Is a “Consumption Tax” Fair?

Is a “Consumption Tax” Fair?

I have argued here and elsewhere (e.g., in newspaper letters to the editor and guest columns) that income tax is the only fair tax because it’s the only tax based solely on ability to pay. (I might include “luxury tax” also.)

In recent years a vocal minority have been calling for a universal “consumption tax” to replace income taxes. I tended to dismiss them as unthinking (to use a nicer word than what I really think) people. Now, however, I read a column in the newspaper by a leading investment advisor, obviously an educated person capable of critical thought, advocating that policy.

So what is a universal consumption tax? The “universal” means across the board, not local, and to replace incomes tax if not all taxes. “Consumption” means what most people call “sales.” In other words, the plan being promoted is to replace federal and (I assume) state income taxes (where those exist) with sales tax.

I consider this one of the dumbest and most regressive social policies ever.

One of the arguments used for it is all the “loopholes” in our complicated federal and state income tax laws. Allegedly, too many people (about 47%) pay no income tax and many affluent who do, like those who live off investments, pay a smaller percentage than middle class wage earners. Without doubt our income tax codes are too complicated and filled with loopholes.

I argue that those are reasons to fix income tax codes (federal and state) and not to discard them.

Let’s examine the idea of replacing income taxes with a universal consumption tax. For now I’ll focus only on the idea of replacing the federal income tax with a national sales or consumption tax.

First, has any government, anywhere in the world, done this? That is, has any nation replaced income tax with a universal consumption tax? If so, how has that worked in terms of raising revenue? What percentage of tax on sales/consumption was necessary to replace the income tax?

Personally, I’m not aware of any country that has tried this. Do people really want to rush into something that’s never been tried? Perhaps so. But I would think they would at least want to know in advance how it will work. So far the plans for it are so wildly diverse that I’m convinced nobody really knows how it would work.

Second, and closely related to “first,” what percentage would the tax have to be to replace income tax? That’s where the proposals fall apart—into wildly diverse estimates. I have heard everything from 25% to 35%. I suspect it would have to be higher because, immediately upon its institution, sales/consumption would drop dramatically. People would immediately delay or cancel plans to make unnecessary purchases.

Third, and closely related to “second,” I believe such a tax change, however gradually implemented, would result in a massive recession that would make 2008-2009 look tame. Many people, perhaps most, would immediately begin looking for ways to “purchase” items that would avoid the tax. How could laws be crafted to tax bartering, for example? I am old enough to remember when bartering became a huge practice. National networks of bartering were set up during the late 1970s. Eventually the government stepped in and passed laws to dampen the practice. I suspect people would find ways to barter to avoid paying a 30% consumption tax.

Fourth, one of the arguments for replacing income tax with sales tax is to do away with the IRS and the huge government bureaucracy related to income tax. I think it would simply have to be replaced with a huge government bureaucracy to oversee and regulate the new tax (e.g., to keep people from avoiding it through bartering, etc.).

Fifth, one of the arguments for replacing income tax with a consumption tax is that “income” is too difficult to define. Imagine trying to define “consumption.” What would be taxed? Your visit to the doctor’s office? What part of your related expense? Your co-pay or the whole amount charged? Your college tuition? Your day care expense for your child(ren)? In my opinion, that is one of the dumbest arguments for replacing income tax with sales/consumption tax. Income is much easier to define than “consumption.” Just because governments haven’t been doing it well doesn’t mean it’s really difficult.

Sixth, one of the often unstated reasons for replacing income tax with sales/consumption tax is to spread the burden of raising revenue to run the government around more evenly. In other words, the wealthy are envious of the poor and middle classes’ escape from paying income tax. So let’s look at what would inevitably be the case. A young woman works for minimum wage and pays no income tax. With the full implementation of the consumption/sales tax she now pays 25% to 35% on everything she buys—on top of its price. Oh, and all the prices for the few necessities she buys just went up to offset the sales/consumption tax on the businesses’ purchases of materials (and, presumably, services).

