Florida Becoming a FairTax State?
From Jim Bennett:
A proposed Florida $9.6 billion property tax swap represents a step in the direction of the Fair Tax at the state level but is not entirely the Fair Tax. Therefore Florida may not become a perfect state laboratory for the Fair Tax, although it still may provide indicators.
The Florida proposal (see article in the Fort Myers News-Press appearing March 23, 2008), probably headed for the November ballot, proposes reducing county and local property taxes by 25% in exchange for an increase in the state sales tax of one penny. In 2000, writes reporter Jim Ash, the state funded 60% of public education, and the county and local governments funded 31%. Today those percentages are nearly reversed, with the state paying 47%, and local governments providing 53% and are projected to become 46-54.
With the total Florida state budget at $70 billion, and discretionary spending at only $30 billion, the $9.6 billion property tax swap would represent nearly a third of discretionary spending. The one-cent sales tax increase is projected to bring in less than half of the $9.6 billion additional cost to the state and would force state lawmakeres to scramble for cuts elsewhere in the budget.
Florida state economist Amy Baker contends swapping consumption taxes for property taxes would guarantee a more stable stream of revenue. This is a Fair Tax point, too. Supporters of the plan also point out that about 15 percent of Florida’s sales taxes are paid by non-Florida residents.
The Florida sales tax, unlike the Fair Tax, does not provide for a “pre-bate” and is not as broadly based as the Fair Tax.
Like the Fair Tax, the consumption tax would stop penalizing investment in real property. An improvement to one’s home today, for example, is likely to prompt a visit from the local or county tax assessor and a bill for additional tax. The Florida proposal furthermore would not entirely eliminate the property tax.
The Fair Tax does not replace state and local taxes but gives state and local governments an incentive to enact “conforming” taxes. States may be persuaded under the Fair Tax to eliminate their own income and property taxes as Florida is on the way to doing on its own.
While it can be said that both the Fair Tax and Florida-style property taxes are “wealth taxes,” property taxes burden wealth when one holds it in the form of real property, taking away the incentive to save and invest that particular way (with an offset in the form of a Federal income tax deduction). The Fair Tax taxes wealth only when spent, leaving the incentive to save and invest intact.
Florida is one of seven states in the United States today without a personal state income tax. Florida recently repealed an “intangibles tax” which levied on stock and other securities. This repeal provided more reward to individuals who save and invest.
Before we conclude, however, that Florida is close to becoming a Fair Tax state, one must recognize that Florids still has a corporate franchise tax. Thus Florida does not remove the tax costs that are embedded in the prices of today’s goods and services and put businesses in a totally tax-free environment as does the Fair Tax.
Michigan Fair Taxers are seeking to put a Michingan state-level Fair Tax on the ballot. If successful, Michigan may become the first true state laboratory for the Fair Tax, with the rest of us functioning as the “control group.”
Sweet! Can you say “momentum?”
The Texas Public Policy Foundation makes the case for this plan to be adopted in TX as well. See The Case for Converting from Property Taxes to Sales Taxes
I don’t understand. Florida already has a sales tax and it doesn’t tax nearly as much consumption as the FairTax. They don’t appear to be suggesting expanding the base (that didn’t go too well last time Florida tried). How does lowering property taxes and raising sales taxes make it a “FairTax”?
Joshua,
Don’t bet the ranch that the Michigan Fairtax plan will go anywhere. The plan is based on a Feb 2008 study done by Wolfram and Kawa. There are a couple of errors in their results. First, the 9.75% rate is an inclusive rate, with the exclusive rate being 11%. The advocates were contacted, but they disregarded my input. There may not be much difference between 9.75% and 11%, but failure to clarify could be a problem, as Michigan residents generally view sales taxes in exclusive terms.
Also, although the study did not include government consumption in their plan, it was treated as an option which could lower the rate. This is the same error in logic that BHI made in all their Fairtax studies. As I reported earlier, when governments tax themselves, there is no change in the rate–provided an offsetting revenue amount is also included. The way the Michigan study is structured, rather than lowering the rate by adding government consumption, the rate will have to rise in order to create the $24 billion in needed revenue.
As a general statement, letting a State, whether Texas, Florida, Missouri, or Michigan, lead the way is a very bad idea, imho.
This situation seems far too different from the desired changes that would arise from the FairTax to really be a good case study, since the goal of the FairTax is to replace (primarily) payroll, income, and capital gains taxes with a sales tax, whereas we’re talking about real property tax here.
Still, this moves the ball forward, at least for Florida and Michigan, toward the realization that taxation of a consumption base rather than an income base makes more sense in the 21st century. I’m especially hopeful in the case of Michigan where, if a statewide FairTax type system is enacted correctly, it could be the U.S.’s own “Irish Miracle” story. Let’s face it, the state of Michigan, in fiscal terms, is beyond messy. Just about any well-thought-out change would be an improvement.
Hank, you stated that “the study did not include government consumption in their plan, it was treated as an option which could lower the rate. This is the same error in logic that BHI made in all their Fairtax studies.”
The economists at BHI (and I’ve spoken to several) and Kotlikoff all deny that any such error in logic was made and that they did include government consumption. You are correct, which they also confirm, that the addition of government does not change the rate (so I can’t speak for what they suggest in the Michigan study - I’ve never read it). But to be clear for other readers, BHI did not offer an option to lower the rate with Government consumption and they reject Hank’s claim that they did not account for government spending.
Morphh,
My claim is not that they didn’t account for federal government consumption, it is that they made no revenue adjustment to account for the tax on spending. BHI can’t on the one hand claim that having the federal government tax itself is a wash–i.e. generates no net revenue, and then claim that the 23.8% Fairtax rate will generate $2228B on the revised consumption base of $8439B. ($9355 - $916 = $8439) The Fairtax rate should have been 26.4%, (not 23.8%), which is a 36% exclusive rate.
Another way of stating the problem is that when BHI added the $916B in federal consumption to the base, they should have added $242B to the revenue neutral amount of $2228B in order to “balance the books”. Either way, the inclusive rate is 26.4%.
I have repeatedly asked BHI to explain, but no response as yet. Perhaps you could go back to them and ask them just where they made a revenue adjustment when they added the federal consumption to the base. The only response I got from Larry K was basically, it’s in there? Am I the only one that can’t find it? No, Bill Gale also agrees that ” 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.” For that to be true, and to hold the net revenue required constant, BHI should have added a revenue adjustment of $242B. (2469B/9355B = 26.4%).
This error in logic applies to the several BHI studies you have identified, as well as the Michigan study. If you have any contact with any independent economists, you might put the question to them? You might get a different answer.
Mr. Gieson, This is Larry Kotlikoff, one of the co-authors of the BHI study.
Here’s our formula that we use in the paper to caculate the effective tax rate te.
te x C = G
You can read this formula as the government buys G without paying the FairTax and does so using the FairTaxes collected on sales to the public.
Now let’s change this formula by adding and subtracting the same thing to both sides:
te x (C+G) = G x (1+te)
This formula can be read as the government pays taxes on its spending but needs that amount in extra revenue. We use the first version of the equation in our study. Either formula gives you the same value for te. If you are still confused, please call me at 617 834-2148 and I’ll sort you out. There is no fraud or fast one being pulled here. The math doesn’t lie and we followed the math.
best, Larry
Larry beat me to it.. but I e-mailed them your post. David Tuerck (BHI economist) responded in an e-mail.
We have tried to keep up with the torrent of emails and blog postings provoked by our work that pick at our calculations one way or the other. Although we want to be helpful by responding to these complaints and queries, we simply cannot take any more time right now to do so. We will be very busy through April with other projects. If you or someone wants to write to us again sometime later, we’ll take another look. For now, our position is that we did everything right.
Hate to throw a wet blanket on the hopes of FairTaxers, but this is more about frustration with property taxes than any move towards a FairTax-like system.
The only way Florida’s sales tax even remotely resembles the FairTax is that it’s a sales tax. There’s no “prebate,” there are lots of exemptions (some of which would be dropped, but those for food and medicine would remain), and the tax rate is only 7 percent (this proposal, of course, would raise it to 8).
And there are problems with the proposal. First, it should be noted that the Tax Reform Commission hired an economist to study the proposal and determine its economic impact. His report was overwhelmingly negative, saying it would cost over 50,000 jobs and $28 billion in personal income would be lost over 10 years. So the commission hired another economist to do another study. That economist’s report was positive, saying the proposal would create 72,000 jobs and lead to $6.9 billion in new construction. The commission, of course, accepted the second study, and went ahead with the proposal. The Miami Herald submitted both studies to three more economists. They agreed that both studies had flaws, but all expressed concerns about the tax swap proposal.
To quote one of those economists, from a Miami Herald article: “Tiger Woods is going to pay less property tax on his mansion, but the renter is going to struggle to find more money when he goes to the store.”
