William Gale’s Calculation of Retail Tax Rate
William Gale published a study in the May 16, 2005 issue of Tax Notes titled “The National Retail Sales Tax: What Would the Rate Have to Be?” (link to PDF).
In the article, Gale argues that, in order to be revenue neutral, the national retail sales tax would need to be much higher than AFFT has calculated.
I am not an economist and have not read the full document; but as far as I can tell, this passage summarizes the thrust of his argument:
I show that even under the strong assumptions made in H.R. 25 — no avoidance, no evasion, no legislative erosion of the private consumption or the state and local government consumption and investment purchases tax base — the NRST [national retail sales tax] would still require a 31 percent tax-inclusive rate (44 percent tax-exclusive) to be revenue-neutral and hold government programs constant relative to current law over the next 10 years.
The differences between those rates and the 23 percent tax-inclusive (30 percent tax-exclusive) rate used in H.R. 25 can be traced to a mathematical or logical mistake made by advocates of NRST. When they estimated government revenues under the sales tax, they (implicitly) assumed that consumer prices (what consumers pay, including the sales tax) would rise by the full amount of the sales tax and that producer prices (what producers receive, net of the sales tax) would stay constant. But when they estimated government spending needs, they (implicitly) assumed that consumer prices would stay constant and producer prices would fall by the full amount of the tax.
Both sets of assumptions cannot be valid at the same time; either the first assumption overstates nominal revenues, or the second assumption overstates nominal required spending, or both. In any of those cases, the inconsistency has significant effects. If H.R. 25 were enacted at a 23 percent tax-inclusive rate, the resulting revenue loss relative to current law would be $268 billion in 2005, almost $600 billion in 2010, and more than $7 trillion over the next decade — even under the strong, optimistic assumptions noted above.
This quote begins near the bottom of first column on the second page, p 890.
Not being an economist, I have only a vague idea of what Gale is saying, and I do not know if his characterization of the AFFT’s methodology is correct.
While the AFFT rebuttals page contains a reply to two of Gale’s earlier papers critical of the FairTax, I was not able to find a rebuttal to this particular article.
If anyone (quadrupole, perhaps?) with a more sophisticated understanding of economics and the assumptions behind the FairTax would care to elaborate on these matters, I would welcome it.
UPDATE: I just found this posted (by Jibaholic) in the comments below a Free Republic article:
They [Gale, et al] even try to sneak in the old stunt [...] of removing government consumption in order to shrink the tax base and thereby dramatically raise the required tax rate
Can anyone verify whether or not Gale does this in the above article?
I’ll have a look at it…
Until then, it would be most helpful if you could tell me whether *my* series on revenue neutrality is comprehensible to you (I tried to break it up into easy to follow chunks):
Toward Demonstrating Revenue Neutrality
The Revenue from the Current System We Need to Replace
The Taxbase under the Current System
The Taxbase under the FairTax
Estimated Prebate Costs
FairTax Estimated Revenue and Revenue Neutrality
Why FairTax Revenue Neutrality Works
I know sharper minds than mine have done the computation of the check, but *I* at least feel much better seeing the computations in black and white where I can follow them.
OK, will do. I have begun reading your materials, but haven’t finished. Once I finish, I’ll let you know if I have any questions.
Thanks for taking a look at the Gale article. Be sure and note my “update” at the end of the post, as well. I think I was posting that about the same time you were reading.
Sleep is overrated, eh?
Finished…. And yes, your calculations make perfect sense. So now my question is, why did Gale come up with such different figures?
[...] Quadrupole just tipped me off that he has written a conceptual rebuttal of William Gale’s article in the May 2006 issue of Tax Notes, in which Gale argued that the tax rate would have to be much higher than 23% in order to be revenue neutral. [...]
A conceptual rebuttal. Wow! Where can we see this gem without subscribing to tax notes? Can’t we just get it on the web? Maybe for the same reason that this none of the “research papers” linked at Fairtax.org actually address Gale’s argument on this point?
Sure, there are multiple papers attacking Gale’s 2005 piece on the issue of Gale’s opinion that state and local governments might be inclined to resist paying fairtax on the goods and services purchases. I don’t find those attacks at all persuasive, but its really a minor point.
What seems telling is that in the midst of rebuttals to Gale’s sideshow, there lies a total absence from the fairtax site of Gale’s apparently careful and seeming airtight mathematical argument that fairtax simply has got it wrong by computing fairtax revenue from unchanged producer prices and government costs from reduced producer prices.
My apologies if I missed something on the fairtax site. If there’s a serious attempt to rebut Gale 2005 on his main point, I’d love to see it.
BTW, Gale 2005 most certainly did NOT attempt to sneak in the old stunt of removing government consumption. To the contrary, he actually purported to show mathematically that, assuming revenue neutrality, inclusion of government consumption in the base would not change the rate by so much as a penny. This certainly seems to bespeak a man who approaches fairtax with an open mind.
Sorry. I’m new to following this debate. I didn’t realize that fairtaxers have admitted “the Mistake”. I’m catching up now.