ROBERT T. PATTON, PH.D.
FINANCIAL AND ECONOMIC CONSULTANT
1100 CHUCKANUT CREST LANE
BELLINGHAM, WA 98229
(360) 647-7777, RES. 676-9055
THE CASE FOR A NATIONAL SALES TAX
A massive jobs program that would actually cut the
Federal budget deficit by 900 billion dollars a year
The federal tax code in 1913 was 400 pages long. Today one hundred years later
the federal tax code is over 75,000 pages with thousands more pages of related
regulations, tax court rulings and other policy statements that control the
administration of this incomprehensible system of generating revenue to fund the
national budget. Americans now spend 7.6 billion hours a year struggling to
submit annual tax returns to the IRS. This is the equivalent of 3.8 million full-time
workers employed year-round, just to handle the paperwork required to report
taxable income. This effort is not available to produce goods and services that
improve quality of life in the U.S. By this measure, the tax-compliance industry is
six times larger than the entire U.S. automobile industry. It is estimated that 82
percent of taxpayers must pay for help in filing annual tax returns. About 60
percent hire an accountant or tax preparer, while the remaining 22 percent use
purchased tax software. The IRS employs about 100,000 people burning through
a budget of $300 billion dollars every year just to process the 240 million tax
returns that are sent to them every year. A sales tax system would eliminate
much of this unproductive effort and expense while stimulating the private sector
to create hundreds of thousands of new domestic jobs in the U.S. Economy and
reducing the Federal deficit by 900 billion dollars a year.
INTRODUCTION
On April 1, 2012, the United States claimed another first place accomplishment. We have assumed the
first place position of having the highest corporate income tax rate in the world. Many will say great,
sock it to those evil corporations. However, this reflects a pathetic understanding of the economics of
taxes on businesses. The fact that everyone must come to understand is that businesses really don’t pay
any tax. They simply build the tax charged to them into the price of everything they sell to the consumer
or they must reduce wages or dividends to offset the tax burden. When you come to understand this, you
realize that ultimately the consumer is the only entity that effectively pays tax revenue to government.
However, most consumers do not realize that the price they pay for goods and services contains a lot of
hidden tax. Politicians like to keep it this way so that voters do not have an accurate understanding of
just how much government is costing them. One of the unintended consequences of this arrangement is
the resulting incentive for businesses to take as much of their activity as possible overseas where they can
even avoid the foreign Value Added Tax on everything exported back to U.S. or to other nations around
the world. The unfortunate result is that millions of jobs that were once held by American workers have
been exported overseas. Until our tax system is dramatically changed, American businesses will suffer
from the unlevel playing field created by our own tax system. A progressive and graduated sales tax
would fix this problem very quickly with several side benefits. All products imported from foreign
companies would be assessed the same sales tax as products produced in the U.S. thus leveling the
playing field. The IRS could be virtually eliminated by having the sales tax collected through the same
sales tax system administered by the States and most tax accountants, attorneys and accountants in
private enterprise could also be employed in more socially valuable positions. Tax cheating would be
mostly eliminated while the taxpayer would be permanently freed from an incomprehensible tax code
and the burden of filling a tax return every year.
WHY IS OUR INCOME TAX SYSTEM SO TERRIBLE?
The U.S. Income Tax Code has grown over a hundred years into one of the most incomprehensible
documents this world has ever seen. Politicians and lobbyists have interacted over the years with
bureaucrats in the Internal Revenue Service to create an out-of-control monster that no average person
will ever have the slightest chance of understanding. The result is that income tax system has spawned a
sizable industry aimed at helping taxpayers report their tax liability to our government. Some will buy
special computer programs each year to assist in the preparation of the annual income tax return. Others
march into their local professional tax preparer’s office and pay out hundreds or even thousands of
dollars to have their tax return prepared for them. All through the year leading up to tax season,
individuals and businesses spend countless hours trying to keep track of the information that will be
needed to file an income tax return. Then the professionals get involved and spend countless hours
assisting in the actual reporting procedure. All of these hours and dollars absorbed by the record keeping
and reporting process add absolutely nothing to the quality of life in this country. In fact, it would be
quite easy to show that this process actually detracts from the quality of life in the U.S. If this time and
money was invested in the production of goods and services that people need as they live out their lives,
it should be obvious that the quality of life would be measurably improved.
The income tax system is also used by criminals to steal tax refunds that are owed to honest taxpayers. It
is reported that numerous taxpayers find that their tax refunds have been paid out to criminals sending in
false tax returns before the real taxpayer has a chance to apply for their refund. This problem then will
take many months of work by the taxpayer and the IRS before the issue is resolved. A sales tax system
would eliminate this problem and would in fact eliminate the need for any tax refunds to any taxpayers.
