South Africa: Constitutional Assembly Resources

PEOPLE’S ENDEAVOUR
TO REFORM TAXES

18 January 1995

CONSTITUTION AND BILL OF RIGHTS - TAX AND FISCAL ISSUES

Please find enclosed a copy of our submission to the Commission of Inquiry into Taxation in South Africa, which is to serve as part motivation for our proposed constitutional amendments and inclusions. For the same purpose, a video tape has been sent under separate cover.

Certain aspects of our proposed tax reforms involve what should be considered fundamental rights, and we therefore seek to have these included in the new Constitution and Bill of Rights :-

1. That the imposition of a taxation penalty on an individual's or company's work and production is morally, philosophically and economically wrong, and that this tax penalty should progressively increase at a higher rate with increased work and production, is also discriminatory and therefore unconstitutional, and should not be allowed, and that;

2. All persons, companies and associations are entitled to their own income, profits, property and inheritances without tax, hindrance or denial by the State, and that;

3. There should be no income, profit, asset, capital gains or inheritance tax of any kind, of individuals or companies, so that;

3.1 The private books and records of an individual or company may not be inspected by the State except in the case of bankruptcy or treason, or as is reasonably necessary to audit consumption tax returns;

3.2 No books and records of financial transactions may be required by the State of any individual or company except in the case of bankruptcy or treason, or as is reasonably necessary to audit consumption tax returns;

3.3 No balance sheet may be required by the State;

3.4 The State may require a transfer duty by stamps, or otherwise, on all deeds of or changes of title to the extent of 5.0 per cent of the sale price, without which no title to property acquired may be valid, and such rate may only be increased by a referendum and a two thirds majority vote in favour of such increase;

3.5 All disputes of money, collections, inheritance and claims amongst individuals, families, companies and associations shall be subject to civil suit to which the State is no party;

3.6 Any official of the State or a company may he charged and tried for bribery or embezzlement on presentation of proof before a court of law, and a warrant signed by the accuser, at which time records may be examined by the court.

4. All businesses and their property, and the property of individuals are guaranteed safe from State expropriation or seizure for taxes, or taxation based on the value of the property other than initial transfer duty.

5. Freedom from all customs duties of whatever kind are guaranteed to the individual and companies, but that:

5.1 The State may charge a single rate consumption tax on all goods and services (excluding property), not to exceed in total 30.0 per cent of the final value accrued from all points of sale, and that;

5.1.1 Such rate may only be increased by referendum and a two thirds majority vote in favour of such increase;

5.1.2 No law may be passed or concession given that may discriminate against another trade or professional practice, or grant favour so that any trade or practice may enjoy special benefit;

5.1.3 It is incumbent upon the State to maintain an efficient and cost effective administration so as to allow a low taxation rate.

5.2 In special circumstances, the State may impose an import duty on a specific commodity or commodity type type, only so as to afford temporary protection for the establishment of it's local production, and that this duty will be phased out over a period not to exceed five years.

6. That no business or person may be made to pay through taxation the keep of adult persons, who will not contribute or suffer the taxation resulting from burdensome State offers of boons to voters, or the creation of an indigent unemployed class supported by the State, but that;

6.1 Pensions of servants of the State and armed forces may be paid;

6.2 War wounds and damage may be compensated;

6.3 Famine and drought areas or areas suffering natural cataclysms may be relieved;

6.4 Displaced persons may be cared for temporarily;

6.5 Epidemics may be handled;

6.6 Chronic widespread diseases may be treated, but no free medical or mental services may be underwritten by the State, or offered by the State, or governed by the State;

6.7 The State may require employers to maintain insurance and social security or pension arrangements for their employees to prevent them from becoming charges on the State;

6.8 The State may run a lottery requiring only voluntary contributions to provide revenue for any social relief programmes.

7. All funds and currencies and banking arrangements valid outside the State are also valid inside the State, and no currency exchange controls of any kind may be imposed by the State or enforced for other States.

8. Prices and incomes, except those of State officers or employees, may not be fixed, regulated or restrained by the State.

9. Rates of interest, bank rates and the extent of private or company loans may not be fixed by the State except that the State may charter BANKING corporations which may act to curb inflation or deflation.

10. The State may not budget or spend more than is collected in revenue so as to place the country in debt, and shall maintain adequate reserves.

The foregoing is offered as an initial draft to immediately make known our views to the Constitutional Assembly for their consideration. Further motivation, modification or expansion will be provided as part of an on-going development process.

We further request to be timeously informed of all organised public fora where these issues may be discussed or debated at any venue in the country, so that we in turn may participate in or contribute to the process.

We wish the Constitutional Assembly every success in this most important task, and offer our services in any way that may be so requested or directed.


Michael Harrison Copeland
Chairman

PEOPLE'S ENDEAVOUR TO REFORM TAXES
THE ALTERNATIVE TAX SYSTEM
SUMMARY

We all reluctantly agree that taxation is necessary to cover the administration costs of Government, but need it be so unfair, punitive, painful and destructive? We think not.

We owe our current income profit based tax philosophy to Karl Marx who, in his book 'Das Kapital' (1867), wrote 'to each according to his need, from each according to his ability to pay'. In short this means "to take from those who work and produce, and give it to those who do not', and amounts to penalizing production.

There is a simple natural law which states "REWARD PRODUCTION'. Failure to do so, and/or rewarding non production, will result in NO PRODUCTION, and so, thanks to Marx, the eventual collapse Of the USSR and'our declining western governments. Of course this I aw could, and should, be applied to more than just taxation.

Income /profit based ta xes penalize production, savings and investments which are the fundamental requirements for economic growth and job creation; the number one priority in our country Savings are in fact penalized twice; once when the original capital is earned, and then again when interest or dividends are received.

It is no wonder we have a savings rate of less than 1 per cent (one of the lowest in the world), and an unemployment rate of greater than 60 per cent (one of the highest in the world). The economically strong nations of the world, all have high savings rates.

What we propose is a greatly simplified tax system that abolishes all income and profit based taxes for both individuals and businesses, and replaces them with a Retail Consumption -Tax (Re!) on all goods and services. This could be collected using the current 'VAT' system, (very complex and costly). or the old "GST' system; whichever produces the highest NETT recovery rate.

All currently zero rated items and interest charged on individual credit would be included in the base. Only rent paid to landlords would be zero rated . The choice to spend and pay taxes or to save and pay none, ,would now be yours; a refreshing change.

Consumption based taxes reward production (you get to keep our whole pay cheque), encourage savings and investment, and thereby provide 'the necessary ca y al for economic growth and job creation. They also create the incentive for individuals to work harder and earn more.


It is individuals who pay taxes not businesses. Taxing businesses is a futile exercise. as they simply pass all tax and related Compliance costs (including the estimated R20 billion in tax "planning") onto the consumer in the form of higher * prices Therefore the prices of goods and.services can include on average about 20 per cent in hidden' tax costs. This is the concealed regressive aspect of income based taxes that impact severely on the poor.

B t taxing businesses, SA goods and services become more competitive on world markets, and as a business tax haven, a flood of foreign investment could be expected.

Contrary to popular belief, it is income taxes and not consumption taxes that hit the poor the hardest. The RCT system that creates employment and reduces prices, is the best one can do for the poor. They need good jobs and not unsustainable, degrading handouts.

Furthermore, by paying ng rebates equivalent to the RCT rate to those earning less than the current SITE minimum thresholds, the introduction on of the system will.result,in NO TAX BURDEN ON THE POOR WHILE ALSO CREATING incentive AND OPPORTUNITY. Even their WHOLE current VAT burden would be removed. These rebates would simply be added onto the employees wage by the employee, and then claimed back on the monthly RCT return. The loss in revenue so incurred would be less than that with zero rated foods.

14 August 1994




TAX REFORM SUBMISSION

We have pleasure in enclosing our submission for due consideration by the Tax Commission.

We represent a growing grass roots movement of concerned citizens who believe that despite past reform failures, there is an alternative to the established punitive, destructive and unfair income tax system.

The South Af rican taxpayers have been taking it on their chins for long enough, and we further believe the time has come for them to stand up for their rights and do something

positive and effective about it.

This submission represents the earnestness of our intentions, and we sincerely trust that it will be favorably received by

the Commission.

We wish the Commission well in it's task and offer any continued assistance and support as may be required and directed.

MICHAEL HARRISON COPELAND

CHAIRMAN

PEOPLES ENDEAVOUR TO REFORM TAXES

PARA. TITLE PG. NO.

1.1 TERMS OF REFERENCE 1

1.2 PRINCIPLE TAX ISSUES AND STATISTICS 1
1.2.1 INDIVIDUAL TAXATION 1
1.2.2 SAVING 2
1.2.3 EMPLOYMENT 3
1.2.4 BALANCE OF PAYMENTS 4
1.2.5 TOTAL DEBT OF GOVERNMENT 4
1.2.6 COMPLEXITY 5
1.2.7 AVOIDANCE / EVASION 5
1.2.8 ADMINISTRATION 6
1.2.9 RECONSTRUCTION AND DEVELOPMENT PROGRAMME 6
SECTION TWO - THE SOLUTION


PARA. TITLE PG. NO.

2.1 TAX REFORM BASICS 8
2.1.1 PHILOSOPHIC BASICS 8
2.1.1.1 REWARD PRODUCTION 8
2.1.1.2 BRINGING ORDER TO A CONFUSION 9
2.1.1.3 FALSE PRINCIPLES 9

2.2 THE MARGO COMMISSION 10
2.2.1 ABANDONING THE INCOME TAX BASE 10
2.2.2 EXTENT AND SPEED OF REFORM 11
2.2.3 POPULARITY AND CONTROL OF GST 12
2.2.4 REGRESSIVE CONCEPT 12
2.2.5 GST VERSUS VAT 13

2.3 TAX REFORM PROPOSAL 14
2.3.1 BASIC PRINCIPLES 14
2.3.2 ENCOURAGE SAVING & PRODUCTIVE INVESTMENT 15
2.3.3 PROMOTE ECONOMIC GROWTH AND EMPLOYMENT 16
2.3.4 EMIGRATION, EXPORTS AND FOREIGN INVESTORS 16

2.3.5 MEETING REVENUE REQUIREMENTS AND CREATING
GROWTH 17
2.3.6 SIMPLICITY AND TRANSPARENCY 19

2.3.7 ENSURE THAT ALL THE PEOPLE PAY THEIR FAIR
SHARE 19
2.3.8 BE SIMPLE AND ECONOMICAL TO ADMINISTER 19
2.3.9 DONATION TAX EXEMPTION AND / OR DEDUCTION 20

2.4 SUMMARY 20

2.5 CAUTION 21

2.6 CONCLUSION 22

ADDENDUM 23

ADDENDUM TWO 24

1. THE RETAIL CONSUMPTION TAX BASE 24
2. CONCESSIONS 25
2.1 Rent 25
2.2 Basic Foods 25
2.3 Low Income Rebate 25
2.4 Donations 26
2.5 Social Security Grants 26
3. THE RETAIL CONSUMPTION TAX RATE 26
4. COLLECTION 27
5. REGRESSIVITY 28
6. CONCLUSION 30

SECTION THREE - DATA

PG. NO.

IMPACT OF A NATIONAL SALES TAX
ON THE UNITED STATES ECONOMY 1 - 20
BY JOHN H. QUALLS, PH.D.

THE ECONOMIC IMPACT OF REPLACING FEDERAL 21 - 40
INCOME TAXES WITH A SALES TAX
BY PROFESSOR LAURENCE J. KOTLIKOFF.

COMPARE FOR YOURSELF
THE INCOME TAX VERSUS 41
NATIONAL RETAIL SALES TAX

CITIZENS FOR AN ALTERNATIVE TAX SYSTEM 42 - 50
FACT SHEET

USA MEDIA CUTTINGS 51 - 58

VIDEOS - FREEING THE USA FROM THE INCOME TAX PARTS ONE AND TWO (30 MINUTES EACH)

DAN SCRMFER WITH VIC KROHN (30 MIN.)

C.A.T.S. (30 MIN.)

N.T.R.C. & C.A.T.O. SEMINAR (35 MIN.)

PEOPLES ENDEAVOUR TO REFORM TAXES
( P E R T )
TAX REFORM SUBMISSION
SECTION ONE - THE SITUATION

1,1 TERMS OF REFERENCE

These proposals are submitted to the tax commission in terms of the Minister of Finances, budget speech (BS) of 22 June 1994, the Department of Finances' Budget Review (BR) chapter one paragraph 2.3.1 and Government Gazette No. 15865.

1,2 PRINCIPLE TAX ISSUES AND STATISTICS

Examination of the statistics and statements contained in the documents mentioned in 1.1 above as well as the South African Reserve Bank's Quarterly Bulletin of June 1994 (QB) and Public Finance Statistics of South Africa 1946 ‑1993 (PFS) , reveals the serious overall decline of our national economy.

Reference is made to the Government' Reconstruction and Development Programme (RDP) where the proposals made in this submission will support the relevant key issues.

The issues which need to be highlighted are as follows:‑1,2,1 INDIVIDUAL TAXATION

Tax on individuals has increased as a percentage of total receipts from 15.4 per cent in 1981 to 39.0 per cent in 1993 (PFS page B-131) Real personal disposable incomes have declined from a high of R4686 in 1980 to R4145 in 1993 (QB page S-129).

This has placed a very severe load on the individual tax payer whose families have also had to cope with the resultant declining standard of living.

The high progressive income tax rate, coupled with fiscal drag, has had a particularly severe effect on the relatively small middle income (salaried) group. It is also a disincentive to work and produce more.

USA Senator, Dan Quayle, said on Good Morning South Africa' on 12-08-1994 that he was very pleased to hear THAT president Mandela is going to reduce taxes. He also reported that President Mandela said he really wants to do that because he considers that the lowering of taxes would be the boost the economy needs to get it going. "This would send a very strong signal to the American Investor who wanted to know what was going to happen over here before making investment decisions", Senator Quayle said.

There is an urgent need for a tax system that will broaden the tax base, reduce the burden on the individual tax payer, be fair and reward production instead of penalizing it.

1*2.2 SAVING

Given the above scenario, it is no wonder that personal saving is low.

