January 15, 2008
Abolishing income tax
All the mainstream pundits agree. Mike Huckabee is a crack-pot. The first piece of evidence is that he is a creationist. But the second point is that Huckabee wants to abolish income tax.
As far as many of my colleagues are concerned this is breathtakingly unsophisticated - the economic equivalent of creationism. However, when I heard Huckabee explain his plan recently in a burger joint in New Hampshire, it sounded pretty good to me. Huckabee - who is one of three front-runners for the Republican Party nomination - advanced several plausible sounding arguments. First - simplicity. He would replace the entire income tax code, with a simple sales tax set at a flat rate of - say - 23%. No more form-filling. In fact the Huckster would abolish the IRS (America’s much-hated Internal Revenue Service). Second, his plan would ease the burden on honest tax-payers. At present drug-dealers and other nefarious types avoid all income tax. But they have to spend - so they would be caught by a consumption tax, just like the rest of us. Also he reckons that his flat consumption tax would encourage saving - because you are taxed when you spend, not when you earn. And the whole thing is designed to be "revenue neutral"; ie if the calculations worked out, it wouldn’t cause a massive whole in the federal budget.
It sounded pretty good to me. But when I mentioned to Robert Guest, a former colleague from The Economist, that I had liked the sound of Huckabee’s tax plan, he grew cold and scornful. Huckabee’s tax plan was mad, he informed me. I fell silent.
The main arguments Guest and others advance against replacing an income tax with an all-embracing sales tax is that such a move would be highly regressive; and that the consumption tax would have to be set so high that it encouraged tax evasion.
Huckabee may be stupid - but he’s not that stupid. He has anticipated the problem that his tax would wack the poor and is advocating a negative income tax. Anyone below the poverty line would get a rebate, so that they would end up paying no tax at all. (Mind you, how do you send them a rebate without having an IRS to calculate it? Get back to me on that one, Mike.) As for tax evasion - clearly too high a sales tax does encourage the black economy. Some 40% of cigarettes in Britain are now though to be sold under the counter. But tax on cigarettes accounts for more than 90% of the cost of a pack in Britain. The Huckabee sales tax would be set much much lower, so the temptation to evade tax would be lower as well.
Nor is it true that all economists reckon that Huckabee’s plan is loopy. Steve Landsburg, who is a perfectly reputable economist, has written an article in praise of it. And Martin Wolf - bustling past my office - said that he thought that something like the Huckabee plan could be made to work; although he thinks that, as well as a tax rebate for the poor, there would probably have to be a wealth tax for the very rich - to iron out the regressive effects of a sales tax.
So Huckabee’s tax plan is not crazy after all. That just leaves the creationism. I will return to that subject, next week.
Hurrah - well apart from the creationist bit. I have long argued myself to get rid of income tax - and tax instead at the point of consumption. Any government that taxes its residents so heavily (note residents!) has to be indefficient. Comparisons with how good we are compared to other countries do not wash - polticians will quote the tax rates - but they forget the more generious benefits received in the case of - say - unemployment that one would get in France for instance. Anyway - wouldn’t it be good if someone with clout had the sense to investigate this one further? Come on George O - you did it on inheritance tax….
Posted by: Gerald Williams | January 15th, 2008 at 8:55 pm | Report this commentNo, Huckabee wants to REPLACE the income tax, it’s Ron Paul that wants to abolish it.
Posted by: Fritz | January 15th, 2008 at 8:56 pm | Report this commentThe plan Huckabee endorses is called the Fair Tax.
Posted by: Kris | January 15th, 2008 at 9:01 pm | Report this commentAbolishing income tax and replacing it with a consumption tax is not a practical idea. What it will lead to is increased spending by wealthy Americans of their income abroad that is earned within the USA. This would be even less practical in Europe where European citizens can quickly jump across the border to pick up a bottle of wine if they wish. To reduce income task and increase consumption taxes countries will have to work in unison something they appear rarely to be able to do…
Finally the tax would be highly regressive and unfair. At a time of a widening income gap i would have to agree Mike Huckabee is a crack-pot…
Posted by: Robert Wild | January 15th, 2008 at 9:42 pm | Report this commentGideon is right on this. The plan is not at all crazy.
The simplest way to do this is to send everybody a cheque (including special cheques for parents), such that the effective tax paid by the poor, on the assumption that they consume all their income, is zero. By adjusting the tax rate and the size of these cheques, one can make the system as progressive as one wants. Sending the cheque only to the poor, as Huckabee apparently suggests, would lower the required tax rate, but would also create significant disincentives to work (though that would also depend on the rate at which this benefit is withdrawn).