WHY IS INCOME TAX ON BUSINESSES PARTICULARLY BAD?
The answer to this question requires that the reader understands that, in reality, businesses don’t pay
taxes. Taxes levied against business are always passed on to the consumer. The tax on business simply
becomes another cost item incurred in the process of creating a product or service. There is only one
source of dollars to pay for any cost item, including taxes that businesses incur in the course of delivering
a product or service to their customers. That source is, of course, ultimately the customer who buys the
product or service. So who really pays business taxes? It is the consumer. However, there is a very
significant negative effect that results from assessing taxes against business activity. That is the taxes
obviously increase the price at which products or services are sold. This is true of everything produced
in the U.S. The problem is that it only affects the price of what is produced in the U.S. The price of
everything produced in foreign countries is not increased by U.S. business taxes because the U.S. has no
authority to tax foreign business activity. Products produced in foreign countries are normally impacted
by the value added tax that is assessed by our trading partners overseas. The catch is that when the
foreign businesses export their products to the U.S., their governments exempt this business activity from
the value added tax. Therefore, products produced in foreign countries enter the U.S. free of the tax
burden that impacts the price of everything produced in the U.S. The reader should recognize that
business taxes in the U.S. could easily be described as a domestically imposed “tariff” on everything
produced in the U.S. while everything produced outside of the U.S. is imported free of this domestically
imposed “tariff”. U.S. businesses are trying to compete with foreign businesses when the playing field is
not level. This is at least part of the reason so many American jobs have been moved to overseas
businesses. When our tax policy prevents domestic businesses from competing effectively with foreign
competitors, our businesses either close down or move their business activities overseas. Either way the
jobs disappear in the U.S. and reappear overseas. Our workforce becomes unemployed.
AN EXAMPLE: The American consumer can buy a Ford sedan produced in the U.S. for somewhere
around $25,000, depending on options. They could also buy a Toyota sedan for about the same price.
However, the Ford will have $3,000 to $5,000 of hidden business taxes built into the price while the
Toyota was exported to the U.S. free of the value added tax in Japan. Therefore, Toyota can add enough
extra quality in their product to attract many American consumers over the Ford. Toyota also would
have the option of selling their product at a lower price because they do not have the tax burden to cover
when they price their product. The result is that many Americans buy a Toyota rather than a Ford.
People who once built Fords are unemployed because the American consumer recognizes a better value
in the Toyota. For this reason relatively more Toyotas are being built and relatively fewer Fords are
being built. This effect is largely due to the U.S. tax system. Just think, if the Ford did not have the
$3,000 to $5,000 tax burden added to the price, Ford would not only sell more cars in the U.S. but they
would also sell more of their cars in foreign markets because of the lower price. Then some of the lost
jobs would come back to America.
WHY DO OUR POLITICIANS CONTINUE TO KEEP BAD TAX POLICY IN PLACE?
There are at least two reasons why politicians like our present tax system. The most significant reason is
that consumers never see most of the tax they pay because these taxes are hidden in the price of things
they buy. This will keep most consumers unaware of the actual cost of government. When consumers
don’t see the taxes they are paying, they are not likely to complain or hold the politicians accountable for
the enormous sums of money they are taking away from the consumer and spending in what is often
wasteful or low priority agendas that fail to move this country forward. When politicians are not held
accountable for their folly, it is much easier for them to get reelected and reelection is always the number
one objective of the politician.
A second reason that politicians like the present tax system is that it requires hundreds of thousands of
workers to administer the system. Many of these workers are members of one or more public employee
unions who give generously to the politician’s reelection fund. The unions also encourage their members
to vote for the politicians who then will help to keep the union employment growing larger every year.
Thus the union leaders receive more union dues every year and they can use the money to increase their
salaries and give more to the right politicians reelection fund. It works better than the most sophisticated
money-laundering scheme. There are also the hundreds of thousands of tax professionals whose jobs
depend on the continuation of the present tax policy. At least some percentage of these will continue to
be loyal to the politicians who are responsible for creating the industry that provides them their job.
CAN A FEDERAL SALES TAX FIX THE PROBLEMS WITH THE PRESENT TAX SYSTEM?
A Federal retail sales tax can be designed in a manner that would collect the same amount of tax, both
hidden and visible, from consumers as they are presently paying. The immediate unthinking response
that many will express at this point is that a sales tax would be regressive. However, I would challenge
these people with the task of making the new sales tax system at least as progressive as the present
income tax system. When they start to actually think about it, they would come up with several ideas.
