The Loophole Factory
April 15, 2008 · Filed under: News
From today’s WSJ Review & Outlook.
“People say all the time: ‘We can’t pick winners and losers.’ Well then fine. Take every single dollar of subsidy out of the federal tax code. Get rid of it all. . . . Let’s have a real level playing field where nobody gets a penny in subsidy.”
– Hillary Clinton, quoted in USA Today, April 5, 2008
Sounds like a FairTax supporter.
54 Responses to “The Loophole Factory”
Ha! Doubtful, but if she was... as bad as I think she’d be for this country in just about every other respect, if she supported the FairTax, and could convince 50% + 1 of the members of Congress to go along with her, I might just have to give Bob Barr a pass in November.
I agree with Hillary!
No subsidies. No deductions. No exemptions. No credits.
Treat everyone the same. If you make x, you should pay y in taxes.
Sounds like a Flat Tax supporter.
Did you catch Tuesday’s (4/15/08) WSJ piece entitled “The Loophole Factory.” They agree with any sane person that the Internal Revenue Code is out of control. They give examples of current legislation in the hopper that will increase the size of the “code” by hundreds, maybe thousands, of pages in answer to requests of such important taxpayers as the National Association of Home Builders and the Realtor’s lobbyist.
Did you know you may be given a $7,000 TAX CREDIT (that’s cash we’re talking) for the purchase of any foreclosed property? If inacted I plan to bid $7,000 on every foreclosure I can find, knowing I get the property for free if I win the bid.
Unfortunately, the editorial writer cries but offers no solution. The FAIR TAX can solve these problems. It is not mentioned in the WSJ.
The IRS doesn’t propose or pass legislation, Congress does. It’s not the IRS that’s out of control - it’s Congress. And while the FairTax bill would get rid of the IRS it doesn’t get rid of Congress. There would be as much tinkering with the FairTax (if not more).
Howard-
Just for the record, the editorial board at the WSJ is in favor of a flat income tax , so it’s not as if they are lacking a dog in this fight.
Fred-
Again, I am utterly confuzzled by your comment. You imply that taxation is something other than a zero-sum game, yet fail to provide even one example to prove it. The reason for this, I would submit, is that no examples exist.
I’m utterly confused by your statement. I have no idea what you are talking about when you say “You imply that taxation is something other than a zero-sum game, yet fail to provide even one example to prove it. The reason for this, I would submit, is that no examples exist.”
What are you talking about?
Simply this, Fred. Under the FairTax, as with our current system, when a loophole is provided for one entity or special interest group, that lost revenue has to be made up somewhere, at the expense of someone else. Give to one, take from another by necessity: a zero-sum game. Gerrymandering of our current tax code has virtually become a national pasttime for our 435-member D.C. country club, because it’s so easy to do when the true tax burden is hidden from those who end up paying it.
Under the FairTax, on the other hand, ANY tinkering with the tax code will be immediately reflected in black and white on the cash register receipt. Since the rate is a flat percentage across the board, everyone from Bill Gates to our board-buddy Bill Hirschi will see the same increase/decrease in retail prices. Five cents more for a cup of coffee at Starbucks all of a sudden and Gates won’t even blink. But I will bet you cash money that, as much as friend Bill complains already, it won’t take more than coffee and a newspaper increasing in price before he’s pounding on his congressman’s front door. Enough blogs and irate videos on YouTube and our Honorable Sirs will either fix it or face a full-scale revolt.
This is not wild economic abstraction or Panza-esque utopian cloud-gathering. This is reality, and it’s why I firmly believe that, while some attempts may be made to tinker with the FairTax, they will be extremely short-lived.
And that’s suppose to stop Congress from tinkering? In my mind that’s an incentive. The more visible the better for politicians.
Gas prices too high?!? Let’s have a summer-long FairTax holiday on gasoline. Mortgage crisis!?! Let’s cut the FairTax on new homes or not charge the FairTax on mortgage interest for a few months. Economy bad?!? Here’s a little extra prebate for the next few months. Auto industry struggling?!? A couple of points off the FairTax rate on new cars should help. Health insurance costs skyrocketing?!? Let’s try a negative FairTax rate on health insurance and subsidize the costs. The possibilities are endless.
All courtesy of your friendly elected politician (he feels your pain). Be sure to remember him on election day.
Bradley –
You say any loophole in our current system forces others to pay higher taxes. That’s true!
But your solution is to impose the largest loophole of all! Completely eliminating income taxes, corporate taxes, estate taxes, social security taxes and medicare taxes. On the whole, these taxes are progressive as the tax burden currently falls primarily on the highest 20% of income earners.
Now, this might be unfair, but by eliminating all of those taxes — that is, by creating the largest tax loophole of all time — you’ve got to make up the lost revenue somewhere. Like you said, it’s a zero-sum gain.
Thus, by replacing a progressive tax system with a consumption tax system, which, by it’s very nature, is regressive (in spite of the “pre-bate’), don’t you understand that you are shifting the tax burden to the middle class and dramatically increasing their tax burden? As you say, it’s a zero sum gain.
Fred-
I love your ideas for a “FairTax holiday” and exempting certain things from the FairTax for a period of time. But, in a zero-sum game, that portion of revenue to the government is gone, so what is congress going to do? Cut spending to keep the budget in balance? Haven’t tried that in a while, and I don’t think they’ll start any time soon. More likely, in that situation, they continue to spend and saddle future generations with even more debt. By the time the FairTax passes, a much larger percentage of the American people will have a much better understanding of basic principles of economics and activism, and simply won’t allow your scenario to take place.
Hayden-
Quit beating a dead drum. The guy playing the spoons is bored out of his mind already. You know as well as I do that the only poor and middle class people who will be hit harder by the FairTax than the mess of a tax code we have now are ones who are living beyond their means anyway. They are the reason we are close to sustained negative average savings rates in this country right now. If the FairTax makes them rethink their own suicidal fiscal policies, I say BRING IT ON! Not for their sake, but for the entire economy.
