The Fair Tax Act, Part LIX
Sorry for the long absence… life does that to you sometimes. Anyway, I’ll post the rest of section 904 today.
`(d) Old-Age, Survivors and Disability Insurance Rate- The old-age, survivors and disability insurance rate shall be determined by the Social Security Administration. The old-age, survivors and disability insurance rate shall be that sales tax rate which is necessary to raise the same amount of revenue that would have been raised by imposing a 12.4 percent tax on the Social Security wage base (including self-employment income) as determined in accordance with chapter 21 of the Internal Revenue Code most recently in effect prior to the enactment of this Act. The rate shall be determined using actuarially sound methodology and announced at least 6 months prior to the beginning of the Calendar year for which it applies.
This is actually sort of interesting. Basically it means it attempts to maintain a revenue-neutral level of funding specifically for Social Security, albeit spread over the sales tax base rather than the original wage base.
`(e) Hospital Insurance Rate- The hospital insurance rate shall be determined by the Social Security Administration. The hospital insurance rate shall be that sales tax rate which is necessary to raise the same amount of revenue that would have been raised by imposing a 2.9 percent tax on the Medicare wage base (including self-employment income) as determined in accordance with chapter 21 of the Internal Revenue Code most recently in effect prior to the enactment of this Act. The rate shall be determined using actuarially sound methodology and announced at least 6 months prior to the beginning of the calendar year for which it applies.
This is a similar method used for Medicare.
`(f) Assistance- The Secretary shall provide such technical assistance as the Social Security Administration shall require to determine the old-age, survivors and disability insurance rate and the hospital insurance rate.
`(g) Further Allocations-
`(1) OLD-AGE, SURVIVORS AND DISABILITY INSURANCE- The Secretary shall allocate revenue received because of the old-age, survivors and disability insurance rate to the old-age and survivors insurance trust fund and the disability insurance trust fund in accordance with law or, in the absence of other statutory provision, in the same proportion that the old-age and survivors insurance trust fund receipts bore to the sum of the old-age and survivors insurance trust fund receipts and the disability insurance trust fund receipts in calendar year 2008 (taking into account only receipts pursuant to chapter 21 of the Internal Revenue Code).
`(2) HOSPITAL INSURANCE- The Secretary shall allocate revenue received because of the hospital insurance rate to the hospital insurance trust fund and the Federal supplementary medical insurance trust fund in accordance with law or, in the absence of other statutory provision, in the same proportion that hospital insurance trust fund receipts bore to the sum of the hospital insurance trust fund receipts and Federal supplementary medical insurance trust fund receipts in calendar year 2008 (taking into account only receipts pursuant to chapter 21 of the Internal Revenue Code).
This means that the incoming tax revenues for Medicare and Social Security are effectively tagged exclusively for their respective trust funds, and cannot be used as general revenue. This is essentially just a best-effort attempt to fund Medicare and Social Security to the levels they are funded today without having to significantly alter the legislation that created these programs.
It is interesting to note that since they are inclusive these two rates essentially tax each other (and the general revenue rate). So a consistent 3% HI rate will generate more or less revenue depending whether the OASDI rate goes up or down. It’s also interesting to note that the statutory 14.91 general revenue rate will generate more or less general revenue if the OASDI or HI rates go up or down.
Basically, you will have a yearly general revenue tax cut or increase (unless, by chance the combined rate doesn’t change) without a vote from Congress. The fact that they can’t naturally be added together is just another reason tax inclusive sales tax rates are a bad idea.
James, I don’t think I agree that the “lockbox” concept is necessarily in play here. The wording in para(g) (1) and (2) is certainly cumbersome, but the way I read it, the bill is talking about how the Treasury Secretary allocates funds in the same proportion as experienced in 2008. That doesn’t mean the Secretary has to allocate all the funds generated by the rate determined in (d) and (e) above. In other words, after determining the consumption sales tax rate which would raise the same amount that the most recent 15.3% FICA/Medicare rate would have raised, the Secretary must then allocate those funds in the proper proportion, but that doesn’t mean to me that he has to allocate 100% of those funds from the general fund to the SS trust funds. He simply needs to allocate enough to pay the bills.
However, if you are correct, then the impact on the general fund would be significant. The reason the lockbox concept would never work is that the annual deficits, currently offset by using the trust fund revenue, would sink the economic “ship of state”. Please don’t misunderstand, I certainly wish the trust funds had something other than government IOU’s in them, but we are where we are, and the lockbox is a non starter IMHO. The difference between SS revenue and expenditures in 2007 is around $300 billion. When added to the CBO 2007 deficit forecast of $244 billion and the Fairtax inventory credit of $365 billion, the total annual federal deficit in the first year of Fairtax implementation would exceed $900 billion, and that’s politically and economically unacceptable.
I agree with Hank. As I read this, I take the meaning that the 23% Fair Tax will include the same amount for Social security and medicare as is raised by payroll taxes today. Just like today all money will go into the general fund and not a lock box. Only IOU’s will go to the social security account. Maybe, it was 25 years ago these funds were accounted for separately from the general fund. Congress just ran a bigger deficit on the non social security expenditures to absorb the available money. This looked bad politically. So they hid the general fund deficit by putting all of the money under one budget.
