Below is an essay that is an edited e-mail exchange between my buddy Adam and some other person in a user group. With Adam’s permission, I have edited this exchange to fit into a question/answer format that we can all enjoy.

1) A National Retail Sales Tax would be bad for American industry and would hurt the economy.

Not only is this untrue, but in reality a National Retail Sales Tax (NRST) would have quite the opposite effect. The cost of doing business would decrease dramatically, allowing corporations to expand and sell goods and services at lower prices. This would lead to increased demand and corporate earnings would skyrocket, thus fueling the economy.

The first point to understand when discussing how a NRST would affect the business world is that, under the current system, corporations do not pay income tax. 100% of the taxes on corporate earnings are passed along to the consumer in the form of price increases. The same goes for labor costs, compliance costs, capital costs, etc. In fact, every expense the corporation has, from paying taxes on income to paying for the janitor’s new broom, are included in the price of whatever good or service they sell. It follows then, that a reduction in, or elimination of, corporate income tax will lead to a decrease in price (market forces will drive the price down as competitors scurry to low-ball each other). Dr. Dale Jorgenson, Professor of Economics at Harvard, finds that repealing the income and payroll taxes would reduce producer prices by 20-35% depending on the industry. This comes as a direct result of eliminating both the corporate income tax and the surprisingly large compliance costs incurred by corporations in an attempt to navigate the current tax code (just picture the army of tax lawyers employed by, for example, Microsoft). But it’s not just the income tax and compliance costs at the retail level that are the problem, it’s also the cascading effect of every step of production incurring the same income tax and compliance cost burden. In addition, compliance costs are a much more substantial economic drag on small business (those having assets< $1million, which represent 90% of all US corporate entities) than they are for larger businesses. According to the Tax Foundation, small businesses spend $724 to comply with the income tax for every $100 they actually pay in tax. To me, that number is very shocking. But it arises from the arcane tax accounting rules (which are different than generally accepted accounting principles) to keep track of: income, inventories, various types of expenses (some deductible, some partially deductible, some not currently deductible, and some never deductible), depreciation, tax basis for assets sold, various pension and deferred compensation rules, payroll taxes such as Medicare and Social Security, etc. etc. Under a NRST, the only question relevant for tax purposes is “How much did you sell to consumers?” Period.

Okay, so prices drop, how much is debatable, but let’s assume Jorgenson’s numbers are near the ballpark ~ 20% sounds good. Now something that used to cost $100, almost overnight, costs only $80. A corporation can now sell that same item for $20 less and make the same profit per item. At the retail level, we then add the 23% NRST: $80 X 1.23 = $98.40. So the price to the consumer is now $98.40 instead of $100. At this point, I’d like to highlight 2 features of the Fairtax NRST that seem to be getting lost in the debate:

A) The sales tax is only applied to finished goods sold at the retail level for final consumption. There is no “cascading effect” because business-to-business transactions, i.e. investments as opposed to consumption, are not taxed. Neither are transactions involving used goods (like buying an old Buick from your neighbor). The numbers quoted by Jorgenson have a lot to do with the fact that EVERY step in the production process benefits from the drop in operating costs afforded by the elimination of income tax/compliance costs, however only at the final retail cash register do we see the 23% tax. This was the fatal flaw in many so-called “sales” taxes tried in Europe; they taxed every step of the way and the cascading effect put them right back where they started.

B) Services are taxed exactly the same way as goods. All new goods AND services sold for final consumption have the sales tax applied. So if you get your pipes fixed by Roto-Rooter, you pay an extra 23% in the bill they send you just the same as if you bought a widget from Wal-Mart and paid the extra 23% at the cash register. Corporations that mainly provide services would reap the same benefits of reduced operating cost by elimination of income tax/compliance costs as would companies that manufacture goods, thus prices for services would drop as well. In fact, the service industry is dominated by small business owners, so the price drop would be more pronounced. Now let’s include the fact that all consumers have a whole lot more money in their pocket, since they get to keep all the money they earn, and you can see how the economy would benefit. Prices would stay about the same, or drop slightly, but everyone has a ton more money to spend. Inflation may rear its ugly head as the economy heats up, but that can be dealt with as it appears.

