United States Federal Reserve Chairman Alan Greenspan recommended to the President’s Advisory Panel on Federal Tax Reform last week that the nation adopt a national consumption tax as a way to reform the current tax system and reduce the federal deficit. Although the panel has until the end of July to make its recommendations, debate is already brewing in Congress with bipartisan recognition of the unnecessary complexities of the tax code and the need for change. Proposing a national sales tax was once considered radical, but has currently received a welcome audience in the Bush administration, including from the president himself. Greenspan’s suggestion to blend consumption and income taxes reveals his personal hesitancy toward a solitary consumption tax, but even a hybrid tax should be rejected because it disproportionately disadvantages the poor and would be ineffective at resolving the budget deficit.
A sales tax is inherently regressive — the poor must pay a higher proportion of their income in taxes because they spend most or all of their earnings. Meanwhile, wealth Americans can shield their earnings through savings or investment, thus exempting a greater fraction of their money from taxation. Although such a sales tax would incorporate exemptions for basic necessities like food, this system would invariably increase taxes for the poorest Americans. Furthermore, retirees on fixed incomes like Social Security benefits would also be hurt by the plan because they would effectively be taxed twice — paying the sales tax without receiving the income tax break.
Since its inception under former President Woodrow Wilson, the national income tax system has been a progressive one. Additionally, it has served as a policy implementation tool — tax deductions for expenses like charitable contributions and college tuition can help promote necessary spending in these areas. According to William Gale of the Brookings Institution, sales tax rates would have to be 26 percent in order to cover the costs of combating these problems through federal grants and subsidies, though other economists have made far higher estimates. A sales tax would likely be translated into direct price increases, with both businesses and consumers shouldering the costs of reduced profits and the likelihood of inflation.
Increasing the marginal rates for members of the upper income brackets would be a more effective and fairer way to increase government revenues. This country has a precedent of progressive taxation — members of the highest tax bracket paid around 90 percent in income taxes following World War II, until levels dropped to 70 percent until the 1980s. While a return to these high rates would be unnecessary, a smaller increase in marginal tax rates for the richest Americans would be effective in increasing revenue without reducing possible incentives to earn.
In light of the current budget deficit and debate about the renewal of President Bush’s 2001 tax cuts, the issue of tax reform has deservedly moved to the forefront. Greenspan highlighted that as the Baby Boomers retire, the need to raise the country’s savings rate and improve labor incentives will become even more important. The pressure for change, however, must not result in regressive taxation that would fly in the face of 90 years of ideology and harm America’s poorest citizens.