The Fair Tax deficit of $365 billion from inventory credit will be offset somewhat by economic growth. The deficit mentioned assumes a static economy. Most economists predcict there will be extra economic growth as the result of the Fair Tax. If the growth is 10%, that would add another trillion dollars to the Fair tax base. 23% of that is $230 billion. This is usually ignored in calculations by those both for and against the Fair Tax. I have not included it because the issue of what will happen is beyond my level of expertise and beyond the level of most people to understand.
Fred: Will there be much any pressure or reason to change the OASDI and HI rates after the Fair Tax is enacted? All the money goes into the general fund. Increasing OASDI rates would add more credits to accounts of current workers and slightly increase their future benefits. Otherwise it would make no difference. In fact, HI rates could be removed from the calculations and just be part of general fund revenue. Health insurance expenditures far exceed revenue raised from this source and health expenditures are likely to grow.
Marvin: The only reason to change the OASDI and HI rates is that the bill requires it, every year.
I wasn’t trying to make a persuasive statement with my analysis, just stating that it appeared that the revenue would be allocated exclusively for its intended purpose in the proportion that exists in 2008.
That simply struck me as being similar to the ‘lockbox’ propoganda that was bandied about from time to time in the 90′s, saying that the only reason SS was in trouble was because Congress had been raiding the trust funds.
I don’t view it as anything like real SS reform, I was just mentioning the similarity.
O.K., James, that’s fine. But we still have a $300 billion issue on the table unless you agree with our interpretation of this section. If there is still some question, perhaps an email to Dr Walby would be appropriate??? Enquiring minds want to know?
Fred: you are right on the bill saying the rate will be adjusted annually. I didn’t read carefully enough. Each year, it will be determined how much revenue would have been raised by applying current rates to the total of all covered salaries and wages. I ignored the fact that total salaries and wages will increase both from total employment increasing and from individual workers earning more. That may require increasing the Fair Tax rate for OASDI and HI.
Of course, consumption will also increase thereby raising total government revenues from the Fair Tax.
There could be a scenario where the OASDI revenue from salaries and wages increased but contributions to the general fund decreased keeping the total Fair Tax rate constant or lower. Whatever is left over in the OASDI after meeting current draw on the fund will end up as a loan to the general fund.
One of the most significant benefits of the Fair Tax is that it ensures long term funding for social security. A day in the not too distant future will come when OASDI does not raise enough revenue to cover promises to retirees and the lock box is empty. The burden on payroll to cover all current expenses will be unrealistic. Thus, the general fund will have to be tapped in some way. The Fair Tax does this without requiring politicians to face this thorny problem. All politicians should endorse the Fair Tax for this reason alone.
Hank, it appears to me that this section only tries to preserve the existing funding of SS, being very careful not to do very much to cover additional costs.
I don’t view this as a $300 billion dollar issue compared to the income tax which apparently has the exact same $300 billion dollar issue.
By using general revenue the FairTax could add more funding to SS, but probably not enough to fix SS all by itself (it simply isn’t designed to be feasible anymore). SS needs real honest-to-god reform, and no matter what form it takes, SOMEONE will end up double-paying or losing benefits.
Marvin, I don’t really understand where you are getting these ideas from. This section clearly states that the FairTax will, by design, collect the same amount of SS revenue as the current system and that revenue goes exacty where it goes today — the trust funds. If anything, the FairTax would me he SS problem significantly worse because it requires SS payments to be increased by the tax exclusive FairTax rate.
James, I think we are missing each other. The issue I’m concerned about is the federal government deficit in the first year of Fairtax transition. Your “lockbox” interpretation of this section would increase that deficit by 50%—(approximately $300 billion added to the CBO 2007 deficit forecast of $244 billion and the inventory credit of $365 billion.) Does it matter? I think our government would have a very tough time selling new bonds to finance this deficit, and interest rates would surely rise. Could lead to an economic disaster. It matters, IMHO.
As for Social Security, this might be discussed in a new thread, but it saddens me to see younger folks buying into the myth that SS is bankrupt-or soon will be. Social Security is not broke!!! And you really need to read Bill Bradley’s new book which lays out four simple changes which would make SS solvent for the next one hundred years: (1) gradually raise the retirement age to 70. Folks are living longer, and working longer by choice; (2) Raise the current $94,000 cap on SS earnings so that the wealthy pay a bit more; (3) incorporate all federal/state workers into the plan; and (4) revise the method used to determine COLA increases. What is so hard about that?
I know- easy for me to say because I’m already collecting mine. But all it takes is a little political fortitude and some foresight to get the job done.
Fred: My comments were made from my understanding of how the social security system has always worked. My limited communications skills may have caused confusion. I confirmed my understanding through google of social security trust funds. Wikipedia and a Heritage foundation article nicely explain the situation. Please read both.