I hate to sound rude or insensitive to their plight, but I am, so that’s how it comes out.
Bradley — It’s not that you are being rude or insensitive, but I see you quickly abandoned your argment about taxes being a zero sum game.
Sure they will...
Hayden-
I fail to see where I did any such thing. In re-reading my post, it seems that, if anything, I reiterated.
Fred-
I’m glad we agree.
Hayden said:
Thus, by replacing a progressive tax system with a consumption tax system, which, by it’s very nature, is regressive...
Hayden,
Can you provide a snippet of math that supports the idea that ...a consumption tax system...by it’s very nature, is regressive...?
The IRS is not out of control. The tax code and the Congress is out of control. The PACs and special interest groups are out of control. And Congress loves it! The IRS is the recipient of the out of control direction of the Congress. I expect that many IRS employees and managers would be thrilled if the tax code was redically simplified. Of course, I don’t think they’ll be thrilled when the FairTax eradicates their agency.
Bradley, In regard to post #1, no need to pass on Bob Barr on this issue. He openly supports the FairTax.
Mark…you asked for a snippet of math.
Laurence Kotlikoff in the Pennsylvania Gazette Sept-Oct 2005: “Before anyone starts screaming that a sales tax is regressive and will hurt the poor, remember that sales taxes are in part wealth taxes because when rich people spend their wealth to buy caviar, BMWs, yachts, and facelifts, they end up spending part of their wealth on taxes. ”
If that logic refutes the statement a sales tax is inherently regressive, the results of (tax paid/wealth = tax rate) should confirm his statement. Let’s apply a simple 5% state sales tax and look at the real world. Not the theoretical world in which all people spend 100% of their wealth. (See note)
Group A has wealth of $1,000 a month (wages) and spends 100% on taxable necessities. Tax rate = $50 / $1000 = 5%.
Group B has wealth of $10,000 a month (wages, savings) and spends 70% on taxable goods. Tax rate = $350 / $10,000 = 3.5%.
Group C has wealth of $100,000 a month (wages, investments) and spends 50% on taxable goods. Tax rate = $2500/$100,000 = 2.5%.
The tax rate decreases as taxable spending becomes a smaller portion of wealth. A sales tax hurts those who have the least flexibility in when, if or how to spend. As a category, that’s the poor and is why a consumption tax is labeled inherently regressive. It’s also why sales taxes sometimes exclude food, clothing, rent or other necessities.
Note: That 100% spending theory contradicts the research paper “A Distributional Analysis of Adopting the FairTax”. The paper documents expenditures as a percent of income decrease significantly as income levels go up. I’m not aware of any study showing those ratios change under a consumption tax.
Ellen, your argument ignores two facts. (1) The “poor” (Group A with $1,000/mo income) pay over 7% in FICA taxes on the first dollar of legal earnings. (2) The “poor” frequently buy used merchandise, barter in tax free exchanges and enjoy monetary assistance such as food banks, Salvation Army stations, etc. where no tax is collected on consumption.
Under the FAIR TAX, the “poor” would be relieved from payment of the FICA tax payment, increasing their real income significantly percentage wise. They would not pay a sales tax on much, perhaps most of their consumption. When you add in the prebate, the “poor” come out like bandits. The FAIR TAX is not “regressive.” The FAIR TAX is FAIR.
Howard
Howard,
My argument was unrelated to the FairTax as proposed. It was in response to a request for a snippet of math supporting the idea that a sales tax is inherently regressive. (See post 15)
Sales taxes are inherently regressive.... if you assume a one-year tax frame, savings are never spent, change the base of measurement, exclude exemptions in the tax base or selective bases (like luxury sales taxes). Yep, then they’re inherently regressive.
Ellen,
Thanks for clarifying the calculation. Below is a quote from a post of mine on a different thread that deals with this issue. The math you are using is the calculation in the middle of the quote:
Tax = Consumption * Rate, therefore Rate = Tax / Income
I don’t believe that many math teachers would vouch for that calculation.
Morph -
I don’t understand what you mean by “exclude exemptions in the tax base or selective bases (like luxury sales taxes).” Please clarify.
Rhetoric aside, I assume we can all agree that consumption taxes are regressive as to income, at least with respec to current income. (Even Boortz and Linder concede that.) The argument that Kotlikoff, Morph and others make that the FairTax is an implicit tax on wealth is that ALL income is EVENTUALLY spent, thus it is all eventually taxed under a consumption tax system.
I have no doubt that is correct in the theoretically models of academia, but I don’t believe that argument holds up in the real world.
For middle class folks, this is probably true. The classic pattern is that people get in debt when they are younger, pay off that debt during middle age, save money in their later working years, and then live off their savings (and social security) when they retire. If they are lucky enough to die without spending a few years in a nursing home, they might leave a modest inheritance to their adult children, who will likely spend the money, either on a house, their kids education, etc. And the cycle will repeat itself. It those instances, all income is eventually spent.
But for wealthy and high income folks, the cycle is completely different. Those people can easily accumulate enough savings that their interest, dividends, capital gains and rent pay not only their living expenses, but can be reinvested in other assets. Thus, their principal is never spent, but continues to grow. (I’m not quite there yet, but I’m getting close.) In that case, much of their income would never be taxed under the FairTax system.
The obvious examples are Warren Buffet and Bill Gates, but even folks with assets of a few million dollars can live without ever touching their principal. Five million dollars in savings a only five percent per year will yield a $250,000 annual. (I suspect that most folks with five million dollars earn substantially more than 5% per year.)
Now, in THEORY, after they pass away their children (or their children’s children) will spend that money, so it will eventually be taxes. But even this really isn’t true. In the first place, if the assets are large enough, the children can continue living off the interest and dividends and never touch the prinicpal. Second, most children of wealthy folks become at least reasonably successful themselves, and thus would earn enough from their own salaries that wouldn’t need to spend their inheritances. Third, the inheritances might easily be spent on non-taxable things — farms, ranches, estates, foreign travel, etc. Finally, even if the inheritance is eventually spent on what would be taxable purchases under the FairTax, you are talking decades or more before this ever translates into tax revenue for the government.
