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.