U.S. Sales Tax Would Have Undesirable Effects, Fed Member Says

Switching from a federal income tax to a national sales tax would create an economic boom followed by a bust and, later on, a permanent increase in prices, a Federal Reserve Board member said Wednesday.

Lawrence Lindsey’s remarks delivered a blow to the national retail sales tax idea championed by presidential candidate Sen. Richard Lugar (R-Ind.) and against proposals for imposing other consumption taxes such as the value-added tax, which is levied at each stage of production.

Lindsey, testifying to a commission appointed by the Republican leaders of Congress, said all the tax-reform proposals being studied should help the economy in the long run by promoting capital formation, entrepreneurship and growth.

But in the short term, he predicted, there would be significant disruption, particularly if the income tax is replaced with a sales tax. Disruption also would result from switching to a flat-rate income tax, he said, “but such changes are of a magnitude that they can be managed.”

The sales tax, Lindsey said, would set off a buying spree in the months before it went into effect, then be followed by a bust as consumers dramatically cut buying and sought to rebuild their savings. That would lead to a recession, probably forcing the Federal Reserve Board to cut interest rates, thereby leading to inflation and “a permanently higher price level,” he said.

In a written response, Lugar said his plan would “create a vibrant economy in which . . . Americans will save more, produce more and make more money.” He said “special interests inside the Beltway are worried about my proposal . . . because they won’t be able to amend the income tax code every other year for new tax breaks.”

Lindsey’s caution about the potential consequences of major changes to the tax system came as the national debate over scrapping the 82-year-old income tax accelerated.

In GOP circles, the two chief contenders for a replacement are the 17% flat-rate income tax advocated by House Majority Leader Dick Armey (R-Tex.) and any of various consumption taxes such as Lugar’s sales tax and a system being developed by House Ways and Means Chairman Bill Archer (R-Tex.).

Lately, the flat tax, which would eliminate deductions and credits and graduated rates, seems to have been gaining adherents, and the sales tax, critics. The leading Republican presidential candidate, Senate Majority Leader Bob Dole

of Kansas, on Tuesday called for scrapping the graduated income tax in favor of “lower and flatter rates.”

Dole steered clear of specifics, having promised to await the scheduled December report of the GOP commission, led by former Housing Secretary Jack Kemp.

Lindsey’s testimony on potential transition problems with the sales tax follows a critical report by Congress’ Joint Economic Committee, which had earlier praised the flat tax idea.

The report said a national sales tax would be “fundamentally flawed.” It would place an enormous burden on state governments, which would have to collect it for the federal government, the report said. And it would be unfair to the poor, who must spend all their income, and to the elderly, who would be subject to a high sales tax as they spent savings they accumulated while subject to a high income tax rate.

Lugar responded to the report with a letter saying the sales tax would be cheaper to administer than the income tax and could be designed to make it fair to the poor.

House Minority Leader Richard Gephardt (D-Mo.), meanwhile, appeared before the Kemp commission to make a pitch for his proposal, which would levy a 10% income tax on 75% of Americans but would impose rates as high as 32% on upper-income taxpayers.