The discussion revolves around the distribution of the burden associated with a revenue-neutral national retail sales tax when compared to the existing income tax system. It is argued that such a tax shift would likely be regressive in nature, disproportionately impacting lower-income individuals.
A key concern is that a national retail sales tax could create a disconnect between the prices paid by consumers and the actual revenue received by sellers. This analysis suggests that the tax burden would ultimately be transferred to consumers through increased prices.
One of the primary reasons for the perceived regressiveness of a retail sales tax is that individuals with lower incomes allocate a larger portion of their earnings toward expenditures when compared to their higher-income counterparts. As a result, the impact of a retail sales tax, measured in terms of the percentage of current income, is more substantial for low-income households and decreases as income rises. However, when looking at the tax burden over a lifetime, the proportional impact becomes more in line with income levels. Nonetheless, even under a lifetime income measurement, higher-income households experience a relatively lower tax burden from a sales tax due to the fact that such a tax doesn't apply to returns on capital investments and capital-derived income, which constitute a larger fraction of total income for the affluent.
In contrast, the current federal income tax system is designed to be progressive. This progressiveness is achieved through mechanisms such as refundable credits for those with lower incomes, a standard deduction that exempts a baseline income from taxation, and a tiered rate structure where tax rates increase as ordinary income rises. Moreover, certain investment-related income from high-income households is subject to additional marginal taxes.
A report from the President's Advisory Panel in 2005 concluded that replacing the income tax system with a national retail sales tax would significantly favor higher-income households. A sales tax rate of 22% would significantly increase tax burdens for the lower 80 percent of income earners in order to replace the income tax revenue at the time. This potential increase, amounting to around $250 billion annually (measured in 2006 dollars), could be mitigated if the sales tax were adjusted to provide relief to lower-income households.
This shift would lead to a noteworthy alteration in tax distribution. The bottom 80 percent of earners, while contributing 15.8 percent of federal income taxes, would be responsible for 34.9 percent of federal retail sales taxes. Conversely, the top 20 percent of earners, who currently cover 84.2 percent of federal income taxes, would see their responsibility reduced to 65.1 percent of federal retail sales taxes.
In addressing claims that a properly tailored national retail sales tax could benefit families, proponents often highlight the proposed per capita cash rebates as evidence. However, it's important to consider potential negative consequences. Families with children may be adversely affected due to the elimination of current deductions for items like health insurance, mortgage interest, and state and local taxes, which often fund educational and governmental services. Additionally, various tax credits that provide support to families, such as the EITC, child care credits, education credits, and child tax credits, could be discontinued.
Furthermore, families with children inherently face higher consumption needs than those without. Consequently, transitioning to a consumption-based tax system like a retail sales tax could place families at a disadvantage. This is because such a tax system doesn't take into account the increased financial demands associated with raising children.
In conclusion, the consideration of a national retail sales tax prompts a careful analysis of its potential implications for different income groups and family structures. The article highlights concerns over its regressive nature and discusses the potential challenges faced by families if the existing income tax system is replaced.