Are we really so stupid as to base a tax plan on what the spending habits of the decendants of the mega-rich are going to be fifty years from now?
The point is, assuming that a consumption tax — whether the FairTax or something else — is going to tax wealth more effectively than would an income tax, a capital gains tax and/or an estate tax, strikes me a being ridiculously naive. So we are back to the point that the FairTax, like all consumption taxes, are regressive as to income.
I’d agree with those points to some degree, though you have some measure of this today. Borrowing on assets is one example. But anyway... good points.
As to “exclude exemptions in the tax base or selective bases (like luxury sales taxes).”, the comment was in regard to all sales taxes being inherently regressive. A sales tax on a yacht, expensive cars, jewelry, or caviar for example, I’d consider to be a progressive sales tax as it is designed to target the wealthy. On the other end, they do things to make sales taxes less regressive, such as untaxing food and other essentials, attempting to lower the tax on necessities. So, by adjusting what things are taxed, you can hit a selective income group or reduce the burden on other income groups. So you have to assume we’re not taking about a sales tax on private jets.
Hate to mention it, but does the annual prebate registration process contain a loophole? Or maybe just an inexplicable expense. Reading through the bill it appears that changes in the family composition don’t require a revised registration. The bill includes a provision that no person can be considered a member of two families so that seems to address children moving out. The child wouldn’t be able to register separately until he/she was removed from the family registration. The bill doesn’t have a different process to create a new family “mid-year”. My real question is about a person counting as a family member after death. It’s an uncomfortable topic; but, there don’t appear to be requirements or timelines for reporting deaths. A revised registration based on family size changes is optional. I know it’s not due to sympathy because Social Security requires notification of recipient deaths within a very short period. Is it simply because it’s more cost effective to overpay prebates than to have the staff required to process all the paperwork? Or did I miss something in the bill?
Answer to 25.
Dear Ellen,
That’s no different than the income tax return now. Either a kid is counted on the family’s prebate or they get their own. It requires a call or email or letter to the Social Security Administration to change where the check is sent and how much it is. I imagine there will be some POed head of households when kids skidoo. (dating myself there a bit, don’t you think?)
Casey Elliott
Reply to 18
Dear Ellen,
The poor family pays $50, the middle income family pays $350 and the rich family pays $2500 in FairTax. OK. Sounds good.
The poor family invests nothing. The middle income family invests some. The rich family invests a lot. Hmmm.
The poor family’s investment generates nothing (they haven’t invested). The middle income family funds, say stocks or a bank, which invests in real estate or another business which supports growth, which enervates the economy which sells stuff and generates - more FairTax. The rich family invests heavily which generates growth and (face it, they are not going to invest in companies that don’t give a return) generates - FairTax. Somebody buys this stuff!
Plus, the middle income people have THE CHOICE of whether they buy new stuff or not. Smart people will not. Heck, poor people have that choice as well. Gardens will make a huge comeback and people will walk instead of ride. They will be healthier and live longer. Wow, what a change.
Come on Ellen! Don’t dwell on the Rich vs. poor stuff. Ask yourself will I be better off? Will I have more money to spend or invest? Will I have a nice spring day on next April 15th?
I don’t think we, any of us, have thought this through entirely. This will change our culture. AND THAT’S A GOOD THING.
Casey Elliott
Response to 22
Dear Mark,
Excellent job. I like your post because of the math and the reasoning. Here is a counterpoint.
I read one post on another website about the FairTax. It suggested that the FairTax is a tax on resources, not income. Huh?
If a fellow like Bill Gates (billionaire type dude) has a year like this one (the stock market tanked) he may not pay any income taxes. I have a few rich friends who brag about how they avoid income taxes. Is that so strange? After all, they can afford those kinds of tax attorneys. However, under the FairTax proposal, our mystical Bill Gates (the name has been changed to protect the rich) would still pay significant FairTaxes. He still consumes.
Thus, Mr. Gates is taxed on his ability to consume, not on his earnings.
Sounds elegant, doesn’t it?
Casey Eliott
Reply to 23
Mr. Hayden Kepner,
I disagree with your assessment about the middle class. The FairTax proposal will allow middle class families to accumulate wealth at rates that are - just impossible - today. The income tax burden not only removes income from such families, but directs how they invest any excess income.
Face it. The current income tax code has been altered by people who use it as a social engineering tool. They (those designers) are not looking out for those middle class families. The results are plain. Middle class families are trapped in the scenario that you describe. They start out in debt. They pay off the debt, and then they save for retirement. Most of those families do not reach the goal of saving enough for retirement. They don’t. They don’t make enough after taxes.
Change the dynamic. Place the control of their income in their hands and allow then to plan for taxes effectively. They will decide whether or not to buy a new car (and pay the Fairtax) or buy used and avoid it. They will have 20 to 30% more disposable income. They will SEE HOW MUCH TAXES THEY ARE PAYING.
The result will be a more vigorous economy, more savings by more people, better use of resources (buy used) and a nice restful April 15th (priceless).
Sounds good to me!
Casey Elliott
Casey –
I appreciate your polite and thoughtful comments. But let me play Devil’s advocate here.
Let’s say you are correct. Middle class folks start spending their money more carefully under the FairTax, thus collectively saving enough in taxes to dramatically boost their savings rate.
The poor are “untaxes” under the FairTax.
The rich see their tax burden fall dramatically under the FairTax.
Just who, pray tell, is left to pay taxes?
Before you answer, “foreign tourists, illegal aliens and the underground economy,” please review my earlier posts on this issue where I actually ran the numbers and showed that the money’s just not there. Of course, you are perfectly free to show your own numbers if you dispute mine.
But the easy arguments that are usually espoused by the more vocal FairTax proponents (and I don’t mean my friendly adversaries on this board) often fade away when you actually look at the numbers.
