Journal of Undergraduate Research
Volume 1, Issue 8 - May 2000

The Case for a National Consumption Tax

Carly Cappello

ABSTRACT

The purpose of this research is to analyze and support the case for a National Consumption Tax. Through statistics, facts, and mere theroetical assumptions, this research proposes a plan to replace the current income tax structure with a sound and beneficial national sales tax.

INTRODUCTION

Tax reform is a necessity in this day and age. American citizens are beginning to question the motives and techniques of the government and the IRS. From the farmer to the politician, they almost all share a lack of respect and understanding for the more than 17,000 pages of the current tax code. Psychologically, the term IRS is associated with an oppressive type of institution. Many people fear the possibility of an audit. The young are growing up with minds embedded with negative thoughts towards the IRS. In 1984 British novelist George Orwell envisioned a future in which the eye of government monitored individuals every move. With personal information being processed and stored everywhere by means of income filing forms, he was not far off. To allow the government this type of power gives them a dominance that invades human respect and privacy.

Our current system is economically inefficient, unfair, confusing, and a disadvantage to Americans in world and domestic trade. It would be pragmatic to say that this system contradicts the moral premise behind our Constitution and the meaning of a democracy. Consequently, a number of proposals concerning tax reform are currently being debated in Congress. The purpose of this research is to analyze the impact of one such proposal, the National Consumption Tax, on the U.S. economy. Supporters argue that this system of taxation is synonymous to an ideal system of taxation. An ideal tax system should be one that promotes economic growth, encourages savings and investment, emphasizes fairness, benefits domestic and international trade, shields the underground economy, is administratively efficient, and dynamically achieves social objectives. America is ready for a new tax system that will aid our economy and return some of the lost patriotism towards our nation. The creation and implementation of a national consumption tax is the solution to this problem.

CHARACTERISTICS OF NATIONAL CONSUMPTION TAX

Promotes Economic Growth

A national consumption tax would repeal the financial distortions created by the current tax system. A new, highly growing economic atmosphere would emerge. Under a national sales tax, no income is taxed until it is consumed. As long as income is reinvested, capital gains and interest income are not subject to taxation. This allows every citizen to receive their paycheck free of any deductions. It is only the goods and services that are sold at retail that are taxed. This will in turn encourage savings and investments. As a result, interest rates would be reduced and economic growth would soar. With lower interest rates, federal borrowing would also decrease. To maintain the lowest tax rate possible, the system must be applied to the broadest base possible.

Encourages Savings and Investments

A national consumption tax would naturally encourage savings and investments. Currently, businesses pass their tax liability on to consumers through higher prices, lower wages, and lower return on investments. Under a national sales tax, businesses will no longer be required to pay taxes. Since domestic and foreign investments rely heavily on saving and investment rates, businesses will invest money in new machinery, plants, worker training, and equipment. The result would be more educated, motivated, and successful workers. Using a simplified life-cycle growth model, the conversion to a consumption tax would result in an immediate increase in the capital/labor ratio. The cause for the short-term improvement is the result of the initial impact on the saving elasticity. This increase in productivity of capital per worker would correlate to an increase in American real wages.

The choice to invest tax-free would also encourage investments in the U.S. financial markets. Currently, the United States taxes capital gains more severely than most other industrial nations. A recent survey by the OECD (Organization for Economic Cooperation and Development) of twelve industrialized countries showed that the United States' capital gains tax rate on long-term gains on portfolio securities exceeded that of all other countries except Australia and the United Kingdom. Naturally, the elimination of interest and dividend income taxation will create a more efficient market. This will be especially prevalent in the municipal bond market. While it may appear at first that tax reform would impair the tax-exempt incentive to invest in the market, it will be beneficial in the long term. Municipal securities would be forced to offer yields comparable to taxable securities. This would create competition between public and private sectors, resulting in a more efficient market. Similarly, the consumption tax will be advantageous to the stock market. By eliminating interest income, debt and equity financing will now compete on the same tax terms. Like municipal securities, competition will drive a more efficient market. Moreover, stock prices will soar as the taxation of capital gains and dividend income is eliminated. In summary, a national consumption tax would result in an increase in savings, investments, wages, and capital accumulation.

Simplicity and Fairness

Simplicity and fairness are fundamental to any tax system. The current tax code consists of hundreds of thousands of pages of laws, regulations, and rules and interpretations. It has evolved into a system that is not only hard to comprehend, but also consists of conflicting exemptions and terminology. The required filing forms are complex and take an enormous amount of money and time for the average person. In addition, Americans are deceived by "hidden taxes". These hidden taxes are taxes that businesses add to the price of their products to offset their IRS compliance costs. It is estimated that these taxes amount to over $600 billion a year. (refer to Table 1).

