What would a national retail sales tax need to look like to replace current federal receipts without increasing regressivity?
Executive summary
A national retail sales tax capable of replacing current federal receipts without increasing regressivity would require three mutually reinforcing design elements: a very broad tax base, a high headline rate (or higher if exemptions exist), and a universal, refundable rebate or demogrant sized to neutralize tax on low-consumption (poverty‑level) spending [1] [2] [3]. Absent those elements, experience and modeling warn the switch would shift large burdens onto low‑ and middle‑income households while benefiting the wealthy [4] [5].
1. How big a rate, and why: the arithmetic of revenue neutrality
Estimates vary but replacing current federal receipts requires a sales rate substantially higher than typical state rates because the tax base must cover nearly all federal revenue now raised from income, payroll, corporate, estate, and gift taxes; advocates of the FairTax translate the needed tax‑exclusive rate into roughly 29–30 percent (about 23 percent tax‑inclusive) while other macro estimates suggest rates anywhere from the high teens to well over 30 percent depending on base and assumed behavioral responses [6] [7] [1] [2]. Narrowing the base by exempting necessities such as food, medical care, and housing would force the headline rate dramatically upward — Feenberg, Mitrusi, and Poterba showed exempting those three categories could raise a 17.2 percent base rate to about 30.3 percent [1].
2. Base breadth: the single most important design choice
To keep the rate lower and maintain revenue neutrality, the national retail tax must apply broadly to consumption, including goods and many services, and ideally limit carve‑outs; proponents of broad bases argue broad coverage yields lower rates and simpler administration, while critics note state sales taxes already vary widely and real‑world exemptions erode revenue and complicate administration [8] [2]. Studies and policy briefs stress that more exemptions both raise the necessary rate and invite administrative complexity because states may not align their bases with the federal levy [2] [8].
3. Progressivity mechanism: rebates, demogrants, and refundable credits
Every major analysis agrees a flat consumption levy is intrinsically regressive because lower‑income households consume a larger share of income, so protecting progressivity requires a generous, universal, refundable payment — the “prebate” or family consumption allowance — calibrated to poverty‑level spending or similar benchmarks [9] [10] [3]. The design choices matter: a monthly, unconditional prebate tied to household size can make the tax less burdensome at the bottom, but modeling shows such rebates typically do not restore the overall progressivity of the current income‑tax system, and they can be politically and administratively contentious [9] [5].
4. Distributional consequences: who likely wins and who loses
Multiple independent reviews—from the Tax Policy Center to think tanks across the spectrum—find that without very large rebates or other offsets, a national retail sales tax shifts tax burdens away from top earners and onto the bottom 80 percent or middle class, with retirees living on savings and low‑income working families exposed to higher effective tax rates [4] [5] [11]. Proponents counter that taxing consumption rather than income fosters neutrality across savings and investment and can boost growth, but empirical estimates differ on whether growth offsets are large enough to erase distributional shifts [8] [12].
5. Administrative and political frictions: IRS, states, and underground activity
Replacing the income‑based system would also entail dismantling payroll and income collection mechanisms and relying on retail collection channels or state cooperation, which raises administrative frictions: states vary in sales‑tax rules and several have no sales tax; differences could produce compliance gaps and possibly enlarge the underground economy [2] [11]. Proposals claim the IRS could be abolished or repurposed, but analysts caution the transition would be complex and may not save as much as proponents promise [8] [6].
6. Tradeoffs and hidden agendas to watch for
Advocacy for a national retail tax often pairs with deregulatory, pro‑growth arguments and aims to shrink the visible role of progressive taxation, so the political agenda matters: proposals that emphasize “simplicity” and IRS abolition can understate distributional effects, while those promoting large prebates may be implicitly advancing a shift from targeted credits (like the EITC and child credits) to universal cash transfers that change how benefits are allocated [5] [9]. In short, any credible revenue‑neutral plan must make explicit its assumptions about base breadth, headline rate, rebate generosity, state cooperation, and behavioral responses, because each materially alters whether regressivity rises or falls [4] [1] [2].