Friday, May 19, 2006

Making Illegals Pay Up

If the government wants to make sure that illegal immigrants pay their fair share in taxes, it should use sales taxes rather than income taxes. The reason: Sales taxes are harder to evade. So says economist Bruce Bartlett in today's Wall Street Journal:

Illegal aliens probably pay very little state income taxes, but close to their share of sales taxes. Therefore, states that rely more heavily on sales taxes than income taxes are going to get more revenue out of their illegal aliens to pay for the expenses they incur.

This helps explain why California is burdened much more by illegal aliens than Texas. The latter has no state income tax and raises almost all of its state-level revenue from general and selective sales taxes. In 2005, Texas obtained 79% of state revenue from these sources. By contrast, California raised a majority of its state revenue from income taxes, with just 38% coming from sales taxes.

Thus Texas gets the vast bulk of its revenue from sources that are most likely to be paid by illegal aliens, while California gets the bulk of its revenue from sources that they are much less likely to

Update: Jason Furman emails me a well-reasoned rebuttal to Bartlett:

There are a lot of good reasons to switch to consider switching to a consumption tax (although an X-tax would probably be preferable to an add-on VAT with all the unnecessary complications associated with multiple tax bases). But I would not include broadening the tax base to include the illegal sector in my list: my understanding is that this is an often repeated fallacy.

For the sake of illustration, consider switching entirely from an income tax to a sales tax. Drug dealers and nannies would pay taxes when they go to the grocery store. But the employees/owners of the grocery store will no longer pay any taxes on the portion of their income they spend on illegal drugs and nannies. Ignoring complications like the timing of consumption and progressive taxes, the income of drug dealers and nannies that goes untaxed under an income tax is exactly equal to the consumption of formerly taxpaying workers that would no longer be taxed under a sales tax. No new revenue is raised.

Moreover, the economic incidence of taxes wouldn't change either. Although drug dealers and nannies appear to pay sales taxes, they would also have the special privilege of selling their goods and services sales tax free. With competitive markets, a 20% sales tax would lead to a 20% markup in the price of legal goods (with the markup going to the government) and a 20% percent markup in the price of nannies or drug dealers (with the markup going to the nannies and drug dealers, effectively reimbursing them for the sales taxes they appeared to pay). Everyone would have the same consumption patterns as before.

I assume that progressive taxes, systematically different savings rates, imperfect competition, or behavioral issues could all change these results somewhat, but I don't think the change would be first order and I'm not even confident that the sign would be in the direction of the Bartlett claim.