Seventh, whenever I have raised the sixth objection immediately above advocates of a sales/consumption tax start proposing exclusions and adjustments that would keep the working poor from falling further into poverty. “Okay,” they say, “under this new plan basic food stuffs wouldn’t be subject to the consumption tax.” But what about basic clothes? What about transportation to get to work? What about…? Soon the working poor person isn’t paying any sales/consumption tax which defeats a major purpose of it stated in “sixth” above.

In other words, in order to make the plan work so that it does not devastate the poor, so many loopholes would have to be instituted that it would be just like the present income tax (in that regard).

Eighth, suppose I am a millionaire when the new tax replaces the old and I get my joy out of saving, not spending (at least not here!). My goal in my financial life is to build up a huge fortune and then go to a country nearby (and believe me, it wouldn’t be far!) that has no or a smaller consumption tax and live it up there! Here I live in near penury because I don’t like paying taxes. Now I pay very little tax because I simply refuse to buy non-necessities—yet. Soon, however, I have enough money stashed away from untaxed income to buy a home and car in a nearby country and travel there often and live like a monarch.

I guarantee that would be the common practice of the rich and especially the super rich. Sure, they might not live as if they were poor here, but they would spend as little as possible here to avoid the consumption tax and buy their luxuries elsewhere. Imagine the harm that would do to the economy!

My point is that the proposal I’m criticizing here is radically regressive. It would hurt the poor (to say nothing of the economy as a whole) and help the rich. That’s so obvious to me that I cannot help but conclude that people who advocate it either simply have not thought it through or want to hurt the poor and help the rich.

Ninth, one of the arguments for abolishing income tax and replacing it with a sales/consumption tax is that, allegedly, income taxes keep rising unchecked and it’s easier to detect tax increases in sales taxes. That’s utterly bogus, of course. Income tax rates have lowered dramatically in recent decades. And sales taxes have increased without most people noticing it. How? Because politicians simply spread the sales tax to cover more and more goods and services. They boast that they have not increased taxes when they actually have. A few years ago, when I had to have a repair person come out to the house to fix something, there was no sales tax on that service. Now there is. How is that not a tax increase? And yet the politicians who did this loudly proclaim that they have never raised taxes. And the sheep listen and believe.

Tenth, I am not opposed to a “value added tax” on true luxuries like limousines, speedboats, designer suits and dresses, etc., etc. However, when it comes to universal taxes (across the board) the only fair tax is income tax because it is the only tax based solely on ability to pay. People in government seem to recognize this when they don’t tax food. (Most states charge no sales tax on real food in grocery stores) and cap property taxes for senior citizens. However, that intuition hasn’t sunk in deeply enough. Property tax is bad because it forces a new widow (for example) to pay the same amount after her husband, who was the family’s primary source of income, dies. Often she has to sell the homestead and go live in an apartment. Think about it—income tax is the only tax based solely on ability to pay.

Governments have gradually abolished many regressive taxes (ones not based on ability to pay). For example, when I was a kid growing up in a Midwestern city in the 1950s, my parents had to fill out a form annually stating all their personal property—furniture, car, jewelry (they had none), appliances, etc. That even included savings accounts. Then the county or state (it doesn’t matter to my point and I don’t remember which) levied a tax on their personal property. This was a huge financial burden on them and us (their children). We were lower middle class if not poor. My parents never had savings or disposable income (money to spend on non-necessities). I recall that one year the taxing government did not believe their report and sent an agent to our house to inspect it. I was home when that happened. He went through drawers and cabinets and closets looking for unclaimed items such as jewelry, expensive clothes, etc. Of course, he found none and concluded that my parents had stated their personal property correctly. Sometime later, I don’t remember when, the government abolished that tax. It was extremely regressive. For example, suppose you were poor but inherited a piece of jewelry with sentimental value (such as your grandmother’s wedding ring set). You had to declare it and pay “personal property tax” on it annually. That tax had nothing whatever to do with ability to pay. That’s why it was abolished. But the same principle applies to real estate property tax (on homesteads) and, I argue, sales tax on clothes, services such as plumbing repair, etc. Those should also be abolished because they are regressive. The only progressive taxes are income tax and luxury tax.