Should the U.S. Institute a National Sales Tax (or Similar Taxes Such as the "Value-Added Tax" or "Fair Tax") to Replace the Income Tax?

In a Nutshell

Yes

No

  1. A national sales tax discourages consumption, leading to a conservation of resources.
  2. The removal of an income tax encourages saving and investing, which is the key to job growth.
  3. Individuals would have an extra incentive to work hard and earn income, leading to a far more productive nation.
  4. A sales tax would be a much simpler system, eliminating the need for individuals to comply with complex tax reporting requirements and freeing up all the money & time lost on the income tax process.
  5. Tax rates can be targeted to encourage or discourage the consumption of certain items.
  6. Consumer prices of certain items would fall since labor and tax compliance costs would be cheaper to businesses.
  7. It would allow a greater collection of tax money from those carrying out illegal transactions, since their income is hid from the income tax system but will be taxed when they spend it in a sales tax.
  8. It's a tax system consistent with a free society; i.e. Americans have a choice regarding their taxes, unlike our current confiscation system.
  9. Many of the most intelligent people in the country have devoted their worklife to understanding a ridiculous tax system; those accountants & other professionals could be redirected to cutting costs and improving planning, productivity, and profitability.
  10. Social Security, Medicare, Obamacare, and other government spending has put the federal budget on an unsustainable path, so we have to try something new before America is totally bankrupt. If the U.S. can't pay its bills, the rest of the world will also be thrown into chaos.
  11. A sales tax is easier to see and track, whereas income & payroll taxes are usually divided among 24+ time periods and partially absorbed by the employer; most people don't really look at the tax as part of their actual pay, so they take it for granted.
  12. Eliminating the income tax would lower employment costs for businesses, allowing them to hire more people or reduce prices. Thus, the net effect of the lower costs + a sales tax would mean total prices are relatively the same as before the change.
  1. A sales tax would be a regressive tax; i.e. low-income individuals would pay a much higher share of their incomes than wealthy individuals.
  2. A national sales tax is a risky system that may not raise near enough money to support all our needs in defense, education, health care, etc.
  3. Consumer spending, which drives a thriving economy, would likely drop as people save and invest more rather than spend.
  4. Many incentives built into our tax system (such as education, home ownership, charity, etc.) would be eliminated.
  5. Tens of thousands of attorneys, accountants, and human resource workers would likely lose their jobs due to the simpler tax system.
  6. Real estate values would likely plummet since the tax advantages to ownership would vanish.
  7. Mortgage and other consumer debt would likely explode since consumers would be forced to finance the taxes also.
  8. We would have to come up with another way to raise or set aside funds for social security.
  9. The transition costs of such a change would be extremely expensive.
  10. Tax evasion and instances of black market purchasing would likely increase.
  11. Consumer prices of many items would go up by a much greater rate than the sales tax rate since raw materials would also be taxed.
  12. Retirees and others who have earned the majority of their life income have already had their money hit with income tax; thus, they will pay extra sales tax with money already subjected to income tax.

Related Links

Overview/Background

It is estimated that the cost to Americans of complying with our incredibly complex system is over $200 billion per year as well as over 7 billion hours of time (Source: The Tax Foundation ). Many complain that our tax system punishes hard work, investment, and success while encouraging consumption. With out-of-control government debt and deficits, one of the ideas currently being considered is a national sales tax, or " Fair Tax ". A similar tax called the " value-added tax " hits businesses at each stage of production, which ultimately hits the consumer through increased prices of goods and services. In other words, you would be able to keep your employment earnings but would have to pay an additional amount whenever you buy something (e.g. 15 or 20 percent tax). A compromise system would likely tax consumer items at different rates with complete exemptions for necessities such as food. This is a debate of the merits of a sales-tax system over an income tax system.

Yes

  1. A national sales tax discourages consumption, leading to a conservation of resources. One of the biggest complaints other countries around the world have about the U.S. is that we consume more than 25 percent of the world's resources despite comprising less than 4 percent of the population. Especially when it comes to scarce, non-renewable resources such as oil, few people would argue that we need to cut wasteful consumption. The basic economic law of supply & demand says that as prices go up for an item, demand will go down. Thus, as a society, our national consumption should decrease with a national sales tax.