Hayden- this is already a dead issue, but you still are under the delusion that the rich will see their tax burden fall “dramatically.” This has been proven to be a ridiculous statement, so I’ll not rehash it here. Suffice to say that capital gains rates right now are 15%, the FairTax (exclusively) will be around 30%. I don’t know any middle class families that will buy half-million dollar yachts or mansions, or even 75K luxury cars.
Also, no one is saying the tax burden on the middle class will necessarily be reduced under the FairTax, only that it CAN be, based on their choices. These choices do not exist now, and never will under a system of point-of-the-gun income tax withholding.
No offense, Brad, but I am curious as to what Casey thinks.
Since he’s a new-comer here, he might not yet have his opinion set in stone on all the issues. So, I’ll elaborate on my comment.
1. The “rich” currently pay the vast majority of the federal income taxes (35%), capital gains and dividend taxes (15%) and estate taxes (45%)
2. Under the FairTax, all of those taxes (among others) will be elimnated, to be replaced by a national sales tax at a 23% “tax inclusive rate.
3. The “rich” tend to spend a smaller portion of their incomes than do the middle class. Or, to put it another way, they have a lot more money to save and invest.
4. Moreover, only spending on NEW goods and services WITHIN the United States for PERSONAL CONSUMPTION are taxed under the FairTax. That is, neither the purchase of a $100 million existing mansion or a $100 million ranch would be taxed. Nor would yachts or villas purchased in the Bahamas, or private jets purchased for “business” reasons, etc.
5. Thus, only a portion of spending will actually be taxed under the FairTax.
For the foregoing reasons, it is my contention (and that of virtually every economist who’s studied the FairTax other than those who are being paid by AFFT) that the FairTax would substantially reduce the tax burden on the “rich.”
That might be all well and good, but my question is, if the tax burden on the rich is substantially reduced under the FairTax, who makes up the difference?
I’m not trying to bash the rich here. I’m merely pointing out that in order for the FairTax to be revenue neutral, if one group of people enjoys a substantial tax reduction, some other group is going to get burned. And I believe it would be the middle class who would get burned.
Hayden-
Fair points all, but you are leaving out one important factor. The revenue neutrality of the FairTax doesn’t come from collecting the same amount of taxes from the same group of people. A consumption tax, by its very nature, substantially broadens the tax base, bringing in a fairly large group of foreign tourists, illegal immigrants, and sectors of the underground and shadow economies that are not hit with income & capital gains taxes currently. Thus, it is entirely possible for both the rich and the middle class to pay less under the FairTax and still fund our government at its current haphazard spending levels.
And, again, the rich spending a smaller *percentage of their INCOMES* is an entirely irrelevant point when discussing a consumption tax. What a person makes matters not a whit when the base being taxed is consumption spending.
Hayden,
Question about number 30. I looked for your previous post that you refer to and I missed it. Is is in another line? Or deleted? Anyway, send me a copy personally and I’ll valiantly defend my position. Plus I get to do some research. That’s acutally good, although I detest research.
Also on 32. I would appreciate a reference or two to your numbers. It’s amazing how an initial reference will lead to other astounding information.
Thanks.
Casey Elliott
casey.elliott@earthlink.net
Casey — Below is the gist of my argument as to why the FairTax cannot work and why the lost revenue will not be made up by illegal aliens and the undergound economy. Since it repeats many of the points I have previously made on other threads, I apologize in advance for being repetitive.
If you want to review studies and reports opposed the FairTax, please read (1) the study by William Gale of the Brookings Institution published in the May 15, 2005 edition of Tax Notes, and (2) Chapter 9 of the Report of the President’s Tax Reform Commission published in 2006. If you want to review a study that supports the FairTax, please read the study done by Laurence Kotlikoff and a number of economists with the Beacon Hill Institute that was published in Tax Notes in 2006. This last report is availabe on the fairtax.org website.
A. The FairTax would not raise enough mone to fund the government.
1. There are approximately 300 million citizens in the country. According to the U.S. Census Bureau, that translates into approximately 110 million families.
2. Under the FairTax, prebates to a family of three would total approximately $6000/yr. So, total annual prebates would be $660 billion dollars.
3. GWB just proposed the 2009 budget of $3.1 trillion. To that you would need to add the $660 billion for the prebate, so, if the FairTax were enacted today, total federal spending in 2009 would be $3.76 trillion.
4. To pay for this spending, the average per-family tax obligation would be $3.76 trillion divided by 110 million families, or $34,000 per family.
5. At a 23% tax-inclusive rate, each family would be required to spend, on average $148,000 per year on taxable goods and services. (i.e., $34,000 divided by 23% = $148,000).
6. According to the census bureau, the mean family income is $66,000.
7. Thus, if every family in American spent 100% of its income on taxable goods and services, the FairTax would not generate even half of the required revenue necessary to fund the government. (And, of course, not all spending would be taxable under the provisions of the FairTax.)
B. The lost revenue will not be made up from foreign tourists, illegal aliens or the underground economy.
Certain FairTax proponents routinely claim that the government will receive extra revenue from these groups. I believe when you do the numbers you will realize this is a red herring.
1. Foreign Tourists. FairTax proponents claim that we’ll get extra tax revenue from foreign tourists, which they allege total approximately 50 million per year. Even if this is true, we would lose revenue when our citizens travel or live abroad, since their foreign purchases would not be taxed. I have not seen any recent figures, but I think it is safe to assume that Americans spend at least as much abroad as foreigners do here, so, at best, this would be a wash. That is, we would not receive any net revenue from tourism.
2. Illigal Aliens. The highest estimate of the number of illegal aliens in this country I’ve seen is 12 million. Let’s assume this is true, and that half are adults and half are children. Now let’s assume that each of the adults works and earns an average of $20,000 per year. (Note: This is an overly optimistic figure. I’ve seen that the average illegal immigrant family earns only $15,000 per year.)