Another of those economists pointed out that several studies of Florida’s sales tax over the years have found that 70 to 80 percent of the poor’s expenditures are subject to the state’s sales tax, while only 20 to 30 percent of the of the rich’s spending is subject to the tax. “It’s a very regressive tax,” the economist told the Herald.
Florida Tax Watch, a non-partisan group which has done a good job in the past of advocating the interests of all Florida taxpayers, also did a study on the proposal in 2007 and concluded the impact on Florida’s economy will be negative. They haven’t taken a position on the actual amendment yet, but my hunch is, based on their study, they’ll oppose it.
All that said, the frustration with property taxes here is so great that this proposal, like Amendment 1 in January of this year (which Florida Tax Watch also opposed), will probably pass. Unfortunately, like Amendment 1, it will likely create further budgetary pain for Floridians, especially in areas like education, and won’t do that much to reduce property taxes for the average homeowner. And if the first economist hired by the Tax Commission, the three economists consulted by the Herald and the folks at Florida Tax Watch are right, it will hurt our economy overall.
So if you’re looking at this proposal to boost the FairTax’s propects, you’re probably going to be disappointed.
Hi, in my entry 9, the te stands for the tax-exclusive rate. That’s the nominal 30 percent rate you’d pay at the store. I was typing in a rush and referenced this as the effective rate. I meant that it’s the tax exclusive or nominal rate. It’s not the effective rate, which is te divided by 1+te. If te is 30 percent, the effective rate is 23 percent. Our study supports a roughly 23 percent effective rate and a roughly 30 percent nominal rate. Larry
Larry –
Thanks so much for posting here and elevating the level of our discourse!
Now I’ve got to be careful when I post “Kotlikoff really meant this” or “Kotlikoff messed up when he said that!”
But now that we’ve got you here, maybe you can answer a couple of questions we’ve been debating about the BHI study on the FairTax rate which concluded that teh 31.25% tax-exclusive rate would be revenue neutral.
1. The BHI study assumes a deficit of $476 billion for 2007. What would the rate need to be in order to have a balanced budget?
2. The BHI study did not appear to take into consideration any shifting of consumption away from the purchase of taxable goods and services. In other words, if the FairTax were enacted, cheapskates like me might buy used houses and cars to avoid paying the FairTax. Retired folks like Hank might live out their golden years in Mexico and leave us gringos holding the tax bag. Entrepreneurs like Joshua (the web-host) might buy that mountain palace and run his web-empire from there so he can buy it FairTax free.
Don’t some reasonable assumptions about such expected shifts in consumption habits need to be incoporated into any study of the FairTax rate? And if only 10% of expected tax revenue is lost due to such a shift in consumption habits, won’t that dramatically effect the required FairTax rate (since, presumably, the prebate will need to be adjusted upward as well)?
I’ve got plenty of other questions, but I’d love to get your comments on those two.
Thanks for visiting us here!
Hayden
For what it’s worth, I would LOVE for Florida, Michigan, Texas or even Georgia (where I live) to enact their own versions of the FairTax. Such an experiment would certainly answer many of the questions we’ve been debating here.
If a state-specific FairTax proves to be a roaring success, then we critics would be shut up once and for all. If it works OK but some problems crop up, those could be identified and addressed. And if its a collosal failure, it will be much easier to reverse at the state level than out the federal level.
And I agree with Bradley. Might as well start with Michigan. I mean, what do they have to lose at this point?
Hayden, you’ve mentioned the deficit many times before and it seemed that you used it to suggest the rate should be higher. Of course, we all understand that a balanced budget would require a higher tax rate, as it would also under the current system; however, the FairTax is meant to be revenue neutral - we’re not trying to go for a tax increase or decrease - only tax reform. The rate required (using those economic figures, which we now know to be low) for a balanced budget should be easily factored $476 (deficit) + $2288 (revenue projected to be replaced) = $2764. 2,764/9,355 = 29.54%
A similar raise in taxes under the current system would have also been required for an fair comparison. Using such a rate is similar to using a reduced tax base though. I don’t understand the point. While I’d agree with you that we need a balanced budget, that has no place in the FairTax discussion. At that point you’re not discussing the FairTax anymore but a tax increase. It is only useful as an observation, just like showing the rate would be 20.35% without the prebate. What if scenarios..
Dr. Kotlikoff, the thing I haven’t been able to figure out is how your equation, te x (C+G) = G x (1+te), becomes equation 27 from your paper.
Also, I did find one obvious error in the calculation that I detailed here. It’s relatively small - but it is an error.
Larry, Morphh, Fred, et al,
First of all, I regret that BHI hasn’t got the time to engage in what is a very interesting discussion, and I’m very pleased that Larry Kotlikoff checked in on this site. Very educational at the least. And let me assure you, Larry, that I never suggested that there was any fraud or “pulling a fast one” on the part of the BHI study team.
What started out as a question about “Who pays?” the federal government’s sales tax bill, on the assumption that only people pay taxes, resulted in several emails and phone calls with Bill Gale, Larry, and David Tuerck. They convinced me that no one pays, that it doesn’t matter if the federal government taxes itself or not, the Fairtax rate remains the same, provided that revenue is adjusted to account for adding the federal consumption to the base. My question then became “Where is the revenue adjustment?”, as I could not find any adjustment in the BHI base/rate study. I then assumed (incorrectly) that the rate would have to be 26.4% in order to raise enough additional revenue to pay the federal government’s sales tax bill. I was wrong.
According to Larry’s email above, Te x C = G, which means that when you multiply the exclusive rate times the consumption base, you get a pile of money to fund federal government spending. Now, the revenue neutral amount needed to replace the income, payroll and estate/gift taxes was $2228B in 2007 according to the BHI study, and the consumption base used was $9355B. This resulted in an inclusive rate of 23.8% and an exclusive rate of 31.3%.
What I, and I suspect many others did not realize was that when the exclusive rate is applied by all retailers of new goods and all services to the consumption base, the sales tax would raise $700 billion over and above the revenue neutral amount of $2228B. When Larry told me “it’s in there”, he wasn’t kidding. The federal government will be awash in revenue, enough to balance the budget, account for taxing itself, offset evasion/avoidance, and any other criticism we might have, I guess. This fact, at least to me, is a revelation of sorts. I’ve found the missing $200+ billion in offsetting revenue, and then some!
A few points to consider.
(1) Is the Fairtax revenue neutral? Hardly, if it raises $700 billion more than needed to be revenue neutral. Is that good or bad?
(2) Larry has previously advised me that taxes are not included in GDP. I believe that Larry assumes that prices will rise by the full 30%, and the GDP would be unchanged. But, using the Arduin, Laffer, Moore study results, they believe that pretax prices will fall by 11.55%, which seems to mean that initially, the GDP will also fall by that percentage. After doing the higher math, the new exclusive Fairtax rate after adjusting the GDP downward would be 36.8%, and the revenue generated would be $3045B, $817B more than revenue neutral.
(3) Since it doesn’t matter if the federal government taxes itself or not, after adjusting the base to account for the lower GDP, we could remove both the $916B in federal government spending and the $337B in offsetting revenue. The rate will be unchanged, but there will now only be $480B in excess revenue, still enough to balance the budget and account for evasion /avoidance.
Through the magic of inclusive/exclusive rates, I no longer believe that the rate needs to be increased to pay for the federal government taxing itself. But, now there would seem to be a bunch of related issues that might be discussed here? I will email Larry this post in the event he doesn’t check in very often. Any comments would be appreciated.
Morph and Hank –
1. Morph — Thanks for your reply and calculation. The reason I keep harping on the deficit issue is as follows:
a. The BHI study assumed a deficit of $476 billion for 2007. The actual deficit was around $150 billion. That in itself is a material difference. The fact that the BHI study would “bury” the deficit number in their paper, and never explain the discrepency, in my opinion, goes to the credibility of the study. A skeptic (like me) might wonder if they buried something else. I’m not necessarily saying that they did, but it does make me wonder just how objective the study really is.
b. Regardless of the projected deficit, the key tax rate is the rate that would be neceesary to balance the budget, that is, how much do we need to raise to pay for the cost of government. Implementing a plan that the backers themselves admit will add half a trillion dollars a year to the deficit means that in five years will have another $5 trillion added to the national debt, plus accruing interest (and that’s excluding all of the unfunded future liabilities for Social Security and Medicare.) Who would loan money to the U.S. government if even the most optimistic projections show that it is going deeper and deeper in the hole?