  2. The removal of an income tax encourages saving and investing, which is the key to job growth. The national savings rate is currently a putrid 4 percent of income. When Americans increase saving & investing, interest rates go down and the economy expands since banks and corporations have more funds to invest in new projects, new stores, new businesses, etc. A national sales tax would encourage increased saving & investing for two reasons: 1) Earnings from investments wouldn't be taxed; thus, the effective rate of return would increase; 2) Americans are never taxed unless they spend money, which they would have to do on much more expensive consumer goods; thus, they have extra incentive to refrain from frivolous spending.

  3. Individuals would have an extra incentive to work hard and earn income, leading to a far more productive nation. Our tax system is completely backwards when you consider the fact that the majority of government revenues come from tax on our earned income. National employment drives the productivity of the country. Since we tax personal incomes, we are actually punishing people for working. What's worse is that we have a "progressive" tax system, meaning rates go up as you make more. This in effect punishes the most successful and the hardest workers. Corporations, which provide the greatest amount of national jobs, are even taxed twice: once at the corporate level plus a second time when earnings are distributed to shareholders. If you take away the income tax, you give every worker in America a raise (except those that don't pay an income tax), which encourages citizens to work more hours. Think about it, if your take-home pay was $20 per hour instead of $14 per hour, would you be willing to work more hours?

  4. A sales tax would be a much simpler system, eliminating the need for individuals to comply with complex tax reporting requirements and freeing up all the money & time lost on the income tax process. Hundreds of billions of dollars are spent every year and billions of hours wasted complying with the incredibly complex American income tax system. Replacing the income tax with a national sales tax would free up all the resources necessary to fulfill those tax requirements. Only businesses that sell goods would be required to file federal tax returns, and the system would be much simpler since they would only have to multiply each sale by the specified rate. As a nation, we would no longer have to waste time & money figuring out depreciation recapture, itemized deduction phase-outs, alternative minimum taxes, charitable deduction caps, and so on. Think about how happy the environmentalists will be when they hear about all the trees that will be saved from the elimination of all those tax forms & schedules!

  5. Tax rates can be targeted to encourage or discourage the consumption of certain items. A national sales tax doesn't mean one standard rate for every consumer good sold in the country. We can customize the rates to help the poor provide for basic necessities as well as discourage or encourage the consumption of certain items. For example, food and lower-priced clothing could be tax-free. Gasoline, cigarettes, fast food, alcohol, and fuel-guzzling automobiles could face steep tax rates. Hydrogen & electric-powered cars, equipment used in a business, and home improvement material could be given minimal tax rates. Get the picture? Once again, the economic law of supply & demand will increase/decrease consumption of particular items.

  6. Consumer prices of certain items would fall since labor and tax compliance costs would be cheaper to businesses. Every cent that goes into producing a product or service is reflected in it's price. For example, if a law firm pays a clerk $25 per hour to service a client, it must charge the client at least that much to avoid losing money. Any business will usually add a certain markup to ensure an adequate profit for the effort and risk. Thus, if you cut the underlying cost, you cut the final price charged to consumers. Elimination of the income tax means a reduction in payroll taxes for businesses as well as the elimination of the need for much of the human resource & payroll departments. Consequently, the cost of offering related products & services drops.

  7. It would allow a greater collection of tax money from those carrying out illegal transactions, since their income is hid from the income tax system but will be taxed when they spend it in a sales tax. Drug dealers, prostitutes, black market dealers, and bookies are examples of people who earn income illegally. Since these and others engaging in illegal transactions obviously don't want the government to know about their activities, the income generated won't be reported on income tax returns. Thus, none of that money is subject to tax. However, with a sales tax, it doesn't matter how money is earned, since the tax is collected immediately by the seller.

  8. It's a tax system consistent with a free society; i.e. Americans have a choice regarding their taxes, unlike our current confiscation system. Our Founding Fathers went to war with England in large part to get away from a stifling tax system like that which we currently face. The U.S.A. is supposed to be a free country with little government interference. However, in our current tax system, we must pay a significant portion of our earnings regardless if we use government services or not. Since our income is taxed and we all have to generate earnings to survive, we don't have a choice. If we institute a national sales tax, the amount of tax we pay is completely up to the individual. We aren't taxed a penny until we go out and spend. Thus, a national sales tax is consistent with the very idea and foundation of America.