There never has been any real restricted assets in the “trust Funds”; only accounting entries. All social security related funds that are collected are deposited into the United States Treasury. Benefits are paid by the Treaury. There has always been a surplus collected over benefits paid out. This excess has been “invested” in interest bearing nontradable treasury bonds. The actual money always remains in the treasury and can be used for any government purpose. There is nearly $2 trillion in these bonds today. The balance will continue to grow from excess FICA tax collections until about 2018. Note that the income tax paid on social security is also credited to this trust fund.
After 2018, the federal government will have to come up with other sources of revenue to pay part of the social security benefits. Congress will also have to figure how to replace the excess FICA collections that have been spent each year. Even if the treasury bonds in the trust fund are redeemed, additional taxes or borrowing will be needed to get the money to redeem the bonds. Because of interest on the bonds being credited to the trust fund, the fund will continue to grow for another 7 years. The trust fund will be completely depleted by 2042 or 2052 depending on who is counting. Any way you look at it, the government is going to have to come up with increased revenues to cover the any benefits that exceed current collections.
After 2018, the deficit arising from benefits paid exceeding collections will gradually increase to about 30% of the total benefits as the ratio of retirees to workers increases. This difference may be covered by raising the retirement age, cutting benefits or increasing payroll taxes.
The system is not broke but hard decisions will be needed to be made. The sooner politicians stop avoiding the issue, the more options there are for solving the problem. Liberals have a simple solution; increase taxes on the rich. By their definition, you and everyone else is richer than you think.
The important thing to realize is that any amount in the trust funds that are called upon can only come from increasing total government revenues. There are no real assets in the funds that can be called upon without raising taxes in one form or another.
The Fair Tax does nothing directly to solve the social security situation. It only shifts the same revenue stream to tap consumption instead of income/payroll taxes.
Social security payments will be increased by the COLA. Price reductions from untaxing business, the prebate and the impact of the Fair Tax will all be considerations in this adjustment. Remember, there is no net impact on average to consumers. The same amount of money will be taken out of consumers pockets as is taken today.
Well I don’t understand why you believe that the inventory credit will necessarily result in a $300 billion shortfall.
The inventory credit for more than 80% of retail will likely be used up in the first quarter of the first year. Not to mention that businesses will still file their taxes from the previous year during that quarter, and be collecting an ever-burgeoning amount of sales taxes at the same time.
It seems to me that would work out in the wash after a couple of years. Not to mention that Federal purchases should work out cheaper in the long run.
Example: If retail prices go up approximately 15% after the FairTax, and the Fed pays for a lot of that, but essentially isn’t taxed because the taxes go into their own accounts, The Feds essentially only pay approximately 89% of the current prices for goods. That’s a pretty significant break over time that will more than make up for the shortfall.
James: It seems like people who disagree with the Fair Tax like to zero in on one side of one point and blow it out of proportion. If the inventory on hand as of Jan 1 were all sold during the first year, there would be less consumption of taxable items. $300 billion of tax means that on hand inventory at cost (not selling price) would be $1.3 trillion or about 12% of total consumption. Virtually every sale would have some component that is taxable unless the retailer is disposing of his inventory at cost. Is that 10% or 20% taxable? Of course work-in-progress at Jan 1 would have an even a higher taxable component.
But the important thing is to replacre the $300 billion (assuming that is the correct amount) of potential revenue shortfall. This assumes no extra economic growth as the result of the Fair Tax. Virtually every economist agrees there will be some extra growth. Some estimate 10% in the first year or $1 trillion of exta consumption.
There will be many sources of economic stimulus. Because, the Fair Tax wasn’t paid on the $1.3 trillion of sales, the consumer will have an extra $200 billion in his pocket. The first $100 billion will have been spent paying higher prices for the used inventory versus new items produced at a 9% lower cost. (no payroll or income taxes on business and lower compliance costs.
The next stimulation will come from the return of $13 trillion now held off shore (per Alan Greenspan). This along with reduced costs to lenders will drive interest rates down; some economists say as much as 25%. Am not certain if interest on Federal debt will fall by that amount. But if it does, government outlays to service the debt will fall by $100 billion.
Foreign investment in the United States will go up because of the favorable tax environment. There will be at least 6 months of advance notice before the law is enacted. I have no idea what the impact will be, but believe it will be substantial. Foreign companies will want to build products in the US both for domestic consumption and for export. American companies will be more competitive against foreign goods.
Finally, in the new year, the treasury will still be receiving the 4th quarter installment on the prior years income tax bills and the amount due with all final income tax returns for the prior year. Don’t know how much will be lost by refunding tax overpayments.
All of these elements and more that I have not even thought off will effect the net revenue collected by the government in the first year.
The economy is dynamic and reacts to influences. People are analyzing the situation assuming the economy is static.
Well, I knew we should have separated the two issues of a Social Security “lockbox”, and the impact of the inventory tax credit. Reading over the above posts, the numbers have gotten pretty snarled up.
With regard to Social Security and the potential $900 billion transition year shortfall, if James would agree that the language in the draft bill does not mandate such a “lockbox”, then we can get off that $300 billion issue.