2. Hank
Sorry to learn that I might have lost you as an ally in the good fight against the FairTax. : ) I’ll make two quick comments:
a. I don’t believe the $2228 billion number you reference above incudes the cost of the prebate, which would be at least $500 billion per year. Nor does it include the one-time $600 billion tax credit for the transition. When you factor these in, we’re back to the huge deficit I discussed above.
b. I’m still a bit confused on the calculations discussed above. If C * te = G, then that means that consumption costs are going to rise by the tax exclusive rate. That is, the cost of everything will go up by 31.25% when the FairTax is added in order to raise enough revenue to fund the government. (If the pre-tax costs of goods decreased under the FairTax, the C would be a lower number, which would yield a smaller G.) Since the cost of all new goods and services will, by definition, need to rise by 31.25%, don’t you have to assume there is going to be decreased consumption?
Hayden, $467 is what was projected at the time with the economic numbers they had. They did not have a crystal ball. They didn’t burry anything. Future events showed that $150 billion is what the deficit actually came out to be because of good economic growth. Now... what makes you think that the economic growth that reduced the $467 to $150 billion, would not also apply to the FairTax when those increased economic figures were used to calculate the tax base? Of course, the FairTax would also generate more revenue and reduce the deficit to a similar $150b. You’re only changing one part of the equation.
As far as B, I couldn’t disagree more with what the key rate should be. I’m not for any tax increase - cut spending to balance the budget. This is why the FairTax is to be revenue neutral - the key rate is revenue neutal, not spending neutral. Any discussion otherwise is no longer the FairTax. It should not add to the deficit, it is intended to maintain the same deficit. I also have issues with additional deficit and larger debt, but the FairTax rate at this point is not the means to address it. That’s a completely different discussion - tax increases. I’m fine with having that discussion, but don’t pass off the FairTax as having xx increased rate to cover lack of spending accountability - the current system doesn’t. Apples to apples - be fair about it.
As for item (a) in the reply to Hank, BHI does include the prebate by subtracting it from the tax base. See table 5 where 2,112 billion is removed. With regard to transition costs, there are other aspects as well that could be factored in the other direction, such as the repatriation of offshore accounts that would send 12 trillion dollars into our markets, which Greenspan stated would happen within months of transition. This is all of course part of what would be a dynamic scoring analysis.
Hayden,
You haven’t lost me as an ally in opposing the Fairtax. I may have lost a skirmish, but the war is far from over.
(a) The $2228B is simply the 2007 amount collected from income and payroll taxes as well as the estate/gift taxes. It is a fixed number, and was supposed to be the target for revenue neutrality. The prebate is accounted for on the consumption side of the equation. The actual taxable consumption in 2007 according to BHI was $11,244B. They simply removed $2112B from the base to account for the prebate, which amounts to around $500B. Close enough for government work?
You are correct that the $600 billion inventory tax credit will add to the federal budget deficit in year one. Could be a record year for budget deficits, but no one ever claimed that the transition period would be easy?
(b) I’ll be calling Larry this PM, but I believe he would agree with your analysis–that is, pretax prices will remain the same, and retail prices will rise by 31.25%. But, although the price rise may reduce consumption, you have to remember that incomes will also rise and, coupled with the prebate, may not change peoples buying and saving habits very much. That certainly will be debated by the economic psychologists if there are any around?
My argument for a reduced consumption base is not based on peoples buying decisions, but is based on the Arduin, Laffer, Moore study which says pretax prices will actually fall by 11.55%. (My best guess was more like a 10% reduction, but who knows what businesses will do with their cost savings?) If any of the estimates come true, then the GDP will also fall, because taxes are not included in GDP according to Gale and Larry. Lower base = higher rate.
Stay tuned!
Morphh,
Give me a break, please. The $11 trillion (or $14 trillion?) in American offshore accounts is a Fairtax myth, fostered by Boortz in the original book, page 104. According to the Tax Justice Network (www.taxjustice.net) briefing paper entitled “The Price of Offshore”, only $1.6 trillion in offshore accounts and investments is owned by wealthy people in North America. And ownership of the $1.6 trillion is spread over the 23 countries in North America, ranging from Panama to Greenland. I can’t tell how much is American owned, but would be willing to bet it can be measured in billions using the fingers on one hand.The bulk of the offshore trillions are owned by Mid East and Asian countries ($4.6 trillion) and Europe ($2.6 trillion).
Those trillions are safely and profitably held offshore, and I can see no reason for any of those funds to return to the USA. Particularly in light of HR25, Section 905, which places a tax on non-resident aliens and foreign corporations in an amount as agreed to by various trade treaties, and Section 801-806 which lays on an implicit tax on investments depending on the going Treasury rates.
I don’t know how the question was put to Mr. Greenspan, but there is no way $11 trillion is going to come “home within months”, because home isn’t here!
Hank, you may want to reread the paper. The 1.6 trillion is from the Boston Consulting Group in their Global Wealth Report for 2003. It was one of three methods they described for estimating assets held offshore, to which the Tax Justice Network concluded “This provides the basis for our estimate that the value of assets held offshore lies in the range of $11 - $12 trillion. We consider this to be a conservative estimate.” I’m not sure who is right or wrong here.. or what would really “come back”. I haven’t researched it. I know Congressman Linder has stated it on several occasions (including the discussion with Greenspan), so it’s not just a Boortzism. I only used it as an example of areas that may be considered in a dynamic analysis as part of transition gains and losses.
It appears the majority of that money is just normal foreign investments (equities, bonds, etc.). Investing in different markets is typical for a diversified portfolio. What makes anyone think this money would come back to the U.S. under the FairTax?
I also don’t understand why the Tax Justice Network thinks these people are avoiding taxes. Sure that money isn’t taxed while it’s invested, but once someone in the U.S. realized their gains, wouldn’t it be taxed? How is this any different than money invested in U.S. equities or bonds?
Here are some links to statements by Congressman Linder. Again, I don’t know if it is a myth or not.. just referring to the statements. Linder is quoted here: “The challenge of U.S. dollars being moved to offshore bank accounts in an effort to avoid paying taxes on capital gains and interest has grown to about $11 trillion (up from 1.3 trillion just a couple of years ago) and is growing by $800 billion per year, resulting in billions of dollars in lost tax revenue every year. Former Federal Reserve Chairman Alan Greenspan said that once the FairTax is passed it would take only months for that money to be repatriated back into U.S. banks where it could then be used to grow the economy.” Linder also states it in this American Solutions video (11min 40sec - 12min 40sec, which is almost 1/4 into the video). He states that he asked Alan Greenspan the question... Anyway...
Morphh,
None of that Linder stuff makes any sense. It is most assuredly another Fairtax myth! True, the Tax Justice Network paper quoted the Boston Consulting Group who were the authors of the $1.6 trillion North American estimate. But Linders statement that offshore accounts have grown to about $11 trillion, up from 1.3 trillion a couple of years ago, and growing at the rate of $800 billion a year defies all logic. Even if all those funds were American, which they are not, you can’t grow 1.3 trillion to 11 trillion in a couple of years at a rate of 800 billion per year. I suspect that Linder has the data all jumbled up! Guess I’ll ask him!
Rather than debate what Linder knows or doesn’t know, I’d like to hear from someone about the impact of HR25, Section 905 and Sections 801-806. My reading is that no sane investor, with funds parked in an offshore account, would want to “come home” to the kinds of taxation and government oversight contained in the legislation.
And, how many of you knew how many countries are in North America? Significantly more than the three I had in mind. Product of a government school system, I guess.
Hank, I think that is a typo or an error in dictation - it should have been “up 1.3 trillion” not “up from”, as he states it is growing at the rate of $800 billion. This lines up with what he has been stating for several years. As far as countries in North America, your again referencing the BCG study. You also have to keep in mind that the data is dicussing high net worth individuals, which is probably limited in Panama and Greenland (to use your examples).
Hank, in response to post #17, don’t sound so dejected that “it’s in there.” You’re acting as if the BHI study being more right than wrong about the positive effects of the FairTax is a bad thing. Are there truly people out there who are twisted enough to want to tear down the best chance we have of reforming a detrimental system (at the risk of doing nothing and destroying the country they claim to love as much as we do), all so they can save face and not be proven wrong? Again, Hank, Hayden, Bill, et al, I know you support other tax reform proposals, perhaps rightly so, but this FairTax movement has gained support from 76 members of Congress and 8 Presidential candidates so far, and the battle was hard-fought to get to this point. Momentum continues to build for this particular plan and, with all due respect, I don’t see a Kepner Plan or FairTax Lite on the Thomas website. Despite arguments over the minutiae over the process of funding our government, I think it’s safe to say that we can all agree on one thing: efficiently taxing a broad consumption base makes more sense than the grossly ineffecient system of taxing a smaller income base we have now. To that end, then, perhaps our collective energies could be more productively focused toward enacting the FairTax so we can begin moving in the right direction for the first time in 95 years. Then we can see what happens and work to change the infinitesimal details of THAT system to better suit our liking. Just a thought.
I will now confiscate my own soapbox and yield the floor.
Bradley - very well said. You have expressed perfectly the frustration of wading through endless bickering over minutia while the big picture is completely lost.
