Abstract - A national retail sales tax has surfaced as a potential replacement for the current system of federal income taxation. A primary concern is that the revenue-neutral required tax rate may easily exceed 30 percent, leading to tax base erosion through widespread avoidance and evasion. This paper examines specific avenues for avoidance and evasion for both firms and individuals under a comprehensive national sales tax and discusses implications for the underground economy. The analysis shows that opportunities for avoidance and evasion will be sustained, not eliminated, by a change in tax structure. Unfortunately, lack of experience in administering a high-rate, indirect tax system precludes definitive statements regarding the likely extent of tax base erosion under a national sales tax.

INTRODUCTION

The current regime of personal and corporate income taxation evokes strong criticism. The income taxes give rise to substantial efficiency losses, administrative and compliance costs are viewed as excessive, and the IRS is perceived by many to be overly intrusive. The search for potential replacements to the federal system of income taxation has led many in the direction of some form of broad-based consumption tax, ranging from a value-added tax (VAT) (and its close cousins, the various flat taxes) to a national retail sales tax (NRST).

Until recently, there was little serious discussion of an NRST as a replacement for the personal and corporate income taxes. An important reason for the shift in sentiment in favor of an NRST is the growing perception of success of state/local governments in administering the current retail sales tax.