Under my example, illegal immigrants would earn $120 billion per year. (i.e. 6 million adults times $20,000 per year.) Let’s assume that they spend 100% of that on taxable goods and services. At a 23% tax-inclusive rate, that would yield approximately $27.6 billion in annual tax revenue, or less than 1% of the government’s annual budget.
Moreover, illegal immigrants would probably spend very little on taxable goods and services. Most illegals live very cheaply. If they own a car, it is most likely a used car. They buy clothes and furniture from garage sales and second-hand shops. If they own a house, it would not be a brand new house. They tend to save money to send home to Mexico or Central America. Thus, only a small proportion of their earnings would probably be taxed under the FairTax. In contrast, most illegal aliens currently have Medicare and Social Security taxes taken out of their paychecks. Thus, it is likely that illegal aliens, on the whole, pay more in federal taxes today than they would under the FairTax.
3. The Underground Economy. The underground economy is very loosely defined. I’ve seen estimates up to $2 trillion per year. Even if it were that high, it would be ridiculous to assume that the entire $2 trillion would make its way into the taxable economy, but let’s assume, hypothetically, that it does. If the entire $2 trillion is spent on taxable goods and services under the fairtax, that would generate $460 billion in tax revenue, or approximately 12% of the federal budget. Nowhere near enough to make up the shortfall under the FairTax.
But let’s examie the issue of taxing the underground economy a little closer. The FairTax proponents claim that the FairTax will tax the underground economy. They claim, for example, that when a drug dealer buys a $100,000 Cadillac, he will be taxed on that transaction. That is, the Cadillac dealer will need to remit 23% of that $100,000 purchase price to the federal government as the Fairtax, or $23,000.
What happens today under our current income tax system. When the drug dealer buys teh $100,000 Cadilac, the car dealer must pay income taxes on the sale. The car salesman must pay income taxes, social security taxes and medicare taxes on his commission. The manufacturer must pay income taxes on its profit, and payroll taxes of its employees, who must also pay income taxes. Etc., etc. This is the so-called “embedded taxes,” which FairTax proponents claim equalt 22% of the cost of goods sold.
Thus, under this example, the FairTax generates $23,000 in tax revenue from the sale of the Cadillac to the drug dealer, whle our current system generates $22,000. So the FairTax doesn’t really generate any significant new income for the government from the underground economy (particularly since the drug dealers, prostitutes, etc. will all be receiving the “pre-bates” under the FairTax.)
The bottom line is that I do not believe it is mathematically possible (let alone, realistic) for the FairTax to gererate anywhere near the amount of revenue necessary to fund the government at a rate anywhere close to a 23% tax-inclusive number. (At that’s even before factoring in tax evasion and tax avoidance.)
Hayden,
In regard to (A), rebates can also be calculated as a reduction of the tax base, which is similar to today’s system that does so with $945 billion. The FairTax is intended to be revenue neutral, so let’s apply your same example to income taxes. Are we not talking about the same 110 million families collecting the same amount of revenue? Would not the mean family income example of $60,000 collecting this amount of taxes also apply? Would not people have to earn on average the same $148,000 per year? This argument somehow reminds me of the missing dollar riddle.
You have a tax base, and the revenue is a percentage of that tax base. It’s not simple math but it’s clear what we’re working from.
In this comment, you stated that corporate taxes (income and employer payroll) were equal to 6%. Hank similarly equated 6%. We know that this collection is 32% of total government revenue (BHI study Table 3). Therefore, by your own calculation, revenue not including the prebate would be about 18%. BHI attributed about 3% to the prebate, bringing this estimation to around 21%.
The FairTax is applied to a base that’s a percentage of GDP (81%). It would be mathematically impossible to achieve revenue neutral rates that you imply on such a tax base. Illegal aliens, tourists, and the underground economy are all irrelevant points in terms of revenue - the tax base is the tax base.
Morph –
I don’t know what you mean in the following paragraph. Perhaps you typed it in haste, but I don’t follow it.
“In this comment, you stated that corporate taxes (income and employer payroll) were equal to 6%. Hank similarly equated 6%. We know that this collection is 32% of total government revenue (BHI study Table 3). Therefore, by your own calculation, revenue not including the prebate would be about 18%. BHI attributed about 3% to the prebate, bringing this estimation to around 21%. ”
I, too, have been wondering out how we fund the government from our current tax system. Given that there are 110 million families, and the budget is $3.1 trillion, that implies that the average family’s tax burden today is $28,000. (It’s smaller than under the FairTax, because there’s not prebate under our current system.)
Now, that $28,000 is “disguised” because it is spread out over so many types of taxes, including personal income, social security and medicare taxes. And, presumably, some of it is included in the purchase price of items we buy from corporations who must pay the corporate income tax and payroll taxes. Further, since we currently have a progressive income tax and estate tax system, the vast majority of our taxes today are paid by the wealthiest of us, which reduces the tax burden on everyone else. And, of course, even then we still have a deficit every year (at least, under GWB), which we must borrow to fund.
Still, it’s an incredibly large number when you think about it. And that $28,000 per family is only the FEDERAL tax obligations, state and local tax obligations make the amount even higher. And it’s just going to get worse over the years as the baby boomers retire.
Quick — Let’s shoot Hank before he takes all our money.
What I meant in the last post was that you equated 6% of production cost to corporate income taxes and employer payroll. Corporate income taxes and employer payroll are 32% of government revenue. So you’ve equated 32% of the revenue as equal to 6% of prices. So 96% of revenue would be 6% * 3 or 18% by your figures. BHI stated 3% of the FairTax rate was the prebate. So adding 3%, brings this up to 21%. We have a 2% fudge factor.
With regard to the rebate, the current system would do this by reducing the base, so instead of the same 110 million families, you’re operating from 100 million... or something. You could do the same thing with the FairTax.. point is - the amount should be about the same.
Hank’s already retired... alright.. who’s a baby boomer?
Below is from Wikipedia as to where federal revenues currently come from. I’m sure someone could find a better link to a pie chart that would be easier to read.