"The ratio of gross domestic saving to gross domestic product declined from 18 per cent in the second quarter of 1993 to approximately 16 per cent in the first quarter of 1994. compared to an average of 23.1 per cent during the period 1981 to 199011. (BR paragraph 1.1.2)

"The discouraging effects of inflation and high rates of direct taxation on savings are cause for concern. Contractual savings flows of about 15 per cent of GDP, to insurance and retirement funds, are largely offset by credit extension by banks to

households .... Policies which strengthen the underlying economic growth trend must accordingly enjoy priority during 1994 and 1995, including strict avoidance of measures which would tend to cut short the recovery". (BR 2.1.2)

Saving is a major index reflecting economic health. Through increased saving and productive investment general economic growth and job creation is facilitated.

A tax system is required that will promote economic
growth and employment.

1.2.4 BALANCE OF PAYMENTS

"The nett outflow of capital which started in 1985 continued up to the first quarter of 1994......... South Africa I s gross reserves at the end of March 1994 amounted to R10.3 billion, equivalent to less than 6 weeks imports of goods and services". (BR paragraph 1.1.6)

We need a tax system that will reverse the emigration flow of skilled and productive workers (and their capital), promote exports and attract foreign investors.

1,2,5 TOTAL DEBT OF GOVERNMENT

The total debt of government continues to rise from R50,924 billion in 1987 to R192,125 billion in March 1994 (QB S-53).

"Government debt increased .... to a ratio of 48.7 per cent of gross domestic product at the end of March 1994. Nearly two out of every ten rand received by the government now has to be used to finance interest payments on the growing public debt" (QB pg 2).

This amounts to an interest on public debt of over R23 billion (BR pg 23-1) . Not only is revenue unable to service this debt but additional loans are also needed to meet the growing budget expenditure.

For all intents and purposes the government could be considered bankrupt.

Government spending now stands at a high 33.82 per cent of GDP.

It is vital that government curb expenditure, not only to reduce the deficit itself and reduce the crowding out of the private sector, but in order to reduce the total debt, at least as a percentage of the GDP.

A tax system is needed that will meet the necessary Government funding requirements and re-create conditions of economic access and opportunity for all the people through the revitalization of the economy.

1.2.6 COMPLEXITY

The complexity of our tax laws is such that they are beyond the understanding of the vast majority of our people. Judging by the often conflicting opinions received, even the experts are confused.

Countless hours are spent in filling in tax forms and making decisions based more on tax avoidance than purely good economic merit.

Vast sums of money are spent on tax consultants and legal services. This is time and money that could be better spent on productive purposes.

Actual total tax costs are hidden in this complexity, leaving the individual unsure of just how much of his hard earned rand he is paying to taxes.

We need a tax system that is both simple to understand and transparent in its penalty.

1.2.7 AVOIDANCE/EVASION

Because of the complexity dealt with in 1.2.6 creating the opportunity, and motivated by an onerous progressive tax penalty, it is not .surprising that many attempt to avoid declaring income.

In the USA it has been estimated that "tax cheats" deprive the state of 20 per cent of revenue due. This necessitates more payment from the honest citizens.

Due to our even more onerous tax rates than that of the USA (31 per cent top marginal rate as opposed to the SA 43 per cent plus a 14 per cent VAT and furthermore our tax brackets are comparatively much lower) , it is not unreasonable to expect our avoidance/evasion rate to be even higher.

There also exists a criminal underground economy whose operators obviously also fail to report income and hence evade paying their share of taxes. Again, more has to be paid by the law abiding citizen to make good their share.

We need a tax system that will ensure that all the people pay their fair share.

1,2,8 ADMINISTRATION

Funding of the finance department will cost the state RI.495 billion in this financial year, of which R620.3 million goes directly to Exchequer financing (BR pg 23-1).

The complexity of our tax system as dealt with in 1.2.6 can be held responsible for the large cost of

collecting taxes.

We need a tax system that will be simple and economical to administer.

1.2,9 RECONSTRUCTION AND DEVELOPMENT PROGRAMME

The central theme throughout the RDP is that it be people driven, and that the private sector be encouraged to share the Statels burden in it's implementation.

Contributions to the upliftment of all the people should be rewarded.

We need a tax system that will reward donations to the RDP as well as registered non profit charitable, religious and educational institutions.


1,3 SUMMARY

We need a tax system that will:-

3,1 Broaden the tax base, reduce the burden on the individual tax payer, be fair and reward production instead of penalizing it.

3.2 Encourage saving and productive investment.

3.3 Promote economic growth and employment.

3.4 Reverse the emigration flow of skilled and productive workers (and their capital), promote exports and attract foreign investors.

3.5 Meet the necessary Government funding requirements and re-create conditions of economic access and opportunity for all the people through the revitalization of the economy.

3.6 Be simple to understand and transparent in its penalty.

3,7 Ensure that all the people pay their fair share.

3.8 Be simple and economical to administer.

3,9 Reward donations to the RDP as w ell as registered non

profit charitable, religious and educational institutions.

These issues will again be dealt with individually in section two.

SECTION TWO - THE SOLUTION

2.l TAX REFORM BASICS

Before embarking on our tax reform proposals, it is necessary that we examine a few basic issues.

2,1,1 PHILOSOPHIC BASICS

Philosophy is a subject which permeates all life's many and varied activities. In depth studies of taxation through numerous learned academic tomes, which cover every intricate detailed deliberation, will not result in any workable solution if basic sound philosophical principles are not applied, or false principles are adopted.

Having given this matter some considerable thought, we believe we have isolated the basic philosophical principles which must be applied to the taxation conundrum in order to achieve a workable solution.

2.1.1.1 Reward production

A basic natural law simply states:

If you penalize an up statistic and/or reward a down statistic, you will get a down statistic.

From the viewpoint of taxation this also translates into ...

If you penalize production and/or reward

non-production you will get non‑production.

overlooking this seemingly simple yet powerful principle, has led to the decline of governments worldwide. It is therefore vital that this principle be thoroughly grasped and applied....

REWARD PRODUCTION AND PENALIZE NON‑PRODUCTION

For example, if the objective is to increase the overall level of wealth in the society at large, the tax system should not penalize wealth creation, but should encourage the production of goods and services which will in turn generate more employment and hence the increased level of wealth required.

2.1.1.2 Bringing order to a confusion

This principle states that ...

To bring order to a confusion, all that has to be done is to use one stable datum to evaluate all the other random data in the confusion.

The stable datum of "reward production,' must therefore be consistently applied in the evaluation of all issues to bring about a successful resolution of the tax confusion.

It is again vital that this principle be thoroughly grasped and applied in order to obtain a rational tax solution.

There are no doubt those who will argue that this is too simplistic. There is however no known prerequisite for complexity in determining validity and workability. Those who promote complexity must surely seek to personally profit from it at the expense of others.

2,1,1.3 False principles

In 1867 Karl Marx stated in his book "Das Kapital", his principle of Ilto each according to his need, from each according to his ability to pay".

This concept of ',taking from those who work and giving to those who don't" has been popularized and adopted as the tax philosophy of governments around the world. It simply does not work and has led to the economic decline and/or collapse of such governments.

A glaring example of this is to be found in the recent disintegration of the former USSR which has left its states and satellites in absolute economic ruin and abject poverty.

The basic reason for this is to be found in the above Marxist principle being in contravention of the natural law "reward production and penalize non production".

2,2 THE MARGO COMMISSION

We refer to the report of the Commission of Enquiry into the Tax Structures of the Republic of South Africa dated 20 November 1986 (Margo Commission).

The Margo Commission addressed exactly the same problems of taxation that we have today. This is laid out on pages 2 and 3 of the above report headed, "The Need and Purpose of Tax Reform".

As dealt with in section one of our submission, and by statistical analysis, it is plain that these problems have not only continued through to today, but have in fact further intensified.

That Commissions recommendations, and what was adopted from them, fundamentally changed little of the existing tax philosophies and structures. We just got more of the same.

This is not a new occurrence in the history of tax reform.

The failure of the Margo Commission to remedy the situation must then surely indicate the invalidity of such philosophies and resultant structures.

We believe that the Margo commission's failure stems from the following basic incorrect assumptions:-

2,2,1 Abandoning the Income Tax base

"The time is not ripe for abandoning income as the base for direct taxation" (Pg 12 paragraph 2. 8) i and "Good reasons exist for using both direct and indirect taxes to raise a required level of revenue .... It therefore seems sensible to conclude that both categories of tax should be used in future" (Pg 70 paragraph 5.16).

The taxing of income/prof its is a direct penalty on production and, in terms of the "Natural law" , it cannot be supported.

It is, in terms of this law, better to broadly tax expenditure or consumption. It would then not penalize production and would encourage in consecutive order, saving, investment, growth and more production resulting in increased employment opportunities; the prime objective in our country.

The increased production would then restart this cycle in an ever widening upward spiral, blossoming into sustainable economic prosperity for all.

This is the fundamental philosophical and structural change,required to reverse our economic decline.

2,2,2 Extent and Speed of Reform

The commission accepted a statement in the Meade Report, ll[w]e cannot jump by one revolutionary movement from the existing tax structure to a completely new one". (Pg 7 paragraph 1.34)

By gradiently replacing the existing income tax structure with a consumption tax, one would merely

be extending the adverse effects of penalizing production, which would result in a retarded recovery rate.

The explosive unemployment situation in our country demands bold decisive action.

Despite conservative opposition, we have led the world in our sweeping political reforms. Why can't we do the same with our tax system?

Given both our natural and people resources, there is no reason why the replacement of income tax with a retail consumption tax, could not be the major factor leading to South Africa becoming one of the world's beet examples of economic reconstruction and development.

2 .2.3 Popularity and Control of GST

at 12 per cent has become a most unpopular tax and there is evidence of extensive evasion of a type that cannot easily be countered" (Pg 342 paragraph 21.98), and "The commission is satisfied however, that the GST system is not suitable at higher rates" (Pg 342 paragraph 21.102).

The unpopularity of GST was more occasioned by the perception of it becoming a growing addition to an already high income tax that was not being reduced, and so was just there to increase the total tax burden.

We believe that with GST totally replacing income tax, this perception would be reversed and evasion reduced.

Furthermore, with the resultant simplified tax administration, additional attention could be diverted to proper control through more frequent field audits.

It is regrettable that the commission did not give more weight to the 1985 Australian tax reform moves where "The issue of consumption tax was canvassed in considerable detail, and it was concluded that there was a strong case for changing the tax mix in favor of indirect taxes thus enabling a substantial reduction in personal income tax rates" (Pg 330 paragraph 21.26).

There is absolutely no reason why GST or a retail consumption tax could not be operated at higher rates on this basis.


2.2,4 Regressive Concept

"On the other hand, sales taxes have the following disadvantages:

(a) The tax is generally regressive". (Pg 332 paragraph 21.35)

As dealt with in 2.2.1 above, a sales tax replacing income tax, would lead to greater saving, investment growth and production. This means more employment.

In view of our massive escalating unemployment rate where millions seek jobs, such issues as tax structures, rates and regressive concepts must appear esoteric and irrelevant to those so effected. They simply have no money at all to pay whatever the taxes are that are levied.

In fact they would dearly love to be in a position to have to pay tax!

Who is, after all, better off? The unemployed, starving and roaming the streets in a fruitless search for work, or the employed having to pay say 21 cents of his or her rand in a retail consumption tax?

Ask any of those in the street and the answer will not be surprising.

A tax system that will create employment for the indigent cannot be considered regressive. In fact it in the direct taxation of income and the penalizing of production, that has led to their existing plight.


2,2.5 GST Versus VAT

"If the recommendation to reduce the rate [of GSTI to 7.5 per -cent or less is not accepted, the Commission recommends a change to an invoice VAT systemll. (Pg 342 paragraph 21.102)

This recommendation was primarily due to the consideration that the VAT system would be less unpopular and would minimize evasion.

These factors can be negated with the rationale already put forward that this would not be the case should a retail consumption tax totally replace an income tax.

The replacement of GST with VAT has incurred some enormous costs and complexities, and the very re=1 advantages of GST have been lost:-

(a) ease of collection and fewer collection points.

(b) minimal refunds.

(c) lower level of record keeping

(d) lower state administrative costs

There is nothing to preclude the implementation of the principle of a broad based consumption tax replacing an income tax under the present VAT system, provided it is very broadly based. This VAT approach, as opposed to a IIGST" approach, would not be ideal f or the reasons stated in the above paragraph.

"The ultimate [Australian] decision in favour of the consumption tax was motivated by the greater complexity of a value added tax and thus the longer lead time required for its introduction". (Pg 330 paragraph 21.28)

Again it is regrettable that the Margo Commission did not follow the Australian example.

It is recommended that a retail consumption tax replace VAT.

2.3 TAX REFORM PROPOSALS

In the light of the foregoing, let us now examine the tax reform needs outlined in section one paragraphs 1.3.1 to

1.3.9 of this submission.

2.3.1 Basic Principles

We need a tax system that will broaden the tax base, reduce the burden on the individual tax payer, be fair and reward production instead of penalizing it.

By replacing both company and individual income tax with a broad based retail consumption tax on all goods and services, the above needs can all be met.

No one individual or business would enjoy an unfair advantage over another. We would all be paying the same basic rate and would no longer be penalized for working harder to earn more.

This implies, of course, that wealzhy or high‑income individuals with large expenditure patterns would contribute much more in total tax revenue and, and with basic foods zero rated, the truly indigent virtually nothing.

The zero rating of basic foods is a political concession and must be approached with extreme caution. It penalizes those that do work and produce with a higer rate, and is a loophole in the tax net that could be exploited.

2.3.2 Encourage Saving and Productive Investment,

A consumption based tax will clearly encourage saving. The more you save the less tax you pay. Also there will be no more "double taxation" on interest or dividends received.

The increased take home pay with the removal of PAYE would more than compensate for the required raised percentage rate of a "total replacement" retail consumption tax.

Furthermore, as companies would no longer be paying company tax and Gross Domestic Fixed Investment is excluded from the consumption tax base, they could reduce prices, invest in growth and increased production or product development and training, in whatever proportion they deem economically necessary. These are all positive factors which would no longer be influenced by tax avoidance complications.

As stated so elegantly in the RE)P (paragraph 4.4.6.1) "To bring about a more dynamic business environment, the democratic state must develop measures to encourage increased productive investment, greater investment in research and development, cooperation with small- and micro enterprise, work place democratisation, and more open and flexible management styles."