As for the inventory tax credit, the estimate was $365 billion per Neal Boortz. Don’t know where he got the estimate, but it does indeed represent $1587 billion in lost consumption tax revenue. It doesn’t matter whether the inventory is exhausted in three months or twelve, the impact is the same. Those are the simple facts.
All the remainder of the arguments put forth that try to mitigate the revenue loss are pure speculation. I have yet to see one economic study that predicts 10% growth in the US economy in year one. Over time, maybe, but none of the studies you all reference take into account the 15%-18% price increases that will occur. That whole price issue seems to be like the third rail for most Fairtax advocates. Read any other related website and you will read that “prices will remain about the same”. Hogwash!
I would also recommend caution about predicting a great influx of foreign corporation arriving on our shores because of our “favorable tax treatment”. James is finally getting to Section 905 which will create some lively discussion I hope. My reading is that a 23% income tax will be paid by foreign corporations on revenue generated in the US. I will be interested in other comments.
And finally, it seems to me to be very fuzzy math to suggest that tax dollars collected in the spring can somehow be used to offset current year deficits. I’m not an accountant, but federal taxes paid are for last year to cover last year’s expenses. How can that possibly help this years deficit?
Well the bill does nothing to prevent Congress from raiding Social Security I suppose, after the funds are allocated.
The specific language only allocates the funds in the closest approximation to the income tax version that is possible, and that’s all.
I will edit my post to remove the ‘lockbox’ comment that everyone is complaining about. My apologies.
James, under the FairTax, federal revenue will be tied to the price level. So if pretax prices drop 11%, they may be paying less (net) for goods, but they would also have less revenue.
Fred, I think you may be right on! The Kotlikoff/BHI base/rate study, that is the most recent justification for the 23.8% inclusive rate, never addressed the impact of prices, although they claimed to. Through the magic of “monetary accomodation”, they simply took a pass on the issue. So their estimated pretax consumption base could be 9%-11% too high. Does that mean that the 23.8% published rate really is not revenue neutral? Should it be 26%+?? What is going on here?
It would be perhaps more accurate to say that revenue would be partially tied to price level. It is also tied to the volume of consumption, so if prices go down, but consumption goes up, then revenue may very wall wash or go up.
Hank, Kotlikoff’s latest paper states that a 23% inclusive rate would require a “cutting discretionary spending by 18 percent.” He also states “Alternatively, maintaining real discretionary spending levels in switching to the FairTax requires a 26 percent effective rate.”
I don’t know about you, but I really doubt Congress is capable of cutting discretionary spending by 18 percent.
Kotlikoff latest paper (April 2007): http://people.bu.edu/kotlikoff/FairTax%20NTJ%20Final%20Version,%20April%2024,%202007.pdf
Base prices will drop by some amount. I have assumed 9% based on removal of the business portion of payroll taxes and corporate income taxes with a small amount of savings from compliance cost reduction. Individuals will have in pocket the prebate, payroll tax not withheld; and personal income taxes and estate taxes avoided. Together these tax savings and price reductions will equal 23% of consumption. Consumption will not change because the same amount of taxes are being taken by the government under both systems. All we are doing is taking the tax out at the end instead of during the production process. Remember the 23% is tax inclusive. It is based on the total amount being spent. There is no change from today.
If the economy expands, there will be more Fair Tax collected based on greater consumption. The only reason to expand the Fair Tax rate is if Congress increases spending to take a larger share of Gross Domestic Product for government wants.
Marvin, this whole subject of consumption and taxes has bothered and confused me for some time. Do you agree that today, consumption totals include the embedded costs of the income tax? That is, the reported GDP numbers include all the so called federal embedded income tax costs as part of the prices paid. We also agree that the pretax costs under the Fairtax will fall 9%-11% or whatever. So, does that mean that the GDP under the Fairtax will include the 23% federal sales tax element? In which case, there should be an immediate 15%-18% increase in the GDP? Because that is the amount that after tax prices will rise, and consumption should remain the same due to all the extra cash consumers have in their pocket?
At this point, I believe that real GDP will fall around 10% and the 23% inclusive tax rate will not be revenue neutral. However, I’ve been wrong before.
Help!!!
If you want a fairly solid explanation of how GDP is calculated, view this:
http://en.wikipedia.org/wiki/Gross_domestic_product
It doesn’t really shine a lot of light on this discussion (GDP is a very complicated thing).
Fred, You are correct about the latest Kotlikoff paper stating that an 18% cut in discretionary spending would be needed to achieve a 23% Fairtax rate. And, IMHO, that won’t happen! There is a train wreck coming wherein entitlements will squeeze out discretionary spending in the near future, certainly in my lifetime. That is why the prebate entitlement is such a bad economic idea. Fairtax advocates correctly point out that the Fairtax rate has been adjusted to pay for the prebate, so there is no problem, but what they don’t seem to grasp is that the entitlement share of the federal budget would rise from 52% to over 60% overnight with the passage of HR25. That would simply accelerate the trainwreck. Entitlements need to be reduced, not increased. After all, isn’t Defense, one of the most important federal government functions, funded from the discretionary part of the budget?
