James Taranto Critiques the FairTax in the Wall Street Journal
From today’s Wall Street Journal:
If you were reading this column last week, you probably anticipated our second reason for criticism of Mike Huckabee’s presidential campaign: his support of the so-called Fair Tax. Just to sum up, the Fair Tax proposes to eliminate all existing federal taxes, including those on personal income, payroll and corporate profits. Replacing them would be a heavy sales tax, just under 30%. (Fair Tax proponents describe it as a 23% tax, a figure they reach by adding the tax before calculating the percentage.)
What’s wrong with this idea? Absolutely nothing, to hear the Fair Tax people tell it. It offers only benefits and imposes no costs. Mike Huckabee ascribes to it occult powers; he tells the New York Times that enacting the Fair Tax would be “like waving a magic wand, releasing us from pain and unfairness.”
Fair Tax proponents claim that it would be “revenue neutral”–that is, it would raise the same amount overall as the current tax system does. This means one of the following three things (or a combination of the second and third):
1. Everyone would pay the same amount in taxes as under the current system.
2. Some people would pay less, but others would pay more.
3. The tax would alter incentives in such a way as to increase economic growth, thereby making people richer without reducing revenues to the government.
We can dispense with the first possibility easily enough. Fair Tax proponents do not claim that everyone would pay the same in taxes under their system–a claim that would be both highly implausible and not much of a selling point (why radically redesign the tax system if the effect is zero)?
But revenue-neutrality remains a zero-sum game: If some taxpayers pay less, others will pay more. It stands to reason that under a system taxing only consumption, those hardest hit would be taxpayers with relatively low income and high consumption, such as young families with children and (as we noted Friday) elderly people living off their (already taxed) assets.
Fair Tax people respond to this point by saying they would counter the added burden with subsidies, which they call “prebates”–a deviation from the elegant simplicity that is the plan’s biggest selling point. Still, no matter how complicated they make the system, there is no escaping simple arithmetic: If some taxpayers pay less, others are going to have to pay more, or else the plan is not revenue-neutral.
As we noted last week, Huckabee acknowledges that a few groups would pay more: “illegals, prostitutes, pimps, gamblers, drug dealers.” This radically simple tax is so precisely targeted that only bad people will pay more. The rest of us will save so much, we can pool our resources and buy the Brooklyn Bridge.
What about the supply-side idea, that the Fair Tax would spur economic growth, thereby generating revenues by way of increased economic growth? The trouble with this is that the Fair Tax is almost ideally unsuited to take advantage of supply-side effects.
It is certainly true that lower tax rates can create incentives for economic activities, thereby increasing revenues. For example, lowering the capital gains tax to 15% prompted investors to unlock their gains, and thereby generated more revenues than the higher rate. But obviously there are limits to this phenomenon, which is why Laffer drew a curve rather than a line. If the capital gains tax were reduced to zero, revenues from it would be zero.
That is what the Fair Tax proposes to do, not only with capital gains, but with earned income, interest, dividends, corporate profits and all other forms of economic activity except consumption. Economic growth would produce revenues only to the extent that people spent more money.
Supply-side effects work on consumption taxes as well. When Congress slapped a “luxury tax” on yachts, people stopped buying yachts. The yacht-building industry was devastated; people working in it lost their jobs; and Congress ultimately repealed the tax. The Fair Tax would impose a 30% levy on all consumption, a powerful disincentive to spend money. People who need to spend money–including the young family and the elderly couple living off their assets–would get hit hard by the tax. Rich people, by contrast, would forgo luxuries or find ways around the tax.
When we wrote about the Fair Tax last week, we got lots of emails from readers demanding to know why we like the current tax system so much. Of course we don’t like it at all, and we don’t know of anyone who does. But as appealing as the Fair Tax may be, it is only a fantasy. A belief in magic is not a qualification for the presidency.
Anybody care to summarize and then answer his criticisms?
Taranto’s obviously been reading my posts! He just says it a lot better than I do.
Summary:
1. Revenue neutral. If someone’s tax goes down, somebody else’s need to go up. Since rich peoples taxes will go down under the FairTax, the taxes on the poor and the middle class must go up. (And, if the poor are “untaxed” by the prebte, then the only group left to take up the slack is the middle class.)
