If there is one thing that almost everyone can agree on, it’s that our tax code is too long and complicated. There have been many proposals on how to reduce and simplify our tax system, including replacing the income tax with a consumption tax.
A consumption tax is a tax on spending on goods and service and has many advantages including bringing the underground economy back into the system and eliminating individual taxpayer audits.
The invasion of privacy that occurs during an audit is necessary due to the nature of taxation. The IRS must determine if you are hiding income and will perform an invasive financial search. Audits are very intimidating and scary experiences for taxpayers, even if they have nothing to hide.
It would be hard to get Congress to switch to a consumption tax because it would mean sweeping change and bipartisan support and agreement. It would also mean nearly 100 years of a functioning system would go out the window. The switch would also bring job loss, not only in the government sector but also in the private sector: CPAs and EAs would need to find a new source of income. Well, that’s the lot of economic evolution. After all, once refrigerators became an ordinary household commodity, ice truck drivers found something else to do. And so we shall.
I think Congress also shakes its head at the idea because this new way of doing business would require an act of faith in every business in this country. Business ventures will be made honorary tax collectors and required to levy and then turn over the funds they receive. Businesses already must collect payroll taxes and sales taxes and they turn those over. However, if a consumption tax is enacted, every bit of tax revenue will be generated and transmitted by business.
Talk about putting all your eggs in one basket.
This is a legitimate source of worry, but there is also an easy and high-tech solution. According to the Federal Reserve Bank, the majority of daily transactions between a business and an individual occur with the use of a credit or debit card.
In an article for the Federal Reserve Bank of Cleveland, research analyst Nelson Oliver and economist Dan Littman, wrote: “When it comes to using cash, it’s like the flip of a coin: Americans still use cash roughly one out of every two times they buy something. And for transactions of less than $10, physical currency—banknotes and coins—rules. Although less popular for higher-value transactions and rarely used in the fast-growing realm of online commerce, cash remains the most common method of payment for goods and services the world over.” Statistics show that debit and credit cards account for 51% of all transactions.
The more expensive an item, the more often a debit or credit card is used—meaning most of the tax revenues that would be generated via a consumption tax would come from credit or debit card transactions.
It would therefore be a simple matter to program bankcard processing machines to split the transaction and route the tax money collected in the transaction directly to the government’s coffers. The base price of the good or service sold would go directly to the business owner’s bank account. Tax on cash transactions would be the only funds entrusted to the business. Those taxes would be reported--just like sales tax is now--and paid over to the government. Or there could be a button to route that money directly to the federal coffers as well.
There would still be a need for audits – primarily to ensure the system is working and to prevent fraud. But in this case it would be a business audit, not one of those scrutinizing invasive audits at the individual level. Instead bank records would be examined to ensure that the monies received were distributed properly and that there was no underreporting.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.