Income Taxes vs. Consumption Taxes
In the discussion for the post “Would the Underground Economy Be a Problem?,” FairTax critic Hayden Kepner concluded his comments with:
So, at least for the forseeable future, we will be forced to rely primarily on the taxation of either income or consumption to fund the government, and, of the two choinces, I continue to believe it is much fairer to levy taxes based on income.
This strikes me as an important point. I am occasionally frustrated by the back-and forth of our FairTax discussions, when it’s clear that there is something more fundamental about which the parties disagree.
If Hayden (or, not to pick on Hayden, any other critic) is fundamentally opposed to a consumption tax, then any discussion of the FairTax’s likely impact on underground economy — or home prices or effective tax rates or retirees or tax evasion or... — is fundamentally beside the point.
Even if the critic’s arguments are demolished by the truly indisputable benefits of the FairTax ;-), he’ll only retreat again, publicly or privately, into the cave of “Sorry I just prefer the income tax.”
So I have two questions for people on each side of this discussion:
1. What are the pros and cons of an income tax?
2. What are the pros and cons of a consumption tax?
I look forward to reading your comments on this one, because I think it will drive us toward a truer understanding of the differences we sometimes bump up against in our discussions of the FairTax.
Income tax
Pros
-easier for govt to estimate revenues
-you’re sure that everyone is paying their “fair share”
Cons
-paperwork
-compliance costs in addition to the actual tax
- withholding makes it virtually invisible to most people, embedded taxes even more so
Consumption tax
Pros
-No paperwork
-limits the number of people/companies who need to worry about compliance
-transparent, you know exactly how much you’ve paid
-promotes saving (money grows pretax)
Cons
-puts many tax attorneys and tax accountants out of work
-congress won’t be able to promote individual activities/investments with tax breaks - too general
-discriminates against dumb or impulsive people as they will end up paying more. (joking on this one, but I could see some people making that argument.)
It could take an entire book to cover this subject. I will only try to cover a few of many points.
Simplification of tax collection is one of the most important aspects in favor of the Fair Tax. The huge savings that will result from greatly reduced compliance costs $250 billion; the impact on the economy from removing taxes from daily decisions made by business and individuals possibly $500 billion; the impact from $13 trillion (per Greenspan) being brought back to the American economy when the present tax system is changed; the increased competitiveness of American products against imports and when exporting; fewer jobs fleeing from America and more foreign companies investing in America adding more jobs..
We have talked a little bit about compliance cost reductions effect on prices. The real economic benefits from the Fair Tax have received very little attention. We have talked a lot about interpreting various details of the law itself and its impact on specific people. Opponents like to find an example where someone will be slightly worse off, but ignore the significant benefits to others at the same income level. Very few seem to be able or willing to look at the big picture and evaluate the plan objectively.
At a subjective level, I believe that people being taxed based on what they consume above the poverty level is much fairer than taxing income at very low levels and labor from dollar one. It incentivizes people to produce more and discourages wasteful consumption.
To me, their are two pros to taxing consumption. One regards system design and the other ethics.
From a system design perspective, taxing consumption seems to incentivize savings which increases capital which increases growth which increases the base. For a self-sustaining system, the consumption design appears to be far superior to income which would seem to have the opposite effect: reducing capital which restrains growth which limits the base.
From an ethical perspective, I think it is much healthier for all involved to measure wealth in terms of what a person spends rather than what they make. If person A makes $100 and person B makes $50 but they both live on $25, who is wealthier? Why should person A shoulder any more burden than person B if he is not enjoying life any more (to the extent that spending money brings enjoyment)? Of course, person A has a greater latent ability to enjoy life should he choose to do so - but if he does choose to do so, then he ends up paying more tax which should make everyone happy.
This perspective of fairness in terms of when to realize wealth also has a closer alignment with the benefits received from taxes. That is, if taxes fund government for the purpose of protecting the freedom of the market to operate and providing basic infrastructure for it to operate, then the more you spend, the more you are enjoying the benefit of these services and vice versa. So in this sense, taxation on consumption is akin to paying for a product at the counter when you receive the product as opposed to when you attain the means to receive it (regardless of whether you actually do receive it or even want to receive it) - the latter striking me as highly unethical.
Not to be glib or cynical, but I honestly don’t see any pro to taxing income - practically or ethically - it fails both tests for me.
As far as transparency and cost of compliance - neither is a function what is taxed, but how it is taxed. We could continue to tax income and have both transparency and low compliance if we wanted. Just eliminate all taxes other than personal income, eliminate credits and deductions, throw in a progressive curve on the rate, then crank up the rate to be revenue neutral and call it a day. Cost of compliance would drop dramatically and everyone would be able to clearly see the cost.
Joshua — This is a good exercise. Below are my thoughts, with the caveat that I am not defending the CURRENT income tax system, but just giving some thoughts as to the concept of a simple income tax versus a simple consumption tax.
INCOME TAX:
Pros:
1. Progressive — Those who have more money and, presumably, have benefitted more from our political/economic system pay more in taxes to sustain that system. Those on the bottom rung of the economic ladder pay less.
2. Easy to collect (for the most part). Most taxes collected via automatic payroll deductions.
3. Relatively easy to verify (for the most part). Employers report wages to government. Banks and brokerage firms report interest and dividends.
Cons:
1. Complexity. (This could be reduced by eliminating deductions, credits, exemptions, etc.)
2. Economic cost to businesses. (This could be reduced/elimintated by eliminating the corporate income tax.)
3. Potential for tax evasion. Particularly by the self-employed, owners of private companies, and those with the means to stash cash and securities in off-shore accounts.
4. Fairness. Middle class and high income families, are frustrated at their high tax burdens when they seem to receive little or no tangible benefit from their taxes. (See Perfectly Legal, by David Cay Johnston, for a good analysis of how the upper-middle class is screwed under our current tax system.)
CONSUMPTION TAX
Pros:
1. Relatively easy to collect.
2. Consumers will have (somewhat) more discrection on when to pay tax and how much tax to pay. (But this must be balanced against other factors, like unexpected medical costs, that could dramatically increase tax obligations, and other costs, such as health insurance, utilities, food and medicine, which people have less control over.)
3. Relatively stable tax base. (At least, that’s what I understand.)
4. Expanded tax base. In particular, the elderly retired would be taxed more than they currently are, which would force them to contribute more to Social Security and Medicare and reduce the tax burden on working families. Of course, the elderly retired or soon-to-be- retired would not consider this a benefit.
Cons:
1. Regressive. More of the tax burden will shift to the poor and/or middle class. (Even if the poor were “protected” by a prebate, this just increases the tax rate and shifts the burden up a notch onto the middle class.)
2. Fairness issues. Those who already own homes, vacation homes, yahchts, etc. will not pay taxes on these items. Those who are just starting out will be taxed if they decide to buy these high-cost items.
3. Opportunities for tax avoidance (i.e., buying used cars) and tax evasion (fake business purchases).
Hayden:
I am fairly new to this blog and I have not read all of the archives - so I don’t know how much this component has been discussed - but the way regressive and progressive are evaluated in any discussion I’ve been in on the issue is very problematic, but shouldn’t be.
In your pros for income tax you say,
>>Progressive - Those who have more money and, presumably, have benefited more from...>>
There is no tangible basis to argue that having money in and of itself is beneficial. The only way benefit can be derived is when money is spent. You cannot actually extract the value of money until you consume it. Just like you cannot extract the value of a product until you sell it.
I can’t help but think that’s why you use the qualifier “presumably”. From that I take that you mean that “because they have more money they will more than likely choose to extract more benefit from it”. So, if this qualifier is necessary, it would seem that we know and recognize where the benefit lies - in spending. So why base an index on something that is presumed? By definition that means that you will be wrong some percentage of the time. Why not base it on the real thing? That way you are guaranteed to be right 100% of the time. By this I mean that when you presume that someone will spend more because they make more but then they don’t - your presumption fails at which point it becomes unfair.
You then say in your cons for consumption tax,
>>1. Regressive. More of the tax burden will shift to the poor and/or middle class.>>
Again, this argument rests on the assumption that unspent money has benefit by itself. In a consumption model, the poor are not those that make little - they are those that spend little. And the wealthy are not those that make alot, they are those that spend alot. So in that case, the wealthy do in fact have a higher burden than the poor. But in proportion to the base it is neither more or less so, by definition, it is flat.
The problem lies in comparing two systems using two different calculations in which the tax base is switched. The definition for regressive-progressive is Tax / Base. So, for instance, “tax-on-income / income” or “tax-on-consumption / consumption”. However, when one says that consumption tax is regressive, they are using the calculation “tax on consumption / income” which does not provide any meaningful relationship assuming that unspent money has no benefit.
If you really want to compare the regressive-progressive effect of a consumption tax in a mathematically correct manner, you have to treat the future tax on unspent income as deferred and include the deferred taxes with the taxes paid now. Of course, if you do this, the result becomes flat, which is what it really is.
Mark:
Wow, well said.
Joshua
Joshua, thanks. Let me offer one other perspective.
I don’t think that it is a political statement to say that government’s first and only imperative is to protect and provide for an economy. Clearly, the government can’t exist without an economy and vice versa. In the politcal realm we can debate all we want that it should also do other things - but I think everyone would agree that it can only do those other things after it has cared for its economy.
Going further, the only outcome from an economy is product. So if an economy cannot exist without government and if the economy’s only reason to exist is to produce product, then the cost of the government becomes a cost of the product.
So to make a product the producer might buy materials and then buy labor to process the materials. He also has overhead costs such as a building to keep the materials and labor out of the elements. Then he needs a police force to keep the vandals and thieves out of the building and he needs a military to keep other vandals and thieves out of the country and he needs roads to move the materials and the finished product.
Obviously the last three items are government costs. And just as obviously, they are a cost of bringing the product to market - there is no difference between those costs and the other costs. So if it makes sense to most people that the cost of products such as material and labor should be recouped in the sale price, why would the costs of government be any different?
The problem is, since the cost of government is a function of the cost of products, the only way we can proportionally and reliably collect it is through the sale of the product. We are certainly welcome to recoup it any way we want. For instance, we could recoup it based on one’s hair length. But that has no relationship to how much of the government service the person is receiving.
Similarly, income has no direct relationship to how much the person is receiving. As Hayden suggests, we can presume a loose relationship. But because there is no direct relationship between, people will get a windfall on some days, a penalty on others and a fair shake on still others. So not only is it destined to be not fair, it is also destined to be inefficient becuase it will do unpredictable things like rise when the system needs it to fall or stay the same when it needs it to rise. That’s because it is based on something totally arbitrary. There is just no way to make it predictable and reliably fair unless it is recouped on the sale of products.
Mark –
You made two comments that I completely disagree with, but interestingly enough, those are the same arguments that Kotlikoff gave me when we were discussing this very issue. So perhaps economists and quantitative types (which you seem to be) think alike on this, though I would argue that it doesn’t work that way in the real world.
Below are your comments with my responses.
1. “There is no tangible basis to argue that having money in and of itself is beneficial. The only way benefit can be derived is when money is spent. You cannot actually extract the value of money until you consume it.”
If you really believe this, then I suspect that you are either a quantitative economist type or still so young that the concept of saving and investing has not sunk in yet.
By saying that money has no benefit until it’s spent, you are ignoring the value of saving and investing, which to many people — particularly middle and high income families — have more tangible and psychological benefit than spending.
Believe me, a family that earns $200,000 per year and spends $50,000 gets a lot more enjoyment out its spending than a family that earns and spends $50,000. The first family knows that it is financially secure, that the breadwinner(s) will someday be able to quit their jobs, and “don’t sweat the small stiuff.” The second family knows it is living day to day, would be financially ruined if its breadwinner(s) ever lost their jobs,and probably agonize over their bills every month. To say that their respective spending gives them anywhere close to equal enjoyment is completely naive. (Sure, you have some families that spend money recklessly on “fun stuff”, but generally they grow out of that as soon as they have kids.)
Moreover, you are confusing “spending” with “taxable spending.” The richer family might buy a lake house, vacation in Europe, or send its children to Harvard, each of which would give that family much enjoyment yet all be tax-free under the FairTax. The second family might have high medical costs, pay expensive rent for a crappy apartment, have high utility and car insurance bills, none of which would provide that family with any enjoyment, yet it would all be taxable under the FairTax.
So, back to my point that I continue to make over and over, a consumption tax is going to weigh much more heavily on the poorer family than the richer family.