2. Underground economy. The money’s not there.
3. Economic growth. When you reduce tax rates to zero (on earned income, capital gains, dividends, estates), you get zero revenue even if there is increased economic growth — UNLESS people spend enough to make up for the lost revenue.
4. When you tax consumption, people spend less. Thus, we’ll likely end up with lower revenue and higher unemployment (at least in certain industries dependant on domestic consumers.) The tax will hit hardest on those who NEED to spend money.
5. He then clearly echoes the example I’ve been using for years about how the yacht industry suffered under a 10% “luxury tax;” just imagine what would happen under a 30% FairTax.
Rebuttals:
The FairTaxer’s (I can hear them now) will claim that (a) he ignores the effect if the removal of the “embedded taxes,” (b) he disses the prebate, (c) doesn’t realize that the US will become an economic engine when all taxes on productivity are removed and trillions of dollars come pouring into this country.
There. I’ve just saved everybody a lot of time. Clearly, there’s nothing more to add. : )
Tom Tancredo is a good man but he is pandering to try and slow Huckabee down. The critics of the The Fair Tax are unwilling to debate its merits which are considerable and its flaws which are significant too so that one may contrast two different theories on how a federal governement may best raise the the necessary funds to governed.
The notion that the a consumption tax would slow the economy therefore it is either a zero sum game or a shrinking pie that would increase the tax burden on the people. is hog wash. The fact of the matter is the proponent believe revenue neutral means the proposal would raise the same net funds to the government but would do so in a fashion that would more fairly spread the burden on those who can afford to pay. And, it would increase the GDP by be exceedingly progrowth… bigger but the same revenue means feds take as a percentage of GDP is smaller thus more capital in the hands of small business which is the engine of growth here and around the world.
Whats the magic in the wand they wave. Well for one thing if you eliminate corporate taxes and taxes on dividends there would thousands of corporation moving on shore from off shore and there by bring back tens of thousands of jobs with them… feels like growth to me. For another thing the American worker both union an non-union can compete with any workers on this planet because of their incredible productivity. Oh yeah, why is that not working now? Well remember that talk about the imbeded price of the current income tax system that 20 to 25 percent that would disappear with fair tax imagine what that would mean for our exports. Today the low dollar is all the talk about spurring exports add a 25% across the board price reduction and refigure the numbers and you will see a huge increase in GDP
Ok we are on a roll so at 4.7% unemployment rate and impending slow down in availability of undocumented workers what happens. Wages up and that is inflationary right. Not if it is growth and we just drop the cost of wages 15% for soc and medicare accross the board so a company could afford to raise wages and higher more folks but where you going to put them. Oops, yeah good point better add to plants and throw in some more machines and computers etc. Oh while we are at it tell all the accounting geeks in the tax department to report cost and get to work on working their magic on our cost so we can get even a bigger share of the market.
Oh oh this is a good one, just how do you expect for all these folks to pay for all that stuff. You know all those dollars that the left has been complaining about that is going to drown the world etc well they will be coming home. Hello world to Sam Waltons America While the hinese are employing their people selling us trinkets they will be buying our intectual services and tractors and engines and infastructure stuff etc its a new thing its called fair trade.
The best part is that exports is a sigfificant but smallish part of GDP domestic is the big show and it will be cooking too. Magic perhaps to the those who do not believe that lowering cost increases demand and that increasing demand increases supply that adds employment and return on capital which incourages more investment well you get the idea.
To be sure no federal tax program is a panecea but this one has too many good points to be demigod by Tancredo and McCain etc because they do not have the courage to support it or debate it fairly. Funny how that word keeps coming up fair tax fair trade fair debate. I wonder are the opponents the unfair?
New Tax Foundation podcast with Bruce Bartlett (anti-FairTax, whose recent written diatribes at WSJ and TNR were exceedingly excoriated). However excellent overview of materials supporting both sides of the debate (including video AEI panel of heavy-hitters):
http://www.taxfoundation.org/blog/show/22815.html
Gardner, you say the fairtax spreads the burden to those who can afford to pay. In reality, it shifts more tax burden onto the middle class and retirees. The poor are untaxed with the prebate. And the rich get large tax breaks by untaxing savings and investments and having a much less progressive tax structure. It seems those who can most afford to pay most are getting taxed less.
