A flat tax, a national sales tax and a VAT, compared for one family

Every few years someone discovers that the tax code is complicated, and announces a plan to blow it up. The plan arrives with a bumper-sticker name, a post-it-sized tax form, and a promise that April 15 will become just another Tuesday. I like the instinct. I also like reading the fine print, because the fine print is where reform ideas either keep their promises or quietly become something worse.

Three ideas come up again and again on the right: a flat tax, a national sales tax, and, in the mouths of people who should know better, a value-added tax. They trade off simplicity, visibility and fairness in very different ways. One of them is a trap for anyone who wants a limited government. Let me show you the table, then the family, then the trap.

Four systems, defined

Terms first, because three of these four are routinely confused.

The current code. The federal income tax under the Sixteenth Amendment, with seven marginal brackets running from 10 percent to 37 percent after the 2018 law, a standard deduction, a thicket of credits and phase-outs, a separate corporate income tax, payroll taxes, and an estate tax. Wages, investment income and business profits are taxed under different rules.

The flat tax. Proposed by the economists Robert Hall and Alvin Rabushka of the Hoover Institution and set out in their 1985 book on the subject. One rate applies to all income above a generous family allowance. Wages are taxed once, at the worker's level, with the allowance protecting a basic income. Businesses are taxed on a cash-flow basis, the difference between what comes in and what is spent on wages, supplies and investment, at the same single rate. There are no other deductions and no separate tax on savings, because interest, dividends and capital gains are taxed once, at the business level, and not again in the saver's hands. Steve Forbes made it a signature campaign idea in 1996.

The FairTax. A national retail sales tax. It repeals the personal and corporate income taxes, the payroll taxes and the estate and gift taxes, and replaces them with a single tax on purchases of new goods and services. The headline rate of 23 percent is a tax-inclusive rate: tax divided by the total price paid. Stated the way a store states it, as a percentage added on top, it is 30 percent. Check the arithmetic: a $100 item carries $30 of tax, the buyer pays $130, and $30 divided by $130 is 23 percent. To protect low spenders, each household receives a monthly check, called a prebate, equal to the tax on spending at the poverty line.

The value-added tax, or VAT. A tax on the value added at each stage of production. A farmer sells wheat to a miller, the miller sells flour to a baker, the baker sells bread to you. Each seller charges tax on the full price of the sale and then takes a credit for the tax already paid on its inputs, so the government collects only on the value that firm added. Nearly every other developed country has one. The United States does not. The tax is built into the price and the receipt often shows it only in a small line at the bottom, or not at all.

The comparison table

I want you to look at the last two rows. They are the whole argument.

One family, three bills

Picture a family of four in Ohio. This is a hypothetical, with round numbers chosen for easy arithmetic and not taken from any bill's actual rates. The family earns $80,000 in wages and spends $70,000 and saves the rest.

Under a flat tax, suppose the single rate were 20 percent and the family allowance were $30,000. The family would owe 20 percent of the $50,000 above the allowance, which is $10,000. The return would fit on a postcard. The family's savings would not be taxed again.

Under a FairTax, suppose the rate is the 23 percent inclusive rate. The family spends $70,000 and pays 23 percent of that, which is $16,100. Now add the prebate. If the poverty-line spending for a family of four were $30,000, the prebate would be 23 percent of $30,000, which is $6,900. The net bill comes to $9,200. The family pays no tax on the $10,000 it saves until the day it spends the money.

Under a VAT stacked on top of the current income tax, the picture gets bleaker. Suppose a VAT of 20 percent is added, and nothing else is repealed. The family's $70,000 of spending contains tax: with a 20 percent tax added on top of prices, one-sixth of what it spends is tax, because the tax share of a price with a 20 percent markup is 20 divided by 120. That is about $11,667 of tax in the family's spending. The family still owes federal income tax on its $80,000. The family has gained a new bill and lost nothing.

The point is not that the hypothetical is realistic to the dollar. The point is the direction of the extra bill. The first two plans replace the income tax. The third, when it arrives in Washington, almost always arrives as an addition.

Steelman: the case for a VAT

I should state the best case for the VAT fairly, because it has smart defenders, some of them on the right.

One, a VAT taxes consumption instead of saving and investment, which is better for growth than an income tax that taxes the return on saving. Two, it has a very broad base and a low statutory rate, so it can raise a lot of money with little distortion. Three, it is collected in stages, so evasion is harder than with a single retail-level sales tax: a seller who hides a sale leaves a trail, because the buyer wants the credit. Four, nearly every developed country uses one, and economists know how to run it. Five, it can replace other taxes, such as the corporate income tax, and it is border-adjustable, which can help exporters.

Each of those points is true. Taken together, they describe a tax that is efficient, and that is the problem.