Table 1 Hidden Taxes in the United States
HIDDEN TAX	COST (BILLIONS)	COST/PERSON
Corporate Income Tax	$201.2	$760
Fuel Taxes	32.1	121
Other Excise Taxes and State Sin Taxes	30.5	115
Hidden Portion of Payroll Taxes	216.4	817
Workers Compensation Taxes(1993)	57.3	216
Unemployment Taxes	28.6	108
Import Taxes	18.7	71
Hotel Room Taxes	6.7	25
Taxes on Flying	2.4	9
State Utility Taxes	8.6	32
Implicit Telecommunications and Electricity taxes	11.0	42
Severance Taxes	4.4	17
Insurance Premium Taxes	9.1	34
Licenses (occupation, corporate, utility, alcohol, and amusement)	11.7	44
TOTAL	638.82	2,413
Source: NTUF "The Less You See the More You Pay," July, 1998 The national consumption tax is distributed equally to every citizen. It is highly visible and easy to understand. It is fairly distributed, allowing no biases or special privileges to any class. Government intrusion will be reduced, as our right to privacy is once again bestowed upon us. The power and control will be shifted from the government to the individual. It eliminates the potential for hidden taxes by compensating retailers for their time and paperwork in the collection process. This simpler tax system would eliminate the IRS completely. Citizens would no longer be responsible for filing income tax returns. Consumers would be able to comprehend exactly how much they are earning and how much they are paying in taxes. This is unlike the current system, which makes the amount consumers pay in taxes highly invisible, due to income tax withholdings. A tax credit is also provided so that no American pays any consumption taxes up to the poverty rate. This will allow lower income individuals to purchase the necessities of life tax-free. This fair and neutral process will reduce loopholes and behavior associated with tax evasion. A national consumption tax will provide a system that is easily visible, simple, and fair. Enforcement will be a lot less intrusive, returning personal freedom and privacy to the American citizens. Promotes Domestic and International Trade A sound tax code will be one that promotes domestic and international trade through productivity and efficiency. The current tax system discriminates against domestic products. Every American manufacturer is responsible for both income taxes and compliance costs. This amount is included in the selling price of every product, shifting the burden on to the American consumer. These costs are embedded, making American exports more expensive than their foreign counterparts. In addition, upon arrival to foreign markets, many countries add their own tax to the products. This makes it difficult for American products to compete internationally, and may drive many companies out of the market. The same holds true against domestic trade. Currently, many foreign goods entering the market are not subject to U.S. taxes (our system taxes income only). Some international governments are also withholding taxes from their export products, allowing them an even greater competitive advantage in the United States. Low levels of investment have been cited as the main cause of the slow growth in the United States over the past twenty years. As a nation, the United States saves less than any of its major trading partners. The World Bank has recently conducted an international comparison, demonstrating that countries with high levels of investment experience faster growth than countries with relatively low levels of investment. This relationship is shown below in Table 2 and Figure 1. Table 2 Investment and Saving as a Percent of GNP and Real GNP Growth, 1974-1993 Country Gross Domestic Saving Gross Domestic Investment Average Annual Real GNP Growth South Korea 30.7 32.0 11.4 Singapore 40.0 41.8 7.6 Thailand 27.3 31.2 7.5 Hong Kong 30.4 28.6 7.3 Malaysia 34.9 31.7 6.8 Japan 32.3 30.9 3.6 Norway 30.0 27.7 3.5 Switzerland 24.9 24.0 3.1 Austrialia 23.2 24.3 2.7 Canada 23.5 21.0 2.6 Germany 23.7 21.0 2.6 United States 17.5 18.8 2.3 France 22.1 22.0 2.0 United Kingdom 17.4 18.1 1.6 Denmark 20.7 19.5 1.6 Source: The World Bank, World Tables 1995 (Baltimore: The Johns Hopkins University Press). Figure 1. Investment and Saving as a Percent of GNP and Real GNP Growth, 1974-1993 Source: The World Bank, World Tables 1995 (Baltimore: The Johns Hopkins University Press). Moreover, the net annual business investment in the United States has in recent years fallen to only half the level of the 1960s and 1970s. The rate has dropped from an average of 8.9 percent of GDP in the 60s and 70s to 4.8 percent in the 1990s. Refer below to Table 3. Table 3 Flow of U.S. Net Saving and Investment (Percent of GDP in Current $; National Account Basis) Type of Saving or Investment Average 1960-1980 Average 1986-1990 Average 1981-1985 Average 1991-1996*** Net Private Domestic Saving 8.1% 7.3% 5.3% 5.3% State and Local Government Surpluses 2.1% 1.9% 1.8% 1.4% Subtotal of Private and State Saving 10.2% 9.2% 7.1% 6.7% Less: Federalbudget Deficit -0.8% -3.8% -2.8% -3.1% Net Domestic Saving Available for Private Investment 9.3% 5.4% 4.3% 3.6% Net Inflow of Foreign Saving* -0.4% 1.2% 2.4% 1.3% Net Private Domestic Investment 8.9% 6.7% 6.7% 4.8% Gross Private Domestic Investment 16.0% 16.9% 15.4% 13.7% Nonresidential Fixed Investment 10.4% 12.2% 10.5% 9.6% Producers' Durable Equipment 6.6% 7.4% 6.9% 6.8% Industrial Equipment 1.9% 1.8% 1.6% 1.6% Producers' Durable