  9. Many of the most intelligent people in the country have devoted their worklife to understanding a ridiculous tax system; those accountants & other professionals could be redirected to cutting costs and improving planning, productivity, and profitability. A Certified Public Accountant typically must go through 5+ years of college and pass a grueling exam. Enrolled Agents must go through a similarly rigorous training program. You have to be both smart and hard-working to make it through such education. However, the brilliant, hard-working people that make it through these programs have often tied up their worklife doing tax returns, trying to make sense of a non-sensical, hodgepodge of laws & regulations. Wouldn't it be great for the productivity and competitiveness of American companies if we could free them up to work on things that really matter, such as cutting costs, improving efficiency, integrating technology, and so on? Improved productivity means a greater GDP, which leads to far more employment and profits for the country.

  10. Social Security, Medicare, Obamacare, and other government spending has put the federal budget on an unsustainable path, so we have to try something new before America is totally bankrupt. If the U.S. can't pay its bills, the rest of the world will also be thrown into chaos. The Federal government is running deficits over a trillion dollars per year; that's an annual increase in debt that's equal to about half of what we take in for the full year! Think of what it'd be like if a family of four that brought in annual income of $100,000 was spending $150,000 every year and already had $700,000 in debt. How long do you think it'd be before that family could no longer pay the bills? How long do you think it'd be before banks stopped extending credit to that family? The cost of all the bloated government programs such as Medicare are simply unsustainable. Now we're adding a behemoth like Obamacare to the top of that. There never seems to be political will in any of the major parties to cut discretionary spending. Much of the spending can't be reduced because of contractual commitments. We have no choice but to try something new that will increase government revenues. More or less the entire world economy is dependent on America. If our economy suffers, it cascades and hits all other countries of the world.

  11. A sales tax is easier to see and track, whereas income & payroll taxes are usually divided among 24+ time periods and partially absorbed by the employer; most people don't really look at the tax as part of their actual pay, so they take it for granted. Every time you buy something, you can look at the receipt and know exactly how much you pay. If the sales tax is raised from 8 to 10 percent, you'll be able to spot the difference immediately the first time you buy a high priced item. For example, if you spend $1000 on a laptop, the tax would be $100, and is rarely ever listed in the published price. Income and payroll taxes are something most people have paid their entire lives. They barely consider it part of their real salary since it's always been taken. Since people's annual salary often changes regularly, and since paychecks are normally bi-weekly or twice per month, it's tough to spot a small change. Thus, government can stealthily increase taxes without most people noticing. Many people don't realize that your employer pays social security tax & Medicare tax equal to what each employee pays every period. If the government raised the business side of the tax, most people wouldn't consider it a tax on them. However, this goes into the total cost of employment and will effectively take away a bit of your next raise.

  12. Eliminating the income tax would lower employment costs for businesses, allowing them to hire more people or reduce prices. Thus, the net effect of the lower costs + a sales tax would mean total prices are relatively the same as before the change. When people tack a job, the only part of the pay that really matters to them is the take-home pay. Each person therefore has an acceptable take-home salary for which they will perform the required services. Assume your actual pay is $50,000, but after taxes, it's $35,000. In other words, you've agreed to work full-time for annual take-home pay of $35,000. If the income & payroll taxes are eliminated, the employer can now pay you $35,000 to achieve the same end result. In fact, if they paid you $40,000, they'd save $10,000 and give you a $5000 raise, so both sides would improve! Businesses can use that cost savings to hire additional people or drop the price of products in order to achieve the same acceptable rate of profit. Taking the example above, assume you want to buy a sports car that costs $50,000 with the old tax system. After a change to a national sales tax, the new price would be $35,000 (and if they don't drop prices, competition could eventually take all their business with lower prices). If the national sales tax was, say, 10%, the tax would be $3,500. So the total cost would be $38,500, as opposed to $50,000 before the tax system change.

No

  1. A sales tax would be a regressive tax; i.e. low-income individuals would pay a much higher share of their incomes than wealthy individuals. Food, housing, clothing, medical attention, and other basic necessities eat up a portion of every American's income. However, with lower-income individuals, these basic necessities already use up almost all of that income. For upper-income individuals, they use up only a small percentage of their income. In other words, all of the discretionary spending of the poor is going to be hit by a national sales tax, but only a small portion is affected for the rich. Thus, a sales tax would be regressive, meaning the percentage of your income that's eventually taxed is at a much higher rate for lower-income individuals, who have much less ability to pay, and the rate decreases as your income increases. Our current income tax system forces you to pay a certain percentage of your earnings, and this percentage increases as you earn more. One of the main benefits of a national sales tax is that the increase in sales tax paid is offset by a decrease in the income tax paid. However, tens of millions of the working poor currently pay zero income tax (Remember that the standard deduction, personal exemptions, tax credits, etc. prevent many Americans from paying anything for federal taxes). In other words, eliminating the income tax provides no benefit at all to those low-income citizens. Thus, a national sales tax would amount to a net increase in total taxes on the poor.