Total receipts
Receipts for fiscal year 2007 were $2,407 billion. FY2007 on-budget receipts were $1,798 billion. FY2007 off-budget receipts were $608 billion. Off-budget receipts include Social Security and Medicare payroll taxes, as well as the net profit or loss of the U.S. Postal Service.
$1,163 billion - Individual income tax
$869.6 billion - Social Security and other payroll taxes
$370.2 billion - Corporate income tax
$65.1 billion - Excise taxes
$26.0 billion - Customs duties
$26.0 billion - Estate and gift taxes
$47.2 billion - Other
Source: preliminary FY2007 year-end estimate from the U.S. Treasury Dept.
The IRS estimated that there were about $345 billion in uncollected taxes, which is sometimes referred to as the “tax gap.”.[1]
I didn’t want to preempt Casey–I feel some new thinking might be instructive, but since you threatened to shoot me or whatever, here is my take on Hayden’s issue of ” Find the Phantom Funds”.
First, you can’t use family size, you must use household size which according to the Census data was 2.61 in 2006, or 115 million households, not 110 million as Hayden figured.
Next, you can either add the prebate to the revenue required or reduce the base as BHI did. Makes no difference, so I will go with the BHI approach.
Next, the Fairtaxers never promised to balance the budget, but only promised to raise $2228 billion per the BHI study.
Finally, HR25 taxes governments as consumers, and the $2009 billion in government consumption will raise $462 billion in revenue, so the revenue required from individuals to be revenue neutral is reduced to $1766 billion.
So, simply divide $1766 by 115 million households and it comes to a tax burden of $15,356. At the 23% inclusive rate, that means that the required income would be $66,765 per year. And that is exactly what Hayden said the mean income is. Magic, isn’t it. We have found the phantom funds!?!
But folks, it isn’t that easy. Hayden’s issue still lives on. Here is why. First, as he noted, someone has to pay the $462 billion assigned to the governments because governments don’t pay taxes, people pay taxes. Which would raise the tax burden on individuals to $19,373 and the annual income needed at the 23% inclusive tax of $84,230. We are getting into trouble here. And, as Hayden wrote, there is no tax avoidance or tax evasion in these numbers.
Another problem is that the figures used above assume that all income is used for taxable spending, which can’t be a reasonable assumption. Realistically, that $84,230 in income needs to be raised by at least 25% to account for untaxed spending. Which puts the annual income at $105,000, considerably higher than the mean of $66,000. Whether the income is 148,000 or 105,000, the issue is still there.
I’m in complete agreement with Hayden’s views about illegals, the underground, and foreign tourists. As for the tourists, the BHI study accounts for their spending by adjusting the base under Travel, (page 12). They added $115 billion in spending in the US by tourists, and subtracted $62 billion for spending by US citizens abroad. There is no issue there.
I give up! I hope Casey has some fresh ideas.
Hank and Morph –
You guys are lost in wonkishness. I can’t follow what you are saying about “reducing the base” due to the prebate. I can’t follow Morph at all, but I think he has fallen too deep into the minutia of equations and can’t speak English anymore.
Hank — I think the BHI analysis is a bunch of crap. (If Joshua is lurking, he’ll ban me for sure.) I mean, I think it is flat-out intentionally dishonest. (Hiding the $476 deficit, for example.) Now, since they were paid by AFFT to come up with studies to advocate the FairTax, I suppose they are just doing their job (just as expert witnesses do in litigation), but that doesn’t mean anyone should rely upon any of their studies for any objective data.
I appreciate that your last post was generally supportive of my position, but I’ll stick with my general points. The FairTax will have to generate $3.76 trillion in revenue in 2009. There are only 110 (or 115) million families in America. Where’s the money going to come from? You can’t get there from here.
Hayden,
I’ll try to explain it again using the Wikipedia data....
Since payroll taxes are split between employer and employee, we’re going to cut this figure in half, so $869.6 becomes $434.8 (employer half). $434.8 plus $370.2 (corporate income taxes) equals $805. Total government revenue (not counting excise and “other” since that is not replaced) using this data is equal to $2,428.8. $805 (corporate income tax and employer payroll) is 33.1% of $2,428.8. You stated that corporate income tax and employer payroll ($805) were equal to 6% of prices (as did Hank), when discussing reductions in production cost. Using the figure that 6% = $805, about 18% would equal $2,428.8. This does not include the prebate, which would add an addition 3%. Hope this helps clarify.
Hayden,
Well, in the last two days I’ve been labeled as an arrogant wonk– a Dutch arrogant wonk at that. (Is “wonkishness” even a word??) You want arrogant, try some of the posts by DrPete and others over at fairtaxgroups.com. Not a good site for civil discourse!
Look Hayden, I agree with your general statement of the issue, I just don’t think it’s quite as bad as you calculated. And your criticisms will just roll off AFFT like water off a duck. Remember, the Fairtax plan never promised to balance the budget–never promised such a rose garden!!
As for BHI and their study, I recall emailing Dr Walby every two weeks for almost a year while she was up in Boston trying to make a silk purse out of a sows ear. I’ll mention again that her base/rate study from 2003 established the Fairtax rate as 19% inclusive and 23% exclusive. Someone up there must have really done a job on her to come up with the 23/30 rates.
Did the study team, including LK and Karen Walby intentionally warp their results. I don’t really know, and I guess I’m not as cynical as you lawyers might be, having never worked with “expert” witnesses. However, here is my list of ten items that I disagree with as far as the study goes:
(1) Right up front, they added price neutrality to the study ground rules, in addition to revenue neutrality. This allowed them to side step the important issue of the Fairtax impact on prices. To this day, we are only guessing about whether costs will fall by 10% and retail prices rise by 17%? (my favorite), but other Fairtaxers, including Boortz, are all over the lot!
(2) As you pointed out, they ignored the deficit of $476B, and perhaps worse, never addressed the first year impact of the $600 billion inventory tax credit scheme.
