August 18, 2004,
It’s a sign of how issueless the presidential campaign has been that voters and reporters alike pounce upon the slightest sign of a new idea from either candidate. Thus, a seemingly offhand remark by President Bush at a Florida campaign rally last week about a national retail sales tax set off two days of fireworks before the White House disowned it. But is the idea really dead?
At first glance, it appears that Bush was not saying anything significant about tax reform at a rally at Okaloosa-Walton College on August 10. He was asked by someone from the audience if he supports H.R. 25. He replied, “It’s an interesting idea. … That’s an interesting idea that we ought to explore.”
One could interpret Bush’s comment as simple politeness toward one of his supporters. But I think it is revealing that although the questioner referred to the proposal only by its bill number, Bush was clearly familiar with its specifics. Obviously, he has a good deal of knowledge about the national retail sales-tax bill sponsored by Rep. John Linder, Republican of Georgia.
Furthermore, Bush made reference at the rally to Rep. Jeff Miller, Republican of Florida, suggesting that he could “explain it all to us.” Indeed, he could have. Miller is a co-sponsor of H.R. 25, something that Bush apparently knew.
My point is that Bush certainly seems to know a lot about a rather obscure bill that has absolutely no support among reputable tax experts. I recently did a thorough review of the academic literature on this issue and could not find a single article in a peer-reviewed journal that did not reject the sales-tax proposal as utterly unworkable.
As I explained in a recent column, the tax rate would have to be prohibitively high to replace all federal taxes. Its own supporters admit that it would have to be 30 percent when compared to state sales taxes. And a new analysis by economist Bill Gale of the Brookings Institution estimates that it would actually take a rate of 60.7 percent.
Linder responded to my earlier column by saying that Harvard economist Dale Jorgenson had signed off on the 23 percent rate in H.R. 25 and supported the legislation. So I asked Prof. Jorgenson if this was the case. He referred me to several publications of his on this topic. One is testimony given to the House Ways and Means Committee on May 9, 2002. In it, Jorgenson calculated a necessary sales tax rate of 28.5 percent, not 23 percent.
It is also clear that Prof. Jorgenson can’t really be considered a supporter of the Linder plan because he has his own plan, which would impose a flat 10.9 percent tax rate on labor income and a 30.8 percent rate on capital, combined with a tax credit on new investment. Jorgenson says he personally presented Linder with a copy of his recent book, Lifting the Burden (MIT Press), in which he explains why his plan is superior to Linder’s. The congressman cannot claim ignorance.
Unfortunately, aggressive ignorance is largely what drives sales-tax advocates and keeps it alive as an issue. It sounds so simple to get rid of the income tax and the IRS and just pay your taxes when you buy things at the store. But even at the deceptively low rate claimed by the legislation, there would be massive problems with evasion and erosion of the tax base. For example, collecting sales taxes on services is extraordinarily difficult, which is why no state even tries to collect sales taxes on all services.
A bigger problem identified by economists, but ignored by sales-tax supporters, is how to make sure that none of the tax applies to business inputs. Unless the tax falls solely on final consumption, it is partly a tax on capital, which erodes much of the economic benefit of the sales tax, leads to cascading (taxes being levied on taxes), and distorts investment.
Again, the experience of the states is instructive. Studies have shown that about 40 percent of all state sales taxes fall on business inputs that ought to be exempt. At the low sales-tax rates imposed in most states, this doesn’t create too much of an economic problem. But at a rate necessary to replace all federal taxes, it would be very severe.
The problems of properly taxing businesses and avoiding evasion are what led every country that has ever studied the matter to conclude that a value-added tax is much superior to a national retail sales tax.
There is no question that the Treasury Department will oppose a retail sales tax if President Bush asks it to study the issue. I hope he does, so that serious tax-reform debate can move forward.