Lawrence Kotlikoff: Why the FairTax Will Work
On his web site, Lawrence J. Kotlikoff has provided a new article titled “Why the FairTax Will Work - Bartlett’s Unfair Attack on the FairTax,” a response to Bartlett’s criticism of the FairTax in the December 2007 issue of Tax Notes.
Thanks to Hayden for the tip.
55 Responses to “Lawrence Kotlikoff: Why the FairTax Will Work”
All right! Now the FairTaxers finally have some serious ammo on their side which we anti-FairTaxers must do our best to refute. I’ve studied and highlighted Kotlikoff’s reponse, and here is my take on one of his primary arguments as to why the FairTax is progressive.
He assumes that all wealth will eventually be spent, and thus taxed. Acccording to him (and, presumably, other economists) people not only spend their entire incomes, they (or their heirs) ultimately liquidate all their assets and spend them as well. Thus, he claims, the rich among us will ultimately pay the entire FairTax not only on their current incomes, but on any wealth they inherit or accumulate along the way.
That might hold true in theory, and maybe even for the majority of Americans, but I don’t think it holds much water when you start getting into high income/high wealth categories.
For example, someone middle class or lower probably spends most of his or her income on current living expenses, saves a bit, then when they retire they live off their savings and social security income. If they are unlucky, they use up all their savings before they die. If they leave a modest inheritance to their kids, their kids might spend their inheritance on a new home, travel, etc. In that instance, all the income and savings of that person is spent and, theoretically, taxed at the (purportedly) 23% tax-inclusive rate.
But for someone in the upper middle class, let alone really high income earner, that’s probably not true. He or she will typically spend only a portion of their income, save and invest the rest, and by the time they retire be able to live off the income those investments throw off, without ever touching the principle. In fact, if one accumulates significant assets, say $10 million or more, it’s pretty safe to assume that the principal will continue to grow throughout that person’s lifetime. So, he won’t be paying anywhere near 23% on his lifetime income and assets.
Kotlikoff then asserts that even if this person leaves an inheritance to his kids, the kids (or their kids) will eventually spend their entire inheritances, plus all interest, dividends and capital gains, and thus the entire income and assets of the original high-earner wil eventually be taxed at the 23% rate.
But there are a lot of problems with this assumption. First, with no estate tax, the heirs will inherit the assets tax-free. If the assets are sufficient enough, the heirs will never need to tap into the principal, and (combined with their own earnings), the priciple will continue to grow tax-free.
Second, as has been repeatedly discussed on this board and elsewhere, even if the heirs were to spend all the money they inherit, there’s nothing requiring them to spend it on TAXABLE goods and services. They may choose to buy a ranch in Wyoming, a villa in the Bahamas, travel around the world, or invest in a new business venture. None of which would be taxable.
Third, it seems a bit naive to assume that any tax system will stay in place long enough to tax the decendants of people currently living. If you are counting on tax revenue from those decendants to equalize everyone’s tax burden, that is a bit of a stretch to say the least.
Thus, the notion that the FairTax is progressive because it (eventually) taxes accumulated wealth strikes me as being wishful thinking, at best. Again, the FairTax strikes me as falling hardest on the middle class, while the rich make out quite well. (That’s not bashing the rich; it’s just stating a conclusion.)
I’ve got other comments as well, but I’ll leave it here for now for someone to explain to me why I’m all wet.
The rebuttal is well stated.
But I sincerely believe there is another explanation for the Bartlett article.
Bruce Bartlett has a long history as an income tax policy analyst. He was an aide to Jack “Flat Tax” Kemp, and a major contributor to the Kemp-Roth tax bill, and the Tax Reform Act of 1986. He was also a deputy assistant secretary for economic policy at the Treasury Department.
It is not at all credible to say that he made ‘mistakes’ or was ‘misinformed’ about the FairTax when he wrote his recent Wall Street Journal article. To say that he was and is not intimately knowledgeable about every factual aspect of the FairTax is simply not believable.
He was and is a dedicated, life-long income tax advocate. His whole adult career is entwined and enmeshed in the income tax. It is fair to say that he would thus most probably stop at nothing to preserve it and do everything to derail the FairTax.
His article simply has to be a deliberate falsehood - propaganda - designed to destroy the FairTax. His article will be quoted and requoted without critique by others his equal, citing his expertise, and the credibility of the Journal, in an unrelenting effort to denounce, decry, and destroy the FairTax.
Bobby Chofters
“When elephants fight, the grass gets trampled”, or so my father used to say. I don’t want to get trampled while these two “economic elephants” have at it, but I’m disturbed by one of Professor K’s comments.
Bartlett made the accurate point that the elderly would view the Fairtax as double taxation on their after tax savings. Kotlikoff intentionally reframed Bartlett’s concern as limited to the rich or wealthy elderly. He wrote: ” Well rich members of today’s older generations may be a concern of Bartlett. They aren’t a concern of mine.” He went on to lay the $10 trillion national debt on current generations, and described it as “fiscal child abuse.”
I’m a senior retiree, and am as ready as the next person to do whatever is necessary to reduce and hopefully eliminate the staggering national debt. My complaint is that what we have is Kotlikoff fully supporting the Fairtax/HR25 which recognizes taxes previously paid by businesses by allowing a $365 billion inventory tax credit. But, HR25 fails to even consider the double taxation of after tax savings on the elderly or anyone else for that matter. And then Kotlikoff makes Bartlett appear to be defending the wealthy/rich by misquoting his piece. Very disturbing, and not something an economic elephant should do.
Bartlett had it right on this one.
This article doesn’t answer my question about the BHI/Kotlikoff 23.82% rate estimate not keeping government spending level in real terms (Kotlikoff restates this claim in this paper). They make the claim but, if you look at the actual calculation, it doesn’t appear that it does.
In this new paper, Kolikoff states “Our formula for the tax rate, ignoring the rebate and other non-essentials, is ti (C+G) = G , where ti is the effective (tax-inclusive) rate, C is real household consumption expenditure, and G is real government expenditures.” This can be simplified as ti = G/(C+G) with G being real government expenditures, i.e., expenditures adjusted for the tax that would be paid on them. But if you look at the calculation “Taxing Sales Under the FairTax: What Rate Works?” [equation (27)], the 2,228 in the numerator (G above) is calculated in Table 3 and is not adjusted for the tax that would be paid. It’s just the estimated 2007 revenue that would be replaced by the FairTax.
That would work if taxable federal government expenditures weren’t in the denominator, but equation (27) clearly does.
I really think Kotlikoff/BHI need to review the specific equation they used (27) to determine the 23.82% rate and explain how it keeps real government expenditures level. It appears to me that they just repeated the error Gale described in his paper.
RE: Hayden...
When the rich save their money, they don’t keep it in their mattress or a large “Scrooge McDuck” safe. They put it in a bank or in investment accounts. Banks don’t keep the money in a safe either. They lend this money out to other people that do spend it.
So even when the money is saved, it will still be used by other people and that gets taxed.