Unfortunately, extracting $3 trillion from 300 million people is going to be frought with problems no matter how you do it. The key is contrasting the number of problems now against the number in the new proposal. That doesn’t happen much. It’s like focusing everything on cost without weighing benefit. It isn’t productive to criticize a new system because it has 100 problems when the existing system has 10,000 problems.
Of course, you can come up with alternate proposals that may be incrementally better, like one that has 95 problems. But as you say, this one has already been hauled so far up the ladder, it doesn’t make sense to start over. It seems to me that most, if not all, of the criticisms at this point can be handled during implementation of this plan.
The key is the big picture components:
- Taxing consumption vs. income
- Eliminating government knowledge of income
- Concentration of of revenue into a single tax
Bradley & Mark:
I’ve said this before, and I’ll say it again. If I attack elements of the FairTax, it’s only to make the broader point that I believe the benefits of the tax are being oversold and the pitfalls are being downplayed.
Let me be aboslutely clear about this: I am against the FairTax because I believe it to be a regressive tax which will relieve the rich of paying their fair share of the cost of running government and dump the burden on the poor and middle class. That’s the big picture. Just because Hank, Hayden and I point out the devils in the details doesn’t mean we’ve lost sight of that.
No, I can’t agree that taxing consumption is better than taxing income, and just because “76 members of Congress and 8 Presidential candidates so far” have supported it doesn’t make it a good idea.
As for “eliminating government knowledge of income,” sorry, but that won’t happen. The government will still have to have access to that information, because knowledge of the status of the economy is necessary, and income is part of that picture.
And how is “concentration of revenue into a single tax” - especially a tax which relies solely on consumer spending, which is notoriously volatile - a good idea? I always thought “don’t put all your eggs in one basket” was good advice.
I agree, Mark. Boortz, Linder, Linbeck, and co. have clearly stated that they know the FairTax isn’t perfect, and are open to constructive changes to the language of the bill. This forum has brought up some excellent suggestions, which is great. I’m all for debating the minutia, as long as it is done in a productive manner, and keeping in mind the myriad of problems with the monstrosity of a tax code we are working to replace.
I had hoped to get some comments on my post #17, but seeing none, here is what I learned last week: THE FAIRTAX IS NOT REVENUE NEUTRAL!!! In fact it should be described as REVENUE-PLUS-PLUS!
Last week, with the help of Larry Kotlikoff and others, we learned that GDP does not include taxes, and that it makes no difference if the federal government taxes itself or not, the Fairtax rate remains unchanged, provided that a revenue adjustment is made at the same time that federal consumption is added to the base. Referring to the 2005 BHI base/rate study, no such revenue adjustment was made, but Larry kept insisting that there was enough revenue to cover the federal tax on federal consumption. And, by email and confirmed in a phone conversation I had with him yesterday, Larry is very clear that the exclusive rate of 31.3% will be added to costs plus profit at the retail cash register. What that means is that the revenue raised by taxing the Fairtax consumption base by 31.3% amounts to $2928B, exactly $700 billion more than the revenue neutral goal of $2228B. That is 31% more than the revenue raised in 2007 from the income and payroll taxes and the gift/estate taxes.
The good news is that there is plenty of revenue available to offset the addition of federal consumption to the base. The very bad news is that the Fairtax is far from revenue neutral.
Rather than stopping here, let’s talk about how this issue can be fixed.
(1) Erase from your vocabulary any talk of inclusive and exclusive. This issue did more to destroy the credibility of Fairtaxers and killed millions of trees as the very weak argument about apples to apples was debated. By now everyone understands that the 23% Fairtax rate can not be directly compared to any income tax rate. So, forget about it! Practice saying that the Fairtax will be a (XX%) tax on all new goods and all services. Just like state and local taxes, there is no need to say inclusive or exclusive.
(2) Remove government consumption from the base. In the case of the federal consumption, it won’t change the rate, and having the feds tax themselves is the second largest credibility problem with the Fairtax plan. As for the state and local governments, taxing their consumption simply hides 12% of the cost of the federal government in higher state and local taxes, and that is certainly not transparent. State and local government taxation will be found to be unconstitutional anyway, so why not head that issue off at the pass. And finally, the stated reason for taxing governments was to stop unfair government competition with the private sector. But that argument went away when the Fairtax exempted all businesses from taxation. The playing field is level, so why tax state and local governments? Makes no sense, and the related issues far out weigh any perceived benefits.
(3) So, what is the sales tax rate? Starting with the $11244B gross consumption base from the BHI study, remove government spending of $2009B for a taxable base of $9235B. In order to raise the revenue neutral amount of $2228B plus $500 billion to pay for the prebate, the rate would be 29%.
(4) Finally, pray that the reduction in GDP due to competitive pricing factors is offset by a rise in GDP through increased economic activity. If the rise in economic activity does not offset the drop in pretax costs, the rate will have to go up.
This is just one possible solution to the problem of reestablishing the revenue neutrality of the Fairtax. There may be others, which I would like to hear about. I believe that this is a serious issue which needs serious discussion. I’m not sure anyone wants to have to defend a 31% increase in the amount of federal tax revenue collected?
>>I am against the FairTax because I believe it to be a regressive tax which will relieve the rich of paying their fair share of the cost of running government and dump the burden on the poor and middle class. That’s the big picture.>>
>>As for “eliminating government knowledge of income,” sorry, but that won’t happen. The government will still have to have access to that information, because knowledge of the status of the economy is necessary, and income is part of that picture.>>
Yes, that is your big picture. But the accuracy of the statement behind it is highly contested. I, for one, completely disagree with your projection on the distribution of the burden. And I know that no one has lost sight of that disagreement because, ultimately, whether or not taxation is or can be used for economic egalitarianism is at the root of each side of the argument. The details and statistics are just strawmen, IMO. The FairTax slices right through the Achilles heel of the wealth redistribution mechanism that is in place now. If one prefers the government to have that ability and believes it is in our best interest for that to be a priority of government, then the threat that the FairTax poses is completely understandable and to be expected.
Some are interested in individual economic liberty as it is conventionally defined and other are not. Plain and simple, that is the bottomline. At least the wrestling over statistics covers that up and keeps the discussions civil
>>And how is “concentration of revenue into a single tax” - especially a tax which relies solely on consumer spending, which is notoriously volatile - a good idea? I always thought “don’t put all your eggs in one basket” was good advice.>>
Call me cynical, but I do not believe that multiple forms of taxation are an example of premeditated risk management. I believe they exist only out of necessity to hide from individuals the true amount they have to pay. When tax fatigue sets in, you have to get creative.
As an example, not necessarily on this blog, but in general consider that one of the popular initial criticisms of the FairTax is how high the rate is. I believe that this is largely because people don’t understand now that that is essentially the rate that is being paid - but once you concentrate it, it is a shock.
Another example is the frequency at which those who are otherwise staunch defenders of progressive taxation jump to support corporate taxes and “penalties” on business when both are effectively consumption taxes that, by your definition, are regressive. That is why I believe corporate taxation exists: it is a great ruse to get the people who are paying for it to actually fight to have it raised because they think they are not paying for it.
I want people to see exactly what they are paying on one simple line item and I would like it expressed purely as their own payment - not the inevitable divisiveness that comes with the smoke and mirrors of trying to make it look like “someone else is paying for some of it”. Personally, my hope is that this will increase the motivation to be more involved in what it is being spent on.
Bill, what basis to you have to state that consumption is notoriously volatile? Consumption is known to be a more stable base then income. Consumption tends to fluctuate less from year to year than income does.
Hank, you stated that you were going to contact Kotlikoff. I was waiting for this to happen so most of the questions would be answered.
Morph:
I have to leave for work in eight minutes, but I’ll answer your last question quickly, and cover the other comments to my post tomorrow morning.
I base the statement that consumer spending is volatile on Florida’s experience with its sales tax. In some years, revenues exceed expectations. In others, they fall well short (this is one of the years revenues fell short).
Again, I have to leave for work, but I’ll work on getting some hard numbers to back the statement up.
Hank — How does your calculations (and BHI’s calculations) mesh with Gale’s? You’ve corresponded with Gale. Does he believe his 2005 study is incorrect?
Mark — You think the FairTax will give you a clear picture of how much you pay in taxes. Quick: How much did you pay in state sales tax in 2007?
Don’t worry; no one else knows either.
Mark — I didn’t mean that last comment to be as sarcastic as it came across as, so please accept my apologies. I was just trying to make the point that most people will have a better idea of how much they pay in income tax every year than they will in how much they pay in consumption tax.
(And one reason I would like to see a simplified income tax system with no exemptions or deductions is to make it even easier to figure out how much we pay in taxes.)
Dogpile on the naysayers! Drat, Morphh beat me to it! Conjecture and debate can be constructive, and there’s a certain beauty to be derived from dissonance, but when you beat a dead drum for so long, even the guy playing the spoons gets bored. But, since Hank picked the drumsticks up again, here we go.
