Monday, September 28, 2015

Flat Tax vs National Sales Tax: Which is better?

Tax Reform is a major topic during most Presidential elections. Politicians seek to capture more voters with their position on taxation. Of course, most individuals love to pay taxes! Well, most voters would love to reduce their tax liability. This desire opens the door for the opportunity for many politicians to pitch their tax reduction campaign pitch. The tax reduction campaign typically falls under two camps:  (1) The implementation of a Flat Income tax, or(2) the implementation of a National Sales Tax. The question remains: Which one is better?

Flat Income Tax or "Flat Tax"

The Flat Income Tax, simply stated, is the notion where there is one tax rate percentage. For example, if family earns $100,000 per year, and the flat tax was 5%, their tax liability would be $5,000. Proponents feel this tax is "fair".(this is not about the National Sales tax called the "Fair Tax, that shall be discussed later in this analysis) They feel this way simply due to the same tax rate is charged to all. Is this a good deal?

As with other taxes, it ultimately reduces the free market actor's ability to consumer or save. It matters not if the actor's rate is the same as others in the marketplace, the ultimate effect is the same: The individual has fewer dollars to spend or save. For business owners, the income tax reduces the business owner's ability to invest more into the enterprise. That flat percentage must go to the State first, as the lost opportunity cost of investing back into the business reduces the businesses chances for long term success.

National Sales Tax

The other type of tax reform proposal deals with the national sales tax. There are varieties of this sort of form of taxation, one of which, is known as the "Fair Tax". While this analysis does not dig into the details of the "Fair Tax", thus it is not a specific critique of the "Fair Tax" per se. Supporters of this sort of tax state that its superior to the income tax simply because there is no income tax! Yet, the National Sales tax is still a tax on income.

Consider this example: A business owner operates in a region that has a National Sales tax. This tax is taken at the point of sale, as this is how it is sold to the public. If a final sales price is $100, and the sales tax is 8%, or $8, the business owner actually keeps $92. In this case, it is a tax on income.

Other Consideration: Tax on Capital Gains

Capital Gains tax is another factor in this discussion. Capital Gains is when an asset is acquired, held for a certain period of time, then sold at a higher price. At that point, the sales proceeds, the gain(acquisition price net against the sales price), is taxed.

There are several issues regarding this form of taxation. First of all, the actor acquiring the asset, is using funds that have been taxed. So, once the asset is sold, it is taxed again, exposing the actor to double taxation. The preference would be for the actor to hold the asset longer than usual depending on the amount of tax applied at the time of the sale due to the possibility of double taxation. Secondly, it still is a tax on income, but accrued income. For example, if one purchases an asset for $100, and holds it for 10 years, and it grows in price to $1000, the gains is taxed. But, the tax is based on the accrued income for those 10 years to reach the $1000.  It is not taxed each year as the "value" of the asset grows. Thus, it is a form of income tax, but its not taxed on the income in the year it is actually earned.


Both the flat tax and the sales tax are taxes on income. The economic implications are, as it is with all sorts of taxation, on the original factors of production: Land, Labor and Capital. Both forms of taxes, to include taxes on Capital gains, adds additional costs on capital, making it difficult for those starting out to move up the socioeconomic ranks. 

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