The talk about the embedded costs of a 22% cost reduction assumes employees will voluntarily give all of the money they used to pay the government in taxes, and give it to their employer instead, as a gift, so they can lower their prices 22%. I don’t think I have to tell you this will never ever happen. If you discard this employee pay cut fallacy, the embedded costs are half that, more like 10-11%.
Good question about how will the people pay for all of this stuff. In another thread, it was found that only 90 million out of 135 million tax filers actually paid tax. That means the burden of matching revenue neutrality of 2.55 trillion falls on only 90 million households. That would mean the average household would have to spend $126,000 on taxable goods to be revenue neutral. How is that possible when the mean household income is only $60,000?
Oh good, you believe that lowering costs increases demand just as I do. Then you must also believe that raising costs lowers demand. So when a 30% exclusive tax(16% after embedded costs) is added to the price of goods, demand will fall. Which lowers employment.
Of course when all other variables are constant, Increased cost can lower demand but we’re also talking about an increase in income – we’re talking about inflation and purchasing power. A candy bar use to cost 5 cents, with a cost ten times that today the candy business would be dead if we were just talking about price increases. Prices are realtive, and so are price increases. We’re also not talking about a single item. If prices rise on yachts (with income consistant), you look to spend your income elsewhere. You may spend it on a sports car or a bigger house, where ever you think your dollar value best meets your wants or needs. We’re talking about an increase across the board. So the value of one item will not greatly change in relation to other items (except in relation to U.S. and foriegn goods where we level the field). So the question then becomes.. are Americans savers or spenders? If they do save some, is that a bad thing?
Ian — Thanks for the link to the Tax Foundation Podcast.
I just listened to it. Bruce Bartlett is being interviewed on the FairTax. He discusses his upcoming article in TaxNotes Magazine on the FairTax. (That’s the same tax journal that the William Gale article and the Beacon Hill/Kotlikoff studies on the FairTax were published.)
I am proud to say that Bartlett makes the same arguments that I, Kublikhan, and Hank have made on this very board (and other boards from which we have each been banned) for several months. I also note that Bartlett is not shy about using the L-word (i.e. “liars”) when referring to some of the FairTax proponents. (Gee. I wonder who he might be referring to.)
Finally, I would note that Bartlett makes it clear he’s not a liberal. He says, for example, that he doesn’t particularly care that the FairTax weighs most heaviliy on the poor and the middle class, he just says that the FairTax folks need to be more honest about that. He also comes out at the end for a flat tax, which he explains is more of a true tax on consumption than the FairTax. (Personally, I don’t favor a flat tax either, but that’s because I’m a commie lib!)
Once again, Kudos to Joshua for giving us a forum to have honest debates and discussions on his excellent board.
Seems like James Taranto did not really study the FairTax Act at all.
does he have some other motovation?
After truly understanding the FAIRTAX:
The only people who hate it are the “income tax profiteers”. Included are career politicians, lobbyists, tax lawyers, tax accountants, the non working rich, IRS agents, and illegal aliens. Get ready for even more distortions and lies by those who profit from the income tax system.
As far as I know, neither
I (bankruptcy lawyer)
Kublikan (who knows)
Hank (retired geezer)
Bruce Bartlett (conservative columnist/author)
James Taranto (WSJ)
Rich Lowrey (National Review)
William Gale (Brookings Institution)
Dale Jorgenson (Harvard)
Jim Poterba (MIT)
Congressional Joint Committee on Taxation (economists)
President’s Tax Reform Commission (miscelaneous)
or the other gazillion or so FairTax critics
are “income tax profiteers.”
But, then again, you never know.
Hayden, thanks for the summary, it makes it easier to respond to.
1. “If someone’s tax goes down, somebody else’s need to go up.” Complaints along these lines rely upon a belief that the current tax system is set up perfectly, and that a replacement is judged based on whether or not it taxed everyone the same as the old system. If that was the point of a replacement, why replace it?
