Tax Reform Watch: Consideration for a National Sales Tax – July 07, 2017 by Tracy Monroe

Last week Congressman Jim Renacci (R-OH 16th District) spoke about tax reform to a group of corporate controllers at our Ohio CPE Day program. I was interested to hear that he too believes that tax reform should consider a consumption tax in addition to our existing income tax system. So why hasn’t the “A Better Way” blueprint for tax reform or the President’s plan provided for a tax on consumption in addition to or as a replacement for our existing income tax? The answer may be a resistance to indirect taxes.
In May, OMB Director, Mick Mulvaney, presented the President’s FY2018 budget which reported projected receipts of $3,654T and outlays of $4,094T for a projected annual deficit of 440 billion dollars. Broken down, federal spending historically shows that roughly 70% represents entitlement programs (social security, Medicare, and Medicaid) and interest on the national debt; 15% represents defense spending and 15% is for everything else. Since no one is currently supporting entitlement reform and interest expense is fixed, 70% of expenses cannot be reduced. No one wants to reduce defense spending either, so that leaves only 15% of the entire budget to work with in an effort to cut costs and reduce the deficit.
However, something else that was striking to me in Director Mulvaney’s press conference was his comment regarding the tax gap being $486 billion for 2016. The tax gap is the difference between the amount of tax revenue that should be collected versus the amount that is actually collected because of non-filing, underreporting of income or underpayment of taxes. Mr. Mulvaney commented that simplification would increase the tax revenue collected because it will be easier for people to file and pay their taxes. While this may raise some revenue, much of the tax gap exists as a result of income that cannot be traced and therefore, is not reported. In many businesses, cash will be collected but will not be reported to the government in terms of a W-2 or a 1099.
It is interesting to me that the tax gap is so significant and represents 13.3% of the total budgeted revenue. Any of my clients would work very hard to tap into that level of lost revenue. Our current income tax system and that which has been discussed as part of tax reform will not significantly tap into the tax gap resulting from under reported income. However, a consumption tax, like a national sales tax or a value added tax (VAT) would subject those individuals to tax when they make a purchase.
In addition to simplification for individuals, another major goal of tax reform is to allow U.S. businesses to compete in the global market. Reducing the U.S. corporate income tax rate to 15% is a step forward on this goal since most other countries have an income tax rate of 23-28%. Additionally, almost all other countries have a value added tax to complement their income tax. In fact, the U.S. is in the odd company of Somalia and North Korea as countries without a VAT.
A VAT or a national sales tax is considered an indirect tax. An indirect tax is one that is paid indirectly by the final consumer of goods or services. Since the cost of the tax does not vary according to income it is also considered a regressive tax as it imposes a greater burden on the poor than on the rich. This is because both the rich and the poor pay the same amount of tax for the consumption of a specific good. However, with the large tax gap it may be necessary to have a tax system that has aspects of direct and indirect taxes. Although having an additional tax system does not align with the core tax reform concept of simplification, it may be necessary to provide the level of tax revenue necessary for fulfilling our obligations.
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