  2. A national sales tax is a risky system that may not raise near enough money to support all our needs in defense, education, health care, etc. According to the Congressional Budget Office, our current tax system brings in over 2 trillion dollars in revenue per year. On top of that, we're already running a trillion dollar deficit. There is no way to accurately predict how much revenue a sales tax will generate. There is no way to accurately predict what sales tax rate will generate the most revenue. What happens if we only generate 500 billion dollars of revenue in the first year? Does that mean we tolerate 3 trillion dollar annual deficits while we wait for the system to work? Does that mean we cut vital funding for education, social security, the military, homeland security, etc.? The value of the U.S. dollar has already plummeted in the last few years. What would happen to it if our economic viability is put in question? Think about how high interest rates will rise if we're running 3 trillion dollar deficits, along with the stifling effect it has on our economy. In the middle of a war, with the U.S. economy just beginning to recover, this is not a good time to be taking such a risky action.

  3. Consumer spending, which drives a thriving economy, would likely drop as people save and invest more rather than spend. Would you spend $3000 for a big-screen TV with DVD and surround sound? Maybe, maybe not. How about if the same TV cost $4000? How about if it cost $5000? It's possible that you may buy the TV even if it's $5000, but there's no doubt that you are less likely to buy if the price is $5000 than if it's $3000. That's basic economic supply & demand. Elimination of the income tax would mean that Americans could invest all their money tax-free. Why should they go out and spend money on unnecessary items when they can accumulate unrestrained wealth by saving? While saving & investing are definitely a good thing, consumer spending is also necessary to drive economic growth. For example, if you buy a car, the automaker makes money, as well as the raw material companies that sell tires, radios, car batteries, etc. The shareholders of the auto company can then spend their earnings on other items like computers, furniture, home improvement projects, etc. Consumer spending has a positive chain reaction effect on the economy. A national sales tax may stifle that. In Japan, the national savings rate is about 25 percent of earnings, yet it has been in an economic funk for over a decade. This is largely due to the fact it doesn't have potent consumer spending to add some juice to its economy.

  4. Many incentives built into our tax system (such as education, home ownership, charity, etc.) would be eliminated. There are numerous incentives in our current tax system that benefit the individual as well as society as a whole. Education credits provide an incentive for continuing education, leading to a highly-trained population, which is vital in the technological environment of today. Home ownership, which is rewarded in our tax code, leads to stability, stronger families, and better maintained property. The list goes on and on. Businesses are given credits for using renewable energy, for hiring disabled or low-income individuals, and for investing in new equipment. Individuals are rewarded for giving money to charity, for holding investments long-term, and for setting aside money in retirement accounts. All those incentives would instantly go down the drain with the elimination of the income tax.

  5. Tens of thousands of attorneys, accountants, and human resource workers would likely lose their jobs due to the simpler tax system. Thousands of Americans have trained and devoted their work lives to implementing our current tax system. A national sales tax would mean all those citizens would likely be out of work or have to start all over, and their years of training would be wasted.

  6. Real estate values would likely plummet since the tax advantages to ownership would vanish. The value of any investment is basically determined by two things: 1) its risk, and 2) its rate of return. In fact, any real estate appraiser or investment analyst will factor these two items into a model that determines the value. If you eliminate the tax deductions of real estate, you reduce the annual return produced by the investment. Thus, the price of all real estate will drop. Think of it this way: if you rent a 3-bedroom house, you may have to pay $700 per month in rent. However, if you buy that house, the mortgage payment & property taxes would likely lead to a monthly cost of $1200 or more. So why would people spend that extra money? By far the biggest reason is that they get to deduct the mortgage interest and property taxes against other income. The whole "ownership society" philosophy would go right down the tubes with the elimination of the income tax. There would also be far less incentive for businesses to build more malls, apartment buildings, etc., leading to a further depressive effect on the economy.