The Kotlikoff/BHI study from last September, “What Rate Works”, stated that discretionary spending would only have to be reduced by 2.73% in order to achieve a 23% Fairtax inclusive rate. I can’t begin to explain the two vastly different conclusions made by the same economics professor, but suspect that the study you referenced was a long term, 100 year analysis, whereas the September 2006 study was a one year (2007) snapshot. Other studies by Kotlikoff have also found that the rate would have to rise over time to accomodate the baby boomer costs, failing overall reductions in federal spending.
Perhaps someone else can shed some light on this very puzzling issue?
Hank – That is what I like about this blog. Not only am I learning a lot and grtting a better understanding of the Fair Tax but I am also forced to think.
Taxes embedded in product costs. Linder and others say that the 22% is arrived at by including all income and payroll taxes but not estate taxes. It is easy to see how corporate/business taxes and business share of payroll taxes fall directly to product costs. Gross wages also fall directly to product costs. That of course includes the employee share of payroll taxes and income tax withheld from employees earnings. Taxes on individual earnings from interest and dividends is a little tougher to follow. It can be argued that interest rates would be lower because the receiver only cares about the net interest not the gross. That is why municipal bonds can pay lower rates than corporations. So most income taxes seem to end up in product costs.
However, because the Fair Tax advocates say you will get your entire paycheck, only the direct costs of corporations will find their way to reduced prices. My 9% estimate of price reductions could be increased somewhat by interest and dividend reductions. I don’t think it is practical to assume that wages will be adjusted downward to their net amounts.
I have to research more to determine if the Fair Tax will be included in GDP numbers. Are state and local sales tax included in todays GDP?
Hank
After reading a bit more it seems to me that sales taxes are and the Fair Tax will be included in GDP. The definition of GDP includes all consumption; which is defined as the amount that consumers pay for goods and services.
I have not looked at the reference paper deeply, but I have done a lot of calculations around revenue neutrality of the FairTax. One thing to keep in mind is that we are experiencing astounding growth in tax receipts currently. Between 2003 and now tax receipts have grown tremendously. It would not surprise me if the revenue neutral FairTax rate calculated in 2003 was lower than the rate calculated in 2006 if for no other reason than there was so much more revenue to replace in 2006.
Marvin, major breakthrough!! Do you know that through your research on GDP, as well as your pricing analysis, you have reduced the inclusive Fairtax rate from 23.8% to under 19%, and saved the government over $120 billion in annual prebate payments. Not a bad days work, and you should get some sort of a bonus, don’t you think?
On a more serious note, why do you suppose that all the economic gurus missed this aspect of the Fairtax plan? Maybe they should have payed closer attention to the price issue after all!
Quadrupole:
For 2004, 2005 2006 GDP was $12 trillion; $12.7 trillion; and $13.5 trillion. Total income and payroll taxes and estate taxes collected (in trillions) were $1.757; $2.024; $2.264 for those same three years. As a percentage of GDP that is 14.6%; $15.9%; and 17.8%.
The rapidly increasing tax collections are the result of a healthy growing economy. More importantly taxes are taking an increasing share of GDP. Individual income taxes grew by 29% over the 2004 amount. Corporate taxes are 87% higher and social insurance taxes are up 11.5%. Other than Katrina, Iraq and homeland security are there any other reasons why there should still be a large budget deficit with this amount of tax increases. Is it a surprise to anyone that the Fair Tax rate will have to increase beyond 23% to keep up with this out of control spending.
These statistics were taken from the Congressional Budget Office.
Hank: your thoughts are too deep for me. The economic gurus are making assumptions that I can’t follow. They don’t give enough data to allow analyses that would either cause me to agree or disagree with their conclusions.
I can’t figure out why Kotlikoff says that social security benefits will increase by 30% to maintain real income for retirees or how he concludes that discretionary spending will have to be reduced by 18% to make a 23% rate work. I can believe the need for something near a 26% Fair Tax rate to cover the budget deficit and the spending increases that are looming. But those increases will be necessary under the income tax system as well. Spending is out of control with no fiscal restraint from congress in sight.
Marvin, a deep thinker i’m not. Let’s review why I think you have made a major breakthrough. First, you showed us why pre tax prices might fall 9% and after tax prices will rise 18%. Next, you discovered that tax payments will be included in total GDP. Finally, you and others believe that consumption won’t lag due to price increases because everyone has lot’s more cash in their pocket. Put it all together and it seems that, using the Kotlikoff September 2006 study data as a baseline, that the revised tax base will be $11,038 trillion($9355 x 1.18 = $11,038), and the new Fairtax rate would then be 20.18%($2228/11038 = 20.18%). And, at the new rate, the total annual prebate cost would be reduced to around $370 billion, a large reduction from the old $485 billion.
Does this make any sense?
