A 17 Percent Sales Tax Could Replace all Income and Estate Taxes

Summary of working paper 5885

...exempting food, medical care, and housing would raise the sales tax rate from 17.2 percent to 30.3 percent.

How high would a national retail sales tax have to be to replace not just the personal income tax, but also the corporate income tax and estate and gift taxes? According to a recent NBER study, Distributional Effects of Adopting a National Retail Sales Tax (NBER Working Paper No. 5885), the answer is 17.2 percent. Authors Daniel Feenberg, Andrew Mitrusi, and James Poterba derive what the tax base for a comprehensive retail sales tax would have been in 1991, $3,274.9 billion; given the $564.4 billion sum of personal income taxes, corporate income taxes, and estate and gift taxes that year, they compute the 17.2 percent figure.

The authors also consider the taxes that different types of households would pay under a retail sales tax. They point out that while many studies rank households by their annual income, this is a poor indicator of wealth or well-being because incomes vary from year to year. A family's expenditure on consumption, they note, measures the family's well-being better than income does: it is more stable, and therefore a better indicator of a family's income over a life time. They therefore focus on taxes paid as a percent of consumption expenditures rather than taxes paid as a percent of income. Families that spent more than $200,000 on consumption in 1991, for example, paid taxes totaling 40.2 percent of their consumption expenditures; families that spent $10,000 to $15,000 on consumption paid taxes equal to 10.2 percent of their consumption. Replacing these taxes with a retail sales tax would have brought taxes for both families to 17.2 percent of consumption. If households were grouped according to income rather than consumption outlays, the apparent increase in taxes on the less well-off groups would be larger than in this consumption ranking.

Some proponents of retail sales taxes have advocated exempting food, medical care, and housing from a sales tax on the grounds that low-income families spend a higher percent of their income on these items. Feenberg, Mitrusi, and Poterba show that exempting these three items would raise the sales tax rate from 17.2 percent to 30.3 percent. They also show that the tax relief for less well-to-do families, whether measured by income or consumption expenditures, would be minimal. A family that spent $10,000 to $15,000, for example, would pay 16 percent of its consumption expenditures in taxes, down only slightly from the 17.2 percent it would pay with a comprehensive retail sales tax. The reason the tax relief would be so small, they note, is that the share of household expenditures allocated to food, housing, and medical care is not that much higher for higher-consumption households than for lower-consumption ones.