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D. Shifting and Incidence: A General Sales Tax
The most popular example of a tax supposedly shifted forward is the general sales tax. Surely, for example, if the government imposes a uniform 20-percent tax on all retail sales, and if we can make the simplifying assumption that the tax can be equally well enforced everywhere, then business will simply “pass on” the 20-percent increase in all prices to consumers. In fact, however, there is no way for prices to increase at all! As in the case of one particular industry, prices were previously set, or approximately so, at the points of maximum net revenue for the firms. Stocks of goods or factors have not yet changed, and neither have demand schedules. How then could prices rise? Moreover, if we look at the general array of prices, as is proper when dealing with a general sales tax, these are determined by the supply of and the demand for money, from the goods and money sides. For the general array of prices to rise, there must be either an increase in the supply of money, a decrease in the demand schedule for money, or both. Nothing in a general sales tax causes a change in either of these determinants.44
Furthermore, the long-run effects of a general sales tax on prices will be smaller than in the case of an equivalent partial excise tax. A tax on a specific industry, such as liquor, will push resources out of this industry and into others, and therefore the relative price of the taxed commodity will eventually rise. In a general, uniformly enforced sales tax, however, there is no room for such shifts of resources.45
The myth that a sales tax can be shifted forward is comparable to the myth that a general union-imposed wage increase can be shifted forward to higher prices for consumers, thereby “causing inflation.” There is here no way that the general array of prices can rise, and the only possible result of such a wage increase is mass unemployment.46
In considering the general sales tax, many people are misled by the fact that the price paid by the consumer necessarily includes the tax. If someone goes to a movie and pays $1.00 admission, and if he sees prominently posted the information that this covers a “price” of 85¢ and a tax of 15¢, he tends to conclude that the tax has simply been added on to the “price.” But $1.00 is the price, not 85¢, the latter sum simply being the revenue accruing to the firm after taxes. The revenue to the firm has, in effect, been reduced to allow for payment of taxes.
This is precisely the consequence of a general sales tax. Its immediate impact lowers the gross revenue of firms by the amount of the tax. In the long run, of course, firms cannot pay the tax, the loss in gross revenue of firms being imputed backward to interest income by capitalists and to wages and rents earned by owners of original factors—labor and ground land. A decrease in gross revenue to retail firms is reflected back to a decreased demand for the products of all the higher-order firms. The major result of a general sales tax is a general reduction in the net revenues accruing to original factors. The sales tax has been shifted backwards to original factor returns—to interest and to all wages and ground rents. No longer does every original factor of production earn its discounted marginal product. Original factors now earn less than their DMVPs, the reduction consisting of the sales tax paid to the government.
Let us now integrate this analysis of the incidence of a general sales tax with our previous general analysis of the benefits and burdens of taxation. This is accomplished by remembering that the proceeds of taxation are, in turn, spent by the government. Whether or not the government spends the money for resources for its own activities or simply transfers the money to people it subsidizes, the effect is to shift consumption and investment demand from private hands to the government or to government-supported individuals, by the amount of the tax revenue. The tax has been ultimately levied on the incomes of original factors, and the money transferred from their hands to the government. The income of the government and of those subsidized by the government has been increased at the expense of the tax producers, and therefore consumption and investment demands on the market have been shifted from the producers to the expropriators by the amount of the tax. As a consequence, the value of the monetary unit will remain unchanged (barring a difference in demands for money between the taxpayers and the tax-consumers), but the array of prices will shift in accordance with the shift in demands. Thus, if the market has been spending heavily on clothing, and the government uses the revenue mostly for the purchase of arms, there will be a fall in the price of clothes and a rise in the price of arms, and a tendency for nonspecific factors to shift out of the production of clothing and into the production of armaments.
As a result, there will not finally be, as might be assumed, a proportional 20-percent fall in all original factor incomes as the result of a 20-percent general sales tax. Specific factors in industries that have lost business from the shift from private to governmental demand will lose proportionately more in income; specific factors in industries gaining in demand will lose proportionately less—some may gain so much as to gain absolutely from the change. Nonspecific factors will not be affected as much proportionately, but they too will lose and gain according to the difference that the concrete shift in demand makes in their marginal value productivity.
It should be carefully noted that the general sales tax is a conspicuous example of failure to tax consumption. The sales tax is commonly supposed to penalize consumption, rather than income or capital. Yet we find that the sales tax reduces, not just consumption, but the incomes of original factors. The general sales tax is therefore an income tax, albeit a rather haphazard one. Many “right-wing” economists have advocated general sales taxation, as opposed to income taxation, on the grounds that the former taxes consumption but not savings-investment; many “left-wing” economists have opposed sales taxation for the same reason. Both are mistaken; the sales tax is an income tax, though of a more haphazard and uncertain incidence. The major effect of the general sales tax will be that of the income tax—to reduce the consumption and the saving-investment of the taxpayers.47 In fact, since, as we have seen, the income tax by its nature falls more heavily on savings-investment than on consumption, we reach the paradoxical and important conclusion that a tax on consumption will fall more heavily on savings-investment than on consumption in its ultimate incidence.
- 44. It might be objected that the firms can pass along the sales tax because it is a general increase for all firms. Aside from the fact that no relevant general factor (supply, demand for money) has increased, the individual firm is still concerned only with its individual demand curve, and these curves have not shifted. A tax increase has done nothing to make a higher price more profitable than it was before.
- 45. Resources can now shift only from work into idleness (or into barter). This, of course, may and probably will happen; since, as we shall see further, a sales tax is a tax on incomes, the rise in opportunity cost of leisure may push some workers into idleness and thereby lower the quantity of goods produced. To this extent, prices will eventually rise, although hardly in the smooth, immediate, proportionate way of “shifting.” See the pioneering article by Harry Gunnison Brown, “The Incidence of a General Output or a General Sales Tax,” reprinted in R.A. Musgrave and C.S. Shoup, eds., Readings in the Economics of Taxation (Homewood, Ill.: Richard D. Irwin, 1959), pp. 330–39. While this was the first modern attack on the fallacy that sales taxes are shifted forward, Brown unfortunately weakened the implications of this thesis toward the end of his article.
- 46. Of course, if the money supply is increased after a wage rise, and credit expanded, prices can be raised so that money wages are again not above their discounted marginal value products.
- 47. Mr. Frank Chodorov, in his The Income Tax—Root of All Evil (New York: Devin-Adair, 1954), fails to indicate what other type of tax would be “better” from a free-market point of view, than the income tax. It is clear from our discussion that there are few taxes indeed that will not be as bad as the income tax from the viewpoint of the free market. Certainly sales or excise taxation will not fill the bill.
Mr. Chodorov, furthermore, is surely wrong when he terms income and inheritance taxes unique denials of the right of individual property. Any tax whatever infringes on property right, and there is nothing in an “indirect tax” which makes the infringement any less clear. It is true that an income tax forces the subject to keep records and disclose his personal dealings, thus imposing a further loss in his utility. The sales tax, however, also forces record-keeping; the difference again is one of degree rather than of kind, since here the directness covers only retail storekeepers instead of the bulk of the population.