Redefining Regressive?
At the end of this post, the discussion turned to the definition of “regressive” in the context of taxation. I thought this discussion should be promoted to its own topic because, even though it may have been discussed before, it is worth reviewing from time to time. In a culture centered on income taxation, the use of the term “regressive” gets pretty loose.
I have always understood the measurement for determining tax proportion as dividing a tax by its base. If that proportion decreases as the base increases, it is known as “regressive”. If it increases, it is known as “progressive”. If it stays the same, it is known as “flat”.
So, for our current income based system, one’s rate is tax / income. In our current system, if one’s base (income) increases, does the tax rate? Yes. So it is progressive.
Prebates aside, for the FairTax, one’s rate is tax / consumption. In this system, if one’s base (consumption) increases does the rate increase? No. Does it decrease? No. Does it stay the same? Yes, 23% inclusive – no matter what you spend. So it is flat.
Now throw in the prebate. The prebate is a fixed value by which everyone’s tax is reduced. Because the prebate value is fixed (that is, it does not increase or decrease based on the amount of consumption), it ends up being a larger percentage of the tax paid as the tax paid goes down. Because of this, after the prebate, the tax rate increases as the base increases. This makes the FairTax progressive.
So, how is it then that so many people casually refer to the FairTax as the exact opposite? How can something that is progressive be so commonly referred to as regressive without being challenged?
The reason is that in the calculation for rate, the variable for the base is switched with income. So instead of the rate being calculated as tax / base, the calculation is changed to tax / income. Of course, this is fine if the base is income.
But the base for the FairTax is not income – it is consumption. So the math has been changed. The implication is, no matter what is taxed or how it is taxed, when all is said and done we have to divide the final tax paid by income to determine the tax rate.
In other words, we have to marshal the FairTax back into being an income tax.
I wish that arguments for the FairTax would expose this issue more often and refuse to allow the discussion to be framed in this way. Aside from the fact that math should not be twisted for ideological purposes, converting the FairTax back to an income tax undercuts the foundation of a consumption based model which is that the rich are those that spend a lot – not those that make a lot.
The confusion arises because some people believe that money has inherent utility. They envision extremely rich people as some sort of Scrooge McDuck, diving into their vault and swimming around in heaping piles of gold coins.
If you go to dictionary.com, one definition from the dictionary.com source says “noting or pertaining to a form of taxation in which the rate increases with certain increases in taxable income.†Another definition from the American Heritage Dictionary source says “Increasing in rate as the taxable amount increases: a progressive income tax.†One of these believes income is part of the definition while the other believes income is just one type of progressive tax. If the dictionaries don’t have a consensus, it’s probably going to be difficult for us to get one.
But here is my two cents. I think a progressive tax is any tax that progressives, socialists, collectivists believe is “fairâ€. Regressive taxes, on the other hand, are anything that they deem “unfairâ€. After all, “progress†to them is defined as moving all decisions one will make in life to a central authority. Personally, that’s what I thought America’s founders were trying to get away from.
You can tell the dictionary.com definition is strictly income based since they state it increases with “taxable income”. This only applies under an income tax, since no income is taxable under a consumption tax.
I’ll take a stab at explaining why describing the FairTax as progressive is difficult.
With progressive taxes, the tax rate applied goes up as the taxable base increases. The key word is “taxable” – taxes aren’t levied against nontaxable dollars.
The FairTax prebate provides $X amount of nontaxable spending. That simply reduces the taxable spending base against which the tax will be applied. It doesn’t create lower or higher tax rates to be levied against that taxable spending base. The same FairTax rate is applied to Person A with taxable spending of $25,000 and to Person B with taxable spending of $150,000. The prebate doesn’t make the tax progressive. Nor does the fact that Person B pays more in tax dollars. The FairTax is still best described as a flat tax.
Ellen,
I would agree that the FairTax is fundamentally flat. After all, there is only one rate. The problem is, to have multiple rates, you would have to have the consumer track and report his consumption. Clearly this would breach the wall that the FairTax places between the government and the taxpayer which, for many, is one of its most attractive features.
Now, the prebate can be spun and accounted for any you want – but the bottomline is that it results in less taxes paid. And because it (the prebate) is also a flat rate, the result is an effective tax that is progressive while the compliance cost is very low and taxpayers retain freedom from the government.
Ellen, most flat taxes, implemented as well as proposed, are considered progressive as they exempt a certain level of income. Exemptions in the tax base are included when estimating progressivity. I would argue that the base is not reduced so much as a portion of it is taxed at 0%. They effectively creates two marginal rates (the first being 0%). So while they’re often called flat taxes, they are not true proportional taxes, they’re progressive. It seems you’re thinking in terms of a single marginal or statutory rate, but the effective tax rate is the more common measure of a tax system’s progressivity. The effective rate includes tax offsets defined in the code, which in this case is the prebate.
