The Wisdom of Replacing the Federal Income Tax With a Universal 8% Federal Sales Tax.
Given that monetary policy is an imprecise tool, the Federal Reserve should be given a fiscal policy tool so it can rely less on monetary policy. Just as Congress has delegated monetary policy to the Fed, it could delegate a fiscal policy power to the Fed, consisting of raising and lowering federal income tax rates. That would be a fairly precise tool for braking and stimulating the economy with no side effects. It can be accurately calibrated with no major lag effect, contrary to monetary policy.
Furthermore, the Fed should not be limited to lowering federal income tax rates in order to stimulate a weak economy. It should be authorized to distribute tax rebates (funded through QE). Tax rebates have immediate effect by putting fresh money in consumers’ pockets, and they can be accurately calibrated so as to avoid creating excess aggregate demand and inflation.
Actually, an optimal fiscal policy would consist of a more radical reform: having the federal income tax replaced by a federal sales tax. For two reasons. First a federal sales tax would greatly increase the efficiency and accuracy of fiscal policy. Second, it would be much fairer than income taxes which can easily be avoided by the wealthy through various legal tax shelters, which by the way distort capital allocation (a significant negative for the economy). Furthermore, since high-income citizens spend much more than low-income citizens, a sales tax is inherently very progressive. A federal sales tax can be made even more progressive by having the Fed send all low-income taxpayers an annual federal sales tax “prebate” every January 1, based on the sales taxes they would incur by spending their total annual income. For example, if the federal sales tax were 8% and it was desired that all taxpayers earning less than $20,000 should effectively pay no federal sales tax, such low-income taxpayers would receive a $1,600 check from the IRS each January.
A good case can be made that an 8% universal federal sales tax (that is on all sales, not just retail sales) would raise more revenues than current federal income taxes, fully covering federal spending, leaving no budget deficit. In fact, using 2019 figures (pre-Covid), GDP was $21 trillion; federal spending was $4 trillion; federal income tax revenues were $3 trillion; the federal budget deficit was $984 billion. Meanwhile, retail sales were $5.4 trillion; wholesale (B-to-B) sales $8.6 trillion; real estate sales $4 trillion; stock sales $23 trillion; and bond sales about $12 trillion. Total sales were therefore $53 trillion. An 8% universal federal sales tax would bring in $4.2 trillion ($53 trillion X 8%), thereby leaving a federal budget surplus of $200 billion. With such reform, there would be no more income taxes (including capital gains taxes), and no more unconstitutional estate taxes (around $27 billion in 2021). (Short-term traders could elect to have a special brokerage account dedicated to short-term stock, bond, option, and commodity trades, whereby ordinary income tax rates would apply to their capital gains, dividends and interest, in lieu of incurring the 10% sales tax which would be prohibitive for many short term investments.)
The effect of eliminating capital gains and estate taxes would unlock enormous amounts of “frozen”, stagnant investments (“frozen” due to the widespread reluctance to sell them and incur substantial capital gains taxes). That would lead to greatly increased spending on consumption and more productive investments, thereby raising GDP and retail and wholesale sales, and increasing federal sales tax revenues which could allow the federal sales tax rate to be reduced to 7% or 6%, if not lower. (By the way, long-term capital gains taxes are unfair when capital gains are solely due to inflation and do not represent real gains. Notoriously, many citizens selling their home in view of moving or trading down, end up after capital gains taxes with much less money than an equivalent new home would cost. That is incredibly unfair. With the federal sales tax, home sellers would pocket the entire sales price and owe no sales tax, borne instead by the buyers.
As for criticisms that this fiscal reform would benefit the wealthy, not the poor, everyone must realize that poverty has not been solved for over 50 years since LBJ proclaimed the “War on Poverty”, under the regime of income and estate taxes, both of which the wealthy largely avoid through legal tax shelters. The wealthy would generally pay more in federal sales taxes than they do with income taxes. Furthermore, since poverty is the result of a very inadequate education, the solution is not soaking the rich; rather it is greatly upgrading all our public schools so that every single youth gets a truly excellent education. That requires public schools to be run as the best private schools, with strict discipline; lots of homework/study hall; individual attention for students having academic or psychological difficulties; and, of crucial importance, an enlightened curriculum. Eliminating poverty would then lead to a very low federal sales tax rate, under 5%, to widespread economic and social prosperity, and political harmony. There would be no class warfare. It should also be universally understood that without many wealthy citizens and profitable businesses, no nation can have strong, sustained investment and economic growth. Furthermore, it should be understood that whatever the wealthy do with their money is good for the nation. If they spend on consumption, that’s good for the economy and employment. If they invest, that’s good for economic growth, employment, and technological advances.
What would be an enlightened high school curriculum? One which includes four years of the following courses: 1) psychology (taught in conjunction with group therapy and good parenting workshops); 2) economics/finance/investing, putting mainstream theories to the test of statistical correlation and rigorous logic; 3) detailed, analytic 20th Century world history; 4) history of art/architecture/design; 5) history of music; 6) the United Nations’ Charter and its Universal Declaration of Human Rights; 7) the world history of human rights violations; 8) comparative religion studied through direct, analytic readings of the holy books along with the history of the major religions; 9) logic, critical thinking, and media literacy, with case studies; 10) ethics and empathy, with case studies; 11) foreign languages and cultures; 12) introductory and Constitutional law; 13) Latin; 14) the major mistakes in economic, social, and foreign policy of the past 100 years in the United States, Latin America, Europe, Africa, and Asia, and which would have been the correct policies. (I personally would have greatly benefited from such a high school curriculum, getting an invaluable head start in understanding the world in all its complexities.) For uniformity of public school excellence nationwide, we need an enlightened, ambitious national public school core curriculum along with a prestigious national high school graduation exam.
Had the above public high school reform been implemented fifty years ago, today we would have hardly any poverty, addiction, violence (including gun violence), crime, social strife, political strife, racism and other violations of human rights, dishonesty, unwanted pregnancies. We would have very few mentally disturbed citizens. With educational parity at a uniformly high level, integration would have progressed naturally and not been met by the widespread resistance which occurred with government enforced integration. We would have no budget deficits or accumulated federal debt. We would have much lower tax rates. We would have widespread economic and social prosperity. There would have been no January 6. Our politicians would be much more qualified.
The political choice and commitment to make sure every single public school provides a truly excellent education to every single youth should be unanimously understood as the right choice. So should having the federal income and estate taxes replaced by a universal federal sales tax (initially of 8%, but soon to be much lower); having the Fed use fiscal policy tools instead of monetary policy to stimulate or brake the economy (the fed funds rate would be put on automatic pilot, updated monthly at the 3 or 6 month trailing CPI rate); and having FDIC/SIPC insurance for cash deposits replaced by an unlimited Federal Reserve guarantee combined with effective incentives to ensure prudent risk taking by banks and brokers. What rational, informed arguments against these measures could there possibly be, by Democrats and Republicans? Why should we continue to be stuck in the mud with outdated and ineffective tax and educational policies, and with a Federal Reserve not having the precise tools necessary for implementing an optimal economic policy.
© Edward Sonnino 2023
April 28, 2023
