Arizona Policy Choices

Balancing Acts: Tax Cuts and Public Policy in Arizona

Why Tax Income?

Thomas P. McGovern, Special Assistant Attorney General
Office of the Attorney General

On July 4, 1861, President Abraham Lincoln called the U.S. Congress to a special session. In his remarks, Lincoln warned against a secessionist movement determined to undo the Union. Congress reacted quickly. They enacted the first income tax ever levied by the U.S. government.

If the rule of self-preservation existed then to justify government's forcible confiscation of individual property, then surely that same logic could apply to the current age. Only this time, the necessity is found not in a call to suppress a rebellion, but to prevent one.

In Arizona and across the U.S., workers today who are less than 40 years of age probably will see their earnings taxed at 50 percent or worse. The average taxpayer already works five months just to pay his/her yearly tax liability. Private enterprise has always been incentive driven. It meant taking risks for greater gains. It meant having rewards for self-confidence in one's own ideas. When the incentive to earn is surpassed by the obligation to pay, no risk will be worth taking.

After 136 years of expansion and convolution, the behemoth federal tax code and the Internal Revenue Service might come closer to threatening our Republic than General Lee's Army of Northern Virginia did running around the Pennsylvania countryside. The concept of an income tax, once thought of as the only means to save the Union, now stands as the biggest threat to it.

Several states operate successfully without an income tax. Evaluated against the nation's annual Gross Domestic Product (GDP), a modest national sales tax would generate as much or more revenue as taxing income. The only reason a sales tax or at least a simplified lower flat income tax concept hasn't received more attention in Washington is because legions of special interest groups, lobbyists, accountants, and the IRS itself have a "thing" about letting this Kervorkian idea spend any time with their golden goose.

Under the current tax code, federal or state, the largest industries now operating in the nation pay nothing to the tax collector. Larger than any consortium of banks, high-tech firms, or oil companies, the illegal black markets of this country continue to enjoy tax-free status while "earning" billions in an illicit drug trade. Add to that the millions of Americans who go to great lengths to not pay some or all of the taxes they owe, and there exists in the culture of lawlessness an untapped reservoir of tax revenue sufficient to negate the national debt.

Under a sales-tax system, however, every time that drug dealer goes to buy jewelry, luxury clothing, a Lamborghini, or a beachfront mansion he pays his taxes on time and in full. That's because he is and always has been a consumer of goods and services. He just doesn't volunteer to the IRS that he works for a living. Moreover, instead of Uncle Joe burning the midnight oil trying to figure out how he can claim his toupee as a dependent, he will be forced to pay his legal taxes every time he trades up for that new hairpiece at "Heads R Us."

Under the tax code we currently have, the vast majority of Americans who try to pay their correct tax might find it easier to try quantum physics than to keep abreast of the ever-changing tax code. What can be said on behalf of a system where the top five percent of our most educated citizens have to hire someone else to figure out what they owe? Under a simplified pay-as-you-go sales tax instead, the physicist in you could continue to ponder the origins of the universe while Shirley at the cash register swipes the bar code on your new atom separator, calculating your total tax due in a fraction of a nanosecond. Sorry H & R Block.

Under the tax code we currently have, the vast majority of Americans who try to pay their correct tax might find it easier to try quantum physics than to keep abreast of the ever-changing tax code.

With a national sales tax, instead of "death by 1040" every April 15th, there would be no tax forms, tax loopholes, or tax calculations to conjure. If the income tax were eliminated overnight, what would become of the IRS, its staggering and costly infrastructure, its thousands of investigators and bureaucrats? Can you say: "Last one out turns out the lights?" Consider the befuddled private sector that will have to figure out what to do with the billions it spent every year hiring tax experts to devise tax strategies or pay lawyers to fend off the audit resulting from last year's expensive tax plan.

Forget the effect on the IRS and consider the effect on the average worker and his or her family. What would they do with an additional 20 percent in every paycheck throughout the year? There are only two choices and both fuel a healthy economy. One family might spend 100 percent of its newfound wealth thereby contributing all of it back to the government. Or one family might decide to engage in the only remaining form of legal tax avoidance: saving and investing. (Remember, interest income would not be taxed in the post-income tax era.) Not every taxpayer would or could opt to save or invest. But the decision not to save the additional money should delight the local retailers in his community, Uncle Sam's kinder and gentler tax collector. With this unprecedented surge in both consumption and investment, lending institutions should be in a position to provide much needed monies as loans for new businesses, for business expansions, or to fund home mortgages.

The arguments against the sales-tax system, or more accurately the arguments for the income-tax system, don't have relevance except as effective campaign demagoguery. Critics will point out that the sales tax will increase the cost of goods and services which will disproportionately affect the poor and working poor. But nothing so disproportionately affects the poor as having less income or no work.

For a head of household earning only $18,000 per year, net take home pay would increase from $540 biweekly to $700. But won't that new income be consumed by the rise in costs of goods? Not necessarily. Many items, such as foods, baby items, and certain clothing, could be exempted from the tax or taxed at lesser rates. Competition in an exploding free market will ensure moderate prices on most essentials for families. Every head of household must still make prudent decisions on where to shop, what to buy, and what not to buy just as they do today. But the individual, rich or poor, will spend his money more wisely than the federal government. Letting the individual keep more of it is more noble than the income-tax structure that prevails today.

Another argument will assert that a value-added sales tax imposes a significant bookkeeping burden on the business owner who will be obligated to calculate the correct tax, collect it, report it, and transmit it to the government. This threat rings pretty hollow to anyone who has ever run a business, big or small, in the past 30 years. The business community already calculates and transmits many collections and fees for local and state taxing authorities. They are set up to collect a tax and are doing so right now. Besides, under the sales tax, if it ever becomes burdensome to take money from the customer, it must mean that the business is burdened by sales. A ringing cash register is rarely a burden.

Another argument against the sales tax is that consumer-purchasing trends are too volatile for Congressional estimating. But has Congress performed any better under the more "reliable" income-tax system? If only one maxim outlives the IRS, the Grand Canyon, and Elvis impersonators, it just might be the reality that Congress will spend exactly 150 percent of what it has available however the revenue is collected. After replacing income tax, the personal wealth and spending of all Americans will yield sufficient fruit for the federal alligator to feast on as usual.

When President Lincoln addressed Congress 136 years ago and pleaded for the means to save the Union, he stood just a few miles to the north of Bull Run. Maybe the drums down the road in our times are not as foreboding as the ones he heard, but it would be a tragedy of great irony if the tax that was once needed to save the free Union turns out to be the driving force in its disintegration.


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Morrison Institute for Public Policy