2. “If you really want to compare the regressive-progressive effect of a consumption tax in a mathematically correct manner, you have to treat the future tax on unspent income as deferred and include the deferred taxes with the taxes paid now. Of course, if you do this, the result becomes flat, which is what it really is.”
This assumes that a family is eventually going to spend all of its savings. Maybe that is the case in the theoretically world of economics, but the whole point of saving and investing in the real world is to build up a big enough nest egg so that one day you can live on interest, dividends and earnings, while leaving the principal alone and allowing it to continue growing in value.
As an extreme example, Bill Gate’s decendants will never, ever need to sell a single share of Microsoft. They could live like kings off dividends forever while the value of their holdings appreciate. (Sure, in real life they would probably diversify their holdings, but the point is the same.) Those of us with more modest holdings have the same general idea — let our assets accumulate in value and live off interest, dividends and earnings.
The point is, we all hope that our actual savings will never be spent, and thus never taxed. Again, maybe we would theoretically get more enjoyment in life we spent 100% of our incomes on taxable goods and services, but that ain’t the way it works in the real world.
i don’t know of any benefits of the current system from a taxpayers point of view other than a nice refund every april which just means you paid too much and let the government have an interest free loan for several months. i dispise the current system but i can be objective in a comparison.
1)current system- underground economy is untaxable. this includes drug dealers, prostitutes, under the table employees, illeagle immigrants, the mob and others that don’t pay taxes on income.
fairtax- the underground economy including all parties mentioned earlier love to spend money and it will not matter where the money came from when it is spent the tax will be paid.
2)current system- visitors and illeagal immigrants are not taxed
Fairtax- both visitors and illeagal immigrants pay the tax when they spend money
3)current system- payrole taxes(medicare, social security and income taxes) removed from your paycheck, even if you are poor and get a full refund on income tax portion you are still paying medicare and social security taxes on every penny you earn
Fairtax- you keep your entire paycheck and you get a monthly check to cover taxes on essentials up to the poverty level truely and completely untaxing anyone living at or below the poverty level.
4)current system- discourages hard work(the more you work the higher the tax bill)
Fairtax- encourages hard work(the more you work the more you make) if you spend $200 your tax bill is the same weather you earn $500 or $5000 a week.
i can go on for days but i have to go for now.
Hayden
In responding to the questing of taxing income versus taxing consumption, I am using consumption to build a system that attempts to align the payment for government services at the time the benefit of the service is realized and for the amount that is realized.
You, on the other hand, use income to align the payment with one’s ability to create the potential for realizing the benefit of the services (regardless of whether the benefit ever gets realized) and you justify the inevitable difference of realization vs. payment with a moral judgment that is indexed on the payer’s presumed emotional feelings of financial security. Specifically, those who feel more financially secure should pay more simply because they feel more financially secure (despite the fact that their heightened sense of financial security has no relationship to what they are paying for - that is, when they pay more taxes they do not get more financial security in return - in fact, its the opposite).
So, not surprisingly, the fundamental difference boils down to one system that seeks equality in the eyes of the law (in this case the law that levies taxation - thus the use of the term “fair tax”) versus another system that sacrifices legal equality in a search for equality of substance within a population. An age old argument to be sure and I won’t bother trying to resolve it here.
However, I would be interested in hearing your thoughts on why we should mix the two. Consider the cost of a product:
Material
Labor
Overhead
Government Services
Currently the first three are recouped at the time of the sale on a flat rate (my consumption model) while the fourth item is recouped arbitrarily (at least as it regards the sale) both before and after the sale and not based on the amount of the sale (your income model). So my question is, if your model is preferable, do you suggest applying it to the first costs as well? Shouldn’t the entire cost of the product be based on one’s ability to gather the potential to purchase (regardless of the amount actually purchased)? If that is what you want for item 4, why would not want it for items 1 through 3?
Joshua –
You started this thread with the question of the relative merits of a consumption tax versus an income tax in order to get a better understanding of how the two sides thought. I don’t think you could get a clearer example of the two philosophies than those of Mark and myself. Without trying to be insultive, I feel like we are living in parallel universes because I cannot even begin to understand his logic. Nor does he appear to understand mine.
Mark seems to equate the benefit of government with buying products and services, so that one would pay a portion of his or her share of government each time he or she bought a product or service. The underlying assumption seem to be that one “benefits” from government each time he or she purchases something; therefore taxes should be levied at the time of purchase in proportion to the price paid for the products or services consumed. In this way of thinking, one’s income has no relation to what one should pay for government (other than indirectly in that higher income individuals will have a greater ability to purchase goods and services.)
In contrast, it seems perfectly logical to me that taxes should be levied in some proportion to one’s ability to pay the tax. The underlying assumption is that those of us who are better off financially have benefited more from our economic/political system than those of us who are worse off. Hence, taxes should be levied more or less in proportion to ones income. In this way of thinking, the purchase of products and services has nothing to do with one’s responsibilty to pay for the government.
It’s like dog lovers versus cat lovers. A dog lover will never be able to convince a tax lover of the superiority of a dog as a pet or vice versa. They can’t even understand how the other person thinks. Maybe that’s the way it is with proponents of consumption taxes versus proponents of income taxes. We can’t even understand how the other person thinks. Like I said, maybe we live in parallel universes.
That’s interesting Hayden that you think our differences are not understood by each other. I understand your side perfectly - I know exactly why you like the income model. I don’t agree with its merits either eithically or practically - but I totally understand where you’re coming from.
Likewise I’m surprised that you don’t understand my model - it is very simple. I’m not surprised, nor do I expect you to like it - but it is not complex. My perspective assumes that government is (and can be nothing more) than a cost of production in the economy that supports it.
Just like you can’t make a chocolate shake without chocolate, you can’t make it without the military and the police. Therefore, just like you pay for the chocolate when you buy the shake, so should you pay for the military and the police. And if you drink 10 shakes a year and I drink 5, you are using twice as much military and police than I am, therefore, you should pay for twice as much.
Joshua,
Well, you asked for all the pros and cons of income versus consumption taxes, and I think most of them have been identified. We now seem to be engaged in esoteric discussions of “parallel universes” and “equality of substance” or whatever. Actually, I have no particular objection to the concept of funding the government through a consumption tax, I am simply opposed to the concept as outlined in HR25, the Fairtax. Here’s why.
In my opinion, the group of Houston tax lawyers that put together the bill seriously overreached. As a result, HR25 has the potential to become an economic disaster (at least initially), a social nightmare, and is a political non starter.
Economically, at a point in time when the federal budget is getting consumed by entitlements, the Fairtax $600B prebate entitlement will exacerbate an already disasterous situation. Protected from inflation, the prebazte will grow to over $1 trillion in a very few years, and heaven help us if inflation gets away from the Fed and we see a return to the Carter years.
One size (except for Hawaii and Alaska) really doesn’t fit all, and the proposed prebate will go to millions of citizens who don’t really need it.
The federal budget will see a huge deficit in the first year of transition due to the inventory credit feature as well as the added cost of governments taxing themselves.
And prices are going to rise by 15%-18% with unknown consequenses for everyone.
Socially, the prebate, coupled with the concept of getting rid of both income and FICA taxes, will create a new class of economic “freeloaders” who may never in their life pay any net tax to the government and yet will collect full Social Security retirement and health care benefits. That is just unacceptable in a democratic society. It is particularly unacceptable to this old retiree who, after faithfully paying FICA taxes for over 50 years, now learns that under the Fairtax, I will resume paying for the freeloaders through my sales tax dollars. How on earth can Fairtax advocates justify the creation of tens of millions of such “freeloaders”, a major departure from the very few families today that pay no net income and FICA tax due to the EITC refund.
Politically, despite 60 co-sponsors and an estimated 20,000 hardcore Fairtaxers, HR25 is going nowhere. Congress is basically conservative and prefer evolutionary change to revolutions such as the Fairtax. Risking the economy overnight on rosy scenarios provided by a few economics gurus just isn’t the Congressional style. The notion of completely untaxing businesses and lowering the tax burden on the wealthy just isn’t going to sell, particularly to the current regime on the Hill.
There are many more details that could be addressed–the devil really is in the details–but I’ll close by proposing a tax reform plan that would overcome all of my concerns and might even get Congressional approval. Bear with me, surely we have learned something after years of debate? I call it “Fairtax Lite”.
Fairtax Lite replaces the income tax with a 14% national sales tax levied on all private consumption. Here is a list of modifications to HR25 for consideration:
Hayden
Your position seems to be that taxes should be paid by those who can most afford them. The higher tax rate the better on those that earn the most money with low or zero rates on the poorest citizens. The idle rich find ways to avoid paying a significant amount of taxes. However, they consume a disproportionate amount of the nations resources. Large and numerous houses, many expensive autos, private jets and the very best of everything. Can’t these high living non taxpayers afford to pay toward the cost of government.
One of the biggest problems with the income tax/payroll tax is that it puts an undue burden on the working poor. The present system punishes those that produce and discourages producing more items of value to society. Most people measure their well being by how much of the good things of life they can afford to consume. Certainly, they save and invest and work hard to improve their lot in life even more. They want long term security. But, they also want to have that expensive auto and take exotic vacations and are willing to work for them.
If you want to make the fat cats pay for the government, the best way is through the consumption tax not the payroll tax. The way to improve conditions for the poorest citizens is to eliminate business taxes which are passed along to every purchaser at the same rate; rich and poor alike.
It seems to me that you are making a solid argument for the Fair Tax while blindly proclaim the virtues of the income tax.
Joshua,
Well, you asked for all the pros and cons of income versus consumption taxes, and I think most of them have been identified. We now seem to be engaged in esoteric discussions of “parallel universes” and “equality of substance” or whatever. Actually, I have no particular objection to the concept of funding the government through a consumption tax, I am simply opposed to the concept as outlined in HR25, the Fairtax. Here’s why.
In my opinion, the group of Houston tax lawyers that put together the bill seriously overreached. As a result, HR25 has the potential to become an economic disaster (at least initially), a social nightmare, and is a political non starter.
Economically, at a point in time when the federal budget is getting consumed by entitlements, the Fairtax $600B prebate entitlement will exacerbate an already disasterous situation. Protected from inflation, the prebate will grow to over $1 trillion in a very few years, and heaven help us if inflation gets away from the Fed and we see a return to the 18% of the Carter years.
One size (except for Hawaii and Alaska) really doesn’t fit all, and the proposed prebate will go to millions of citizens who don’t really need it.
The federal budget will see a huge deficit in the first year of transition due to the inventory credit feature as well as the added cost of governments taxing themselves.
And prices are going to rise by 15%-18% with unknown consequenses for everyone.
Socially, the prebate, coupled with the proposal to get rid of both income and FICA taxes, will create a new class of economic “freeloaders” who may never in their life pay any net tax to the government and yet will collect full Social Security retirement and health care benefits. That is just unacceptable in a democratic society. It is particularly unacceptable to this old retiree who, after faithfully paying FICA taxes for over 50 years, now learns that under the Fairtax, I will resume paying for the freeloaders through my 31%sales tax dollars. How on earth can Fairtax advocates justify the creation of tens of millions of such “freeloaders”, a major departure from the very few families today that pay no net income and FICA tax due to the EITC refund.
Politically, despite 60 co-sponsors and an estimated 20,000 hardcore Fairtaxers, HR25 is going nowhere. Congress is basically conservative and prefer evolutionary change to revolutions such as the Fairtax. Risking the economy overnight on rosy scenarios provided by a few economics gurus just isn’t the Congressional style. The notion of completely untaxing businesses and lowering the tax burden on the wealthy just isn’t going to sell, particularly to the current regime on the Hill.
There are many more details that could be addressed–the devil really is in the details–but I’ll close by proposing a tax reform plan that would overcome all of my concerns and might even get Congressional approval. Bear with me, surely we have learned something after years of debate? I call it “Fairtax Lite”.
Fairtax Lite replaces the income tax with a 14% national sales tax levied on all private consumption. Here is a list of modifications to HR25 that resulted in the 14% rate:
- Phase in over five years.
- Governments aren’t taxed
- FICA taxes remain in place.
- Education is taxed. (Don’t let the camel’s nose under the tent flap).
- No prebate. Let the States deal with the truly needy using existing social programs.
- No inventory tax credit.
So, that’s Fairtax Lite. You all claimed to really want to get rid of the income tax and it does just that. The phase in meets Congressional evolutionary needs, FICA taxes take seniors off the hook and put businesses back on the hook, somewhat.
Everyone might remember that all legislation is a compromise. Nobody gets everything they want, and the absolutely necessary needs to be separated from the nice to have.
