Taxing Times: Squabbling between Flat Taxers and Sales Taxers Could Allow the Internal Revenue Code to Escape Unscathed

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Imagine, if you will, a damsel in distress. She has been captured by an evil ogre, who is dragging her into a dark forest for unspeakable purposes. Riding to her rescue are two gallant knights, each possessing strength, virtue, and courage. But both knights are so anxious to be the hero that they fight each other for the privilege of defending the lady's honor. They are so consumed by this contest that the ogre is able to sneak off with the damsel, giving our story an unhappy ending.

Unfortunately, the same thing may happen with tax reform. Economists have long argued that America's multiple-rate, loophole-ridden tax code penalizes productive behavior. The good news is that most Americans, including a surprisingly large number of politicians in Washington, agree that the current system stinks. The bad news is that advocates of change are divided between proponents of a flat tax and proponents of a national sales tax. (For an outline of the debate, see "Rewriting the Code," July 1995.) And just as the squabbling between the knights allowed the ogre to escape, any disunity among the tax reformers will strengthen the ability of special interest groups to defend.the status quo.

Since congressional Republicans haven't decided upon a unified strategy for replacing the current Internal Revenue Code, flat tax and sales tax advocates will spend the next couple of years vying for the hearts and minds of Americans who want genuine reform. The flat tax advocates include House Majority Leader Dick Armey (R-Tex.), likely GOP presidential contender Steve Forbes, Citizens for a Sound Economy, and Grover Norquist's Americans for Tax Reform, while the Cato Institute and Citizens for an Alternative Tax System back a retail sales tax. Armey has introduced a bill that would replace the current income tax with a 17 percent flat tax. A proposal backed by Deputy Majority Whip Billy Tauzin (R-La.) and Rep. Dan Schaefer (R-Colo.) would replace the income tax with a 17 percent retail sales tax.

What makes this split particularly frustrating is that the flat tax and sales tax are virtually identical. Both would junk the current system. Both would restore fairness by taxing at one low rate. Both would eliminate all forms of double taxation, and both would wipe out special preferences. The only real difference between the two would be the collection point: The flat tax imposes one low tax rate on income when it is earned, and the sales tax imposes one low tax rate on income when it is spent.

In the long run, the biggest winner in the debate between the flat tax and the sales tax may turn out to be the current system. There is an obvious solution: Either sales tax fans have to rally behind the flat tax, or flat tax partisans must shift their allegiance to the sales tax. That transition should happen in the next year or two so that both sides are united and fully prepared for the tax reform battle after the next presidential election. The question, of course, is which side should give in. As a flat tax advocate, I clearly have some biases. Nonetheless, I have defended the sales tax in speeches, in the press, and in congressional testimony. I am perfectly willing to abandon the flat tax if there is compelling evidence that the sales tax is a more politically realistic way of achieving our goals.

But to convince me that the sales tax is better than the flat tax, supporters of the sales tax need to answer some questions. Their inability to answer these questions may suggest that they, rather than advocates of the flat tax, need to change horses.

* Since no political jurisdiction in the world has ever successfully replaced an income tax with a sales tax, why should we believe the United States is different? I see no plausible scenario in which a sales tax could receive 51 votes in the Senate, 218 votes in the House, and a presidential signature. The sales tax also has not fared well in public opinion polls. Perhaps major advertising and promotional campaigns could change the political dynamics, but an honest assessment of the potential impact of such an effort also has to consider the possible effectiveness of a negative campaign by defenders of the status quo. …