George Will (subscription required) has an interesting article in WaPo today about a bill to eliminate the IRS and income taxes and just have a national 23% consumption tax. When I heard about this a couple of years ago, I thought it was a great idea. Which is why it will never happen.
First, why is it a great idea? Well, it's harder to dodge your taxes when it's included in every purchase you make (unless you purchase things on the black market, in which case you're committing other crimes as well). Even criminals who don't report their illegal income will have to pay this tax. And because the U.S. has a tremendous tourism industry, we may even get some unexpected income from foreign tourists that wasn't possible with the income tax. The sales tax may not need to be as high as 23% because so much money will be saved by not having the IRS and so much revenue that tax evaders weren't paying would be regained. It could be 20%. Or 15%. You would never have to pay someone to do your taxes again. And neither would corporations. I think there would still be lobbyists trying to get laws passed that favor one group or another, but the financial rewards of such campaigning would not be nearly as direct.
No more tax forms. No more deductions (although, with the cost of living refund for low-income people that is proposed in the bill, there might have to be something). No more refunds, but also no more unexpected tax bills either. It's better than a flat tax because a flat tax will eventually re-evolve into a behemoth like the tax code we have now (after all, the income tax started out as a flat tax). A consumption tax is dependent on how much money is flowing into the economy.
Also, because you feel the tax every time you pay it, you as a citizen are more likely to question where all this money is going. The income tax is sneaky in that you never really see the money, so you're less likely to miss it. So it's easier to inch that tax up, giving the government more money to spend on whatever it can find to spend it on. The consumption tax makes the government more accountable for its spending habits by effecting the spending habits of its citizens.
But why won't this happen? So many reasons. First, sticker shock. Yes, people will be getting more money in their paychecks. But they’ll have to learn to save that money because the price of goods will, at least temporarily, go up. Depending on where you live, you may already pay 11 cents on the dollar for the things you buy. Add in another 23 cents, and even the cheap stuff starts looking a might expensive. Many people won’t understand that they were already paying that money before, just in a different way. Others will understand it, they just won’t like it. It may be good to feel the tax burden in terms of citizen oversight of government, but if you have the pay the tax anyway, most people don’t want to feel it.
Also, what would the economic effect be of eliminating the IRS and the primary business model for several different companies around the country? H. & R. Block and companies like them would quickly have to shift to being a better broader financial services company (they already have other financial services, but tax preparation is their primary source of income). All of those IRS employees would have to find work somewhere, too. The lives of accountants would become much less interesting (and you thought it couldn’t get any more boring). So because of a flood in the market of potential employees and a drop in the demand, accountants and financial advisors may experience a downturn similar to that of engineers and computer programmers after the tech bubble burst.
The payroll tax would also be eliminated under this system, so Social Security and Medicare as we know it would be dead. President Bush’s private accounts wouldn’t work under this system. Even the current system of tax-free IRAs and 401ks meant to encourage retirement savings would go away. So if we kept Social Security and Medicare, their funds would have to come from general revenue. But now that no one needs to report their income anymore, how do you determine who gets how much money? If your goal is to eventually eliminate entitlement programs like social security and medicare, this may actually hurt because all of the tax advantages of saving for retirement have gone away. And since a lot of people can’t think past the end of the day, even when they have the money to save, more people will be depending on that social security check to be there for them when they retire. At this point, to make it easier for people to have savings, you have to make it more difficult for them to go into debt. To do that, you would have to eliminate credit cards. I don’t really see that happening, either.
I think the consumption tax could work. All we have to do is build a time machine and go back to
1913…
