Milton and Rocco are having a heated debate regarding a national sales tax. Milton argues that a national sales tax is a proportional, vertically equitable tax. Rocco argues that a national sales tax would be a regressive, vertically inequitable tax. Explain both sides of the argument.

Question

What will be an ideal response?

Answer 1

A sales tax by definition is a proportional tax-i.e., as taxable purchases increase, the sales tax rate (i.e., the marginal tax rate) remains constant. For this reason, Milton is correct. Nonetheless, when you consider that the proportion of one's total income spent on taxable purchases likely decreases as total income increases, the sales tax may be considered a regressive tax. For this reason, Rocco is correct.

Vertical equity is achieved when taxpayers with greater ability to pay tax pay more tax relative to taxpayers with a lesser ability to pay tax. One can view vertical equity in terms of tax dollars paid or in terms of tax rates. Proponents of a sales tax (e.g., Milton) are more likely to argue that vertical equity is achieved when taxpayers with a greater ability to pay tax pay more in tax dollars. Opponents of a national sales tax (e.g., Rocco) are more likely to argue that taxpayers with a greater ability to pay should be subject to a higher tax rate. This view is based upon the argument that the relative burden of a sales tax decreases as a taxpayer's income (e.g., disposable income) increases.