(3) As near as I can tell, they assumed zero monetary accommodation, which means workers would get only their current net pay, and prices would remain about the same depending on what businesses do with the cost savings. Very unrealistic, imho!
(4) I’m quite certain that we will soon learn that the study team never added an appropriate revenue offset when they included federal consumption in the tax base. Governments can’t tax themselves and generate any new revenue. Therefore, the inclusive rate should have been 26.3%.
(5) By assuming that the embedded costs of the income tax were “taxes” in the base, they used an exclusive equation and labeled it inclusive when calculating the rate. Quite different from the 2003 Walby study approach?
(6) The study team ignored the HR25 definition of “wages”, and overlooked an opportunity to actually reduce the Fairtax rate somewhat, burdened wages being significantly higher than base wages.
(7) They went to considerable effort to demonstrate how a fixed rate of exactly 23% could be achieved by reducing discretionary spending by “only 2.73%, a remarkably small adjustment”. Rather than determine what rate was necessary, the study report showed how to get to 23% as described in the legislation, which might have made AFFT and Linder happy, but seems somehow inappropriate, at least to me.
(8) Using finely tuned phrases, the study team effectively hid 12% of the cost to fund the federal government in higher state and local taxes. This is neither simple, fair nor transparent!
(9) One of the goals of HR25 of HR25 was to prevent multiple or cascading taxation, yet, the study team noted that the states could “tax the tax” in order to reduce the Fairtax impact on state and local budgets.
(10) The 31.3% exclusive rate, when applied by businesses to retail sales, will raise over $700 billion more than the revenue neutral goal of $2228 trillion. The Fairtax is not revenue neutral.
That’s my take and I’m sticking to it!
Cheers!
I did send the e-mail yesterday. I haven’t received a response yet from anyone.
Hank — I agree with you about Dr. Pete and some of the other folks over there. I know you and I and some others must irritate the heck out of Morph, Mark, Bradley and the like, but at least they let us have our say.
I agree with most of your criticisms of that study. I’m sure the BHI and LK get irritated at us as well by asking to defend some of their assumptions. Something tells me they know in their hearts that their study was seriously flawed, but they need to bite their tongues given their relationship with AFFT. I’ve had some lengthly discussions with LK, as I guess you have as well, and one on one he’s pretty open about the problems with the FairTax. I wish he would be a little more candid about its flaws in his public writings.
Regarding Post 43, points 4&7: interesting that a paper by Kotlikoff (quoted under another topic) concludes that sustaining a 23% rate requires an 18% cut in discretionary federal spending or, alternately, a tax rate of 26% would be needed to maintain real discretionary spending levels.
One of my problems with the study is the use of HHS poverty level figures as if they represent family budgets. That’s not a mathetmatical or theoretical problem - it’s a misuse of data both the census bureau and HHS state is for statistical use and not reflective of actual budgets. That doesn’t mean I’m in favor of giving anyone a “free ride” on taxes - it means I question every other figure and assumption used as well as the conclusions reached about real world implications.
Ellen,
I share your concerns!! Please provide the name of the Kotlikoff study you are referencing, or better yet a link?? I’ve read most of his stuff, but can’t remember the 18% number?
Thanks
Hank, here is where you will find the paper. Simulating the Dynamic Macroeconomic and Microeconomic Effects of the FairTax
If this address doesn’t work, just google Macroeconomic microeconomic FairTax and you’ll get several other links. At least one of those links sends you to a site from which you can download it free. This particular paper doesn’t go into detail about why 18% other than the fact that their model requires it to maintain that 23% tax rate.
What struck me in the paper was the conclusion that shifting the taxation burden to “initial older generations” from young and “future generations” is a key to the productivity gains and higher real wages predicted. It’s the first paper I’ve read of his that honestly spelled out that known generational shift of taxation.
Ellen, I think Kotlikoff would say that it is counteracting some of the generational shift of taxation onto young workers and future generations. From what I’ve read, he’s speaking of wealth taxation.
Morphh,
I’ll apologize in advance for the length and philosophical nature of this reply. While Kotlikoff might say it’s counteracting some of the generational shift onto young and future workers, another will argue that the “elderly” bore that same generational burden as they paid for prior generations with their income and payroll taxes. As has been said before, the FairTax is not the only or necessarily the best way to address that generational shift.
The wealth he’s talking about is the savings of the middle class retired and near retired. A quote: “the middle class and rich elderly finance much or most of their consumption from their accumulated wealth. The purchasing power of this wealth is reduced by the Fair Tax.” The elderly he refers to are the baby boomers.
In the theoretical world it makes sense to tax this wealth at a higher rate than occurs under the current tax system. In the practical world, it’s a shaky foundation. There are many baby boomers who planned retirement based on the expected tax rates for investment income supplemented by untaxed Social Security benefits. Many saw defined retirement plans replaced by defined contribution plans and health coverage disappear. For some that’s occurred too late in their careers to compensate for the resulting reduction in future available income. I haven’t seen data to support the assumption that the “middle class elderly” have the wealth to absorb the impact of a significantly higher tax burden without reducing their consumption. Nor have I seen studies to support the associated assumption that concern for outliving their savings will somehow disappear as medical costs, insurance, state and property taxes become a larger portion of their necessary expenditures.
If the FairTax calculator could accommodate income other than wages a clearer picture would emerge. I’m an early retiree living off taxable investment income and the calculator cannot replicate my true tax situation - I pay only capital gains, not income or payroll, tax. The calculator significantly overstates my tax burden by including both those taxes in the results. I will receive Social Security and the calculator can’t accommodate that income at all. The calculator is designed to show how much better off those who pay income and payroll taxes will be. It’s not designed to show those who live off their “wealth” that they’ll be worse off. That wouldn’t be consistent with the argument that the FairTax is fair for everyone. As a middle class retiree, I’d pay several thousand dollars more per year. Some would call that fair, I wouldn’t. We all get to define both wealth and fair for ourselves.