Morphh -
Regarding dictionary.com, I believe you are correct. Most definitions that I’ve seen that use income as the denominator are also assuming that income is the base. This makes the definition correct, albeit narrow.
Andrew -
I don’t believe that the definition for regressive/flat/progressive is an issue of consensus or opinion. I am sure there is a formal term, but it is a matter of math and it transcends taxation. If A = B * C, then C = A / B. I’m not sure how subjectivity can enter into something that simple.
How can we, as a matter of consensus or opinion, arbirtrarily say that C = A / D? Where did D come from? What does D have to do with anything? In this case, I believe there is a cultural and emotional preoccupation with D. But that doesn’t mean the math changes.
Mark,
The fact that the prebate is a flat rate and results in less taxes paid doesn’t turn the FairTax from flat to progressive. ( Applying the concept in both definitions provided by Andrew.) For comparison purposes, the prebate is no different than the income tax personal exemption or standard deduction: the taxpayer doesn’t pay income tax on exemptions/deductions and a taxpayer wouldn’t pay tax on the spending covered by the prebate. It isn’t spin to state that the prebate is designed to reduce the taxable base or that a tax rate is tax / taxable base. The taxable base could be income or consumption – it doesn’t matter.
You correctly point out the problem with designing a consumption tax that could be considered progressive. This topic isn’t really about “redefining regressive”, it’s about redefining tax rate. I don’t have a problem with doing that as long as the same defintion is applied to all tax plans for comparison purposes.
As we all know, some cultures have changed scientific and mathmatical definitions to align their outcomes with things like emotion, morality or religion – and looking at history, it is a practice that usually doesn’t turn out well
Ellen,
First, let me note that my post #9 was not a response to your #8 but a tag onto my #7. You’re #8 snuck in while I was drafting.
Regarding the prebate, I don’t agree that it is the same as an exemption or deduction in the current code. Existing exemptions and deductions reduce the base. The prebate reduces the tax directly. I believe that the counterpart for the prebate in the existing system would be the tax credit.
But no matter how you classify it, the net transfers between me and the treasury would seem to be the tax paid – so I guess I have a hard time seeing why that needs any more massaging or defining.
Mark,
As far as I could gather, progressive/regressive are complete political terms, i.e they are not math terms. That is where the subjectivity comes from. Technically, math terms could also have subjectivity, but they tend be well-defined. For instance, if you say arithmetic or geometric series there won’t be alot of argument as to what that means.
However, even if there was a mathematical definition for some sort of progressive series, I think when you call it a progressive tax, the subjectivity will return based on the numbers one wishes to use for the series, e.g. income only in the denominator, the data that’s the basis for the tax, etc.
Mark,
I agree that progressivity is generally best measured by the rate actually paid, not a marginal tax code rate. It doesn’t matter to me what label is put on a tax plan – I care about consistency in application. I also agree with Andrew that progressive is a term subject to personal opinion. Here’s an example that might get at both issues:
Let’s say the yearly tax exempt spending is $13,000 for a one adult with child household (A), $20,000 for a two adult couple (B) and the FairTax rate is 23%. Note that I use the term tax exempt spending instead of prebate because the prebate is consistently referred to as “tax free” or “untaxed” spending. The nontaxable spending amount in my scenario is simply the yearly tax exempt amount divided by 12. Both households earn and spend $2000/month – above poverty level consumption but not rich.
Household A: $917 in taxable spending; $1083 in nontaxable. Total tax paid is $211.The taxable spending rate is, of course, 23%. On total spending, the rate is 10.5%. The prebate was $249.
Household B: $333 taxable and $1667 nontaxable spending. Total tax paid is $77. On taxable spending, the rate is the same 23%. On total spending, the rate is 3.9%. The prebate was $383.
The tax rates are identical based on taxable spending. The effective tax rate on identical total spending and family size is significantly higher for Household A. Does this result reflect a progressive consumption tax? Given identical spending but a different family makeup (adult couple vs adult with child), is the result reflective of your comment #9?
Ellen,
I am not entirely sure what you are getting at. But that is not necessarily because you aren’t explaining it well – its quite possibly me not understanding.
First off, to run your example myself, I used the 2008 prebate table and got slightly different numbers – but bottomline the same model. Family A has a $14,000 allowance and a $3,220 prebate. Family B has a $20,800 allowance and $4,784 prebate.
Similar to your results, my results for effective tax were 9.58% on A and 3.07% on B.
