The little law that would make liberals love sales taxes

I don’t know about you, but the unequal distribution of wealth doesn’t actually bother me at all. What bothers me is the unequal distribution of consumption.

In other words, I don’t care about your paycheck. If you’re just going to put it in the bank, knock yourself out; I hear they need the money. I sure know my own employer could use a decent loan right now.

No, the inequality I care about is practical: unequal distribution of yachts, yoga classes and Yeah Yeah Yeahs concert tickets.

That’s why I support revenue-neutral sales tax reform to include the taxation of services. It’d be the first step towards a fairer, more efficient tax system that penalizes what we don’t need — stuff — instead of what we do need — work.

Living a few thousand feet from the border between Washington (the second-highest-sales-tax state in the union, after Tennessee) and Oregon (one of three no-sales-tax states) means thinking about sales taxes a lot. And because Washington is one of seven no-income-tax states and Oregon has the highest tax rate in the union on low-wage income, it also means thinking about income taxes a lot.

Folks, I’m coming to you from the lower middle class with a strange and geeky message: if sales taxes were done right, they’d be better. And the first step toward doing them right would be slapping them on those concert tickets.

Yes, they’re regressive. Today, poor people (and comfortable people, like me) spend a larger share of their income on taxable goods than rich people. But this isn’t because rich people’s consumption is beyond our power to tax. It’s because we’ve chosen not to tax the things — entertainment, education, health care, landscaping — that rich people consume.

Buy a dumbbell; pay sales tax. Buy a gym membership; duck it.

Only three states (Hawaii, South Dakota and New Mexico) include most services in their sales taxes. More states should be moving toward this. Because it’s very hard to sell to voters (think of the ads — an education tax!) it’d have to be accompanied by a drop in the sales tax rate, with the goal of raising exactly as much money through the new, broader tax as was raised through the old, narrow one. In geek-speak, it’d be revenue-neutral.

If this change were to take place, we’d be ready for:

Step 2: Replacing sales taxes with a value-added tax like those in England or India, which are basically just a cleverer way to calculate sales taxes. And then

Step 3: Having fixed the sales tax system, the real work could begin: using it to replace some or all of our expensive, loophole-prone income tax system. A “prebate,” like the one being pushed by Mike Huckabee and his “Fair Tax” friends, would make the system more progressive; basically it gives every family a check for $400 or so on the first day of each month, to make up for the higher tax rate. We could deal with the remaining regressivity by retaining a simple income tax system for the rich, which would be less susceptible to political tinkering because it would effect no more than, say, 15 percent of the population. (In fact, that’s how income taxes were first imagined in the United States.)

What would we get for all this? Well, we’d be putting my brilliant friend Corey, the tax lawyer, out of a job. In other words, we’d be freeing his colossal brain to do something more useful than income tax evasion.

But more fundamentally, we’d be following the first rule Corey must have learned in law school: if you dislike something, tax it. If you like it, don’t.

I don’t like consumption. I like production.

– posted by Mike

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16 Responses to The little law that would make liberals love sales taxes

  1. Mike says:

    One of the forces at work here, by the way, is the fact that many families with very high incomes don’t have those incomes permanently; they just happen to have had a very good year. Once that money is finally spent, the family may be back to a more normal income, maintaining their more normal lifestyle throughout. It’s one of the dirty secrets of the tax system.

  2. Roy Huggins says:

    How come I’d never heard of this before… This does sound like a good solution to me. When I moved to Oregon I was introduced to the repressiveness of sales tax and was instantly set against it. Honestly, a progressive sales tax-ish system would be a boon in Oregon. Income tax is far too high and the state doesn’t have any money to show for it.

    Now that I think about it, though, isn’t this essentially a luxury tax a la that space on the Monopoly board?

    PS: I want to know what Corey thinks. 😉

  3. Mike says:

    Spoken like a guy who’s living income-tax free, Roy. 🙂

    There’s been a little discussion of this in think-tank land; see this article, hidden around the corner from one of the links above, or this one, by the down-the-line lefty Center for Budget and Policy Priorities.

    And I could be wrong, but isn’t Luxury Tax basically a head tax — $75 flat when you land on it? There are those awful Community Chest/Chance cards that assess you cash based on the size of your housing developments, but that’s different. And there’s the $200-or-10-percent square. Which is sort of like a pre-Roosevelt income tax, really!

    Once, during an epic Monopoly game against my parents in the early 1990s, I slipped that property-tax card out of the Chance pile and hid it beneath our hearth rug, because I was so afraid of drawing it. True story.

  4. Mike says:

    Oh, and the guy who put this on my radar was actually Tom Vilsack. He tried to broaden the Iowa sales tax in 2004, IIRC, but it failed in part because it was a revenue-raising proposal.