As prices could be reduced and production increased, a transition to a retail consumption based tax could therefore also be considered as anti-inflationary.

2,3.3 Promote Economic Growth and Employment.

As already dealt with in 2.2.1 and 2.2.4, a total i7etail consumption based tax switch would greatly enhance growth and employment.

The encouraged higher saving rate dealt with in 2.3.2 will create a pool of funds available at lowered interest rates for business formation and expansion.

The small business man can in particular benefit from this. Not only will he have more funds available for cheaper loans, but he will not be bogged down with complicated tax reporting procedures.

This simply means more production of goods and services, more jobs and an increased level of average wealth in society.

As stated in the RDP paragraph 2.2.4.2 "boosting production and household income through job creation, productivity and efficiency, improving conditions of employment, and creating opportunities for all to sustain themselves through productive activity."

The positive factors affecting company management in 2.3.2 would also improve our competitive position in the international markets, thus increasing exports.

2.3.4 Emigration Exports and Foreign Investors

Reverse the emigration flow of skilled and productive workers (and their capital), promote exports and attract foreign investors.

With the creation of employment, the violence in

our country can be expected to decrease. The increased political stability and economic growth prospects will not only stem the emigration of skills and capital but reverse them to a nett Immigration inflow.

Such positive tax reform measures would also send very strong signals to the international community, and foreign investment (with all its positive ripple effects) could be expected to increase dramatically. (See again USA Senator Dan Quayle's comments in section one paragraph 1.2.1)

2.3.5 Meeting Revenue Recluirements and Creating Growth

Meet the necessary government funding requirements and re-create conditions of economic access and opportunity for all the people through the revitalization of the economy.

To replace the personal, corporate, VAT and donations taxes for the 1994/1995 budget would require R85 billion in revenue from a retail consumption tax.

The average personal income tax rate is 13.21 per cent, which when added to the current VAT of 14 per cent, would give a total of 27.21 percent average total tax bill for the individual.

Please refer to a study done by Jo@in H. Qualls, Ph.D. of Manassas, USA entitled "The Impact of a National Sales Tax on the United States Economy" dated August 16, 1991 (See pages 5 to 7 in the data section of this submission), wherein a national sales tax rate is evaluated and calculated using various base models.

The base chosen in this study suggests a rate of 16.3 per cent. Due to our high relative tax rate caused by high state expenditure, and aggravated by massive unemployment (low per capita production), we could expect this rate to be somewhat higher in the South African context.

Unfortunately, due to our limited time and resources, we have not been able to convert these studies into the South African context.

The following figures indicate how the consumption tax would replace all revenue from personal, corporate and value added taxes in South Africa:-

94/54 personal and corporate tax = R 56 billion

94/95 VAT = (BR Pg C.1) R 29 billion

TOTAL REVENUE REQUIRED R 85 billion

94/95 estimated GDE = R 393 billion
94/95 estimated value of imports = R 82 billion
1'QB Pg S-95) R 475 billion

94/95 less gross domestic

fixed investment = R 62 billion
(QB Pg S-95)
94/95 less estimated zero rated

basic foods = R 6 billion
(7.3*i of total 193 PCE on food beverages and tobacco)
1:QB Pg S-97)

TOTAL RETAIL CONSUMPTION TAX BASE R 405 billion

The retail consumption tax rate would have to be pegged at 20.99% to yield the R 85 billion required revenue.

Given that personal current income amounts to R 280 billion and that direct taxes amount R 37 billion

(QB page S-113) the average direct tax rate is 13.21%. To this (as an approximation) should be
added 14'6 VAT to give a "total effective" tax of 27.21%.

This would represent an effective 6 per cent reduction in the current "total effective" tax rate of 27.21 per cent. This reduction is made possible by the broadening of the tax base.

The average person would immediately have 6 per cent more money which could either be spent or saved according to his or her needs.


Ironically, the positive side of our unemployment situation is that a growing cycle of economic revitalization has the potential of rapidly reducing the retail consumption tax rate and/or the budget deficit and total public debt.


Reduced costs of tax collection have not been entered into this equation which should further effect the results positively.

[Please refer to ADDENDUM and ADDENDUM TWO at the end of section two]

2.3.6 Simplicity and Transparency

Be simple to understand and transparent in its penalty.

A retail consumption tax is undoubtedly the simplest of all taxes to understand. what is more, the citizen is always totally aware of the tax penalty on each purchase, and just how much the state is taking of his hard earned money.

This in turn would place an increased and healthy restraint on the State to limit public spending.

2.3.7 Ensure that all the people pay their fair share.

As previously dealt with in 2.2.3, the expected increased public acceptance of the fairness and equitability of a retail consumption tax, will result in the inclination and incidence of evasion being reduced.

Opportunities for "tax planning" and avoidance are reduced to virtually nothing.

Informal sector transactions will be brought into the tax net to a greater extent with the increased rate and the broader base of a retail consumption tax.

Furthermore, the criminal underground economy is also brought into the tax net as soon as they use their illegally gotten gains to make purchases of goods and services in the legitimate sector.

These factors should greatly reduce the tax burden of the honest citizen.

As stated in the RDP, paragraph 1.4.23.5, ',improved and reformed tax systems will collect more tax without having to raise tax levels (as the RDP succeeds, more taxpayers will be able to pay and revenue will rise)fl.

2.3.8 Be simple and economical to administer

Sales tax is much simpler to collect-. than income tax, which should result in substantial savings.

Initially some of the existing tax collection Infrastructures could be retained and used for the efficient policing of the system.

2.3.9 Donation Tax Exemption and/or Deduction

Reward donations to the RDP as well as registered non profit charitable, religious and educational institutions.

This principle can, and should, be applied regardless of what tax system is in use.

A central theme of the RDP is that the private sector should be encouraged to discharge its civic duties towards the upliftment and improvement of all its people. In rewarding them for doing so by making such donations tax exempt and/c)r deductible, the necessary encouragement would be supplied.

In this case too, the sales tax system is easier to control and monitor, and opportunities for evasion are reduced.



2,4 SUMMARY

The following tax reforms are proposed:-

(a) The abrogation of all personal and corporate income taxes.

(b) VAT to be replaced with a broad based retail consumption tax which would also replace the revenue required from (a) above.

(c) Donations to registered non profit charitable, religious and educational institutions, to be tax exempt and/or deductible.

For- the purposes of this submission all other taxes would, for the time being, remain the same.

The primary benefits of a broad based retail consumption

tax over income tax are as follows:-

(a) It is simple to understand, and administer.

(b) It rewards production rather than penalizing it.

(c) It gives both the individual and business the power of choice over using their money.

(d) It places public restraint on State expenditure. The Government can no longer simply raise taxes to fund its appetite for spending.

(d) It would help boom the economy by encouraging savings and productive investments.

(e) And most importantly, it creates employment.

2.5 CAUTION

As a grass roots movement, we have approached the tax issue from an objective perspective, and consider our proposals as benefiting the broader national interest.

All. we ask is that these proposals be so judged according to their true merit, and without bias or fixed ideas.

In the current complex tax system, and possibly because of it, there exist special vested interest groups who enjoy tax concessions and advantages which they would be anxious to protect.

Consequently such groups may well view our proposals, with its simplification, as a threat to their position, and therefore seek to invalidate them.

The failure of previous tax reform initiatives to provide workable solutions that actually bettered the situation instead of worsening it, could well be placed in their court.

Such groups are not always without considerable power and influence, so there will also be those who feel threatened by them, and consequently reluctant to speak out against them.

The Commission is therefore cautioned to recognize such actions for what they are, and prevent vested interest groups from holding our country to ransom.

2*6 CONCLUSION

Section three contains supportive data which we were fortunate to obtain from sources in the USA that share similar views to our own.

This consist of reports, news letters, circulars, media cuttings, two different video tapes and two very valuable authoritative impact studies on the implementation of a National Sales Tax on the United States economy.

The Commission may well be advised to have these impact studies placed into the South African context by a suitably competent body.

The Commission is also urged to study the rest of the data section carefully. It shows a large and growing support for these proposals from Americans in all walks of life. The similarity to our own situation is remarkable; differences being more one of magnitude than character.

We appreciate having had the opportunity to submit these proposals and make known our considered views. As a demonstration of our sincerity in believing these views vital to the bright future and prosperity of our country, we offer, and would welcome the opportunity, to continue our support and assistance to the Commission in any way it so requires and directs.


MICHAEL HARRISON COPELAND

FOR: PEOPLES ENDEAVOUR TO REFORM TAXES

ADDENDUM

With specific reference to paragraphs 2,3,5 Meeting Revenue Requirements and Creating Growth:-

It must be recognised that, due to our limited time and resources, the figures quoted in the above paragraphs do not accurately reflect all the parameters that need to be taken into consideration in determining the retail consumption tax base and the rate required to replace all VAT, personal and corporate income/profit taxes. This rate may be higher than the 20.99 per cent suggested.

Issues such as what constitutes capital investment rebates, what basic foods should qualify for zero rating, imputed rent., capturing avoidance/evasion revenue and the Informal sector are some of those requiring attention.

This needs a detailed study which we are still in the process of doing. We will report our findings and recommendations to the Tax Commission in due course.

What is stated :In our submission, and Is becoming increasingly clear, is the enormity of the extent of South African State expenditure compared to that in other countries,, and the onerous tax burden this places on the individual productive South African citizen.

The transparency of a retail consumption tax rate really brings this point home, and should spur the State into reducing it's expenditure, and then into reducing the rate, at the first available opportunity.

This of course may not be entirely politically popular, but one cannot ignore natural laws and solid economic fact.

None of this invalidates any of the broad principles and recommendations contained in this submission. In fact it only strengthens them,

We believe this submission contains the only sustainable long term solution to the tax conundrum which will result in economic growth and job creation, Let us start NOW I



MICHAEL HARRISON COPELAND
CHAIRMAN
PEOPLES ENDEAVOUR TO REFORM TAXES

ADDENDUM TWO

THE RETAIL CONSUMPTION TAX BASE.

The basic principle is that a Retail Consumption Tax (RCT) should be levied on all goods and services at the retail or "final consumer" point of sale.

For this purpose we have used private consumption expenditure (PCE), consumption expenditure by general government, and interest charged to individuals on credit facilities, as the RCT base. (See SARB Quarterly Bulletin page S-95).

The following figures are estimated for 94/95.

Private consumption Expenditure = R244.129 billion
Consumption expenditure by Gen. Govt. = R 86.439 billion
Individual finance charges on credit = R 28.630 billion

TOTAL R359.198 billion

Note that the following are NOT included in the RCT base:-

Gross domestic fixed investment (GDFI) Corporate input consumption.

Long term insurance. (Savings).

Pension / provident fund contributions.

Investment in equities. Investment in participation mortgage bands.

Property transactions (subject to transfer duties).

This results in a zero tax rate for businesses, and money thus saved (including that spent on tax planning - a total of approx. R33.5 billion), could be used for reducing product prices, product research and development, raising wages, growth and, most importantly, job creation.

The above factors would also apply to finance houses, and, coupled with increased saving, would allow interest rates to be dropped. This would further assist the establishment of new businesses (especially small businesses), growth and again job creation.
.

2. CONCESSIONS

Any concession opens the door to abuse that can and will be exploited. These therefore have to be approached with caution and suitable control measures devised and instituted. With the predicted economic recovery, the situation should be re-evaluated from time to time.

As a political concession, and to address any alleged initial regressive impact (the subject of regressivity is further dealt with in 5. of this addendum) , the following concessions could be considered

2,1 RENT

Residential rent paid to landlords as well. as owner occupied imputed rent is included in the PCE total.

As taxing imputed rent would not be feasible (or politically astute), and not taxing tenant - occupied rent would also address the alleged regressivity of the RCT, the total rent could be excluded.

2.2 BASIC FOODS

The current list of basic foods that are zero rated for VAT purposes, could also be excluded from the RCT base. This would further address the issue of alleged regressivity.

The disadvantages of zero rating basic foods are that it creates a loophole for exploitation, and that it does not specifically target the genuine needy.

2*3 LOW INCOME REBATE

As an alternative to zero rating basic foods, consideration should be given to the payment of a rebate to those individual who currently earn less than the minimum SITE thresholds.

The total annual national value of all individual incomes that fall below these thresholds is currently estimated at approximately R9.0 billion.

This could be paid as a monthly percentage of the individuals wage equal to the RCT rate, and would therefore result in those individuals effectively still paying no tax.

The loss in revenue would be substantially less than that in zero rating basic foods as it only targets

the needy. Also, as the benef it to the needy would be greater, this system could be considered superior: provided of coarse a suitable method of identifying

those qualifying for the rebate can be devised. Perhaps it is time we instituted a national register of individuals and families requiring welfare along the lines established in other countries.

Further investigation is required.

2.4 DONATIONS

As dealt with in 2.3.9 of the submission, donations to the RDP as well as registered non profit charitable, religious and educational institutions, should be tax exempt and/or deductible.

2*5 SOCIAL SECURITY GRANTS

To compensate these recipients for the difference between the current Vat of 14% and the proposed RCT rate of 25% (see 3. below), it is suggested that social grants be increased by 11%.

Recipients should then further benefit from the price reductions resulting from the factors mentioned in the second last paragraph of l., and also 2.3 above

3, THE RETAIL CONSUMPTION TAX RATE

Using these preceding factors, the RCT base and rate for the! 1994/95 budget could be calculated as follows :-

RC7' base per 1. = R359.198 billion

Less rent = R 17.425 billion

Less zero rated basic foods, (or Low Income Rebate)

Fi 11.ooo billion

TOTAL R330.773 billion

Note: The "Low Income Rebate" should correctly be considered as a deduction from revenue, and as this would be based on only R9.0 billion and also on an effective rate that would be less than the actual RCT rate, it would amount to a lesser loss of revenue. For the purposes of this submission we have taken the higher "zero rated basic foods" option.

Therefore should the "Low Income Rebate" be opted for in place of "zero rated basic foods". the RCT rate would be approximately a third of a percentage point lower.

195)4/95 Estimated revenue required (BR Pg C.1)

VAT = R 28.600 billion
Individual income tax = R 42.160 billion
Companies (including mining) = R 13.519 billion
Donations tax = R .025 billion
Plus 11% of Social Security Grants = R 1.240 billion

TOTAL = R 85.544 billion

Therefore in order to replace all the above revenue requirements for the 1994/95 budget, the R@.T rate would
need to be 25.86 per cent.