Now, before we get into your scenario, let me clarify my statements above that used the prebate to show progressivity. When I referred to the prebate as being a fixed rate, I was keeping the prebate category the same from consumer to consumer but increasing consumption. In other words, take 4 families at the 1 adult, 1 child category with monthly consumption of $2,000, $4,000, $8,000 and $16,000 and you get effective rates of 9.58%, 16.29%, 19.65% and 21.32% respectively.
That is the progressivity I was referring to. You may have already understood this – but I just wanted to clarify.
Now you are exploring the effect of switching the axes by keeping the consumption fixed and moving between prebate categories. And what you found is that A is getting hit harder than B. It looks to me like that is the case because they are spending significantly more over their prebate allowance than family B.
And to me, that is how I would expect the model to work. If you are getting prebated at $14k but spending $24k, then you should expect the rate to go up. On the other hand, if you are being prebated at $20,800 and spending $24k, you would expect an increase, but much milder than the other case because you are not nearly as far over your prebate.
So this is where I don’t understand where you are going. What is wrong with this picture? It looks right to me. Is it a value judgment that maybe two adults should be prebated less than 1 adult with child instead of the other way round? Again, if I am being dense, I apologize in advance.
Mark,
I thought it would be interesting to test the progressive concept using like-sized families. I’m still using 2007 figures; but, the 2008 figures you give are consistent. Here’s what I take from that -
The prebate is based on HHS poverty guidelines which are derived from census bureau poverty thresholds. The 2 person family poverty level figures are:
1 adult/1child household: Census bureau – $14,291; HHS – $13,690; Prebate: – $13,690
2 adult household: Census bureau – $13,884; HHS – $13,690;
Prebate – $20,420
The lower effective rate for Household B is due to the significantly inflated spending allocation given a “couple”. The logic(?) behind that is to avoid the marriage penalty. Given a single rate tax and no HHS spending difference for couples, there is no spending penalty for marriage. Instead of avoiding a disparity, the prebate creates one. One additional bit of data: the 1 adult/2 child household HHS spending guideline and prebate are $17,170. Despite higher spending guidelines, that 3 person family receives a lower prebate than a couple.
Even without consensus on definitions, here’s my conclusion:
The FairTax with prebate creates “couples” spending brackets that are unsupported by census bureau or HHS data. A tool useful in the multi-bracket income tax, marriage status, impacts prebate amounts within identical HHS spending guideline brackets. Because of that it’s reasonable to argue the FairTax has a regressive component – the one adult family is allocated significantly less tax-free spending than the 2 adult family with identical or lower spending guidelines.
It’s likely that’s a political decision rather than a value judgment. It’s certainly not an economic decision based on the data.
Ellen,
You might have added that in America, the definition of the poverty level is not an income level necessary for subsistance living, but is defined as “income necessary to provide an adequate standard of living”. Big difference!! In addition, the HHS poverty level income does not include food stamps, housing assistance, EITC, Medicaid, or school lunches. When you add in the 30% upward revision made by AFFT to somehow remove the marriage penalty, poverty in the USA is not all that grim. I’ve flown all over the world during my Air Force career, and if you want to see real poverty, try going to Bombay or Calcutta. Makes one wonder if there is a Supreme Being?
Frankly, I still think a targeted prebate makes much better sense than mailing checks to everyone. Maybe Bill Gates won’t cash his monthly check???
Ellen,
Good point. There are way too many moving parts in the prebate table – looks like an invitation for politics. Seems like a fixed amount per person would be more consistent with the rest of the system.
I’m veering way off the original post but here goes.
Hank,
I’d also rather see a targeted prebate. That requires a basis for determining who gets the prebate. There’s no yearly tax return to file. There’s no reporting of any income, spending or taxes paid. There is a record of Social Security earnings and benefits paid but not all income is reported. How does the prebate get targeted? Particularly in those states without an income tax – they don’t have data to ship off to the prebate administrators.
A fine but important point: the HHS poverty guidelines are spending levels: cost of the USDA economy food plan times 3 equals spending for an “adequate standard of living”. Even with the FairTax, income has to be used to determine eligibility for assistance. EITC goes away so that’s no problem. A solution might be to combine all the available assistance pools into one (per state?) to ensure the total spending assistance given to a family allows it to meet, but not exceed, the applicable HHS guideline. The HHS guidelines don’t include tax so the calculated spending capacity wouldn’t either – the prebate takes care of the tax.
Mark
I don’t like a universal prebate to start with; but, if there is one, a fixed amount per person beats artificially inflating the prebate based on a fictional “problem”. I see two areas ripe for political examination: exempting specific goods from taxation and creating additional prebate tables based on geographic cost of living.
I may be way off base here, but I was under the impression that HHS coordinates their data with the census bureau as a means of factoring in geographical cost of living discrepancies before finalizing the poverty numbers. But a fixed per-person amount for the prebate makes more sense for sure. A single person with one child getting a smaller prebate than a married couple with no kids sounds too much like legislating morality for my taste.