Have a great Memorial day holiday!
In contrast to Hank’s idea, I’d prefer to replace the FICA taxes with a consumption tax. Replace one regressive tax with another, and keep a simplified progressive income tax.
I realize this will require old farts like Hank to be doubly-taxed (i.e., they’ve already paid FICA taxes while working), but — hey — screw ‘em!
Best to all.
There are numerous problems with some of Hank’s suggestions. Hank complains about paying Fair tax as a retiree after paying income tax on his money all the years he worked. I have no idea what Hank’s personal financial situation is. These comments apply to the average retiree. Today the retiree pays income taxes on 85% of his social scecurity, 100% on pensions and money withdrawn from his IRA (unless a Roth) and on any part time work that he does. His social security payment is at risk because funding depends on a labor force shrinking in size relative to the number of retirees. The fair tax that Hank will pay has to be netted against, the income taxes that he wont pay. What about not having to pay an estate tax when he dies. Is that worth anything?
I would like a system where there were no taxes and everyone had access to all the things they desire. Of course, that isn’t possible and we have to make compromises. The question isn’t; Is the Fair tax perfect? We have two viable choices the current system vs the Fair Tax. Which is the better system for the large majority of Americans.
I would prefer not to tax governments if we can avoid government providing more services to people to avoid the tax. This would certainly be abused. Also hundreds of billions of dollars of state and local tax burden would be transferred to the federal government. Prices on products and service to government would fall. Also, they would not be subject to employer share of payroll taxes. Do we want to make the federal government even larger?
How would states determine who deserves to receive the prebate? most of the income reporting mechanism will have been dismantled.
Transition inventory credits wont be as big a problem as many think. Remember the entire sale wont be exempt, just the cost basis of the inventory on hand at the effective date of the tax. How much markup does a retailer have? There will be no inventory of services to avoid being Fair Taxed. There aren’t more than a few months manufacturing inventory on hand and much of this is work in process or raw materials. With access to the data, it wouldn’t be difficult to put a number on it.
Hayden, I had considered introducing a small national consumption tax as a possible way to bail out Social Security. But I believe that FICA taxes really are just mandatory insurance premiums on a policy to provide some minimum support in old age. Nothing wrong with that, and I strongly believe that paying the premiums is an individual responsibility. I certainly don’t expect you to help me pay my car and home insurance and I don’t want to pay a higher sales tax in order to pay someone else’s premiums–tens of millions of someone elses it turns out.
If you believe Bill Bradley, the SS trust funds can remain solvent for the next hundred years by (1) raising the retirement age gradually to 70; (2) Raising the $94,000 cap on payments to the originally intended 90% of gross income (hurts the very wealthy, but “screw ‘em”, right?; and (3) revise the cost of living annual increases to more accurately reflect alternative buying habits. No problem doing all that, just need to get over the “third rail” mentality in Congress.
If you still believe its O.K. to screw us old farts by including FICA payments in the list of taxes to be replaced by the Fairtax, fine. But set aside a lot time for that project because there are over 37 million AARP members you will be screwing and most of them vote.
Marvin, you missed my point. As a matter of principle, I’m complaining about paying a higher than necessary Fairtax rate in order to pay for tens of millions of “freeloaders” that will pay no net federal tax (due to the inflation protected prebate) and still get full retirement and health care benefits. After paying FICA taxes all my working life, the idea of resuming payments into the trust fund through my sales taxes doesn’t sound fair to me! Simplify the Fairtax by taking FICA out of the equation, and you are well on the way to getting my vote! And possibly 37 million others?
As for how the States would determine who gets the prebate, you might also ask how the Federal government determines who gets the prebate? And the answer is they couldn’t, so everyone gets the prebate and a $600 billion gorrilla will be let loose in the annual federal entitlements budget. Income reporting data will still be required for SS purposes, so the States might have that basis for providing economic assistance. How do people qualify for food stamps and housing assistance today? Don’t you think that pushing the problem down to the State level might be a better approach. Or are you a believer that the Federal government is better equipped to deal with local issues? I don’t!
As for the inventory credit, you are right that the retailer markup will still be subject to the Fairtax, but my concern is really over the fact, written in the Boortz bible, that the cost of the inventory tax credit in lost revenue the first year is estimated at $365 billion. That is not an insignificant amount, and the federal annual budget deficit would soar, not a good political situation to have to deal with.
Hank -
you say that you don’t want to pay for others social security. It should come from the earnings of the individual. However, when you tax payroll the entire cost of the FICA tax ends up in the price of products that everyone pays for when they buy the products. Yes, half is deducted from gross salaries. But those gross salaries are included in the cost of products you buy. Those salaries are higher because of the payroll tax deduction. People are inspired to work by their net salary not the gross. The Fair Tax will give a immediate pay raise to every worker because FICA wont be deducted. Eventually slaries and wages will return to the same relationship to other items that are part of production. There probably wont be direct reductions to gross salaries. But, pay increases will be reduced until the market equilibrium is once again reached. This will reduce or minimize price increases for all products and services over time. This is how the eventual price reductions will reach the 20-25% level claimed by Fair Tax supporters.
All consumers will pay the same amount to the social security fund under the Fair Tax as they do today. The only difference is that it is hidden in product prices today and will be visible as part of the Fair Tax in the future.
Hank
You say a $600 billion gorilla will be let loose on the economy to the benefit of freeloaders. The prebate is now at about $465 billion I believe. As the population grows and prices increase and the poverty level is adjusted upward, the amount will undoubtedly reach $600 billion some years down the road. Of course this assumes that federal spending for other items will also increase proportionally. Whatever amount the prebate is there will be zero effect on the economy. XXX hundred billion will be injected into the economy by the prebate and the same amount will be removed from the economy via the Fair Tax on consumption up to the poverty level. As long as every citizen gets the same amount, this is just a transfer of funds to the government and back. More will ultimately be collected from those that consume more tp pay the cost of government.
To me a freeloader would be someone who is able to pay his own way but doesn’t make the effort to do so. There are some of those in our society today. But, the vast majority who don’t work or work at low paying jobs do so because that is all they are capable of. Mental or other disabilities, intellectually challenged, poor education etc doesn’t necessarily make a person a freeloader. The challenge to society is to encourage these people to be more productive; for their own good and for the good of society.
The prebate wont encourage more to freeload. It will only pay the tax on the necessites of life. They still have to acquire those necessities through some means. If the means happens to be welfare, then the prebate will keep welfare payments equal. The Fair Tax should reduce the amount of money paid to welfare receivers because prices will initially be 10% lower. Theoretically, the prebate should be lower if price reductions (before Fair Tax) reduce the poverty level.
I agree that any program is better administered at the lowest level of government that is possible and practical. In principle, I like the Libertarian idea of apportioning the federal tax bill to the states. The problem lies in how this can be done in a practical manner. As for the states determining who would get a prebate, it isn’t practical. You say through payroll tax reports to SSA. That is only one part of a persons income and doesn’t consider wealth. Besides, the SSA wouldd have to go to added expense to report all payroll data to the states. Welfare recipients today apply to local authorities for benefits. By whatever means they investigate and provide temporary assistance on a relatively small scale. Your proposal expands this area significantly.
Hank
If tax revenue lost in the first year due to transition inventory rules is $365 billion, that would be 16% of the total money raised by the Fair Tax including the prebate. This does not consider any economic growth and does not consider that people will have that $365 billion in their pockets. Spending it will spur economic growth.
I don’t like deficit spending by governments and think we should always pay as we go. However, I don’t think that the $365 billion not collected will directly result in a $365 billion deficit. We bloggers always deal with the economy as static because to do otherwise is far too complicated and requires guesses as to what will happen. But in truth, the economy is very dynamic and will respond positively to an extra $365 billion in peoples pockets. But to close the gap add a temporary 2% to the fair tax rate for one year.
Marvin, you wrote:”If tax revenue lost in the first year due to transition inventory rules is $365 billion, that would be 16% of the total money raised by the Fair Tax including the prebate. This does not consider any economic growth and does not consider that people will have that $365 billion in their pockets. Spending it will spur economic growth.”
I’m a little slow on the uptake, so how about a more detailed explanation about how that $365 billion got into my pocket? I paid that $365 billion last year through the embedded costs of the income tax as it affected prices, and now, the $365 billion is back in my pocket??? Just because the federal government doesn’t get it due to the inventory credit, why does that necessarily mean that I do get it? And can spend it and help the economy? Is it real?
Sorry, but our universes seem to be diverging lately.
Hank
Based on your writings, no one will ever accuse you of being slow on the uptake. With that respect and my propensity for mistakes, I reviewed my previous comments. In fact, I made two errors in that post. $365 billion represents 13.5% of the total Fair tax collected $2,700 billion. I forgot to include amount collected to cover the prebate. Second, I got lazy and jumped to the erroneous conclusion that if you didn’t pay the money as Fair Tax you would still have all of it in your pocket. However, you will only have 2/3 of the amount $243 billion left over. We agreed in an earlier discussion that prices before the Fair tax is added will decrease by 9%. Tax included price will be 18% higher (100-9 times 1.30 equals 118). You bought an item from inventory free of tax paying $100. with the fair Tax it would have been $118. You saved $18 which is still in your pocket. I know; like most of us, you spent it on something else.
For me, the biggest flaw is the “low income allowance/grant”. i do not think there should be such an allowance. Consider the 12 million “undocumented workers” and their families that would continue to benefit from the system without contributing to it. The only way for the “fair tax” to be truly fair is if it applies equally to everyone regardless of your status. State sales tax operates this way. Federal sales tax should be no different. It also removes the burden to the individual and the government for reporting and documenting income for purposes of the “low income allowance”.
Lastly, the sad fact is that the entirety of our taxation serves merely to pay the interest on the national debt.
Mark
I agree that our national debt and the interest on it are a concern. Continuing to run budget deficits is not good for the long term well being of America. Even though the economy keeps expanding and generating more tax revenue each year, congress continues to increase spending at an even higher rate. Buying more from international trading partners than they buy fom us is an even bigger concern.
By the “low income allowance” that you speak of, I assume you are talking about the monthly prebate. The prebate is based strictly on family size and goes to everyone equally without regard to income level. To apply for this “prebate”, you must have a valid social security number. To get a valid social security number, you must be a legal resident of the United States. There is no requirement to document your income level to qualify for the prebate.
Interest on the national debt now costs the government $400 billion per year. That amounts to about 18% of all the taxes now placed on income (corporate and personal), payroll taxes and estate taxes.
With the Fairtax bill as it stands, could the tax be avoided by leasing? If interest rates are low enough, one could easily lease any new product for 2 to 4 years with interest being less than paying the tax, then buy it used for the residual value at the end of the lease. I imagine someone already thought about this.
Mark B
Leases are explained under section 804. Finance costs and base product cost are “disaggregated” by best method available as spelled out in the act. The base cost is fair taxed in full on the date the lease is signed. The finance cost will be taxed according to the section on financial intermediation services. When the leased product is sold, it will be sold like any other used item with no tax on the transaction.
Leasing companies may work this all into lease arrangement so that the monthly costs are equal over the term of the lease but the leasing company would have to pay the Fair Tax upfront just like they will pay for the product upfront.
Marvin -
Perfect. My thought was that since ownership doesn’t change the tax wouldn’t be triggered. But obviously an exception is made for leases. Thanks.
Hayden says “In contrast, it seems perfectly logical to me that taxes should be levied in some proportion to one’s ability to pay the tax. The underlying assumption is that those of us who are better off financially have benefited more from our economic/political system than those of us who are worse off. Hence, taxes should be levied more or less in proportion to ones income. In this way of thinking, the purchase of products and services has nothing to do with one’s responsibilty to pay for the government.”
Can you say communism? “From each according to his ability; to each according to his need” Karl Marx
It boggles my mind for anyone to think that an individual should be required to pay a higher rate of tax simply because he has the ability to earn more. What about the expenses that the individual incurred to gain that ability to earn more? Shouldn’t it be deducted from his tax liability? To be honest, the rich pay a considerably higher tax rate than the poor and yet benefit much less from government. How many rich people receive handouts from the government?
Hank says “As for how the States would determine who gets the prebate, you might also ask how the Federal government determines who gets the prebate? And the answer is they couldn’t, so everyone gets the prebate and a $600 billion gorrilla will be let loose in the annual federal entitlements budget.”
The prebate isn’t an entitlement. It is simply a payment that RETURNS a portion of the tax paid by an individual.