No allowance has been made for capturing the underground economy and non compliance. It is anticipated that this could have a nett positive effect on the revenue actually collected.

As can be seen from table 2 of the Katlikoff model (Pg 34 of the data section of the submission), the RCT rate decreases with economic improvement by 2.6 percentage points over f ive years (in the USA example) . Table 2 is chosen as, with the inclusion of State (Provincial) and local taxes, it more closely approximates the SA situation.

Given our higher unemployment rate, it is reasonable to assume that the decrease in the RCT rate would be even more marked in the SA example. Furthermore this can also be achieved whilst still reducing the deficit and national debt as a percentage of the GDP. Please refer to the video submissions and impact studies in the data section.

This is a highly desirable situation with very positive ripple effects.

4. COLLECTION

With the abolishment of PAYE, individual income and corporate tax returns, the administration and collection costs of taxes would be considerably simplified and reduced. The existing infrastructure and procedures for collecting VAT would be more than adequate to collect the RCT.

To avoid paying off all redundant staff, it is suggested that some excess Inland Revenue staff be initially utilized to tighten control and reduce avoidance/evasion. The! penalties for cheating should nevertheless be made ''too terrible to contemplate".

It is anticipated that through public acceptance of the basic fairness of the RCT, the inclination to cheat will be reduced, and anyway the opportunity is less than that with income/profit based taxes. In the USA, where 47 states have a sales tax, compliance is estimated at 98 per cent.

Eventually, with the forecast economic growth, all excess staff should be encouraged to seek better employment positions in the private sector, and so reduce State expenditure.

With the VAT collection system in place, it is possible to introduce the RCT without changing much of it. Collection costs are higher and the tax is less visible with the VAT system as opposed to the IIGST" system; both being major disadvantages of the VAT system.

It is proposed that businesses also be required to pay the! RCT on all purchases of goods and services and then claim rebates from the RCT collected. It should be a basic principle that rebates should only be allowed on bona fide business input costs, and not on anv personal expenditure or consumption in an effort to avoid the RCT.

In this regard, consideration should be given specifically (but not only) , to excluding expenditure on food, beverages and clothing. A proportionate amount (maybe even all) of the RCT should be paid on company vehicles and fuel purchases that are alsc) for private use.

The ideal collection system would simply allow bona fide exemption at the point of sale without the added complexity of claiming rebates. This saves costs for both business and State. With a computerized tax collection system it is possible to have comprehensive audit trails to control compliance.

5, REGRESSIVITY

The commonly held belief that consumption or sales taxes are regressive, is probably one of the biggest tax hoaxes ever.
It must- be bourne in mind that at the end of the day it is the final consumer that pays for all input costs; including taxes ( R13.5 billion per anrium) and tax planning costs (estimated at some R20 billion per annum). BuE;inesses simply build these into the price of their goods and services. On average this amounts to approximately 20 per cent of the retail price.

Every time the State introduces a new or increased tax on businesses, this is just passed onto the consumer in the form of higher prices, and this impacts the hardest on the poor. As this tax is hidden, the poor are unaware of it, and have been conditioned into believing that it is just "inflation or something", and beyond their control.

With the introduction of the RCT and the removal of all taxes on businesses, the costs of R33.5 billion would be saved and used to retluce prices (or create jobs - see 1. in this addendum).

Furthermore it must be remembered that with the RCT the individual gets to keep his whole pay without SITE or PAYE deductions.

A tax that is visible or transparent is highly desirable in that the individuals (especially the poor) are always exactly informed as to how much of their money the State is taking, and can therefore raise objection to ever increasing State expenditure; even to the point of saving instead of spending and thereby not paying tax.

IT IS INCOME TAX AND NOT CONSUMPTION TAX THAT IS

REGRESSIVE

Income tax penalizes saving twice. once when it is earned and then again when interest or dividends are earned. Most economists will agree that low savings rates are attributable to this. SA has one of the lowest savings rates in the world.

Saving is required to generate capital for business creation and expansion and hence more employment. As the RCI' will be encouraging saving, it will be facilitating the creation of more jobs which is the best possible thing you can do for the poor. Not only can the unemployed now have increased prospects for getting a job, but low wage earners can move up the ladder to better ones.

Furthermore, with the R33.5 billion in tax related costs saved as detailed above, the price of our exports become more competitive on the world markets. This should lead to a much improved national export performance which again translates into more jobs.

In economic hard times it is the poor who suffer the most. Should low wage earners seek to raise their income through overtime or an extra part time job, they get to keep all the fruits of their l@abour.

Is it not more fair and logical in this fashion to shift taxes off from those who work the hardest (the poor) and onto those who consume the most (the wealthy).

IT IS INCOME TAX AND NOT CONSUMPTION TAX THAT IS
REGRESSIVE

This is a very important issue, and the Tax Commission is referred to pages 44 and 45 of the data section of our submission, as well as the video tapes supplied.

6, CONCLUSION

This remains a broad outline of the major issues concerning our proposal for a RCT. Further work still needs to be done in finalizing the detailed mechanics.

The Commission is requested to use some of it's budget to finance an expert impact study on the switch to a RCT in South Africa, and to bring over a respected economist from the USA, versed in these concepts, who can give a personal input to the Commission.

In this regard, we have called for the credentials of Dr. Stephen Moore of the CATO institute in Washington which, upon receipt, will be forwarded to the Commission for consideration.



MICHAEIJ HARRISON COPELAND
CHAIRMAN
PEOPLES ENDEAVOUR TO REFORM TAXES

THE IMPACT OF A NATIONAL SALES TAX
ON THE UNITED STATES ECONOMY
by John H. Quails, Pb.D.
August 16, 1991

with the decline in domestic private savings, resulted in a surge in foreign capital inflows to make up the difference. Simply put, as a nation we did not generate enough funds internally to satisfy both our private investment needs and our growing budget deficit. Foreign investment filled the gap.

Unfortunately, the only way for foreigners to obtain dollars to invest in the U.S. is to sell us more goods than they buy from us in return. When this happens, a trade deficit occurs. In essence, foreigners find that U,S. assets are more attractive than are U.S, goods -- they prefer investment in these assets preferable to consumption of U.S.-made goods, This is the so-called "twin deficits" argument; the federal budget deficit gives rise to the foreign trade deficit,

Some analysts reject this "twin deficits" argument,, pointing out that Japan has a proportionally higher budget deficit, while at the same time running a record trade surplus -- implying that they are investing a record amount of capital in other countries, including the U,S. However, this simply points out the importance of domestic savings in the equation. Japants savings rate is much higher than that of the U,S. Their internally generated funds are of such magnitude as to fund a high level of domestic investment, a large government surplus, and still export capital to the rest of the world, Such is the power of a people that save,

There was another more insidious side effect from the lethal combi‑nation of a declining private savings rate and an exploding govern‑ment deficit. Real interest rates (that is, interest rates adjus‑ted for expected inflation) rose to and remained at uncomfortably high levels. This was necessary in order to induce foreigners to invest their hard-earned dollars in the U,S.

These high real interest rates, combined with the intricacies of the new tax cut legislation of the early 1980s. caused a shift in investment toward very short-lived capital items and away from the sorts of long-term investments which have the most substantial impact on productivity. Thus, while the level of capital invest‑ment appeared reasonable during the 1980s. the type of investment had changed, with more of an emphasis on quick payout, short time horizon items.

One potential solution to this problem is a reduction in the level and/or growth rate of government spending. Unfortunately, Congress has been wrestling with the deficit for over a decade now, with a singular lack of success,

The other possibility is an increase in the pool of domestic private savings -- i.e., an increase in the private savings rate. The most straightforward way to achieve this is through the elimination of the federal individual and corporate income tax, replacing it with a national sales tax.

RATIONALE FOR THE NATIONAL SALES TAX

Remember the major tenet of the supply-side school -- taxation of an activity results in less of the activity being performed. Thus, if we tax income, we get less income-producing activity. In a like fashion, if we tax consumption, we would expect to get proportion.‑ally less of it. In effect, we would be diverting activity from consumption to saving and investment.

The complete replacement of the federal income tax, both individual and corporate, with a national sales tax would, in effect, drop the marginal tax rate on income to zero, while increasing the realized cost of goods by the percent of the tax. Thus, income-producing activities would be encouraged, while consumption-related activi.‑ties would be discouraged.

What impact would this tend to have on the economy? In theory, we would expect the higher level of investment to lead to more produc.‑tivity and more economic growth. The resulting higher level of the capital stock would tend to increase the marginal product of labor, resulting in higher levels of employment at any given wage rate,

Abstract theory, while interesting in an academic context, is not sufficient to advance the policy debate in the political arena. What is needed is a way of measuring the probable impact of a complete switch from the current system to a national sales tax.

THE WASHINGTON UNIVERSITY MACROECONOMIC MODEL

The best way of measuring the probable impact of such a large-scale switch in the major source of federal government revenue is with a comprehensive macroeconomic model of the U.S. economy. In general, there are two types of models -- those designed for forecasting purposes and those designed for policy simulation. Although forecasting models can be used to analyze minor changes in policy, they are not ideal vehicles for the analysis of massive policy changes. For technical reasons having to do with their design and construction, they tend to take many years to settle down to a steady state condition.

Another problem in selecting the appropriate model to use lies in the basic economic philosophy of the model under consideration, Many rnacroeconomists would agree that the U, S, economy is Keynesian in the short-run and neoclassical in the long-run. That l s j, government monetary and fiscal policy can alter the short-term path of the economy, but, in the long-run, output is determined by the availability of capital and labor, as well as the existing state of technology. A good example of this would be in the way in which a model handles monetary policy. In the short-run, a faster growth of the money supply would be stimulative to an economy, raising real output as short~term interest rates dropped. However, in the long-run, a faster money supply growth would only create more! inflation, as the output potential of the economy would bE! unchanged.

The model selected for use in the national sales tax simulation iE; a variant of the Washington University Macroeconomic Model (WUMM) called COREMOD. COREMOD is a modification of WUMM, designed specif ically to f acilitate simulation of the equilibrium ef f ects of changes in monetary and f iscal policies. Both COREMOD and WUI*L were built and are maintained by Laurence H, Meyer and Associates (LHM&A)t a St. Louis-based economic consulting and forecasting firm, LHM&A performed the policy simulation that is described in this paper. Appendix A gives more technical details on COREMOD and its simulation properties.


POLICY CHANGES IN THE SIKULATION

The purpose of this study was to measure the impact of a ' comiplet(@ replacement of both the corporate and individual income taxes by a national sales tax. The first policy question which arises has to do with the specific categories of goods and services which would be subject to the national sales tax. This question is not trivial -- its answer will determine both the actual efficiency and perceived equity of the change to a sales-tax based revenue system,

The most obvious place to start was with consumer spending, as this is the largest component usually included in state sales taxes. However, not all items included in the personal consumption expenditure (PCE) category can be taxed, In its reporting of GNP and its components, the government includes a category called "Housing Services", which includes rent on owner- and tenant.‑occupied dwellings, Tenant-occupied rent is easy to understand; it is the sum which renters pay landlords, However, owner-occupied rent is the amount which homeowners "pay themselves" each month I-- imputed rent. In other words, it goes out of one pocket into another. Since it would not be feasible (or politically astute) to ask homeowners to pay a national sales tax on their "imputed rent" each month, it was decided to exclude the total rental component of Housing Services from the tax.

This decision had the added benefit of excluding actual rent paid to landlords from the tax, which partially.addresses the problem of the alleged regressivity of a sales tax, Unfortunately, as can be seen from the table on the next page, this places the required national sales tax rate at almost 19 percent, well above the 16 percent range which was a desirable goal for the maximum rate.

Another possibility was to tax business purchases of goods, services, and capital equipment. However, such a decision would be unwise, for the following reasons:

A tax on purchased inputs, such as raw materials and businesf; services would give an unfair advantage to vertically inte-‑grated conglomerates, since they could transfer goods and services without paying the tax.

A tax on capital equipment would discourage purchase. Thii; would directly and adversely impact the only sure way to im-‑prove the productivity and living standards of all Americans, Businesses don't pay taxes -- people pay taxes, Businesses,, including corporations, are just conduits through which moneli flows. Any time a business is taxed, it passes this tax oil through to people -- its customers, employees, suppliers, and stockholders. The evidence from the experience with the value-added tax in Europe indicates that the primary incidence of a business transfer tax is on the customers, with the fina'l incidence being on the consumer, However, because of the large number of intermediate steps through which the products passes, the actual amount of the tax is disguised. One of the fundamentals of a national sales tax is that the exact amoun-. of the tax should be readily apparent to those who end up paying it. This is only possible if the tax is applied to the final transaction -~ i.e., when the consumer buys the good.

Other categories considered for inclusion in the sales tax base were residential investment and state and local purchases of goods and services (excluding employee compensation), I4uch thought was given to excluding food purchased for off-premise consumption (i.e., from grocery stores). While this would further address the issue of alleged regressivity, it results in an increase in the required tax rate of over two percentage points, as can be seen in the following table, based on actual 1990 data. This table shows all of the possible combinations actually considered for inclusion in the base for the national sales tax.

Total Income Tax to be Replaced = $587.7 billion

Item Amount (in $BB) Tax Rate

Total Consumer Spend, $31657,3 16,1%
- Total rent 54608
Taxable base #l $3el10,5 1819%
+ Resid. Invest, 222,0
Taxable base #2 $31332.5 17,6%
+ St. & Loc. G&S 273,2
Taxable base #3 $30605,7 16*3%
- Food off-prem. 4l5cO
Taxable base #4 $31190,7 18,4%
- Resid, Invest. 222*0
Taxable base #5 $2f968,6 1918%
- Sto & Loc. G&S 273&2
Taxable Base #6 $21695.4 21,8%

Option #3 was finally chosen, due to its closeness to the 16 percent rate considered to be a desirable goal. other combinations could be used, with little or no impact on the aggregate results produced by the simulation. Obviously, however, inclusion or exclusion of specific items would have a large impact on the share of spending allocated to those items, as well as on the perceived equity of the tax.

The exact answer as to the goods and services to be included in the base for a national sales tax is more of a political question than an economic one. The most important element, from the standpoint of COREMOD, is that capital investment not be taxed, as that would be quite inimical to productivity.