How is that legislating morality? What’s the moral? They believe that an adult cost more (they have to purchase the roof, transportation, more food, etc.).
Regarding number 20: “they” might believe an adult costs more but the data doesn’t support that. As I demonstrated in post 15, the census bureau data supports the opposite conclusion for the sample family. I agree it wasn’t about morality. It was either due to ignorance or politics. I picked politics as the reason.
I can see your point to a certain extent, Morphh. But the roof over head costs just as much whether the second person is an adult or a child. I also don’t know many adults who require over $1000 a year in diapers, have regular vaccinations, emergency room visits, and outgrow shoes and clothes 2-3 times a year. I can see a single parent of one child spending at least as much as two adults on basic consumption on an annual basis, if not more. So, as I said, it seems that two people, regardless of age or marital status, should receive a two-person prebate. The discrepancy seems to give preferential treatment to those who have chosen marriage, which to me equates to legislating morality. Not trying to be intentionally obtuse here, just speaking from my experience of 3-plus years as a single father.
And just to reiterate, I am behind the FairTax 100%. I have served as a grassroots Community Coordinator here in Virginia for over 3 years now. I just happen to agree with some of the more enthusiastic dissenters here on the prebate discrepancy issue. Again, this is in no way meant to imply that I oppose the FairTax, but as some have pointed out, there are some issues regarding the minutia that need to be resolved. I believe these will be ironed out in the House of Reps, but we need to continue educating the population about the idea before we can even get to that point. Boortz and Linder have stated numerous times that the FairTax is not perfect, and are open to suggestions for improvement. This is one I would submit to that list.
Brad, there is no difference between two single adults and two married adults for the prebate, they both receive the same amount. Marriage has nothing to do with it. Mother and Father both get an adult rebate – maybe it’s a child support issue at that point. While certainly a child can cost a lot, there must be an adult first, who has the full prebate. An adult may or may not be on their own – a child can not be. There must first be some basic needs that only an adult can provide, and then a child adds to those needs. You’re correct that in many cases two adults may not cost any more then an adult and child. Perhaps they just don’t want to create another EITC incentive to pump out babies for taxpayer dollars. Perhaps the child credit needs to be adjusted, I’m not against it, I’m just confused on how it is legislating morality. There is not advantage or penalty for marriage.
Ellen, it looks like the prebate can be done on a state level. Alaska and Hawaii have different poverty levels and different FairTax rebates.
Morphh,
Yes..I saw the separate prebate tables for Alaska and Hawaii. The census bureau and HHS data for those two states are the basis for the differrent prebate amounts.
One other comment on the “marriage bonus”, I wouldn’t have a problem with it if it weren’t totally inconsistent with both census and HHS spending data. And if it were actually based on the type of logic you’re presenting. However, there is no distinction made between an infant, small child or teenager. It’s difficult to argue that a 17year old “child” in a single parent houeshold costs significantly less than a 21 year old spouse or roommate. This appears to me to be a major and expensive flaw in the prebate. I’m not saying we ought to give the one adult family side of the tables more in prebate; I’m saying we ought to get rid of an arbitrary “bonus” that doesn’t have merit under a single rate spending tax.
What bonus are you speaking about? The difference between children and adults? There is no bonus for being married (vs two non-related single adults). I believe that if the 21 year old was still living with his/her parents, they would only get the child rate (like the 17 yo).
If I could throw in my two cents, if a couple gets more money for being unmarried (that is two single adult rebates) vs. being married (some sort of rebate reduction based on the assumption that a married couple lives together) there will be a financial incentive to remain unmarried. It’s existence is not arguable, maybe it’s negligibility may be. However, an unmarried couple would recieve more money than a married couple.
On the other hand, the higher you make the child rebate, the more incentive there is to have children. I agree with Morph’s point that a child will always be with an adult, so the assumption that some basic needs, like housing, will already be taken care of.
Andrew, no one is advocating that two single people receive a greater prebate than a married couple. I’m simply saying that the prebate should take into account some of the expenses relative to children that may not necessarily apply to adults. Ellen raises a good point about age, as well. If the qualification for the adult prebate is an age such as 18 or 21, isn’t it unreasonable at best to conclude that, because someone is a year younger, the prebate amount should be considerably lower?
As far as your assertion that a higher child prebate will incentivize people to have more children, this is asinine. More children = more exemptions under our current tax code. This has helped out many people on the lower end of the income scale where I was, not too many years ago. While I have heard people jokingly refer to their child as “my little tax deduction,” the exemption was a consequence of the child being there, not the impetus for it. This is akin to saying that people give to charity for the tax deduction. While the deduction is nice, the fact is that they give because they want to, just as they have children because they want to start a family. For whatever miserable individuals are out there who might have more children for some perceived monetary benefit, there are plenty of government programs already in existence to enable them to do so. The FairTax does not address this one way or the other, nor should it, IMO.