Point 1: The inclusive/exclusive debate hasn’t killed millions of trees, for starters. I am aware of the date on the calendar and I’m not getting fooled by that one. I presume you mean the newspaper articles on the subject, but those papers would have been printed with or without those articles. Personally, I’m more worried about the acres of rare BlackInkFlowers that were harvested to print the text :D. I digress. Income and payroll taxes, as I’ve stated elsewhere, are quoted inclusively. The FairTax is designed to replace them, thus must be quoted in the same manner. That’s all. No percentage comparisons can exist, since the FairTax has one rate and the current monstrosity has half a dozen or more.
Point 2: I’ll have to admit, your point seems logical. Perhaps someone else here will debate that with you, but it appears to me that you have it right.
Point 3: 29% inclusive or exclusive?
Point 4: I think the case could be made that a 31% net increase in government revenue may very well be a good thing (for the reasons of budget deficits, national debt, and any enforcement issues that may arise, as you previously stated). The point has to be raised that, by the time the FairTax movement reaches critical mass to push the issue into implementation, (hopefully) an amendment to the Constitution will have been repealed, and the prominence will be such that most Americans paying attention (still a minority, to be sure) will know the proposed rate of the tax. This, it is my firm belief, will raise plenty of questions as to why the government requires so much of our purchasing power to be sacrificed to its fiscally irresponsible whims. In this, I agree, it would be beneficial to be as close as possible to revenue neutrality. However, if true neutrality cannot be achieved, and a surplus is inescapable, then the size of the national debt (already widely publicized) can be cited as the reason for the built-in surplus, to be directed automatically toward that debt. The general population, realizing their full tax burden for the first time since withholding took root, will stage a massive revolt if the promised debt shrinkage somehow is not forthcoming. Call me Sancho Panza, if you will, but one must be somewhat optimistic from time to time.
In response to post 32 from Mark, well said.
Don’t worry about Hayden’s response. He asked me the same thing. To which I responded 7.75% of everything I spend. Maybe he lives in a state where they don’t print it out on the reciept as much as they do here. It’s in my face everytime I buy something.
Morphh wrote, “Consumption is known to be a more stable base then income. Consumption tends to fluctuate less from year to year than its income does.”
I know Morphh specifically referred to income as a tax base, but referring back to Joshua’s original post about replacing Florida property taxes with sales taxes, a couple of University of Georgia researchers published a 11/2/07 paper comparing the stability of sales taxes and property taxes and concluded, “Using a large panel dataset of county governments in the state of Georgia across two most recent economic cycles, we find that LOST [local option sales taxes] adds to the variability of own-source revenues, confirming that consumption taxes are less stable than property taxes they displace.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1029697
Further on the issue of volatility, the Congressional Quarterly reported, “States have tools available to tamp down tax revenue volatility and to ease its impact. They can reduce the overall revenue ups and downs by building a diversified portfolio of taxes, relying not just on a single tax or on a single industry but instead using several taxes, such as an income tax, a sales tax and selective excise taxes. Such a diversified base can sometimes draw a large portion of its revenues from sales taxes, which are themselves diversified among various areas of consumption. Individual taxes imposed on different bases almost never move in lockstep, even in recessions and booms, so their instabilities tend to offset each other partially, reducing the volatility of total tax collections...Overall, the assessment found that almost every state had at least a 15 percent reduction in volatility due to diversification of its taxes — the portfolio effect — and that three-quarters of them had a benefit of 26 percent or more...A diversified tax base generally is more stable than a non-diversified base.”
Food for thought.
Here is the link to the article I was referring to in the third paragraph of my post above.
http://www.governing.com/articles/1taxrev.htm
Helena, I would agree with that. Property taxes are a very stable base.
Andrew –
You say that you know exactly how much you spend in sales taxes: 7.75% of everything you spend. I think you have just proven my point. Nobody knows how much they pay in sales taxes.
In the first place, most people don’t have any idea how much they spend in any given year. So, 7.75% in the abstract doesn’t tell them anything. (In contrast, they know to the penny how much they earn.)
Second, not everything one purchases is subject to a state sales tax, nor would everything one purchases be subject to the FairTax. However, everyong would certailnly know what is NOT subject to the FairTax and gear their purchases towards those tax-free items (e.g., used cars, business expenses, private school education, foreign travel, etc.).
Just curious, was that 7.75% inclusive or exclusive?
Brad, (aka Sancho)
Point 2: I don’t care what you call it, I call it a sales tax on your purchase. When you buy something in Virginia, do you ask if the state tax is inclusive or exclusive? I think not. My 29% rate is the tax you will pay on your purchase. Forget about inclusive/exclusive. The tax rate is enough to raise X revenue from Y spending. Get out of the box and stop thinking about sales taxes in inclusive terms.
Point 3: You are right, but if the revised goal of the Fairtax is to fund the federal annual deficit, retire the national debt, or whatever, then you need to stop saying that the Fairtax is revenue neutral, because it isn’t. Extracting an extra $700 billion from us taxpayers, when compared to the current revenue from income, payroll, and the estate/gift taxes, is not going to be an easy sell in Congress. I’d prefer to reduce spending, but darned if I know how to go about it. I still like Boortz’s “10th amendment commission idea. Does that qualify me to be known as Sancho also?
Fred- Of course, when talking about current state sales taxes, the number is exclusive. Don’t let’s be silly.
Hayden- “They know to the penny how much they earn” may well be true. Try this on April 16th- ask a co-worker how much they paid in income taxes last year. From the ones who answer, you’ll likely get blank stares, and probably more than a few nonsense answers like “Nothing, man. I got a refund.” Sure people know how much they earn- in take-home pay. The majority have no clue how big the interest-free loan they gave to the federal government was. And that’s a major problem.
How can we get a movement started to curb wasteful government spending when even the portion of an individual’s share that is printed right on their W-2 form is an unknown quantity to them? (Much less the larger share that is intentionally hidden from them in a system designed not so much to fund government as to manipulate behavior.)
A graduated income tax makes no sense in a global economy and the U.S. looks like it’s going to be the last player in that global economy to realize this rather important fact. Most of the world’s industrialized nations have gone to flat income or consumption-based tax structures, except US. America used to lead the way. Now we’re rapidly being left behind. And before you start advocating a flat income tax, know this: Steve Forbes, who has, for all intents and purposes, married himself to a flat tax system, has stated privately that the FairTax is far superior to his plan. Kinda hard to say that in public after you’ve run for president on an idea you admit is inferior, eh? The “flip-flop” chanters from the ‘04 prez race would be out in full force.
Okay, I’m going to get some shut-eye, so it’s time to shut mouth.
The 7.75% is exclusive. That is how it appears on my receipts. In fact, that is how I hope they quote the fair tax when they put it on receipts, so people get more irate at the fact we are paying so much in taxes. But until we start quoting the top income bracket as 54%, I’ll use the inclusive rate for the fair tax (until it’s passed. Then I’m all exclusive).
Hayden,
The 7.75% is extremely meaningful to me. I’ve given this example before, but it bears repeating. My 10 year old nephew understands the 7.75%. Every time he buys something for $0.99 and has to shell out $1.07 he questions why.
As for “everyone” knowing what they earn, I’ll concede that. But if they also know what they’ve saved, now they know what they’ve consumed. Multiply it by 7.2% and you know how much you paid in sales tax, except for the exemptions (but I’m against those). Now let’s say I’ve earned $65K this year. Tell me my tax. Not enough info. That’s alright. Just bound my tax.
Thanks to Helena for posting the info from Georgia.
I’ve been surfing since about 7 a.m. (eastern time) this morning (it’s 9:11 as I type this), and basically have found that both income and sales taxes face about the same amount of volatility. Sales taxes seem more volatile in the short term, income taxes in the long term. The conclusion of most of the papers I read was the same as Helena noted, that states should use a mix of taxes, along with other strategies, to ease volatility.
So, Morph, I’ll concede that point to you with the caveat that both can be volatile.
This does not change my position that the FairTax is regressive, nor does it dampen my opposition to it.
Hayden:
You make a good point regarding people not knowing what they pay in sales tax. I’m going to do a self-study in April, and it would be interesting if others on this blog who pay state sales taxes do the same. I’m going to track all my expenditures in April and discover what percentage of my April income I spend in state sales tax versus the percentage of my April income that goes to FICA, Social Security and Medicare. It may not prove anything, but it will, I think, be educational.
Morph:
You keep talking about spending being a better indicator of wealth than income. In my research this morning, I finally found an article which seemed to explain that line of thought.
The article noted the same Bureau of Labor Statistics Spending Survey I used data from in my original Ocala Star-Banner “Other Voices” column on the FairTax, which showed that those in the bottom income quintile tend to spend substantially more than they make. The article concluded that this was possible through the easy availability of credit (also a point I’ve made on this blog). The conclusion drawn from this fact was that poor people are better off than their incomes would indicate, and therefore, poverty should be re-defined by spending rather than income.