Marvin says “...Tax included price will be 18% higher (100-9 times 1.30 equals 118). ...”
This is a rather inaccurate way to compute the FairTax. It really isn’t a 30% exclusive tax. It’s closer to 29.87%. The accurate way to compute the FairTax based on cost of product or service is
COPS = cost of product or service
FairTax = COPS / (1.00 - 0.23) - COPS, not COPS * 0.30
For example: If a product costs $12.48 the FairTax would be
$12.48 / 0.77 -
$12.48 = $3.73 ($3.7277922077922077922077922077922 unrounded)
it wouldn’t be
$12.48 * 0.30 = $3.74 ($3.744 unrounded)
Even if you used the more accurate 29.87% is still wouldn’t be 100% accurate like the first computation.
$12.48 * 0.2987 = $3.73 ($3.727776 unrounded)
COPS / 0.77 - COPS is 100% accurate for determining a 23% inclusive rate base on COPS.
Mark B says
“Marvin -
Perfect. My thought was that since ownership doesn’t change the tax wouldn’t be triggered. But obviously an exception is made for leases. Thanks.”
Mark, there is no EXCEPTION. While a purchase of a vehicle would incur the FairTax because it is a purchase of a PRODUCT, a lease of a vehicle would incur the FairTax because it is a purchase of a SERVICE.
Hank says “As for how the States would determine who gets the prebate, you might also ask how the Federal government determines who gets the prebate? And the answer is they couldn’t, so everyone gets the prebate and a $600 billion gorrilla will be let loose in the annual federal entitlements budget.”
The prebate isn’t an entitlement. It is simply a payment that RETURNS a portion of the tax paid by an individual.
———————————-
To follow up, technically it is an entitlement in a few cases (when someone spends below the poverty level), but the bottom line is that the vast majority of the $600 billion is not an entitlement, but rather a RETURN of taxes paid to the individual who paid them.
The prebate is no more of an entitlement than the child tax credit we have on the books now.
For people who still pay net positive FairTax after the prebate, their prebate check is no more an entitlement than their income tax refund under the current system.
If you the IRS today collected $2 trillion in taxes through withholding and refunded $500 billion, would you call that $500 billion a part of the entitlement budget? I know I wouldn’t.
Your computations are more accurate. I was only rounding for simplicity. Estimated that costs to business would be reduced by 9% from elimination of certain expenses. An item that cost $1 under the current tax system would now have a base price of $.91. Adding the 30% (approximation) tax rate would boost the total cost to about $1.18
Dale/Quad, I’m sorry, but your continued insistance that the prebate isn’t an “Entitlement” is misguided. Here is the Wiki definition of Entitlements.
“Entitlement is a guarantee of access to benefits because of rights, or by agreement through law. (Note: HR25 would guarantee access to the prebate.) There are two types of government spending — discretionary and mandatory. Discretionary spending, which accounts for roughly one-third of all Federal spending, includes money for things like the Army, FBI, the Coast Guard, and highway projects. Congress explicitly determines how much to spend (or not spend) on these programs on an annual basis.
Mandatory spending accounts for two-thirds of all government spending. This kind of spending is authorized by permanent laws. (Note: HR25 would be a permanent law.) It includes “entitlements” like Social Security, Medicare, and Food Stamps — programs through which individuals receive benefits based on their age, income, or other criteria. Spending levels in these areas are dictated by the number of people who sign up for these benefits, rather than by Congress.” (Note: The prebate benefit is based on family size, and the federal spending amount will be dictated by the number of people who sign up for the benefit.)
But, no matter what you wish to call it, CBO will score the prebate as an entitlement. Passage of HR25 would increase the percentage of such mandatory spending significantly and that will lead to a budgetary train wreck in the not too distant future.
And no, Quad, an income tax refund isn’t an entitlement. It’s simply a refund of overpayments made by fools who think it’s OK to give the federal government an interest free loan!
And no, Dale, the prebate isn’t just a return of a portion of taxes paid by an individual. No matter what an individual spends, the prebate amount remains the same–based solely on family size, not spending habits.
Hank,
If the law is structured such that I am required to pay FairTax on all consumption above the poverty line for a household of my size, then the prebate is simply refunding the money I have overpaid at the cash register in taxes. This is directly analogous to being refunded overpayment due to witholding from my paycheck. It’s just the retailer doing the witholding rather than my employer. It is a refund of tax overpayment, just the same as under the current system.
For the case of folks who receive more in prebate then they pay in FairTax, you are directly analogous to someone receiving more back from the earned income tax credit than they pay in taxes. The CBO *does* account for the refundable part of that credit as entitlement spending. I am willing to concede that the excess prebate over what an individual pays *is* an entitlement.
It is not possible to discern how much of the prebate is tax refund and how much is entitlement spending (ie, analogous to the EITC). We can put a back of the envelope ceiling on it though.
According to the US Cencus Bureau in 2004 there were about 37 million people living in poverty, 13 million of whom were children. If we take the poverty line for an adult as $10k and for a dependent child as $4k (these are high, but close), the the prebate is $2300 per poor adult and $920 per child. For 24 million adults and 13 million children, that comes to $67.160 billion. So $67 billion dollars is the maximum prebate cost of all persons in the US in poverty. Since even the poor have to buy stuff, not all of that will be part of the ‘entitlement’ portion of the prebate, some will be a ‘refund’ of taxes overcollected. But it gives us a ceiling. We can say with some confidence that the ‘entitlement’ portion of the prebate is less than $67 billion.
Now $67 billion is a lot of money, but it’s nowhere near the $600 billion number you claim. By way of comparison in 2004 the federal government spent $170 billion on income support (defined as ssi disability, unemployment benefits, and refundable tax credits, NOT social security or medicare) according to the CBO.
Hank says, “And no, Dale, the prebate isn’t just a return of a portion of taxes paid by an individual. No matter what an individual spends, the prebate amount remains the same–based solely on family size, not spending habits.”
I’ve already stated in a previous post that the individuals paying less in taxes than the prebate are receiving an entitlement. That entitlement is equal to the prebate minus the taxes paid. For everyone else it is NOT an entitlement.
The definition of entitlement (a guarantee of access to benefits because of rights, or by agreement through law) doesn’t apply in this case. The prebate is not a BENEFIT, but rather a RETURN of monies paid.
Hank says, “It includes “entitlements” like Social Security, Medicare, and Food Stamps — programs through which individuals receive benefits based on their age, income, or other criteria. Spending levels in these areas are dictated by the number of people who sign up for these benefits, rather than by Congress.” (Note: The prebate benefit is based on family size, and the federal spending amount will be dictated by the number of people who sign up for the benefit.)”
Technically, Social Security is not an entitlement in most cases. You are receiving Social Security payments, not benefits, because you paid that money to the government when you were working. Food stamps is a benefit because the people who get food stamps NEVER made a prior payment for those stamps. Hank, you have fallen victim to today’s entitlement mentality.
Hank says, “And no, Quad, an income tax refund isn’t an entitlement. It’s simply a refund of overpayments made by fools who think it’s OK to give the federal government an interest free loan!”
Hank, income tax refunds are EXACTLY the same thing as the prebate, an overpayment of taxes due, period.
quadrupole, nice post for #37. I couldn’t have said it better. If this doesn’t dispell the myth that a prebate is an entitlement then nothing will.
Quad/Dale,
I’m well aware that “you can lead a horse to water, but you can’t make him drink”. I’ve done all I can to show you what the definition of an entitlement is as opposed to discretionary spending. We’ll just have to agree to disagree.
Perhaps a more interesting question might be just why you two and other Fairtax advocatges seem to get their shorts all knotted up when the word entitlement appears? The Presidents Tax Reform Commission called the prebate an entitlement, and perhaps that’s why you take offence? Vilifying the commission members seems to be the major Fairtax reaction to their report. Or could it be that you all really do understand the potential budgetary train wreck which comes with the huge growth of entitlements? And it wouldn’t be a good idea to add the largest entitlement in history into the budget, would it?
Answer these questions: (1) Is HR25 going to be permanent law? (2)Does HR25 need to be reauthorized each year? (3) Does the total cost of the prebate depend on how many families apply for the benefit? (4) Does family size determine what the monthly prebate amount will be?
If if something walks like a duck, squacks like a duck, and looks like a duck, it’s probably a duck, not a tax refund!
Hank,
If you refuse to see the logic of my side of the argument, then we will just have to disagree. I find it unfathomable that someone would consider a refund of overpaid income tax to NOT be an entitlement, but considers a refund of overpaid consumption tax to BE an entitlement.
I encourage you to bring your common sense to the debate. There is no need to check it at the door.
Hank says, “I’ve done all I can to show you what the definition of an entitlement is as opposed to discretionary spending. We’ll just have to agree to disagree.”
A mandatory payment is not necessarily an entitlement. If it were so then I guess my payments to my creditors would be entitlements. And so would income tax refunds. If I’m not mistaken, the government is REQUIRED to send any overpayments of income tax back to the payer. The only difference with the currrent system and the FairTax is that the FairTax requires everyone to overpay their taxes in order to avoid creating exemptions, which can lead to political misuse of power.
Hank says, “Answer these questions: (1) Is HR25 going to be permanent law? (2)Does HR25 need to be reauthorized each year? (3) Does the total cost of the prebate depend on how many families apply for the benefit? (4) Does family size determine what the monthly prebate amount will be?”
(1) I hope so. It will be if the 16th amendment is repealed within five years of enactment of HR25.
(2) No.
(3) Yes.
(4) Yes.
What’s your point? If I sign a contract with you to accept payment in advance for a future product with the stipulation that you will receive back any difference in cost if the cost of the product is lower than anticipated, does the money that I return to you constitute an entitlement? I think not.
You seem to have a difficult time distinguishing between an overpayment and an entitlement. As I stated earlier, Social Security is NOT an entitlement because you are simply receiving back the money that your were required to give to the government while you were working. It could be considered a mandatory overpayment of taxes that is given back after retirement. Granted, in some cases, part of the payment is an entitlement since some people will live much longer than expected and wind up receiving more than they paid in. Likewise, some will die early an not receive everything that they paid in. Welfare IS an entitlement because the person receiving it never made a prior payment for the welfare. The welfare payment comes out of general funds. Why do you think the revenue that pays for Social Security is generated by a separate tax from the income tax? Because SS is not an entitlement. The taxes paid for SS are simply returned to the payer at a later date. Welfare comes from revenue generated from the income tax which is used for general funding.
Hank says, “If if something walks like a duck, squacks like a duck, and looks like a duck, it’s probably a duck, not a tax refund!”
Some people don’t hear and see as well as others. Especially those that are getting up there in ages.
Hank,
Which do you think is a more efficient way to make HR25 progressive?
(1) Make everyone pay 23% on consumption and refund the portion below the poverty level,
or
(2) Allow people below the poverty level to apply for an exemption card to be presented at purchase.
Option 2 would generate less total revenue but more net revenue as those above the poverty level are cheated out of the taxes paid on necessities. But it would also generate a significant additional government expense to maintain an apparatus to oversee the exemptions (and create a mechanism to allow politicians to create exemptions for political gain). Bottom line is the actual net revenue would be about the same or less than option 1 in the long run.
Post 44 brings up another question. Should an exemption be considered an entitlement? In my opinion, yes. So this would mean that our current system has a massive entitlement called the standard deduction.
Dale’s last comment is a pretty fair point.
The ‘prebate’ replaces all other forms of deductions and credits in the current tax system. So what’s better?
I don’t have numbers on this, but might someone please look these up:
Taxes relieved due to:
Standard Deductions + Total Itemized Deductions
Credits paid due to:
Earned Income Credit
Lifetime Learning Credit
Other credits, etc.
And compare them to total cost of the prebate.
Some have claimed the prebate is significantly smaller than all these other forms of tax rebates/credits, and if that is true, then I think we should see it as a reduction in tax welfare, rather than an increase in entitlements.
Dale –
There is no way to make a consumption tax progressive. By definition a consumption tax is regressive.
All the prebate does is (a) raise the tax rate, since the government must now pay the cost of the prebate, and (b) push the primary impact of the tax up a notch onto the middle class.
I realize that I hold a minority position on this blog, but thems the facts.
This disagreement seems to be largely a matter of semantics. The prebate as now proposed is a means of untaxing the poor without deep inspection of individual earnings to determine elgibility. If the government did not give the prebate to those living in poverty, by definition there would be a need to increase welfare payments by an equal amount. Is it more efficient to issue the prebate to everyone or to determine eligibility for those who make claims?