Some of these might be no sales tax on food, medical services, gasoline or the first $5,000 of a vehicle
purchase. However the sales tax applied to a vehicle purchase would apply to both vehicles produced in
the U.S. and vehicles produced in foreign countries. That would give American producers a level playing
field for the first time in decades.
The individual taxpayer would no longer be required to spend many hours and/or many dollars reporting
their income tax liability each year. They in fact would have no time or money invested in the reporting
of tax obligations because the tax would be collected at the point of sale when they purchased items
subject to the sales tax. Under a sales tax system there would be more than two hundred million fewer
tax returns being sent to the IRS each year. This means that at least 95% of the IRS staff could be
released to go to work building Fords, or some other useful product. The same would be true for the
hundreds of thousands of tax professionals who would no longer be needed to process tax returns for
their clients. This would eliminate an enormous amount of inefficiency that exists in our present tax
system.
Under a sales tax system, tax cheating would be substantially eliminated. People who do not report all
their income would now pay the same as everyone else when they spent their income. People who take
payments under the table would pay the same sales tax as the worker whose income is presently tracked
through the payroll tax deduction. People who gain income illegally would also pay the sales tax every
time they spend the illegal money. The billions of dollars lost to tax cheaters every year would no longer
be lost to government and it would cost government nothing to fix this problem.
A sales tax system would have the added benefit of tending to encourage saving among consumers. To
the extent that it would cause more people to hold back on their consumption patterns to a more
reasonable level, we would have fewer people going through bankruptcy proceedings or needing
government assistance to meet their living requirements. The sales tax system would help to instill a
higher level of personal responsibility among American consumers.
A final benefit that can be realized is the elimination nearly all of the IRS function. There are only five
states that do not collect sales tax at the state level. The national sales tax can be collected using the
existing state systems with a small payment back to the states for providing this service to the Federal
government. Under this arrangement nearly all of the $300 billion dollars per year spent by the IRS
could be applied to deficit reduction. The 100,000 IRS employees could be reassigned to replace retiring
Federal workers in other needed government positions or they could help to build the increased demand
for American made products that would result from substituting a sales tax system in place of the income
tax system.
HOW MUCH OF THE FEDERAL DEFICIT WOULD BE ELIMINATED?
If states collect the new Federal sales tax through existing state systems, nearly all of the 300 billion
dollars wasted through the present income tax system could be saved. In addition, virtually all tax
cheating would be eliminated bringing in another estimated 400 billion dollars to the Federal
government. Also, another 200 billion dollars would come into the U.S. Treasury when U.S. industry
was released from the domestically imposed duty (Federal Income Tax) adding to the cost of everything
produced in the U.S and reducing our competitive advantage in world markets. This would be the result
a significant increase in economic activity in the U.S. The total of 900 billion dollars could then be
applied to reduce the Federal budget deficit. Our fiscal problems are largely a result of our own
ineptness in funding our Federal government. If Congress would like to help our economy grow by 4
percent or more with one simple change in national policy, shed the income tax system and adopt a
national sales tax to fund the Federal budget. This would turn into a real jobs program for the country.
HOW DOES THIS COMPARE TO THE FAIR TAX PROOSAL
A simple national sales tax system is superior to the fair tax for several reasons. First, the fair tax
proposal would still require reporting income to the government. This means continuing some level of
bureaucracy and expense in the process of generating revenue to finance government. The simple
national sales tax avoids this expense and unproductive time involved in the collection of tax revenue.
Revenue is collected at the same time as state sales tax at the point of sale. Second, the fair tax proposes
what is called a “prebate” payment monthly to taxpayers in an effort to eliminate the regressive effect of
a flat sales tax. This again involves more bureaucracy and expense that is not needed. A sales tax system
can be designed to be as progressive as would be desired by not taxing items that low-income families
can not avoid buying such as food, utilities, fuel, medical services, etc. All of these items now contain
hidden income taxes that are built into the retail price. If the income tax system were eliminated in favor
of a sales tax system, the cost of these items would actually go down and then consume a smaller part the
budget of low-income families. Third, the fair tax still allows for the same tax evasion behavior by tax
cheaters as the present income tax system. Nothing is simpler or more efficient than a sales tax collected
at the point of sale. This approach to funding government is the best answer that is available to either
state or national government.
SUMMARY
It is way past time in America to overhaul the tax system used to finance government activity. A national
sales tax makes a great deal of sense. This still would not release our politicians from the responsibility
to reduce government spending and reduce the size and scope of government. A government that spends
in excess of 18 to 20 percent of its gross domestic product is a government that needs to go on a serious
weight reduction program.