Flat consumption tax, with exemption for the poor, would reduce taxes

July 31, 2012

Free Market Foundation

(Eliminating compliance costs and distortions could annually save the U.S. $500 billion)

Replacing the U.S. federal income tax with a flat consumption tax would boost tax revenues, lower marginal taxes on work and savings, and lower the tax burden of the poor, says economist Lawrence Kotlikoff.

Today, the tax code is some 17,000 pages long, providing politicians with plenty of places to hide kickbacks to special interests, Kotlikoff says. The complexity of the tax code also disproportionately helps the rich. Moreover, despite recent tax cuts, tax rates on work remain too high:

If one adds all the federal, state personal income, payroll, excise and sales taxes, effective wage tax rates can easily reach 50 percent.

The poor are also hard hit; when low-income families work, they lose welfare, health-care benefits, and tax credits, with the net effect being high taxes on labour income.

Kotlikoff says introducing a consumption tax, in the form of a national sales tax, would broaden the tax base (the amount of economic activity subject to taxation), significantly reduce tax rates and improve economic efficiency. The current flat tax bill in Congress would:

Reduce the amount of taxes paid on earnings from 50 cents per dollar to roughly 30 cents.

Reduce the economic distortions in the economy, saving about 2 per cent of national income or about $250 billion annually.

Eliminate wasteful tax compliance costs, which are estimated to be as high as $250 billion.

Also, the tax would not adversely affect the poor the flat tax proposal would rebate each household their sales tax payments on consumption expenditures up to the poverty line.

Source: Lawrence J. Kotlikoff, The Case for the ‘Fair Tax’, Wall Street Journal, March 7, 2005.

For text (subscription required): http://online.wsj.com/article/0,,SB111015936466471833,00.html

For more on National Sales Tax: http://www.ncpa.org/iss/tax/

FMF Policy Bulletin/ 22 March 2005