Morphh, I stand corrected on the morality issue. I did not see where two single adults were specified as a household in the 2007 prebate chart I was looking at. If these numbers are the same whether married or unmarried, as you say, then I apologize for my ignorance of that fact. I still maintain, however, that it makes little sense for a single adult with 7 children to receive a few more monthly prebate dollars than a married couple with 4 children. Do the children of single parents somehow require less nourishment, shabbier clothes, or a smaller house than a smaller family unit simply because the parent in that house is unwed?
I can’t see the logic in this, and I’m trying very hard.
Bradley,
I don’t believe the Fair Tax Act specifies an age for an adult (18 or 21). If they are not the primary parent(s) in the household, then they are dependents (if related). I’m not sure we should think of it as a child credit but just a family allowance based on size. The dependent could be 8 or 80. There is a point of diminishing costs. A family of one requires more per person to live then a family of two, three, four. Each person on average decreased the per person costs as they share resources. If a child moves out on their own, then they are a household to themselves and receive the full amount. Two single adults will each get the full amount and when two adults are married, they enjoy the same amount – no penalty.
It takes two adults to have a child. Now at some point a parent could leave or pass away, but this is an issue of child support (since the other parent receives a full prebate), life insurance (preparing for a loss of income due to family death), or some other method outside the tax code. So I’m not sure why one would have shabbier clothes or less nourishment. Two parents living together in marriage or two parents being split up seems to be a personal issue that the tax code should not play a part in. Could the child rebate be more? – Sure.. It is likely an arbitrary calculation that could be increased. But based on what your saying, I see only two solutions – There should either be a marriage penalty or dependents should get the same rate as parents. I don’t see either as being something I’d support.
After reading some of the comments about the “marriage bonus”, I’ve had to slightly re-think my position that it has no merit. It does have merit if one is willing to ignore the stated purpose for including a prebate in the FairTax plan: cover the tax associated with purchasing taxable necessities (shelter, food, utilities, clothing etc.) up to household poverty level. A little data: 2007 census bureau poverty spending: $10, 787 for one adult , $13,884 for two adult and $16,218 for three adult households. Per person that’s $10,787, $6942 and $5406.
No surprise, the data show combining individual adult households reduces per person taxable spending for necessities. The prebate doesn’t reflect that.
Unrelated adults sharing household expenses will each receive, as far as I can tell, the same prebate as a one adult household. Either someone forgot the prebate is supposed to be based on taxable poverty level spending needs and/or nobody thought of a method to identify households shared by unrelated adults. In either case, inflating the prebate for some individuals ensures inequity in the tax plan and is the basis for “marriage penalty” fix. If two unrelated individuals sharing household costs each receive the one adult prebate amount, you can’t deny that break to a married couple. Those not getting an inflated prebate are single parent families and one adult households. I’m not sure if related adults (grandparents, siblings, adult children etc.) living in one household will also receive their own personal one adult prebate. My position is that the marriage penalty could be eliminated by creating prebate tables that apply the cost savings for multiple adults sharing a household.
Instead it seems the prebate tables might be designed to give all adults a flat “personal tax exemption”. If so, it seems contradictory to the underlying reason for the prebate; but, it’s consistent with keeping it as uncomplicated as possible. I, for one, would rather see a prebate that treats taxpayers equitably, based on spending data, than one that fits in as little space as possible.
Ellen, I think you are incorrect regarding unrelated adults. See Chapter 3, Sec 301(b)(1) of the Fair Tax Act. Two single adults living together would each receive the rate for a single household ($2,392) for a total of $4784. Two married adults would receive $4784. If other dependents live in the household (grandparents, siblings, adult children etc.), they would get the dependent rate. What it looks like they did was treat the dependents as additional adults in the household (looking at the 2007 census bureau poverty spending). So a single adult has a $10,000 allowance and $14,000 allowance with 1 dependent. The did treat each adult as having a $10,000 allowance, unless that adult is living with family (minus married couples as not to create a penalty).
To further expand on the explanation to Bradley. A married couple with two kids would receive $6,440 a year. A single parent household with two kids would receive $4,048, but the other parent would receive the other $2,392.
What if there is no other parent, like the widow/er in Hank’s (ridiculously lowball income) example in another thread? I’m mostly playing devil’s advocate at this point.
Brad, As I said above in post 30, I expect this would fall to life insurance or some other method of personal action to make a family whole after the loss of a family member (and their income). Perhaps not the perfect solution
Bradley,
You state that “For whatever miserable individuals are out there who might have more children for some perceived monetary benefit, there are plenty of government programs already in existence to enable them to do so.†Is your point that adding one more monetary incentive makes no difference? I think that some miserable individuals who think it’s not worth the current monetary benefit, might be pushed over the edge once the child prebate is added on.