RESULTS OF THE MODEL SIMULATION - INVESTMENT SRARE OF REAL GNP

In order to allow for a complete adjustment of the economy to the new tax policy, COREMOD was run for a 20 year period, through the year 2010, The results of the simulation, quite frankly, exceeded initial expectations. As expected, the investment share of real GNP jumped, as can be seen on the chart below,


The next chart shows the year-by-year trend in investment and compares the base case simulation with the national sales tax alternative.

[ Ed’s note: Chart not able to be scanned in ].



Note that real business investment rises between $100 and $170 billion in any given year. (All dollar amounts refer to constant 1990 dollars,)




RESULTS OF THE MODEL SIKULATION - IMPACT ON THE SAVINGS RATE


The higher level of business investment is financed by an increase in the domestic private savings rate of almost three percentage points, as can be seen in the following graph.

[ Ed’s note: Graph not able to be scanned in ].

This increase in the domestic private savings rate is sufficient to reverse most of the downward trend which occurred during the 1980s.


RESULTS OF THE MODEL SIMULATION - IMPACT ON REAL CAPITAL STOCK

The higher level of capital investment has a profound effect on the net real capital stock of U.S. business, In essence, this amount, shown on the graph below, represents the 1990 dollar equivalent of all the business structures, machinery, and equipment which is used to produce the goods and services consumed in the U.S. and exported abroad.
[ Ed’s note : Grapgh not able to be scanned in ].

This higher level of capital stock enables American workers to work more effectively and produce eL higher level of goods and services, in effect raising the productivity of the U.S, economy.



RESULTS OF TRE MODEL SIMULATION - IMPACT ON PRODUCTIVITY

In many people' s minds, capital investment is synonymous with auto‑mation, which in turn implies replacing workers with machines. In actuality, this is emphatically not the case. A higher level of capital investment raises the productivity of labor. Given the same wage rate, this means that a profit-maximizing business would hire more workers in order to increase its profits, In effect, the higher level of capital investment in turn leads to more, not less employment. The actual number of new jobs generated by the national sales tax reaches 900.000 by the year 2000 and 1,600,000 by the year 2010, This is shown in the graph on the following page.

[ Ed’s note: Grapgh not able to be scanned in ].


RESULTS OF THE MODEL SIMULATION ~ IMPACT ON REAL GNP

The combination of more capital and more labor means that real national output, or real GNP, rises substantially after the introduction of a national sales tax. As is shown in the graph below, real GNP is up over $200 billion by the year 2000 and up almost $400 billion by 2010w


[ Ed’s note: Grapgh not able to be scanned in ].




RESULTS OF THE MODEL SIMULATION - INFLATIONARY IMPLICATIONS

The argument is often made that a national sales tax would be inflationary, in that it would set off a wage and price spiral. In fact, imposition of a national sales tax would not impact the list prices of goods, as it would be added on in the same fashion as state sales taxes are currently, at the point of sale. In fact, the national sales tax actually results in a small but significant reduction in the inflation rate, as is shown below.

[ Ed’s note: Grapgh not able to be scanned in ].



However, according to current government regulations, all sales taxes are included in measurements of the Consumer Price Index (CPI), which is used to make cost of living adjustments (COLAS) in labor contracts and for social security recipients, This leads to a problem in administration -- workers and recipients of government transf er payments would be rewarded twice when a national sales tax is imposed:

· first, by the complete elimination of income tax withholding from their paychecks (or by the elimination of filing estimated tax payments)

secondly, by the escalation of their incomes due to the COLA provisions

This would be patently unfair to those workers and transfer paymen-. recipients without full COLA protection. Thus, some allowance will have to be hiade, In the model simulation, it was assumed that no COLA coverage was allowed. This could be most easily accomplished by changing the rules covering collection of CPI data to exclude the national sales tax from the data.


RESULTS OF THE MODEL SIMULATION - FEDERAL BUDGET DEFICIT

The national sales tax simulation was constructed so that real (inflation-adjusted) federal government spending was kept at a constant percent of real potential GNP. However, since real potential GNP grew so much more because of the national sales tax, real federal spending also grew considerably faster.

As an alternative to allowing this growth to occur, a simulation was run holding real federal spending to the same absolute level as in the base case. Thus, the resulting federal budget deficit was considerably lower, as is shown in the chart below.


[ Ed’s note : Grapgh not able to be scanned in ].


As can be seen, the federal budget deficit was cut by more than 45 percent, due to the replacement of the current income tax system by a national sales tax, Over a 20 year period, the cumulative deficit was over $3.5 trillion lower ($3,507,300.000,000, to be precise), thanks to the national sales tax.


As an alternative to reducing the deficit, the national sales tax rate could have been cut, thereby putting more money in the pockets of consumers, It would be interesting to see the rate reductions which could be achieved via this approach.


CONCLUSIONS

Based on the results of this initial work, the replacement of the current U.S. individual and corporate income taxes by a national sales tax would result in faster economic growth, higher levels of employment, more business investment, higher productivity growth, and an increase in the private savings rate.

In short, implementation of a national sales tax would go a long way toward rectifying the U.S,'s decline in international competitiveness.

APPENDIX A

DESCRIPTION THE COREMOD POLICY SIMULATION MODEL

COREMOD was built by modifying the commercially available Washington University Macroeconomic Model (WUMM) specifically to facilitate simulation of the equilibrium effects of changes in monetary and fiscal policies.

COREMOD shares much in common with WUMM. In both models, short-ruii fluctuations in real GNP are determined primarily by fluctuations in aggregate demand, while in long-run equilibrium, output is governed by the availability of capital and labor as well as the existing state of technology. The transition from the short-run to the long-run is governed by an expectations-augmented Phillips curve which allows for a short-run trade~off between unemployment and inflation but no long-run trade-off. Indeed, in the long-run, inflation is determined primarily by the rate of monetary growth,

In COREMOD, consumer behavior is explained by the "life-cycle" hypothesis, according to which household saving is determined primarily by disposable labor income and household net worth, Investment is explained by a neoclassical growth model in which equilibrium capital/output ratios are determined by real after-tax user costs of capital, Government spending is erogenous with the exception of interest payments on the national debt, Exports are determined by foreign income and the terms of trade, while imports are determined by domestic income and the terms of trade. Esti‑mated values of the modelts key behavioral responses are taken from wumml

Line WUMM, COREMOD includes six classes of capital: consumers durables, owner-occupied housing, renter-occupied housing, pro‑ducersf durable equipment, nonresidential structures and business inventories. The supply of labor is specified to be an increasing function of the real after-tax wage, the personal saving rate is positively related to the real after-tax rate of return, and cap‑ital flows from abroad depend upon interest rates in the U.S. rel‑ative to those abroad, Therefore, COREMOD allows for the possibility that the proposed implementation of a national sales tax may: (1) reallocate investment among classes of capital; (2) affect the flow of personal saving available to support domestic investment; (3) affect the flow of foreign capital available to support domestic saving; and (4) affect the supply of labor. In these regards, the treatment of a national sales tax in COREMOD is quite thorough.

Relative to WUMM, COREMOD suffers no analytical disadvantages and offers three important advantages. First, the programming language in which COREMOD was developed renders easy the task of modifying the model to accommodate the introduction of the specified national sales tax. Second, the only erogenous variables in COREMOD are the money stock, tax rates and government spending, the latter expressed as shares of potential output. Hence, implementation of a national sales tax requires only that a small number of tax rates in the model by altered. No subsequent judgmental management of the model is necessary to ensure sensible results in simulation.. Finally, the short-run dynamics of COREMOD have been intentionally specified to quickly dampen the oscillatory behavior that, in WUMM, would obscure for decades any emerging equilibrium effect oo-' changes in the tax code.

THE ECONOMIC IMPACR OF REPLACING
FEDERAL INCOME TAXES WITH A SALES TAX

by Laurence J. Kotlikoff

Executive summary

This study examines the crisis in U.S. saving, its im‑plications for the hationts economic performance, and the contribution our current tax structure has made to the cri‑sis. A computer simulation model is used to evaluate a pro‑posal to raise U.S. saving by replacing all federal personal and corporate income taxes with a national retail sales tax. The f indings are quite dramatic. The shift in tax structures is predicted, in the long run, to raise the stock of U,S. capital by at least 29 percent and potentially by as much as 49 percent and to raise U.S. living standards by at least 7 percent and potentially by as much as 14 percent,

A national sales tax would eliminate many of the distor‑tions of current income taxes. It would do away with the differential tax treatment of corporate and noncorporate businesses, which distorts business decisions; of capital gains and dividends, which affects decisions about retaining earnings; and of investment in equipment, structures, and inventories. A sales tax would also end encouragement of current relative to future consumption, the tax exemption for health insurance premiums, and the work disincentive associ‑ated with the progressivity of the present tax structure.

A national sales tax could be made progressive by combining it with a refundable tax credit. Each household could file a form requesting the tax credit and receive a check from the Internal Revenue Service equal to the amount of credit for which the household qualified.
Laurence J. Kotllkoff Is a professor of economics at Boston University and a research associate of the National Bureau of Economic Research.

Introduction

This study considers the impact on U.S. saving, invest‑ment, and growth of the total elimination of federal person‑al and corporate income taxes in favor of a uniform national sales tax, The national sales tax would be paid at the cash register by all consumers when they purchased goods and ser‑vices from retail establishments. Sales of all goods and services would be taxed at the same rate,% Elimination of all federal income taxation in the United States would end taxation of all capital income, including capital gains. In the short run, the rate of the proposed national sales tax would be roughly 17 percent, over time, as the replacement of the income tax by the sales tax stimulated economic growth, the national sales tax rate would, according to the predictions of this study, fall to 11 percent.

A full switch to a national sales tax would represent a radical departure from current fiscal arrangements, but nothing short of radical change will ever transform the tangled provisions of the income tax code into a clear and simple system of taxation, A national sales tax might be the one tax that would have enough clarity and simplicity to put an end to our politicians, constant, and very costly, tinkering with taxes. In choosing a national sales tax we also would finally be making a choice between taxing con‑sumption and taxing income, and we would be picking the tax base, namely consumption, that is most conducive to growth of saving, investment, labor supply, and output,

Switching to a national sales tax from the income tax would also improve the efficiency of the economy by elimi‑nating a host of economic distortions that have arisen under our current tax structure. Of course, a national sales tax would introduce distortions of its own, but the net impact of replacing federal income taxes with a national sales tax would, it appears, be a significant overall reduction in the misallocation of economic resources.

There are two main arguments against a proportional national sales tax, The first is that it would reduce the progressivity of the tax system. The second is that an immediate switch from the existing tax system to a national sales tax would lead to the shifting of tax burdens to older generations that have already paid income taxes on their earnings and now would have to pay a second large tax on their earnings as they consumed them during retirement,

The first concern--the lack of progressivity of a pro‑portional national sales tax--has been overstated, because progressivity has been measured in terms of annual, rather than lifetime, income. At some point, all income is con‑sumed, In any case, a national sales tax could be made progressive by combining it with a refundable tax credit. Each household would file a form requesting the tax credit and receive a check from the Internal Revenue Service equal to the amount of the credit for which the household qualified, The value of the tax credit could be fixed per household, independent of the household's income, or gradu‑ated (made to decline as the household's income increased), In addition, the value of the household credit might depend on the number of children and other dependents in the house‑hold.

In principle, if the tax credit were set sufficiently high, the same degree of progressivity that characterizes our current income tax system could be achieved with a na‑tional sales tax and a graduated refundable tax credit. The need for, and the stigma associated with, our welfare system could also be eliminated.

The second concern associated with switching tax re‑gimes, the shifting of greater tax burdens to the current elderly, could be addressed by compensating them directly (e.g., by raising their Social Security benefits).

Rather than consider in detail all the arguments for and against a national sales tax, I will examine the dimen~ sions of the current U,S, saving crisis and how our failure to save is affecting our rates of investment and productivi~ ty growth. Then I will address the saving, investment, labor supply, and output implications of a switch to a na‑tional sales tax.

The crisis in U.S. savinci and Investment

In 1991 the U.S. net national saving rate was just 1.7 percent--the lowest rate observed in the post-World War II period,' While 1991 was marked by recession, as Figure 1 shows, the U.S. saving rate had been below 4 percent for each of the previous six years. In contrast, the U.S, sav‑ing rate averaged 9.1 percent between 1950 and 1970 and 8*5 percent between 1970 and 1980.

The saving rate is important because domestic saving# together with the saving invested in the United States by foreigners, provides the funds that business uses to engage in investment--to purchase new machines, build new facto‑ries, and the like, Economists refer to the stock Of COM‑puters, machines, factories, real estate, and the like as capital stock. Since capital and labor are the two primary inputs to production, the larger its capital stock, the larger will be the economyfs output and the greater will be the productivity of labor, since labor productivity is mea‑sured as output per unit of labor. Higher labor productivi‑ty translates into higher real wages. So less saving means less investment, less investment means less growth of capi‑tal stock, less growth of the capital stock means less growth of output and labor productivity, and less growth of labor productivity means less growth of real wages.

The national saving crisis has indeed produced a crisis in national investment. Last yearts rate of domestic in‑vestment, 2.0 percent of net national product, set a dismal postwar record. Since 1980 our domestic investment rate has averaged 5.6 percent per year, compared with 8.2. 7.9. and 7.9 percent in the 1950s. 1960s. and 1970s, respectively. Thanks to the inflow of foreign capital, U.S, domestic in‑vestment did not decline during most of the 1980s as sharply as did U.S. saving. In Figure 1 the rate of domestic in‑vestment is measured as the vertical difference between the investment rate and the saving rate curves, That vertical distance reached a postwar high of 3.4 percent of net na‑tional product in 1987. In that year, as well as in 1986t foreigners financed more investment in the United States than did Americans. The desire of foreigners to invest in the United States has, however, waned, Since 1988 the rate of foreign investment in the United States has fallen, leaving the bulk of U.S. domestic investment to be financed by meager U,S. saving.