How would a NRST affect US businesses in the international arena? What about product “dumping”? Selling goods to other countries at a lower price then they’re available here (due solely to the 23% sales tax) is not dumping. Manufacturers would not be selling products below cost, or even at cost, to other countries. They would be selling products for the exact same price, and same profit mark-up per item, that they do domestically. Thus international sales and domestic sales are treated the same. If other countries choose to impose a 23% defacto tax on all goods imported from America, that’s up to them. Selling products in, say, Canada, for less than it costs a Canadian company to produce the item, is not dumping. That’s just being competitive. Another international wrinkle that few people are aware of is the debilitating effect that corporate income tax laws have on American businesses attempting to manufacture and sell goods in other countries. The U.S. is one of the few industrialized nations that taxes both profits made domestically and (entirely) internationally. For example, if I own a widget company in Atlanta and I decide to build a factory in Germany, then I have to pay U.S. income tax on all earnings in Germany as well. Even if the widgets are entirely designed, built, and sold in Germany. I also have to pay, of course, German income tax on those same profits. Now let’s look at the analogue. A German company is free to build a manufacturing plant in Atlanta and all the profits they make on goods made and sold here are income tax free in Germany. They need only pay the U.S. income tax. Obviously, this puts us at a significant competitive disadvantage. A NRST would do away with all that.

So where does the 23% come from? I have to admit, I’m not knowledgeable enough in economics to understand entirely how they came up with 23%. I refer you to the Fairtax.Org website for a more thorough discussion. Basically, what they did was look at how much federal government revenue was generated by corporate and personal income tax (about 17.56% of the GDP in 1995) and figured out how high a consumption tax rate would have to be to make up for the lost income tax. GDP = Consumption + Investment, so using 1995 numbers, GDP = 83.6% consumption + 16.4% investment. Therefore our tax base for a NRST is 83.6% of the GDP, but we only need 17.56% GDP to make up the difference. 17.56% divided by 0.836 = 21%. The key here is that the consumption tax base is so huge, that a low rate (21%) can make up for all the lost government revenue from elimination of corporate and personal income tax. The Fairtax tacks on another 2% to account for the planned rebate program, bringing the final NRST to 23%. And remember, this is all with no reduction in government spending. And if we could figure out a way to cut out some pork, then the NRST would be even lower.

2) A NRST unfairly shifts the tax burden to the poor.

I really can’t understand the logic behind this argument. Under a NRST with rebate, not only is everyone living below the poverty line completely removed from any tax burden, but they get to keep all of their paycheck. Under the current system, they don’t pay any net income tax, but so called “payroll taxes” such as Social Security, Medicare, etc. still take away a large chunk. These would all be eliminated. As if that wasn’t enough, consumer prices may actually drop. True, a NRST would be a fantastic boon to the business world and many wealthy people would become significantly wealthier, but so would everyone else, across all levels of affluence. I can only surmise then, that this argument against the NRST is less of a plea for the downtrodden (since they would clearly benefit), and more of a class-warfare potshot at the rich. Apparently, if a law or policy helps the rich get richer then it must be evil, even if it helps the poor in the process. But enough of the soapbox, let’s look at some facts.

The additional 2% sales tax built into the NRST would go toward a rebate program whereby everyone would get a monthly (or quarterly or however is most efficient) check for the sales tax paid on essential living expenses for that period. Assuming a family living at the poverty level spends their entire annual paycheck on the necessities of life (no savings or investment), then they pay 23% times the HHS poverty level of $16,050 for a family of 4, equals $3,692 in sales tax each year. So every family of 4 in the country (regardless of income level) gets a rebate check for $3,692/12 = $308 per month. Thus, there is no sales tax on purchases up to this “essentials of life” threshold.