    I should also note that I’m definitely not an expert on this and I reserve the right to reject and denounce all of the above if presented with evidence that it’s dumb.

  5. poetloverrebelspy says:

    I have had a difficult time understanding the intention of this post, mostly because Minnesota already appears to do what you suggest. In fact, I think it does it better by being progressive in certain areas (i.e. no one pays sales tax on food or clothing). In your scenario, why tax education? It’s a public good. I’m sort of amazed that people don’t pay tax on gym memberships or haircuts somewhere?!

    That said, I still don’t understand the logic of “don’t tax the things you like” > “I like production” > “tax services”? Is your ultimate message here simply “don’t tax my income, please”?

    Sounds like the solution to your individual situation is to live and work in WA and shop in OR. Is this a popular work-around in your area?

  6. Mike says:

    You probably know a lot about Minnesota taxes that I don’t, Hilary — is the 2007 list linked above out of date in Minnesota?

    Here‘s what looks like research for a proposal to broaden it.

    My general impression is that the variety of services that are and aren’t considered sales taxable varies widely by state, presumably based in part on which industries have political clout.

    Not taxing food and clothing, which many states do, seems to me like a very crude way to progressivize the system, especially compared with a prebate. A lot of the benefit is wasted by subsidizing rich people’s purchases of fancy food and clothing.

    And though education might be a public good, I’m skeptical of the public’s interest in helping my upper-class parents drop $200,000 on their children’s education. The taxes on that service could have bought an awful lot of public goods. A bunch of poor kids’ degrees at Iowa State, for example.

    Finally to your question: Yes, my message is indeed “don’t tax my income, please.” Tax my pleasures instead.

  7. Mike says:

    As for crossing the border, that is indeed a popular (and technically illegal) workaround.

  8. poetloverrebelspy says:

    Of course, “fancy food and clothing” is relative — what about people who have to buy wacky flours and goat cheese because of severe allergies or other health problems? Or people who need expensive shoes because of orthopedic issues?

    It’s better for all of us that your parents drop that money educating you (wherever you choose to go) rather than buying another house or fancy boat or what have you. And I’m sure they would do it anyway, but if they are encouraged by the tax benefits, then so be it. In your words, why tax what you like?

    Reading the FairTax flyer, it appears that it is essentially a VAT with a universal rebate (not adjusted for cost-of-living variations across the country). Is this not a “socialist redistribution of income” that people are always arguing against? You and I would get $200 back per month — at my current income level, a definite boost to the household economy. Would such a system actually ENCOURAGE spending? Do you have any idea how much you are currently spending on tax and how much that would change if everything were taxed at a flat rate? And why in the world would we give people making over, say, $250,000 such a payout each month?

    Finally, can we actually finance all government expenditure on just this plan? I am sceptical.

  9. Mike says:

    Sorry I didn’t get back to you for a few days, Hilary. I hope you catch this.

    Last point first: yes, overloading the VAT would be a major problem. The heavier any single tax gets, the bigger the black market becomes and the higher the cost to those who do business on the up-and-up. I’m certain that a 50 percent sales tax, like the one suggested by the FairTax folks, would be unworkably high. This is part of the reason for retaining some taxes on income and property.

    A $200/month payment sounds nice today, but it wouldn’t go very far if you were paying 20-30 percent federal sales tax on everything you did with it. Still, yes, it would be a modest cash payment. That makes me a social democrat, but not a socialist.

    I make $33,500 a year, about $6,000 of which goes to income and payroll taxes. I’d guess that another $400 a year goes to direct sales and alcohol tax, plus maybe $250 for gasoline taxes. Say $80 for airline tickets, cell phones, utility taxes. My share of my landlord’s property tax bill this year will be $662; let’s assume she passes that entire bill to us. So a high estimate for what I pay in direct or nearly-direct taxes is $7,400 annually. That’s 22 percent of my income, or equivalent to a 28 percent sales tax if it were levied on everything I earned this year.

    Let’s say that instead of paying 22 percent of my income in taxes, I had to pay 28 percent, which is the combined federal/state/local government’s share of the total U.S. economy. (This would translate to a 39 percent sales tax on my purchases.) That’d be $9,380 per year, about $2,000 more than I pay today. Well within the range that could be offset by a monthly prebate, by the income/property taxes that would remain, and by the share of government revenue that comes from fees.

    Remember, I imagine the top 15 percent of earners would still have to pay income tax at a somewhat reduced rate.

    You’re right that I like education. But do I like it SO MUCH that I want to totally exempt it from taxes? No. Slippery slope. Better to use government spending to encourage education, rather than exempting it from government revenue.

