William G. Gale, Evan F. Koenig, Diane Lim Rogers, and John Sabelhaus
In recent months, proposals to replace all or most of the existing federal tax system with a national retail sales tax have received increased attention. The most prominent proposals include those by Reps. Dan Schaefer, R-Colo., and Billy Tauzin, R-La., and by a group called Americans for Fair Taxation (AFT). Schaefer-Tauzin (S-T) would replace existing personal and corporate income taxes, the estate tax, and some excise taxes with what they term a 15 percent sales tax. AFT would replace taxes on personal and corporate income, estates, and payrolls with what they term a 23 percent sales tax. These proposals raise a number of interesting issues.
One of the more controversial and interesting features of these proposals is that all consumption and investment purchases made by federal, state, and local governments would be subject to the sales tax. These provisions increase the statutory sales tax base by more than 40 percent. The proposals would also tax all private consumption of goods and services sold by the government to households.
In this report, we examine the treatment of government in a national retail sales tax, with emphasis on three issues: What are the alternatives for taxing federal, state, and local governments under a national retail sales tax? How does taxing government affect the sales tax rate required to maintain the real value of government programs? What are the implications of these results for existing sales tax proposals?
We find that taxing federal, state, and local government purchases in a national retail sales tax would provide consistency in comparisons of the sales tax with other taxes, such as the income tax or the flat tax. It may also help establish neutrality between public and private provision of goods or services in a sales tax.
However, we also find that taxing government purchases does not affect the tax rate needed in a sales tax to maintain the real value of government spending. This result may be surprising. How can it be that increasing the tax base by 40 percent by taxing government does not reduce the required tax rate?
