Sales tax

Posted on December 25th, 2007 by Tim.
Categories: General/Misc..

There are a few presidential candidates (including Ron Paul) who advocate getting rid of the income tax, and instating a higher flat sales tax instead. The economic theory is sound behind this, since it increases incentives to work harder, save more, and spend less. This translates to higher worker productivity and higher MPS (Marginal Propensity to Save).

The problem with this, of course, is that a flat sales tax is an extremely regressive tax, compared to our extremely progressive income tax. However, it occurred to me that a sales tax doesn’t necessarily have to be a regressive tax. In our modern age of digital finance, it would be easy (in relative terms) to have a sales tax rate which is dependent on income level. This could in theory maintain the progressivity of the current tax rates while rearranging incentives to promote long term economic growth.

Are there other downsides that I’m missing?

2 comments.

John K. Paul

Comment on January 18th, 2008.

How would this income-dependent sales tax work? I don’t know what you mean about digital finance. In the real world, there are millions of people that don’t use credit cards and there are millions of stores for consumer goods that don’t accept credit cards. Even if everyone did use credit cards for everything, how would the IRS be able to assign you a particular sales tax before you file your taxes, unless there was some big-brother-like constant reevaluation of bank accounts and employment payrolls.

Also, as a downside if this did work out, it is a very different paradigm to live under. It inherently makes sense to me that some money can be taken off the top of our income (although I admit, that is because I live with this system.) It doesn’t make sense at all to me, and would actually scare me a little bit, if one day I paid $5 for a gallon of milk, and after a promotion, I now have to pay $6 for a gallon of milk. Replace that with any other fairly inelastic item, and you hopefully see what I am getting at.

Tim

Comment on January 18th, 2008.

You’re right, it would be hard for this to work well unless all transactions were electronic. There are other ways to make this work though. The difference between what we make and what we spend is the amount that we save. The government already knows how much you make and how much you save, so we can use this information to infer how much money you spend. It essentially works out to a very progressive income tax with a large rebate for saving money.

Granted, this system introduces incentives to get around the system (like making money under the table), but these are not horribly different from current incentives to cheat.

As for living under a different paradigm, I think you’re right that it would be completely different. A changing price from day to day would probably not be a reasonable policy, but year-to-year is likely more reasonable. In this paradigm, you have a very large incentive to save as much money as you can. While it seems counterintuitive to discourage spending, a high MPS is good for long term economic growth.

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