Answering James Taranto’s Critique of the FairTax
A reader named Derek has done an excellent job of answering Hayden Kepner’s summary of James Taranto’s critique of the FairTax in the Wall Street Journal. I’m pasting Derek’s answer below, with a few of my own comments added in italics.
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.
In addition to paying the correspondingly-lower sales tax rate, as explained above, middle class taxpayers will (like all taxpayers) benefit from a reduction in the embedded taxes in our current prices ... which will vary from one industry to the next, but in some circumstances are as high as 20% of the current price of goods.
Also, like everyone else under the FairTax, the middle class — which is increasingly savvy about investing their money — will be able to make their investments 100% tax-free. This makes it even easier for middle class families to become upper class families.
For these reasons, it’s actually pretty mind-boggling to me why anyone would claim that the middle-class will be hardest hit. The folks who are hardest-hit will be those who currently pay little-to-no income tax (e.g., trust fund babies, drug dealers, etc) but who live lavishly and spend a lot of money.
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.
The amount of money that these people spend each year is no trivial thing, incidentally. Some knowledgeable estimates put it as high as a trillion dollars annually. Currently that money is not subject to the income tax, but it would be subject to the FairTax — potentially raising billions in revenue.
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.
“The folks who are hardest-hit will be those who currently pay little-to-no income tax (e.g., trust fund babies, drug dealers, etc) but who live lavishly and spend a lot of money.”
Very well said, Josh. The FairTax doesn’t hit those who make a lot of money. It only hits those who spend a lot of money.
Re: “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.”
Spending “far beyond the poverty level” can definitely constitute consumption that is being done by the middle class. You’re right to say that a middle class family can manipulate their tax burden under your system, but it is undoubtedly the case that economic models show the middle class bearing a higher economic tax burden overall than it did before (and likewise, a downward shift in the tax burden of upper class taxpayers).
Chris, can you offer any evidence for your assertion that “it is undoubtedly the case that economic models show the middle class bearing a higher economic tax burden overall than it did before”?
Joshua — In response to you question about whether any economic models show that the middle class bear a higher economic tax burden overall under the FairTax than under our current system.
I assume you are aware of the analysis of the President’s Tax Reform Commission (that Morph put on Wikipedia) that essentially shows (or, at least, asserts) that taxes will need to go up under the FairTax for families making less than $200,000 per year, while taxes will go donwn for families making more than $200,000 per year..
Now, I know that many FairTax supporters are critical of that analysis because it did not take into consideration the effect of ending the regressive payroll tax. But there is another study done by the Beacon Hill Institute (A Distributional Analysis of the FairTax, available on the BHI website) which seems to indicate that families under $75,000 will, on average, see their net incomes reduced under the FairTax.
See Table 6. This study is another one of the very-difficult-to-follow studies done by BHI that were paid for be AFFT. Without trying to be argumentative, in my opinion, the reason that the BHI studies are so difficult to follow is that they stretch so far to try to spin their results into a light most favorable to the FairTax.
For example, in this study, their own models show that the FairTax will have an adverse income on families with lower INCOME levels. So they ignore that, and instead spin their findings to try to show that the FairTax has a positive impact on families with lower SPENDING levels, in that they will end up spending MORE under the FairTax.
Basically, this study makes no sense to me whatsoever.
I would be happy for someone smarter than I to explain this study to me. But it certainly seems to me that it shows the FairTax is a raw deal for the folks in the middle class and lower. (And, of course, the study assumes that the FairTax will be at the 23% tax-inclusive rate. The burden on the middle and lower classes would obviously much worse at a higher rate.)
Hayden, I have gotten an e-mail from Jonathan Haughton (the study’s lead author). I think one of the most striking things is that low-income is not what we may think as lower-class, etc. In table 6 - how could someone with an after-tax income of $4,363 under the current tax regime have an after-tax income of -$5,490 under the FairTax (the figures used in table 6)? The answer is that this person might be spending $56,329. This is not just a bizarre hypothetical example. It reflects what is happening (on average) at the low end of the income distribution: there are a number of people who report negligible incomes yet are spending very substantial amounts.
Some of these people may have suffered capital losses; or be farmers who had a bad year. But it is hard to argue that these people are, by dint of low reported incomes, necessarily poor in any fundamental sense. The reason that the results (income and expenditure) differ so strikingly is that income is surprisingly poorly correlated with expenditure. The main explanation is that income is more volatile than expenditure - we try to maintain our spending even if our income takes a temporary hit.