Is this what you meant? If not, please elaborate.
Well, another day, another revelation! By now, many of you may have tuned me out as an old man whose brain has turned to mush. However, read on and I might be able to explain that: “THE FAIRTAX IS REVENUE NEUTRAL AFTER ALL, PROVIDED A SMALL ADJUSTMENT IS MADE TO THE REVENUE SIDE TO ACCOUNT FOR INCLUDING FEDERAL CONSUMPTION IN THE BASE. THE EXCLUSIVE FAIRTAX RATE IS 26.1% AND THE INCLUSIVE RATE IS 20.7%.”
Surprised? Me too, but I just couldn’t understand where that extra $700 billion came from that Larry K was using as a revenue source to offset the inclusion of federal consumption in the tax base. Back in May of 2003, Karen Walby, Director of Research for AFFT published a White Paper
(I’ve still got a copy) that calculated what the inclusive and exclusive rates would be. I was surprised that her inclusive rate was only 19+%, but figured she might have made a mistake. Last night I finally checked several online sources for the definition of exclusive and inclusive taxes. Here are the definitions.
Exclusive tax: the tax is not part of the base when calculating the rate. Sales taxes are typical of exclusive taxes.
Inclusive tax: the taxes are included in the base for rate calculations. Income taxes are typical inclusive taxes.
If you are still with me, turn to page 18 of the Kotlikoff/BHI September 2005 Fairtax base/rate study. Using a revenue neutral amount of $2228 trillion and a taxable base of $9355 trillion, BHI correctly calculated that the rate would be 23.82%. (2228/9355 =23.82%) When converting that exclusive rate to inclusive, the tax amount must be added, not subtracted to the base. The inclusive rate therefore is 19.23%. (2228/(9355+2228=19.23%) Karen Walby got it right, and it appears that BHI made a serious error when they subtracted the taxes from the base.
One word of caution before you revel in the new, low inclusive rate of 19%. If the Fairtax plan causes the consumption base to fall, the rate will have to rise. (Remember, taxes are not included in the GDP). For instance, some Fairtaxers still believe that business costs will fall 22% per the 1997 Jorgenson study. This would reduce the taxable base to $7297T and the exclusive rate would then be 30.5%. For the rate to remain at 23.8%, costs would have to remain unchanged and prices would then rise by the full 23.8%. As I wrote earlier, pray that any reduction in costs is offset by increased economic activity, which is what most Fairtaxers believe will happen anyway.
One last point. Because there is no longer any excess revenue with which to offset the inclusion of federal government spending in the base, the rate needs to be adjusted. In order for the federal government to tax itself, $217 billion needs to be added to the revenue neutral amount for a total of $2445T. The exclusive rate would then be 26.1% and the inclusive rate would be 20.7%.
In summary, I expect to see a 26% tax added on to the merchants costs plus profit at the cash register. And if anyone still insists on saying it’s a 20% inclusive tax, be my guest. It really doesn’t matter, does it?
Hank, Equation 27 shows the rate calculation as being for the inclusive rate.
And the 913 in the denominator is “Federal Government Consumption Adjusted for Administrative Fee.”
Fred,
Which is the same thing as saying: ti = 2228/9355=23.82%. And that is an exclusive tax rate calculation, not inclusive, Fred. That is the error BHI made for reasons not clear to me. What they did was properly calculate an exclusive rate, then erroneously called it an inclusive rate, and adjusted that rate to arrive at an incorrect exclusive rate of 31.27% The inclusive rate should have been 2228/(9355 + 2228) = 2228/11583 = 19.2%. ti calculations must include the taxes, and the $9355 base does not include any taxes. BHI labeled it ti, but it should have been te. Look up “exclusive tax” on any online reference source, and you will find that I am correct.
And the adjustment for the Administrative fee is around $3 billion which has to do with the 1/4 of 1% fee, and has nothing to do with the $200+ billion in revenue that should have been added to offset the inclusion of $913B in federal consumption in the Fairtax base.
I can no longer find the rate calculation paper done by Dr Walby on the Fairtax site. But I can assure you that she got it right. Basically, a 23% exclusive tax and a 19% inclusive tax. Doesn’t the fact that when you multiply the BHI “exclusive rate” of 31.27% times the base of $9355T, and get $700 billion more than the revenue neutral amount of $2228B seem to indicate to you that something is wrong?? It did me.
The full amount of the 2228 in the numerator is not taxable. The 913 in the denominator represents taxable federal government spending (adjusted). Table 2 shows what’s included in this number.
Fred,
I don’t understand your comment. The 2228 in the numerator is the revenue neutral amount that is currently collected through income, payroll, and gift/estate taxes. And it isn’t found in Table 2, it’s in Table 3. (2288 unadjusted).
Table 2 is the taxable portion of the national GDP, and as shown, amounts to 81% of GDP, a very large percentage, never been tried anywhere else as far as I know?
Please clarify?
Fred,
A post script—are we looking at the same study? My reference is the September 1st, 2005 BHI study entitled “What Rate Works?” Just a thought on why we seem to be so far apart?
Fred,
Make that September 1, 2006. Sorry, a typo or maybe ALZ is setting in?
Sancho (aka Hank),
Welcome to the club on the 10th amendment. I’d also love to see the 17th repealed, but those are fights for other days and other blogs, I suppose. Still, I repeat my statement, which I think you may agree with, that a consumption tax implemented nationally and printed clearly on the receipt would go a long way toward waking people up to their share of the runaway cost of government.
Out of time for now.
I’m using the Tax Notes version dated November 13, 2006. The 913 in the denominator is calculated in Table 2.
I would like to take a moment to criticize the BHI paper. This paper is really hard to follow. It’s almost as if they were intentionally obfuscating. An example is the inclusion of the IRS savings. This number is so insignificant that there is no way it could affect the final rate calculation. Why include it? It’s as if they were trying to make the political point that the FairTax gets rid of the IRS.
Bill, in response to post #48, I still don’t understand how you consider the FairTax regressive. It is far from simple to calculate effective rates under the current tax code. With the Fairtax, calculating your family’s effective tax rate is so easy a caveman could do it.
A quick illustration, if you will. For purposes of equality, we’ll use a family of 4 in each case. The FairTax has been implemented with the 23% tax rate, and each hypothetical family receives a household prebate of $506 per month. Effective tax rates have been rounded up)
Family A: New goods & serv. spending- $2200/mo. (26,400/yr.)
FairTax paid- $506
Prebate- $506
Effective tax rate- 0%
Family B: New goods & serv. spending- $3K/mo. (36K/yr.)
FairTax paid- $690
Prebate- $506
Effective tax rate- 6%
Family C: New goods & serv. spending- $5K/mo. (60K/yr.)
FairTax paid- $1150
Prebate- $506
Effective tax rate- 13%
Family D: New goods & serv. spending- $16,666/mo. (200K/yr.)
FairTax paid- $3833.18
Prebate- $506
Effective tax rate- 20%
Point made, I believe. You can blather on all day about the poor paying a larger percentage of their income, the middle class paying more than that, and the wealthy paying the smallest percentage of anyone on consumption. Let me illustrate how your logic breaks down on this point:
Single guy A makes 30K per year, with 25K used just for consumption expenditures.That’s a whopping 83% of his income.
Single guy B makes 60K per year, with 55K used just for consumption expenditures. That’s an even more astonishing 91.6% of his income.
Evil filthy rich greedy corporate thug single guy C makes 500K per year, with only 80K going to consumption expenditures (fuel for the private jet and fleet of luxury cars, furniture and electronics for the 15,000 square foot McMansion, his new 150 foot yacht, etc.) Well, that is only 16% of his income! How dare this fat cat pay a smaller percentage of his income than people who are barely surviving? Look again at the numbers. Percentages mean nothing. He has put as much back into the economy as guys A & B combined (really more, since his purchases employ people who get paid very well to produce these big ticket items).
So, Bill, look at these numbers (not irrelevancies such as “percentage of income”), compare them to the facts in illustration 1, and tell me where the FairTax is regressive.
Fred, Not sure if this will be helpful or not, but Kotlikoff has an earlier version (Sep 1, 2006) published on his site, which is 34 pages (vs the 19 pages published in Tax Notes). Seems it was likely condensed for the publication. Anyway.. perhaps this version has some details that my help your research.
Morphh/Fred,
This isn’t rocket science–and it doesn’t matter which version of the study you use, the base and revenue numbers are identical–that is, $9355T for the base and $2228T for the revenue needed for revenue neutrality. The tax on 9355T must be 23.82% to raise 2228T. (2228/9355 = 23.8%) That is an exclusive tax calculation, no revenue included in the denominator. To convert that exclusive rate to inclusive, you must add the revenue to the denominator, resulting in:ti = 2228/(9355+2228) = 19.7% . And these are the rates that Karen Walby arrived at in her May 2003 study which used 2003 data but an identical process.
