Memo to Bruce Bartlett: Just Do the Math
The Beacon Hill Institute’s David G. Tuerck has published a new article in Tax Notes titled “Memo to Bruce Bartlett: Just Do the Math” (link to PDF).
The article begins:
In the November 13, 2006, issue of Tax Notes, my coauthors and I published an article (the BHI/Kotlikoff study) in which we hoped to resolve issues related to the FairTax proposal, under which the federal government would replace almost all existing taxes with a sales tax.1
Our article was aimed largely at correcting and updating findings reached by William G. Gale in his earlier critique of the FairTax.2
We hoped that our article would elevate the discussion of the FairTax, which is gaining increased attention in national politics. We also hoped that, by presenting the underlying mathematics in painstaking detail, we could dispel the confusion that had long lingered over the calculation of the FairTax rate.
Now, in a recent article, Bruce Bartlett launches an attack on the FairTax in which he lapses into the same confusion that we (and Gale before us) had attempted to dispel.3 Bartlett singles out our study for criticism, accusing us of duplicity in our efforts to work through the mathematics involved.4 In the process, he brings his readers back to square one in getting things right.
Although some of Bartlett’s arguments are substantive, much of his article is directed at how people (proponents, voters, politicians, analysts) perceive the FairTax. Perceptions are important, but they should be based on fact, rather than error. The problem is that Bartlett’s article is strewn with errors — errors that he could have avoided simply by comprehending what we and Gale had already put before him.
Although Bartlett covers many issues and in the process makes many mistakes, I will limit my comments here to his attempt to work through what he calls the “distributional consequences” of the FairTax. This is no easy task insofar as Bartlett barely sketches the mathematics that underlies his reasoning on this issue or any issue. It means revisiting many issues already addressed in our article. It also means engaging in some mathematics and, in effect, correcting Bartlett’s mathematics (or what his mathematics would show if shared with us). It is important, nevertheless, to undertake this task because, left unchallenged, Bartlett’s article will only sow further confusion.5
Of Bartlett’s mistakes, I will focus on six:
1. misstating the calculation of the effective tax rate under the FairTax;
2. concluding that the removal of existing taxes in anticipation of the FairTax would reduce prices;
3. observing that imposition of the FairTax would raise prices by the inclusive rate, rather than the exclusive rate;
4. implying that the FairTax rebate is intended to compensate consumers for rising prices;
5. alleging duplicity in how BHI/Kotlikoff handles the rebate in calculating the FairTax rate; and
6. erroneously claiming that the FairTax would impose a burden on the federal government and on state and local government.
See the full article in PDF format for more.
Thanks to Morphh for the heads-up.
I had to chuckle when I read this: “By trying to reinvent the calculation of the effective rate, Bartlett steers the reader into a mistake of his own making.” That’s exactly what I said. Bartlett tries to reinvent how effective rates are calculated — nonsensical as Tuerck put it. Overall, I thought it was a pretty good. I wish Tuerck had more space to debunk all of Bartlett’s other erroneous statements, which were numerous. Kotlikoff also has a rebuttal paper titled “Why the Fair Tax Will Work – Bartlett’s Unfair Attack on the FairTax.”
I’ve been arguing with a man that is a Bartlett sycophant.
The 57% mentioned by The Joint Committee on Taxation was in a MEMO by Lindy Paul to John Buckley, chief tax counsel for the House Ways and Means Committee. It is dated Apr 07, 2000.
The Study of the Overall State of the Federal Tax System was published in April 2001. It DOES NOT mention the Fair Tax Act of 1999. The 106th Congress ended it’s 2nd session on January 3rd, 2001.
Furthermore, there is no Joint Committee on Taxation study of Fair Tax Act of 2001, 2003, 2005, or 2007.
The MEMO by Lindy Paul to John Buckley does not cite methodology or where the rates come from.
Joshua,
The following discussion might better be treated as a stand alone topic, but for now, it is most closely related to the Bartlett/Kotlikoff/Tuerck debate.
The Fairtax rate is not 23.8% as claimed by Kotlikoff/BHI in their September 2005 Fairtax base/rate study. I believe the study team made a fundamental error of omission. When they added the $916 billion to the Fairtax base, they neglected to add an offsetting revenue amount. Had they done so, the correct rate would have been 26.4%, not 23.8%, and the exclusive rate would climb to 35%.
I have spent the last three months working with Gale, Kotlikoff, and Tuerck, trying to understand how the federal government can tax itself. The answer is, they can, but in doing so, there is no net revenue created. According to all three experts, it doesn’t matter if the federal government taxes itself or not, the rate should remain the same. That is so, because if, for instance, you remove the $916B from the base, you have to remove an appropriate amount of revenue and the rate remains unchanged.
