¶ … countries that do not have an income tax. The first are small tax-shelter countries that seek to attract high net worth individuals. Their economies of tiny, and based on the value of transactions that such individuals bring to the country. Monaco, for example, requires substantial amounts of money to be deposited into its banks, which allow those banks to lend the money out (Maverick, 2016). Such countries succeed because they are tiny, and have minimal local populations and infrastructure needs. Another type of tax-free country is the failed state. A place like Somalia lacks the infrastructure for collecting taxes, and therefore lacks them. But such countries also provide zero services for their people, and are entirely unattractive places in which to live, despite on paper being the libertarian paradise of zero government intervention in daily life. The third category are countries that generate sufficient revenues in other ways that income taxes are not necessary. Typically, this means oil. The United Arab Emirates is one of these countries. Many of the GCC states lack income taxes, as they derive sufficient revenues from their oil exports to fund their governments. In the past couple of years, lower oil prices have raised the specter of income taxes, illustrating that dependence on a single commodity for the national budget is not sustainable, especially when the commodity itself is not sustainable (Bouyamoun, 2016). Most Gulf states are currently running deep budget deficits in this environment of suppressed oil revenues. The reliance on the oil has made the UAE budget quite precarious, especially in an environment where its citizens are demanding higher levels of services. The UAE government tries to provide education and health care, and has also invested significantly in infrastructure as well. This is most evident in the largest emirates -- the oil-rich Abu Dhabi and the services-rich Dubai. Other emirates have much smaller budgets, and only receive some benefit from the federal coffers.

The United States could not adopt any of the different models of life without income tax. The UAE produces 2.82 billion barrels per day of crude oil and exports almost all of it. The country is almost entirely dependent on oil and gas exports for its budget. The United States does not have this luxury. The UAE ranks 8th in the world in crude oil production and proved reserves, but 29th in consumption (CIA World Factbook, 2016). The United States ranks 3rd in crude oil production and 11th in proved reserves, but is 1st in the world in consumption, so is a net importer of crude oil. While the U.S. has a much more diversified economy, such diversification has never in any country been a model that could sustain zero income taxes -- only the easy, found money of oil has been able to sustain a zero income tax rate.

The U.S. cannot balance its books now. The defense budget is 20% of the total budget, and while that could be pared down somewhat, it is unlikely that the U.S. would sacrifice its dominant position in the world for a lower tax rate. Indeed, the defense budget never really comes up in such discussions, despite the U.S. really only having two meaningful borders. It's not going to war with Canada or Mexico, and would annihilate the Bahamas or Cuba in less than a minute, but the U.S. has a global empire of interests to defend. It is not politically viable to cut social security, because seniors vote. While it may make sense to means test Medicare, again, seniors vote. And none of those cuts would get the U.S. to a balanced budget today. The problem with making budget cuts is that the biggest budget programs are also the most popular, and politicians have pretty much zero incentive to cut people's entitlements for long-term budgetary gain, because they are elected in the short run.

Even if significant cuts could be obtained, the numbers don't work. Income taxes in 2015 account for $1.541 trillion, with another $344 billion in corporate income taxes. The federal budget that year was $3.688 trillion in outlays. The total receipts were $3.25 trillion. Take away personal income taxes and the federal deficit would go from $438 billion to $1.979 trillion. The deficit as a percentage of GDP would go from 2.9% to 11.8%. The U.S. already has one of the highest debt-to-GDP ratios in the world, and this would only exacerbate that. There is legitimate risk that without income taxes, the U.S. would not only have to cut just about all of its entitlements and defense budget, but would also lose its credit...

So these are just a few of the disadvantages, to say nothing of how many millions of people would lose their jobs -- good jobs, at that -- without the income tax. There are zero advantages to this model for the U.S., so it would be absurd to pretend that there are.
There is no particular way for the U.S. to replace that revenue. The only countries that have been able to do this are tiny countries with low overhead that have positioned themselves as tax havens. The U.S. does not have this low overhead -- without a nation full of high income earners it has to keep its entitlements, and its global empire requires a strong military. So it would have to replace the revenue. The U.S. will not become the global hub for high net worth individuals simply by abolishing the income tax, not the point where the government could ever replace that revenue. The U.S. has a lot of petroleum, but uses it, so will never be a major oil exporter. If the U.S. cannot cut its costs to account for the decline in revenue, and cannot increase its revenue either, then there is no conceivable way to increase the income tax.

Then comes the question of how to execute a zero income tax model. Now this is a stupid exercise. Replacing $1.5 trillion in revenue? Not going to happen. The proposed tax base can only be corporations. Would taxpayers at certain income levels be exempt, or should they? In a zero income tax model, they are all exempt, by definition. The IRS wouldn't calculate a tax rate because the tax rate would be zero. Tax equity is a pipe dream. It doesn't exist now, and it won't exist under any other system either. There isn't even a consistent definition of equity -- is a flat tax equity? Or is distributive justice more important? Equity isn't even part of tax policy, not in the U.S. or anywhere else, so why this is even mentioned as a criterion I have no idea.

So where does revenue come from? Corporate taxes would have to quintuple. Good luck with that. Corporations have the ability to move, and they will. The U.S. would instantly become the least competitive country in the world, well maybe still ahead of North Korea, but that's about it. Corporations would bail en masse, and the economy was be utterly annihilated. Canada's national budget would look a lot better, with all those new corporate HQs setting up camp there. Government expenditures would be cut significantly to account for the revenue shortfall, because quintupling the corporate tax rate wouldn't quintuple the corporate tax revenue. Tax revenues would collapse almost entirely as economic activity grinds to a halt under this scenario.

A more reasonable scenario might be a national sales tax, which most OECD countries have, but with the collapse in economic activity, it is doubtful that this would be sufficient to make up those revenues. In April 2016, U.S. retail sales were $453 billion (Reuters, 2016). Assuming a more normal $445 billion monthly, total retail sales annually are in the range of $5.34 trillion. To account for zero income tax, and maintain full government spending, the sales tax would have to be around 28.8%. So higher than in Scandinavia. Even discounting the instability that would cause, and the fact that a sales tax is regressive, this would be a tough sell politically, but at least it makes the numbers work in a crude, back of envelope way. But such a move would suppress GDP, because it would reduce the buying power of people who are below the income tax threshold currently, and reduced economic activity might cause the actual revenues from this plan to drop below the expected revenues.

In the unlikely event that replacing the income tax with a massive sales tax near 30% does not have a significant cooling effect on the economy and actually just replaces revenue dollar for dollar, fiscal policy can still be adhered to. Monetary policy has nothing to do with this question; the Federal Reserve implements monetary policy, not the IRS.

References

Bouyamoum, A. (2016). Get ready for taxes, Christine Lagarde tells UAE and other Gulf nations. The National. Retrieved May 13, 2016 from http://www.thenational.ae/business/economy/get-ready-for-taxes-christine-lagarde-tells-uae-and-other-gulf-nations

CIA World Factbook (2016). United Arab Emirates. Central Intelligence Agency. Retrieved May 13, 2016 from https://www.cia.gov/library/publications/the-world-factbook/geos/ae.html

Maverick, J. (2016). Five countries…