Marvin said “I can’t figure out why Kotlikoff says that social security benefits will increase by 30% to maintain real income for retirees”
Marvin, the FairTax bill increases Social Security benefits by 30% (Title III, Sec 303) to accommodate for the FairTax the recipients would pay on those benefits. If the bill didn’t do this, the “real” value (i.e., purchasing power) of those benefits would have been reduced. Unless they are adjusted for the FairTax, the “real” value of all government transfers are reduced.
Interestingly, this includes the prebate. It’s “real” value would be reduced by the amount of FairTax that would be paid when the prebate was spent. Since the prebate is the poverty level times the inclusive FairTax rate, unless the poverty level is adjusted to include the FairTax paid — and the bill makes no provision for that — a person can’t purchase the poverty level of goods and services without paying FairTax.
Example: Let’s assume that the poverty level is $10,000. That means the prebate is $2,300. Let’s also assume that the poverty level has not been adjusted to include the FairTax paid on the poverty level of goods and services. I spend $10,000, I get $7,700 worth of goods and services (the $10,000′s “real” value) and pay $2,300 in FairTax. I spend my $2,300 prebate and get $1,771 worth of goods and services (the prebate’s “real” value) and pay $529 in FairTax.
Even with the prebate, my $10,000 only got me $9,471 worth of goods and services. Again, this is because the “real” value of all government transfers would be reduced by the inclusive FairTax rate.
Fred, your analysis is right on, and I’m reminded of this issue being raised on the Fairtaxgroups site some time ago. When this point was made, some (hopefully)otherwise intelligent folks countered with, “but the prebate isn’t income! It’s simply a rebate of sales taxes paid”.??? Very odd logic, don’t you think?
The truth is that taxes on purchases of goods and services up to the poverty level can never be completely offset by the prebate. Mathematically impossible- or impractical at least. Just another example of the myths that have grown up around the Fairtax as talkshow hosts and other marketeers try to put the best face on this rather complex scheme.
Hank, if they had used the exclusive rate, as they did with the increase in SS payments, they could have essentially untaxed poverty level spending. I don’t know if, in using the inclusive rate, they just assumed that the poverty level would be adjusted to include the FairTax or if this was just a mistake or if it was intentional to reduce the cost of the prebate.
If the poverty level is adjusted to include the FairTax, that opens up a whole other can of worms. There are numerous programs (federal and state) that use the poverty guidelines to determine eligibility or the amount of benefits. If the poverty level is not adjusted to include the FairTax, then the prebate clearly does not untax poverty level consumption.
Again, this is because with a NRST the “real” value of all government transfers are reduced. To “untax” government transfers under the current system, you just don’t include them in taxable income. To “untax” transfers under a NRST, you have to increase the nominal amount of the transfer.
It seems to me that everyone including Kotlikoff is missing one big point. Kottlikoff says social security will have to increase by 30% to maintain real purchasing power. But that doesn’t consider the relative drop in prices that I believe will be about 10% in the first year and more in subsequent years as business are saddled with fewer tax costs; both direct and indirect. Labor will not be able to command this artificial advantage over capital. Market forces will reestablish an equilibrium closer to today’s situation. The supply of labor with the appropriate education level in conjunction with demand will determine long term wage rates.
Say a retiree gets $25,000 per year in social security benefits. Increasing that by 30% gives him $32,500. Give him a prebate of $2,400 per year. Then cut the prices on everything he buys by 10%.
Under the current income tax system, this single individual could buy $25,000 (less a small amount of income tax which I ignored) worth of products at todays prices. He would get $22,500 of products after the 10% price reduction.
Now give this same person $34,900 to spend. Deduct 23% for the Fair Tax and he will be able to buy $26,873 of products. Everyone will get the prebate. Therefor everyone on social security would get a $4,373 extra benefit from the Fair Tax. I have never (and it doesn’t seem like anyone else has) included this in comparing Fair Tax to current system for retirees.
I finally found the pertinent section under “other matters” sec 303 social security indexation. Kotlikoff and the rest of you are right for the initial year. But, this should only last for one year. The following fall the CPI will adjust for the falling prices (before the Fair Tax) and social security benefits will be adjusted downward accordingly. Wont people really love that.
Disagree with Hank that purchases up to the poverty level can not be comletely offset by the prebate. There will probably be a similar situation to the above example on social security. The poverty level for the year will be established based on prior year prices. The prebate will be calculated on that base. In the next year when prices (before the Fair Tax) drop, the poverty level should be adjusted downward and the prebate should drop accordingly. Of course part of this will be offset by normal price inflation. I call already hear the cries “president X cut my prebate and my social security.”
Marvin, regardless what happens to prices and, thus, the poverty level — unless it is adjusted to include the FairTax — poverty level consumption is not untaxed under the FairTax. This a simple mathematical fact that results from calculating the prebate by multiplying the poverty level by the inclusive rate instead of the exclusive rate. Obviously, if the poverty level doesn’t include (and there is no provision in the bill to assure that it does), then using the inclusive rate does not untax poverty level spending.
Since poverty level is calculated each year by HHS, wouldn’t it be reasonable to assume they would be the ones responsible for altering their calculations to include the FairTax?