The problem is that there is no offsetting revenue in their Fairtax rate calculation. When they chose to add federal consumption to the base, they should have also added offsetting revenue of $242B. Without this revenue allowance, it is impossible to raise the $2228B revenue neutral amount with a 23.8% rate.
Because it doesn’t matter if the federal government consumption is taxed or not, they should have first calculated the tax rate without the $916B federal consumption in the base, and the rate would have been 26.4%. Then, if they wanted to tax federal consumption, both the consumption base and revenue required would be adjusted as explained.
So, the issue all along has not been “who pays?”, but where is the offsetting revenue adjustment in the BHI study. There is none!
In fairness to Kotlikoff and Tuerck, here is their explanation of where the additional revenue comes from.
Kotlikoff: “PS, The Government pays taxes when it buys things simply because we don’t want to issue exemption cards. But the government collects enough revenue to cover the costs of having to pay taxes when it buys things. ”
Tuerck: “Concerning your inquiry, everything is accounted for: When we compute the
rate, federal consumption appears both in the numerator and in the
denominator (the base). Think about it like this: If the government
currently imposes a 23% income tax, then every time the government
consumes an hour of government labor, the worker providing that labor pays
23% of his wage to the government. So if the government pays $10 for the
hour of labor, $2.30 is paid back to the government as tax. Under the
FairTax, nothing substantive changes. Assume “no accommodation,” so that
the wage falls to $7.70 an hour (we could assume full acccommodation, in
which case the wage would remain at $10.00 an hour). Just as before the
government pays $10 for the hour of labor, of which $2.30 comes back to it
in taxes. So the inclusive rate is 23% without any need to adjust the
amount of revenue collected by government.
I don’t agree with either explanation and would appreciate any and all comments on what appears to me to be an error in calculating the rate.
Hank, did you see my previous comment regarding two other errors in BHI’s rate calculation?
Hank — I am not smart enough to figure this out. I would be curious what Gale has to say about it, since he was the one that originally claimed that the way the fairtaxers calculated the government taxing itself was incorrect.
I guess the first thing to ask is just how much tax revenue the government currently receives from its consumption. Obviously, it receives no revenue from interest payments and expenditures abroad.
With respect to its employees, it receives their share of social security tax, medicare tax and income tax. The social security and medicare taxes would amount to 7.5% of their salaries. Since most government workers probably earn less than, say, $60,000 per year, their income taxes will be quite low. So I would say that for every $100,000 the government currently pays its employees, it gets back maybe $12,000. (I.e., 12%) Under the FairTax, with no accomodation, the government takes back 23%, and the worker(s) only gets $77,000. So it seems that the FairTax would force government workers to take a significant pay cut.
When the goernment pays third party contractors, the contractors pay corporate income tax, but that is only on the profits those contractors actually realize, if anything. If the contractors make a 10% profit, assuming they are in the 35% corporate tax bracket, they would pay 3.5% of their revenue in taxes to the federal government. Under the FairTax, with no accomodation, the government would pay 23% less to the contractor, so the FairTax would force that contractor to take a tremendous hit on its revenue, which would mean it would need to slash its employees wages (and somehow reduce the costs of its inputs, including foreign-made inputs.)
So, it seems to me that in order for the FairTax to tax government spending, you have to assume that there will be a tremendous contraction on real wages, which would of course suppress consumption, which would lead to a necessary increase in the FairTax rate.
That’s about as far as I can think through the process. I am more concerned about (a) the fact that the Beacon Hill/Kotlikoff study assumed a deficit of $476 billion, (b) it did not account for any reduction of consumption due to consumers shifting their consumption from taxable items to non-taxable items, and (c) it did not account for the increase in state taxes that would result because states would need to pay the FairTax to the federal government on the states’ spending.
But, really, I think Gale will need to explain the government-taxing-itself issue. It gives me a headache just thinking about it.
Hayden,
The question isn’t how much revenue the federal government receives from their consumption–that answer is zero because there is no current federal sales tax—but the question is what should the revenue neutral amount be? According to the 2005 BHI study, the answer is $2228B, but that isn’t correct. When the study group added $916B in federal spending to the consumption base, they should have added $242B to the revenue neutral requirement in order to offset the sales tax on their consumption.
Think of it this way. Under the Fairtax, when the federal government purchases goods or services, they have to write a check for the price including the sales tax. The seller then returns the amount of the sales tax to the federal government (more or less), and the net revenue from the transaction is zero! (the “more or less refers to the fact that 1/2 of 1% does not come back, but is the fee paid to the seller and the state.) Therefore, the tax on state and local, as well as individual consumption has to create the entire $2228 revenue neutral amount, and that rate has to be 26.4%, not 23.8%. It doesn’t matter whether you tax the federal consumption or not, the rate would remain the same provided you adjusted the revenue when you added the consumption. Otherwise, if you remove federal consumption, you have to remove revenue for the rate to remain unchanged. But, the revenue requirement is fixed–it’s the amount the federal government gets from all the current payroll, income and gift/estate taxes.
