The general definition of the efficiency of a tax is how hard it is to avoid. I view the income tax as inefficient in four ways:
1. Inefficient in calculation
2. Inefficient in retrieval, easy to work around
3. Inefficient in aligning tax policy with national interests
4. Inefficient to reverse in order to stimulate consumption in a recession
As a result of these inefficiencies, I think it is important at fundamentally changing how taxation works in this country. There has been the occasional talk of a consumption tax either in the former of a value-added tax (VAT) or a federal sales tax.
I support getting rid of the federal income tax for most income brackets and replacing it with a federal sales tax – only if implemented correctly. A flat sales tax is regressive in that those with lower income would spend more of their income and, as a result, a higher percentage of their incomes in taxes. I would never support a sales tax that didn't correct this behavior. There have been discussions of a 23% flat sales tax (the so-called "fair tax"). I cannot emphasize how strongly I would oppose such a proposal.
The correct implementation of a federal sales tax, as I will describe below, resolves all four of the aforementioned inefficiencies. The calculation is transparent to the consumer and there will be no need to file a tax return. An individual can't easily avoid paying a sales tax as it would require massive collusion from all the stores they shop at. A tax on consumption would encourage saving and fundamentally change the way the economy works for the better (more on this later). Lastly, in a recession tax cuts and refunds are created in the hopes that consumers will spend the extra cash. In many cases this is saved, which limits the economic impact, "the multiplier effect", of that spending. A cut in sales tax, however, would only be realized when money is spent which would provide more effective stimulus.
I support a sales tax over a VAT as it is more transparent to the end consumer. Additionally, a sales tax would do more to correct the 4th inefficiency as it would be calculated at the time of the consumer transaction rather than the various steps along the supply chain. The latter would create a lag limiting the immediate impact of policy changes.
The foundation of my implementation of a federal sales tax is a web service and corresponding API. At the point of purchase, when a product is scanned, several parameters will be sent to an IRS web server where based on those parameters the tax rate for the item will be calculated and returned. The parameters required for all products are product price and product category code. It would be flexible to accept additional parameters based on the systemic risk, externalities (e.g. environmental impact), and other miscellaneous economic incentives associated to a product. The application that would handle this logic would only take a few hundred lines of code, would return results in milliseconds, and would be easily maintainable to keep up with policy changes. It would not collect any information pertaining to the person purchasing the product and wouldn't need to track the store where it was purchased. That option could be available for stores to publish their transactions in real time. The IRS would keep track of the total amount due at tax time (whether monthly or annually) and would send a retailer the bill for the amount. If a retailer adopted this path, the only burden would be sending out a check (or a direct bank account withdrawal) at the required interval. This real-time data would also be tremendously valuable in tracking economic activity.
The suppliers of the purchased product will be the party responsible for determining the parameters that need to be passed so scores of individual retailers aren't forced to do duplicate work for the same items. This is a small price for them to pay to avoid a VAT and dramatically reduces the effort to implement this system for retailers. This will also help small businesses by putting huge e-commerce web sites that are not subject to sales tax on a more level platform.
Some sample examples of transactions (with arbitrary numbers):
- Someone buys an article of clothing (product category) that is $20 (product price) since this product category would be considered "core", at this price there would be no sales tax
- Someone buys an article of clothing that is $500, since this would be in a "luxury" tax bracket they would have to pay a sales tax of 15%.
- Someone buys an article of clothing that is $20 manufactured in China in a coal power plant, this would be subject to a 5% sales tax based on the environmental impact of its production (The WTO would allow taxing imports based on environmental impact if we implemented a carbon tax or cap-and-trade system domestically).
The progressivity of this sales tax would be guaranteed by several factors:
1. Items defined as "core" would not be subject to a sales tax by default. These items would include clothing, groceries, and other essential items that if taxed would place a large burden on low and middle income families.
2. Items would be based on price bracket (whether defined in tiered, linear, exponential equations, etc.), more expensive items would be subject to more progressive taxation. This ensures that high-wealth individuals that buy luxury items will pay a larger share of taxes.
3. The income tax wouldn't be abolished entirely. Nominal tax rates would be dramatically lowered, and new tax brackets would be created (e.g. incomes over 1 million, 10 million, 100 million, 1 billion, etc.). These taxes would be enforced as necessary to guarantee a progressive tax code.
4. Most high-wealth individuals earn their income through capital gains which is taxed at a much lower rate. By taxing consumption, more of their economic activity will be subject to taxes. This could also allow for the reduction, or elimination, of the estate tax or other taxes resulting in a simpler tax code overall.
To prevent a shock to the economy, this change wouldn't occur overnight. Over a period of five years, the income tax would be phased out and the sales tax would be phased in by twenty percent increments every year. This will allow consumers to adapt to paying a federal sales tax and realizing they get to keep more of their income. If it were done overnight, then people may be likely to pull back consumption more drastically. It also will provide the ability to track tax policy and ensure things are taxed at the appropriate levels prior to solely relying on the federal sales tax for revenue. This process should start one or two years after the legislation passed (depending on time of the year) to ensure retailers have time to implement the new systems. For retailers that use out-of-the-box point of sale systems, the software companies would likely be able to implement the necessary code in months and seamlessly integrate it into existing business processes.
The application code would be open-source and the database would be available, so if a retailer didn't have internet access or didn't want to expose their internal systems to risk by connecting to the internet, they could integrate the application into their systems for offline access. When rates changed they'd only need to download a new database and distribute it on their computers. The same would go for any embedded application changes if a new version were released.
Retailers that don't have computer-based systems would need to keep track of their inventory (which they should be doing already) and what products sold. Each product would be subject to the mean effective tax rate on the item over the fiscal year. This would prevent them from having to calculate the sales tax on an item in real time and would ease their burden considerably. Subsidies and rebates would be available for businesses switching over to digital point-of-sale systems and inventory management tools.
While there may appear to be a lot of moving parts to this system, the impact to the end consumer would be minimal. It would align our tax policy with our priorities, would ensure a fair tax code, would be adaptable to change in seconds rather than months or years, and would allow for efficient tax collection. What's most important is that it would change this country from a consumption-based economy to an investment-based economy. The recent booms and busts of the economy have been the result of shocks to private consumption and overhanging debt. When in recession, people cut back which requires large efforts from the government to boost demand and restore economic activity to healthy levels. By taxing consumption, saving is encouraged which provides additional capital available for investment. This investment will allow for additional technological innovation and entrepreneurship which are the key sources for long-term, steady, and sustainable economic growth.