Commentary

Time to Replace the Income Tax

On April 15, millions of Americans will again dutifully march off to the mailbox to send in a detailed report to the federal government on how much money they earned last year, how they earned it, and how much has been taxed away. The income tax code has become absurdly complicated over the years, resulting in what experts estimate is an annual compliance cost to the American people of about $200 billion. There is increasing evidence that that burden is compounded by the negative impact of the income tax on economic performance.

But, while death and taxes may be inevitable, there is a fledgling but growing movement that indicates that the income tax may not be. Emboldened by the success of the term-limitation movement in challenging the establishment status quo, grassroots activists across the country are joining forces with scholars and policy wonks in an effort to replace the federal personal income tax, corporate income tax, and capital gains taxes with a federal retail sales tax. Such a move could have a profoundly positive impact on our nation.

It should be stated at the outset that this proposal, if it is to gain popular support and if it is to succeed, must be clearly understood to call for an immediate replacement of the income taxes, not something that will be phased in over time or traded off against a (temporary) reduction in income tax rates. The last thing we need is a national sales tax on top of our current tax structure.

The second thing that should be understood about this proposal is that it definitely is not a value-added tax (VAT). Because VATs tax goods and services at each level of production, the bulk of the tax is hidden from the consumer (who nonetheless pays the VAT). A major benefit of a federal retail sales tax is that the consumer will see right on his receipt the cost of the federal government to him. VATs are much easier to increase (witness the experience in Europe) than would be a federal retail sales tax. In fact, one of the advantages of the sales tax is that it is so simple it would create taxpayer solidarity. Instead of grabbing for our wallets whenever a politician mentioned “tax reform,” we could just vote for the candidate who proposed lowering the sales tax.

There is support for replacing the federal income taxes with a retail sales tax within a surprisingly broad spectrum of the economics community. Supply-siders view it as the ultimate boost to incentives, and liberal economists see it as a way to end the manipulation of the tax code by special interests. Virtually all economists agree that such a proposal, if implemented, would result in a massive increase in savings and, hence, productivity. Boston University economist Laurence Kotlikoff, an adviser to the Clinton administration, has written, “Because of its clarity and simplicity, a uniform federal retail sales tax might be the one tax that would have enough staying power to put an end to our politicians’ constant, and very costly, tinkering with taxes.”

Kotlikoff estimates that such a radical change in the way government is financed would “immediately and dramatically” increase the savings rate, increase real wages significantly, and boost per capita economic output by one-half of a percentage point each year. A few years ago even the status quo-oriented New York Times asked in an editorial, “What about scrapping the personal and corporate income tax codes, which often discourage savings and investment in favor of a consumption tax that would encourage them?”

Ultimately, what is most hopeful about the tax replacement scheme is not the increased economic efficiency and productivity that would undoubtedly result. Rather, it is the psychological impact it would have on the American people, who would suddenly find themselves living in a nation where it was none of the government’s business how much money they made or how they made or spent it. The Internal Revenue Service is today an intimidating force in society. The IRS creates in the citizenry a certain deference toward government that is unhealthy for both our freedom and our prosperity. A free society shouldn’t tolerate such an agency, particularly when the government doesn’t need it to raise revenue.

Without the income tax, attitudes would change in short order. We would see an awakening of what George Will refers to as the “figure of Hawkeye”—the fictional American folk hero from The Last of the Mohicans. At one point in that saga of the war in the colonies between the French and the British, Hawkeye is reprimanded by an effete British officer who snears, “You call yourself a patriot and loyal subject to the crown?”

Hawkeye replies dryly, “Don’t call myself subject to much of anything.” Perhaps that healthy respect for the dignity of the individual (and lack of submission to institutional control), which lies dormant, for the time being, in the American people, will be reawakened by the movement to rid our nation of income taxes. Wouldn’t it be nice if April 15 were just another pretty spring day?

Edward H. Crane is president of the Cato Institute.