Every claim that the FairTax is regressive uses comparisons based on the familiar income tax year. That is, under the FairTax, if person A makes 40k and spends 39k and person B makes 100k and spends 50k, then clearly person A (with the lower income) is spending a higher percentage of his income in taxes.
But this ignores the fact that a consumption tax does not have a tax year. There is no April 15th with the FairTax. As such, the money you make is never in the clear - that is, there is never a time when you are done paying your taxes other than when you have spent every last penny.
So if you are going to make projections on what percentage of a person’s income they will spend, it is highly misleading to imply that the only spending of that money will happen in the year that it is made and that 100% of the remainder will not be spent ever or at least for longer than the life of the FairTax code.
Under the FairTax, any money earned that is not spent becomes tax deferred income, the same as 401ks now. And any honest analysis would account for it as such.
Fred,
Any tax the government pays, it is paying to itself, so there is no loss or gain. Any increase in prices that increases the cost of government is offset by the increase in the tax base by the same price increase. The tax is a percentage of prices, so both cost and revenue increase with any price increase.
Both Gale and BHI show that it doesn’t matter what the price level is with regard to real spending/revenue. Producer prices under the FairTax (PPft), are given by PPft = PP07 (1-T)(1-alpha) where PP07 are current producer prices (i.e. the prices that producers charge, before sales tax is applied), T is the rate by which the producer price would fall under the FairTax if there is no monetary accommodation, and alpha is the increase in prices that results from accommodating monetary policy. They show that alpha is irrelevant to the determination of the spending-neutral FairTax rate.
The left hand side shows revenue, including t.G07 which is tax revenue on government spending. The right hand side also has G07 (which is government spending on goods and services under current rules; and they argue would purchase the same quantity of real goods and services under the FairTax). One can use this equation to solve for t, the FairTax rate that would ensure that revenues + deficit cover costs, and real spending is maintained.
Now suppose government does not tax itself. Remove the t.G07 from the
left hand side, and subtract t.G07 from the right hand side. The resulting tax rate is essentially unchanged, and gives the 23.8% figure. They keep tax-inclusive federal spending in the base; revenue has to be enough to cover this, and they make sure that it is.
Morphh,
The left hand side of equation (27) is 2,228 - which is the revenue for 2007. Show me how this number includes “t.G07 which is tax revenue on government spending.”
Johnie and Mark –
You have each apparently missed my point. Johnie is apparently saying that any savings are eventually recycled into the economy where it will eventually get spent and taxed. Mark seems to be saying that the FairTax is progressive on spending, and that’s all that matters.
While those points might be worthy of debate, they are NOT the point that Kotlikoff is making in his rebuttal to which I am responding.
Kotlikoff argues in his paper that the FairTax is progressive on INCOME (not just on SPENDING) and WEALTH. He says that is so because, according to him, all of one’s INCOME and ASSETS are eventually spent, either immediately or at some time in the future when one (or one’s heirs) liquidate their accumulated assets as spend the cash.
I tried to point out that that argument does not hold water for high income/high asset individuals for the simple reason that they never need to liquidate the substantial assets they are able to accumulate. In fact, absent and taxes on income, capital gains, dividends, interest, inheritances, etc., it is logical to assume that those assets will continue to grow in value. So those assets (which consist of inherited assets plus accumulated savings plus capital gains) will NEVER be taxed under the FairTax.
Thus, the lifetime tax rate of the wealthy and high-income individuals is NOT going to be the (purportedly) 23% rate that Kotlikoff claims it will be. It will be much, much lower. Thus, the FairTax is NOT progressive as to income or assets when one reaches a certain threshhold of income and assets.
To follow up on Hank’s point, Kotlikoff is arguing that the FairTax will hit middle-class and rich seniors by taxing their accumulated savings. It will tax those savings in two ways.
First, as discussed above, Kotlikoff believes that all such savings will eventually get spent (on taxable good and services) and thus taxed. While this might be true for middle class seniors, it is not true for wealthy seniors for the reasons I’ve previously discussed.
Second, since Kotlikoff concedes that prices for good and services will rise under the FairTax, the FairTax is an implicit tax on savings and accumulated wealth, since the purchasing power of that savings and wealth will decline by 30% (or more) when the FairTax is enacted. Again, the wealthy can avoid this devaluation of their assets by simply investing in foreign bonds and currencies before the FairTax is enacted. (The middle class could also do this to a lesser extent, though they probably have a smaller percentage of their savings in liquid assets that could easily be converted into foreign currencies.)
Kotlikoff says this tax on seniors is a GOOD thing, because otherwise the burden of caring for seniors will be borne entirely by younger generations, and that burden will be too high. Without debating the merits of Kotlikoff’s argument, I will point out that (a) it is the MIDDLE CLASS retirees who would get screwed in that scenario, and (b) this is NOT what the most vocal proponents of the FairTax claim would happen.
Even though Kotlikoff chastises Bartlett for lumping all “FairTax proponents” in one category, and disavows any responsibility for exagerated or unsubstantiated claims made by certain proponents, I believe the Bartlett is correct in saying that the FairTax folks (i.e., AFFT) appears to be using a double-standard (to put it chartiably when are so quick to attack any criticism of the FairTax, but never bother to correct any of the numerous misstatements that are repeatedly made time and again by many of its most vocal proponents.
Fred, I think you may be misunderstanding that the base is the denominator of the calculation of the rate. That is not true. The FairTax base as defined by
HR 25 is personal and government consumption. What ends up in the denominator for the calculation of the tax-inclusive rate comes from solving the balanced budget equation for the rate.
Waitiaminit...You folks are ASSUMING Domestic Government entities will be forced to pay the tax on the FAIR TAX on their own purchases...(for example, the Government having to pay 23% more on a tank it buys from M1/Abrams)
Under the current system we have now 501(c)(3) entities do not pay ANY TAXES at the register WHEN THEY SHOW THEIR ‘501(c)(3)’ card, and then the cashier pushes the ‘tax exempt’ button to roll back the price to “PRE-TAX” total.
The “Governemt” should not have to pay on itself.
Also, with respect to inflation and monetary policy...
Here’s an idea that I read from Dr. Jacque Jakarin’s book “Debt Virus” published about 10 years ago....
have it so that instead of Government allowing the Fed to LEND money at interest into the economy....have government CREATE the dollars needed and then SPEND it into the economy, (just like the Fed allegedly does when it needs petty cash for pens pencils, and stationary, toilet paper, etc)
Make THIS the only way money goes into the economy...not lending....so that the money has intrinsic value, for a fixed purpose,at a fixed time,
and the way money comes OUT of the economy is to make all the Dollars in circulation have a LIMITED SHELF LIFE, and when it reaches it limited shelf life (or gets close to it) it must be put into a US bank account.