  7. Mortgage and other consumer debt would likely explode since consumers would be forced to finance the taxes also. It's common knowledge that Americans aren't very disciplined when controlling their spending; the vast majority of citizens have some kind of debt outstanding. This debt will likely increase since every purchase will reflect a cost for the item itself plus the additional taxes. For example, if you buy a house for $200,000 and assume a 15 percent tax rate, you'd have to pay an additional $30,000, which most people would simply have to mortgage. Over a 30 year loan you might end up paying $60,000 for the taxes after you factor in the interest. The situation is much worse when credit cards come into the equation since interest rates can be as high as 20 percent.

  8. We would have to come up with another way to raise or set aside funds for social security. The amount of social security tax collected for each individual is determined by his or her income. If we eliminate the income tax, how are we supposed to collect the funds for social security? If we continue to require businesses to collect the tax, we partly eliminate one of the advantages of a national sales tax; that is, reduced complexity.

  9. The transition costs of such a change would be extremely expensive. Here are some of the changes required with a national sales tax replacement of income tax: the entire Internal Revenue System would have to be eliminated or reorganized; tax software would have to be re-written; accounting packages such as QuickBooks & Peachtree would have to be redesigned; accountants, lawyers, payroll clerks, and human resource workers would have to be retrained or find new employment; a new tax collection auditing system would have to be created; new tax forms & instructions would have to be created and distributed. I could go on, but you get the idea. Our current tax system has had almost 100 years to become entrenched. It won't be easy to make such a drastic change.

  10. Tax evasion and instances of black market purchasing would likely increase. With our current system, it's relatively easy to track down most individuals who don't pay their taxes. If you work for an employer, your income is reported to the government. If you invest money with a bank or stock broker, your income is reported to the government. If you earn large amounts of cash without reporting it, an IRS agent can audit your bank statements and ask you to explain every deposit. However, for businesses, the process isn't so easy. Small businesses and independent contractors have by far the highest rate of audit precisely because it is so easy to hide their income. For example, consider a small bar & grill business. Such a business is almost entirely cash-based. Assume they take in $4000 for one night of sales. What's to stop that business owner from pocketing $1000 of the money and telling the government he took in sales of $3000? If you institute a national sales tax, the entire tax compliance burden shifts to businesses, which are in the best position to cheat. In fact, a sales tax would add even more incentive to cheat than already exists since the tax is on revenue, not profit. You're also going to increase the instances of black market purchasing. For example, assume the cost to produce a certain box of cigars is $1.00 per box, but the tax per box is $9. If you legitimately sell the item at $12 per box, you make a $2 profit. If you illegally sell the cigars at $6 per box, you make a $5 per box profit. The incentive exists to sell illegally since you make more money, plus the incentive also exists to buy illegally since you only have to pay half the cost. Consequently, an "underground" economy develops. Examples of this type will only increase with the implementation of a national sales tax.

  11. Consumer prices of many items would go up by a much greater rate than the sales tax rate since raw materials would also be taxed. If you put a 10 percent national sales tax on automobiles and one you want normally costs $10,000, it's logical to assume that the total price including tax will be $11,000. However, it's not that simple. What about the sales taxes the carmaker must pay on the raw materials that make up the automobile? Is there a tax on the tires? How about the battery, windshield wipers, glass, spark plugs, CD player, and so on? If there's a tax on each of those items the cost of the entire car is likely to go up proportionately. Assume the total price of that car now goes up to $14,000. Now imagine a business like Hertz Rent-a-Car. The cost of its inventory now goes up and consequently, their rental rates go up. Now all business travelers must pay a higher rental car rate, which will be passed on as higher prices to the customers they serve. The chain reaction continues. This is only one example. Virtually every business will be forced to raise prices to cover increased costs. A national sales tax will in effect change the whole pricing structure of the economy.

  12. Retirees and others who have earned the majority of their life income have already had their money hit with income tax; thus, they will pay extra sales tax with money already subjected to income tax. While the reduction or elimination of an income tax will help Americans pay the extra sales tax, it's not going to help older Americans who have earned the majority of their lifetime income. Many retirees are living on a fixed income or funds drawn from savings. A decrease in income tax is going to increase the disposable income of those that are still working, but it won't help those who've already had their income taxed. Consequently, older Americans will bear an incredibly high burden of the new tax load.


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Written by:
Joe Messerli
Page Last Updated:
11/04/2011

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