Bruce Bartlett: Why the FairTax Won’t Work
December 30, 2007 · Filed under: Criticisms, Education
Bruce Bartlett has published an article in Tax Notes called, simply enough, “Why the FairTax Won’t Work.” (Thanks to Morphh for the tip.)
Bartlett was formerly Treasury deputy assistant secretary for economic policy and executive director of the Congressional Joint Economic Committee.
I’ve not read the article yet, but somehow I have the feeling I may disagree with him. 
20 Responses to “Bruce Bartlett: Why the FairTax Won’t Work”
Joshua,
I’m sure you will disagree with him, but it’s mostly just one man’s opinion versus another. After a quick read, I can only find a couple of factual errors dealing with the prebate. Bartlett states that family age is required on the FCA application, that failure to refile will result in an immediate cut off of the prebate, and that the prebate WILL go to members over the age of 18. None of which is accurate. I guess when someone like Bartlett is used to working at stratospheric levels in government, minor errors in details like that are to be expected?
The 14 page report basically covers all the points we have discussed on this blog. In fact, it almost looks like Bartlett was a regular reader of Josh’s site? He covered evasion, but not avoidance (sorry, Hayden), and did come up with an issue we haven’t discussed much regarding the likelihood of states participating in the Fairtax plan. He closes with an impassioned support for the Flat Tax.
I’ll try to send Josh a new thread with a summary of what HR25 calls for, and Bartlett’s “State Collection” rebuttal.
Bartlett should have been reading this blog more! In my opinion, he didn’t go nearly far enough in his criticism and missed some obvious openings if he’d spent a little time thinking things through.
He makes some very good points, particularly showing the inconsistencies of the claims of the FairTax’s most vocal proponents (not those on this board, of course) and concluding that they are being inconsistent at best and intentionally dishonest at worst.
In examining his footnotes, it’s obvious that he actually read (and, probably, even understood) the various studies of the FairTax, including the Beacon Hill/Kotlikoff studies, the Gale studies, the Tax Reform Commission, the Joint Committee on Taxation, etc.
He even examined the footnotes in those studies (always a wise thing to do) and points out some of the assumptions that some of those studies made that might not be completely realistic (to put it mildly).
I believe his most “on the point” criticism is the issue of the FairTax being applied to federal and state/local spending. He essentially concludes, as many on this board have done previous (good job, guys) , that (a) the tax on state/government spending will just increase state/local tax burden on their citizens, and (b) the tax on federal spending doesn’t yield any net revenue to the goverment, and is only done to artificially deflate the required tax rate.
He also points out that the “revenue neutral” study that Beacon Hill did was (intentionally) deceptive because they used a tax year in which revenue to the government as a percentage of GNP was about 4% below normal (thus yielding a far higher deficit). Using a more normal tax year would have required the FairTax rate to be much higher to be revenue neutral.
It will be interesting to see what Boortz says about this study. It’s going to be hard for him to credibly argue that Bartlett “changed the FairTax” when most of Bartlett’s analysis uses the AFFT studies as his starting point. Having said that, Boortz attacks anyone who dares to criticize the FairTax, so I’m sure Bartlett will get the same treatment.
By the way, thanks to Morph (a FairTax supporter) for sending the link to a critical review. It’s really nice to be able to have open discussions of the pros and cons of the FairTax.
Now, if we could just get the mainstream media to pay attention to this blog we’d save them all a lot of work!
As a supporter, I don’t agree with most of his assertions. However, he did mention what I would consider to be the biggest danger. Transition costs. In my opinion, the difficulty in predicting if wages raise or prices fall, or more accurately how much inflation is affected, could have the most disastrous side effects in consolidating to a NRST.
I think it’s Hank that often predicts that prices will rise by 17%, or there will be an immediate 17% inflation. This is my biggest problem because if this immediate inflation does occur, people who have saved a lifetime for assets will all of a sudden have those assets be 85% of their previous value. One of the few jobs I think the federal government should do is keep inflation at a reasonable, predictable level.