My preference would be to avoid large transfers to and from the government. A 23% consumption tax would require a prebate of close to $400 billion. As shown in other posts, the rate will have to be well above 23% as HR 25 is now written. A 35% increase would raise the rate to 31% and increase prebate costs to $540 billion.
Is the poverty level today defined as income net of taxes? If not, elimination of payroll and income taxes would give many now living in poverty a big real increase in disposable income. Also price reductions (estimated at 10%) will improve the status of those living below the poverty line. This condition may be corrected in the second year when the poverty level is recalculated on new price levels.
It seems to me that calculating the prebate at current prices may overstate the necessary prebate. This could have a substantial impact on the total “prebate” whether applied just to those below the poverty line or to the general population.
When we analyze provisions of the Fair Tax, most of us look at the short term (up to one year) but give little thought to what happens in subsequent years.
Hayden
As I understand the term progressive when applied to taxes, it means charging more taxes to those that have greater resources to pay those taxes.
Payroll taxes are not progressive because everyone pays the same rate. However, those that earn more pay more total taxes and receive proportionally lower benefits. That seems to fit the definition of progressive.
Income taxes are considered progressive because higher rates are paid on higher earnings and it follows that more total tax is paid by higher earners.
Consumption taxes take the same rate from everyone less the prebate. So very low incomes pay no taxes. As incomes increase the overall rate paid approaches but never reaches 23%. That seems to meet the definition of progressive.
I agree that the prebate adds to the amount that must be collected to maintain revenue neutrality. I disagree that the prebate pushes the tax burden up a notch to the middle class. The tax burden will be carried by all consumers with the rich paying the most based on their total consumption.
Those living below the poverty level are eligible for government assistance. Whether this comes through the prebate or from the welfare office makes little difference to the individual tax payer.
Marvin,
The disagreement about whether (or rather how much of) the prebate is an entitlement is not a question of semantics, but rather a question of consistency of application of terms.
I really don’t much care how you choose to define entitlement, as long as you apply that definition evenly. That definition of entitlement which causes every dollar paid out for the prebate to be counted as an entitlement would also require in an honest analysis that every dollar of income tax refund also count as an entitlement. After all I am guaranteed a right to the benefit of my income tax refund by law. After all, income tax refunds are a permanent law, do not require reauthorization, depend on how many families apply for a refund, and depend (at least in part through exemptions, EITC, child credits, etc) on family size. In short, they meet the criteria you are attempting to impose on the prebate.
Counting income tax refunds as an entitlement, as consistent application of your definition would demand, would require asking things like: how much did the federal government spend on the home mortgage interest entitlement, or how much did the government spend on the child tax credit entitlement.
Holding the conversation on those terms would be consistent, but it would also be misleading. It would be misleading because most people don’t think of their tax refunds for overpayment as an entitlement, and would thus be confused.
The reason I object to the use of entitlement to describe the entire amount of the prebate is precisely this tendency to mislead. It is the same nature of deception as refering to the FairTax exclusive rate in a way that will naturally lead to a comparison with the income tax inclusive rates: an attempt to compare apples and oranges.
Please note, that I have previously conceeded that a portion of the prebate, the excess received by those who do not pay FairTax net the prebate, is an entitlement, and have given computed ceiling for it above.
Quadrupole
I am not trying to characterize the prebate as an entitlement. What I am saying is that it doesn’t matter what you call it. The question is should those living below the poverty line be exempt from taxes? Saying no means too bad if people don’t have enough to pay for the necessities of life. Saying yes means that even those that aren’t willing to work should at least have a subsistence living.
Freeing those below the poverty level of paying taxes can be accomplished in at least a couple of ways. Welfare payments can be increased to cover the taxes that must be paid. That is done today when taxes are rolled into the price of products. Another alternative is to rebate the tax on the necessities of life. If this rebate applies only to the poor, how do you determine eligibility without an elaborate audit of applicants? Giving the rebate to everyone eliminates the need to verify financilal qualification; everyone gets the same amount.
The problem with paying everyone is that a $450 million prebate would require about a Fair tax 5% rate against the $9 trillion personal consumption base. If you spread the tax over government consumption, you will have to raise more tax revenues to replace the increased cost to government. Governments can not pay taxes only people can. Every cost of government has to be eventually paid by individuals in the form of higher taxes.
My apologies Marvin, I intended to address my commentary to Hank.
Marvin (this time I really am addressing you
),
I think it is somewhat more productive to think of the prebate as a reduction in the tax base, rather than a cost in and of itself.
As a starting point, consider that the income tax base in 2003 was $5,747 billion out of a GDP of $10,960.8 billion (according to the BEA). So about 52% of GDP was part of the income tax base.
The back of the envelope tax base for 2003 for the FairTax was $9246.2 billion dollars., or about 84% of GDP.
That $9.2462 trillion dollar tax base would be reduced by $2.185 trillion if you treated spending up to the poverty line as being unFairTaxed. That would leave you with a prebate adjusted FairTax tax base of $7.0162 trillion, or about 64% of GDP.
So the FairTax, even with the prebate, has a significantly broader tax base than the current income tax system.
Marvin,
As to your point about not taxing government consumption, wouldn’t the same argument insist that we shouldn’t tax the income of government employees under the current system?
Hayden says, “Dale –
There is no way to make a consumption tax progressive. By definition a consumption tax is regressive.
All the prebate does is (a) raise the tax rate, since the government must now pay the cost of the prebate, and (b) push the primary impact of the tax up a notch onto the middle class.
I realize that I hold a minority position on this blog, but thems the facts.”
Hayden, a flat consumption tax is neither progressive or regressive. It is flat. The payroll tax is the most regressive tax ever implemented.
Our current system becomes progressive by taxing individuals with higher incomes at a higher rate. To me, this is very unfair. Why should an individual pay a higher rate when the same rate would still require them to pay more?
The FairTax becomes progressive by eliminating the tax on the necessities of life. To me, this seems the fairest way to make a tax progressive.
Quadrupole Re: #54
Same concept holds true under current system. Any increase in cost to government requires a higher tax rate to offst that cost. There are so many hidden taxes in current system that I don’t know an effective way to eliminate taxes from cost of government purchases today.
Eliminating the consumption tax from government purchases would be relatively easy and much more efficient. Including government consumption doesn’t raise any net revenue. it only requires that tax rates be increased to cover the taxes the government paid. Isn’t one of the main objectives of the Fair tax to make everything as simple as possible? Why throw this extra compexity into the program?
The consumption tax concept is a tremendous benefit to America. But, there are hidden transition problems that people are glossing over. Kotlikoff does a good job of showing what will happen over a hundred years. But, there will be major revenue shortfalls under HR 25 in the first year. Do we create several hundred billion dollars of government deficits in the first years while putting the same amount of extra cash into the hands of individuals? Wont this be inflationary at a time when the economy is very strong?
Dale –
To understand the rationale behind a progressive income tax, it might be helpful to re-read some Dickens and Steinbeck. I don’t mean that to be sarcastic, but for most of our history we had a very small middle class. The great masses of population lived literally hand to mouth. They had no savings from which to pay taxes. Under an income tax system, it would be unfair, and probably, unfeasible, for them to pay taxes at the same rate as those with higher incomes who had far greater discrectionary incomes and abilities to save and invest that income. Thus, they had a far greater capacity to pay taxes.
If you spend much time in any less developed country today, you’ll see the same economic pattern. None of those countries have effective income tax systems, because the rich control the governments and are able to evade their tax obligations. Those nations tend to rely on import duties and VATs, both of which are regressive, subject to a great deal of evasion, and, ultimately, innefficient. In my opinion, as I’ve expressed several times, a consumption tax — rather in the form of a VAT, the FairTax, or any other variation, will be regressive, subject to evasion, and, ultimately, inefficient.
Marvin — We will just have to agree to disagree on whether the FairTax is regressive or not. I think we’ve each made our positions clear, and I guess we just see the world differently. But I’m sure we’ll find other issues about the FairTax that we can continue to debate.
Hayden says, “...those with higher incomes who had far greater discrectionary incomes and abilities to save and invest that income. Thus, they had a far greater capacity to pay taxes.”
Just because the rich have the capacity to pay a higher rate doesn’t make it fair. If government services cost more than the sum total of the fair and equal percentage of everyone’s wealth, then those citizens should demand less government spending rather than unfairly taxing the rich at a higher rate.
Hayden says, “We will just have to agree to disagree on whether the FairTax is regressive or not.”
Hayden, the FairTax is progressive and that fact is not up for debate. For example:
With an assumed poverty level consumption of $10,000 and the prebate ...
One who spends $10,000 will have an effective tax rate of 0%
One who spends $20,000 will have an effective tax rate of 11.5% (2300 / 20000)
One who spends $30,000 will have an effective tax rate of 15.3% (4600 / 30000)
One who spends $100,000 will have an effective tax rate of 20.7% (20700 / 100000)
As spending goes up so does the effective tax rate. This is PROGRESSIVE. Without the prebate it would be FLAT. This is undeniable.
Dale —
I cannot think of a way of responding to your comment that the FairTax is progressive without repeating posts I have made many times on this blog. If you are really interested in this topic, you might want to read some of my earlier posts to understand an opposing view. In a nutshell, I think it is pretty self-evident that the FairTax is regressive when it comes to incomes (as opposed to spending) for the simple reason that a family making $50,000 must spend a much greater percentage of its income to keep its head above water than does a faminly making $500,000. The prebate might help to a certain extent, but at some point the benefit of the prebate is less than the cost to that family of the combination of higher tax rate (to pay for the prebate) and the higher percentage of spending.
Moreover, as I’ve also pointed out many, many times, I believe the actual rate of the FairTax will need to be much, much higher than the 23% rate that is normally claimed to be revenue neutral, and would most likely need to be in the range of 50%-60% at the federal level, and higher still when you add state and local taxes. No need to repeat all of those arguments here. Let’s just say that the required tax rate is subject to considerable debate.
Hayden says, “In a nutshell, I think it is pretty self-evident that the FairTax is regressive when it comes to incomes (as opposed to spending) for the simple reason that a family making $50,000 must spend a much greater percentage of its income to keep its head above water than does a faminly making $500,000.”
So what? You need to find another word to indicate this. Regressive isn’t it.
Regressive means that the tax rate decreases as the TAX BASE increases. The tax base in this case is spending.
Hayden
Let’s look at things this way. The current take from federal taxation is about 18% of GDP. In order for the tax rate to be in the range of 50-60% you would have to have a tax base in the range of 30-36% of GDP (much smaller than the current tax base, which is about 55% of GDP). How exactly do you see the FairTax *narrowing* the tax base that dramatically?
Hayden,
The really fundamental question is whether one cares about progressivity in income or consumption.
For me, this is a very easy moral question to answer: one cares about progressivity in consumption, not income.
To see why, consider what income really is. Your income, in general, represents how much you are contributing to society. Your consumption represents how much you are taking out. It makes no sense to me at all to tax based on contribution rather than consumption.
It helps further to consider that income can be used one of two ways: invest or consume.
When you consume (no matter who you are, or how rich or poor) only the consumer benefits. Consumption is fundamentally a selfish act.
When you invest you are driving economic growth. We currently invest about 15% of our GDP to drive about a 3% GDP annual GDP growth rate. So the GDP return on investment of a dollar invested is about 20%. This rate is pretty high, and should make you start questioning my analysis. After all, everybody has it in their heads that the long term stock market returns are about 10%, where is the other 10% of GDP returns going?
The answer is: into labor. Typically (and it fluctuates over time) labor and capital split GDP gains due to investment more or less up the middle in the US. So when I invest a dollar, I am not only enriching myself, but enriching other people participating in the economy. Or to put it differently, while the motivation of investment may generally be purely selfish, the result is about half-selfish and half-altruistic.
Finally, let’s give this ye olde gut check. If you make $20k a year and spend it all, you get $20k a year in consumption. If I make $200k a year and spend $20k a year, I get $20k in consumption. Why exactly is it that I should pay *more* taxes for exactly the same thing just because I contributed more to society (made more income)?
If your response is something like ‘Because you still have $180k you can invest and grow to consume later’ I would say ‘Fine, I will pay the tax when I consume it later.’
On the flip side, if I make $200k a year and and spend $20k a year and you make $200k a year and spend $200k a year, why exactly should I pay the same level of taxes you did? You got $180k more out of the economy than I did (or about 10 times as much), why should we pay the same amount of tax.
