Why is sales tax regressive

And if saving rises following the implementation of a sales tax, consumption would have to fall, which would reduce the tax base and raise the required tax rate further. The clear result, then, is that any realistic sales tax plan would have tax rates much higher than the 23 percent rate promised by the AFT.

Sales taxes at such high rates raise crucial questions about enforceability. Tax simplicity and tax enforcement should be analyzed together—any tax can be simple if it is not enforced. If it could be enforced, the sales taxes would be quite simple for the typical household, but problems would arise for businesses. The likely rate of evasion in a sales tax is a key issue. Sales tax advocates admit that evasion would be a certainty, yet make no account for it in their estimates and hope that sentiments of fairness will induce taxpayers not to cheat.

They also point to low marginal tax rates as an inducement not to cheat, but as shown above, the tax rate would not likely be low. Another claim is that detection of cheating would rise dramatically since only retailers would have to be audited, but this is misleading. Under the sales tax, businesses that make retail sales would be responsible for sending tax payments to the government, unless the buyer used a business exemption certificate, in which case no tax would be due.

But the buyer would have the legal responsibility for determining whether the good is used as a business input or a consumption item. This means that auditing and enforcement would have to focus not just on retailers, but also on all businesses that purchase from retailers, to ensure that business exemption certificates were used appropriately.

One study found that, in Florida, where sales taxes have never exceeded 6 percent, 5 percent of all purchases made with business exemption certificates were used inappropriately to exempt personal consumption from taxes. At the much higher tax rate needed in a federal sales tax, a much larger percentage of sales to businesses might be expected to fall into this category. Most importantly, the sales tax would generate tremendous opportunities for evasion. For example, in the income tax, the rate of evasion is around 15 percent.

But income where taxes are withheld and reported to government by a third party has evasion rates of around 5 percent. For income where taxes are not withheld and there is no cross-reporting, evasion is around 50 percent. Since the sales tax would feature no withholding and no cross-reporting, the possibility of high evasion rates needs to be taken quite seriously.

Advocates also assert that the sales tax would be more effective than the current system at raising revenue from the underground economy. The classic example is that of a drug dealer who currently does not pay income tax on the money he earns, but would be forced to pay taxes under a sales tax if he took the drug money and bought, for example, a Mercedes. The problem with this argument is laid out best by Rep.

In the end, neither system taxes the drug trade. Many other countries have attempted to implement a retail sales tax, or variants, and almost all have abandoned the tax and moved to a value-added tax. Governments have gone on record as noting that at rates of more than 12 percent, sales taxes are too easy to evade. The most optimistic assessment would be that there is no historical precedent for a country to enact a high-rate, enforceable, national sales tax.

That does not mean it is impossible, but extreme caution would be appropriate. Finally, some sales tax advocates would eliminate the IRS and have the states administer the tax. Even though the states would keep 1 percent of the revenue they collect, they would have poor incentive to collect federal taxes adequately. For reasons of equity, efficiency, and simplicity, establishing a broad tax base is a key element of sales tax proposals.

The broader the base, the lower the rate can be. As the income tax shows, allowing specific exemptions creates a political slippery slope. Loopholes accorded to one group breed additional loopholes, by fueling demand from other groups for equally favored treatment and by weakening congressional resolve to stem the tide of special requests. But taxing a broad base will be hard. Some items are quite difficult to tax, like imputed financial services.

Other items may not be taxed for reasons of social policy. Child credits, rental payments, and some or all food may fall into this category. Finally, some sectors might not be taxed because of strong political influences—housing and health, for instance, though exemptions here may also be related to social policy. These issues create serious trade-offs.

For example, taxing health insurance would raise the number of uninsured by an estimated 6 million to 14 million people. Not taxing it would raise the sales tax rate by several points. Even with extreme political discipline in avoiding subsidies, it will be difficult to tax more than 80 percent of personal consumption. Retaining some of the major preferences in the income tax could reduce the private consumption base to about 60 percent of personal consumption. Would you consider telling us more about how we can do better?

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