I truly lament that I am getting to the point where I have real trouble understanding folk-economics. Unlike many economists I explain economics to a non-captive, non-economist audience regularly. Yet, still the ability to understand some of their thinking is slipping.
Here is an example. Ken Hoagland writes to the National Review to complain about an article that criticized the Flat Tax. He says
No, Mr. Ponnuru, the FairTax does not solve illegal immigration, but it does bring millions of illegal immigrants into the tax base as consumers — as well as the illicit profits, when spent, of drug dealers and others in the $1.5 trillion–a–year underground economy. The dramatic expansion of the tax base achieved by taxing consumption instead of earnings was ignored by Mr. Ponnuru, and answers his apparent bewilderment at how various income groups can all benefit under the FairTax without tax revenue declining.
Now, it just seems inescapable to me that if the Flat Tax sweeps these folks into the tax base by taxing their consumption, it must likewise sweep part of our consumption out of the tax base when we buy their services. That is, the drug dealer now pays tax at the grocery store but I now avoid taxes when I buy drugs.1
I am not sure how you think about this issue without that occurring to you, but apparently Mr. Hoagland has.
Now, of course I usually rail on the Flat Tax on the grounds that it will drive more people into the underground economy since the profit margins from doing so are so high. This is unlike a VAT in which the benefits from tax evasion are roughly proportional to ones legal profits.
However, to think that the Flat Tax eliminates underground evasion is just wild to me.
(1) Note to Mothers and Employers: I am using the philosophic “I” by which I mean one. Not me of course.