Morphh,
I think we’re saying the same thing in a different way: two unrelated adults sharing a household each receive the single adult prebate amount. So as a household, they get double the single adult amount. Hence the need to give the same “break” to a married couple.
Because of the way the prebate tables are built, I honestly don’t know if a related adult household member is treated as a “child” or not. I didn’t see that confirmed in any section of the bill. The HHS data is the basis for the prebate calculation and it doesn’t distinguish by age so that might be true. To me, it’s open to interpretation – not a good situation.
That reinforces my consistency question: given the HHS data threshold is number of people in the household, why would two unrelated adults sharing a household receive double the one adult prebate amount? Why exacerbate that by crying “marriage penalty” when one doesn’t exist based on spending and “fix” it by doubling that prebate as well? This all costs money!
Those questions actually belong in the “is the prebate too complex” topic.
Ellen, just to clarify.., which I think we’re saying the same thing.. If two adults are unrelated, they are two households (not one), just sharing a residence. A married couple is one household with the couple rate (two adults), which receives the same amount as two unrealted adults.
A related adult that is not the spouse in the household is considered a dependent. See Chapter 3 Sec 302b
`(1) IN GENERAL- To determine the size of a qualified family for purposes of this chapter, family members shall mean–
`(A) an individual,
`(B) the individual’s spouse,
`(C) all lineal ancestors and descendants of said individual (and such individual’s spouse),
`(D) all legally adopted children of such individual (and such individual’s spouse), and
`(E) all children under legal guardianship of such individual (or such individual’s spouse).
You could also have the two non-related adults, having a child each (sharing a residence), which whould be two households each having one adult and one dependent. This would be the same rate as married with two dependents.
Morphh,
I agree your explanation in post 37 gives the most probable interpretation of how the prebate is being allocated. Your example of 2 non-related adults each having a child and sharing a common residence receiving the same $6440 prebate as a couple with two children is not comforting. That’s equates to a yearly “allowance” of $28,000 in spending yet HHS data shows a 4 person household or family requires $21,200 in spending. Let me do a sanity check using 3 person households. The HHS data – 3 person household or family spending figure is $17,600. The FairTax provides for:
3 non-related adults – allowance is $31,200; prebate is $7176 – $2392 per person
Couple/1 child – allowance is $24,400; prebate is $5612 – $1871 per person
Adult/2 children – allowance $17,600: prebate is $4048 – $1349 per person
Adult/2 elderly parents – allowance $17,600; prebate is $4048 – $1349 per person
( I spy a “senior citizen penalty”!)
So far I haven’t gotten an explanation of why the prebate amounts are based on the faulty premise that household expenses are only reduced if all the members are related. Everyone participating in this discussion knows sharing shelter, utility, food and other common household expenses reduces the cost per person regardless of whether those sharing the expenses are related. Were those writing the bill unaware of that fact?
I realize I’m late in responding to Mark’s original post here (and on the other post from April 5 in which he argues that income is irrelevant in discussing the merits of the FairTax), but sometimes he says things that are so outlandish I wonder if he really believes them.
FairTax proponents can redefine “progressive” if they wish, just as they can make up new ways to calculate sales tax rates (i.e. “tax-inclusive”), but it doesn’t alter the basic point of critics of the FairTax, which is that the burden of the FairTax falls hardest on middle-income families who need to spend a higher percentage of their incomes on goods and services just to keep their heads above water than do high-income families.
I believe the efforts to redefine the terms “progressive” or “regressive” fall in the same category as referring to the rate as “tax-inclusive” and claiming that people will “keep 100% of their paychecks.” These are just attempts to hide the ball so that the masses of the people who hear about the FairTax won’t realize that their pockets will be the ones that’ll be picked if this proposal ever comes to fruition.
Hayden,
I don’t see any similarity between the “inclusive”, “exclusive” issue and the “regressive”, “progressive” issue.
Inclusive and exclusive are expressions that use the same components:
Exclusive Rate = Tax / Base
Inclusive Rate = Tax / (Base + Tax)
Note that the same 2 components are used in each expression: Tax and Base.
The FairTax will be implemented as inclusive. That is, at the point of purchase, prices marked will include the tax. So, when addressing the proposed use of the tax, it is completely valid to use the inclusive rate.
On the other hand, sales taxes are currently implemented as exclusive. That is, the price on the shelf is the base and the tax isn’t added until you get to the register. So, when comparing to existing implementations of the same tax model (consumption), it is also completely valid to use the exclusive rate.