Such a system could well be quite progressive at the bottom, but as incomes rose, the rich would have a lower average rate of tax than the ordinarily well off, because the former spend relatively low proportions of their income. This could be dealt with, if deemed necessary, through lifetime gift, inheritance or wealth taxes. I would personally favour such interventions, since the accumulation of vast untaxed fortunes should not be a goal of policy, in my view.
Posted by: Martin Wolf | January 15th, 2008 at 9:50 pm | Report this commentMr Wild’s percfectly reasonable objection can be met, as Steve Landsburg himself suggests, with “unlimited IRAs”. As I understand this system, earned income could be deposited directly into investment accunts and any investment income would be untaxed. But sums would be taxed on withdrawal. Essentially, the same thing can be done with unlimited ISAs (the UK system), where tax is paid before the money is deposited in the account, but there is no tax on accumulations or withdrawals.
The underlying idea of an expenditure tax has good “progressive” credentials. James Meade, Nobel-prize winning economist, and definitely not a conservative was a protagonist of this idea. But he recommended a wealth tax, as well.
Posted by: Martin Wolf | January 15th, 2008 at 10:07 pm | Report this commentAre there any studies which show at what level of taxation on consumption would black markets begin to be significant? This would be a major determiner of whether this proposal would fly. Once a major portion of taxation shifts from the income tax to higher consumption taxes, cheating on the income tax (by working under the table, paying out corporate profits as ‘dividends’ rather than as wages, etc.) would change to cheating on consumption taxes (not ringing up sales, unlicensed businesses, etc.)
Posted by: c gilbert | January 15th, 2008 at 10:37 pm | Report this commentre: “unlimited IRAs”. For a majority of people in the U.S. who do not save or invest because all income is used for living expenditures, ‘unlimited’ IRAs would seem to be irrelevant. Basically, we’d be back to the income tax: taxation of all income for most people. Only the wealthier will get to shelter money above and beyond living expenses in IRAs, but now an unlimited amount, rather than the $3,000 for wage earners or the 13 - 20% for the self-employed or those with 401Ks here in the U.S. Or am I missing something here?
Posted by: c gilbert | January 15th, 2008 at 10:43 pm | Report this commentOne of the key reasons that sensible economists are wary of Mike Huckabee’s plans is that the transition from the current system to a consumption-only tax would be very difficult. The method suggested by the authors of the Fair Tax requires that every item held on inventory in the entire country be valued at the same time.
Posted by: James | January 16th, 2008 at 12:22 am | Report this commentGideon, Martin; It certainly is a lot easier than a flat tax although in certain cases (such as in Europe), a combination of a flat income tax plus VAT would be more ideal. I’m impressed though, the combined force of your opinions cannot be dismissed. You might be on to something! Certainly the US and most Western European countries can use a radical rethink on how to finance government. Who would be more eminently predisposed to keep these wheels moving than FT columnists? By all means!
Posted by: felix drost | January 16th, 2008 at 12:24 am | Report this commentGreater reliance on a consumption tax would aid US trade balance insofar as the tax burden on exports would decrease and those on imports would rise.
Posted by: Christian VanSchayk | January 16th, 2008 at 12:44 am | Report this commentIf you think there is cheating on taxes now, just imagine what it would be like if there were a 23% federal sales tax. And I’m sure Americans would welcome the new federal sales tax police force with open arms. They’d be as well loved as your average IRS auditor is today.
Posted by: RWB | January 16th, 2008 at 4:33 am | Report this commentEbay is lobbying against Huckabee right now…or perhaps for…can you imagine how the American informal economy (ebay/craigslist/barter) would explode under a VAT?
Posted by: charlie | January 16th, 2008 at 5:31 am | Report this commentMr Gilbert is right: a comprehensive income tax and a comprehensive expenditure tax are essentially the same thing. The difference is that the richer would be taxed only when they spent their money. If one cared about the accumulation of unspent wealth, one would introduce a wealth tax, as well. If one did not do so, one would just leave it as it is.
It is worth noting that under the current income tax codes of both the US and UK, it is easy for rich people to turn income into capital gains, which are much less heavily taxed. Just look at the treatment of so-called “carried interest”. In the US, the spending of this income is not taxed by the Federal Government. So the so-called income tax is much less progressive than a comprehensive expenditure tax would be.