For example, seller sets the price of a object, government pays for it by creating the paper dollars for that purpose and then handing it over to seller for the object.
then the seller has money which he can now circulate around.
and the moeny is now circulating around...changing hands, etc.
going from bank to hand, hand to bank, etc, etc. until that dollar reaches it’s End-of-life, printed on the dollar. when that time comes it must be put into a US DOMESTIC BANK ACCOUNT, to be collected, destroyed, and put out of circulation.
but does the holder of that “Dead dollar” lose the value that is now put into that bank account. NO! if the cash was deposited BEFORE the deadline he retains the checkable deposit amount. If he deposits it AFTER the deadline, THEN he only gets a fraction of that dollar depending on how long after that dollar “died”
like lets say....3 days after the dollar died, and then deposits it... he only gets maybe, 85 cents, 10 days - 50 cents, one year and beyond - 30 cents....
the idea being is that the holder(whoever or WHEREEVER) has to get it into a US bank account before or really close to the deadline so that he gets the most ‘bang for the buck’ so to speak....
and then when the holder want to withdraw he gets newly minted money with a 5 year life, that he can spend and then that dollar eschanges hands over and over until it’s time to turn it in again.....
I know you guys want to shoot this idea down, but..... i been kicking around this idea in My head and I wanted to at least put it out there so that maybe you could ‘take the ball and run with it’ if you want.
morphh, isn’t it was Gale calls the effective tax base?
Morphh,
I still believe that Fred is correct. The BHI rate comes from simply dividing the $2228B in revenue required by the $9355B consumption base. (see pg 18 of the September 2006 Kotlikoff/BHI “What Rate Works” study report.) There is no revenue in the $2228B to account for the federal (or state/local) taxes. Even more misleading is the fact that there is no revenue in the $2228B to account for the prebate. Instead, the consumption base of $11,467B was reduced by $2112B to “pay for” the prebate. However, the consumption base was not adjusted to account for the government taxes. So, the overarching question ought to be “Who pays?”
There is no explanation in any of the BHI reports as to how the federal government pays for the additional Fairtax. Some Fairtax advocates have suggested that the government is simply paying itself, so it’s a wash. If we first agree that governments don’t pay taxes, people pay taxes, then this argument about it being a wash makes no sense. As I’ve written before, if it made any sense for a government to tax itself, then why not tax the $916B federal consumption at 100%, and reduce individual tax burdens by half? Governments can’t tax themselves, so the question remains “Who pays?”
The same Kotlikoff/BHI report does suggest that state and local governments can either raise other taxes to pay for their consumption tax, or “tax the tax” as a partial solution to raising revenue. Taxing the tax might seem to be at odds with the second goal listed in HR25, i.e. to prevent cascading taxation. And it would seem that 21% of the revenue needed to fund the federal government is hidden in higher state and local taxes. Not simple or transparent?
In the September 2007 BHI study “Fiscal Federalism: The National Fairtax and the States”, BHI assumes that the States will “tax the tax” in their calculations of required State sales tax rates. Interestingly, this study also assumes that the States will tax all Federal, State and Local consumption except for education. The State average rate is 5.43% exclusive, and would be applied to federal consumption within each state. So again, “Who pays?” this added cost to the federal government, (which can be estimated at $50 billion.) ($916B x 5.43% = $49.7B).
I expect that the second BHI study will be followed by the third in the trilogy, the impact on local governments. And again, the question will be “Who pays?” How can local governments tax themselves? Makes no sense!
I might also point out that in all of these studies, not only are the rates revenue neutral, but they are also spending neutral. In other words, the studies do not address the price issue, which I think we are generally agreed on would be in the range of 15% -20% higher under the Fairtax, assuming everyone takes home their gross pay. This price increase would certainly compound the problem of “Who pays?”
Kotlikoff’s rebuttal to Bartlett says that the Federal government is required to pay the Fairtax, but claims that there will be extra revenue to compensate for the tax payments. My question remains, where does this extra revenue come from? There is no explanation, other than to write “....levying taxes on both household and government consumption provides enough nominal revenue to cover the government’s nominal costs of buying the initial amount of G, where these costs include paying the Fairtax.”
When you tax government consumption, Who Pays?
Hayden, I agree with your point that if the principal is never withdrawn it would never be taxed. Though I’m left to think if this is a bad thing. The money is in the economy. Such investment is not taxed today until withdrawn and then taxed at 15%. They would have to spend very little in relation to large returns to get a 15% rate under the FairTax. I think the more valid point is where they spend it.
Hank, I think Kotlikoff was trying to show that low income elderly make out the best under the plan as they have an increase in SS plus the rebate. This would happen at all levels for seniors and progressivity would follow spending. It is a comparision to the current system. Of course such effects will depend on your saving situation, but from his studies, those that are hit the hardest are the wealthy elderly.
First, savings and investments are good for the economy when measured as a percentage of GDP. Most analyses indicate that as savings and investments as a percentage of GDP would benefit by an increase. In fact, we have a lot of room for increase before approaching any imbalance.
Secondly, look at historical family fortunes. After several generations, they number of beneficiaries to inherit has multiplied, the wealth is divided into such small portions that the do get spent or significantly depleted through donation to charity, etc. I think this is the pattern of the vast majority of such fortunes.
As for double-taxation by the FT, it is a myth. If a coffee maker cost $30 today, it will cost $30 tomorrow after the FT. The retiree who is spending after-tax dollars has to spend $30 either way. The only argument that holds any water is people who converted before-tax dollars to after-tax dollars before the FT. In that case, they have fewer dollars to spend than someone who did not convert their dollars. The decision to convert pretax dollars to after-tax dollars is no different than placing a bet in Vegas — except in this case the bet is on the direction of future tax policy. The mercurial nature of tax policy has always bitten people who bet wrong and it is one of the negatives of existing tax policy that the FT will eliminate.
Government consumption does not include wages paid to government employees, correct? Most federal government employees now pay payroll taxes. http://www.taxpolicycenter.org/publications/url.cfm?ID=1000540
So I assume the government pays its share of those payroll taxes now. If so then the savings from that may counteract any increased cost of government consumption.
There are reasons that government consumption must be taxed. It makes the calculations easier. It would be a nightmare figuring out all the minutiae of what exactly is or is not taxed. The government should not have an advantage over private industry or we would discourage the use of private contractors. I’m sure there’s more.
I disagree with an assumption often stated here that prices are guaranteed to rise; that all depends on the elasticity of supply and the assumption demand will increase. In the case of government consumption, I assume much of that are military and big ticket items. While the supply is certainly inelastic for, say, an F-22 Raptor, the demand is constant, from a single customer that makes contracts at a per unit price and will take delivery whenever units are ready. Looks to me like much of government consumption will see significant price decreases.
On the subject of current retirees living off of savings; while it may be double taxation on investments made with after tax dollars, it’s no taxation on investments made with pre-tax dollars until it’s spent. Every employer retirement program I’ve seen in my life has used pre-tax dollars. It may have been different for those retired now. Existing inventories are really not an issue since we know they were taxed, no so with retirees savings.
Quote from: http://en.wikipedia.org/wiki/FairTax
“An estimated $11 trillion is held in foreign accounts (largely for tax purposes), which former Federal Reserve Chairman Alan Greenspan predicts would be repatriated back to U.S. banks if the FairTax were enacted, becoming available to U.S. capital markets, bringing down interest rates, and otherwise promoting economic growth in the United States.”