If so, then wouldn’t it also be fair to assume that future years after the FairTax was enacted would almost certainly work that way?
Why would you assume that HHS would include the FairTax in the poverty level? Why wouldn’t the bill make that law? If not, why not add a condition like they do in Title III, Section 303 where it basically says “If the CPI includes the FairTax, use the inclusive rate. If it doesn’t, use the exclusive rate.”
Also, if the poverty level is increased by the amount of the FairTax, then we need to look at how that would affect other government programs that use the poverty level in their calculations.
Does the responsible agency look at future prices in setting the poverty level or is it based on the prices of a “basket of products” at the date the survey is done? That would be in the previous fall. The calculator would be blind to future price increases or decreases unless the methodology changes by congressional edict.
Suppose, $20,000 is established as the poverty level based on current prices. The prebate is calculated at 23% of that or $4,600. Under the current system, the consumer gets $20,000 worth of products. Under the Fair Tax for the same products, he will pay $18,000 x1.3 or $23,400 for those same products . But, he had $24,600 in his pocket ($20,000 + $4,600). It seems to me that he is $1,200 ahead of the game.
If we ignore the price decreases and keep prices constant, the consumer will pay $26,000 and only have $24,600 in his pocket. He is now $1,400 in debt or has missed a few meals. I guess if you deny price reductions will occur, you can make your case. I happen to believe their will be price reductions that will occur fairly rapidly. Business costs will go down, as of January 1. Compettition will force the price reductions.
What if every business ignores the forces of competition and keeps the money as extra profts? The extra billions will fund economic growth, increased wages and higher dividends. The same amount of money will stay in the economy. Poorer people would be hurt the most by that scenario. My understanding of the business world leads me to believe that prices will come down.
Well the CPI is what is used to calculate the poverty level each year, along with many other things.
If we include sales taxes in the CPI, that would seem to me the best way of keeping the prebate on track, as well as providing realistic benefits levels for other programs so that they aren’t devalued.
This is why I would assume that. Perhaps it is language that should be added to the bill to ensure it was done in that fashion, but I see no reason why the Congress would leave that particular issue out in later years. It would seem to me that if it was left out as an oversight, that its effects would become obvious in the first year or so and it would be rectified under public pressure within the next year.
Perhaps everyone is making this whole thing more complicated than it really is. Dr Kotlikoff and Dr Gale have studied the Fair Tax for many years. They draw different conclusions from the same set of facts. Each says tthe other has made big mistakes and they can’t understand what the other is saying. They have prepared detailed analysis with complex algebraic equations proving or disproving the theories of the Fair Tax. They make assumptions which seem vague and defy understanding by the layman. We try to analyze bits and pieces of the law in isolation and may arrive at faulty conclusions.
But if we look at this on a macro basis, there are only four important categories to consider; federal government, state and local governments, business, personal. Each transaction is a positive for one or more of these categories and a negative in equal amounts for one or more of the other categories. Only a few items have one side of the equality that falls outside of these four areas.
First business will have positives (in billions) from elimination of corporate income taxes ($353.9 ); employer share of payroll taxes ($346.8); compliance costs ($200.0);and interest paid to individuals (?? amount). The business sector will lose revenue from lower interest rates from individuals. Whatever the actual interest amounts and compliance savings, the net cost reductions will be passed on to individuals and federal, state and local governments through price reductions estimated to be 10% on all products and services. If for some reason business doesn’t drop prices the full amount possible, the “savings” will remain with the business. Eventually, the full amount will be passed on to individuals in the form of higher wages or dividends. If the business has opportunities to grow, the available profits will be used to expand the economy. The best thing is that each of those decisions will be made without consideration for taxes.
State and local governments will have reduced costs (in billions) of ($52.8) from employer share of payroll taxes and ($100 billion) from price reductions. These government entities will pay ($251.4) more in the Fair Tax. A growing economy may provide significant additional revenue. The exact amounts of each of the above items don’t really matter. The state and local governments will adjust their tax rates to provide the same amount of revenue as they have today. This will come from individuals. Even if the states choose to tax business for some of the needed extra revenue it will end up eventually coming from individuals.
The federal government will lose revenue from the elimination of the covered taxes ($2.264 trillion). The Fair Tax at 23% times a tax base of $11.050 trillion will raise $2.5105 trillion. $.2107 trillion of that will come from the federal government leaving a surplus of $35.8 billion. The government will save in billions ($19.3) on employer share of payroll taxes, ($8) on IRS operating costs, ($90) on reduced prices on products and services purchased. This adds up to a surplus of $153 billion. Unfortunately, there are significant additional costs; Prebate ($436 billion); 30% index of social security ($163 billion); transition inventory exemption ($385 billion). The net deficit would be $831 billion requiring a Fair Tax rate of about 30% inclusive rather than 23%. Fortunately all of the extra funds needed to pay this increased tax are in the hands of individuals. Compliance cost savings ($200 billion) and any amounts generated by economic growth will leave significant additonal amounts in the hands of individuals even after the increased Fair Tax assessment.