Someone needs to explain to my why the 2228/9355 does not result in an exclusive rate. All online references support my claim, but I’d sure appreciate some input from some of you. It is so mind blowing that a team of economic experts could have made such an error, that I’m having doubts about my sanity. But if I get some agreement, I will notify Linder that he has a real problem. And by the way, maybe he will be happy, because the new inclusive rate is only 19.7%, which is a lot better than 23.8%??
Please comment!!!
Hank, I’ll try to take a look this weekend. Stay tuned...
Morphh,
Thank you! Maybe you can get Larry K reengaged in order to explain what seems to be an error in the BHI study?
The issue is simple. All the online reference sources explain that: T-exclusive = Revenue/Consumption base. In the case of the Fairtax study, the real numbers are: Te = 2228/9355 = 23.82%. That is an exclusive rate!
To convert an exclusive rate to inclusive, the equation is: T-inclusive = Revenue/ (Consumption base + Revenue). Again, the Fairtax inclusive rate is: 2228/(9355+2228) = 19.23%.
I can find no logical reason for the BHI study team to calculate an exclusive rate, call it inclusive, and convert it to an exclusive rate of 31.3%. Makes no sense to me. Good luck!
Hank, what I’ve been trying to explain is that $913 billion of that $9,355 billion base is taxable federal government spending. That $913 billion is the “revenue included in the denominator.”
Fred,
Not exactly. Yes, there is $913B in federal government spending in the denominator, but there is no revenue in the denominator, just spending. What’s missing is the $200+B revenue offset in the numerator. Remember, there is no new net revenue created by having the federal government tax itself. On that, I think everyone agrees? So, if you want to add $913B in spending to the denominator, there must be an appropriate addition of revenue in the numerator to “balance tha books”. It is this failure to add revenue in the numerator that I think was the first mistake made in the BHI study.
Perhaps an easier way to think about this issue is to accept the fact that having the federal government tax itself creates no net revenue, which places the burden of raising $2228 in revenue on individuals and state and local governments. Remove the $913B from the denominator-it makes no difference— and the new exclusive rate calculation looks like this: T= 2228/8442 = 26.4%. Inclusive rate would be 2228/(8442+2228) = 20.9%.
Hank,
The 23.82% is inclusive if one assumes the pool of consumption spending is “capped” at $9355 - given a total available consumption pool of $9355, what tax rate will direct $2228 of that spending to the government. If one assumes the available pool of consumption dollars will expand to accomodate an additional $2228 in taxes, you’re correct that a basic error was made. When I read the study, I concluded the first assumption was used for the calculation. That seemed a more realistic approach given high consumer debt and low savings levels.
Ellen,
Good thinking, and thanks for helping this discussion along. I happen to agree with the economic experts that there will be full monetary accommodation and the dollars will be available to maintain current consumption ($9355T) and pay the tax of $2228T in addition. Wouldn’t your alternative scenario mean that the GDP would have to fall by the net amount of the tax? That won’t happen, imho.
I will agree that the consumption pool is capped at $9355 for purposes of the rate calculation, but taxes are not included in GDP so it doesn’t matter. I’ll reread the study, but I’m almost sure they assumed full monetary accomodation–that is, the money supply will expand to accomodate the taxes.
And I still maintain that when you divide the revenue by the base, you get an exclusive tax rate, not inclusive.
Hank,
On page 13 of the pdf Tax Notes paper, you’ll find a statement that the first assumption made is no monetary accommodation occurs. But, there are also statements the accommodation assumption is irrelevant and made only to simplify the rate calculation.
I don’t actually have an alternative economic scenario - I’m commenting purely on the math used in the study. To arrive at the stated rates, the $9355 base had to include the tax. Unless that was a basic error in the formula used, the only explanation I come up with is a somewhat hidden real consumption base reduction (found in the exclusive calculation). Perhaps the experts have confused themselves by the need to create an inclusive rate for what is actually an exclusive sales tax? Sorry...a bit of sarcasm.
I’ll be interested to know what actual clarification you’re able to get.
Ellen,
Right, I found those comments also. It seems to me that if there is not full monetary accommodation, all businesses in the USA will go bankrupt? There is no way they can send 30% in tax revenue off to the state/Treasury without raising their retail prices by somewhere around 15%. What I mean is that if businesses can drive 12% in costs out, then the addition of the 30% sales tax would require a 14.4% increase in retail prices in order to preserve their profit margin.
I’m hopeful that Morphh can get Larry K to respond, because clearly the BHI team hasn’t got time for our questions. Too busy?!?
Given some level of monetary accommodation, it seems to me that it would be correct to portray the rate as 23% exclusive and 19% inclusive. That has many benefits including a reduced prebate cost, less impact on retail prices, less impact on state and local governments, etc. etc. Given a choice, why wouldn’t everyone embrace lower tax rates???
Bradley
Percentages DO mean something, especially, in this case, the percentage of taxes versus income.
Let’s start with the definition of “regressive tax,” according to Ivestopedia.com (a service of Forbes, not exactly a flaming liberal or socialist institution): “A tax that takes a higher percentage from low-income people than from high-income people. A regressive tax is generally one that is applied uniformly. That means it hits lower-income individuals harder.”
Forbes uses a cigarette tax as an example: “If a person has $10 of income and must pay $1 of tax on a package of cigarettes, this represents 10% of that person’s income. However, if the person has $20 of income, this $1 tax represents only 5% of that person’s income.”
Finally, according to Forbes, “Sales taxes that apply to essentials are generally considered to be regressive as well, because expenses for food, clothing, and shelter tend to make up a higher percentage of a lower income consumer’s overall budget. In this case, even though the tax may be uniform (such as 7% sales tax), lower income consumers are more affected by it because they are less able to afford it.”
The key phrase is “lower income consumers are more affected by it because they are less able to afford it.”
That puts us onto the subject of the marginal utility of money.
Simply put, $1 means more to a poor person than to a rich person.
To a poor person one day away from payday, with no food in the refrigerator and no money left in his or her wallet or bank accounts, $1 means being able to buy something to eat for the day. To a rich person with a $5,000 refrigerator stuffed with delacacies and millions of dollars in the bank, that same $1 means nothing.
Now, let’s use your example:
Person A makes $30,000 and spends $25,000. In real numbers, he has $5,000 left to spend or save - in other words, $5,000 remaining in disposable income.
Person B makes $60,000 and spends $55,000. He also has $5,000 remaining in disposable income.
Person C makes $500,000 and spends $80,000. He has $420,000 - 42 times more than Persons A and B combined - in disposable income to save, spend, invest, whatever.
Now let’s add Persons D & E, to illustrate where your example breaks down.
Person D is someone closer to my situation. He makes $15,000, and spends the same percentage of his income - 91.6% - as Person B in your example. That’s $13,740. But that leaves him with only $1,260 in disposable income.
Person E is another (to use your words, not mine) “fat cat” who makes $500,000. But he’s also a big spender, and spends the same percentage of his income - 91.6% - as Persons B and D. That means he’s spent $458,000. But he’s still got $42,000 in disposable income left. That’s 2.8 times more than the TOTAL Person D earned.
Which brings us back to the marginal utility of money.
Person E’s Bentley Continental breaks down, and the repair bill comes to $2,000. No big deal. He can either spend the two grand, or just use another of his cars to get around.
But if Person D’s car breaks down, and the repair bill also comes to $2,000, he’s walking (or, more likely, he has to go into debt to get it fixed so he can get to work).
It’s certainly true, as you point out, that the rich person in your example has put more back into the economy (and paid more in FairTax) in real dollars than the other two people combined. But the inverse is also true: He has more money LEFT after making his purchases and paying his taxes than the other two combined as well.
As for your point that the rich person’s spending helps the economy as a whole, that’s another place where reality doesn’t bear you out. Look at the examples you gave: Fuel for the private jet and fleet of luxury cars, furniture and electronics for the 15,000 square-foot McMansion, his new 150-ft. yacht, etc. The fuel MIGHT have been refined here by relatively well-paid workers. But the people transporting and selling the fuel are probably struggling. The private jet MIGHT have been built in the U.S. by relatively well-paid people, and certainly the broker who sold it is well-paid. Same with the yacht. But those jobs aren’t going to make a significant dent in the economy, because the labor pool for private jet and yacht-building and selling is relatively small (and the jet and yacht are just as likely to be imported as domestically produced). The furniture for the McMansion was very likely imported, and the electronics almost certainly were. And the McMansion was, statistically, very likely built by poorly-paid illegal immigrants.
So how much, REALLY, has Person C contributed to the health of our economy.
