The merits of the consumption tax are being debated, with Mike Huckabee, a backer, contending for the GOP nomination,
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Since 1999, a radical but intriguing plan to shred the patchwork-quilt federal income tax system in favor of a hefty national retail sales tax has languished in Congress. But as one of its champions, former Arkansas governor Mike Huckabee, emerges as a serious contender for the Republican presidential nomination, the so-called consumption tax has moved into the national political debate.
That has energized a grass-roots movement looking to seize the moment for its cause. In the days before Thursday's Iowa caucuses, Americans for Fair Taxation has raised its profile, traveling around the Hawkeye State in a colorful bus, parking outside presidential candidate events, and handing out T-shirts and literature.
Critics have long dismissed the consumption tax as a partisan nonstarter (of 71 sponsors in a Democratic-controlled Congress, 70 are Republicans), and contend its marketing understates its cost and potential side effects. Adherents, however, see simplicity in the tax that would eliminate the voluminous Internal Revenue Code, sweep away hundreds of complex tax forms, give consumers control over their own taxes, and stimulate economic growth along with personal savings.
The "FairTax" according to their website, "is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system." The fair taxers contend a levy of 23 percent built into the price of all goods and services would generate the same revenue as all current income taxes combined. Opponents say that's misleading because, calculated as a typical sales tax, the levy would add 30 percent to basic retail costs.
That argument shortchanges the larger issue, said Laurence J. Kotlikoff, a Boston University economist who has produced several studies supportive of a consumption tax.
"This is not a proposal one can quickly toss aside," Kotlikoff said. "It's got a lot of terrific features. Economists in public finance have been talking about this idea for decades."
As conceived, a national sales tax would replace federal taxes on wages and salaries, dividends and interest income, estates, gifts, capital gains, and corporate profit. It would also eliminate separate taxes on income to pay for Social Security and Medicare.
In exchange, the tax would be levied on all consumer goods, including food, clothing, and medicine - which are typically exempt from state sales taxes. Also taxed would be services, such as legal fees, doctor's bills, rent payments, and interest on loans.
Sales of new homes would be taxed but older homes would be exempt; similarly, buyers of new cars would pay the tax but used-car buyers would not. Wholesale business-to-business purchases, investments, and education expenses would be exempt, but purchases by federal, state, and local governments - everything from military weapons to police cars - would be taxed.
Still, there is a basic dispute over the size of the tax and how it is computed.
The fair taxers describe it as an inclusive tax, meaning it is 23 percent of the cost of the goods or services, in much the same way that an employee's salary or hourly wage includes the amount of federal taxes that are withheld. For example, if a consumer pays $130 at the checkout for an item, the tax will be $30 - 23 percent.
That's misleading, opponents contend, because most consumers would view a $30 tax added to a $100 retail price as a tax of 30 percent. Either way, the critics say, the consumption tax plan assumes negligible or no cheating. The current rate of evasion of federal income taxes is estimated to be at least 15 percent.
Though the idea of a national sales tax has high-profile doubters across the political spectrum, some of the harsher critics are conservatives.
Bruce Bartlett, a commentator who held policy and treasury posts in the Ronald Reagan and George H.W. Bush administrations, wrote in the Wall Street Journal that the proposal "is too good to be true, and voters should not take seriously any candidate who supports it."
The conservative National Review editorialized that the consumption tax is "fatally flawed" because of its "political impracticality." Criticisms have also zeroed in on collection and enforcement issues, and some of the underlying assumptions about the presumed economic benefits.
Gerald Prante, a senior economist at the Tax Foundation, a nonpartisan Washington-based research organization that has not taken a formal stand on the tax, said the proposal has weaknesses and strengths.
"They're overly optimistic on many things, such as the administration of the tax and the elimination of the [Internal Revenue Service]," Prante told The Globe. "It's a public relations thing because everyone wants to get rid of the IRS." Yet if the proposal became reality, Prante said, state agencies would be responsible for collecting the revenue, and "you'll have 50 IRSes."
On the other hand, a consumption tax, over time, would eventually tax virtually all wealth, Prante said. "All income is consumed at some point except that small fraction that would be passed on in the form of an estate forever and ever," he said.
Kotlikoff said that is the way to view the consumption tax, as a proportional levy on what he calls "lifetime resources," not merely current income.
To cushion the impact on the poor, who pay a disproportionate amount of income on necessities, everyone with a Social Security number would receive a monthly check from the US Treasury, called a "prebate" - an amount equal to the sales tax on what the federal government calculates as poverty level expenditures.
The amount of the prebate would be determined by family size; for example, a couple with two children would receive $6,297 a year, or $525 per month, according to a table compiled by the fair taxers.
But critics say that would require a large new federal bureaucracy to administer and monitor an annual program that would pay out more than $600 billion a year, according to a US Treasury estimate; about $485 billion, according to the fair tax advocates.
The fair taxers contend that the "prebate" will mean a net reduction of taxes for the poorest families and create a progressive effect on the taxes of others. Opponents contend it will mean less taxes paid by the wealthiest Americans. Competing studies dispute how the impact would be spread across the majority of middle-income Americans.
Along with eliminating the IRS, fair taxers say they would seek to repeal the 16th Amendment to the Constitution, which gave Congress authority to levy an income tax. That would require approval of two-thirds of both chambers of Congress and ratification by 38 states - a huge political leap considering the sales tax initiative has languished in Congress.
Kotlikoff acknowledges it's a radical idea but not without precedent, citing the income tax itself and the Social Security system as similar examples
"We've done radical things in the past," he said.
© Copyright 2008 Globe Newspaper Company.
