http://www.cato.org/pubs/pas/pa-272.html Uncle Sam already taxes themselves and the states by taxing their employees wages and salaries....
A Note on the Sales Tax and Government Output
Under the sales tax system outlined in this study, government output would not be exempted from the sales tax. Hence, government output is included in the tax base. Since this is an issue of some controversy, the following is a brief explanation of the logic for this tax treatment. [35]
Our goal is to create a sales tax system where the government can provide the same amount of output at the same real cost as it does under the current income tax structure. We want to ensure that the relative prices of a government service versus a privately provided service are unaltered after the tax shift. In sum, the government should be held harmless by the switch to the national sales tax.
The Gross Domestic Product includes both government value added and private value added. Government value added is included at "cost," which is approximately equal to the wages paid to its employees. Under the income tax, output is taxed whether the source is government or the private sector. The government pays its employees a gross amount and then deducts the income tax from their paychecks. IN OTHER WORDS, BY IMPOSING AN INCOME TAX ON THE WAGES AND SALARIES OF GOVERNMENT WORKERS, UNCLE SAM ESSENTIALLY COLLECTS A TAX FROM ITSELF. It could, of course, just pay them a lower tax-free wage, but we choose not to do that and have higher spending (from paying pre-tax wages) and higher tax revenue (from the income tax on wages paid by the government). If government did not impose a tax on the wages of government workers, then we would not want to do so under the sales tax regime, or else those workers would be adversely affected.
Subtraction method value added taxes or VATs (sometimes referred to as "business transfer taxes" or BTTs) do not typically tax government value added. By contrast, the Hall-Rabushka flat tax introduced by Rep. Armey (R-Tex.) and Sen. Shelby (R-Ala.) does tax the income of government workers. [36] Unlike a normal subtraction method VAT, the flat tax allows a deduction for wages and then taxes wages at the individual level. Its tax base is consequently larger than a normal BTT.
Similarly, under a sales tax system, if government payrolls were not taxed, the tax base would be smaller than it is under the current income tax and under the proposed flat tax. The rate of tax on all other goods and services would thus have to be higher than under the flat tax because of that difference in the tax base.
One way of examining this issue further is to simply take the National Income Product Accounts and start calculating the tax base under the various tax systems. If one goes through that exercise to demonstrate the oft-repeated equivalence of the various consumption tax plans, it becomes clear that the flat tax has a broader base than a sales tax that does not tax government output because the flat tax taxes government wages. Similarly, a pure income tax is broader not only by the amount of unconsumed capital income but also by the amount of government wages. [37]
In the context of a sales tax, then, a payroll tax on government wages simply achieves parity with the income tax and the flat tax. Failure to impose this tax would exempt government value added from tax for the first time and constitute a dramatic incentive to consume through the medium of government. [38] In other words, failure to tax government output would alter relative prices in favor of government output. A sales tax should also be imposed on government purchases from the private sector. [39]
Government Services and Purchases
The question of the proper tax treatment of government services--such as municipal garbage collection, utilities, visits to national parks, and rides on Amtrak--presents special problems. [56] To the fullest extent possible, a national sales tax should provide parity between government services and private services. Excluding commercial activities of the government from the tax base would provide a tax advantage when government is competing with private providers of services. Hence, when the government sells a good or service, such as public transit or publications, the sales tax should be imposed on the sale price. [57]
The complication is that most government goods and services are not sold in the marketplace. They are often given away and in many cases no market price exists for the services in question. Moreover, the recipients or beneficiaries of the services are unclear or unknown. For example, how would we allocate the benefits conferred on the public by national defense, the State Department, the Environmental Protection Agency, National Public Radio, or the White House?
Taxing this part of the economy is not as administratively simple under a sales tax as it is under an income tax. Government services are taxed by both the current graduated income tax and the flat tax--through the income tax imposed on government workers' wages and salaries (i.e., most of government value added). One conceivable way to tax government fully and equally under the NST system would be to impose a separate excise tax on government wages. That is the approach we have adopted in this study. [58]