Will the FairTax Create “Welfare Families”?
From reader Hank Van Geison:
In order to protect lower income families from the regressive consequences of a national sales tax, HR25, the Fairtax, incorporates a “prebate” of taxes paid on consumption up to the national poverty level. But, however well intended, it appears that the Fairtax could eventually create approximately 50 million “Welfare Families”.
To explain: According to 2004 Census data, 132.2 million individual income tax returns were filed. Of these, 50.4% or 66.6 million family units reported adjusted gross incomes of $30,000 or less. Using AFFT Fairtax calculation work sheets, it is possible to estimate that, depending on family size, 50 million families with AGI’s ranging up to $30,000, could pay no net federal tax.
Under current law, approximately half of all Americans pay no income tax. But all workers pay the 7.65% payroll tax! Their contribution to the Social Security trust funds assures them of a retirement pension and medical care upon reaching the appropriate age. Under the terms of the Fairtax, an estimated 50 million family units will pay no net federal tax, yet they will all qualify for the same Social Security benefits that they would have received under current law. Is this “family welfare”good for the country?
Today’s retirees paid into the trust funds for from 40 to 50 years, and now pay nothing and collect pensions as well as medical care benefits. Under the Fairtax, these same retirees, depending on gross income, will resume funding the SS trust funds through their consumption taxes, essentially helping to pay the pension and medical care costs of the 50 million family units that pay no net federal tax. Is this fair?
What might be done? It is interesting to note that the latest Flat Tax plan continues to collect payroll taxes to fund the Social Security trust funds, and adopts a 17% flat tax to fund federal government operations. What would the Fairtax look like under a similar concept?
Using the 2007 Kotlikoff/BHI data base, the Fairtax rate without replacing the payroll tax revenue would be 14.5% inclusive, 16.9% exclusive including a prebate An important added benefit would also be that the total annual Fairtax prebate entitlement amount would fall from $485 billion to $305 billion due to the lower sales tax rate.
Readers might point out that the 50 million workers will surely increase their gross incomes over time and gradually begin to pay a net tax. And some will. But for those that are accustomed to getting only a cost of living raise every year, they will never get out of the “welfare family” category. As the cost of living rises due to inflation, pay increases, but so does the prebate amount. And the prebate increase is proportionately greater than the cost of living pay raise. The two diverge. Only by retraining or pursuing a higher education can lower income workers move out of the “welfare” category.
This issue won’t totally manifest itself for another forty to fifty years. But it might be more appropriate to address the issue on the front end rather than leave future generations to deal with the unintended consequences of the Fairtax.
Comments, anyone?
Why not replace the payroll tax (Medicare and Social Security) with a consumption tax?
True, a consumption tax would need to be paid by retired folks as well as working families, but that is consistent with a key reason Kotlikoff supports the FairTax in the first place. That is, by taxing consumption, we would be forcing retirees to help finance a portion of their current social security and medicare benefits. (Otherwise, as we know, the full burden of paying for social security and medicare benefits falls on working families; and that burden will only increase in the future.)
Also, since payroll taxes are already regressive, it won’t offend us liberals that much if we replace those taxes with a consumption tax, which everyone (even Joshua) knows is also regressive. [I do? -Ed.] I suppose we could throw in a modest rebate (similar to the FairTax), but I think that will just complicate matters and increase the tax rate.
As a bonus, we could simplify the personal income tax system, do away with corporate income taxes, and keep a moderate estate tax. Then — voila! — the perfect tax system.
Now if we can just fund universal healtcare.
I dispute this notion on a couple of fronts:
One: a cost of living raise is roughly the same thing as what one would get in a prebate raise each year, as they are often calculated in the same way (sing poverty level as a reference point). I don’t think the prebate will necessarily outpace cost of living/inflation (it is generally just indexed directly to inflation).
Two: the data that I have read about people’s incomes is that nearly no one remains at poverty level for 40-50 years straight. They move up and down with the slings and arrows of fortune. That should mean that on average everyone will pay a net tax over 40-50 years.
Three: I don’t believe anyone today is ‘assured’ of any SS pensions at all in 40-50 years. It’s supposed to go bankrupt as I recall. Either benefits will be down, taxes will be up, or the whole kit n’ kaboodle will be phased out. I think that for the next 30 years the only thing we can be assured is that today’s taxpayers will continue to pay for today’s retirees, and after that, there is a very good chance they’ll have nothing to show for it.
Good grief! It’s lonely being the only senior citizen participating on this blog. First Hayden wants me to accept the ideas of the worlds most liberal economics professor and his wealth redistribution plans. I’m not buying it. I paid in my share and I expect the government to keep their end of the bargain.