The retirees with pre-tax savings have enjoyed compounded interest at rates that were probably higher than what they will be after the FairTax for any similar low risk investments. They will also have available a wider range of investment opportunities with economic growth. In the worst case scenario retirees may have to re-evaluate their investment portfolios and assume some risk for higher returns. Risk is minimized with sustainable long term economic growth which is the main promise of the FairTax.
The opponents of the FairTax apparently expect concrete estimates of the results of the FairTax with every possible negative consequence considered. The reality is the main benefits arise more from a philosophy of economics, proven throughout history, than from the relatively new equations that were derived to try and explain and predict those philosophies.
Erica,
So, which is it? Is double taxation a myth or a crap shoot? Seems like you know that all current savings accounts and Roth type IRA’s are after tax dollars, and will be double taxed when spent under the Fairtax. So, it’s not a myth by your own admission.
As for your $30 dollar coffee maker, it will most likely cost $35 dollars under the Fairtax. You seem to be repeating the Fairtax “free lunch” myth that you will take home your gross pay or pension, and prices will remain about the same. Can’t happen! The best you can hope for is a 10% reduction in business costs and a 17% increase in retail prices. But, don’t worry. Your net income will also rise, and your standard of living will be relatively unchanged. And none of this price discussion has anything to do with double taxation.
dculling,
Let’s start with the Fairtax rationale for taxing governments. Under current law, governments don’t pay income taxes, so businesses are indeed at a competitive disadvantage. Get rid of business taxes and it would seem to me that the playing field is now level. Going beyond that by taxing governments seems to me to be a massive overkill with serious unintended consequences. And, there are other legislative means to get government competition out of the private sector , if necessary. See HJR23, Sec.1, for example.
Next, as explained to Erica above, the most likely scenario is that prices will rise by 17%. But, unlike individuals, governments have only the 7.65% payroll contribution to offset those price increases. It’s not a wash by any means.
For instance, the increased cost of federal consumption of services (burdened payroll) would be $130 billion annually, offset by $22 billion in FICA savings for a net cost of $108 billion. If you would like a copy of my “Fairtax Financial Impact on Governments” study, just email me at vanlinda@comcast.net.
Finally, I’d refer you to the discussion of Kotlikoff’s rebuttal of the Bartlett Fairtax criticisms. If someone on this blog can’t explain just how governments can tax themselves into prosperity, the exclusive sales tax rate would need to be 40% in order to be revenue neutral, and would approach 50% when state and local taxes are added. How high is too high?
Assume current law. Let C = $800 and G = $200. You could imagine that production consists only of widgets, which are produced and sold for $1.00 apiece. Consumers get 800 widgets and government 200. Government gets its 200 widgets by imposing an income tax of 20%. Thus: National income is $1,000, of which government collects 20% or $200.
Now impose the FairTax. And suppose the government wants to provide a rebate for which the base B is $133. The FairTax inclusive rate as calculated is ti = G/(C + G - B) = 200/(800 + 200 - 133) or 23%.
What happens? The ti implies a te of 30%, so let prices rise by 30%.
Now widgets cost $1.30. Individuals continue to get the same $1,000 they got before plus the rebate. Because prices have risen by 30%, the rebate equals $40 (= .23 X $133 X 1.3). So individuals have $1,040 to spend. At $1.30 apiece they buy 800 (= $1,040/$1.30) widgets, just as before. As for government, it collects $240 (= 800 X $.30) in tax revenue on the 800 widgets bought by individuals, of which $40 goes for the rebate. That leaves government with $200. Now government buys 200 widgets, just as before but now paying $1.30 apiece. In buying these widgets, it pays itself $60 (= 200 X $.30) in taxes. Add that amount to the $200 in taxes collected on sales to individuals, and the government collects altogether $260 in taxes. And that is just enough to buy the 200 widgets. (200 X $1.30 = $260.)
You could assume that widget prices remained at $1.00 (no inflation), and
the result would be the same.
I still don’t see why billionaires do not get an enormous advantage out of FairTax. Take a man like Bill Gates, mentioned in the article and with a personal worth of $50 billion in unspent earnings.
How much money can the incredibly rich spend? I think even a serious spender would struggle to spend more than say $2 million a week on fairtaxable goods. If we assume 50 years of living at this level, that is only about $5 billion spent over a lifetime on personal consumption.
Now for taxes. At a 15% income tax rate, our man would have to earn about $65 billion and pay $10 billion in capital gains tax. On his spending of $5 billion, he would pay $1.5 billion in tax, still a fair sum but a saving of 85% and a shortfall to Treasury of $8.5 billion.
The article claims the tax rate will almost double for the wealthy. So - where did I go wrong in my figures?
Morphh, how does the government buy 200 widgets with $200 when they cost $1.30 after the FairTax? You have them pulling $60 out of the air. This is the point. They can’t give it to themselves if they don’t have it. They need $260 to keep real expenditures level.
Would the FairTax fail if property held in the form of Roth and regular savings before transition to the FairTax were not “double” taxed (relative to traditional IRAs)?
If not, it is about as easy to exempt them from the FairTax as it is to make the ‘prebate’ payments - and we would overcome what is for the opposition perhaps the number one major legitimate FairTax complaint.
Thanks,
Bobby Chofters
If you believe in embedded taxes, there is no “double taxation.” If you purchase goods with after tax dollars now, you pay the 22% embedded tax on average. You pay a higher percentage when the good has a higher domestic production cost and a lower percentage when the good has a higher foreign production cost. If you purchase goods with after tax dollars under the Fair Tax, you pay a 23% inclusive tax always.
On government taxing itself and the accuracy of the fair tax rate calculation: You can assume a Fair Tax price inflation of 0%(all embedded costs gone), 17%(Hank’s favorite estimate), or 30%(before tax prices are exactly what they appear to be today). Just be sure to multiply the consumption base by 1.0, 1.17, or 1.30, respectively, before calculating your rate. All calculations I’ve seen have used real data, which by default uses 1.0. It really doesn’t matter what you use as long the tax base and required revenue are adjusted appropriately.
Ok, I admit the government consumption expense increase due to the FairTax had me scratching my head for a while. Like Fred Johnson suggests even Morphh’s equation appears to pull $60 out of thin air. However, consider that switching to the FairTax also means we are switching from a yearly or quarterly collection system to a continuous collection system. I think I read that suggestion here somewhere and it just took a little while to sink in.
The FairTax is collected monthly. So assuming it will start at sometime when the government has plenty of revenues the FairTax expense on the consumption that the government does for a month will come right back the next month no matter how high the expense may be.