Posted by: Martin Wolf | January 16th, 2008 at 6:34 am | Report this commentI think that Martin Wolf’s last post put it best: a comprehensive income tax and a comprehensive expenditure tax are essentially the same thing.
Is not the conclusion one should draw that it would be simpler to make the income tax comprehensive than to upend the system totally by going to a consumption tax? Removing the special treatment of capital gains would be a big step in that direction (tell me again why the current system makes sense).
A few posts have pointed out the difficulties of a consumption tax, such as a black market, smuggling, barter, etc. It is also open to question whether 23% would be high enough. The higher the levy, the more incentive there will be to cheat.
Posted by: RTW | January 16th, 2008 at 8:05 am | Report this commentSince we are looking at alternative ways to skin the cat (or pluck the goose, which is more sustainable), my preferred system is a tax not on income nor on consumption but on transfers. Tax every non-cash financial transaction, at the sender rather than the recipient, i.e. I pay you £100 but my bank account is debited £100+tax.
This has elements of the Tobin tax but I am not motivated to discourage financial transactions as a goal. The reasons for suggesting this are instead:
- simple to introduce. No need for a national inventory: just call in the banking records since the date of introduction (retrospectively if necessary) and calculate the back tax due.
- simple to administer: it just requires rewriting some of the banking software to wire a % to the government (rather like that urban myth of the bank thief who reprogrammed the banks to send the rounded fractions of pennies to his account). There are no armies of assessors for income or consumption, and all returns are automatically generated.
- not regressive, because the poor use cash disproportionately. The advantages of banking and electronic money (safety, portability, interest etc.) will outweigh the tax for anybody moderately wealthy.
- possibly progressive (which is not of itself a good goal; taxes should be neutral), because the rich use more financial products. Dividends, interest, share dealing etc. would all be taxed.
- large volumes ==> low % rate per transaction
- I do not think such a tax would impose material friction in financial markets, as it is little more than an electronic stamp duty, but it might encourage “farming” over “trading” at the margins. If the tax were material, there would be a one-time flight of capital (taxed as it leaves) from the City, as dealing accounts were off-shored, and thereafter the tax would be irrelevant (and the City would continue trading); given the removal of income and capital tax from profits and gains, the money may well continue to move around on-shore, being clipped as it goes around.
I am curious to know whether, by analogy with currency-clipping, I am right to call this proposal an “inflator-tax”, i.e. it reduces the purchasing power of money, but according to its velocity, not the passage of time. The resulting relationship between tax, interest and inflation rates could be intriguing. Changes in public expenditure (and therefore taxation) would change private inflation. Changes in overall inflation would alter the burden of taxation. Changes in interest rates would have a magnified effect on the savings incentive because money left on deposit would bear interest and no tax, whereas money spent (or invested without interest) would lose interest and bear tax.
As a separate policy, the government should pay from taxation a flat rate minimum income to all citizens, on the basis of universal benefits. Mandatory health etc. insurance contributions should be required, but with no restriction on provider and the government re-insuring the uneconomic risks in the manner of the terrorism pool arrangements, e.g. expensive terminal illnesses. The income level should be set low enough to provide incentives to work.
Posted by: rtah100 | January 16th, 2008 at 9:10 am | Report this commentOn the political side of this thing, is Giuliani not considering something similar, given that Steve Forbes (the Team Rudy economic advisor) ran his own presidential campaigns in 1996 and 2000 promising to replace income tax with a flat federal sales tax?
On the fiscal side, it’s hard to see how the IRS can be abolished under an expenditure plan. Income taxes deals with a fairly homogenous subject (pound notes) whilst expenditure deals with heterogenous subjects (nappies, ferraris) and would envitably fall prey to myriad tweakings in the name of progressive or neutral taxation: tweakings that would make the system unworkable in practice.
Posted by: justin | January 16th, 2008 at 9:20 am | Report this commentHow on earth would this be enforced?! Thousands of snooping mystery shoppers seeing whether things are run up on tills properly? Services being given free of charge in exchange for gifts in kind? The rich buying all their luxury goods abroad and the poor stuck paying the same tax on their essential bills as a multimillionaire? Vast shopping complexes lining the borders? The collapse of tourism as foreigners baulk at 25% VAT? Add in the cost of upheaval, and any benefit from scrapping the bureaucracy is outweighed. Just think it through - the man believes the universe was created in 6 days, and Eve from Adam’s rib. Is he rational?