Because of the past and current methods being different, taxpayers will end up being well versed in both. But in the end, it doesn’t matter because they are mathematically equal.
The regressive debate, on the other hand, does not involve mathematically equal expressions. Here is the grade school math:
Tax = Base * Rate
Rate = Tax / Base
Note that the two equations use the same components and are natural corollaries.
But what if we did this:
Tax = Base1 * Rate
Rate = Tax / Base2
Huh???
This equation arbitrarily introduces a component that does not exist in the first calculation (Base2, which represents income). But it is implied that the first calculation is its corollary – an implication that is utterly not the case. So, effectively, what the regressive debate tries to argue is this:
Tax = Consumption * Rate, therefore Rate = Tax / Income
You think that is a mathematically honest statement? You think that is the same as the inclusive, exclusive expressions?
The reason for the switch in math is to view the tax from an income perspective. And there is certainly nothing wrong with that if you want to turn the camera to see things from a different angle. In fact, if you wanted, you could also divide by shoe size, number of miles on your car or the weight of your laptop. Each of those alternate perspectives are also just as valid as dividing by income so, to the extent that it answers questions for you, great.
So, to say, “The FairTax is flat but, when viewed as a function of income, it is regressive” would be a true statement. However, that is not the statement that is being made. Instead, the statements made are “The FairTax is regressive” or “Consumption taxes are regressive”.
The last two statements are based on math equations that are not equal. Statements regarding inclusive and exclusive are based on math equations that are equal. That’s a huge difference.
Mark,
Nice explanation-crystal clear!!
Now, please explain to me why, when BHI divided the Fairtax base into the revenue neutral amount (T/B), they called the rate an inclusive rate? ( 2228/9355=23.8%) Using your equations, that 23.8% would be an exclusive rate. The inclusive rate would be 2228/(9355+2228) = 19.4%. What’s wrong with this picture?
Mark –
Here is why (in my opinion) the whole “tax inclusive” rate is nonsense. (My examples below assume that the FairTax rate will be 23/30%, which, as I’ve argued many times, is woefully low.)
1. The tax-inclusive rate was developed solely because the market-researchers and focus groups hired by AFFT (which made up the bulk of the “$20 million in research they and Boortz brag about) found that any tax rate above the mid-20′s would not be acceptable to the voting public. So AFFT quoted the FairTax rate as a “tax-inclusive” rate for the sole purpose of making the tax rate sound lower than it really is. It had nothing to do with making the rate comparable to the income tax rate.
2. People are familiar with current sales tax calculations on a tax-exlusive basis. Tax exclusive rates are used in every state in the nation that has a sales tax. Throwing in “tax-inclusive” rate just confuses people because not one person in a thousand know what tax-inclusive is, so they assume it is a tax-exclusive rate. Even columnists who should know better write about a “23 percent” tax rate without explaining (or, perhaps, even realizing) that they are talking about a tax-inclusive rate.
3. As Kotlikoff/BHI have conceded, the “tax-exclusive” rate will need to be added to the cost of goods and services, so the prices will go up by the tax’exclusive rate. So, it’s a little bit ridiculouse to say that the tax will be 23% of the price of goods and services that have risen by 30% because of the addition of the FairTax. It’s much more honest to simply say that the tax will be 30% on top of the price of the goods and services (in addition to state and local taxes, which are quoted in tax exclusive rates.)
4. To put it in perspective. Say a toaster costs $100 on a pre-tax basis. If a business owner goes into a store and purchases a toaster for his business, he will pay $100 for the toaster because it will be free of the FairTax. If a consumer goes into the same store and buys the same toaster for his own personal consumption, he will pay $130, because he will need to pay the FairTax. The consumer will realize that he is paying 30% more than the business owner. To tell that consumer that he is “only” paying a 23% tax-inclusive amount is totally disingenuous. He will know that he is paying 30%.
On the same vein, the whole concept that “the FairTax is progressive as to spending” is equally misleading. I suppose the Stamp Act was progressive as to spending as well. So were the consumption taxes in pre-French Revolution times in France. Regardless of semantics, when the government shifts the tax burden onto the poor and middle class, they will not be happy.
I realize we are never going to agree on this, but instead of playing hide-the-ball with semantics I would really like to see FairTax proponents just admit that the tax burden on the middle class will increase under the FairTax and try to argue that the economic benefits (or whatever) of a consumption-based tax will make up for the shift in the tax burden.
Hank,
Unfortunately, I am not up on the nuts and bolts of the studies – at least nowhere near the level that you and Morphh are.
With this post, I am only trying to reconcile the high level math and logic fundamentals of the model with the rhetoric that criticizes it – two things that are not quite in line.
That said, I assume that the 9,355 is truly just base? It is not 7,127 base + 2,228 tax?