Nations that fail to invest experience relatively slow growth in real wages. Since 1970 the productivity of U.S. workers has increased at just over 1 percent per year, which is only 40 percent of the productivity growth rate recorded from 1950 through 1969 and only about a third of the Japa~ nese rate over that period, Labor productivity ultimately determines how much firms will pay for labor, So the de‑cline in the productivity growth rate has meant a slower rate of growth of wages. Since 1975 total compensation (wages plus fringe benef its) per employee in the United States has increased, in real terms, by less than 3 percent, That is a very poor record considering that in the 15 years before 1975 total real compensation per worker rose by 35 percent,

The Choice of Tax Base and Its ImRact on Saving

To understand the different tax bases available to government and how they affect saving decisions, consider a government that wants to tax all output at a fixed rate (t) It can levy a tax at rate t on output as it is sold by firms to the private sector, or 'It can levy a tax at rate t on the factors of production--labor and capital--as they receive the proceeds from the sale of output in the f orm of wage income and capital income. A third possibility is to tax income recipients when they use their income to purchase goods and services or to acquire assets (i.e., when they save). Since what is saved is invested (i.e., saving equals investment). the hypothetical government can also tax income by taxing consumption plus investment.

A little math helps to clarify the equivalency of those four ways of taxing output:

X = I + Xk = C + S. = C + I

where

X = aggregate output or income,
I = aggregate labor income,
Xk = aggregate capital income,
C w aggregate consumption (including government con-

sumption),

= aggregate saving,, and

= aggregate investment

Taxing output X at flat rate t is equivalent to taxing both and Y. at rate t. and both, in turn, are equivalent to taxing C + S or C + I at rate t,

But there is no requirement that government tax all output either directly, when it is produced and sold, or indirectly, when it is received as income or is used to purchase goods and services or acquire assets (finance in‑vestment). Government can, instead, choose to tax only a component of income. For example, it can choose to tax labor income, but not capital income, Or it can choose to tax only one use of income, say consumption, but not anoth‑er, say investment,

If government chooses to tax consumption, it can do so directly, by taxing the purchase of goods and services,, or indirectly, either by taxing income when it is received by individuals in the form of wage income and capital income, but allowing a deduction (or subtraction) for the saving those individuals do, or by taxing wage income at the per‑sonal level and capital income at the business level (before it is paid out), but allowing a deduction at the business level for investment. The equivalence of those ways of taxing consumption can be seen from our simple identity: consumption (C) equals income (X) minus investment (S) , but it also equals Y plus the difference between Y. and .I
In the United States we have attempted to tax consump‑tion indirectly both by allowing deductions from personal income taxes for certain forms of saving and by allowing full deductions from business profits taxes for certain forms of business investment, Except for gasoline and other federal excise taxes, the federal government has never at‑tempted to tax consumption directly through a uniform na‑tional sales tax. A national sales tax is the most trans‑parent method of taxing consumption. Unlike David Bradfordfs proposed progressive personal consumption tax, which would involve the filing of personal tax returns and thus could incorporate progressive tax rates, a uniform national sales tax would tax the consumption of all Ameri‑cans at the same rate regardless of the level of their in‑comes or their consumption.2 That potential inequity of a national sales tax could be addressed through the adoption of a household tax credit,

Given that government can tax consumption directly or indirectly and that it can do so at either progressive or proportional rates, why would it want to tax only output that is consumed and exempt from taxation output that is saved (invested)? The answer is that a consumption tax provides more incentive to save (invest) than does an income tax. As X = C + S indicates, taxing output can be viewed as taxing saving as well as consumption. Economists view sav‑ing, not as an end in itself, but as a means of financing future consumption. By taxing consumption and saving, an income tax effectively taxes future consumption twice, once when households save funds for future consumption and again when they engage in that consumption, Since current con‑sumption is taxed only once, an income tax provides an in‑centive, at any point in time, to consume more now and save less for the future.

Consider the case of an individual who earns $10.000 and faces a 20 percent income tax, Suppose the individual is trying to decide how much of his $8.000 in after-tax income to consume this year and how much to consume next year. If he consumes it all this year, this year's consump‑tion will be $8.000. Alternatively, if he consumes none of it this year, his consumption next year could be $8.000 plus the after-tax interest income he might earn by investing his $8,000 for one year and then paying income taxes on the interest earned. Suppose the interest rate is 10 percent, In a year, an $8.000 investment will earn $800 in pretax interest, of which 20 percent ($160) will have to be handed over to the government in income taxes, So saving $8,000 this year will finance only $8,640 ($80000 + $800 - $160) in consumption next year. The ratio of next yearts maximum consumption to this yearfs maximum consumption is $8r6401 $8,000 = 1.08. Clearly, each dollar more that is consumed this year means $1,08 less to be consumed next year,

If the income tax were replaced by a 25 percent con‑sumption tax, a dollar more consumed this year would mean $1.10 less to be consumed next year, implying a greater incentive to defer consumption under a consumption tax. If an individual spends all his $10.000 in income on this yearfs consumption, he'll end up consuming, after paying consumption taxes, $10.00011,25 or $8.000. Alternatively, if the individual saves the entire $10,000 so as to maximize consumption next year, he will end up consuming, after pay‑ing consumption taxes, $11.00011.25 or $8.800. So under consumption taxation the ratio of next yearfs maximum con‑sumption to this yearos maximum consumption is $Sosool$soooo m 1.1. Every $1.00 of additional consumption this year means $1.10 less to be consumed next year,

In addition to providing better saving incentives, a consumption tax produces a one-time intergenerational redis‑tribution from older generations to younger and future gen‑erations. That redistribution lowers aggregate consumption and raises national saving. The intergenerational redistribution occurs because older generations pay a larger share of consumption taxes than they do of income taxes. And intergenerational redistribution lowers aggregate consump‑tion and raises national saving because older generations, whose members are closer to the ends of their lives, have a greater propensity to consume than do younger generations.3 Thus, the proposed change in the tax structure would trans‑fer resources from generations with high propensities to consume to generations with low propensities to consume.

The Legacy of Tax Flip-Flops
A-Hybrid U.B. Tax Structure

Over the past dozen years we Americans have had a great penchant for reforming our tax system, We did so in 1981, 19820 19840 1986. and 1990. and we may well do so again in 1993. We seemingly cannot decide whether our taxes are too high or too low, too progressive or too regressive, too replete with loopholes or too devoid of incentives. In addition, we seem unable to make up our minds whom--business or individuals--or what-~income or consumption--we want to tax, And we cannot decide whether to tax all components of a given tax base, such as income from dividends and income from capital gains, at the same rate,

The products of that indecision are four, First, in reforming every couple of years the previous tax "reform,," we fall to give any one set of tax incentives enough time to produce its intended result. Second, the prospect that a given tax incentive will be eliminated in the near future limits its effectiveness. Third, by continually changing taxes, we destabilize the overall economy or, at least, important sectors of the economy. Fourth, we enact partial, rather than full, reforms with the result that we arguably end up with a worse tax system than the one with which we started.

In 1981 we attempted to move the tax structure toward consumption taxation, not by taxing consumption directly, but by taxing income less investment, which, as indicated above, equals consumption, Our method of trying to tax the difference between income and investment involved increasing the tax deductibility of business investment. But in trying to provide those deductions, via the investment tax credit and other features of the Accelerated Cost Recovery System (ACRS). we went overboard. The result was a system that provided, in many cases, deductions that were too large and, consequently, too expensive in terms of lost revenues. As a result, we scaled back the ACRS with the Tax Equity and Fiscal Responsibility Act of 1982 and the Deficit Reduction Act of 1984. Then, in 1986, we completely reversed course by passing the Tax Reform Act, That new law reduced tax deductions for business investment to levels that were less generous than those available before enactment of the ACRS. The see-saw pattern of investment incentives led to over‑expansion of certain sectors, such as real estate, in the early 1980s followed by a crash in the late 1980s, That explains, for example, the empty high-rise office buildings we now see in most major cities of the country.

In addition to destabilizing specific sectors of the economy, tax legislation of the 1980s (as well as the 1970s) has left us with a hybrid federal personal tax structure, with some f eatures appropriate to an income tax and some appropriate to a consumption tax, The prime example is our treatment of tax-favored saving accounts, including IRAS. KEOGH accounts, 401K plans, and employer-provided pension plans. Because funds placed in those accounts are deduct‑ible from personal income taxes, those accounts afford con‑sumption tax treatment (the taxation of X - S) to saving.

The problem is that to truly tax output less saving (i.e., consumption), the government must permit deduction from income of net saving only (gross saving minus gross borrowing). not simply gross saving, But to ensure that households deduct only net saving, the government must re‑quire them to add to their taxable income any borrowing they do, be it in the form of a home mortgage, a car loan, or an outstanding credit card balance. The federal government has failed to do that.

The following distortions, which are contained in the current tax system, would be eliminated by switching to a national sales tax:

& the differential tax treatment of corporate and non‑corporate business that distorts business ownership and control decisions;

* the differential tax treatment of capital gains and dividends that distorts firmsf decisions about retain‑ing earnings and prevents investors from selling shares of stock that have accrued capital gains;

* the encouragement of current relative to future con‑sumption (the tax on saving) associated with the taxa~ tion of capital income;

* the differential tax treatment of investment in equipment, structures, and inventories;

the work disincentive associated with the progressivity of our present tax structure;

* the distortion in corporate financial structure due to the deductibility of interest payments and the non‑deductibility of dividends; and

* the tax-exempt status of health insurance premiums.

The distortion of labor supply incentives associated with income taxation would also be eliminated by the pro‑posed tax shift, But a national sales tax would distort that margin of choice as well: the larger the national sales tax, the less consumption could be purchased for each dollar earned, So the incentive, at the margin, to earn more in order to consume more is reduced, Because both the national sales tax and the income tax distort labor supply incen‑tives, one needs to compare the efficiency gains from elimi‑nating the income taxfs distortion of labor supply with the efficiency losses caused by adding a national sales taxes distortion of labor supply. There is good reason to expect the tax shift to result in a net reduction in the distortion of labor supply, A national sales tax would extract a large share of its revenues from older people, many of whom are retired. As a result, the total tax that would need to be collected from working generations would be smaller under the national sales tax than it is under the income tax.

Simulating the switch from Income Taxation
to a National Sales Tax

The Auerbach-Kotlikoff computer simulation model can provide some sense of the potential effects on saving, in‑vestment, and growth of shifting to a national sales tax (a more detailed summary of the model is provided in the appendix),

In simulating the switch from income taxation to a national sales tax, one needs to specify the economyfs ini‑tial position as well as the way the tax change takes place. Assume that the economy has a 15 percent proportional income tax and a 14 percent sales tax. The 15 percent income tax figure is based on the 1991 ratio of the sum of federal, state, and local personal and corporate income taxes to net national product, Of the 15 percentage point tax rate, 12 points are due to federal income taxation. In the simula‑tions, the 12 percent federal income tax rate is eliminated in favor of a national sales tax.

The 14 percent initial sales tax figure is based on the 1991 ratio of the sum of federal, state, and local sales and excise taxes to total personal consumption.4 In the simula‑tions, the national sales tax is added to the 14 percent initial sales tax to determine the total sales tax. Ini‑tially, the 15 percent income tax and the 14 percent sales tax are used to finance government spending as well as to pay interest on the government debt, The level of govern‑ment debt is initially set at 50 percent of output, During the transition to a national sales tax, the level of per capita government debt is held constants In addition to those features of fiscal policy, the economy is assumed to have a pay-as-you-go Social Security system with a 15 per‑cent payroll tax rate,


Findings

Table 1 shows the transition path of the economy that results from replacing in year 0 the modelfs 12 percent rate of federal income taxation with a national sales tax, while maintaining a 3 percent rate of state and local income taxa‑tion. The new national sales tax rate is set at the level needed, in conjunction with the preexisting 14 percent sales tax and the 3 percent state and local income tax, to continue to finance the same level of government spending as well as pay interest on the government debt, The first row in the table indicates the economyfs initial (year 0) posi‑tion. With no change in tax policy, the economy would re‑main in that position through time. Annual saving rates, annual interest rates, and tax rates are measured in per‑centage points. The units of measurement for the other variables are arbitrary, so each of those variables is de‑scribed in terms of an index that has an initial (base-year) value of 100,

Initially, the economy features a 2.5 percent saving rate, a per capita capital stock of 100, a per capita labor supply of 100. a level of per capita output of 100. a real wage rate of 100. a real interest rate of 10,0 percent and a zero national sales tax rate, The 2,5 percent saving rate is close to the current U,S. rate of saving, and the 10.0 percent real interest rate is close to the annual real rate of return that has been earned, on average, on the U.S. capital stock in the postwar period,

The remaining rows in Table 1 show how each of the variables reacts to the introduction of a national sales tax, The major responses to the tax change are as follows:

Table 1

Results of Simulating an Immeffiate Switch from Federal Income Taxation

to a National Sales Tax

Capital Labor National
Savings Stock supply output Wage Interest Sales
Year Rate Index Index Index Index Rate Tax Rate

0 2.5 100 100 100 100 10.0 0.0

1 7.6 100 104 103 99 10.3 17.4
2 7.2 102 104 104 99 10.1 16.7
3 6.9 104 104 104 100 10.0 16.2
4 6.6 106 104 104 100 9.8 15.8
5 6.4 108 104 105 101 9.7 15.4

10 5.3 115 103 106 103 9.2 13.9

20 3.9 123 102 107 105 8.6 13.3

60 3.0 128 101 107 106 8.3 11.3

90 3.0 129 101 107 106 8.3 14.3

15@ 3.0 129 101 107 106 8.3 14.3

Ine capital stock, labor supply, output, and wage figures are indices of the per capita values of those variables.

"Year 150 is the final steady state.

* An immediate and dramatic increase, from 2.5 percent to 7.6 percent, occurs in the economyts saving rate. While the saving rate gradually declines after year 1. it remains above 5 percent through the 10th year of the transition. The long-run (year 150) value of the sav‑ing rate is 3.0 percent--20 percent greater than the year 0 value.

* Investment, and therefore capital stock, increases. By year 150 the switch in tax regimes leads to a 29 percentage point increase in per capita capital stock. The increase in capital stock is gradual; only about one-half of the ultimate increase occurs in the first 10 years of the transition.

The increase in capital stock raises the productivity of workers and thus their real wage. In the long run, real wages are 6 percentage points higher than they are initially. The new tax policy also lowers the return on capital.