Fred,
The government sends one of its bureaucrats to the widget store with the $200 it collected from individuals and tells the clerk to hand over 200 widgets. The clerk says, “But that’ll cost you $260.” The bureaucrat says, “Don’t worry about that. Remember that when you hand over the 200 widgets, you also have to pay the government $60 in sales tax. So as soon as you hand me the widgets plus the $60, I’ll add your $60 to my $200 and we’ll be even.” At this point the clerk scratches his head, wondering why he couldn’t just sell the 200 widgets for the producer price of $1.00 apiece and be done with it. The bureaucrat has an answer for that, too. He says, “Look. You didn’t complain when the government was collecting 20 cents in taxes from every dollar you made under the old income tax. And remember, that meant that when we went to buy a widget then, 20 cents of the dollar price went back to the government as a tax. Furthermore you should keep in mind that the 30 cents out of every dollar that goes back to the government now reflects inflation (6 cents) and the rebate (4 cents), which we added to the 20 cents originally paid to get the sales tax.”
Morphh, so basically you are saying the government doesn’t pay or collect the tax on it’s purchases (I agree - it’s a wash). So wouldn’t your equation become ti = G/(C - B)
Morphh,
I think the government has to go through the motions of paying itself the tax or we’re back to giving the government a competitive edge over private contractors.
Then there’s the possibility that bureaucrats can figure out how to scam the system for personal purchases.
I’m sure there’s more reasons.
dculling, I agree. It was an example to show where the $60 comes from in response to #22.
Morphh,
I guess you are focusing on a different angle of this than I am. I’m focusing on the widely quoted argument made by Bartlett and the President’s Panel on Tax Reform that AFFT didn’t account for the increased expense of government consumption due to the FairTax.
It appears to me they looked at static figures and neglected the continuously collected dynamic nature of the FairTax. Within a month the government gets back any FairTax it paid no matter how high it might be.
Bartlett and PPTR made an egregious error for highly paid professionals.
What they are usually talking about are the early studies done by AFFT, which I don’t think anyone disputes at this point - referred to as “the mistake”. The BHI/Kotlikoff study didn’t even come out until after the tax panel publication, so they had to be referring to the early work. Since this was pointed out in Gales paper and clearly pointed out and excepted, BHI and Kotlikoff were aware of it and would not have repeated it. Bartlett is the only one that I know of that has charged that the BHI study does not include this, to which both the BHI economists and Kotlikoff state is false. Again reaffirming that they accounted for this. Bartlett has made a so many factual errors and misrepresentations in his list of FairTax articles that I’d take his “claims” with a grain of salt. You’re correct that the rate studies are based on a static analysis.
I very much believe that there are embedded taxes. However, there is still a very real “double” taxation that will happen, but only with respect to Roth and regular savings when compared to traditional IRAs.
A better term might be “twice” rather than “double” taxation.
What is twice taxed is the labor that was exchanged in the first place for the portion of the wages and salaries that became either a traditional IRA, or a Roth or regular savings account .
The traditional IRA took relatively fewer hours to generate than a Roth of equal value, since the IRA was never income-taxed - and won’t be income-taxed if held at transition to the FairTax.
The Roth took relatively more effort to generate since the original wage was income-taxed.
This is the only valid “double” taxation argument, and it’s the one that has very real merit. It has nothing to do with embedded taxes.
It would be a straightforward matter to credit at some level Roth and regular savings that have been income-taxed to even the playing field, that is, to make it fairer to Roth and regular savings account holders.
Would the FairTax fail if this were done?
Thanks,
Bobby Chofters
Morphh,
Despite your best efforts, I really don’t think we are getting any closer to joint resolution of the issue of governments taxing themselves, who pays, and what the Fairtax rate might need to be.
I recall that you may have sent off an email to BHI, perhaps on this subject. What is the status? And, if your query didn’t involve the government taxation issue, I’m prepared to send them an email, unless you already have the wheels in motion.
Please advise.
“The Mistake” from http://www.fairtaxblog.com/pdf/gale-william-retail-tax-rate.pdf
“When they estimated government revenues under the sales tax, they (implicitly) assumed that consumer prices (what consumers pay, including the sales tax) would rise by the full amount of the sales tax and that producer prices (what producers receive, net of the sales tax) would stay constant. But when they estimated government spending needs, they (implicitly) assumed that consumer prices would stay constant and producer prices would fall by the full amount of the tax. Both sets of assumptions cannot be valid at the same time; either the first assumption overstates nominal revenues, or the second assumption understates nominal required spending, or both.”
Assume revenue neutral means the FairTax brings in the same amount of revenue as a previous year with the income tax. Assume government consumption is the same for the income tax year and the FairTax year.
Case #1: Consumer prices rise the amount of the FairTax after it goes into effect.
Case #2: Consumer prices plus the FairTax equals the previous year’s prices including the income tax.
In case #1 the calculated revenues needed for government consumption is not enough to pay for the FairTax on that consumption, however, no matter if prices rise the full amount of the FairTax the government gets it right back in a month, increasing revenue to meet the increased cost.
In case #2 the calculated revenues needed for government consumption are correct. The FairTax is generating the same revenues and can pay for the same consumption.
It appears to me as long as the data for government consumption from the previous year under the income tax was used as the base then it doesn’t matter which case or any combination is the result. The FairTax will self correct within a month. Surly a possible deficit for a month is no big deal.
Conclusion: No mistake ever made.
Am I missing something?
dculling, perhaps your right there about what they were discussing, I was going from memory... but whatever the mistake it was or wasn’t, it is unlikely that BHI/Kotlikoff repeated a known methodology error.
Bobby, the FairTax gives a credit to retailers on inventory, so perhaps a credit on Roth or CD investments might be something that is doable. The might be able to mimize the impact on middle class savers in some areas without exempting large amounts of wealth. Interesting thought...
Bobby, Morph,
The inventory credit is given precisely because of the embedded taxes. When the Fair Tax is implemented, all inventories will already have the embedded tax (except the part that comes from selling the inventory). Double taxation will occur if the fair tax is applied on top.
When you originally received those after tax dollars, (now stay with me here) you didn’t pay your payroll or income tax. Instead (because you work for net) those taxes were included as costs in whatever service or product you were part of providing. The government “rewarded” you for saving for retirement by letting you build that asset tax free. In fact, if you saved for retirement, but produced less (in monetary terms) you were “rewarded” even more by being able to you use “pre-tax” dollars through a traditional IRA.
You can’t pay tax on your income (including payroll) and have an embedded tax that includes those items (unless you assume some of tax is embedded and some is directly on income). I am assuming the 22% often quoted includes employee income and payroll, but I haven’t been able to track down the calculation.
Erica,
You present an interesting comment in item 16, the last paragraph. You say that the ‘only argument that holds water is [for those] people who converted before-tax dollars to after-tax dollars before the FT’.
Everyone does that when we earn income and pay taxes. We all convert before-tax dollars to after-tax dollars every paycheck. All anyone gets to take home and spend or save is after-tax dollars. The only decision a person has to avoid this is to make deposits in Traditional IRA or 401k type accounts, in which case we are still paying Social Security and Medicare taxes on those dollars. So I guess, according to you (and me), the FT will bite most everyone and it will not be pleasant. I am glad you understand this and thanks for pointing out this big weakness in the FT proposal.