As I said, this is a somewhat philosophical argument but I think it might be helpful to understand why I see opposition to the FairTax by many “middle class retired” and near retired as well as those who understand the implications of using poverty level numbers as a surrogate for a consumption budget. These are separate but inter-related issues that don’t usually crop up in the technical or idealogical discussions of what’s good and what’s bad about the FairTax.
Now for a question: Kotlikoff mentions that Social Security benefits will be increased by 30% to preserve their purchasing power. Is that additional revenue requirement detailed separately in any of the research you’ve seen? I don’t recall seeing it.
Ellen — First, congratulations on retiring early. I keep trying to do that, but the “number” at which I would feel comfortable keeps exceeding my savings! Besides, I’ve got to set a good example for my kids. If they see me lying around all day I’ll never be able to make them study.
I believe that LK’s main argument is that the cost of paying the retirement benefits (i.e., Social Security) and medical benefits (i.e. Medicare) of retired folks and baby-boomers will pose a crushing burden to the workers of today and, in particular, tomorrow. I’m sure you’ve seen the numbers, social security taxes will need to rise to “x” percent of wages and medicare taxes will need to rise to “y” percent.
And, even though we’ve all been paying in to social security and medicare during our working lives, if you add up all of the social security and medicare contributions paid by retired folks and baby-boomers, it doesn’t come close to the value of the benefits they will receive. Thus, LK views the FairTax as shifting a portion of the cost of social security and medicare on the recipients — i.e., retired folks like you and Hank.
I don’t necessarily have a problem with that concept, except — as you state — the real burden will shift to middle class retired folks, who can ill-afford to see their tax burdens rise. Moreover, it’s not as if the FairTax would shift taxes away from working folks onto retired folks in some uniform fashion.
As I’ve argued over and over again, it would drastically reduce taxes on the wealthy — both the working rich and the non-working rich and their heirs —
and force both retired and working middle class folks to take up the slack. And if prices rose too much under the FairTax, wealthy retired folks could more easily move to, say, the French Riviera or San Miguel de Allende to live out their golden years FairTax free.
LK also says that the FairTax will be an “implicit tax” on wealth, because the value of savings will immediately decrease by 30% when the FairTax is implemented, though I think it will be fairly easy for the wealthy to shift their assets into non-dollar denominated accounts and equities, so they wouldn’t necessarily experience any decrease in the purchasing power of their savings.
In any event, if one really believes that retired folks should bear more of the burden of their upkeep, I think one less-drastic solution would be to replace the current Medicare tax with a consumption tax. The rate would obviously be much lower than the FairTax rate and thus less of a burden on everyone. You wouldn’t need to bother with a pre-bate. Workers would get a slight reduction in their overall taxes and businesses would benefit from no longer having to pay their portion of Medicare taxes. Alternatively, we could make all income (not just wage income) subject to Medicare taxes, so that capital gains and dividends that retired folks live on would also be taxed. I think a straight consumption tax would work better though.
Ellen,
As for your question about increased SS income, go to the “You Decide” thread and scroll down to the last two entries. I was quite surprised to read Section 303 in HR25 which deals with SS indexing. The bottom line is that the SS index, currently around 212, would be multiplied by 1.29% to adjust for the increase in retail prices/consumer market basket, provided the sales tax is not already included in the index. Which means that all government pensions would go up 30%, which is absolutely amazing to me. I haven’t thought this thing through, but offhand it would seem to increase the cost of government pensions significantly? So where is the revenue coming from?
Read Section 303 first, then the plain English version of Sec 303 on the AFFT site, and see if you can come to grips with the intent? At the moment, I agree with Morphh’s interpretation.
Hank....I had read Sec 303 and understood it was an effort to maintain the purchasing power of SS benefits. What I don’t recall is a remark or footnote in one of the many studies I’ve read that details what that increase added to the revenue requirement. I would think it’s a big enough amount to warrant a mention. I’ll have to go back to the studies to determine if it’s embedded in the overal SS revenue required - an odd choice given the detail in most of the papers. I’ve also pondered if the revenue needed for food stamps, child care or housing subsidies will rise to maintain purchasing power. I haven’t seen that possibility mentioned anywhere.
Hayden....you’re right - I do understand the issue of continuing to burden workers with paying benefits promised to older generations. The argument I presented is the flip side - the burden placed on middle class retired or near retired whose accumulated wealth isn’t sufficient to absorb a significant tax increase. You presented one of the other available options for addressing the issue; Hank has presented a different option. As you know, my point is simply that everyone doesn’t “win” under the FairTax and not everyone has the same menu of consumption choices. To some degree that menu of choices becomes more limited by age as medical needs increase. But choices are also an issue for those of any age who face higher regional costs of living, limited job opportunities or who have a family member with a lifelong medical condition. Just 3 of many possible family situations.
I can’t offer a solution to your early retirement “number” problem; but, I can tell you volunteer and charity work will fill your time and provide an excellent example for your children.:)
Hank,
I believe I have the answer to the cost of the 30% increase in SS benefits. I think it needs to be added to the revenue shortfall. There is a brief mention of the HR 25 requirement in the Tax Analysts Special Report detailing the 2007 FairTax rate. Apparently the actual dollars don’t matter because the intent of the FairTax is to raise the same tax revenues as the replaced taxes. The revenue to be replaced is $2,228b regardless of what expenditures are. One might ask why IRS “savings” were subtracted from gross revenue needed but that answer is clear. I do wonder why the additional SS benefit costs weren’t added to Table 6 that details revenue and expenses to arrive at a 2.73% revenue shortfall. I could assume that the 30% increase would add another $150b to the $500b for Social Security spending. That would result in an 8% shortfall instead.
But, I need some help with Table 6 because it starts with $2,586 in FairTax revenue raised on a base of $11,244 consumption. Table 5 calculates the 2007 tax rate using revenue to be raised of $2,228 on a consumption base of $9,355. Maybe someone could explain to me what the purpose of Table 6 is as it relates to 2007 revenues and expenditures. Too many numbers and too few obvious, to me, explanations.