I think the best thing that could happen would be if employers would roughly pay employees their net salary immediately. Then prices would fall pretty dramatically. But that is highly unlikely. I think best case would be that employer keep his and employees’ payroll contribution.
Even though I’m for the fair tax, I think I could also support having it implemented over a period of time (I think Hank also suggested this). That way, maybe some of the market distortions created by the switch over could be mitigated. Maybe year one, get rid of corporate, employer payroll, capital gains, and start reducing income/employee payroll. Over a few years keep reducing income/employee payroll until they are gone. Smaller yearly raises could accommodate a more natural state of wages. Just a thought.
Joshua, this could be a new thread or just a continuation of the bartlett one.
State/Local Participation in the Fairtax Plan.
The recent Bartlett report published in Tax Notes, 24 December 2007, entitled “Why the Fairtax Won’t Work”, raised an important issue that has not had much discussion. Bartlett suggests that the States will not join in the Fairtax plan, and will very likely scrap all sales taxes in favor of a State income tax when the Federal government gets out of the way. Here is a brief summary of the Fairtax plan for State/Local participation and a review of Bartlett’s arguments.
Fairtax Plan. HR25 finds that practical experience in administering sales taxes resides with the States, that it would be desirable to harmonize Federal and State collection and enforcement activities, and that a good policy would be to foster administration and collection at the State level in return for a reasonable fee paid to the states.
HR25 defines Conforming States as those States that would adopt the same definition of taxable property and services as found in HR25. The legislation further defines an Administering State as a State that maintains a sales tax and enters into a cooperative agreement with the Treasury Secretary. Conforming and Administering States will receive a ¼ of 1% fee. Based on an assumption that population density relates closely to consumption, the fee would amount to $25,000 per day for Montana, and $1,600,000 per day for California. The total fee for the States can be estimated at $5 billion annually. (A similar amount would go to retail tax collectors.) An additional inducement for a State to become a Conforming State is bill language which would allow such States to collect internet revenue.
Bartlett Response. Problems with having the States collect the Federal government’s revenue include: (1) Five States have no sales taxes and would have to contract with an administering State, or have the Federal Treasury Agency come into the State and set up a collection and enforcement mechanism; (2) No two States have sales taxes alike and none tax a consumption base that is even close to the Fairtax. This would mean that there would be massive confusion over what is taxed by the State and what is taxed by the Federal government. Alternatively, States could adopt a State version of the Fairtax; (3) If States are pressured into piggybacking on a federal tax, there would be a real or perceived loss of State sovereignty.
Bartlett also reports that when asked by the President’s Tax Reform commission about a national retail sales tax, State tax officials suggested that if the Federal government gave up taxation of incomes, “States would view this as a tax base now available to them to tax more fully. Since all but seven States have an income tax, it could be better to get rid of State sales taxes and let the Federal government collect its own revenue.” Also, in 1990, a GAO survey found that 80% of the State tax officials queried voiced strenuous opposition to a federal consumption tax like the Fairtax as an intrusion on a tax base that traditionally belonged to them.
I am certainly not prepared to take sides on this issue yet. But, Bartlett quotes input from two legitimate sources, the Tax Reform Commission and the GAO, in support of his position. I’m not aware that the Fairtax authors in Houston queried any State tax officials in the mid-1990’s when they conducted their focus groups. It would be important to know if they did.
Here is a circular bit of logic that may help clarify the State choices. If Bartlett is right, and States wish to adopt the income tax as their revenue base, but the Fairtax plan includes repealing the 16th Amendment, thus making the income tax unconstitutional for all governments, then why would the States ratify the proposed Amendment? And if they don’t ratify it, then Congressman Linder and AFFT have said that the Fairtax provisions will sunset in five years.
Wow, what a tangled mess!!
Comments, anyone?
Hayden, just for clarification - the study discussed for the tax year GDP point was with regard to the Arduin, Laffer & Moore Econometrics study “A Macroeconomic Analysis of the FairTax Proposal”, not the BHI rate study.