John H
Andrew,
Although I’m having a little difficulty “staying with you”, I think you are generally correct. What bothers me about the inventory tax credit is that the Fairtax rate was not adjusted for year 1, so the estimated revenue shortfall of $360 billion caused by the inventory credit will simply be added to the annual federal budget deficit. Might have been cleaner to have a one time 4%(gasp) increase added to the 23% inclusive rate to pay for the inventory credit, and let it all expire at the end of year 1. But, that’s not the Fairtax plan.
You are correct in assuming that the oft quoted 22% embedded costs of the income tax system include employee payroll and income tax withholding. In fact, two thirds of the 22% can be attributed to employee income/payroll tax withholding. You don’t have to take my word for it, just turn to page 9 of the September 2006 Kotlikoff/BHI rate study. There, you will find that for 2007, individual income taxes sent $1101 billion to the Treasury, Corporate income taxes sent $290 billion, and the payroll taxes sent $871 billion. By splitting the payroll taxes between employers and employees, you can estimate that 67% of the government’s revenue from income taxes came from individuals and 33% from corporations. And it follows that one third of the embedded costs are business costs which may be removed so that when the 30% sales tax is added back, prices will rise.
Now, people have been trying to get a copy of the Jorgenson 22% study for years with no luck. It seems the study was done under contract to AFFT, and is not in the public domain. As for why it is not part of the AFFT $23 million research library for all to see is unknown?
Although some on this blog may disagree, I think a lot of confusion over “embedded taxes” would go away if folks just thought about it as “the embedded costs of the income tax system”. You see, there is no such thing as an embedded tax. Not one dime goes to the federal Treasury when a retail sale is rung up. The taxes have already been paid in one form of another, and what is happening is that the retail customer is offsetting the business tax burden through higher prices. The embedded costs affect only prices, which is why I continue to maintain that business costs will be reduced by 10% (including compliance costs) and prices will have to rise by 17%. Failing a professional price impact study, which has never been done by AFFT, that’s my story and I’m sticking to it.
Quote from Hank Van Gieson, #39
“Now, people have been trying to get a copy of the Jorgenson 22% study for years with no luck.”
You mean this?
I just found it last night. Of particular interest to me is where Dr. Jorgenson defines what he considered as household income on page 62.
“Finally, the income of the household sector is the sum of incomes from the supply of capital and labor services, interest payments from governments and the rest of the world, all net of taxes, and transfers from the government.”
I take “all net of taxes” as all actual taxes paid and implying “take home 100% of your pay.” For his econometric model Dr. Jorgenson appears to have used “net of taxes” as a variable that was assigned to household income for the case of a consumption tax. Thus resulting in the chart of embedded costs which is what is copied in The FairTax Book , minus the Flat Tax data.
This observation is in direct conflict with statements by AFFT.
“Graetz misstatement: “If you are now making $10 per hour and $3 per hour is taxes, the FairTax people are saying that your after-tax pay will be $7 per hour.”
FairTax rebuttal: That could be the case, but only if one is also assuming that all tax cost savings to businesses from repealing the federal tax system are used to lower prices (Jorgenson makes this assumption in his study) rather than increase wages.”
Either I have this completely wrong or the AFFT and many others do.
Maybe I should email Dr. Jorgenson for an explanation? However, I feel a bit intimidated at the thought. I’m worried about the fact that Dr. Jorgenson released his own tax reform plan “Efficient Taxation of Income” that is basically in competition with the FairTax.
http://en.wikipedia.org/wiki/Efficient_Taxation_of_Income
It appears AFFT stopped using Dr. Jorgenson’s 22% average embedded cost estimate not long ago. If this was some kind of misunderstanding it would really help AFFT to have it straightened out.
Regardless, it’s best to get some feedback here first.
dculling,
Good work on finding the Jorgenson study. I believe the timing is off by more than one year for this document to be the one done under contract to AFFT. However, it clearly contains the same producer cost data that was eventually published in the Boortz/Linder book.
I don’t see any problem with you emailing Jorgenson. He seems to respond to such questions as you may have. However, as you point out, he does not support the Fairtax, so don’t expect any help there.
What is really needed is a price impact study, which no one has done yet. Perhaps it requires too much speculation for the economic gurus taste?
Hank, that’s not the one Jorgenson did for the AFFT - although it’s similar. If you email them and ask for they’ll send it to you.
dculing — Good for you for doing your own independent research!
Dr. Jorgenson is pretty good about responding to short, polite emails, though I’m sure he gets swamped at times and is concerned about his responses being posted on various sites and possibly taken out of context.
One of his email responses to this very question was posted on freerepublic.com of all places. If you google “Jorgenson” and “fairtax” and freerepublic” and, possibly, “Dan from Ga” you should be able to find it.
Essentially, he made it clear that the embedded taxes could only be removed from of goods and services if employees wages were reduced to their current net (i.e., after-tax) levels.
I believe he also said that profits and rents would also need to be reduced, by which I believe he meant that corporations would need to accept reduced profits and landlords would need to accept reduced rents to further squeeze the embedded taxes out of prices.
All in all, my impression is that he doesn’t believe this is particuarly likely, and that it is more likely that prices would simply rise by whatever rate the FairTax would be, which he has indicated in other places would need to be quite high.
Fred,
How do you know it’s not the one done for AFFT? Did you get a copy? Do you mean we can ask AFFT to send us a copy at the Info@fairtax.org address? I wonder why it’s not a pdf at the site, maybe a copyright? I’m already working on getting a copy, but from a different source.
Hayden,
Yes I’ve seen that one on freerepublic.com. Frankly I’m wondering if it isn’t a fake email after finding that study.
I find it hard to believe that Dr. Jorgenson just assumed employees would willingly take a pay cut. Whether I found the same study or not it is about a consumption tax and produces the same producer price savings figures. Maybe I’m wrong, but “net of taxes” in a list of household income suggests to me employees keep their taxes.
Also, I didn’t see a thing about compliance costs in that study. This is conformation of a statement on page 5 here:
http://www.fairtax.org/PDF/FairTaxRebuttal.pdf
“It is important to note that the Jorgenson study did not take into account the reduction in compliance costs...”
As I pointed out in an earlier post, compliance costs savings could huge, potentially far greater than the oft quoted $265 billion conservative estimate of the AFFT.
Read about it here.
Now employees might willingly give up their portions of payroll taxes for a plan to save Social Security and Medicaid. This could be acceptable because no matter how many deductions one may claim one will never get payroll taxes as take home pay.
I think all this suggests there is certainly “room” for prices to fall at least the amount of the FairTax considering all these savings will affect the entire supply chain of every product or service. However, whether prices can fall depends on the unique economic factors of each and every product or service which includes all those in the supply chains.
Hank’s price impact study sounds good and I’d suggest adding wages as well. I have no idea what would be involved or the costs. Producers and employees would certainly like good estimates of what might happen. Maybe businesses could take care of their own data and send it to some central location for number crunching the totals.