The fact is, the current tax system taxes income, while the FairTax taxes consumption over the poverty level. So of course, it will go up for some and down for others.
However, claims that the poor and middle classes get hard by this are ridiculous. First, the FairTax removes all tax burden for those at or under the poverty level. They can spend 100% of their income on consumption and pay zero taxes, whether explicit or embedded in the price of the products. This is not true today, where even the poorest pay about 22% of all of their consumption spending on hidden, embedded tax costs. Anyone who argues that the poor will be adversely affected by the FairTax either doesn’t understand it or is purposely being deceptive.
For the middle class, the degree to which they get hit by the FairTax is completely dependent on the degree to which they spend money beyond the poverty level. So for those just beyond poverty, there is very little tax cost. For those spending at 2x times poverty, which probably covers most people, their tax cost is half of the FairTax rate (11.5% of their spending). The full FairTax rate is only felt once you get to spending far beyond the poverty level, at which point you are probably no longer considered middle class.
2. The underground economy is a lose some, gain some. We currently have no way to tax underground income now (taxing income of prostitues and drug dealers) – under the FairTax, we won’t be able to tax underground consumption (taxing the payment of prostitutes and purchases of drugs). There’s really little difference there. You move the imposition of income tax on the person purchasing an illegal product or service to imposition of consumption tax on the person spending the money achieved through illegal activities. I agree that this isn’t a reason to enact the FairTax, but it’s not a reason to criticize it, either.
In theory, though, it does bring more elements of the underground economy in line since even a drug dealer has to buy food at the grocery store, buy gas for their car, etc., all of which is participation in the taxable economy.
3. Economic growth. “When you reduce tax rates to zero…” Tax rates are not reduced to zero. They are replaced by consumption taxes. And in that scenario, businesses will no longer have to focus on the tax costs of their decisions, and it will free up businesses to make decisions based on growth and profitability without worry about taxes. It also makes US companies much more competitive globally – our current tax structure is a major impediment to US economic growth.
4. “When you tax consumption, people spend less.” Is it assumed that the only reason people spend money is because it’s already been taxed as income? Certainly tax decisions influence consumption decisions – but the desire, need, and drive to consume will always be there. If people decide to spend less and give more to charity to avoid paying consumption taxes, isn’t this true under our current system? And if people decide to spend less and save more to avoid paying consumption taxes, doesn’t this help create jobs and expand the economy?
“The tax will hit hardest on those who NEED to spend money.” And it will only hit money spent beyond the poverty level. And that is consistent no matter how much you spend. And if you don’t spend it, you can only either give it away or save it. Both of them are positive things.
5. “The yacht industry suffered under a 10% ‘luxury tax;’ just imagine what would happen under a 30% FairTax.” The reason luxury taxes don’t work is because it shifts incentives from one category to another. If you raise taxes on a specific luxury (or class of luxuries), then other items because more favorable because they are taxed less. So rather than buy a yacht, maybe I’ll consider a 2nd home since that won’t be taxed as much. The FairTax avoids this because all products and services are taxed *equally*. It is, in reality, completely different from a luxury tax and the comparison doesn’t hold.
To whom it may concern:
Most people need a visual representation on how the economy works and its relationship to the tax system as present and how it can be when the fairtax pulls through. Research into the various mind map tools, and collaborate, some tools can be networked for free.
“We can dispense with the first possibility easily enough. Fair Tax proponents do not claim that everyone would pay the same in taxes under their system–a claim that would be both highly implausible and not much of a selling point (why radically redesign the tax system if the effect is zero)?”
The net effect is close to revenue neutrality, but Laffer’s 2006 study indicates that more revenue would be raised because more people would be paying taxes, and as more jobs are created, the economy (70% consumption grows).
Read the study here: http://www.fairtax.org/PDF/MacroeconomicAnalysisofFairTax.pdf
See Tables 2 and 3.
“But revenue-neutrality remains a zero-sum game: If some taxpayers pay less, others will pay more. It stands to reason that under a system taxing only consumption, those hardest hit would be taxpayers with relatively low income and high consumption, such as young families with children and (as we noted Friday) elderly people living off their (already taxed) assets.”