I am a strong supporter of the principles that the Fair Tax is built on. I believe there are many benefits to be realized from this program. But, I am troubled by some of the details and the miscalculations of what rate is necessary to ensure revenue neutrality.
The above attempt at simplification can probably be simplified even more. We know how much revenue will be lost by the treasury from the Fair Tax ($2,264 billion). We have estimated that prices will be reduced by about 10% as the result of eliminating payroll and corporate income taxes plus reductions in interest expense and compliance costs.
We have to recognize that neither governments nor business pay any taxes. They only serve as a conduit to move tax from individuals to the government. Thus, the Fair tax rate should be calculated based on the personal consumption taxable base. It will also be necessary to determine government savings from elimination of the employer share of payroll taxes and from the 10% reduction in prices; estimated to be federal $110 billion and state/local $150 billion.
Personal consumption adjusted for provisions of the Fair tax would be about $9,000 billion for 2006. To replace the lost Federal revenue ($2,264) less cost reductions and payroll tax savings ($110) less child and earned income tax credits ($52), the Fair Tax rate would need to be 23.35%. The prebate is based on the Fair Tax rate times the poverty level. The poverty level should be determined by the cost of goods and services to cover the necessities of life. Those costs should be reduced by 10% before the Fair Tax. I can’t find any evidence that Kotlikoff considered this in his calculations. Assuming the Fair tax rate ends up at 30%, the total prebate would be about $500 billion. That would require an additional rate of 5.55% for a total of 28.9% to cover lost federal revenue and the prebate. Indexing social security by 30% would cost another $163 billion or 1.8%.This brings the total to 30.7%. The collection fee paid to retailers and the state would be insignificant for this analysis. There is still the one time problem of taxes lost from the transition inventory (about $500 billion). On the other side of the ledger, state and local governments will have reduced costs of $150 billion which will come back to individuals in the form of lower taxes. When is all over, individuals will have several hundred billion extra in their pockets from reduction in compliance costs.
Total taxes aren’t increased and everyone should benefit fro increased economic growth. However, there will be an additional transfer of wealth to the poor and social security recipients. This doesn’t invalidate the Fair Tax but it should be analyzed based on these higher rates rather than 23%.
Help me understand how Social Security benefits will be determined by FairTax. Under the current system, lifetime earnings are used to calculate benefits. Without the current income tax system, employers and self-employed folks can report any income amount to the SSA. IE- if I am self-employed I tell SSA I made $200,000 last year to bump up my future benefits. How would they know the difference? Where are the checks and balances? How can this reported income be verfied under FairTax?
Rob has a pretty good point on a lot of levels.
FairTaxers like to claim that it’s none of the government’s business how much money we make — except that we’ll need to tell the government how much money we make each year or we won’t get social security benefits. That’s really pretty funny, when you think about it.
Rob K
The current reporting of Social Security Income will continue. It is the only method currently available for determining benefits and the report is made directly to the Social Security Administration.
I would argue that employers today could essentially report any income they wanted to the SSA if they wished, the main reason they don’t is fear of being prosecuted. Being taxed more on fictional income isn’t a problem if one is already falsifying the reported income already, you just falsify it to more than one party (high to the SSA and low to the IRS, but beware the audit flags). So I think the real deterrent is the fear of being audited and caught, and in addition, the fact that an employer does not benefit by falsifying information for an employee’s SSA benefits.
Under the FairTax, I think things are much the same. Your employer (or yourself if self employed) still reports income to the SSA, and falsifying that information is still a crime. Is it harder to catch you if you commit this crime? Perhaps, but conversely, since only businesses are going to be tax-audited post-FairTax and not individuals, it would likely be harder to avoid being audited or prosecuted.
In addition, the paper trail for taxation is far more informative for a taxing agency under a consumption tax than an income tax. With the FairTax, a business has to report its gross receipts and its rebatable purchases in order to remit tax. This typically would have to be backed up with accounting records by law, to provide on demand in case of audit. Based on the amount of rebatable purchases you claim (business inputs) and also the level of gross receipts you provide, a tax agency can make a rough estimate of your profit margin and take-home pay. If you start bumping profits on your SSA forms, it will likely set off audit flags if you stray too far from the rough estimate. Outside parties provide the information on your tax-free purchases as well (whenever you use your business certificate to buy something tax-free they have to provide a record of it to protect themselves from remitting too much tax), and those would presumably be largely free from corruption.
Contrast this with the income tax, wherein a single business owner can completely fictionalize his entire business history if he wishes, and only a review of his bank accounts could reveal the truth.
But to be fair, this issue comes up frequently, and so I am sure a number of businesspeople will get the same idea and try to hustle this scheme themselves, but I doubt many will succeed, and I think most will abandon the effort. I think the potential penalties (thousands of dollars in fines and potential jail time for defrauding the government) outweigh the potential benefits (several hundred dollars more per month that one cannot collect until retirement, provided one could maintain the scam for a decade or more to make it worthwhile).