There is really only one reason to have the federal government tax itself, and that is to reduce federal government competition with the private sector. And, as I have written before, there are a lot simpler legislative ways to prevent such unfair competition.
As for what Gale thinks, here is an email exchange that we had which might help.
“Dr. Gale,
A quick postscript to my last email. Is it possible that Larry Kotlikoff and the BHI team erred when they added federal government consumption to the Fairtax base, they did not add any offsetting revenue? Had they added $242B to the revenue neutral amount, the rate would have been 26.4%, and that rate would not change if federal government consumption was removed from the base provided the revenue neutral amount was also lowered appropriately.”
Gales response:
“I haven’t looked at their stuff recently. But you are correct to think that a property of the correct rate should be that the rate is invariant to whether federal consumption is included in the tax base or not. What I am not sure of is whether they included the adjustment on the “spending” side. ”
And another one in response to my original question of “Who Pays”:
“You wrote — “Taxing government does not change the required rate”. That’s exactly right. In either case, in the two examples I gave, private consumption is taxed at 20%. The “tax” on government does not raise any NET revenues — it just increases revenues and outlays by the same amount. Therefore, no one bears the tax on the federal government because there is NO NET tax paid by the government. It’s crazy, but true.
This applies to federal taxes on federal purchases. For federal taxes on state or local government purchases it is a different story. ”
Hayden, I certainly agree with your three other concerns about the study, that is, balancing the federal budget, legal tax avoidance, and the impact of the Fairtax on state and local government budgets. And Fred has also uncovered some more possible errors which he will be reporting on at some point. I’m not sure any of this really matters, but it tends to make me believe that not all of that $20 million in research can be depended on, no matter what the source?
Hayden,
You seem to be a very bright guy but you always leave out significant facts in you your post to make the Fair Tax look bad in your examples. I work for a government contractor, eventhough we do not do all of our business with the feds, it’s a big chunk. First of all your assumed profit margin is about four times too low, it would not be worth the hassle to bid on a goverment contract for that amount. Next, what about the cost savings for our sub-assemblies and raw materials, that are not taxed at all with the Fair Tax. The bottom line is that under the Fair Tax the government will not be taxing itself any more than it is already. No matter how you massage the numbers.
Joshua,
This may deserve a stand alone thread.
The fate of the Fairtax largely depends on the reaction of state and local governments. Repeal of the 16th Amendment will require 38 states to ratify any constitutional amendment. In addition, the Fairtax plan includes taxing state and local consumption which could be found to be unconstitutional if the states resist the plan.
Here is a direct extract from the 2008 National Governors Association (NGA) policy statement regarding taxes:
“Since adoption of the U.S. Constitution, Congress has generally respected state sovereignty with regard to state taxes. It is essential that the federal government not preempt, either directly or indirectly, sources of state revenues, state tax bases, or state taxation methods. Unfortunately, over the last few years, Congress has increasingly restricted the rights of states to determine their own tax structure and has not considered the significant impact that its decisions can have on state authority. Recent legislative examples include the moratorium on the taxation of charges for Internet access, prohibiting the taxation of nonresident pension income, and the accelerated elimination of the state death tax credit. Other examples include bonus depreciation that would reduce state revenues and proposals that would restrict business activity taxes.
9.2 National Sales or Value-Added Tax
The nation’s Governors oppose a national sales or transactional value-added tax. Such taxes would intrude into a tax area that has traditionally been reserved for and relied on by state and local governments. If enacted, either of these taxes would seriously threaten the ability of state and local governments to maintain their tax base.
9.3 Current Income Tax
If Congress decides to reform the current tax system, they should reduce the complexity of current income taxes; increase incentives to work, save, and invest; and increase efficiency and fairness. As part of any modification of the current income tax, the nation’s Governors support the deductibility of state income taxes, sales taxes, property taxes, and the interest on state and local bonds.
9.4 Business Activity Tax
The nation’s Governors oppose any further legislative restrictions on the ability of states to determine their own policy on business activity or corporate profits taxes. This is an issue of state sovereignty. The U.S. Constitution adequately protects the interests of both states and business.”
In my recent poll of state Treasurers, I found basically the same threads running through their replies. All of which should give pause to anyone who believes that getting approval of HR25 as written, and amending the Constitution will be a walk in the park. It is also quite clear that the Houston AFFT team that authored the Fairtax did not coordinate their plan with any state government agencies, specifically Texas. The Texas Treasurer, upon request, conducted a records check and could find no data that anyone from AFFT ever made contact with their office on the subject of the Fairtax.
Clearly, the Fairtax grassroots effort has a long way to go!