting that we abolish the IRS and replace the income tax with "a national sales tax or a value added tax." Drudge claims with no particular evidence that this will be the "domestic centerpiece of the Bush/GOP agenda for a second Bush term."

Well, maybe. After all, this has been a conservative wet dream for decades, and maybe Bush has caught the fever. But before you get too excited about abolishing the IRS, here are a few factoids to chew on:

  • Forget the idea of a national sales tax. It's common knowledge among tax experts that sales tax levels much above 10% don't work because the incentives to cheat are simply too great. Many states already have sales taxes close to this level, and tacking on an extra 20-30% in federal sales tax is a complete nonstarter.

  • So how about a value added tax instead? Instead of one big tax tacked on to the final consumer sale, a VAT breaks things up into smaller pieces by taxing the amount of value added to goods and services at each stage of production and while it may sound more complicated than a sales tax, it turns out that it's actually easier to monitor and control. Tax experts tend to like VATs for a variety of reasons.

    But here's the problem: VATs don't raise nearly as much money as breathless newspaper op-eds would have you believe. Take Great Britain as an example: it has a basic VAT rate of 17.5% (excluding food and a few other items), and last year this raised (roughly) $100 billion. This is approximately 6% of Great Britain's GDP.

    In America, personal and corporate income taxes account for about 10% of GDP. This means that if we adopted a VAT similar to Great Britain's, and we wanted to use to it to abolish the IRS completely, our basic VAT rate would have to be around 30%. Ouch.

    Because of this, Great Britain, like other countries, does not rely solely on VAT. In fact, the Brits have all the same taxes we do: an income tax (22% is the basic rate), social security, capital gains, stamp duties, excise taxes, inheritance tax, corporation taxes, etc.

  • Sales taxes and VATs are examples of consumption taxes, which are designed to tax what you consume, not what you earn. So another way to implement a consumption tax is to keep our tax system the way it is but exclude taxes on any income that's plowed back into investments: stocks, bonds, savings acounts, etc. By definition, everything that's left over is money that's spent on consumption. The economic effect ends up being pretty similar to a VAT.

    Unfortunately, this wouldn't abolish the IRS, it would just eliminate taxes on a big chunk of investment income. Now, there are some economists who think this is a good idea, and there are lots of wealthy Republican contributors who think this is a great idea, but you'd better check your wallet before you decide you like it too. Investment income is still mostly an artifact of wealth, and if we allow wealthy taxpayers off the hook for paying taxes on their investments we have to make up this revenue somewhere else. That means surprise! higher rates on everyone else.

So aside from letting the rich pay lower taxes, how do conservatives defend the idea of abolishing the income tax? Bruce Bartlett, for example, suggests that consumption taxes are inherently more efficient than income taxes (true), so we could make up for their non-progressive nature by having a higher tax rate than we do now (with no loss in economic growth) and then spending the extra money on the poor.

I hardly need to point out the problems here, do I? First, far from proposing higher taxes, most consumption tax proposals are deeply dishonest about the rates needed just to replace the current income tax. They're mostly proposing lower rates, not higher. Second, the increased efficiency of consumption taxes is fairly modest, and their proponents routinely inflate them beyond recognition.

And third, increased spending on the poor? In whose universe? Certainly not Denny Hastert's or George Bush's.

Kevin Drum 1:56 PM Permalink | Trackbacks

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