Huckabee's tax plan is brilliant, so why is it getting trashed?

How the dismal science applies to your life.
Jan. 10 2008 12:05 PM

Huckabee's Tax Plan Is Brilliant

So why is it getting trashed?

Mike Huckabee's tax plan might not be so stupid 
Click image to expand.
Mike Huckabee's tax plan might not be so stupid

Mike Huckabee is not my favorite candidate, though I relish the irony of an evolution-denier whose basic appeal is to voters' most apelike instincts. But I do give him credit for one thing: an innovative tax plan that's being trashed by journalists who almost universally fail to understand its consequences.

Basically, Huckabee's plan is to eliminate the income tax and replace it with a national sales tax. To a first approximation, that's not such a radical change. As long as you spend what you earn, a sales tax feels just like an income tax. If you earn $1,000 a week and spend $1,000 a week, it doesn't matter whether I take 20 percent of your income or 20 percent of your spending.

In the long run, most people, or at least most families, do spend what they earn. (Why earn it if you're not going to spend it?) True, some of us die with money in the bank, but usually our children or grandchildren step in to spend the remainder for us. So, as far as your dynasty is concerned, a 20 percent income tax and a 20 percent sales tax are equally painful.

Except for one thing: With an income tax, you pay up front. Earn a dollar in 2008, and you'll pay 20 cents tax in 2008. (Actually, you'll pay more, of course; I'm assuming a 20 percent tax rate for the sake of illustration.) With a sales tax, that 20 cents sits in your bank account earning interest until the day you spend your earnings. Let me say that again: Your pretax earnings sit around collecting interest until the day you withdraw and spend them. Where have we heard that before? It's exactly what happens when you invest in a traditional IRA!

So, one way to mimic the effect of a sales tax is to let you deposit every dollar you earn directly into an IRA. As far as your family—or any family—is concerned, the effects are identical. A sales tax is the exact equivalent of an income tax with a provision for unlimited IRA contributions (and no withdrawal penalties). The merits and demerits of the Huckabee tax plan are identical to the merits and demerits of a vastly liberalized IRA policy.

A lot of economists, myself included, think that there's a lot to be said for unlimited IRAs. Any conceivable tax system discourages work, which is unfortunate but unavoidable. But the current system also discourages saving, which is avoidable. A liberalized IRA policy—or, equivalently, a sales tax—eliminates that problem. The downside is that when IRAs grow, there's less income to tax, so tax rates must be higher—which increases the disincentive to work. But for the past decade or so, the macroeconomics journals have been rife with papers arguing—on highly technical grounds—that the terms of that tradeoff are well worthwhile.

Bottom line: Unlimited IRAs, coupled with somewhat higher tax rates, have advantages and disadvantages, but the advantages are bigger. And whatever can be said about unlimited IRAs coupled with somewhat higher tax rates can equally be said of a national sales tax.

Another alleged difference between sales and income taxes is that income taxes can be graduated, while sales taxes can't. Maybe, maybe not. There might be a way to design a graduated sales tax. Your credit-card providers have a pretty good idea how much you spend each year, and the government could in principle use that information to set your tax rate. Yes, there are a lot of details to be worked out, and yes, it's highly intrusive—but I'm not convinced it's any more intrusive than what we've got now.

But the good news is that the details don't matter, because there's an easier way to design a graduated sales tax. Namely, keep the graduated income tax and add a provision for unlimited IRAs. Presto, you've got the equivalent of a graduated sales tax.

That's not necessarily desirable. You could well argue that a flat tax rate is a feature, not a bug. But that's a topic for a different column. The point of this column is that the whole flat-versus-graduated issue is quite tangential to the sales-versus-income-tax issue. And the underlying issue becomes a lot clearer once you realize that a sales tax is a modified income tax. The right question is: Is the proposed modification a good one? The answer, according to a growing consensus among macroeconomists, is: Yes.

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