Examine your feelings. Most of the people I know who are emotionally invested in income progressive taxes are actually using them as a proxy for consumption progressivity. They are out to tax money which might have otherwise been spent on a Rolex or a Yacht, not money that might have otherwise been used to expand a business or build a factory. Consumption progressivity captures what people are really feeling about taxing the rich, income progressivity doesn’t really.
Quad — You make some very good arguments. Here are my two quckie responses:
1. The FairTax does not tax all consumption, only SOME consumption. Under the Fairtax, I can buy the largest, most expensive mansion in the world tax-free if (a) it is an existing mansion rather than brand new, or (b) it is located in a foreign country. On the other hand, anyone who is too poor to buy his or her own home will be taxed on each rent payment that person makes each month. Similarly, I can buy the most expensive yacht in the world tax-free in the Bahamas. If I want to sail it to US waters tax-free, I simply have my Cayman Island corporation buy it, hire me as President, and make the yacht available to me to entertain clients. I could come up with a thousand similar examples where the wealthy can completely avoid paying the FairTax, and, in fact, would have an easier time of doing so than the middle class. This is not weath envy; it’s reality. It is human nature for folks to try to avoid paying taxes; under the FairTax, those with means will take the steps necessary to avoid paying taxes on their largest purchases. This is so obvious to me, I have a hard time understanding how someone as clearly intelligent as yourself wouldn’t realize this. As I’ve said in other posts, it’s as if we’re living in parallel universes, where our arguments don’t make sense to the other person because we somehow view the world in fundamentally different ways.
2. Regarding the tax rate. Obviously, many intelligent people (including yourself) who have examined the FairTax have come up with vastly different rates that would be required under the FairTax. I can’t argue with your numbers, mainly because I wouldn’t know whether they are accurate or not, or whether you’ve made some miscalculations that would only be detected by an economist. I can only point you to the Gale study (and even the Beacon Hill study which, in my opinon, proves that the FairTax won’t work at anywhere close to 23%. But that’s the subject of another thread.)
Regardless of the studies, however, I believe if you do some analysis using real world examples, you will conclude that there is just something here that cannot possible add up. In my case, the FairTax (as written) would reduce my tax obligations by over 90%. Most other upper middle-class families would realize similar tax savings. Those with incomes in the seven figures would save even more. That lost revenue has to come from somewhere. Where?
Let’s look at an average family of 4 with an income of $50,000. I believe that family currently pays an average of about $12,500 per year in taxes. (i.e., $7500 in SS and Medicare taxes; $5000 in federal income taxes.) (I’m counting both employer and employee portions of SS and Medicare taxes.) Under the FairTax, if that family spends the entire $50,000, its taxes would be $11,500 (i.e. 23% times $50,000). When you subtract the prebate (around $6500), that family’s net tax obligation under the FairTax would be $5000. So, even a completely average middle class family would save dramatically under the FairTax. And, as FairTax advocates claim, the poor will be completely untaxed.
So where’s the tax revenue going to come from? Claims that the “tax base will expand” ring hollow, at least to me. Who, precisely, is going to pick up the tab? It’s not going to be tourists, illegal aliens or the underground economy. Even if the FairTax increases the tax rates on those groups (which in itself is a debatable proposition), that’s not going to be enough to make up for the lost tax revenue from everyone else. (And, the real group that will be shafted from the “expansion of the tax base” will be retired folks, but even they get a break at a 23% rate.) Thus, there is just no way the 23% rate will work.
Quad — You seem to be a quantitative type of guy. I would be interested in you doing a few “real world” calculations to see if you will come around closer to my way of thinking.
In your “real world” examples, remember that most upper-middle class folks and better already own their own houses and, if they need to buy a new house, are going to tend to want to minimize their tax obligations (i.e., they’ll buy an existing home rather than a new one from a builder.) Moreover, folks at these income levels tend to save and invest a good portion of their incomes. And, for that matter, many of their expenditures could legitimately be classified as business expenses. Just to be fair, make a few calculations as to how much NEW tax revenue will be realized from illegal aliens.
I’m telling you man, you’re going to be surprised at what your calculations will show. Or, who knows, maybe I’ll be the one who’ll be surprised.
Regards,
There are no pros with either of them!
The Land Value Tax is a much better tax than the FairTax or an income tax unless you like urban sprawl (inefficiency and monopolization of land) and people reaping the wealth from the productivity of others around them (land speculation).
“In my opinion, the least bad tax is the property tax on the unimproved value of land, the Henry George argument...” - Milton Friedman
Karl Marx didn’t like it so it must be good!
Let’s see:
No exemptions!
No Loopholes!
One rate for all! (THE SINGLE TAX!)
No tax for anyone at the poverty level! (IT CAN’T BE PASSED ONTO PEOPLE IN APARTMENTS!)
No land speculation!
Np urban sprawl!
No traces of Marxism!
No Evasion!
22% embedded taxes gone!
100% of paycheck!
No monopolization of land!
It’s revenue neutral!
You choose how much you’ll pay by moving to more valuable or less valuable land!
It’s progressive with no big entitlement program!
cons: NONE!!!
“The FairTax does not tax all consumption, only SOME consumption.”
Hayden, the FairTax taxes ALL products and services exactly once. The FairTax would have already been paid on used products and would be included in the resale price. While used products would not be taxed, their base cost excluding depreciation would be more than that of new products. Granted, this additional cost would not go to the government as taxes, but it would tend to decrease the consumption of used products. The only savings realized in the purchase of used products would be due to depreciation except in some cases when used products are discounted significantly.
“Similarly, I can buy the most expensive yacht in the world tax-free in the Bahamas. If I want to sail it to US waters tax-free, I simply have my Cayman Island corporation buy it, hire me as President, and make the yacht available to me to entertain clients.”
You could shelter your entire income from the U.S. government today by basing your company overseas. Many companies have already done this and leading economists have predicted that most of these companies would move back to the U.S. and foreign ones would follow. With the tremendous increase in jobs, the U.S. would see a significant increase in consumption.
“So where’s the tax revenue going to come from? Claims that the “tax base will expand” ring hollow, at least to me.”
Throughout the history of the U.S., consumption has been not only a larger base but a more stable base than income.
“I’m telling you man, you’re going to be surprised at what your calculations will show. Or, who knows, maybe I’ll be the one who’ll be surprised.”
You sound like an intelligent man, but I think I’ll put more trust in economists. The vast majority of leading economists do believe the FairTax will work. Laurence Kotlikoff is a hard core democrat economist who is a staunch supporter of the FairTax. He believes that the FairTax rate could be lower than 24% and work.
Hayden,
I’d quibble with you over some of your numbers in your examples–for instance, that family of four doesn’t pay anything like $5,000 in income taxes, more like $1,500. And your Fairtax examples are worst case in that every one will surely have some untaxed spending such as installment payments, state/local property and sales taxes, savings, mortgage payments, etc.
But none of that really matters, nor does it shed any light on why the 23% rate works. I believe that the major contributor to making the 23% rate work is the fact that HR25 treats all governments as consumers and taxes them accordingly. This adds over $2 trillion to the tax base and lowers the inclusive rate by around 7%–from 30% to 23%. And by the way, because the relationship between inclusive and exclusive rates can be shown as a parabolic curve, failing to include government consumption would raise the exclusive rate to over 43%. Big number!
All of this wishful speculation about tourists, illegal aliens and the underground economy has absolutely nothing to do with the 23% rate. Nor is tax evasion, tax avoidance, or a booming economy included in Kotlikoffs detailed derivation of the rate. Nor is the pretty clear fact that prices are going to rise by 15% or thereabouts. All of these unknowns work both for and against the accuracy of the 23% rate. In short, no one really knows what the rate might be which is why I continue to advocate a phased transition rather than the “cold turkey” approach described in the bill.
A voice in the wilderness???
quadrupole,
Taxing consumption rather than investing should only increase the economy thereby increasing the tax base. This explains at least a portion of the so called missing tax based that Hayden gripes about.
Ryan,
I haven’t researched your Land Value Tax. It might be better than the FairTax. I really don’t know. But the problem isn’t creating a bill for the best possible tax. It’s creating a bill for the best possible tax that can actually become law. The FairTax has enormous grassroots support and will likely become law in the near future. IMO and that of many leading economists, it is a much better tax than the one we are currently strapped with.
I doubt very seriously that there are no cons to the Land Value Tax. For one, wouldn’t it discourage land ownership. The FairTax would make it easier for someone at the poverty level to become a homeowner (hence landowner) and do away with their recurring rent expense.
Dale — I agree that I would trust an economist’s analysis of the FairTax over my own analysis.
Kotlikoff is clearly a smart guy, wants what is best for this country and supports the FairTax. (Though, with some modifications you might not be aware of.) Fair enough.
So, what about Dale Jorgeson of Harved, Jim Poterba of MIT, the economists on the Congressional Joint Committee on Taxation, the economists on the President’s Tax Reform Commission, the economists at the Institute for Taxation and Economic Policy, and, of course, William Gale of the Brookings Institution. All of them have studied the FairTax for years and are opposed to it. They all make essentially the same arguments, the rate would need to be too high, there would be too much tax evasion, and the tax is too regressive.
If you say you trust the economists who have studied the FairTax, then you might want to check with some of them. Incidentally, none of the ones mentioned above have been paid to take one position or the other. On the other hand, some (if not all) of the economists that publicly support the FairTax have been paid by Americans for Fair Taxation. That doesn’t mean they are wrong, but it does mean that one needs to maintain a healthy degree of skeptism when reading their reports.
Also, if you are really interested, you might want to check with some of the 80 or so economists who signed the Letter to the President that fairtax.org used to prominently display on their website. I did. You might be surprised at what you learn.
Let’s try something very simple.
Question 1. Which is greater, the gross national earnings subject to income tax or the gross domestic product subject to the FairTax?
Question 2. Which is greater, the average current income tax rate after exemptions and deductions or the FairTax rate including the Prebate?
Question 3. Which has the greater cost of collection associated, the income tax or the FairTax?
Perhaps Mr. Kepner or one of the others would care to answer these three simple questions and then explain the financial basis for their opposition to the FairTax.
So what did you learn, Hayden?
Wow, found this thread, great discussions!
First, I just wanted to throw in a quick thought about regressive and progressive taxes. If a progressive tax weighs more heavily on the rich than the poor (vice versa for regressive), then i submit that ALL taxes are regressive. People who are rich are so because they recieve more money than they personally exchange labor for. They realize profits from OTHER peoples labor. If you were to not tax anyone (on an “income” model) unless they produced at least three times the national average there would still be very little “burden” on them as individuals. Their money comes from the producing and selling of goods and services. Their proffit is a result of the cost of goods sold verses the amount they can sell that product for. If the “rich” are expected to pay higher taxes, they will either become less rich because the govn’t took their money away (thus eliminating your tax base) or they will recoup those taxes in the prices of their goods and sevices. If the “poor” have to pay less taxes, then the majority of people in this country will have more money to spend. The value of the dollar will drop as more are available to more people and after all balances out the common citizen will still be able to purchase the same goods and services based uppon the value of their own personal labor.
All taxes have the immediate effect of depressing the economy. They siphon rescources from the economy to provide services wich are needed to protect the environment of the economy. Those with the least economic rescources are the ones who will most feal the burden of the drained economy. Those whose only economic rescources are recieved from selling their own personal labor are always going to carry the majority of the tax burdon no matter how you collect it. That is why I say all taxes are regressive.
I love the banter going back and forth about the value of a dollar before you spend it. I have never met a person who would not feel better off spending 50k per year and being able so sock away 200k than a person who spends 50k per year and that is all they have. I must say though that I am with Hayden on this one. While having 50k worth of goods and services and another 200k in the hand has more value than just the 50k alone, the value of the 200k can only be catagorized as “potential” value. Unless those dollars are spent there has been no realization of value. If those dollars are NEVER spent but put into securities to produce intrest income, then the only value it has is the actual intrest income which when spent will be taxed by a consumption tax.
To answer the post’s question, lets see, the only benifit i can see in an “income” tax is security. Not for the people, but for the government. This is of course only and advantage for the people, in my opinion, in a situation where we have a kind, fair, and just government.