The real interest rate falls by almost 2 percentage points in the course of the transition. Although the real wage ultimately ends up 6 percentage points higher than it would have been without the tax change, for the first few years of the transition the real wage actual‑ly falls by I percentage point because agents respond to the prospect of higher real wages and higher short‑term real interest rates by increasing their labor supply, In the short run, before capital stock has had much of a chance to increase, there is an increase in the supply of labor relative to the supply of capital. As a result, labor in the first few years of the tran‑sition becomes relatively abundant, ' meaning that the price it can command in the market--the real wage--falls. Eventually, as the interest rate falls, the incentive to work more in order to save more and receive higher rates of return on the additional saving diminishes. As a result, labor supply declines. In the long run, the supply of labor is only I percentage point greater than it is in year 0.

* An increase in the per capita level of output results from changes in the supplies of capital and labor. Between year 0 and year 1. there is a 3 percentage point increase in output. In the following 10 or so years the switch in the tax structure raises the econ‑omyts growth rate by six-tenths of 1 percentage point per year, In the long run, the level of per capita output is 7 percentage points higher than it is in year 0.

* The year 1 value of the national sales tax rate is 17.4 percent. But the rate declines through time, and its value ends up at 14.3 percent in the long run. The tax rate can decline because the growth of the economy permits a higher level of consumption and thus produces a higher consumption tax base. In addition, the reduc‑tion in the interest rate lowers required interest payments on the governments debt,

To summarize the findings in Table 1, the simulat!..-)-,i of a switch to a national sales tax produces a significant increase in saving, capital accumulation, the real wage, and the level of per capita income* Although the dynamics are nonlinear (e.g.. labor supply first rises and then falls). all the results make intuitive sense.

Table 2 repeats the simulation run of Table 1 except that it eliminates state and local as well as federal income taxes and replaces all those taxes with a national sales tax. As a comparison of the two tables indicates, replacing all income taxes leads to larger long-run increases in capi‑tal stock, the real wage,, and the level of per capita output than does simply replacing federal income taxes. For exam‑ple, in Table 2 the long-run increase in the capital stock is 37 percentage points compared with 29 points in Table 1, The greater grovth of output means that the national sales tax rate can fall even faster.

Table 2

Results of Simulating an Immediate Switch from Federal, State, and

Local Income Taxation to a National Sales Tax


Capital Labor National
Saving Stock Supply output Wage Interest Sales
Year Rate Index Index Index Index Rate Tax Rate


0 2.5 100 100 100 100 10.0 0.0

1 8.9 100 105 104 99 10.4 22.8
2 8.5 103 105 105 99 10.2 22.0
3 8.1 105 105 105 100 10.0 21.4
4 7.8 107 105 105 101 9.8 20.8
5 7.4 109 105 106 101 9.6 20.2

10 6.1 119 104 107 103 9.0 18.1

20 4.3 130 102 108 106 8.3 16.0

60 3.1 137 101 109 108 7.9 14.8

90 3.1 137 101 109 108 7.9 14.7

1501, 3.1 137 101 109 108 7.9 14.7

The capital stock, labor supply, output, and wage figures are indices of the per capita values of those variables.
Year 150 is the final steady state.

]Maintaining a Constant National Gales Tax Rate

As an alternative to having the national sales tax rate decline through time, we might want to have a tax rate that was constant through time. Ifve used the model to simulate such a policy and found that if the tax rate is set equal to 16 percent, the model produces deficits in the short run, since the additional tax revenue raised with the 16 percent tax falls short of the loss in revenue occasioned by elimi‑nating the 12 percent federal income tax. Over time, the growth of output and the consumption tax base associated with the reform raises the amount of revenue collected by the 16 percent tax. That permits the full retirement of the additional debt that is issued in the short run. In the constant-tax-rate simulation, the long-run capital stock and output levels are 27 and 6 percentage points higher, respec‑tively, than their year 0 values, Those long-run increases may be compared with the 29 and 7 percentage point increases of Table 1.

Are the Results Reasonable?

Given the magnitude of the modelis predicted response to a switch to a national sales tax, one might ask whether the results are really plausible or simply reflect some ex‑treme assumptions about labor supply and saving behavior, Actually, the labor supply and saving responses assumed in the model are quite conservative. They are certainly well within the ranges of response that have been estimated in the empirical economics literature. In addition, the life‑cycle used is the basic bread-and-butter model of neoclassic cal economics.7

There is, however, one feature of the model that may make the transition occur faster in the model than it would in the real world: the modelis assumption that new capital can be immediately added to the existing stock of capital without the incursion of installation costs, As discussed elsewhere,& the addition of installation costs would slow the transition but not alter the magnitude of the long~run change in any of the economyos variables.

Another issue, which has not yet been addressed, is the progressivity of the income tax that is to be replaced. The model can handle progressive as well as proportional tax rates, In the case of a progressive income tax, the degree of progressivity of which is roughly comparable to that-of the present U.S. income tax, the year 0 position of the economy from which the transition begins has a 2.2 percent, rather than a 2.6 percent, saving rate, a per capita capital stock that is 18*1 percentage points smaller, a per capita labor supply that is 5.2 percentage points smaller, a per capita output level that is 8.6 percentage points lower, a real wage that is 3.5 percent lower, and an interest rate of 10,4 percent rather than 9,4 percent. Since the switch from the progressive income tax to a proportional sales tax pro‑duces the long-run outcome indicated in the last row of Table 1. the saving, capital accumulation, and growth ef~ fects of the tax change are all magnified by assuming that the initial income tax is progressive. For example, the long-run increase in per capita capital stock is 49 percent‑age points, and the long~run increase in per capita output is 14 percentage points.


The Impact on the Initial Elderly

Although switching to a national sales tax has a lot to recommend it, its advantages do not include the treatment of the initial elderly who, as mentioned, end up paying much more in consumption taxes than they would have paid in in‑come taxes. For example, in the simulation of Table 1. the oldest elderly in year 1. those who are age 55. suffer a 17 percent decline in their final yearts consumption, There are different ways to avoid, or at least mitigate, redistri‑bution away from those who are old at the time of the switch. one is to make additional transfer payments to the initial elderly by, for example, raising social security benefits. The problem with making transfer payments to the initial elderly is that those payments will lead the elderly to consume more and the additional consumption will limit the increase In saving and capital accumulation.

Table 3 shows the transition arising from an immediate switch to a retail sales tax, with governmental transfer payments to all generations alive at the time of the transi~ tion to ensure that no generation is made worse off by the tax switch. The transfer payments are, of course, largest for the oldest generations alive at the time of the tax switch, since they do not benefit as much from the elimina‑tion of income taxes as do younger generations, While of compensation of the initial generations limits the addition‑al saving generated by the sales tax,, there remains, none~ theless, a substantial saving response. According to Table 3. there is a 20 percentage point increase in the economyfs long-run capital stock. Although that is less than the 29 percentage point increase of Table 1. it is still quite sub‑stantial. With the compensation scheme in place,, the long~ run increase in per capita income is 6 percentage points (compared with 7 points with no compensation), If we re‑place all income taxes (state and local as well as federal)

Table 3

Results of sinmulating an Immediate Switch from Federal Income Taxation to a
National Sales Tax with Full Compensation Paid to the Initial Elderly


Capital Labor National
Saving Stock Supply output Wage Interest Sales
Year Rate Index Index Index Index Rate Tax Rate


0 2.5 100 100 100 100 10.0 0.0

1 5.9 100 104 103 99 10,2 16.9
2 5.7 101 104 103 99 10.1 16.4
3 5.5 103 103 103 100 10.0 16.1
4 5.4 104 103 103 100 9.9 15.8
5 5.2 105 103 104 100 9.8 15.5

10 4.5 110 103 105 102 9.5 14.4

20 3.7 116 102 105 103 9.1 14.2

60 2.8 120 102 106 104 8.8 12.4

90 2.8 120 101 106 104 8.8 12.4

150b 2.8 120 101 106 104 8.8 12.4



and also compensate the initial elderly, the long-run in‑crease in capital is 33 percentage points, rather than the 37 percentage points given in Table 2. and the long-run in‑crease in per capita output is 8 percentage points, rather than the 9 percentage points given in Table 2. To sun~ marize, we can compensate initial generations as we switch to a national sales tax and still make future generations significantly better off. That reflects the inefficiency of an income tax structure relative to a consumption tax struc‑ture.

CONCLUSION

Our nation is facing a grave crisis with respect to its rate of saving. We are saving at record low levels, and

unless we start saving more, we will continue our slide toward second-class economic status. A shift to a national sales tax has the potential for dramatically increasing our saving rate. It would do so by improving incentives to save. The distortion of saving behavior is so great under our current system of income taxation that it appears that we could switch to consumption taxation, fully compensate the initial elderly for their higher tax burden, and still end up with much higher rates of saving and capital accumu‑lation and a higher level of per capita income.

Appendix: The Auerbach-Kotlikoff Dynamic

Life Cycle Simulation Model

The Auerbach-Kotlikoff model calculates the time path of all economic variables in an economy over a 150-year period. The model has 55 overlapping generations. Each adult agent in the model is considered for 55 years (from age 20 to age 75). The version of the model used here as‑suraes a closed economy, (i.e,, there are no net capital flows to or from other countries),

There are three sectors in the model: households, firms, and government. Households (adult agents) make deci‑sions about how much to work and how much to save on the basis of the after-tax wages and after-tax rates of return they can earn in the present and the future on their labor supply and saving, respectively. The work decision involves not only deciding how much to work in the years that one is working but also when to retire. The modelis particular form of consumption and leisure preferences that agents use in making their labor supply and saving decisions were cho‑sen in li7ht of evidence on actual labor supply and saving behavior.

As agents age in the model, they experience a realistic profile of increases in wages. That age~wage profile is separate from the general level of wages, the time path of which is determined in solving the model. Fiscal policies affect households by altering their after-tax wages; their after-tax rates of return; and, in the case of consumption taxes, the after-tax prices of goods and services. The model is equipped to deal with income taxes, wage taxes, capital income taxes, and consumption taxes. It is also able to handle progressive as well as proportional tax rates,

The production sector is characterized by perfectly competitive firms that hire labor and capital to maximize their profits. The production relationships that underlie firms' hiring decisions and production of output are based on empirical findings for the United States. The government sector consists of a treasury that collects resources from the private sector to finance government consumption and an unfunded pay-as-you-go social security system that levies payroll taxes to pay for contemporaneous retiree benefits. The model does not distinguish federal from state and local government. Hence, when the model simulates the elimination of income taxation in favor of sales taxation, all state and local income taxes, as well as federal income taxes, are in effect replaced by the sales tax. There is no money in the model, and thus, no monetary policy. There is, however, government debt, and the model can handle deficit-financed tax cuts. It can also handle gradual phase-ins of one tax for the other.

The model handles a great number of complex processes, and its predictions need to be viewed cautiously for several reasons. First, the model does not deal with several of the real-world distortions associated with the income tax. For example, it does not distinguish corporate from noncorporate production, housing consumption from nonhousing consumption, different forms of corporate finance, different types of investment, or differences in capital gains and dividend tax rates. Nor does it permit the kind of tax arbitrage that is available to most tax-paying Americans through tax-deduct‑ible saving accounts.

Second, the model0s agents are heterogeneous only with respect to their age. There are no welfare recipients or millionaires, whose saving and work behavior might differ dramatically from that of the modelis agents. Third, the model does not include saving for purposes other than re‑tirement, such as bequests. Fourth, the model does not incorporate uncertainty with respect to individual or macro‑economic outcomes. Fifth, the model ignores illegal tax avoidance, an issue that would certainly arise in implement‑ing a national sales tax. Although the model abstracts from a small portion of reality, it can, nonetheless, suggest the degree to which a; switch to consumption taxation from income taxation night raise U.S. national saving,

Notes

1, The net national saving rate is defined as net national product less personal consumption expenditures less govern‑ment purchases of goods and services divided by net national product. There are a variety of measures of U,S, saving.

The net national saving rate is the most comprehensive mea‑sure of a countryls saving.

2. See David Bradford, U.S. Department of the Treasury,

Blueprint for Basic Tax Reform (Washington: U,S, Government

Printing office, 1976).

3. The finding of an increase in the propensity to consume is based on unpublished results of a study currently being conducted by the author, John Sabelhaus, and Jagadeesh Gokhale on how the propensity to consume changes with age. The propensity to consume at age 20 is close to 3 percent; it rises to about 13 percent for people in their 80s and 90s.

4. The taxes used in forming this ratio are indirect busi‑ness taxes reported by the National Income and Product Ac‑counts. Personal consumption is the National Income and Product Accounts' measure of expenditures on personal con‑sumption minus its measure of indirect business taxes.

5. This figure lies between the debt-to-output ratios sug‑gested by calculating total government debt by adding esti‑mates of state and local debt to the Office of Management and Budgetts estimate of federal debt and adding estimates of state and local debt to estimates of total government debt derived from National Income and Products Account data.

6. The decline in the real interest rate as well as the rise in the real wage rate would be smaller if the model were modified to permit international trade in goods and capital.

7. Indeed, Franco Modigliani of MIT won the Nobel Prize in economics for developing the neoclassical model.

8. Alan J. Auerbach and Laurenc'e J. Kotlikoff, Dynamic Fis~ cal Poli£y (Cambridge: Cambridge University Press, 1987).

9* All agents are assumed to have the same preferences, so differences in behavior across agents arise solely from differences in economic opportunities, Since all agents within an age cohort are assumed to be identical, differ‑ences in economic opportunities are present only across co‑horts. Although some versions of the model consider chil~ dren of the modelts adult agents, in the simulation present~ ed hare, children are ignored and the number of adults is assumed to grow at a constant 1 percent rate,

FACTSHEET

Citizens for an Alternative Tax System (CATS) is a national grass roots public interest group established to solve the very serious problems caused by this country's destructive and unfair income tax system. The answer: do away with the federal income tax completely and replace it with a retail National Sales Tax, using rebates so there is no additional tax burden on the poor or elderly. This change will eliminate the penalty on work and savings caused by the income tax and also dramatically reduce the waste and abuse so widespread in our current system,

CATS was incorporated in October of 1990 as a non-prorit corporation and has been granted a tax exemption under 501(c)(4) of the Internal Revenue Code. In this brief period of time CATS has expanded from nine local offices to over 450 chapters across the country and has conducted over 4,200 radio shows, as well as distributing three 30-minute video presentations, which outline the group's proposal. Over 100,000 citizens have contacted CATS as a result of these public education efforts.

