Beware A Sales Tax In The Name Of Simplicity

Taxes on consumption would hurt the middle class and the poor

By Robert Kuttner

President Bush is having a difficult time selling Social Security private accounts to America's middle class. But just wait for the backlash when he proposes his tax reforms. Packaged as tax "simplification" and savings incentives, the likely changes would shift the tax burden from the rich who tend to save more (they have more to save) onto the middle class.

As people rush to meet the Apr. 15 tax deadline, a tax commission appointed by President Bush is laboring to produce recommendations toward the President's stated goals of simplifying taxes, maintaining revenue neutrality, and promoting savings and growth. This charge is a mission impossible.

It's an open secret that the commission is expected to offer a blueprint for the longstanding conservative goal of shifting taxation from income to consumption. The simplest mechanism would be a national sales tax. Unfortunately, to be revenue-neutral it would also require a sales tax rate of about 60%, according to calculations by William Gale of the Urban-Brookings Tax Policy Center. That's because taxable retail sales are less than a third of all economic activity. A revenue-neutral national sales tax would produce a massive shift of the tax load on to middle- and lower-income taxpayers. So it's a political nonstarter.

Rather, the commission is likely to pursue consumption taxation by stealth and indirection. By leaving the income tax nominally intact, but chipping away at taxes on capital income, the commission could produce a blueprint for a de facto consumption tax. Consumption-tax advocate Ernest S. Christian terms this approach Five Easy Pieces: Don't pursue consumption taxation directly, but slash taxes on capital gains and dividends, estates, all savings, and allow business to expense investments.

This scheme is nimble, but it defies all three of the President's stated goals. First, far from simplifying the tax code, it would add to its complexity. Even if tax deductions for savings were consolidated, it is not IRAs and Keoghs that are cluttering up the present tax system.

Second, this approach would not increase the national savings rate. The new shelters would increase deficits in order to give well-to-do taxpayers yet another tax break. Anyone who has ever shifted ordinary savings into an IRA or Keogh knows that tax preferences for savings do not increase savings rates. They just give you a tax break for moving around assets.

Thus, this approach cannot be revenue-neutral unless, like a national sales tax, the formula increases taxes on wage and salary income. The problem is compounded by the mother of all stealth tax increases, the alternative minimum tax. This device, legislated in 1970 to prevent very high-income taxpayers from avoiding taxation entirely, now hits most upper-middle-class taxpayers, by limiting such deductions as local property taxes. For upper-middle-income taxpayers in the $100,000-$300,000 bracket, mostly Bush supporters, the recent tax increases caused by the AMT often exceed the savings of all the Bush tax cuts. But reforming the AMT will cost the Treasury an estimated $1 trillion over the next decade. So the commission cannot fix the AMT without raising other taxes or increasing the deficit.

If Bush had pursued consumption taxation early in his Presidency, before squandering so much revenue on other big tax breaks, he might have pulled it off. But a massive revenue loser is implausible in the current fiscal climate, and a big tax hike for the middle class is inconceivable.

Meanwhile, the Democrats have managed on Social Security something that eluded them throughout Bush's first term -- unity in opposition to a key Bush goal. Few if any Democrats will support a tax hike for the middle class, and many Republicans will think twice.

Jumping the gun on Bush, the liberal think tank the Center for American Progress has rolled out a tax-simplification plan that could become Democrats' rallying point. Unlike the Bush plan, CAP's plan cuts most people's taxes, provides genuine simplification of the tax code, and raises net revenue.

The White House had hoped to gradually generate public support for consumption taxation, building on an anticipated big win on Social Security privatization. But with his Social Security plan in trouble, Bush could instead face two high-profile, back-to-back defeats.

Robert Kuttner is co-editor of The American Prospect.

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