-show me one-
I am in favor of replacing our “income” tax with a consumption tax. The biggest reason I guess is hard to see unless you look at things from a certain point of view. That view can best be summed up by saying “We Are a Free People”. We are subserviant to no other person. We we are born in debt to NOBODY. Without choice we HAVE to do NOTHING. We put together our government not to rule us and parent us and become our king that we must swear to, but to do the minimal mount nescessary to protect our FREEDOM. Our labor is part of us, it is our most sacred ecconomic possession. This isn’t something we “make” or “produce”. Our own individual labor is a peice of our lives. To catagorize compensation for labor as some kind of “profit” is a lie. As a free people we OWN OUR OWN LIVES BEFORE WE SELL IT. The only way we can have a profit from our individual labor is if we sell it for more than it is worth and how in the world can anyone decide that other than yourself? Looking at it ecconomically the fair market value is established at the initial selling/purchasing of a product so at the least your labor is worth whatever you can sell it for and at that first sell there can be no profit realized from the individual selling of one’s own labor. That purchase is at the very least an even exchange or trade. No person that trades their time and labor directly for dollars is more wealthy after the exchange than they were before they made it unless one was to argue that they did not have the rights to their own life before they sold it.
True wealth is the result of engaging in buisness activity in which one purchases goods and services and then sells them or another that they use those to produce for a proffit. Certainly a profitable buisiness owner that has no personal time and labor into the buisiness he owns is wealthy. Even though I would say this person is wealthy, this business is still his property that he built (or bought with money that was exchanged for labor). For our government to put a mandatory tax on peoples property weather that is the value of a buisiness, or worse, the value of our own lives for no other reason than because we have it is an action completely against the concept and intent of our government. That would sugguest that we actually live in a communism where the government/community has initial rights to ALL property including our lives and it is the governments job to distribute that property among the people as IT see’s fit.
However, we unfortunately cannot have a government unless we are willing to fund it. Thats the drawback of a consumption tax is that it is a tax. However we fund it will drain our economy and be most burdensome on those who have to sell their own lives to survive. The most simple way i can put this is that an “income” tax puts the power and initial ownership of all american wealth in the hands of the government. A consumption tax recognizes that it is the people who own this country and not washington D.C. We pay a tax when we realize a benifit from our government. We pay for our government, our government doesn’t take what it wants and then let us have the scraps.
Something else about the Fair Tax that i believe is worth pointing out. We have rich people. We have poor people. We have a middle class. We always have and always will. The way our current tax system works, the class of rich people is a group who is most efficient at manipulating the government to give them an unfair legal advantage in the marketplace. With a simple consumption tax the wealthy would be forced to be the group of people who are most efficient at producing the best goods and services for the cheapest price. That in my opinion would make all honest americans alot better off.
Quad –
One of the thing you said in a prior post reminded me of a conversation I had with Dr. Kotlikoff. I was doing my usual spiel about how unfair it was that a gazillionaire with several mansions would not pay a dime of FairTax on his mansions, where the poor bricklayer who rents a hovel from the gazillionaire has to pay tax on every monthly rent payment.
He agreed that this was a flaw in the FairTax, and suggested amending the FairTax so that the imputed rental value of homes, mansions, ranches, yachts, etc. were taxed. That is, if you own a mansion that would rent out at $100,000 per year, you would pay the FairTax on that rental value (i.e., $30,000). That would be the missing ingrediant in order to tax existing wealth.
Now, I don’t want to put words in Dr. Kotlikoff’s mouth. He made that remark to me in a private conversation and for all I know his view has changed. but, just out of curiosity. How would Quad and the other FairTax supporters feel about that idea. That would certainly make the FairTax less regressive and less biased against people who currently have few, if any, real assets.
Further, in order for this to work, the FairTax would have to apply to ALL significant assets owned or purchased by an American citizen anywhere in the world. So that if you owned a chateu in France or a ranch in Mexico, you would be subject to the same tax on the imputed rental value.
Personally, I think the latter idea would be unfeasible, but assuming it were feasible, how would that affect your view of the FairTax?
Hayden,
You have now addressed two very interesting posts at me since last I have been able to respond. I am completely underwater right now and it will be at least this weekend until I can give them the sort of answer they deserve. I just wanted you to know I am not ignoring you.
Gentlemen:
You have missed one important premise of the FairTax. Taxable goods and services are only taxed ONCE. The FairTax is not applied to resale property because the seller purchased the property with post tax dollars so the expenditure was taxed when the income tax was deducted from the workers paycheck.
What is a regressive tax? To me, the most regressive tax in the U.S. is the payroll tax (Social Security and Medicare). The FairTax avoids being regressive because ALL AMERICAN households are exempt from being taxed up to the poverty level and at the same time does away with the payroll tax. This insures that the poorest among us pay no tax at all. This makes it easier for the poor to think about home ownership because they are now dealing with all pretax dollars.
Eric:
A consumption tax is much more stable for the government than the income tax. During a recession people loose their jobs and the income tax stops immediately. That person must still buy the necessities of life and would be paying the consumption tax even with no income.
So many intelligent posts since I have been away. There are a few basic truths that everyone should consider in evaluating the Fair Tax.
Kotlikoff and others are looking at the long term impact and they are right. Gale and other opponents are concentrating on the short term impact and they are right. Both sides need to consider both the short and the long term effects.
Anecdotal analysis of a specific situation is useful for those people falling under the same circumstances. It does not shed light on the total economy and all people. It is invalid as an argument for or against the tax.
Neither governments nor business can pay taxes. Both, can collect taxes and remit them to a taxing authority. But, both must pass those costs along to individual people. Governments must increase tax rates to replace the lost revenue, cut spending or operate at a deficit. Business must increase prices that people pay or accept less profit which will fail to attract the capital to sustain or grow the business. Eventually the business will go into bankruptcy when their capital runs out.
If you take the total revenue now raised by payroll, income and estate taxes and divide that number by the tax base as spelled out by the Fair Tax including both personal and government consumption, you will come up with a Fair Tax rate of 20+ per cent. The prebate at 23% would require another 3-4% added to the Fair Tax rate. Economists and others make these calculations and say a rate of 23% works.
However, there are some big items being ignored. Inventory on hand on the date of implementation (both finished goods and work -in-progress) will be exempt from the tax. This will cause an estimated $400 billion of lost revenue in the first year only. Social security will be inexed by 30% to cover lost purchasing power. This will cost about $160 billion. Fair Tax collection fees paid to states and business 1/2 of 1% will cost $10 billion. A 23% Fair Tax will cost states about $250 billion and the federal government $200 billion on purchases. There is also a current annual federal deficit of $200 billion that should be eliminated. On the other side eliminating employer payroll taxes will save states over $50 billion and the federal government about $20 billion. Reduced product prices estimated at 10% will save states $100 billion and federal about $90 billion.
Also keep in mind that the same amount of net tax will be collected as under the current system. Thus if governments get less individuals will have an equal amount of extra money in their pockets.
All of the above numbers are broad estimates but can be used for directional purposes. They show that the Fair Tax rates must be raised substantially or the government must operate at a much larger deficit to cover all of the increased transfers to individuals.
Fortunately, most of these complexities and rate increases can be avoided by phasing in the Fair Tax over a few years (3-5 perhaps). I will cover how that would work in a seperate long post.
Marvin says, “Eliminating the consumption tax from government purchases would be relatively easy and much more efficient. Including government consumption doesn’t raise any net revenue. it only requires that tax rates be increased to cover the taxes the government paid. Isn’t one of the main objectives of the Fair tax to make everything as simple as possible? Why throw this extra compexity into the program?”
Boortz addresses this in the FairTax book. Eliminating taxes on government consumption makes it harder for private businesses to compete with the government. It would create an environment which would favor a government owned business. Government owned businesses tend to be less efficient than privately owned ones. The desire should be to make in unprofitable for government to get in to business.
Marvin,
Taxing government consumption would not require a higher rate if government comsumption was not considered part of the tax base. I believe this is the case with the FairTax. The tax on government consumption would simply be a movement of funds temporarily to the retailer who would then return it to the government. It would not be revenue for the government, hence, government consumption shouldn’t be consider part of the tax base.
Government consumption is a part of the Fair Tax base as the law is now written. Whether Governments pay the Fair tax thru retailers or directly to the Federal government, the products and services they buy will cost more. The governments must replace this revenue in some manner through some sort of fees or taxes or cut spending. There is only one place to get this money; from individual tax payers.
I am aware of the theory behind taxing governments to prevent unfair competition with the private sector. No sane person wants more taxes to support more government than we now have. There needs to be a mechanism to prevent this unfair competition. I just think there are easier ways to accomplish this objective than through the taxing government consumption. Spell it out in the Fair Tax law
Couldn’t it be written into the law that governments would not be exempt from paying the Fair Tax on purchases that were made for the benefit of individuals? For example, the things purchased to operate a police department would not be taxed. A necessary service but for the general good of the community not for any identifiable individual. On the other hand, government run water sewer and refuse collections serve identifiable individuals. Governments should collect and remit the Fair Tax on these services. This would not cost the local government any revenue loss because the tax would be collected from individuals. If local governments decided to provide these services free, they would have to raise local taxes to cover the Fair Tax due.
I think a similar set of guidelines could be established preventing the Federal government from engaging in activities that are services to identifiable individuals. If the Government does, the tax would be collected from the individual not the government and there would be no loss of revenue or increased expense to the government.
Dale in #78 you say they are just moving money to the retailer who is sending it back to the government. The problem is the money from the retailer has been counted as part of the federal governments revenue needed for neutrality. You can’t count it as part of revenue and then say it isn’t an expense because the money is returned to the government. Try this with real money from your pocket and see if you don’t come up short on one end.
This all seems very clear to me. I hope my explanation isn’t confusing people.
Duane;
Good points. However i do not look at the tax ‘burden’ in only dollars and cents and just because the people who have less money pay less directly to the government doesn’t mean they do not realize a burden from the increased cost of living in the society as a result of the tax. Any tax will be most heavily weighed on the shoulders of the comon laborer.
When i said the biggest advatage to an in come tax is security for the government i wasn’t referring to its stability or regualrity. I was more sugguesting that because the government exercises the power to take peoples property because they have it then the initial power lies in thier hands and not the peoples. This gives them the power to protect itself or to make itself more secure from the people they rule.
Eric
The government has the power to take only the amount of tax that congress authorizes. We the people have the power to influence congress if we choose to exercise it. If we abdicate our collective responsibilities as citizens, congress can and will follow the few that make the most noise. That is usually those who want more “free” goods and services from the government. We bitch about taxes on one hand then indignantly clamor for more goodies. Universal health care, medicare, social security, fighting diseases, saving the victims of disasters, welfare, subsidies for farmers, fishermen and anyone else you can think of all cost lots of money. You want them, you have to pay for them. The government only gives us what we ask for through our elected representatives. To paraphrase Pogo, the enemy is us.
Eric and Marvin;
From the Libertarian viewpoint I agree entirely with both your statements. Marvin takes the next step to recognize that when the government “gives” us something they are really “selling” us something for which the payment is not a direct payment from the purchaser, but rather a payment from the entire society. Once we move past the abstract and accept that some government services are necessary and must be paid for we can then discuss the best mechanism for accomplishing that collection. Rather than getting into a discussion of which programs are worthy we should simply accept the basics provided in the Constitution, Life, Liberty, and the pursuit of Happiness.
Now we can discuss the best mechanism for paying the government to provide services. I believe the FairTax provides that best mechanism.
Duane
You hit the nail squarely. Many of us think that government is too large, but recognize that we don’t have the political muscle to make it smaller. All we can hope to do is find the best method for collecting the taxes necessary to support the services that people want. At the same time, I hope we can educate people about the total tax bill and how everyone is paying a lot more than they realize.
“Dale in #78 you say they are just moving money to the retailer who is sending it back to the government. The problem is the money from the retailer has been counted as part of the federal governments revenue needed for neutrality. You can’t count it as part of revenue and then say it isn’t an expense because the money is returned to the government.”
The taxes on government consumption are not a government expense. The cost of the tax is paid from the same pocket that it is going to be returned to. The one half of one percent fee that would be incurred by the government for this recycling of money would be the only cost to the government. So all that should really be of concern is this collection fee. It must be substracted from the revenue generated by all other consumption to determine the tax rate that would be needed for revenue neutrality.
Continuation of previous post.
Marvin,
Do not forget that the purpose of the FairTax is to collect the revenue necessary for revenue neutrality while adding as few exceptions as possible. Exceptions equal Congressional power.
Dale,
The purpose of the FairTax is to collect the revenue to pay for the function of the government, Revenue neutrality is an arbitrary starting point. The starting point could have been set as easily to equal the current budget or even higher to reduce the debt.