Morphh,
You didn’t respond to my request for an update on your question posed to BHI, so I went ahead and emailed Dr Tuerk the following:
“Dear Dr. Tuerk,
I have carefully reviewed both the BHI September 2006 base/rate study report, and the September 2007 Fairtax and the States report. My questions stem from the belief that governments can not tax themselves into prosperity. The issue, therefore, is “Who Pays?”.
In the 2006 report, there is no mention about how the cost of the federal government tax burden is accounted for. The report does state that state and local governments can raise other taxes or even “tax the tax” as a partial solution. The AFFT claim that the Fairtax is revenue neutral at 23% is only true if (1) we recognize that 21% of the needed federal revenue is hidden in higher state and local taxes, and (2) Some explanation of who pays the federal tax tab is provided.
In your 2007 study, again, there is no explanation about who pays for the state and local tax burden, although you have assumed that they will tax the tax. The report also suggests that the states will tax federal consumption within the state borders. This adds an estimated $50 billion to the federal tax burden, with no explanation about who pays?
The Fairtax plan adjusted the rate to account for the prebate, but failed to similarly account for the inventory tax credit, and the government tax burden.
I would appreciate a response from you as to why the rate wasn’t adjusted to account for these costs, and specifically, who pays for the government tax burden. ”
His reply:
“Dear Col. Van Gieson:
The short answer to your question has two parts: (1) Federal and state
government are already paying taxes to the federal government on their
existing purchases. If government pays $X million for a new airplane,
some fraction of that purchase ends up going to back to the Feds as tax
revenue. The FairTax simply has the federal government collecting that
same revenue at the point of purchase, rather than upstream at the point
of production. (2) The FairTax does erode the base on which state taxes
are collected and thus effects a transfer from states to state taxpayers.
That problem can be fixed if state government make simply adjustments in
their tax laws.
I’m afraid I don’t have any answer to the inventory tax credit problem.
Perhaps one of my colleagues, copied here, will. You might also find the
answer on at www.fairtax.org.
By the way, I have an article forthcoming in Tax Notes, where I explain my
earlier point in some detail. I suggest you watch for that article. I
have suggested the following title to the publisher: “Memo to Bruce
Bartlett: Just do the Math.”
Thanks for writing.”
I wasn’t clear about his response so sent the following:
“Dear Dr. Tuerk,
Thanks for your prompt response. I will look forward to reading your Tax
Notes piece. Should be very interesting and may lay to rest a lot of
criticisms of the Fairtax. Can you provide any time frame for publication?
I hope you won’t think I’m quibbling, but a couple of your statements in
your response puzzle me. To the best of my knowledge, Federal and State
governments do not currently pay taxes on their purchases. I agree that
governments do pay higher prices due to the taxes already paid by the
producer which are generally recovered in the retail price. If the
government pays $X million for an airplane, some fraction of the price has
already gone to the government in the form of producer taxes. But not one
dime goes to the federal government at the time of the retail transaction.
It seems to me that by taking the position that the federal
government is simply moving the point of collection from the upstream point
of production forward to the point of purchase still does not answer the
fundamental question of “Who Pays”? Upstream, the producer paid the tax under current law.
How can the government pay taxes to themselves at the point of
sale? Are you suggesting that governments can tax themselves into
prosperity? If so, why not tax federal government consumption at 100% and
reduce every individual’s tax burden?
Taxing governments also puts you in the business of advocating higher government costs.
Under the Fairtax, by removing tax burdens from the producer, there was an
excellent chance to reduce government costs by at least 10%, (the business
tax percentage that is embedded in the producer costs). A balanced federal
budget was within our grasp. Instead, you are advocating an increase in
government costs. I believe that removing 10% of producer costs will result
in a 17% minimum price increase. (1.00 x .9 x 1.3 = 1.17). (This assumes
that employees will receive their full gross pay. Two thirds of the
embedded costs can be attributed to employee payroll and income tax
withholding per your September 2006 rate study.) This would add almost $500 billion to government revenue requirements.
The argument that it’s necessary to tax governments in order to keep them
out of the private sector business pales into insignificance when compared
to higher government costs rather than lower government costs. I would
certainly agree that governments have a current advantage over the private
sector who have to pay taxes. But, by removing business taxes under the
Fairtax, the playing field is then level, and adding taxes to governments is
a huge overkill of a relatively minor concern, and immense unintended
economic consequences for our governments.
I am awaiting a response. In the interim, I’d appreciate any input regarding my claim that Fairtax advocates in effect are supporting an unnecessary increase in the cost of governments?
Dculling, I don’t know why it’s not on the AFFT’s site. I emailed them about 3 years ago for a copy and they sent it to me with no problems. I have uploaded my copy to a free file share. You can download it here.
Listen. I worked 25 years to build a company, taking out enough to live while I owned it, which I sold a few years ago. I paid 7 digits of tax to the Fed and 7 digits to the State. I split the take 50/50 with my employees and now I live off those AFTER TAX proceeds. I have no current wage based income. I don’t care how you slice it, if I spend that money under the (Not) Fair Tax, I get dinged twice. The newbie who is spending his paycheck on the same item I am purchasing pays less. Take out all the BS about “embedded taxes” because the bottom line is people who saved get screwed. So if you want to kid yourself that it is not double taxation, than by definition it is Zero Tax for the newbie and Single Tax for me because I am paying more than he. Not many people seem to care because not many people have saved anything.
If this passes I second the motion about the 2nd Amendment rights. Pass the amunition.
Pedro,
“Pass the ammunition” ... I’m afraid that remark doesn’t rise to the level of civil discussion. Please take yourself elsewhere.
And I say that as a fellow gun-owner. If this is your response to discussions of tax reform that rub you the wrong way, then sir you do a disservice to other gun owners.
Joshua
Fred Johnson,
Thanks, but I already have a copy. I’m sure others will find your link useful though.
pedro,
I know it looks like double taxation, but it’s really not. Currently you are probably paying something in taxes on the returns of your investments. When you go buy something, all the costs involved are passed on into the price. This includes all the business or corporate taxes plus payroll taxes plus all the embedded costs involved in paying taxes. As I showed in another thread, these later costs averages out to be $0.65 wasted for every dollar paid.
After the FairTax you will pay no taxes on the returns of your investments and prices with the tax included will be close to what they were before the FairTax.
There is an insane amount of waste involved in all the time and money spent trying to pay taxes or trying to pay as little as possible. It makes complete sense to me eliminate all unnecessary burdens on businesses so they can run as efficiently as possible, competing as effectively as possible in the free market, creating as much wealth as possible.
Now what we should really be worried about is getting the taxes from all those pre-tax or tax deferred investments of retirees’ that will never pay the taxes they should have and which make up about 80% of current retirees’ investments.
Nah, we’ll play nice and let that slide...well, as long as retirees play nice anyway.
dculling,
Well, I read that you still believe that retail prices will remain about the same after the Fairtax is applied. Be careful what you wish for!!! I have just concluded an email exchange with Larry Kotlikoff, and he believes that prices will rise by the amount of the Fairtax. That is in direct conflict with what Boortz and Linder are saying; i.e. we are just replacing one tax (embedded) with another (fairtax), and prices will remain about the same.
