The National Sales Tax: Fair or Not?

In the early days of our nation...

by Mariah Wojdacz

With grassroots support for the federal sales tax growing across the nation, it seems the proposed tax might well become reality. But what would replacing the federal income tax code with a national sales tax really mean for Americans? Would it be a boon for the economy, or as catastrophic as the critics claim?

By some estimates, over 50 percent of our incomes go to pay federal, state, and local income taxes; state and local sales taxes; property taxes and gas taxes; as well as "hidden" taxes that are included in the prices of the goods and services we consume. Americans in the top tax bracket pay up to 35 percent in federal income tax alone. While most Americans consider the burden of income tax inevitable, a brief look at the history of taxation in this country reveals that this has not always been the case.

In the early days of our nation, the federal government was supported exclusively by internal taxes on liquor, sugar, tobacco, carriages, corporate bonds, auctioned property, and slaves. The expense of fighting the War of 1812 prompted Congress to enact America's first national sales tax on silverware, gold, jewelry, and watches. After the war, in 1817, Congress eliminated all internal taxes and collected revenue only from tariffs on imported goods.

America's first income tax law passed in 1862. Levied to support the Civil War effort, this income tax was accompanied by more sales taxes, excise taxes, and the first inheritance tax. But Congress abolished this income tax in 1872, and focus shifted back to tobacco and alcohol taxes to fund government activity. Although Congress attempted to reinstate the income tax in 1894, a year later the Supreme Court ruled that federal taxation of income was unconstitutional.

How, then, did the current tax code become law? The only way it could – through a constitutional amendment, of course. Ironically, the 16th Amendment was introduced by the very people who opposed it. It began as a scheme, a plan to nip income tax legislation in the bud.

In 1909, the income tax was a hotly-debated issue in the Senate. Democrats generally supported it, while Republicans generally did not. A senator from Texas, Democrat Joseph W. Bailey, introduced an income tax bill in order to embarrass the Republicans, who he believed would openly oppose it. He was surprised when many of them supported his bill.

But Republicans who opposed the income tax devised a plan. Just when the bill was about to pass, they proposed a constitutional amendment granting Congress the power to lay and collect income taxes. The Republicans believed the conservative states would vote against the amendment, thus killing it and the income tax bill. They were wrong. The public rallied behind this "soak the rich" amendment; it was ratified and went into effect in 1913.

Why would the public enthusiastically support income taxation? At first, it did not seem so bad – people paid a mere 1 percent on their first $20,000, and no one paid over 7 percent. To put the numbers in perspective, $20,000 in 1913 equates to over $250,000 today. In 2004, the tax rate on $250,000 was 35 percent.

In 1913 Congress touted the income tax as "the fairest and cheapest of all taxes." But because the tax exempts non-profit organizations, the wealthiest citizens in America immediately began using their resources to shelter their incomes from taxation. As tax rates continued to increase, the wealthy began shouldering more and more of the national tax burden, and naturally redoubled their evasion efforts. This means that a vast amount of income in America goes untaxed. Moreover, any income earned on the black market obviously goes untaxed – an estimated $100-300 billion annually.

Before the 16th Amendment passed, New York Congressman Sereno E. Payne called it "a tax upon the income of honest men and an exemption…of the income of rascals." Payne said the income tax would make "a nation of liars;" that it was the most difficult tax to enforce and the hardest to collect. Considering the current problem of tax evasion and income sheltering, history seems to have proven Payne right.

The national sales tax has been dubbed the "fair tax" for a reason. If passed, the legislation would repeal the 16th Amendment and do away with the current tax code altogether. It would stop all federal payroll withholdings, including Social Security and Medicare withholdings, but would fund these programs more effectively, proponents argue, than the current tax code does. No taxes would be levied on necessities like food, and no taxes would be paid on items purchased used.

Many Americans feel that a national sales tax would empower them to choose how much of their money goes to the federal government. Additionally, the fair tax eliminates all "hidden income taxes" that are passed on to the consumer in the form of higher prices – 22% on goods and 25% on services, according to Dr. Dale Jorgenson of Harvard University. Repealing income taxes on individuals and businesses means prices immediately go down.

The fair tax would also effectively abolish the IRS, saving Americans $225 billion in annual compliance costs. The current tax code is over 60 thousand pages, and the IRS reportedly gives out incorrect information more than half the time. The fair tax bill, at 132 pages, is simple and easy for Americans to understand.

According to Congressman John Linder (R-GA), primary sponsor of the fair tax bill, implementation of the national sales tax would prove profoundly beneficial to the national economy. It is estimated that the Gross Domestic Product would increase by over 10% during the first year of enactment. Investment, exports, real wages, work incentives, and household incomes would all increase dramatically, while interest rates will fall by an estimated 25 to 35 percent.

Opponents of the fair tax argue that it is an unreliable revenue source, and that the wealthiest Americans will figure out ways to purchase big-ticket items overseas. But some pundits speculate the criticism is really born of jealousy – that no party wants the other party to get credit for implementing what might be the most welcome legislation of our time.

The fair tax idea has been tossed around congress by Republicans and Democrats alike, although they have never been able to work together to pass this sweeping tax reform. Perhaps when the new fair tax bill, HR 25, comes up for debate, both parties will be able to put partisanship aside and finally give Americans some real tax relief. Then again, who knows? Death and taxes, after all, remain the only certainty.