Dale,
There is no way that governments can tax themselves into prosperity. The whole idea is idiotic. By including government consumption in the Fairtax base, the Fairtax rate was reduced from 30% inclusive to 23% inclusive. There are two issues arising from this scheme: (1) Federal taxation of state and local governments will likely be found to be unconstitutional under the long held Supreme Court doctrine of “intergovernmental tax immunity”. (2) That portion of federal government consimption that is going to be taxed is nothing but a shell game. You are right that the funds will simply be taken from one pocket and returned to the other pocket of the Treasury. But, in addition to the collection fees, you have to consider the potential for evasion by the government contractors when considering potential losses of revenue in transit. Most importantly, if taxing governments is such a keen idea, why not raise the rate to 100% and the rest of us won’t have to pay anything? The whole concept is ludicrous IMHO!
Rather than play this game, why not just raise the rate to 30%, don’t tax governments, and stop flim-flamming the public?
Hayden #63,
I apologize for taking so long to respond to you, I’ve been quite busy. I will reply in pieces, starting with the first and easiest bits.
You had said that you believed that the FairTax rate would have to be 50-60% to be revenue neutral.
I responded rather hastily with a back of the envelope calculation showing that seemed quite unlikely, and failed to cite my numbers. Here is the argument reproduced (with uncited data bolded):
*********************
Let’s look at things this way. The current take from federal taxation is about 18% of GDP. In order for the tax rate to be in the range of 50-60% you would have to have a tax base in the range of 30-36% of GDP (much smaller than the current tax base, which is about 55% of GDP). How exactly do you see the FairTax *narrowing* the tax base that dramatically?
*********************
Here are the citations.
CBO estimates of federal revenue as a percentage of GPD were 18.4% in 2006, I will also note they were 16.3% of GDP in 2004 (this is important because much of my *other* data is from 2004, best data available).
In 2004 total taxable income according to the IRS was $4,977.9 billion (2004 is the most recent data available). According to the Bureau of Economic Analysis the US 2004 GDP was $11,994.8 billion. $4977.9/$11994.8 = 41.5% of GDP (please note, the 55% number I quoted in the original was way off, I was working from memory of 2003 data, mea culpa).
If, as you suggest the FairTax rate would have to be 50-60% to replace the 16.3% of GDP the feds taxed in revenue in 2004, that would suggest that the tax base was
16.3%/50% = 32.6% of GDP
to
16.3%/60% = 27.1% of GDP
So 27.1-32.6% of GDP, which is still much lower than the 41.4% of GDP that made up the 2004 tax base. I find that highly improbable, for reasons macro-economical. According to the BEA the Personal Consumption expenditures of Americans in 2004 came to $8,800.6 billion, or 73% of GDP. Now don’t get me wrong, the PCE has to be slightly adjusted to match the FairTax rate. You have to subtract out imputed rents on housing, add back in new construction, etc. But it gives you a good rough notion of the size (before subtracting prebate mind you) of the FairTax taxbase.
Please note, none of the above is a real detailed run through, it’s all back of the envelope, do-these-numbers-make-sense kinds of stuff.
Hayden #63,
You brought up, in your point 1, that there are ways for the rich to avoid paying the FairTax on their purchases. In particular you note:
“(a) it is an existing mansion rather than brand new, or (b) it is located in a foreign country.”
That is true. Used goods are not taxed, including housing, to avoid taxing the same good multiple times. Additionally goods purchased abroad are only taxed upon repatriation to the US. I see you as having two sets of objections around these, first, you seem to be concerned that I am claiming these sorts of items towards consumption for the purposes of revenue neutrality. Second you object to them on grounds of fairness, as you see them as ways that the ‘rich’ can consume without paying the FairTax.
On the issue of revenue neutrality, let me assure you the calculations I have done and seen others do are based on slight modifications to the BEAs personal consumption expenditures and would *not* be effected by either purchased of used goods or foreign consumption.
On the issue of Fairness... my only question would be: compared to what? If I’m really to a place where it is reasonable to have my Cayman Island corporation purchase my yatch abroad and let me use it in the US to entertain clients under the FairTax, why the hell not just recognize my profits in the Cayman Islands under the current system and not repatriate them to the US and thus shield all of my consumption abroad under the current system?
My basic point is, the FairTax is prone to no more abuse by the ‘rich’ than the current system through manipulation of foreign consumption.
On the issue of used goods, yes, you will find the ‘rich’ buying used mansions, like Donald Trump did with Mar A Largo, but those same rich then tend to dump millions into remodels (all FairTaxable). In addition as the population of ‘rich’ continues to grow in this country, clearly their new consumption of ‘mansions’ will have to come from the ranks of new construction (thus FairTaxed).
I would also like to add that the purchase of new homes is an equal opportunity tactic for avoiding the FairTax as we have existing homes in this country appropriate for purchase by the non-rich.
In summary I don’t think we are living in different worlds. I think our difference comes down to this: you see the FairTax as disproportionately allowing the rich to avoid paying taxes. You see it this way because you can imagine ways for them to do so. I acknowledge that there are ways, but I see them as being both harder than you do to use, and/or less egrigious than what we have now.
Hayden #63,
In your second point, you address the question of what the FairTax rate will have to be to acheive revenue neutrality. I think our disagreement comes down to this (and correct me if I’m wrong). I trot out the macro numbers in terms of adjusted BEA personal consumption expenses and ceilings on the prebate exclusion from the tax base and the current revenue needed to be replaced, etc, etc, etc. Macro arguments.
You look at some micro examples and find that as near as you can tell no one pays more under the FairTax than the current system. Since the total tax paid is the sum of all the taxes we pay individually, and since you can’t find anyone paying more under the FairTax and many people paying less, you doubt the macro arguments. Frankly, the appearance of micro-mismatch with the macro data should make you suspicious.
Let me start by telling you what I won’t argue in opposition to your micro-doubt. I’m not going to spin you a pretty tail about illegal immigrants being taxed (I honestly can’t find any decent data to make any decent guesses at what that effect would be). I’m not going to talk to you about taxes paid by tourists. I tracked down the data and ran the numbers once, I seem to recall it was an order $10 billion dollars in revenue sort of effect, not chicken feed, but nothing I would expect to assuage your doubts.
Sadly, I wasted a part of my youth looking at the comparison of the FairTax and the current system in their impact on different income levels (assuming 100% if income consumed). You can find my attempt here. I learned two things from this exercise:
1) While you can do a decent job of estimating the tax liabilities of the very poor, as affluence increases the number of different ways one family of the same size with the same income can be taxed explodes.
2) Even trying to get it right for the very poor is fiendishly difficult. You have the EITC, the child tax credit, the partially refundable portion of the child tax credit, etc, etc,etc. It’s ugly.
Basically, under the current tax system there really is no concept at all of an average family of 4 making $50k a year. If you let me decree them to be non-home owners who are married with two kids who make no charitable contributions using the standard deduction I can tell you they probably paid an effective tax rate of around 18.4% (and you can see the detailed calculation by clicking on my table on the above referenced page). But as income increases, so do the available choices that effect how much tax is paid under the current system. Once you get to the rich, the amount of tax you pay varies significantly depending on the games you play.
For example. Imagine I have $30 million dollars in assets under the current system. I can invest all $30 million dollars in munibonds at 4% and get $1.2 million in income tax free which I can spend. So under the current system I get $1.2 million dollars worth of stuff and I spend zero dollars on taxes. Under the FairTax that $1.2 million in consumption would get hit with $276k worth of taxes. That’s only the simplest possible example. Far more complex options are available involving charitable remainder/lead trusts etc to those who have the money to avail themselves of them.
The real bottom line on the micro argument sadly is that it is basically an annecdotal argument, our existing tax law is so convoluted that it is basically non-rebuttable, because the amount of taxes paid on the same amount of income vary so wildly. All I can really do is point to the macro data and say ‘*somebody* is consuming all this stuff, the maximum possible consumption excluded by the prebate is x, and so I can tell you that we will get this much revenue from that much consumption, even if I can’t tell you *who* is buying it all’ Please note I really am not trying to dodge your question here. I am just pointing out that it’s effectively *not answerable* at the micro level because the current system is so screwed up.
The government now collects about $2.264 trillion dollars through the sources that would be eliminated by the Fair Tax. They will need to collect several hundred billion more to cover the prebate. A 23% Fair tax on $11 plus trillion of consumption will raise the necessary amount.
The Fair Tax will provide a few hundred billion of the $2.264 trillion on purchases by state and local governments; lets use $200 billion from states and $100 billion on federal purchases just for simplicity. Governments will pay the $300 billion in addition to the purchase cost of the items they buy. Now you and I have to replace that $300 billion in some way. For the states they can raise their sales taxes, income taxes or property taxes. The Feds are pretty much stuck with increasing the consumption tax rate to replace their shortfall.
Just because business collects and remits the tax to the government doesn’t mean the business is paying the tax. Assuming no price reduction, the various governments will be paying $300 billion more for the items they purchase. Where are they going to get it? Don’t look too far, You are going to pay it in the form of higher taxes.
If you want, you can say the money is collected from the government and returned to the government and it is a wash. However, then you have to reduce the total revenue raised from $2.264 trillion to $1.964 trillion and you are $300 billion short.
Hey, Joshua — We need a new thread!
Quad — First of all, I think I owe you an apology. I had assumed you were one of those “Damn the torpedos (or facts), full speed ahead!” type of FairTaxers I find so annoying. But it’s clear that you have really given this a lot of thought, probably more than me, so I commend you.
Also, I think you are correct that I have taken a micro-view of the FairTax rate; that is, I tend to focus on what individuals would need to pay. And, frankly, that’s because I’m not qualified to take the macro-view, and once the numbers get too large, I get totally lost. (Also, though, I believe that the macro numbers can be manipulated by making assumptions one way or the other that the lay-person could not catch. Not that you are doing this, but I’m always suspicious when the numbers get too large that they can’t be closely examined as to what is exactly behind those numbers.)
So, I’m afraid I can’t debate you on the macro level. You are too good at that! I’m just a lowly lawyer, so I’ll have to leave that debate to Marvin and Hank, who have proved themselves to be far more adept at that than I.
But there must be some way to reconcile our macro- versus micro- analyses. I mean, either I’m missing a lot of new sources of tax revenue in my micro-analysis, or you are over-estimating the true tax base (and, what would truly be taxed) at the macro-level. Maybe somebody smarter than I can figure this out.
But, just for grins, here are my quick comments on the macro-model used by the Beacon Hill/Kotlikoff study of last year.
1. Even under that study, the closest they could get to a revenue neutral rate was 31.25% (tax exlusive).
2. The tax year they chose was 2007. If you look at Table 6 of that study, they assumed that the federal government would have a deficit of $476 billion during that year.
3. That means that a 31.25% tax rate would leave the federal government $476 billion short. I would argue that this proves the FairTax does not work at the proposed rate.
4. In taking out my calculator and recalculating the numbers in the study to eliminate the projected deficit, it would have taken a tax rate of around 39%-40% to fully fund the government. (And, of course, you would need to increase the pre-bate, which would require higher tax rates.)
5. But their numbers do not explicitly take any tax evasion into account. (They say they implicitly took some tax evasion into acount, but could not quatify it.)
6. They also ignore rational tax-avoiding behavior of consumers. That is, some consumers are going to seek to minimize their FairTax obligations by buying used cars, etc.
7. They are also assuming that there will not be any political or practical difficulties in taxing everything that is theoretically subject to the FairTax (credit card interest, for example).
8. If you assume a very modest 10% erosion in the tax base, due to tax evasion, tax avoidance and difficulities in taxing everything), the required tax rate to fund the government raises to around 45%.
9. That’s only at the federal level. You’ll need to add state and local taxes to that. Assume that states also get rid of their income taxes and adopt mini-FairTaxes, and assuming that state tax levels are a third of federal tax levels, you need to add another 15% to the federal tax rate, for a combined federal/state/local tax rate of 60%.
10. And, of course, that’s assuming the numbers used and the calculations done by the Beacon Hill study are accurate.
So, I’m back to my argument, that even at the macro level (which, admittedly, I’m not really qualified to address), and even using the favorable assumptions of the FairTax folks, we’re talking pretty high tax rates here.
By the way, I emailed these comments to Kotlikoff earlier these weeks. He was traveling and said he’d get back to me next week, so I’ll post his responses when I get them, but I’m curious as to your thoughts.
I’m shutting down this thread since it’s gotten so long. (Whoa, over 90 responses!) You can find Quad’s reply to Hayden, which I’ve promoted to its own thread, here: Putting Revenue Neutrality in Context.