September 14, 2004

Tax Reform Proposal

Chaka Fattah, Representative of Pennsylvania's 2nd Congressional District, has proposed replacing the income tax system with a "transaction fee" - as far as I can tell, it's a VAT.

I don't know enough economics to compare VATs to other kinds of sales taxes, nor to determine if such taxes help or inhibit growth nor to what extent. With all of those disclaimers out of the way, I'd be very, very happy to see this proposal discussed. The income tax is a tyrannical way to generate government revenue, and inherently lacks limits. With both Republicans (including President Bush and Speaker Hastert) and Democrats now pushing for replacing the income tax with a better system, we might actually see movement on this in the next few years.

UPDATE: Reading through the bill, there are a couple of comments I have about this specific proposal. First, for all love please call it a tax! It's not a fee; it's a tax. Call it what it is.

It's actually not a proposal for a tax change, by the way. It's a proposal for a study to determine if it makes sense to change the tax system according to the set of guidelines laid out in the bill.

This bill does not actually propose a fee. Instead, it sets guidelines for the fee such that it would match the revenues generated in 1986. I'm not sure why that year was chosen; one would think you'd want to set the fee to match the last fiscal year before its passage. On the one hand, that's before recent tax rate changes, but it's also before the Internet boom and after Reagan's tax cuts. All in all, that might be a quite reasonable standard to use.

Sec.3(b)(4)(B) would have to go, I think. It's a list of suggestions for other uses of the fee. Proposing new programs and other reasons to generate more revenue - even good reasons like enforced paydown of the national debt - do not belong in a tax reform proposal. Those should be separately discussed, or they become stealthy ways of raising actual taxes.

I don't think you can exempt cash transactions less than $500 as a general category, because that would cause a shift in people's behavior that would reduce revenue with no real benefit. The better way to do it would be to exempt categories of spending, such as food and clothing purchases (and several others, I would imagine, such as charitable contributions) of less than $500. In reality, small cash transactions between individuals wouldn't get taxed, because they wouldn't be reported, but they could and should be collected by those entities currently collecting sales tax.

The problem, of course, is that as soon as you start adding exemptions, there's no real end to the exemptions that could be justified. In order to "protect the poor" you would have to exclude certain items, but drawing that line with so many special interests sending lobbyists and money to get their pet exemption, crafting reasonable exemptions would be very, very difficult.

I do like the idea of having a maximum rate of 1% for small transactions, but I'd prefer to see one rate above that, say a maximum of 3%. Otherwise, people will shift behavior for many large purchases, with deleterious economic effects. (Don't believe me? Go look up the "luxury tax" that was passed that killed domestic yacht building and new general aviation aircraft production. It was quickly repealed, but not quickly enough.)

Overall, I strongly approve of the idea of gathering the kind of information that the bill requires, including comparisons of economic impacts of this system versus the current system.

Posted by Jeff at September 14, 2004 10:59 AM | Link Cosmos
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