The premise that savings has already been taxed is incorrect. Savings is what remains after taxes and consumption are deducted from income. That the present income tax system taxes income is a myth. It taxes consumption because consumers pay all taxes of every business and every employee and owner of every business. It’s built into the price of all the goods and services sold to consumers. One might ask, “Where did the consumers get their money?” They were either paid it in current or prior years, but neither businesses nor consumers (excepting the government) print their own money (and government is just an organized collection of consumers). From raw materials through applied labor processing to finished product, none of those business intermediaries is the source of funds used to pay taxes. In the case of consumables like all services, foods and medicines it must be quite evident that the final payer is the consumer, and in the case of durable goods, the first consumer pays all the taxes and only if the product is resold is a portion of the taxes paid reimbursed by the subsequent owners. Regardless of how many consumers hands a product goes through, the ultimate payer of the taxes associated with that products creation (including all taxes on labor) is consumers. It does not matter how complicated the tax system is made, how many tax collectors are involved in collecting, calculating and remitting taxes–the consumers are the only tax payers in the real world. When government tax people, the taxpayers are the consumers of government services for which they pay the taxes even if there is no direct and immediate benefit to a particular member of the public so taxed.
So, rather than have the complex and costly consumer-paid tax system we now suffer under, the FairTax proposes to eliminate all that complication and replace it with a single flat rate tax imposed on the purchase of new goods and services at the point of retail consumption purchase. Equal treatment under the law for every taxpayer / consumer is strong evidence of fundamental fairness. The current tax system fails that test while the FairTax passes it with flying colors.
“Fair Tax people respond to this point by saying they would counter the added burden with subsidies, which they call “prebates”–a deviation from the elegant simplicity that is the plan’s biggest selling point.”
The prebate codifies Thomas Jefferson’s (1801 Inaugural Address) prescription that the sum of good government is to leave people free to pursue their own happiness so long as they do no harm another AND that the government should not take bread from the mouth of labor. What did Jefferson mean by that analogy but that the government has no just claim to the property of a person that is necessary to provide sustenance to himself and his dependents? The FairTax exempts all legal residents from paying the FairTax on all goods and services up to the nationally defined poverty limit level of spending. It is handled this way because it makes the whole tax collection simpler to tax ALL new goods and services without exception–and to provide ALL with the same standard of exemption for necessities without having to maintain lists and categories of exempted products. Both the uniformity of the tax rate and the uniformity of the exemption for the tax necessity spending speak to the basic equal treatment under law each lawful resident of the country is entitled to receive from their government. This is much simpler than any state sales tax–and much fairer to everyone–without the government picking and choosing winners or losers.
“Still, no matter how complicated they make the system, there is no escaping simple arithmetic: If some taxpayers pay less, others are going to have to pay more, or else the plan is not revenue-neutral.”
The plan only approximates revenue neutral, and has the authority considered the utter folly and complexity of the system of exemptions, deductions, and tax credits of the current tax system? Please, the FairTax has but two general rules: (1) Everyone pays the same tax rate for new goods and services at retail, and (2) all lawful residents may claim exemption from the tax for necessity spending by household size. How many rates does the current tax system have, how many categories of taxpayers, and how many loopholes?
“As we noted last week, Huckabee acknowledges that a few groups would pay more: “illegals, prostitutes, pimps, gamblers, drug dealers.” This radically simple tax is so precisely targeted that only bad people will pay more. The rest of us will save so much, we can pool our resources and buy the Brooklyn Bridge.”
Those people who routinely evade income consumption taxes would pay more. The poor (those with income less than the poverty limit) would pay $0 or receive a net tax benefit due to the prebate) if they spent all their income on new goods and services. Those spending twice the poverty limit would face an 11.5% effective consumption tax rate. Those spending 4 times the poverty limit are looking at an effective consumption tax rate of 17.25%.
