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Shifting Tax Base To Consumption Tax Is Bad Idea



ANNETTE NELLEN

In January 2020, a Nebraska legislator introduced LR300CA, to amend the state constitution to prohibit all forms of taxation other than a consumption tax. The proposal states that the tax is to be at a single-digit rate. Presumably, both the state and local governments could have a single-rate tax. It would apply to all new goods and services, but does not define this term. It sounds like it means tangible personal property and services, possibly also travel and entertainment, but not clear.

It is unlikely that such as tax can raise as much revenue as an income tax, even with no exemptions to the sales tax. High income taxpayers don’t spend all of their income, they save it and invest it. So that drops the tax base compared to an income tax. Consider these two formulas and you’ll see the base for an income tax is broader.

Income = consumption + savings

Consumption = Income less savings

And, with an income tax it is easier to have a progressive rate structure to increase vertical equity in the system.

One new category that would become taxable and affect higher income individuals more than lower-income is to tax food. Currently, Nebraska doesn’t impose sales tax on food. According to data from the Bureau of Labor Statistics, the top 20% of income earners buy 1/3 of total food purchases. They also buy 41% of all entertainment spending. Hopefully the Nebraska proposal intends to apply sales tax to entertainment.

The proposal is likely to be a tax increase for low-income individuals as there is no exemption for low-income as there easily can be for an income tax. With removal of income and property taxes and only a single-digit sales tax, it is likely that government would have to cut services which would also disadvantage lower income individuals.

What about alternatives? Here are a few ideas:
Repeal income tax preferences such as the mortgage interest deduction.
Impose sales tax on food but provide an income tax credit to low-income individuals to reduce the impact to them of the tax.
Expand the sales tax base to include high-end consumption such as entertainment, travel, and household help.
Also in 2020, a California legislator introduced AB 2712. This calls for a universal basic income amount of $1000 per month to be paid to individuals age 18 or older with income below 200% of the median per capita income for the person’s county of residence (measured by the BLS). This amount would not be subject to tax in California or affect income based tax and other benefits. AB 2712 defines “universal basic income to mean unconditional cash payments of equal amounts issued monthly to individual residents of California with the intention of ensuring the economic security of recipients.” The payments would be handled by the FTB.

To pay for this, the bill calls for that “on or before July 1, 2024, the California Department of Tax and Fee Administration shall submit a report to the Legislature on the feasibility of establishing a new state tax to finance the California Universal Basic Income (CalUBI) Program. The report shall consider the feasibility of establishing a value-added tax on goods and services in the state, an analysis of the feasibility of taxing the sale of services offered in the state, and an analysis of the feasibility of raising the corporate tax. The report shall also include projections of expected tax revenue.”

Adding a VAT on goods and services to fund the UBI would impose a burden on those receiving the UBI. Aside from rent, much of what is left over each month is spend on goods and services with most of the goods (other than food) subject to sales tax. Adding a VAT on top of the sales tax would also add complexity. Consideration should instead go to replacing the sales/use tax with a VAT with a broad base and low rate.

A higher corporate rate will be borne by employees, owners and customers and so can also hurt low-income individuals.

Why not remove tax breaks that primarily benefit high income individuals such as the mortgage interest deduction, sales tax exemptions for household utilities, personal service, entertainment and food? And consider if the EITC should be increased in place of a UBI although the EITC is only for workers.

Two of my colleagues and I wrote a paper in 2017 on a proposal for a different type of consumption tax that could be paid along with one’s state income tax, but exempt low-income individuals. And businesses would not be subject to it (similar to how a VAT work and how a consumption tax should work to avoid pyramiding). Please check it out. I think it would be groundbreaking for the first state to adopt it in terms of removing regressivity of this consumption tax and making the state very attractive for businesses.

A UBI should be discussed as a way to help low-income individuals to know if it will help more than other programs such as greater education opportunities and medical care for all.

And we have lessons learned from the pandemic and federal and state programs aimed at helping those with health and financial needs. This included funds for businesses of all sizes, unemployment benefits extended to self-employed individuals, economic impact payments and other provisions. Were these benefits equitably distributed? Did they help those most in need? How will the increased deficits and debt (and its interest expense) be paid?

How will these topics get attention in the public arena?

What do you think about such proposals?

Annette Nellen

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Annette Nellen, CPA, Esq., is a professor in and director of San Jose State University’s graduate tax program (MST), teaching courses in tax research, accounting methods, property transactions, state taxation, employment tax, ethics, tax policy, tax reform, and high technology tax issues.

Annette is the immediate past chair of the AICPA Individual Taxation Technical Resource Panel and a current member of the Executive Committee of the Tax Section of the California Bar. Annette is a regular contributor to the AICPA Tax Insider and Corporate Taxation Insider e-newsletters. She is the author of BNA Portfolio #533, Amortization of Intangibles.

Annette has testified before the House Ways & Means Committee, Senate Finance Committee, California Assembly Revenue & Taxation Committee, and tax reform commissions and committees on various aspects of federal and state tax reform.

Prior to joining SJSU, Annette was with Ernst & Young and the IRS.

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3 thoughts on “Shifting Tax Base To Consumption Tax Is Bad Idea

  1. Avatar Norman Benoit says:

    Consumption tax is the easiest tax to avoid. All you need to do is pay cash for services ie trades people, maids, landscapers etc. Stolen merchandise is also sold for cash.

  2. Avatar Russ Soule' says:

    I can never understand why so many so-called experts want to tax the successful people to pay for the unsuccessful. “Take away the mortgage interest deduction”, “Take away the sales tax deduction”, “Raise the percentage of taxation on those ‘rich’ people”. Do you not understand the lack of incentive when success is taxed higher than un-success? Have you learned nothing from the expansion of unemployment to $600 per week from the Feds plus the state amounts and that those individuals now do NOT want to go back to work? Take a moment to reflect on the human foibles involved in all this taxation. There is a truth in “The more you give, the more they want”. When success is taxed, incentive to succeed is removed and what you end up with is a true stratification of society – the very rich(Millionaires and Billionaires) and the very poor (those who have no jobs because there are no businesses).

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