On General Sales Taxes: No How, No Way, No Exceptions

Laurie Roberts recently reported on Doug Ducey’s semi-confrontation with business leaders over a possible ballot initiative to raise sales taxes by one percent point in order to restore education funding.

Okay, get your dart guns ready, because I’m on Ducey’s side on this one, albeit for entirely different reasons.

General sales taxes or, to use the broader term, consumption taxes, are unjustifiable as a policy choice. I don’t have a problem with certain targeted excise taxes, such as those on gasoline and cigarettes. But general consumption taxes that apply across the board to all or most economic activity are, in my mind, unconscionably bad public policy.

It shouldn’t be hard to figure out that when the folks pushing a policy choice all are at or near the top of the income ladder, the policy is not going to favor the poor or middle class. So it is with the idea to replace income taxes with sales taxes or other consumption taxes. I’ve yet to meet a poor person who is itching to lower income taxes and raise sales taxes.

Why do many upper income folks favor this idea?

The real reason is that it will shift the tax burden away from them. Sales taxes are regressive. Because poor and middle class people consume a larger piece of their income than upper income folks, their sales tax burden, as a percentage of income, is higher.

Of course, that will never be the reason you’ll hear. But dig deep enough and you find that the stated reasons advocates of consumption taxes provide are mere smokescreens. The logic falls apart if they’re forced to answer too many questions.

I wrote a post last year on an email exchange I had with a conservative friend: Successfully Nailing Jell-O to a Wall. My friend started out explaining how a national sales tax would encourage savings. After that, he gave expedient answers to a series of questions I asked on how he would implement his plan to encourage savings. Eventually, he flat-out contradicted his supposed justification for the tax, stating that a consumption tax would not impact people’s spending decisions.

Another example is Bill Gates, the richest man in the world. Gates wrote a blog post last year, Why Inequality Matters, in which he gave his take on Thomas Piketty’s Capital in the Twenty-First Century, which he purported to have read in its entirety. Gates starts out by agreeing with Piketty that high levels of inequality are a problem, but then he goes on to show how he knows more than Piketty, which was sort of hilarious. A large part of Gates’ post was about how he would favor a consumption tax over an income tax in the effort to reduce inequality. This was based on his comparison of three wealthy individuals, one who contributes to charity, one who invests, and one who engages in conspicuous consumption. Making what seem to be value judgments about the behaviors of the three individuals, Gates concludes that the third should be taxed most heavily.

Here’s a shining example of why we should not listen to people just because they’re billionaires, especially if their remarks are self-serving. Remember that the context of Gates’ remarks is how to address high levels of inequality through tax policy. At an abstract level, our tax policy on this front gets it right in the following broad sense: The manner in which we tax income, consumption and philanthropy is consistent with the goal of reducing inequality. We tax income progressively because high incomes add to inequality. We tax philanthropy negatively (that is, we confer tax benefits on charitable gifts), because philanthropy reduces inequality on a voluntary basis. At least in theory, those who make charitable gifts receive no consideration for their gifts. We tax consumption lightly or not at all because consumption reduces inequality, but the reduction is not voluntary. The consumer is getting something in return for the reduction in wealth. So, we don’t reward consumption tax-wise, but we don’t tax it very highly either.

Gates, however, in proposing how to reduce inequality, would tax income less and consumption more. The proposal would be guaranteed to increase inequality, the very problem he was proposing to solve. It’s idiotic. That’s especially true at the tippy top of the income and wealth ladder, where Gates sits. If someone has an income in the billions, but only spends in the tens of millions, how could you possible impose a consumption tax large enough to limit the growth in his wealth to the same extent as an income tax?

The regressive nature of sales taxes is easily recognizable. Proposals abound as to how to ameliorate that problem, but it can’t be eliminated completely. Even more difficult is the challenge of making consumption taxes progressive. Gates proposes to accomplish that by basing the tax on one’s overall level of consumption. Gates acknowledges the administrative challenges such a system would present, but the depth of his understanding is questionable. Wealthy individuals are able to structure their affairs to avoid tax on their income, the timing of which they only have limited control. They have complete control over the timing of their expenditures, however. Moreover, if the rate of taxation was too steep, the expenditures could be curtailed, thereby making inequality worse.

What Gates entirely fails to comprehend is that a sales tax is not borne entirely by the consumer. Part of the tax is “passed back” to the seller. Economist Polly Cleveland explains “it’s the ‘passed back’ portion of sales taxes that do the most damage, because — unlike profit taxes — they take a bite from gross revenues before expenses. Moreover, a uniform tax rate does not mean uniform impact.” Sales taxes, according to Cleveland, “fall hardest on small, labor-intensive retailers, with high volume and low profit margins.”

Cleveland uses the following example to demonstrate this:

Consider two New York City businesses: One is a furniture store; the other is a Sabrett’s hot dog cart. Assume for simplicity the “passed back” portion of the 8 ½ percent sales tax is 5 percent. The furniture store invests $9,000 a year in an inventory of sofas, which it sells for $10,000, earning a $1,000 before-tax profit. A 5 percent sales tax is $500, half of profit, and 5.5 percent of the $9,000 investment.

The hot dog cart invests $200 a day in buns, dogs, and labor. It earns $210 a day, or $76,650 a year in sales and $3,650 in profit. A 5 percent sales tax collects $3,833, wiping out profit and amounting to 1916 percent of the $200 investment! Moreover since most of the cost of the cart is labor, the tax adds 5 percent to the 18 percent or so in payroll taxes!

I’ll add this: Even businesses that incur losses would incur the “passed back” portion of the sales tax. Most new businesses incur losses in the early going. They would be especially hard hit.

To sum up, sales taxes are inherently regressive, would exacerbate inequality, and would have a non-uniform impact on businesses, most adversely impacting small, labor-intensive businesses and new businesses.

Thus, our reaction to a proposed increase in general sales taxes should be “no how, no way, no exceptions.”