Looking at the current income / consumption tax system as a purely consumption tax means that the average embedded cost consumers pay–excluding tax compliance costs is about 22% [(Jorgenson, Dale W. (1998-05-18). "The Economic Impact of the National Retail Sales Tax" (PDF). U.S. House of Representatives. Retrieved 2008-02-20.] When tax compliance costs are thrown in to the mix, then you may expect that the embedded tax burden (tax and compliance costs to be around 25% of the current retail price. That, however, is not the way to view what would likely happen shortly after the transition to the FairTax. Laffer (ibid.) projected an 11.55% decline in American production costs incl. Workers would take home all their gross pay, and households would receive the prebate. Since the FairTax exclusive rate is 23/77, prices would be expected to rise about 29% on foreign goods and services sold in the U.S. and about 15% on purely domestic content. However, there could be wide variation across products depending upon how much embedded taxation is removed and the willingness of producers to lower prices once their tax collection and remission burdens are lifted. The market will set and reset prices until supply and demand are balanced, and this static analysis does not consider the effects of new market entrants, increased demand or supply shortages, for a few examples.
“What about the supply-side idea, that the Fair Tax would spur economic growth, thereby generating revenues by way of increased economic growth?
…obviously there are limits to this phenomenon, which is why Laffer drew a curve rather than a line. If the capital gains tax were reduced to zero, revenues from it would be zero.
That is what the Fair Tax proposes to do, not only with capital gains, but with earned income, interest, dividends, corporate profits and all other forms of economic activity except consumption. Economic growth would produce revenues only to the extent that people spent more money.”
All true–and only on new goods and services. 70% of the economy is consumption. This is a far larger tax base than the current tax system. The FairTax taxes both wealth and income at the point of consumption.
“Supply-side effects work on consumption taxes as well. When Congress slapped a “luxury tax” on yachts, people stopped buying yachts. The yacht-building industry was devastated; people working in it lost their jobs; and Congress ultimately repealed the tax.”
True, Congress singled out the rich, tried to pick winners and losers, to punish those wealthy people–and those wealthy people resented being targeted in that way and responded with a boycott. The FairTax does not favor ANY segment of business more or less than any other. It does not show favoritism to the rich or the poor but treats everyone equally under law at the point of sale and in terms of qualifying for the exemption upon necessities.
“The Fair Tax would impose a 30% levy on all consumption, a powerful disincentive to spend money.”
The tax inclusive FairTax tax rate is 23%. On U.S. content, as was explained, about 11.55% of costs are squeezed out, then the 23/77 rate is applied with the result being about a 15% increase in total cost including the FairTax. $115 x 23% = $26.50. 115 – 26.50 = 88.50 = 100 – (100 x 11.5%). Foreign content will be less competitive in the U.S. because it faces its own embedded foreign tax load to which the FairTax is added. So, American products will be more competitive in all markets, leading to investment, job growth, and increased consumption in the U.S.
There will always be a large disincentive to waste money. However, the 22% of average price embedded in today’s supply chain vs. the 23% of gross retail price offset by the prebate means that the differential is not likely to be the full 30% claimed. Purchasing power may decline 1% in the aggregate, but the increased relative incentives to buy and produce American products will more than offset that loss. That loss, BTW, arises from replacing non-supply chain taxes by adding them back at retail.
“People who need to spend money–including the young family and the elderly couple living off their assets–would get hit hard by the tax.”
The prebate prepays the tax on necessities. By providing the money up front, young families can spend or save that money as they see fit and arrange their budgets accordingly–and decide between buying new or used. If they buy used, then they only pay the seller an amount for (1) their use of the item, and (2) their portion of the FairTax for their use of the item. The government does not collect another amount of tax after the initial retail sale and the FairTax is paid once. Double taxation is completely eliminated.
“Rich people, by contrast, would forgo luxuries or find ways around the tax.”
Rich people will not forego utilities, financial services, food, clothing, shelter, new cars, boats or aircraft because they might pay a higher retail tax given that their incomes are not subject to tax and they need no longer keep an army of tax accountants and lowers employed coming up with schemes to lawfully avoid paying their fair share of taxes. Equal treatment under law tends to bread respect for the law. Of course, they can buy used, keep their money tucked in mattresses but even if they do not consume so much, that means that their money is invested in making them more money–and that means jobs through financial intermediaries. Banks and lenders will be loaning money to business that recognize the great opportunity that opened up in America. They will repatriate billions of dollars parked overseas in order to avoid U.S. income taxation. That money will grow the economy, make the rich and everyone else wealthier. Then the rich will consume–and in a big way.
