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May 26, 2005
News Analysis: Fair Tax, Bad Tax: The National Sales Tax's Insidious Influence
Joseph J. Thorndike

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And the winner of this year's prize for Worst Idea in a Serious Public Policy Debate: the Fair Tax. In all likelihood, this plan for a national retail sales tax has already exhausted its 15 minutes of fame. Sometime later this summer, President Bush's commission on federal tax reform will probably put it out of its misery.

But before the Fair Tax disappears from serious discussion -- well, the discussion was never all that serious to begin with, at least among Fair Tax supporters -- let's take a minute to consider the worst aspect of this very bad idea.

First, though, we have to sort through an embarrassment of riches: How can we identify the worst quality of a tax that has so many? As numerous critics have pointed out, the Fair Tax would raise too little revenue and prompt too much evasion. Its popularity depends on unreasonable assumptions and misleading descriptions. It would never work as advertised -- a fact that many of its supporters either choose to ignore or secretly celebrate.

Still, one aspect of the Fair Tax deserves special opprobrium: the damage it does to public debate. By focusing popular attention on a lame idea, it distracts attention from serious alternatives. In particular, it muddies debate over the proper base for federal taxation, obscuring discussion of federal consumption taxes behind a particularly facile version of the same idea.

Taxes are tedious, at least for most people. Paying them is a chore, and talking about them may be even worse. Getting the public to focus on broad and substantive issues of tax reform -- difficult under any circumstances -- is particularly hard when so many political leaders indulge their fondness for empty, antitax rhetoric.

In such an environment, the Fair Tax makes things even worse. It degrades the quality of public debate by encouraging Americans to latch onto something familiar amid a raft of confusing alternatives.

Everyone understands the sales tax. Most Americans pay one every day, and those who don't probably revel in the fiscal probity of their state lawmakers. Supporters of the national sales tax have capitalized on that familiarity, offering taxpayers an apparently simple alternative to the confusing federal income tax. But in the process, they have engaged in some dubious sleight of hand, quoting rates in tax-inclusive, rather than tax-exclusive terms. (Tax- exclusive rates reflect the ratio of the tax to the pretax price of an item, while tax-inclusive rates are the ratio of the tax to the after-tax price of the good, including the tax itself.)

Fair Tax advocates defend this fiscal legerdemain, insisting that it facilitates comparison with the income tax (the rates for which are typically quoted in tax-inclusive terms). Perhaps. But it also obscures comparison with state sales taxes, the only reasonable point of comparison for most taxpayers.

In a recent article for Tax Notes, economist William Gale evaluated plans for a national sales tax, concluding that rates would necessarily be much higher than advertised. Gale was careful to offer an even-handed explanation of the difference between tax-inclusive and tax-exclusive rates. "Neither method of quoting a tax rate is incorrect," he generously observed, "but public discussion could be greatly improved if the difference between the two rates was clarified." (For Gale's article, see Tax Notes, May 16, 2005, p. 889.)

You can say that again. From an economic perspective, both exclusive and inclusive rates may be correct. But in the political arena, the tax-inclusive rate is very, very wrong. It is clearly designed to mislead voters, minimizing the apparent price of that reckless fiscal reform and artificially boosting its popularity.

That maneuver seems to have worked, at least so far. Hundreds of thousands of Americans have signed on to support the Fair Tax, inundating the president's tax reform commission with letters and emails expressing ardent support. Advocates have staked out the commission's hearings, quickly establishing themselves as the most prominent special pleaders in the debate over tax reform alternatives.

All of which would be fine, were it not for the lost opportunity it represents: We could be having a much better debate about the tax base, and those Fair Tax folks could be leading the charge. The Fair Tax rank and file are a valuable and scarce resource: They are voters who think seriously about taxes. And while there is plenty of vapid, antitax rhetoric surrounding the Fair Tax, many of its supporters are well-intentioned, well-informed citizens. They are the same public- spirited people we should seek to mobilize in a more serious debate over consumption taxes.

Most substantive plans for a national consumption tax are complicated. The VAT, in whatever form, belies easy description, at least in the popular media. And the piecemeal redefinition of the tax base through various savings vehicles -- while potentially very important -- unfolds under the guise of our existing income tax. Among tax experts, proposals for expanded, tax-free personal savings accounts may seem like an obvious step toward consumption taxation. I suspect, however, that few voters understand that process of incremental reform.

And try explaining to nonexperts that the famous flat tax is actually levied on consumption, not income. That point has been consistently obscured in public debate, largely because advocates have emphasized its administrative similarity to the income tax.

The sales tax, by contrast, is easy to understand. It clearly taxes consumption by focusing popular attention on the act of consumption, with much talk of cash registers and such. Meanwhile, other forms of consumption taxation, including the VAT, remain mired in complicated jargon. In a world where few people want to think seriously about taxes, the sales tax is the simple route to consumption taxes.

But it is not the best route. Not by a long shot. Yet its familiarity, enhanced by a misleading description of its rates, has made it pretty much the only consumption tax proposal getting serious attention from the popular media. And that's a shame.

The nation could use a good debate over consumption taxes. During the past couple of decades, we have developed a hybrid revenue system, moving slowly but steadily toward a consumption tax, chiefly through the preferential treatment of capital income. The tax reform commission seems likely to endorse additional steps in the same direction. Over time, that gradual transformation of the tax base promises to remake the fiscal foundations of modern America.

Previous federal tax regimes have ended with a bang, as wartime exigencies forced lawmakers to experiment with new taxes. But the demise of the modern income tax seems likely to unfold on the sly, with few Americans aware that something big is in the works. And that's bad news for everyone.