The tax man.

Photographer: George Frey/Getty Images

Gary Johnson's Unfair, Expensive National Sales Tax

Ramesh Ponnuru is a Bloomberg View columnist. He is a senior editor of National Review and the author of “The Party of Death: The Democrats, the Media, the Courts, and the Disregard for Human Life.”
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Gary Johnson, a former governor of New Mexico, is running for president as the Libertarian Party’s nominee to draw attention to his ideas. One of those ideas is a 28 percent national sales tax to replace the federal income, payroll and corporate taxes. He would repeal the 16th Amendment, which authorized the income tax, to make his plan stick.

But the more attention his idea gets, the less attractive it will be.

Johnson is advancing a modified version of a proposal called the “FairTax.” That proposal addresses one obvious potential problem with a national sales tax by adding a “prebate” to it: a check from the government to all households that has the effect of exempting the poor from the new tax.

But the tax rate is higher than it appears to be. Let’s say Johnson’s tax ideas prevailed, and a Kindle sold for $139 -- with $100 going to Amazon and $39 to the new federal sales tax. Advocates of a national sales tax would say that’s a 28 percent tax rate, because 39 is 28 percent of 139. That method makes for a clean comparison to the income-tax rates that the sales tax would replace. (Income tax rates are “tax inclusive,” too, if you stop and think about it.) But state sales tax rates aren’t calculated that way, and most people will get the wrong idea when they hear Johnson say he’s for a 28 percent tax, and when reporters repeat it.

And many of the claims for the national sales tax are overblown. In a Republican presidential debate last year, Mike Huckabee promised that pimps, prostitutes and drug dealers would not be able to avoid sales taxes the way they avoid income taxes. Maybe that would be true for the things they buy. But they’re unlikely to charge the sales tax to their customers, so the same transactions that go untaxed now would keep going untaxed.

Actually, the underground economy would almost certainly grow much larger as people try to avoid the new sales tax. European countries try to minimize this problem by relying on the value-added tax, levied at each stage of production, rather than using retail sales taxes. (The VAT has other administrative advantages.) But even those countries have lower rates than Johnson is considering. The average VAT rate in the European Union is 22 percent. We should expect much more tax evasion under Johnson’s 39 percent tax.

Johnson treats the sales tax as a free lunch. Today’s taxes raise the price of everything, he says. He says that if you got rid of those taxes, a $1 can of Coke would cost 72 cents. Add 28 cents for his new tax, and you’re right back at a dollar.

“It’s actually, in theory, not going to add cost to products,” Johnson says. You may be wondering, then, who pays the tax? Good question. The answer is that if the price of everything falls, that has to include the price of labor. So either prices rise and people pay the tax as consumers, or prices stay flat and they pay it as employees. The cost of the tax has to come from somewhere.

Senior citizens would be hit hard. If prices go up because of the tax, then any of their savings that aren’t shielded from inflation will fall in value. Future retirees’ Social Security benefits would be lower, too, since those benefits are based on wages, and the tax would reduce the value of those wages.

Johnson says that his 28/39 percent sales tax would raise as much money as the current tax code. If that’s right, then it has to sock the middle class: The poor are mostly protected by the prebate, and rich people come out ahead from the abolition of the progressive income tax. His revenue projections are almost certainly too optimistic, however, because a rate that high would cause so much tax evasion.

The best feature of the sales tax is that it would remove the tax code’s bias against saving and investment, meaning we would get more of both. But there are better ways to move in that direction. One would be to keep the income tax but exempt the return to savings from taxation. That would pose problems of its own, of course. But it would avoid the serious administrative problems a national sales tax would involve. And you wouldn’t have to amend the Constitution to get there.

  1. Johnson’s example shows that he understands what the 28 percent tax rate means. The seller gets 72 cents and the federal government gets 28 cents. Calculated normally, that’s a 39 percent sales tax.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Ramesh Ponnuru at rponnuru@bloomberg.net

To contact the editor responsible for this story:
Katy Roberts at kroberts29@bloomberg.net