It does not happen all at once. It takes time to unfold, but it would unfold very close to the outline above. It is not a quick fix, but a systemic restoration of the constitution of the U.S. to one of liberty and prosperity from one of tyranny and deprivation.
“When we wrote about the Fair Tax last week, we got lots of emails from readers demanding to know why we like the current tax system so much. Of course we don’t like it at all, and we don’t know of anyone who does. But as appealing as the Fair Tax may be, it is only a fantasy. A belief in magic is not a qualification for the presidency.”
The FairTax has over 60 sponsors and co-sponsors in the U.S House. It is a serious proposal based on considerable economic research. Those who defend the status quo might just as well express their love for the tyranny of the income tax–for how would their behavior be any different if not so?
It’s nice to see some action on this board. I won’t respond to all of Paul’s points except to discuss what is in my opinion the fundamental flaw of the FairTax: it necessarily raises taxes on the middle class.
Below is the analysis.
1. Assume that the poor will be “untaxed” because of the pre-bate. (Not really true, but for the sake of argument I’ll accept this.)
2. The rich will necessarily see their taxes drop dramatically under the FairTax.
3. Use Warren Buffett as an extreme example. He famously pays “only” 17% of his income in federal taxes. So if he makes $1 billion, he’ll pay $170 million in taxes uner our current tax system. But he also famously lives frugally — living in the same home for the last 35 years. So he probably spends less than $100,000 per year. But even assume he spends $1 million per year (and that all of that would be taxable under the FairTax), his taxes would go down to $230,000 per year. That’s a loss of annual tax revenue of $169,770,000 from only ONE person. Just who do you think is going to make up the difference?
4. Even upper middle class people will see their taxes drop significantly. A doctor making $300,000 per year pays, on average, about $75,000 in federal taxes. (A 25% effective rate.) Under the FairTax, even if he spent $200,000 per year (and all of that was taxable), his taxes would drop to $46,000/yr. (minus the prebate). A loss in tax revenue of around $35,000/yr. if he has a family of four. But, of course, he probably doesn’t spend that much, and if he does, most of it would not be taxable. His current mortgage payment will not be taxable. (And he’d only have to pay taxes on the purchase of a new home if it were a brand new home from a builder.) His vacations to Europe are not taxable. The private school tuition for his children are not taxable. His vacation home is not taxable if he either buys an existing vacation home or rents it out when he doesn’t use it. Etc., etc. Thus, his TAXABLE spending will probably be less than $50,000/yr. Even it were double that, his taxes under the FairTax system would be only $23,000 (minus the prebate).
5. Spending as a percentage of income goes DOWN as income rises, so mathematically, those at the highest incomes will come out way ahead under any consumption -based tax system, and as shown above, will come out dramatically ahead under the FairTax.
6. Now, you might say, wealth is different from income. There are people who are wealthy but don’t have much, if any taxable income. They would be taxed under the FairTax as they pay for things out of their savings. Fair enough. But people who are that wealthy generally (a) inherited their wealth, (b) have capital gains income, and (c) aren’t that numerous anyway. Since under the FairTax, the estate tax and capital gains tax will be eliminated, we’ll lose that tax revenue. And, if the independantly wealthy really want to avoid paying taxes under the FairTax, they would just move overseas where none of they expenditures would be subject to the FairTax. After all, since they’re independantly wealthy, they’re not tied to a job and can live where they want.
7. What about “illegal immigrants?” We’d finally get to tax them under the FairTax (or so you say). Let’s look at the numbers. Assume there are 10 million illegal immigrants, half of whom are adults and half of whom are children. Assume all of the adults work at an average salary of $20,000/yr. That means they earn a total of $100 billion. Now, let’s assume they spend 100% of that income on TAXABLE goods and services. That means we’d generate a whopping $23 billion a year in tax revenue from illegal aliens. That’s less than 1% of the annual $3.5 trillion budget. And, of course, the average salary of illegal aliens is less than $20,000 per year, they don’t spend all of their money, and much (if not most) of their spending would not be taxable. Finally, illegal aliens get payroll taxes withheld from their paychecks when they work at legitmate jobs. So, the end result is, we wouldn’t get squat from illegal aliens under the FairTax.