The Fairtax.Org website claims that this tax is not regressive, but in fact is highly progressive. I don’t really agree with that in the sense that if you make more money you will, by mandate, pay a higher percentage of your income in taxes. It is progressive in the sense that, the more you consume, by choice, the higher percentage of your salary will go to taxes. So if you’re a frugal middle-income family who can live on items equivalent to $308/month in sales tax, then your effective tax rate is zero. If you’re a dumbass who blows your rebate check on liquor (except Guinness, Guinness is okay to blow money on…), then your effective tax rate is much higher because you’ll be consuming more. The beauty of this is that there’s no incentive for wealthy people to avoid consumption because prices are about the same, but they have a ton more money burning a hole in their pockets. They will either invest this money (i.e. create jobs) or spend it (i.e. pay taxes to the government). They may also dig into their savings and spend some of that as well, which wouldn’t be taxed at all under the current system (to buy an expensive house for example), but would be under a NRST. Remember, right now income is taxed, but accumulated wealth is not.

The effect is to flatten out the tax burden extremes that the current system imposes. Clearly, there is a group of extremely high-income individuals that would almost certainly pay less under a NRST, but the flipside is that those at the extreme bottom benefit as well. The key is that your personal tax burden is determined by your own spending choices, not by some government official’s idea of who should pay how much. The overall tax burden is then shifted onto those who most enjoy conspicuous consumption.

3) A NRST would be bad for the housing market.

Again, this is not only untrue, but 180 from truth. Yes, the sales tax eliminates the mortgage interest deduction, but these benefits would not “disappear” in a negative sense. They could not exist in the sales tax world since there would be no income against which the deduction could be applied. The only reason deductions for mortgage interest, or student loans, or depreciated capital, etc. exist is to make sure these items are paid for with pre-income tax dollars, presumably as “incentive” to do what the government thinks is best for you. With a NRST, everything is paid for with pre-income tax dollars because the income tax doesn’t exist. Here’s an analogy (warning to sensitive people, sarcasm imminent): imagine someone is tapping you in the head with a small hammer, constantly. It’s painful and annoying, but you can’t do anything about it. Now, the hammer-person has agreed to give you a five minute reprieve, as incentive, if you buy a house. The NRST people come along and say, “hey, let’s get rid of the hammer all together.” We then hear howls of anger from those being hammered, screaming “but what about the 5-minute reprieve? I enjoyed it so much! Now why would anyone buy a house?”.

New homes/condos/townhomes being sold for use as a residence would be taxed at 23%. Investment real estate would not be taxed, just as inputs to any other business endeavor would not be taxed. Bear in mind that overall housing costs would be affected by the same market forces that drove down prices of other consumer goods, i.e. elimination of corporate income tax and compliance costs on the company that makes nails, wood planks, and the architecture firm that designed it all. This results in finished home prices being about what they are today, or perhaps slightly lower, and prices for investment real estate being significantly less. This is wonderful for lower income people who typically rent instead of own, since their monthly rent would drop like a rock.

4) A NRST is prone to abuse and cheating.

Compared to the current system, I don’t think we have anything to worry about. Under the income tax, numerous loopholes exist for high income earners to “not pay their fair share” (whatever that is). Fictitious deductions, unreported income, etc. Under a NRST, all these evaporate. Everyone’s “fair share” is determined by their own personal spending choices, and there’s no way to avoid paying tax on items purchased for consumption.

What about the unscrupulous retail companies out there that would simply pocket the 23% and never send it to the government? Well, these are most likely small business owners (since they have less to lose by getting caught) and if they’re inclined to cheat on a NRST then they’re probably cheating the income tax system right now. And ask yourself this, which system is easier to cheat on, the NRST which only has 1 reporting requirement (how much did you sell to consumers? Send in 23% of that please) or the current system with 7000 sections of tax code riddled with loopholes? Not only is it easier to cheat with the current system, but you might be doing it and not even realize it. The last TCMP audit showed that 40% of Americans are not in compliance with the income tax and it also gave the reasons. A principle reason: taxpayers lacked the requisite knowledge of the tax laws.