James, I agree that the prebate won’t outpace inflation, but the point I was making was that the tax free status will never change if both the prebate and the employee gross get the same COLA. A $20,000 gross with $18,000 taxable consumption, will pay $4140 in sales tax and get $4402 back in prebates, a $262 dollar “surplus”. Now, inflate both the gross pay and the prebate by 5% and the taxable consumption is $18,900, the tax is $4347, and the prebate is $4622, a $275 dollar surplus. It seems that the numbers diverge.
I’d like to see any source that says that everyone pays a net tax over 40-50 years. But even if that is accurate, does it really matter in terms of the fairness issue I raised? There may be a net tax burden, but won’t the retirement benefits far outweigh the tax burden?
As for your pessimistic outlook for Social Security, I would suggest you read Bill Bradley’s latest book. He believes that Social Security can be made solvent for at least the next 75 years (that ought to cover you?)by: (1) gradually raise the eligibility age to 70; (2) remove the earnings cap on just 2% of the amount over the current cap; (3) phase government employees into the system, and (4) calculate the annual COL index (and the prebate) using the chained cpi methodology. There now, that doesn’t sound too bad, does it?
We can agree to disagree on this one, but I still think that retaining the payroll tax has merit.
I don’t know if there is a source that says EVERYONE pays a net tax, but the things I have read by Milton Friedman and Thomas Sowell have generally dsiputed the entire notion of there being a permanent set of poor people that never have any financial mobility. Their work (or at times opinions of others work) seems to indicate that there is virtually no such thing as a permanent underclass of poverty-stricken citizens. Poor people are apparently, transients for the most part. There might be some small percentage that stay low enough be net tax gainers, but that is probably unavoidable in any tax system that provides any notion of relief based on ability to pay, and is unlikely to provide a standard of living acceptable to even the most indigent citizen.
As for Bill Bradley’s SS solution, I have heard about 50 different plans to fix SS. The problem isn’t unsolvable, it’s just that no one wants to touch it. People have been insisting on SS being insolvent ever since I can remember (I seem to recall my Mom telling me when I was about 9 years old that SS either wouldn’t be enough to live on or wouldn’t be there, and that’s what... 1985?). Serious SS reform has been attempted and tabled 10 times since I have been paying attention. Each time it had about 3 senators who wanted to do it, and each time it got shut down for increasing taxes or reducing benefits.
I will agree to disagree on the notion of payroll taxes. They just suck. Much smarter men than I have decried them on other places for years.
Case in point:
http://www.cooperativeindividualism.org/friedman-milton_interview-1978.html
Maybe I’m being dense, but I don’t see the problem. If, as Hank says, there are low-income workers who will never get out of the 0% tax rate, what’s the problem? The FairTax already sees its fiercest opposition from the left, who should be overjoyed at the prospect not having an equivalent to FICA for low-income workers.
For retirees, you can look at your FairTax burden after retirement as going into the trust fund and coming right back out into your pocket again in the coming months. Think of it as deferring part of your tax burden earlier in life until later in life. A temporary change could be made to Social Security to increase benefits for current recipients to offset the increased tax burden, slowly decreasing for people born in later and later years, until the offset reaches zero for people who haven’t started paying FICA at the time that FairTax is enacted.
Barry, you are far from dense!! The elimination of FICA taxes should be very appealing to all workers, and especially low income ones who presently pay no income tax, but still get socked with the 7.65% payroll tax.
However, as a representative of the seniors (AARP card and all that), you will have a tough time selling me on the concept of continuing to pay into the trust fund after retirement. Deferred tax burden? Not likely. I applaud you for your suggestion that benefits could be increased in order to offset the sales tax portion earmarked for Social Security, but it’s probably an added complication that won’t get much support until the 37 million AARP members get energized? Stay tuned!
One other point that should be noted. Most low income familes effectively don’t pay the Social Security and Medicare Payroll taxes anyway.
The reason is because of the earned income tax credit. The earned income tax credit is a negative income tax for low income earners. The money paid out through the earned income tax credit essentially wipes out the payroll tax liability for most low income earners.
Now it still *looks* on the books like they pay it. But if you pay $765 into payroll taxes and I give you a $800 earned income tax credit (net), are you really contributing to FICA and Medicare?
Quadrupole,
You are correct, however, only 2.975million returns in 2004 took the EITC. All single and married tax payers, regardless of gross income, paid a net tax when the FICA taxes are included in the calculations. It is only the married tax payers with two or more dependents and incomes below approximately $30,000 that got a net overall refund, and in 2004, there were approximately 5 million such returns.