The answer: efficient is the wrong word to want

One: a tax that is efficient at raising money is a tax that is efficient at raising more money. James Madison wrote in Federalist No. 51 that if men were angels, no government would be necessary, and that in framing a government you must first enable it to control the governed and then oblige it to control itself. A good tax is one the people can feel. A VAT is built to be painless. The economic virtue, a broad base with a low and nearly invisible rate, is the political vice. If the rate is a few points and no one sees it, a few more points can be added with little protest. The OECD put the average standard VAT rate among its member countries at about 19 percent in 2024. Look up the rate of any country you like, the rate it started with and the year it adopted its tax, and judge for yourself whether the rate stayed put.

Two: it funds a bigger state. The European welfare states built on a VAT do not have the VAT in place of an income tax. They have both, and they spend a much larger share of national income than the United States does. A VAT did not cause that, but it made it politically easier to finance, by making the bill hard to see. Research on OECD countries finds that countries with a VAT collect somewhat more revenue relative to their economies, although the same research does not show that the VAT itself caused government to grow.

Three: the Sixteenth Amendment is already in the Constitution. A VAT added to the income tax means two federal levies on the same economy. The income tax is not going to be repealed by statute alone, because to end it the country would have to repeal the Sixteenth Amendment, and the people who will vote on that are the same people who today are told the income tax pays for Social Security. Without a repeal, a new consumption tax is not a replacement. It is a supplement.

Four: visibility is a feature of liberty. A flat tax puts the whole bill on a paycheck and a postcard. A FairTax puts it on a receipt. Both let a voter see the price of government, and a voter who can see the price asks whether he is getting his money's worth. A VAT is the only one of the three that hides.

The conclusion is simple. If conservatives want to simplify the code, they should insist that anything they pass repeals the old tax before it creates the new one, and that the new one is visible.

Which suits a country that wants limited government?

Each plan has costs.

The flat tax is the easiest to understand and it keeps the income tax's one great virtue, which is that it can be adjusted for a family's circumstances through the allowance. Its weakness is that a single rate is easy to raise by statute. Politicians would be happy to reintroduce brackets, deductions and credits, one by one, and we would be back where we started inside a decade. A flat tax needs a political guard rail.

The FairTax is the most radical in its design: no payroll tax, no income tax, no tax on the act of earning. It puts the visible price on every purchase and rewards saving. Its weaknesses are practical and political. A 30 percent add-on at the register is a shock, the prebate is a new monthly federal check, and critics say it invites a black market in used goods and personal services. It also takes the income tax out of the Constitution's mix only if the Sixteenth Amendment is repealed, and every serious version of the plan includes that guard rail for a reason: without it, a future Congress could enact the sales tax and the income tax together.

The VAT is the best-tested in the world and the least safe for a free people. It is worse in this country than elsewhere, because in places like Germany it replaced an earlier turnover tax, and here it would be new.

My verdict is this. For a country that wants limited government, the flat tax and the FairTax are both defensible, and a conservative should choose between them on the guard rails they come with. The VAT, added to the existing income tax, is the worst outcome on the table, because it hands Washington a second, harder-to-see revenue source without taking away the first. If a VAT ever appears in a reform plan, read the repeal clauses first. If the income tax and payroll taxes are not repealed in the same bill, you are not looking at reform. You are looking at a tax increase with a good public relations plan.

What the Founders would make of it

The Constitution lets Congress levy "Taxes, Duties, Imposts and Excises," in Article I, Section 8, and requires in the same section that "all Duties, Imposts and Excises shall be uniform throughout the United States." A national sales tax is an excise, and the uniformity requirement is a feature, not a bug. The income tax needed the Sixteenth Amendment in 1913 precisely because an income tax had been treated as a direct tax that required apportionment by population; the story of that bargain is in The Sixteenth Amendment and the 1913 bargain that built the income tax. A consumption tax does not face that problem.

The reason to care about the form is the reason the Founders cared about form. A tax is power, and power ought to be visible, limited and answerable. For the tax code that exists, a good starting point is tax complexity is a subsidy for lobbyists, and the code shows how it works. For the withholding system that makes the income tax feel painless, and therefore easy to raise, see withholding began as a wartime emergency in 1943 and simply never left. The question to ask of any reform is whether it leaves the voter better able to see what he pays and say no.

The case in brief

1. The current code is complex because it is full of exceptions that serve those who can afford to lobby for them.
2. A Hall-Rabushka flat tax taxes income once at one rate above a family allowance, and a FairTax taxes consumption at a visible rate with a prebate; either can simplify the code if it truly replaces the income tax.
3. A VAT is hidden in prices, efficient at raising revenue and nearly always added on top of existing taxes, which is why it should alarm anyone who wants limited government.
4. A VAT stacked on an income tax is the worst outcome: a new bill for the family and no relief on the old one.
5. Judge any reform by what it repeals in the same bill and by whether the voter can see what he pays.

What you can do: when any tax reform plan is introduced, read its repeal section on Congress.gov before you read its rates, and ask your representative in writing which existing taxes the bill ends.