Posted by: Techmo | January 16th, 2008 at 9:37 am | Report this commentDon’t look at creationism next week. Rather, have a look at evolution and the lack of scientific evidence (grains of dust to rats; rats to monkeys).
Sure, if one doesn’t believe in creation, evolution is the only game in town - but the evidence is patchy. Even “we’re all taller than four hundred years ago” just shows that humans are becoming taller, not that they are becoming anything else.
“Ah, but we are becoming something else”
“No we’re not.”
There’s not really much science there.
Posted by: Alan Bright | January 16th, 2008 at 3:20 pm | Report this commentAnother who favours the idea of a consumption rather than income tax is Nobel-prize winning economist Vernon Smith. In a recent interview with the FT, he made the case that concern about the poor is really a question of inadequate consumption levels, and that the keystone issue how to provide people with enough incentive to work, save and invest/spend intelligently.
You can find his article, which explains these idesa much better than I do, at:www.ft.com/longterm.
Posted by: Ravi Mattu | January 16th, 2008 at 4:04 pm | Report this commentThe probability of a 23% tax is probably underestimated. It may be closer to 30-35%. However, the 23% is misleading. If you purchase an item, the tax is really 30% as they calculate the 23% from $130(which is $100), not from $100!Therefore, the 23% is really 30%. If you buy a home for $500,000, does that mean you are paying an additional $150,000? Wonder if he told that to his beloved Iowans who love him because he is a nice guy.
Posted by: Robert Cohen CPA,CFP | January 16th, 2008 at 4:25 pm | Report this commentBut how does one make the sales/consumption tax progressive without added bureaucracy?
I believe Huckabee is proposing means-tested tax credits for the poorer consumer.
Meanwhile, the rich spend a smaller percentage of their income on consumer goods (there’s only so much you can buy), spend far more on luxury services and travel and will easily be able to import goods or buy abroad themselves to avoid taxation. To combat this will require extra customs security and trade tariffs.
And will services purchased only by the well off, such as private schooling and private medical care, also be subject to the sales tax?
These are the same problems posed by carbon taxes - VAT is a regressive tax unless a lot of effort is put into making it fairer…
Posted by: Dave | January 16th, 2008 at 6:02 pm | Report this commentMassive reductions in income and corporate tax are effective, benefit the economy, attract investment, businesses, entrepreneurs, skilled workers and wealthy individuals, increase efficiency and productivity when there is COMPETITION (this is the key) in tax rates at local levels e.g. cantonal (in Switzerland). Canton Obwalden even tried in the recent past to introduce a degressive tax rate system (the more you earn the lower your tax rate) but this was ruled to be against the constitution. On its homepage it states that its corporate tax is 6,6% and that its income tax is especially attractive for incomes exceeding Fr300 000.
Posted by: FH | January 16th, 2008 at 10:07 pm | Report this commentAll cantons have their homepages and, as they are competing with each other on the matter of tax rates, they usually mention the tax advantages which they offer. There is no Swiss canton which has wholly abolished income or corporate tax, afaik.
A mix of flat income tax around 20 % with a non taxable threshold for small jobs and marginal employment , a Goods and Services Tax of 20% plus the universal check rebate seems do-able .
The percentages and amounts could be varied as circumstances dictate
The idea of a saving account where tax is applied on withdrawn only is similar to superannuation funds in Australia , people are free to invest it as they see fit but cannot get the money before 55 tax is then payed
real estate and land sale would be taxed as a good
I don’t know what to do with import taxes !?
all other taxes could be abolished
keeping the G.S.T. ( VAT )Lower would be a disincentive to black market ,
a low and flat income tax rate , with no loopholes would similarly , make avoidance shenanigans somewhat less attractive ,
It would also reinforce the most important sense of fairness in the system
the universal rebate check would make sure people are actively registered in the great data bank in the sky .
The disappearance of the tax department will of course , never happen !
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Posted by: jeannick | January 16th, 2008 at 11:04 pm | Report this commentMr Wolf
Your suggestions are good but i do think you will begin to have problems firstly with people avoiding consumption taxes (think of all the smokers buying cigs from friends and work) and secondly people still working in the black economy and not putting money into these unlimited IRA’s/ ISA’s as they know when they spend this money they will be taxed (dont they still have an incentive to work for cash in hand).
Finally a wealth tax does address one of my key concerns about the abolishment of income tax however this is something i will myself have to read into further and i do know wealth taxes can create some perverse incentives.
Posted by: Robert Wild | January 16th, 2008 at 11:17 pm | Report this commentReplacing income tax for a 23% sales tax?
