National Sales Tax & U.S. Fiscal Policy — Detailed Study Notes

National Sales Tax (NST) – Core Idea

• Replace the entire federal income-tax system with one federal sales tax collected at the point of purchase.
• Tax is levied in addition to existing state & local sales taxes.
• Administrative simplicity:
  • Could shrink or nearly eliminate the IRS.
  • Compliance shifts to retailers rather than individuals.

Immediate Mechanics & Examples

• Example: A TV priced at 1200 pre-NST might cost 1350 after NST (illustrative uplift).
• Everyone who makes a purchase pays the tax, so tax base includes the entire consuming public, not just wage earners.

Short-Run vs. Long-Run Economic Effects

• Short-run (SRC):
  • Higher consumer prices → reduced discretionary spending.
  • Possible chain reaction: lower retail sales ⟶ layoffs at Best Buy ⟶ laid-off workers buy fewer groceries ⟶ grocery stores cut staff, etc.
  • Could trigger a recession if implemented abruptly.
• Long-run (LRC):
  • Penalizes consumption, rewards saving/investment.
  • Higher household savings → larger capital pool → more investment in small businesses & long-term growth.
  • Addresses U.S. negative savings rate noted by Fed Chair Ben Bernanke (pre-2008): \text{Savings Rate}<0.

Household Resilience Arguments

• ~50 % of Americans reportedly cannot cover an emergency expense of 500.
• NST-induced saving could reduce vulnerability to shocks.

Distributional Concerns

• Regressive impact: lower-income households spend a higher proportion of income on goods => larger effective tax burden.
• Mitigations discussed:
  • Exempt “necessities” (e.g., groceries in Texas).
  • Impose luxury-tier rates on non-essential goods.
  • Politically contentious: which items qualify for exemptions/​luxuries?

Underground Economy Capture

• Cash-based/illegal activity often evades income tax but still buys goods, so NST would harvest revenue from:
  • "Pimps, prostitutes, drug dealers," weekend lawn-mowing cash earners, unreported tips, etc.

Political Feasibility

• Large, immediate consumer price hike → politically “suicidal”; unlikely near-term adoption.
• A governing party that passes NST would own responsibility for any induced recession and likely receive no political credit for long-term gains.

Fiscal Policy Measures – Four Quadrants

1. Tax Cuts
   • Short-term: \uparrow\,\text{Deficit} \ (\downarrow\,\text{Revenue}).
   • Politically popular (people keep more money).
   • Championed mainly by Republicans.
   • Potential LRC: growth could raise revenue (supply-side argument).
2. Spending Increases
   • Short-term: \uparrow\,\text{Deficit}.
   • Popular when benefits are direct; intensity of recipients > general opposition.
   • Typically promoted by Democrats, though both parties spend when in power.
3. Tax Increases
   • Short-term: \downarrow\,\text{Deficit} \ (\uparrow\,\text{Revenue}).
   • Politically unpopular ("Ask Walter Mondale ’84").
   • More often proposed by Democrats.
4. Spending Cuts (real, not baseline)
   • Short-term: \downarrow\,\text{Deficit}.
   • Unpopular when programs you benefit from are slashed (Greece riots, WI teacher protests).
   • Rhetorically favored by Republicans; limited follow-through (recent example: 9\,\text{billion} rescission = “drop in the bucket”).

Definition: Fiscal policy = any combination of tax and spending actions Congress/President take to influence the economy.

Historical Debt & Deficit Patterns

1980s – Debt Surge

• National debt rose from 0.8\,\text{trillion} (1980) → 3.2\,\text{trillion} (1993).
• Drivers:
  • Tax cuts concentrated on high earners (supply-side revolution).
  • Spending increases: Medicare, Medicaid, and defense (e.g., “Star Wars” Strategic Defense Initiative).
  • Philosophy: outspend USSR → intensify Soviet financial strain.

1990s – Budget Surpluses

• Perfect-storm contribution:
  • Mild tax hikes (George H.W. Bush, Clinton).
  • Actual spending cuts via GOP-Congress vs. Clinton standoffs (1994 "Republican Revolution").
  • Economic boom (Internet era).
  • Debate: Did 1980s tax cuts lay groundwork for 1990s prosperity? Economists disagree.

2000s–2020s – Large Structural Deficits

• Presidents Bush 43, Obama, Trump, Biden: deficits routinely >1\,\text{trillion}/yr.
• Ongoing factors:
  • Tax cuts (2001, 2003, 2017, etc.).
  • Entitlement growth: Medicare (average worker pays 100\,000, receives 300\,000 benefits), Social Security.
  • War spending: Afghanistan, Iraq.
  • Stimulus responses to Great Recession & COVID-19.

Macroeconomic Theories Guiding Policy

Classical (Laissez-Faire)

• Associated with Adam Smith, "The Wealth of Nations" (1776).
• Belief: Invisible hand ensures self-adjusting equilibrium. Govt interference distorts markets.
• Dominant in U.S. from Civil War → 1930s.
• Overlaps historically with Social Darwinism ("survival of fittest" applied socially/​​economically).
  • Extreme European manifestation: Nazi eugenics/​​Holocaust.

Keynesian Economics

• Founder: John Maynard Keynes.
• Bottom-up philosophy: In recession, govt should increase spending to boost aggregate demand and employment (e.g., New Deal "dig holes, fill them").
• Once recovery occurs, theoretically pull back spending (rarely followed).
• Backbone of U.S. policy 1930s – 1970s; still influential in Democratic platforms.

Supply-Side Economics (Trickle-Down / Reaganomics)

• Austrian-school roots; popularized in 1980s.
• Top-down view: lower marginal rates & deregulation for high earners/​​firms → spur investment, job creation, growth.
• Typical Republican alignment.

Quick Party Mapping (broad generalization)

• Democrats: Keynesian (bottom-up stimulus, progressive taxes).
• Republicans: Supply-Side (top-down tax relief, deregulation).
• Politicians often hold only superficial understanding of theories.

Political Symbols & Origin

• Donkey = Democratic Party; Elephant = Republican Party.
• Popularized by 19th-century political cartoonist Thomas Nast.
• Nast also shaped enduring U.S. imagery: Uncle Sam and modern Santa Claus.

Exam-Oriented Quick Hits

• NST would shift tax burden from income to consumption, potentially improving savings but harming low-income spenders.
• Fiscal measures’ short-term deficit effect is straightforward; long-term effect speculative.
• Know chronology: 1980s deficits ↔ supply-side + defense; 1990s surpluses ↔ mixed tax hikes/cuts + spending restraint + boom; post-2000 large deficits ↔ tax cuts + entitlement & war spending.
• Match theories to advocates: Smith → classical; Keynes → New Deal; Reagan → supply side.
• Define fiscal policy vs. monetary policy (Fed not covered for test).
• Symbols, dates, figures (9\,\text{billion} rescission, 50\% can’t cover 500, etc.) are fair game.