Approaches of Different Tax Systems

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Table of Contents

Fair Tax/ National Sales Tax
Flat Tax
Value Added Tax
References

Fair Tax/ National Sales Tax

Taxation is basically taking a cut from the earning of the taxpayers. From taxpayers’ point of view, taxation of any kind can never be not fair to them. Taxpayers always seek reasonableness and not fairness in any taxation system. The proposal to replace income tax with national sales tax may contain certain attributes of reasonableness but it can never be fair to taxpayers.

When 5% sales tax is levied on purchases of $100, the cost to consumers is $105. The consumer feels a tax burden up to 5% of tax on purchases. But when the goods or services are sold for a price of $105 that is inclusive of taxation of $5, the consumer may feel that the rate of taxation is only 4.8% of its purchase price of $105. That means fairness or reasonableness of tax system from the point of view of taxpayers depends upon the feeling that the taxation system generates. Otherwise, all taxation systems are unfair from taxpayers’ point of view. Therefore replacing federal Income tax with National sales tax can only be an effort to change the feeling of taxpayers about the impact of taxation.

The advantage of National sales tax is that it is not a direct tax and accordingly the taxpayers may not feel that as a cut from their income is being made directly. Instead, it will generate a feeling that consumers are paying the purchase price of the product or services being enjoyed by them. This advantage may be called fair or reasonable because of its psychological impact, but the real effect is the same as a direct cut on taxpayers’ income.

‘The proponents of fair tax points out that the prices on consumer goods contain what are called “hidden taxes”. Under current laws, the corporations have to pay taxes on their earnings. Moreover, businesses have to pay social security taxes for each employee. The money to pay taxes has to come from somewhere, and the Fair Tax supporters argue that the cost is passed on to the consumer.'(Joe Miller, 2007).

Whatever may be the arguments of fair tax supporters, the net effect of taxes is always on the income of taxpayers. Therefore under the American system of taxation replacing Federal Income Tax with National Sales tax may not be called the introduction of a fair taxation system. However, there is likelihood of making a psychological impact on taxpayers that their income is not subject to a direct cut and nothing more than that.

Flat Tax

Flat tax implies that tax is being levied at single rate at all levels of taxable income. There are no slabs where under-tax rates rise gradually. This is a simple method of taxation; and supporters of flat tax believe that ‘simple tax will influence the American economy profoundly: improved incentives for work, entrepreneurial activity, and capital formation will substantially raise national output and standard of living.’(Robert Earnest Hall and Alvin Rabushka,1995).

According to Daniel J. Mitchell (2005) ‘a flat tax treats all taxpayers equally…. …. And unlike the current system, which punishes people for contributing to the nation’s wealth, a flat tax would lower marginal tax rates and eliminates the tax bias against savings and investment, thus ensuring better economic performance in a competitive global economy.’

Assuming flat rate is fixed somewhere at say half of the rate at present higher slab, it will be seen that most of the taxpayers will be freed from the liabilities to pay taxes. Those paying taxes at middle rates will have to pay taxes at a higher rate; higher rate taxpayer will gain by paying a lower rate than earlier. But is also a fact that those who are paying taxes at higher rates fall under the group having fluctuating income in any economy. That means the real brunt of taxes under flat rate shall only be borne by middle taxpayers who are actually the backbone of any economy. Thus in a way flat tax will work against those who are actually responsible for sustaining the development of economy that has already been achieved. This is certainly a big limitation of flat-rate tax system.

Douglas Dunn (2006) states that flat tax has three flaws:

it seeks to improve something that is already completely equal;
it force middle-class taxpayers to subsidize the wealthy;
it confuses much-needed tax reform and tax simplification in defining taxable income with unrelated issue of whether the rate applied to the income is flat or graduated.

He further argues that ‘graduated progressive taxes are fair because of three reasons:

they treat all taxpayers exactly the same;
they treat dollars with an appropriate difference based on differing levels of marginal utility;
those who receive most benefit should pay for the disproportionate benefit derived from the system.

Evaluating both sides of flat tax system it is clear that simplicity is not the answer to tax reforms. Flat tax system will create more problems in the American economy than providing the real benefits.

Value Added Tax

Value-added tax is being followed in many countries. The modus operendi is that tax is levied at multi-stages in the chain that make value additions at every stage of the chain while determining the final price for the consumer. VAT normally contains provisions for adjustment of input taxes against output tax before remitting the net tax. One of the benefits of VAT is that it eliminates the distortions in tax structure that carve up the nation into small markets instead of big markets.

But the problem with VAT is that with value additions at multi-levels, the ultimate price of products gets affected and may be counterproductive from consumers’ point of view unless checked effectively by the authorities. Another limitation is that VAT is based on multiple rates as per priority of products in the economy and varieties of factors are considered before settling tax rates under VAT. This multiple rate system distorts the choices of both consumers as well as manufacturers.

The point that goes against VAT is that it is an indirect tax and is mostly used to replace or modify taxes on sales of goods and services. Therefore such a tax cannot be a replacement to income tax and the American economy cannot introduce VAT for taxing income of its citizens.

References

Joe Miller, Unspinning the Fair Tax, Fact Check.org, 2007. Web.

Robert Earnest Hall and Alvin Rabushka, The Flat Tax, page 83, Hoovers Press, 1995.

Daniel J. Mitchell, A Brief Guide to the Flat Tax, 2005. Web.

Douglas Dunn, Flat Tax Fiasco, 2006. Web.

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Approaches of Different Tax Systems

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