Equipment Less Info. Processing and Related Equipment 5.2% 5.0% 4.6% 4.5% Personal Saving 5.4% 5.7% 3.8% 3.6% Net Business Saving** 2.7% 1.6% 1.5% 1.7% *In the 1960-1980 period the United States sent more capital abroad than it received; thus net inflow was negative during this period. ** Net Business Saving = gross private saving ­ personal saving - corporate and noncorporate capital consumption allowance. *** Includes only first, second, and third quarter figures for 1996. Source: Department of Commerce Bureau of Economic Analysis, National Income Accounts. Update prepared by American Council for Capital Formation center for Policy Research, February 1997. A consumption tax will remove all hidden costs, forcing prices to be lowered. As productivity is increased, investment in the U.S. will rise. Reduced operating costs and the removal of all taxes on non-consumed income will attract foreign capital to the states. A cycle will be created with foreign companies creating and investing in American firms. This will create many new jobs. Higher real wages will result and the unemployment rate will be lowered. To compete, U.S. manufacturers will be more efficient and productive. This improvement in national productivity will allow the U.S. to be more competitive in the global market. Exports of goods and services will no longer be subject to taxation, while imported goods and services will be. For the first time in years, foreign companies will once again be forced to compete on the same terms as American companies. The capital inflow resulting from import taxation will aid in lowering the consumption rate. This will encourage business expansion, development, and employment. The ability to compete internationally will increase American exports. The U.S. trade balance would improve and American-made products would have an economic advantage domestically and globally. Administratively Efficient The current tax system is highly intrusive and complex. Administration is inefficient and difficult to supervise. Individuals and businesses spend more than $300 billion on compliance costs alone. Not to mention the time and aggravation spent on filing out tax reforms. The IRS operates at a huge cost and employs many individuals at unproductive rates. Complications lead to errors by both the IRS and confused tax- payers. Taxes should be simple to collect and administer. The system should use the advancements in technology and knowledge to minimize form usage and administration techniques. A national consumption tax would abolish the Internal Revenue Service. A time period of four years will be given as a transition period. The new tax system will be administered by the Secretary of the Treasury and filings by citizens would be abolished. Achieves Social Goals and Objectives Taxation should be a medium for achieving social goals and objectives. The tax system today has created animosity towards the IRS and the federal government. The deeper this distrust grows, the greater the risk the nation faces of anarchical related behavior. Many have already begun to challenge this authority through evasion and disruptive actions. A pervasive feeling has been created that the government is cheating the taxpayers out of something. No citizen should have to abide by a law that is so complicated and coercive. As taxpayers, American citizens should be granted the ultimate right of control. In a time when our nation is fighting discrimination, rebellion, and hate crimes, our tax system appears to be a hypocrisy. It discriminates based on wealth, and fuels class conflict and hostility. A consumption tax is fair, simple, and highly visible. There would be no class distinctions or special privileges awarded. The discrimination against the American taxpayer, in favor of illegal aliens and foreign competition would end. Also, individuals would no longer feel the misery associated with filing and compliance costs. CONCLUSION America has just entered the year 2000 and is awaiting a new century. It is a time to benefit from current information and technology. It is a time to recognize society's interests on tax reform. The people are ready and the time has come. A National Consumption Tax would be the most efficient means to bring about this desire. Long term it would create a healthy and prosperous economy. This study has exemplified the tremendous benefits that would arise from its implementation. Benefits that would supercede any drawbacks that may expectedly or unexpectedly result. It is at the heart of the American consumer; providing them with a fair system of taxation that would improve the standard of living and lower the unemployment rate. It is the American consumers who through taxation maintain the social and economic existence of their country. And it is the United States whose power and finances control world commerce. Therefore, it is the Americans who indirectly maintain the responsibility for global economic existence. It is only right to give back to these consumers. They should be afforded the most fair and efficient system of taxation. They should be given the opportunity to grow as a nation under a National Consumption Tax. --top-- Back to the Journal of Undergraduate Research College of Liberal Arts and Sciences | University Scholars Program | University of Florida | © University of Florida, Gainesville, FL 32611; (352) 846-2032.