I still think there is a vast difference between 5 million family units with no net tax burden today, and potentially 50 million “welfare families” under the Fairtax.
I would need to look into your figures a bit, but I would assume that vrtually 90% of the 50 million potential problem families you note up there will be paying net taxes (however small).
It would be those same married couples with kids that have a shot at a negative tax burden.
HOWEVER, I believe for those in situations of poverty, virtually all of them will get to at least a zero tax level or above. Why? Because they will more than likely spend every dollar of income they have to include their prebate. It will be very few of them at that low level of income who manage to save money (although it will probably be easier than before).
James, It’s nice to see you believe that the prebate is indeed “income” and will in all likelihood be spent and taxed accordingly. Believe it or not, I really got flamed on another website for making the case that many of those at or below the poverty level will actually pay a net sales tax when they spend the prebate. Folks kept insisting that the prebate was just a refund of taxes and was not income any more than a refund of income tax over payments was not income??? Some even went so far as to suggest a “prebate alpha” which would untax the prebate!? Where would that ever end?
As far as the impact of spending the prebate on the “welfare families” goes, you are right. I did a quick estimate and found that all single taxpayers below $20,000 gross would have a net tax burden if they spent the prebate. Married couples with gross incomes between $15,000 to $20,000 would also have a net tax burden (below $15,000 are still “welfare families”), and as you predicted, Married with 2 children still have a negative tax burden at gross incomes below $20,000. It’s hard to estimate what that does to my overall claim of 40 million (originally said 50 million but forgot to remove retirees from the data base–sorry!) , but it more than cuts the number in half.
All of these numbers are very rough, but my point was the unfairness of asking retirees to resume paying into the trust funds, and seeing tens of millions of workers pay net zero! This issue probably won’t go away, particularly when AARP and their 37 million members get engaged during debate on the bill–if that ever happens.?!
Well then we should clarify by saying that the FT will in fact not result in a lot of welfare families, but will instead take retirees out of the ‘welfare family’ category?
That’s ironic.
HR 25 does NOT exclude MONEY as a commodity, i.e., money is purchased millions of time daily via credit card purchases, loans of all sorts, mortgages, etc. Therefore, whenever ANY purchase is made (new or used goods) and there is a loan associated with that purchase that is not paid off in the first 30 days, the Fair Tax will be imposed on the amount of money used to purchase the item(s) sold. Because of this flaw in the law (HR 25), big ticket items will be taxed TWICE.
Example 1: John purchases a new Ford truck with a purchase price of $20,000. The purchase is financed by his credit union. He finances or purchases $17,000 in funds to pay for the truck. Taxes: Fair Tax plus state sales tax = $6,000 or 30% of the purchase. Fair Tax on money purchased (loan) = $3,900. How many John’s are going to be able to come up with approximately $13,000 to purchase and finance a $20,000 new vehicle. By the way, there is NO financing entity that will finance the tax and if they did that money purchase would also be taxed.
Example 2: William and Judy purchase a USED home for $200,000. They must purchase money (a mortgage) for $160,000 (20% down). Taxes to be paid = (1) Fair tax on the purchase of the house = none or zero because the house is used. (2) Fair tax on the money purchase or mortgage = 23% or $36,800. Therefore the new buyers must come up with $76,800 at closing. How many couples will be able to come up with that sum of money??
Example 3: Patricia goes to Sears and spends $250 on goods and charges the purchases on her VISA in January. She pays only $50 on that charge in February. Taxes: (1) Fair Tax included in the sale; state sales tax of 7% = $14.00 (actual cost of goods is about $200). (2) Fair Tax on the $200 balance on the VISA = $46.00.
The above will destroy big ticket purchases and create more personal bankruptcies imaginable.
Please respond factually, specifically, and intellectually based on the law HR 25.
DB Wilshin
Interesting reading above and I am also “retired on SS”. My take on the poor staying poor and others becoming poor is a more practical question: why should Sally Smith with 5 children from unknown fathers spend the new monthly check received for basics of food, housing, clothes when she already gets these from food stamps, Sec 8, goodwill, and other dependable welfare sources? She will take the new $ and buy extra retail or used items. So Sally will have LESS incentive to break out of the welfare cycle and by having more children can increase this new monthly check. Others who may be considering exiting the welfare lifestyle may reconsider when these checks start arriving every month to others in the neighborhood. The street price of crack, ice, cheese my fall in response to the new surge of cash in the welfare market.