You use the phrase “Evil filthy rich greedy corporate thug,” to imply that I believe all rich people are evil, greedy thugs. I don’t believe that at all. I’ve said it before and I’ll say it again: I admire entrepreneurs who start with nothing but a good idea and turn it into a thriving business. Nor do I begrudge rich people their wealth, or the toys that go with it. I do wish they’d stop complaining - while they’re sitting next to their $1 million swimming pool knocking back a $400 bottle of cognac on the $500,000 Italian marble patio behind their $5 million home - about how overtaxed they are. But other than that, I bear the rich no ill will.
However, I will maintain that the concentration of wealth in the hands of a few is not healthy for our country. Despite the insistence by you and others on this blog that the rich help everyone by investing in the creation of jobs, statistics show that far fewer new jobs have been created in this country since Ronald Reagan made the first large-scale implementation of supply-side economics, and the jobs that ARE being created don’t pay nearly as well as the jobs that existed before the Reagan era (even Clinton, who led every other administration since Reagan in job creation, presided largely over the creation of low-paying service jobs). What that means is that the majority of people in this country are seeing their standard of living eroded. I see that as a problem. And the problem ISN’T that rich people and corporations are being overtaxed. The problem is that the acquisition of wealth by individuals and the acquisition of profits by corporations have become ends in themselves, rather than the MEANS to the end of driving the economy as a whole forward.
And a regressive tax won’t make that situation better, IMHO.
Typo:
That should be “Investipedia.com” in my second paragraph, “Ivestipedia.” Sorry. For those wanting to check out the definition to make sure I took nothing out of context, the URL is http://www.investopedia.com/terms/r/regressivetax.asp
Good post, Bill.
Something tells me, by the way, that you make far more than $20,000 per year. You’re either a graduate student, semi-retired, doing an internship, taking a sabattical or something. Whatever it is, you ain’t stocking shelves at Wal-Mart.
Now, I spent most of my 20’s bumming around in low-paying jobs, mainly becasue that was a way to see the country (and the world) without getting too tied down to anything before I was ready to settle down. Maybe you’re doing something similar.
I’d love to hear the real story.
Actually, this has reminded me about something. When I used to hang out in Central America, there were a number of folks (usually ex-hippies who had done a few too many acid trips) who lived down there with no apparent source of income. It turns out they were getting SSI payments, which was payments the government would make to citizens who were either disabled or too f**ked up to hold a job. “Crazy money,” is what these guys called it. It wasn’t enough pay rent in the States, but in Central America they could live pretty well. So they were actually crazy like a fox, as they say.
With the “pre-bate,” I guarantee that you’ll see mobs of Americans hanging out in Central America, Asia, Africa — whereever the cost of living is cheap — living FairTax free and using their pre-bate checks every month on locally produced booze and recreational drugs.
If we passed the FairTax, I wonder how long it would take the Neal Boortz’s of the world to be screaming in the microphone everyday — “We’ve got to end the pre-bate!” Not more than five minutes, but my estimation.
Hank,
I believe the $9T contains all costs needed to arrive at the prices of the products contained in the consumption base. This includes the embedded tax. If the assumption remains that all prices remain constant (which is an okay assumption because estimates up or down cannot bound the error any more than staying the same will), the question is how much of every dollar spent in the $9T needs to go to the government. That is found simply by the equation Revenue/Consumption. The rate is inclusive because they are assuming that for every dollar spent a certain percentage of that dollar must go to the government. Exclusive could be defined as for every dollar spent a certain percentage in addition to that dollar must go to the government. I think its been discussed before that prices will stay exactly the same post tax (based on retail prices falling due to the embedded tax), go up fully based on the fair tax amount, or most likely be somewhere in between. I think we agree the in between point will mostly be based on the wage market.
In addition, I do believe the $9T already includes the $2T in government revenue, but more accurately includes the $2T in government revenue and deficit spending. As I showed before, government taxing itself does alter the tax rate, but only because of deficit spending. Maybe it’s also worth mentioning that the $2T includes the embedded taxes, as well.
Maybe I am misunderstanding your point Hank. Are you saying that the $2T our government spent wasn’t used to consume $2T that our nation produced, i.e. the $2T is not part of GDP?
Bill, Here are the approx. effective rates for the groups you outlined (minus the possible prebate error discussed in a prior thread). Assuming they are each a single adult.
Person A makes $30,000 and spends $25,000... 0% with $5000 tax deferred
Person B makes $60,000 and spends $55,000... 12% with $5000 tax deferred
Person C makes $500,000 and spends $80,000... 16% with $420,000 tax deferred
Person D makes $15,000 and spends $15,000... (-20%) negative rate - receives more in prebate then taxed
Person E makes $500,000 and spends $500,000... 21%
So it may not matter that you are taxed on 100% of your income if you have a negative (-20%) effective rate. Hank has a real issue with this as you’re not paying into social security, in fact the government is paying you. This oddy in percentage comes by applying a strict income tax definition to a consumption tax. Now, as I said previously, what makes this definition regressive is the ability to save and invest before taxation, which is extremely beneficial to the economy. A booming economy is good for all. More people have been lifted out of poverty from a productive economy than any government program. When that money is used for consumption (to by the “$1 million swimming pool knocking back a $400 bottle of cognac on the $500,000 Italian marble patio behind their $5 million home”) like person E, they will pay the tax. In example C, which is the most regressive on income of the examples, the money is working for the country while they live moderately (saving for retirement, a down-payment, etc).
What we’re really talking about is the ability to pay and economic well-being, not twisted definitions on what is “regressive”. Does the tax hurt the poor? What is the difference in income and consumption regarding economic equality? What is a better measure of ability to pay? Does it make sense to tax savings and investment? How does this effect me (regarding my ability to save and live) over one year, five years, retirement? Some of these will very on lifestyle choices.
You might be suprised to know what is happening (on average) at the low end of the income distribution. There are a number of people who report negligible incomes yet are spending very substantial amounts. Some of these people may have suffered capital losses; or be farmers who had a bad year. But it is hard to argue that these people are, by dint of low reported incomes, necessarily poor in any fundamental sense. Point is, using some limited single term to describe something “bad” has little value in analyzing a real burden, effect, and comparison.
Andrew,
Thanks for weighing in on this issue that tends to give me a headache.
All online dictionaries basically define exclusive tax rates as those where the taxes are not part of the base, while inclusive tax rates do include taxes in the base.
There are no taxes contained in the base (denominator) of $9355T by definition because according to both Gale and Kotlikoff, the GDP does not include taxes. Therefore, when you divide the revenue (numerator) of $2228 by the base of $9355, you get an exclusive rate of 23.8%, not inclusive. The inclusive rate is found by this equation: Ti = R/(C+R) or 2228/(9355+2228) = 19.23%.
The only caveat to this argument is that the money supply may have to expand in order to allow prices to rise. Otherwise, retail merchants may find it impossible to send the tax revenue off to Washington and still preserve their profit margins.
To follow this up a bit more, lets assume the 23.8% is inclusive and the exclusive rate would then be 31.3%. For years, we all have been saying that the retailer will tack on the exclusive rate to their cost plus profit to arrive at the sales price at the register. This is confirmed by AFFT in their FAQ (4th from the last) where it clearly says that the merchant will add 30%(31.3%). If you tax the spending base of $9355T by 31.3%, you will generate $2928T in tax revenue, $700 billion more than the revenue neutral amount that was needed. So, the Fairtax certainly wouldn’t be revenue neutral in that case , would it?
My bottom line is that the retail businesses should add 23.8% to their cost plus profit, which will generate the revenue neutral amount needed of $2228T on the base of $9355T. The inclusive rate of 19.23% can be used for marketing purposes if you choose to. Sounds a lot better than 23.8%. And consider the impact of the lower rates when calculating the cost of the prebate, the amount of the implicit tax, the impact on state and local governments, etc. etc.
My headache is going away, and I don’t even support the Fairtax?
Hank, I’m going to put together an e-mail for Kotlikoff, Walby, and BHI stating some of the questions that we have. I’ll look through the thread and put together some questions. Perhaps I’ll then post a pre-email to the board as a new post (for group review) to make sure it sounds good and make sure we have the main questions. I probably should have started a new thread on this a while ago since we’ve gotten way off topic here but I’ll let the current thread get noticed first and then post a new one for this discussion. I want to address the points in the e-mail but don’t want to make it too long. I’d like to hit the main questions regading percieved errors or confusion.
Morphh,
Great approach, and perhaps having more members approval of your email will get better results? I’ve tried all three with the basic question, but got no response. And rather than get the word “error” into your email, I sort of think we should address our confusion and inquire as to their rationale for calling an exclusive tax inclusive? In the case of Karen Walby, let me stress that her original rate calculation in May 2003 resulted in 19% inclusive and 23% exclusive rates. I’d like to know why she changed her mind, which I guess she did because Karen spent the greater part of 2005 in Boston helping Larry and BHI accomplish the study. Her response could be the most educational, at least for me.