CATS has also attracted the attention of several well-known colunmists such as Scott Burns of the Dallas Morning News, Don Larson (former Wall Street Journal correspondent) and Patrick J. Buchanan, whose original column promoting CATS ran in over 70 papers across the country. Also, in October of 1991, a full page ad covering CATS ran in the largest daily paper in the country, USA Today. This ad generated a remarkable response - over 8,000 positive calls and letters.

In July 1991, Citizens for an Alternative Tax System presented the results of its first formal economic study performed by Dr. John Quails, an economist in St Louis, Missouri, to members of the House Ways and Means Committee. The committee was bearing testi‑mony on factors affecting international competitiveness and nearly one-for-one, the major corporations testifying agreed that they would favor replacing the income tax with a consumption tax.

On April 15, 1993, the Cato Institute, a think tank in Washington, DC, released a study by Dr. Lawrence Kotlikoff further demonstrating the economic advantages of replacing the income tax with the retail National Sales Tax.

Today, support for the replacement of the income tax continues to grow with more and more Members of Congress speaking out on this issue. For example, Representative Sam Gibbons (D-FL), the second ranking Democrat on the House Ways and Means Committee. has done a video interview for use by CATS.

In the interview, Representative Gibbons explahis that hi over 25 years of working with the income tax, he has come to the conclusion that it "...is flawed in its conception, it is conceptually wrong" and must be replaced by a consumption tax.

Representative Dan Schaefer (R-CO) has written two editorials promoting the National Sales Tax which have run in a major daily newspaper and weekly papers in his district. He has also hosted a video explaining the National Sales Tax which featured a representative from CATS and aired on TV stations in his district with a strong, positive response.

Other Members of Congress have also expressed interest in supporting the National Sales Tax alternative to the income tax and CATS is working with them. In fact, since January, 1993 CATS has maintained staff members in Washington, DC to strengthen and intensify lobbying activity for the National Sales Tax proposal, while working more closely with the chapters on the densely-populated East Coast.

Testimony in favor of the National Sales Tax is being regularly presented to congres‑sional committees and leaders and the amount of interest and support is increasing dramatically as these representatives come to understand how beneficial this tax reform is and how much support for it is growing at the grass roots level across America.

On April 8,1994 CATS participated in a conference co-sponsored by the Cato Institute and the National Tax Research Committee on Capitol Hill in Washington, DC. The conference was carried live on C-Span cable television and featured an array of tax policy and economic experts, all of whom agreed the income tax must be replaced.

In the fall of 1993, C.A.T.S established a large facility in Manassas, VA as the center for its national operations. Located near Dufies Airport and on the commuter train line to DC, this new ofrice provides the ideal base for concerned citizen lobbying from across the country. With this in mind, the first CATS Citizen Lobby Day in Washington, DC was held on April 13, 1994 - the anniversary of the birthday of Thonw Jefferson and two days before this year's income tax filing deadline. Forty-three CATS members from nine states came to Washington on this day and helped develop further congressional understanding and support for the retail National Sales Tax to replace the income tax.

Given the enormous increase in public awareness about the destructive nature of the federal income tax, there is now a growing political movement in support of an alternative system. The question has become not if, but when we will have this change and whether %,e will replace our present system with a simple, fair alternative such as the retail National Sales Tax, or yet another complicated tax favored by those who profit from special interest and influence.

FREQUENTLY ASKED QUESTIONS ABOUT THE NST

1. ISN'T THIS A REGRESSIVE TAX?

Variations on this question or comment include statements like: "The NST is unfair to the poor because they would have to pay a higher percentage of their Income." or 'The National Sales Tax would benefit the rich and hurt the poor.'

ANSWERS: This is a basic misunderstanding regarding the National Sales Tax. When the National Sales Tax replaces the income tax, A NET INCREASE OF OVER 1.6 MILLION NEW JOBS will be created and the economy of this country will ~ to expand again, WITH A BOOST TO THE ECONOMY IN EXCESS OF 4 PERCENT (against the current rate which is running at less than one percent). Wouldn't an improved economy and more jobs he the very best benefit we could give to the poor ‑enabling them to move up off of the bottom of the income scale? And wouldn't a tax system which more fairly spreads the tax burden off of those who work the hardest and onto those who consume the most be the best way to provide such an improved economy?

Through the National Sales Tax, those at the bottom of the income scale will actually have more opportunity and incentive to improve their economic situation. It is those individuals who are unemployed, forced to work only part-time or holding down a job with low wages who are the most vulnerable to the economic hard times this nation is currently experiencing. The National Sales Tax wW help these individuals the most.

With an improving economy and more jobs, Americans with low incomes would be able to gain all of the fruits of their labor, including all of the money they made from an extra job or overtime. This is how the middle class was formed and strengthened in the United States.

It is also important to understand that currently the poor are paying a higher percentage of tax, in the form of income tax, than people are led to believe. This occurs because when corporations go to pay the up to 34% corporate income tax, they must add it into their cost of doing business (and add their costs of compliance to the income tax as well) and pass it on in the price they charge for their goods or services.
Ultimately, at least ten to 20 percent of the retail price of goods is actually collection of corporate income tax at the Mint of sale. This constitutes a hidden tax on the poor, One estimate puts the income tax compliance costs at $618 billion for 1990. That's $618 billion worth of capital which was not available for job creation, training, education and the like.

With the corporate income tax removed, as it would be with our proposed National Sales Tax, the cost of goods would be reduced at least ten to 40 percent, thus eliminating this hidden form of tax on the poor and those on fixed incomes.

]Because the income tax is applied twice - when someone earns the money and
Ww when that individual chooses to save or invest - it has a negative impact on savings. and investing. Many economists believe this helps explain the low savings rate of Americans, currently below four percent as opposed to the high savings rate of the Japanese which exceeds 15 percent. The income tax-penalized low US savings rate contributes to more expensive, limited capital. Under such conditions it is not the large corporations who are hurt the most but small businesses and people at or below the average income level - they are often unable to finance their needed major purchases such as appliances and automobiles.

Less expensive and more available capital also establishes the rmancial base for small business and entrepreneurs who in turn create 80% of our new jobs in this country. This is an extremely important, beneficial impact on poverty - new jobs, economic growth, higher wages through increased demand for Tabor and cheap, widely‑available capital.

The National Sales Tax can be implemented in a manner which adds no additional economic burden on the poor while prices and capital costs go down and job opportunities are created for them. THROUGH THE USE OF REBATES, THE NATIONAL SALES TAX WILL RESULT IN NO ADDITIONAL TAX BURDEN ON THE POOR WHILE CREATING INCENTIVE AND OPPORTUNITY,

For example a S600 annual rebate per person would represent a return of $2,400 for a family of four - the total amount of national sales tax paid on the runt $15,000 spent by that family for consumption. At present, there is no federal income tax on families earning less than $13,000. This would make spending for necessities tax free and provide a level of minimum support for those individuals at the bottom of the income scale without robbing them of incentive to take advantage of inicreased opportunities and move up.

The economic recovery and the resultant creation of jobs caused by replacement of the income tax by the National Sales Tax roll in turn increase demand for labor and real wages for American workers wW start to go up again.

Because the National Sales Tax doesn't create the economic damage we now suffer from with the income tax, we will have more money available to create needed educational programs and jobs programs which will re-build this country's industrial base. The improved U.S. competitiveness that will result also means more and better jobs. AB of these things are extremely important to provide the real solution to poverty in this country.

By rewarding work and productivity (rather than penalizing it through the income tax) and creating economic opportunity, we can reverse the disturbing trend of able-bodied citizens becoming wards of the state rather than independent workers, taxpayers and consumers.

WHAT PERCENTAGE WILL THE SALES TAX BE?

Variations of likely questions on this topic include 'If we had a National Sales Tax of 16%, that would be on top of the 815% we pay now in the sute of California. Won't that make the cost of goods prohibitive?"

ANSWERS:

At the present time, we are proposing a 16 percent National Sales Tax. This is what would be required to replace all of the money currently raised to fund the federal government by taxing retail purchases of goods and services.

In "ffig to understand what the immediate impact of this tax change would be, it is important to remember that you would now receive all of the money currently being taken away by the personal income tax. In addition, you would see retail prices drop as a result of the elimination of corporate income tax. Last year 91 billion dollars were collected through corporate income tax AND IT COST HUNDREDS OF BILLIONS TO COLLECT that money.

The money to pay those taxes is passed through to the rmal consumer by businesses (this is the only way they have to pay these taxes, to add them into their costs of doing business) and it is calculated and built into retail prices we pay in the stores. When the corporate income tax is eliminated, retail consumer prices will come down from 10 to 40 percent.

The bottom line is that average taxpayers - honest, hard-working people - will actually he paying less tax at the federal level than they were under the income tax. The tax burden will he spread more fairly to those who currently evade taxes such as drug dealers and organized crime (unpaid income tax exceeds 120 b!Won dollars each year and it is the honest taxpayer who has to make up that shortage).

Also, an important point for public advocacy would be to insist on a cut back of government waste so that the percentage of whatever tax we use could he reduced.

Individual congressmen may attempt to INCREASE the percentage of a National Sales Tax, just as they have done with the income tax. The beauty of this system is that if an increase is proposed, the public can exert an influence by simply NOT BUYING (in short, not paying tax) to demonstrate their view on any proposed increase. They could save the money (and build up personal wealth) and buy things later, while communicating their protest to their representatives, This puts the public IN CONTROL of how much tax they pay and when they pay it.

In summary, if one is concerned about the National Sales Tax on top of any state sales tax, consider the following points:

a) One mill he taking home ALL of the money one earns and not prepaying tax via mithholding and therefore will have more to spend (roughly 24 percent wore for the average family with two children).

b) Corporate income tax will he done away with as well. At the present time, corporate income tax is built into the cost of the products we buy. Consumers are paying it now. With the elimination of the corporate income tax, the higher availability of expansion capital available to corporations, and the natural inclination to compete for consumers, we can expect to see a decrease In prices.

c) It is very conceivable that with a bettered economy, state sales taxes could he reduced also.


3, WHAT NEEDS TO BE DONE TO GET THE NST ENACTED INTO LAW?

Variations on this include asking if a constitutional amendment is needed, if the 16th Amendment (the one which authorizes income tax) needs to he repealed to enact the National Sales Tax, etc.

ANSWERS:

First public education and support must be significant enough to get individual representatives very familiar with and in favor of the National Sales Tax.

Legislation must be introduced and presented to the House of Representatives through the House Ways and Means Committee.

The legislation must pass the House by a majority vote (218 votes needed).

It then must pass the Senate by a majority vote (51 votes needed).

It then must he signed into law by the President.

It is not necessary to repeal the 16th Amendment to eliminate income tax as the 16th Amendment merely gives the government the right to tax income. The amendment doesn't say the government has to do it.

There is no new constitutional amendment amessary to enact the National Sales Tax as the government has the clearly defined right to tax in this manner. In fact, these forms of taxes were part of what the frainers of the Constitution intended to be used to fund the federal government.

Once the national sale tax is enacted, it makes sense to rescind the 16th Amendment and thereby close the door on the income tax being reintroduced at a later thne. This is the sequence which CATS proposes ~ to knock out the income tax, replacing it with the national sales tax, and then rescinding the amendment to the

Constitution which allows the federal government to collect income tax in the first place.

4* OK SO WE ARE DOING AWAY WITH THE INCOME TAX, BUT WHAT ABOUT SOCIAL SECURITY?

The Social Security system takes money out of people's paycheeks just like the income tax. The money is taken by the federal government and theoretically, it will be available to the individual once he or she is ready to retire. Many people today don't believe that the Social Security system will have enough money in it to pay them back when their turn comes to draw money out. Other taxpayers disagree philosophically

with Social Security and view it as an example of the intrusive nature of government into our personal earnings and lives.

ANSWERS:

Very good point. But a separate point. Under the current proposal, Social Security is left in place as we are dealing with a specific issue: the elimination of the income tax and the economic damage it causes and the risk it poses to personal rights at the hands ol'the Internal Revenue Service.

Once we enact the National Sales Tax, the resulting econonfic improvement WW generate positive changes of major magnitude. Once it is in effect, we will he in a much better position to evaluate what should and can he done with Social Security.

5, WHAT WILL BE TAXED? WHAT WILL BE EXEMIPTED?

Variations on this include long lists of proposed @eniptions and complex questions about what will he taxed.

ANSWERS:

The current proposal is that all consumable,'retail goods and services would he taxed.

What retail goods and services are is clearly defined by the US Department of Commerce.

As we progress and get further support, the rune points wW be worked out for the greatest benefit and to allow passage.

As described above, through the use of rebates, we can make certain that no additional burden fafls upon low income Americans.

6. WHAT ABOUT STATE INCOME TAX?

A logical question.

ANSWERS:

Of the 46 states which currently have a state income tax, all but three are reliant on the federal income tax, FRS and their computers to make the state income tax system work. Collection of the income tax is extremely costly. When the federal income tax is e@nated, it will he a much easier procedure to go after the remaining state income tax systems, if any remain.

It is important to remember that economic damage comes about with state income tax (see Vedder Report) just as it does with federal income tax.

Inevitably, states will find new systems of raising revenue when it becomes clear that the damage caused by income tax far outweighs any imagined advantages.

7, WHAT SUPPORT IS THERE FOR THE NST?

This is a frequent question from someone who is just becoming familiar with our movement and proposal.

ANSWERS:

The idea of replacing the income tax with a consumption tax has been discussed for many years. There is considerable and growing support. We have economists, political leaders, media and print columnists and corporate leaders who have spoken out about the need to replace the income tax with consumption taxes,

Congressman Sam Gibbons (a Democrat from Florida) and Congressman W. J. "Billy" Tauzin (a Democrat from Louisiana) have been interviewed by CATS on the need to get rid of the income tax and what the advantages are of consumption taxes like the National Sales Tax. Other Members of Congress such as Rep. Dan Schaefer (R-CO) and Rep. John Linder (R-GA) are outspoken on the need for a consumption tax.

In August of 1992, the New York Times, in a featured editorial suggested, "What about scrapping the personal and corporate income tax codes, which often discourage savings and investment, in favor of a consumption tax that would encourage them? Such a tax should be structured to protect low income families. That would be worth fighting for pro-growth and fair.'

These are but a few examples. The list of national leaders and positive media coverage in support of the National Sales Tax continues to expand rapidly.