Will a national sales tax really doom retailers?

DSN Retailing Today, April 11, 2005 by Ken Rankin

A few weeks ago in this space I agonized over the Bush administration's flirtation with consumption taxes and fretted that a national sales tax would dampen industry sales by driving up prices to consumers.

With many retailers hanging on to profitability by their fingernails under the current system, the extra burden of a national sales tax might be enough to push many off the edge, I reasoned.

Since I spouted off, folks in Washington who know more about macro economic theory than I do have spoken up on the issue of a national sales tax. Their conclusion: I'm all wet, and a consumption tax would be a positive step forward in the United States.

Federal Reserve Bank chairman Alan Greenspan, for one, is now urging Congress to consider at least a partial shift toward taxing consumption rather than income. And other consumption tax advocates are coming out with studies concluding that a shift to a national sales tax might actually be good for retailing as well as the economy at large.

One of the most compelling cases for a new federal tax on consumption is being advanced by Americans For Fair Taxation--a group that proposes to abolish all federal personal and corporate income taxes, as well as the federal gift, estate, capital gains, alternative minimum, Social Security, Medicare and self-employment taxes.

In exchange, they would replace these taxes with a dollar-for-dollar, revenue-neutral national sales tax that would provide a rebate to ensure that no American below the poverty level would pay any federal tax.

To accomplish all this, advocates of the so-called "Fair Tax" acknowledge that the rate of the new national sales tax would have to be set at a whopping 23%.

Significantly though, Fair Tax supporters argue that such a stiff new tax would have only a short-term impact on consumer spending.

"Consumers will see their paychecks immediately increase by over $1.6 trillion because income and payroll taxes are eliminated. And once this disposable income begins showing up in paychecks, retail sales will grow at an even faster rate than under the current tax system," they contend.

Indeed, some economic studies suggest that thanks to that additional disposable income, 10 years after the switch to a national sales tax the U.S. economy would be 10% to 14% larger than if no change had been made.

Retail prices, meanwhile, won't increase anywhere near the 23% tax rate, they say. According to Harvard Economist Dale Jorgensen, producer prices will drop between 15% and 25% because of the elimination of corporate income and payroll tax liability.

Retailers, in turn, are likely to pass a "substantial portion" of those producer price reductions on to consumers which will further increase consumer demand, they contend. "But while offering lower prices, retailers will be able to maintain their current profit margins."

The extra costs that retailers incur in administering the federal Fair Tax would be offset by a collection fee of 25 basis points on all federal funds collected. But even without that fee, retailers figure to come out ahead due to major savings in internal accounting and payroll tax administration expenses.

Of course, "like other firms, retailers will enjoy a zero corporate tax rate and their shareholders will not be taxed on dividends or capital gains on their investments," the Fair Tax gang points out.

And as an added bonus, this type of consumption tax would quickly and permanently level the playing field for bricks-and-mortar currently at a competitive disadvantage to remote retailers who don't collect sales tax from purchasers.

Since all retail sales in the United States would be subject to the Fair Tax, "retailers suffering from tax-free direct mail" or Internet competition "would see a major competitive disadvantage removed."

I'm not sure I buy the Fair Tax rosy scenario, but it's clear that a national sales tax wouldn't be all that bad for retailers.