The key to understanding Kotlikoff’s position is his claim that the GDP does not include taxes. What that means is that it is important to him that the consumption base remain unchanged in order to protect the 23.8% rate. If Boortz (and you) are right, then the consumption base must fall by 22%, and the Fairtax inclusive rate would then be slightly over 30%. Think about it. I believe that the professor is correct, and that means that the Fairtax is not revenue neutral at 23%. How high is too high?
Understand that Larry is under a lot of pressure to make the static numbers work out to satisfy the opponents. However, as I’ve said all along the FairTax is really about economic growth.
Here’s a quote from Louis R. Woodhill who is on the Leadership Council of the Club for Growth.
“Here’s another way to look at the potential impact of the FairTax. If you add our national debt to the projected (75-year) “unfunded obligations” of Social Security and Medicare, the Federal government is in a $48 trillion financial hole. However, assuming Federal revenues at their historic average of 18.5% of GDP, a real GDP growth rate of 3.5% would increase the present value of Federal revenues from about $138 trillion to about $236 trillion. This additional $98 trillion is enough to pay off all of our “debts” and pay for a tax cut equal to 3.9% of GDP.
Because higher economic growth has such a dramatic effect on the present value of Federal revenues, it is neither necessary nor desirable to implement the FairTax at its “static-revenue-neutral” tax rate of 23% (“inclusive” rate). A tax cut equal to 3.9% of GDP would bring the FairTax rate down to just over 18%. In fact, it would take a FairTax rate of only 13.4% to produce the same present value of Federal revenues with average real GDP growth of 3.5% as the 23% rate would yield if GDP growth averages 2.0%.”
Economic growth is certainly not static, but all opponents arguments that I’ve seen are based on static assumptions and analysis. Larry knows better, but is hemmed in by opponents that wave off even realistic estimates of growth so he apparently is trying to satisfy them. I am under no such self imposed restrictions.
Notice how Louis Woodhill shows us that just a 1.5% increase in GDP growth will get us past the problem of “unfunded obligations” of Social Security and Medicare. This is very important I believe. Already the Supreme Court has ruled it’s ok to deny citizens the benefits that they have paid for all their lives into these programs. For America to renege on promises to its citizens that they paid for and when they need it most would be most unconscionable I think.
Notice too that Louis Woodhill thinks we could start the FairTax out at a much lower rate and economic growth will make up the difference.
If it was up to me I’d start the FairTax out at 20% or even 15% and hope for the best, counting on great economic growth which I think the AFFT has purposely underestimated. I would also suggest to employees to give up their share of payroll taxes to help keep prices down. For those in any businesses that could increase exports, I would suggest living with whatever they take home today and count on increased exports and capital leading to significant raises in the not to distant future. But alas, I’m not a newly elected president with a FairTax mandate.
You will never get the security you apparently want with any calculations or estimates. I choose to believe that the increase in liberty will make it work far better than what can be estimated on paper.
Dculling –
You are correct that “static” analysis is rarely accurate because it does not take into account a change in economic activity. Thus, many claim that a “dynamic” analysis of tax proposals must be done.
Ahh. But there’s the rub. “Dynamic” analyses are just guesses. At times, they are educated guesses. At other times, they are just favorable (or unfavorable) assumptions designed to boost a particular policy.
The dynamic projections for the FairTax are all over the board. The one you refer to is probably the most optimistic i”ve seen, to put it mildly. Even Kotlikoff sees a very small increase in the country’s economic growth rate, but that’s over a VERY long time span. Other economists see negative growth, particularly over the short run, due the a reduced level of consumer spending that would occur under the FairTax. (Remember, when you tax something, i.e., consumption, you get less of it.
So, just citing a pro-FairTax analysis that says economic growth will grow by x amount and thus will raise y revenue is probably even more misleading than to just using a static analysis.
Great post dculling! Hank, while I agree with your first paragraph, I disagree with your second, which is completely contradictory to what Kotlikoff has stated and printed on many occasions (as well as BHI and Gale). The studies say quite clearly that it doesn’t matter if prices rise or stay the same, the rate is the same. I think you have it in reverse - the consumption base does not fall by 22%. The consumption base either stays the same or increases. The increase in the base pays for the additional government revneue needed for the increased spending. The differences between the two (and Boortz / Kotlikoff) is if the money supply is expanded to fully accomidate the FairTax.
Morphh,
Let me try to explain my position again.
It all started with a recent question to Larry K regarding the GDP.
“Larry,
I do have a question about the GDP. Does it include tax revenue? If not, then won’t consumption fall by the amount of embedded taxes that are removed from the price? Or conversely, it taxes are included, won’t the GDP rise by the amount of the net price increase after the 30% sales tax is added to cost plus profit?’
His reply: “Hank, GDP does not include tax revenue. Larry”
I take that to mean that the GDP does not contain a tax element, and if producer prices fall, then the size of the GDP must also fall. And the Fairtax rate must rise.
I don’t see where anything Gale or BHI wrote contradicts that position. Here is Gale:
“First, as long as real federal revenues and real
federal spending are maintained during the transition
to a sales tax, the required sales tax rate would
not depend on whether federal purchases are subject
to tax or whether consumer prices rise after the sales
tax is imposed.”
Notice that he said that after tax consumer prices would not impact the rate. This does not address what happens if before tax producer prices fall.
I have always taken the position that average producer prices will fall 10% with the elimination of business costs of the income/payroll tax system, and you have generally agreed, although with perhaps slightly different percentages. So, Morphh, if producer prices fall, and the GDP does not include taxes, please explain why the GDP won’t also fall? And, why the Fairtax rate won’t have to rise in my example by around 2.5%?
@Jim Reid
Jim you expressed concern of government entities paying a sales tax on their purchase, while at first this may seem odd but its not that odd , let me explain.
Currently when any city, state, or federal government buys a car, the cost of federal taxes are embedded in the cost of that vehicle, also when a city, state, or federal agency spends by paying its government employees, federal taxes are embedded in the cost of employee labor. Together roughly 22% of any government entity’s budget goes back to the federal government’s general fund, and rebudgeted
The fairtax taxing government purchases as end consumption, just replaces the same revenue stream the federal government gets from taxing the profits from any government spending on products and government employee wages.
Once the fairtax is implemented as is, it might be worth discussing taxing only new goods and services with the one exception of federal consumption of new products and services. This will have the effect of reducing spending by each federal agency by 23%. Then the fairtax would not be required to raise as much revenue. ill take a guess that taxing only non federal government purchases of new goods and services can be maintained by a 23% inclusive tax on non government purchases.
if that is possible it may be worth discussing removing the a sales tax on city and state governments if the federal government gives 23% less back to city and states.
Passing the the fairtax as it is requires a change in thinking and i would suggest working on that first, then discuss making government consumption exempt while lowering the revenue stream requirements to that which funds government pretax consumption