Monday, May 07, 2007

Why I Love Sales Taxes

There's no denying that government spending is sometimes a good thing (unless you're a anarchist, that is). While one can argue how much government should be spending, I don't think anyone (other than the aforementioned anarchists) will argue that we shouldn't have a government at all. That being said, governments need some way to raise money. There's really only one way a government can raise funds: taxation.

Side note: Some of you Public Finance guys out there might take issue with the statement above and say that governments can issue bonds to raise funds. While this might be true in the immediate term, eventually the governments will have to pay off the debt through some other means which comes back to taxation.

Side note 2: OK, I guess the government can also seize assets and sell them off to private individuals in order to raise money but that's not sustainable in the long term and detrimental to a well-functioning state.

Back to the story. With taxation being the only way to raise money, we're left with only two choices: taxing production or taxing consumption. As a firm believer in the free market, I abhor anything that inhibits the creation of value. Taxing production does exactly that. The tax reduces the incentive to produce. Taken to an extreme, there would be no incentive to make goods and provide services people want and shortages would abound (think Cuba -- more on this in the future). Income taxes are a form of production taxes since you pay according to how much wealth you earned.

On the other hand, sales taxes are consumption taxes. They collect funds on transactions that take away from the public good. Each time someone consumes an item, there is less of that item to go around. The more you consume, the more sales taxes you pay.

Many people think that sales taxes aren't fair because poor people can't afford to pay their proportional share of the tax burden. Sales taxes naturally adjust for this since wealthier people can consume more goods/services than the poor and as such would pay more in sales taxes. Wealthy individuals who don't consume goods/services aren't putting a strain on the system and as such shouldn't pay the same amount as those who consume more.

Agree? Disagree? Let me know!

If you just had a sales tax how much would it have to be in order to make up for the shortfall from a zero income tax? I imagine it would have to be quite high. Poor people are barely getting by as it is and they hardly pay any income tax. It's hard to argue that a higher sales tax is more fair and/or better for them. There are enough incentives for rich people to acquire more wealth in this country. I don't think we need to create more incentives for them at the expense of the poor.
Ringo posses a good question. If I had more time, I'd work up a model to show what the implied sales tax rate would need to be in order to make up for the shortfall of eliminating the income tax. The shorter answer is to say that necessities such as fresh groceries would be exempt from sales taxes. Simply put, just have relatively higher sales taxes on luxery items. My proposal is not to eliminate the progressive nature of our current tax system but rather just to change the basis of it's collection. The winners would be frugal people with high incomes while the losers would be big spenders with low incomes.
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