Oh no – I can feel myself being dragged into the mosh pit of study details
Mark,
Come on into the mosh pit, the weather is just fine and so is the view, although a little murky at times?
Yes, you can assume that the 9355 is truly just base, because as Gale and Kotlikoff have assured me, there are no taxes included in the GDP. And the GDP data, as modified by BHI to account for education and other non taxable things, is the Fairtax base. The revenue is simply the amount of revenue that was collected in 2007 from income, payroll and gift/estate taxes. You seem to understand that revenue divided by the base creates an exclusive rate, so perhaps you can share in my confusion about the fact that BHI calculated an exclusive rate, (2228/9355 = 23.8%), labled it an inclusive rate and recalculated a new exclusive rate (2228/(9355-2228)=31.3%). That is how we got to the 23%/30% rates, which I still believe should be 23%/19%. There may be a logical explanation, but so far I can’t find it.
And you really ought to hope I’m right, because it would sure be easier to sell the 23% exclusive rate rather than 30%, wouldn’t it. And the cost of the prebate would drop significantly, And the impact on retail prices would lessen. And the impact on state and local governments would be less. And, etc. etc. etc.!
Hank,
I know that I had the BHI study at one time but I can’t find it now. Can you point to a link?
Here is a link to the BHI Study: Taxing Sales Under the FairTax: What Rate Works?
In fact, here is a link to all there studies BHI Studies on the FairTax
They include:
* A Comparison of the FairTax Base and Rate with Other Tax Reform Proposals
* A Distributional Analysis of Adopting the FairTax: A Comparison of the Current Tax System and the Fair Tax Plan
* The Economic Effects of the FairTax: Results from the BHI CGE Model
* The FairTax and Charitable Giving
* Tax Administration and Collection Costs: The FairTax vs. the Existing Federal Tax System
* Fiscal Federalism: The National FairTax and the States
Awesome, thanks Morphh – I’ll put these links in our Resources section.
Mark,
Now that you are becoming an economic study “wonk”, let me try to help you understand my concern.
Go to the “What Rate Works?” study, turn to page 10, and look at table 5, line 7. It is entitled “Adjusted Tax Base (Inclusive of Tax) components. But the component numbers correlate closely with the 2007 NIPA numbers which form the Fairtax base. And, there is no tax contained in those numbers— BECAUSE THERE WAS NO FEDERAL SALES TAX IN 2007!!! If the sales tax of $2228 trillion was included, the adjusted tax base of $9355 would have had to be $11583, which it isn’t. The inclusive rate of 23.8% is really an exclusive rate, imho.
While you have this chart in front of you, look at the “Revenues to be Replaced” at the top. Can you see an entry of around $242 billion to offset the inclusion of the federal consumption of $913 billion below? No, you can’t because it isn’t there. The adjusted revenue is simply the amount raised in 2007 by the current income, payroll and estate/gift taxes. No adjustment for having the federal government tax itself. You have to add a revenue offset or remove the federal consumption, but you can’t do one without the other. Having the government tax itself raises no new revenue–it’s a wash. The Fairtax rate should have been 26.4%, no matter if federal consumption was taxed or not.
I eagerly await the responses to the email that Morphh is putting together–and the sooner the better
The FairTax IS regressive and I think I can prove it.
Inconvenient truth: Under the FairTax, some consumption is more equal than other consumption.
Specifically, homeowners (especially those with existing or used homes) enjoy housing consumption which is partially taxed and partially exempt from tax.
If homeownership were evenly distributed across incomes, one might be able to argue with a straight face that the FairTax is not regressive.
But homeownership is strongly correlated with income (and especially with lifetime income, which is more relevant than annual income which is often volatile).
Because homeowners enjoy untaxed housing consumption, homneowners enjoy lower effective FairTax rates than renters, and whenever a homeowner and a renter have equal consumption, the renter will pay more FairTax than the homeowner EVERY TIME.
Whenever a homeowner and a renter have equal spending, the renter will pay more FairTax than the homeowner, while enjoying less consumption than the homeowner.
Terry,
I’m still pondering your home ownership argument, but there really is no need to develop new arguments as to why the Fairtax is regressive. By any definition in any business dictionary, all sales taxes are regressive. What AFFT did was to claim that the prebate somehow changes that definition, and “voila”, sales taxes are now progressive according to the new AFFT definition which is based on consumption instead of income. But, you won’t find any support for that fairy tale in any economics books!
I never have bought into that argument. If anything, the Fairtax simply moves the point of regressivity from zero to the poverty level. The scheme is still regressive no matter how Fairtaxers scramble to redefine tax burdens.
If you still want to argue based on consumption, then your post does make sense, but assuming that federal tax burdens are based on consumption rather than income hasn’t been accepted by the experts, yet?