8. Then, you might say, what about the “underground economy.” When all those drug dealers buy cadilacs under the FairTax, they’ll finally be paying into the system under the FairTax. Well, OK, except that they ALREADY pay into the system when they buy their cadilacs under the income tax system. The car dealership will pay income taxes on the sale of the cadilac, the salesperson will pay taxes on his commission, the auto manufacturer will pay taxes, as will its employees and suppliers. That’s what the so-called “embedded taxes” are! So, if you buy the argument that the embedded taxes equal 22% of goods and services, then the 23% tax that the drug dealer pays on the purchase of the cadillac will almost equal the embedded taxes. Plus, the drug dealer will get the prebate! Thus, we’re not going to make anything new from the “underground economy.”
To summarize then: Under the FairTax:
a. The poor will pay nothing.
b. The rich and high-income families will see their taxes dramatically reduced.
c. We won’t get any materially new revenue from illegal aliens or the underground economy.
d. So the people that are going to get screwed are the middle class (particularly middle-class retirees.)
There is just no other mathematical possibility. If you disagree with that, I’d love to see your analysis.
Hayden,
The Fairtax specifically raises taxes on middle class retirees. Last week, I sent the following email to both Tuerck and Kotlikoff.
“Dear Dr. Tuerck,
In October, 2006, Larry Kotlikoff produced a Fairtax study comparing marginal tax rates for 42 representative families using his ESPlanner model. Six months later, you published a Fairtax study on the economic effects of the Fairtax using your CGE model. The bottom line for both studies as far as Fairtax advocates are concerned is that “Everyone would be better off under the Fairtax”. I don’t agree!
More recently, Presidential candidate Mitt Romney responded to a debate question about the Fairtax by claiming that the rich pay less, the poor pay nothing, and the middle class gets hurt. Fairtax supporters immediately went into the attack mode and claimed he was badly mistaken. I don’t agree!
While models are a still mystery to me, I do understand how to calculate taxes for a middle class retired couple for both the income tax and the Fairtax. My simple analysis includes:
Income tax assumptions: A retired couple who take the 2010 tax year standard deduction and two personal exemptions, Social Security income of $32,000, and varied additional income from taxable pensions, investments, etc.. Four gross income cases were studied-$50,000, $75,000, $100,000, and $250,000 (just out of curiosity).
Fairtax assumptions: A $5,000 prebate which is additive to their gross income, and taxable spending of two thirds of gross income. (This last assumption would have been more accurate if I had used a sliding scale to reflect reality, but simplicity won out.) The results are as follows:
(1) At $50,000 gross income, $1000 of the $32,000 SS is taxable, adjusted gross is $19,000, deductions and exemptions are $18,700, taxable income is $300.00 and the income tax is $30. For the Fairtax adjusted gross of $55,000 (includes prebate), taxable spending is $36850 (two thirds), sales tax paid is $8475, offset by the $5,000 prebate for a net federal tax of $3475. The Fairtax increases their federal tax burden by $3445 each year.
(2) At $75,000 gross, the income tax is $5624, and the Fairtax is $7328, a $1704 annual hit.
(3) At $100,000, the income tax is $11494, and the Fairtax is $11,180, a virtual wash as expected.
(4) At $250,000, the income tax is $53,650, and the sales tax is $34,295, a very favorable outcome for the Fairtax.
I conclude that the rich do indeed pay much less, the poor pay nothing (due to the prebate), and millions in the retired middle class have a significantly higher federal tax burden under the Fairtax. Granted, this problem would be just during transition, but transition could last for fifteen to twenty years. Is it really fair to shift a significant federal tax burden to the retired middle class? (We tend to vote early and often!!)”
As this board’s senior citizen, I will continue to argue that millions of retired, middle class folks would be thrown under the bus by the Fairtax. Not only would our taxes rise significantly, but we would be forced to resume paying for our Social Security benefits with our sales tax dollars. After contributing to the Trust Funds for 45 years or so, how can that be fair?