In the Russian Federation the 13% flat tax worked…but just because people is not used to pay taxes after decades of Communism.
Meanwhile, in Western Europe or America citizens accept paying taxes as a legal obligation. After decades of Tax Education, citizens pay taxes and know the consequences of not paying.
People just talk about paying less, but not about not paying anything…
Is ready America or Europe to lose decades of taxpayer training?
On the other side, an increase of sales taxes in Portugal (VAT to 21%) took thousands of Portuguese travelling to Spain (VAT 16%) as for low income consumers that difference is essential to survive.
What is needed in America, and ALL candidates should talk about it, is an increase of taxes on OIL, just to 50% the European average, because if those guys want a closer inconvenient true this is: increase taxes on oil 100% in five years (even if markets have already increased the gallon´s price by 200%…)
Will the Teamsters Union accept that?
Posted by: Enrique | January 17th, 2008 at 3:37 am | Report this commentI haven’t been able to learn too much about Huckabee’s assumptions for his radical tax makeover (such as the level of the rebates for lower income people), but even the 23% figure looks to be highly misleading. This is apparently a figure that is calculated based on the gross(i.e. with tax) price of an item. For something costing $1.30 (to the customer) a tax of 23% would amount to $0.30. To most people (at least to Europeans familiar with VAT) this would appear to be a tax of 30% not 23%. Given the fact that many states and municipalities in the US impose their own sales taxes, you could be looking at rates of 40% or more (assuming that they are able to maintain the suggested 23/30%). This would provide a very great incentive for the development of ‘creative markets’, I think.
Posted by: RTW | January 17th, 2008 at 11:31 am | Report this commentIncome tax is (for most of us) a tax on work, where VAT is a tax on luxury. Surely we have the existing balance the wrong way around.
Posted by: donal | January 17th, 2008 at 3:30 pm | Report this commentRe previous comment (by Donal): I live in Germany and pay VAT on everything, including food. I don’t see how that can be regarded as a luxury tax. Or have I missed something in your reasoning?
Posted by: RTW | January 17th, 2008 at 4:53 pm | Report this commentI think Donal meant a tax on consumption. Something we should welcome, I believe, where it coincides with the abolition of the tax on work.
Posted by: AYC | January 17th, 2008 at 5:13 pm | Report this commentThanks for the clarification. In Germany we are blessed with both taxes…
Anyway, where can I read why a tax on consumption is better than one on work (philosophically or morally or economically)? The question is not facetious, I would truly be grateful for suggestions.
Since world economic growth for the past few years has been driven by America’s preference for consuming over working, what would be the consequences of reversing the incentives? That question might be considered facetious by some…
Posted by: RTW | January 17th, 2008 at 8:53 pm | Report this commentThe arrogance of you humanists is sickening.
Why the vitriol against Huckabee(creationists) and what exatcly makes him stupid. ?The people of Arakansas who re-elected him time and again certainly didnt think him to be stupid neither did those who named him the best governor of of 2005 or thereabout,
Debate the merits of his tax proposal if you will but leave the vitriol out. But then again what then do you expect from those who believe they descended from Apes. Maybe the apple doesnt fall far from the tree afterall .
It takes more faith to be believe in evolution as it does creationsim .
Posted by: Conservativeiin Chitown | January 18th, 2008 at 6:54 pm | Report this commentNo income tax? The IRS would become a border tax agency and US retailers would invest massively in Mexico and Canada. US Postal Service would be overwhelmed, international travel would boom, corruption at the ports would skyrocket, the Department of Homeland Security would gain inordinate powers. The article should have finished at “crack-pot”.
Posted by: John Ormond | January 20th, 2008 at 1:16 am | Report this commentCandidates touting these sorts of plans in the US certainly get taken more seriously than they would in western Europe - Steve Forbes pushed the flat tax when he sought the Republican nomination, and Huckabee has hardly been challenged at all on his proposals as far as I can tell.
Contrast that with what happened to Angela Merkel when she produced a boffin who came up with similarly radical tax plans just before the 2005 German election - her previously enormous lead was almost completely eliminated and the plans and their author were never heard of again.
Posted by: David Wilkins | January 23rd, 2008 at 10:16 pm | Report this commentWhat about people on Social Security, etc? Under Huckabee’s plan, they would have to pay taxes on their living expenses, or does he have some kind of exemption??
Posted by: Chris | January 28th, 2008 at 10:33 pm | Report this comment