Bartlett points out the double tax issue I have been harping about with Morphh in a different thread. I’m glad someone agrees with me on that. Not Morphh, of course.
Hank, be aware, and I say this somewhat in jest, I was politely reprimanded by Josh for mentioning how complicated it is to understand the issues surrounding the FT. [Ed: Actually, you said you couldn’t see how it was any simpler than the current system, which is an outrageous thing to reveal about oneself. –Joshua] After all, it is only a 130 some pages verse the 60,000 we have in the current system.
I wonder how many pages the income tax was on day one... [No doubt far shorter than it is today. And no doubt any new tax reform will eventually get bloated. So the question is how much of a boon we’d all experience by winding the clock back by many decades — and going with a consumption tax rather than an income tax this time around. –Joshua]
Later, John H
Joshua,
I would buy that in a New York minute. But I am not egar to make such a dramatic change in the system today. As many of these articles and posts point out, there is much disagreement about how things would work under the FT system. There are no guarantees except the tax itself. I still maintain that understanding all these issues is complex regardless of the simplicity of the 130 some pages in the FT
John H
John H/Joshua,
Some time ago, in response to the Aaron Russo film which claimed (incorrectly) that there was no law authorizing the income tax, I searched for and found a copy of the 1913 bill that became law on October 3rd, 1913. The law is a total of 27 pages, plus a four page set of instructions. The instructions grew rapidly to over 400 pages within the first year. And, by October 3, 2003, the instructions had grown to 55,000 pages, which I guess has lately been estimated as being over 65,000 pages?
Based on trying to print HR25, I estimate the bill is 80 pages in length. Three times larger than the original income tax law, but one can hope that the instructions wouldn’t grow in a similar manner???
Stay tuned!
John H, I don’t know that it implies that Bartlett agrees with you or that I disagree with Bartlett’s statement. It correctly points out that many will see this as double taxation. Bartlett does not go into detail. I only argue that there is more to analyze when switching tax systems and that the transparency of the current system may have you unknowingly paying additional taxes on that saved income.
Hank, I don’t think repeal of the 16th Amendment would repeal State income taxes. The states would still have the power based on their own Constitution. From what I understand, repealing the 16th would also not remove the possibility of income taxation at the Federal level as the courts have decided they already had the power to tax income. What it would remove was the ability to tax it “from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.” This is why the FairTax legislation calls for an agressive repeal, which not only repeals the 16th amendment but also expressly prohibits a federal income tax.
Morphh,
You could be right that an unconstitutional federal tax would be OK at the state level, but I really don’t know. I’ll ask my constitutional advisors and get back to you. Thanks for raising the question!
Morphh,
So even you agree that many will see this as a double tax. I certainly do. I know you would try to convince me and those who see it that way that it is not really a double tax. I even understand your argument, at a high level, but I am not convinced that it is a wash. It is a very complicated sell with many complex assumptions and it is very difficult to understand the detail, as I have witnessed on this blog. For me personally, I don’t care to pay one dime extra to the government under any conditions. According to what I understood from Bartlett, if it is not the government it could be excessive inflation. Either way, savings evaporate and this is devastating for us old guys.
BTW, I added a comment last week at the end of the ‘Irrefutable Proof…’ thread that I would like you to comment on. It has been a pleasure corresponding with you on this blog over the past few weeks. I have learned a lot. After I read your responses, I may check the site once in a while, but I am going to back off this issue for a while.
Have a safe and prosperous new year.
John H
Score one for morphh and andrew,
The Constitutional experts at Yale tell me that States can still impose an income tax even if the 16th Amendment is repealed. I was mistaken in my belief that they couldn’t!
That being the case, I’d suggest that it adds weight to Bartlett’s prediction that States would simply move to an expanded income tax system rather than become the federal tax collector. It also suggests that the States might be more willing to ratify the repeal of the 16th, leaving only the constitutional question of the Feds taxing States.
As near as I can tell, no one has run this thing by the States, other than a 1990 GAO survey of revenue officials from five states, and the interviews in 2005 of various state officials by the Presidents Tax Reform commission.