So what about enforcing the tax laws? Again, look at which system is easier to enforce. Under a NRST, the IRS needs to only look at corporations that sell finished goods or services to consumers. The company that makes the metal for the machine that makes the tools for the guy that builds the car on the assembly line doesn’t add the 23% into the price of their goods (business inputs), so they have no IRS accountability. Thus a large sector of the economy is incapable of cheating because they simply don’t collect any taxes. This caused trouble with the European “sales” taxes because they taxed, and consequently had to regulate, every step in the production process and were overwhelmed. In addition, since individuals don’t send any tax money to the government under a NRST, then individual Americans are incapable of cheating the system. Thus, the focus of IRS regulation is extremely narrow. Given the same level of funding, the IRS would be an enforcement powerhouse, allowing very few bad apples to slip through the cracks. Contrast that with today’s system where the IRS is stretched thin with thousands of personal and corporate tax audits on the docket and little budget to complete them with. If done right, the IRS budget could be reduced even further under a NRST, and yet provide a higher level of regulation.

5) Features of the NRST that most people haven’t thought about.

Now I’d like to point out a few things about the Fairtax NRST that you might not have considered.

Under the current system, there exists a whole sector of society that is truly not paying their fair share of taxes, under anyone’s definition of fairness. That sector stretches from the petty criminal who steals cars to the drug kingpin who rakes in thousands of untaxed dollars per day. Think of the billions of dollars in criminally obtained money that circulates through the USA every year. So how much do the bad guys actually declare as income on their tax returns? Not very much I bet. Under a NRST, all these people have the same “tax burden by choice” that us law-abiding folks do. Now think about the neighborhood pimp, riding around in his tricked-out H2 with spinney rims, think about what HIS effective tax rate will be under a NRST. I’m guessing his $308 rebate check doesn’t completely reimburse him…

There’s another sector of society that would finally be taxed under a NRST. Criminals, yes, but not as malicious as the gun-toting street thugs. I’m talking about illegal aliens. Right now illegal aliens come to America, use our roads and bridges, send their kids to our public schools, and have access to free healthcare through policies that don’t allow hospitals to turn people away, yet they pay no income tax. This angers me - it might not anger you, but under a NRST all of the debate melts away. Open our borders up! That just means more people to pay consumption taxes. A NRST would also provide them greater incentive to gain citizenship in order to collect their monthly rebate checks. When I say “Open our borders up!” I’m being a bit flippant, because we would still need to have a measure of border control to keep potential terrorists and other violent criminals out, but I’m sure you get my point. The NRST applies to EVERYONE, legal, illegal, sinner, or saint.

This last point is something I bet we can all agree on. Under the current system, the income tax is used as a political tool by sleazy politicians to buy votes. Republicans offer to lower taxes to garner votes from upper and middle income households. Democrats promise to “stick it to the rich” by raising taxes and redistributing the money to lower income people, thereby purchasing their vote. Admittedly, I’m more offended by what the Democrats are up to, but both of these shifty vote-buying schemes disgust me. It’s the beginning of the end for a free society when the masses discover that they can use their voting power to steal money from the public coffer. And politicians are certainly willing to oblige. I can think of no way that a NRST can be used for political gain, except perhaps for the Libertarian Party

I leave you with a quote:

“… in most advanced countries, the following will be pretty generally applicable.
1. Abolition of property in land and application of all rents of land to public purposes.
A heavy progressive or graduated income tax.”

Karl Marx and Frederick Engels, The Communist Manifesto

NOTE: Most of the information in this essay was obtained from the Fairtax.Org website.