Taking Out The Trash

Robert Prather over at Insults Unpunished has a posting about replacing the current income tax code with a transaction tax.

I've mentioned before that I would really like to watch our current tax system go away. It has got to be one of the biggest messes every devised by man.

The transaction tax is an interesting and successful concept. The Europeans have been using it for years - they call it the VAT or Value Added Tax.

Now, for a moment, ignore the negative connotations of the European version of the VAT. The concept is brilliant. It is applied equally to everyone with their contributions based on their consumption of goods or use of services. And because it would tax all factors of production, it would be as close to fair as we could realistically get.

I just have one small problem with the transaction tax idea. It's the same one I have with the European VAT and the same one I have with the current withholding system in the US.

The true cost of the tax becomes hidden.

Think about it for a minute. Every time a transaction takes place, a little tax is taken. The seller is simply going to raise his prices just enough to offset the new cost. With each transaction that takes place, that passed on cost grows, but it becomes built into the price rather than added on afterwards. The actual cost of the tax becomes hidden.

And because it is hidden, people don't react the same to an increase in the rate. Why are US sales taxes generally capped at less than 10% while the VAT in Europe runs around 17%?

It's because in the US we see exactly how much we're paying in tax when we purchase an item. An increase in the sales tax rate translates directly into a larger number at the bottom of every receipt we get. Because we can see the cost to us of the tax, we are more likely to fight arbitrary increases.

In Europe, on the other hand, you don't really now how much of the price of an item is tax. Is it 17%, or was some part of the item taxed somewhere earlier in the production process which created a passed on cost? There's no breakdown on the price tag of the item telling you how much is actual cost and how much is VAT. You don't know. You're operating in the dark and it's hard to distinguish inflationary price increases from small tax increases.

It is this hiding of the actual impact of a tax that bugs me with the current withholding system. Many people don't realize that that line on their paycheck that says "federal tax withheld" represents their money, not the governments. I've heard too many people saying, "well, it's not my money anyways" That's not true. It is your money.

The first step in overhauling our tax system needs to be the elimination of the withholding system. Make people write a check to the Feds every April 15. That alone will almost certainly provide the necessary support among the people to make the change happen.

But then I would still favor a sales tax on consumption over a transaction tax because of its openness in the real cost. A NST would show on the bottom of each receipt, just like a State sales tax. And since it is only charged to the end user, you can feel very confident in knowing the real amount of tax you pay each and every time you pay it.

The transaction tax lacks that openness. That makes it much more susceptible to political manipulation.

Neither system is perfect, but they're both a damn site better than the current screwed up system.