    First point last: Yep, those people would lose out a bit. Too bad.

  10. stevenattewell says:

    I have to say I ferociously disagree.

    First of all, you need to separate out income from wealth. And that kind of inequality does matter – income means economic security, it means being able to cover sudden costs when things go wrong. Like a sudden medical bill or your car breaking down, or needing to replace things that have been stolen, etc. Wealth means even more economic security because it’s an additional form of potential income you can turn to when things get rough – you can rent out a room in your house, you can get a loan using your wealth as collateral, you can get dividends and other forms of investment income.

    Inequalities of wealth and income mean that not only are the poor worse off on absolute terms, but they also are much more exposed to sudden income shocks. Jacob Hacker’s the Great Risk Shift is good on this – when you don’t have much wealth or disposable income to fall back on, sudden loss of a job or a debilitating illness or the loss of a vehicle or a home or your insurance can very quickly push you down from near-poverty or even middle-class status into poverty and below poverty.

    Next, you’re going to run into the problem of marginal propensity to consume. Poor people by definition spend 100% of their income on necessities – and as we’ve seen in recent years, more and more people are spending in excess of 100% to maintain their basic standard of living. The rich, even when you take into account luxury purchases, do not spend as much of their income. Even if you eliminated all tax-free status for the goods the rich buy, you’re still going to be taxing some people on 100% of their income (or more) and other people at much less.

    Next, I don’t see why the simplest solution here is to simplify the income tax by removing deductions and loopholes. Or even expanding our wealth taxes (capital gains and estate taxes).

  11. stevenattewell says:

    One thing I forgot to mention: in any economic system, consumption and production need to balance out. If you increase production, but decrease consumption, you’re going to get a classic “crisis of overproduction” where everyone goes broke because prices fall below costs – thus poverty amidst plenty. We saw this happen before (albiet combined with a crisis of underconsumption) in the Great Depression. It was not fun, let’s not try to repeat it with moralizing against consumption.

  12. Mike says:

    I really appreciate the critique, Steven. (And geeks, check out his new group blog, The Realignment Project.)

    I don’t understand macroeconomics nearly as well as I should, so I’ll take your second comment as fact. (Though I honestly can’t see how productivity increases could possibly be a bad thing, even if there’s a fall in aggregate demand. Isn’t this all we’re talking about?)

    Your normative argument about how great it is to be wealthy and how much it sucks to be poor, per Hacker, is excellent. I’ll have to noodle that, but you may have persuaded me.

    Thanks for reminding me about capital gains and estate taxes, which I’d somehow totally forgotten (just as George Bush would have wanted…). Estate taxes are the endgame here, of course: however little a rich dude might spend of his income in life, I’d say that his estate should be subject to a very high level of taxation at his death. This would address the problem you identify w/r/t rich people’s lower propensity to consume.

    Finally, to your question about why we don’t just simplify the income tax: yeah, that’d be great. But I think history suggests that without some other structural reform, the loopholes will only return.

  13. stevenattewell says:

    Thanks for the plug, Mike.

    Productivity increases are generally good, don’t get me wrong. The problem emerges when there’s not enough purchasing power to absorb the increase in production – then the increase of supply without increase in demand causes a sharp decrease in prices, which causes a crisis of profitability. Now, in an ideal economic order (like the ones that neoclassical economists insist we actually live in), productivity increases are automatically divided up fairly between workers and employers; workers go out and buy the surplus, employers go out and invest, and a virtuous multiplier effect continues. However, in reality, the unequal bargaining power between worker and employer can mean a maldistribution of wealth such that not enough purchasing power exists to consume the increase which leads to a crisis of underconsumption, where purchasing power lags production, and such that too much investment capital is chasing too few investment outlets – which leads to a speculative bubble.

    We saw this happening in the 1920s, and arguably we saw it again in the 2000s.

  14. Mike says:

    18 months later: I was pleased to see, in a link forwarded by friend-to-the-Geeks Matt Wilson, that the Dominici-Rivlin deficit reduction plan includes a proposal very similar to this one: a 6.5% national VAT on most services except education, accompanied by closing the loopholes in the income tax system and including a refundable tax credit of up to $4,100 or so per taxpayer, based on earned income.

  15. 19 months later! Another progressive paean to a smart VAT, from Andrea Louise Campbell in Democracy.

    She proposes variable rates on different items as a system to reduce regressivity. This makes me nervous, but theoretically it’d work. Money quote: “A tax that is progressive with respect to consumption and proportional or slightly progressive with respect to income. … In short, a tax that progressives could embrace.”

  16. stevenattewell says:

    It’s been tried; it doesn’t work. Variable rates destroy the supposed efficiency of the tax, and don’t produce sufficient progressivity.

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