I have sent correspondence to all fifty state Treasurers asking for an unofficial input. If I get any responses, I’ll post them.
As a foreigner, I am interested to know how a ‘fair tax’ would affect tourism. Any American holidaying in my country ends up paying no federal taxes - so this must mean a real disadvantage to your internal tourism industry? On the other hand, foreign tourists are going to find the US expensive and so a less attractive destination?
Of course I could try to subsidise my vacation by selling a laptop or camera purchased tax free overseas - any plans for how you would control this?
Hank, BHI just published an article titled “Fiscal Federalism: The National FairTax and the States” http://www.beaconhill.org/FairTax2007/FiscalFederalismNatFairtTaxStatesBHI-071025.pdf
I haven’t read it yet...
John H, I replied to your post on ‘Irrefutable Proof…’
Bruce does not endorse the Flat Tax - he endorses a VAT, which is something completely different.
Also, if a VAT were enacted, wages would be decreased from the Gross Wage to the Net Wage. This would not happen with the Fair Tax, the purpose of which is to have everyone keep all their Gross Wages (which is a fetish with some people). They would need this money to pay their Fair Taxes.
Finally, Bartlett is totally accurate about the government spending effects of the Fair Tax as written. Unless the spending authority is increased by 23% for all items taxed, the result will be a spending cut. It does not matter that the money goes right back to the Feds - the issue is not cash flow but spending authority. If part of the spending authority is spent in taxes, this must be replaced by additional spending authority.
This is going to be a bit of a tough nut to crack though is it not? The general idea of a reduction in retail prices based upon the removal of the embedded tax component will be variable based upon the specific items. Additionally, the 22% embedded tax estimate was based upon employers reducing the gross pay of employees down to their current net pay, was it not? This means that the average price reduction seen in the market will be something less than 22% assuming that employers simply remit the tax portion of employee paychecks directly to the employees.
How exactly do you propose this increased spending authority when the final retail price of goods and services consumed by the government is not exactly known? My assumption is that the Fed would simply authorize a supplemental spending bill to makeup any shortfalls as a result of increased retail prices once the retail market prices stabilize at the new “post FairTax” levels.
Please feel free to point out my being dead wrong on this as I’m not an economist, and I have absolutely no background in this particular field. This is a really good point though, and one that I have never seen made before in any of my personal research on the subject.
Scott —
Different folks on the board have different views on how much prices will rise under the FairTax, or, even if they will rise at all.
Because this is a complicated issue that nobody really knows the answer to, I believe that most ecomonist (including, in particular, Kotlikoff and the folks at BHI) just ASSUME that retail prices will rise the tax-exclusive rate of the FairTax and that the Fed will expand the money supply accordingly.
This way, employees would keep receiving their current gross paychecks, landlords would keep receiving their current gross rents, banks would keep receiving their current gross interest, and businesses would keep receiving their current gross profits. All new consumer goods would cost 30% (or whatever) more, and government spending would increase by 30%.
That’s really the simplest way to look at it.
The federal government is actually overall from the fairtax inflation. If prices drop by the full 22% embedded, the 23% fairtax addition will basically be a wash. If the embedded taxes stay in the price, federal spending in nominal dollars will need to be increased by 30%, but that’s okay because their revenue will actually be 30% higher. This is because they are purchasing the same items they are collecting revenue from. Of course, if an individual department is budgeted $1B, but needs $1.3B under the fairtax, their budget will have to be raised, but the feds should have the additional $.3B because they have collected more fairtax.
The states aren’t quite as protected based upon their revenue sources. Their sales tax will react similarly to the federal government, but property taxes (which may be based on previous prices) will not automatically increase.
In our previous discussions, most agree that the nominal dollars to pay after tax prices will increase between 0% and 30%. Hank’s estimate is 17% which he sees as a minimum increase, but I see as a maximum (I believe it removes every thing but employee gross pay). As a reminder, this is about nominal dollar increase, not real dollar. The fair tax is revenue neutral in real terms.