The White House's Bad Math — And How to Avoid Making the Same Mistake

Last week, the White House Council of Economic Advisors (CEA) released a paper encouraging state policymakers to shift from taxes on income to taxes on consumption. Although the CEA’s decision to insert itself into state policy deliberations was unusual, there was nothing novel or surprising about the core economic insight, which is consistent with the broad economic consensus that taxes on income are less economically efficient than taxes on consumption.

Where the CEA went wrong is in attempting to calculate the rates at which a sales tax on a broad base of personal consumption could replace existing collections from states’ current individual income, corporate income, and sales taxes. The CEA estimated that an average rate of 6.23% would suffice. I ran the numbers for a Tax Foundation analysis and came up with 17.51% as a national average.

My goal in today’s newsletter is not to pick on the CEA. Instead, I want to explain one of the ways their calculations went awry, because they weren’t the first to make this mistake and they won’t be the last. Perhaps this explanation can spare others some embarrassment and provide useful insight into how to calculate the potential revenue effects of sales tax base broadening.

Let’s use Connecticut as an example. The state currently imposes a 6.35% sales tax, a corporate income tax with an 8.25% top rate, and an individual income tax with a top rate of 6.99%. (As an aside, the state’s income tax features a highly unusual recapture provision, which phases out the benefit of lower rates. In other words, high earners pay 6.99% on all taxable income, not just marginal income.)

The White House believes that these taxes can all be replaced with an 8.77% broad-based sales tax. I’m going to show you why the real rate is at least 17.22%.

Here’s what the relevant taxes raised in Connecticut in FY 2025. The pass-through entity (PTE) tax is an extension of the personal income tax on pass-through businesses, with PTE tax payments credited against ordinary individual income tax liability.

• Individual Income Tax: $12.96 billion

• Corporate Income Tax: $1.40 billion

• Pass-Through Entity Tax: $2.37 billion

• Sales and Use Tax: $6.46 billion

• Total: $23.21 billion

That’s the number to replace: $23.21 billion. Now let’s figure out how to get there.

To their credit, the CEA attempted to design a tax that only applies to final consumption. (About 41% of current sales taxes fall on business inputs.) I will follow their lead on this.

Adjusting to match fiscal year data, Connecticut’s total FY 2025 personal consumption expenditures ran about $251.5 billion. If sales tax were imposed on every last dollar of personal consumption in Connecticut, the replacement rate would be 9.23%, already slightly above the White House’s estimate of 8.77%. We should also recognize that no tax gets perfect compliance. Sales tax revenue estimates typically assume 85–⁠89 percent compliance. At 89%, the revenue-neutral rate is 10.37%.

But stopping there would be fantastically wrong. Even the CEA’s faulty calculations recognized this.

The Bureau of Economic Analysis (BEA) publishes an annual series called Personal Consumption Expenditures. It’s a measure of the economic value of personal consumption, not of transactions. Even if you’ve paid off your mortgage, for instance, you “consume” housing services by living in your own home, which the BEA estimates with an imputed rental price of owner-occupied housing. The sales tax couldn’t apply here even if policymakers wanted it to (and they don’t), since there’s no actual transaction.

The CEA claims it accounted for three exceptions—housing plus two preferential policies:

• The sales tax would not apply to rent or housing more generally.

• The sales tax would not apply to groceries.

• The sales tax would not apply to any category of good that is already taxed under an excise tax or other selective tax (gasoline, alcohol, tobacco, etc.).

Adjust for those (I only included the selective taxes they mentioned, plus insurance, which is subject to insurance premium taxes), and now we’re at 14.13%. And we’re still not done.

As I noted in my Tax Foundation analysis, the CEA’s base includes, among other things:

• All healthcare expenditures, including those covered by private insurance (funded by premiums subject to separate excise taxes) and those paid for by government through Medicare, Medicaid, and other programs (which cannot be taxed as a matter of law).

• Consumption that does not involve a financial transaction, including the full imputed value of banking services that are largely funded by banks’ reinvestment of depositor funds, not by direct fees from depositors.

• The value of services provided by nonprofits at free or subsidized rates, including scholarships and endowment subsidies that reduce college tuition, free or subsidized medical care, aid provided by charitable organizations, and the full operating expenses of houses of worship (none of which are transactions and none of which could be subject to sales tax).

• Other purchases that are not legally taxable, including internet access and purchases from the US Postal Service.

Excluding anything else that doesn’t involve a transaction (uncharged banking services, growing produce on your own land, etc.) and anything that can’t be legally taxed (Medicare, Medicaid, USPS deliveries, internet access, etc.), brings the rate to 20.10%.

But the CEA did offer some preferential exemptions, for groceries and items subject to separate excise taxes. There are arguments against these exemptions, and they certainly aren’t legally or practically necessary, though they’re certainly popular. Adding those back to the base yields the minimum possible legal rate, if lawmakers are willing to adopt a truly broad-based sales tax that falls exclusively on final consumption (avoiding any tax on business inputs).

That rate is 17.22%.

Finally, if policymakers couldn’t stomach taxing health care (beyond government-provided services), private education, financial services, and professional services (accounting, legal, etc.), and also adopted the exemptions the CEA incorporated in its plan, the replacement rate would skyrocket to 30.40%.

Incautious use of the PCE series has led many people awry, not just the economists at the CEA. Perhaps others can learn from their mistakes.

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