How many “nonpayers” can the U.S. afford?
A newly released Tax Foundation study shows that while current law would give 33 percent of income tax filers zero liability next year, that figure would increase to 43 and 44 percent if John McCain’s and Barack Obama’s tax plans, respectively, were enacted in 2009.
In Tax Foundation Fiscal Fact No. 146, “Both Candidates’ Tax Plans Will Reduce Millions of Taxpayers’ Liability to Zero (or Less),” Tax Foundation President Scott Hodge estimates that while 47 million tax filers would see zero liability under current law in 2009, if all of McCain’s or Obama’s tax provisions were instituted next year, the number of “nonpayers” would rise to 62 or 63 million, respectively.
“Both the McCain and Obama plans would increase this number by expanding existing tax benefits or creating new ones,” says Hodge. “The 15 million filer increase in nonpayers under the McCain plan is almost all due to McCain’s health care credit, which dramatically realigns health care incentives and gives people a powerful motive to buy health insurance. Obama uses a longer list of smaller tax credit ideas, including a new ‘Making Work Pay Credit’ and a ‘Universal Mortgage Credit,’ to take 16 million filers off the tax rolls.”
The report states “It is time for a serious public discussion of whether it is desirable to have so many Americans disconnected from the cost of government and what the consequences are of using the tax system as a vehicle for social policy.”
I think you need to specify that those are personal income taxes. If you look at all taxes (payroll, excise, etc.) the number of people paying no taxes is much, much smaller - if not zero. The CBO data for 2005 shows that the lowest 20% of the population had an overall effective tax rate of 4.3%.
And with the prebate and a poverty rate of 12.3% in 2006, how many people would not be paying any taxes under the FairTax. I think if you looked at the actual taxes to be replaced, that number would go up.
And these people would not just pay no taxes, they would get money from the government. And if the FairTax rate increased, they would get more money. How would these people be anymore connected to the cost of government under the FairTax?
I believe the poverty level statistics show about 12.5% of households at or below poverty level.
This might go without saying to some, but I think it’s important to clarify that the assertions above regarding current tax liabilities and potential liabilities under the candidates’ plans are specifically referring to federal income taxes.
Of course, even taxpayers either totally exempted or highly limited in the amounts of federal income taxes owed, are not necessarily excluded from state income taxes, state sales taxes, local property taxes, state and local ad valorem taxes, medicare and social security taxes, highway tolls, various and sundry fees tacked on top of telephone bills/airline tickets and the like. In addition, many of these taxes are regressive in nature, and therefore, actually place a greater burden on those at the bottom of the economic scale.
However, if, in fact, fewer people are paying federal income taxes, then I don’t think that we should be surprised when, relative to the 2000 peak, the poverty rate is up, the middle class has contracted, and inflation-adjusted incomes are down for all but the top 10 percent or so.
We should note that, to the extent that we’ve had economic growth, as measured by GDP, since 2000...all the household growth has gone to Thurston Howell III and his wife, Lovey. In fact, the Howells have had so much income growth that it has offset the losses of everyone else on Gilligan’s Island. That, in a nutshell, is America.
If we want to eliminate any disparities in the federal income tax burden, then I believe that we should also examine disparities in household incomes and disparities in other forms of taxation.
While it’s probable you all have forgotten my study on this subject, I’d like to remind you that by my estimate, using 2006 tax data, less than 1 million workers reduced their income tax liability to near zero by using deductions, exemptions, and credits, and then completely offset their payroll tax amount by qualifying for the refundable EITC and Additional Child Care credits. Compare that number to the estimated 30 million workers that will pay no net federal tax under the Fairtax, due to the prebate, yet will still qualify for full pension and health care government benefits.
Is that good for the country? Absolutely not, imho. That is why I believe that it was a huge mistake to include payroll taxes on the list of taxes to be replaced by the Fairtax. In addition, it is also quite unfair for retirees to be forced to resume paying for their pensions after contributing to the SS Trust Funds for 45 years or so! At some point, we might revisit Fairtax-Lite and get more familiar with an income tax replacement plan that could really work?
I agree with the general proposition that everyone should pay at least some taxes, at least if they have an income. I think we all need to get upset when the government wastes our tax dollars. If a significant number of Americans aren’t paying taxes (whether its because the have tax-free municipal bond income, modest retirement income or are below the threshold for income taxes, they won’t be as concerned about how the government spends its money.
I also agree that we need to “expand the tax base” to include more people into paying taxes for the simple reason that we need the money. It’s not going to be easy when so many people are used to not paying taxes. Yes, many more pay social security taxes than income taxes, but most folks still probably believe that money’s going to a “trust fund” for their retirement. That’s why I am for a simplified, unified tax system — just not the FairTax.
Morphh,
A footnote to your statement in #2 above. While you may be correct about 12.5% of the population being at or below the poverty level, don’t forget that the Fairtax poverty level definition has very little resemblance to the HHS figures. Under the guise of eliminating the “marriage penalty”, the Fairtax plan drastically increases the number of people that would pay no federal sales tax. For instance, if a single person gets a prebate which offsets sales taxes up to $10,000, then the prebate doubles to offset $20,000 or so for a married couple. Under the HHS poverty level rules, the poverty level for a couple is only $12,000 or so. As near as I can tell, almost 50 million citizens will receive a prebate that will offset all federal sales taxes, and 30 million of them are working stiffs. This is a very bad concept for our country, imho!
FairTax.org: “The FairTax actually eliminates and reimburses all federal taxes for those below the poverty line.”
Forgive me if I’m restating something that the regulars here already covered, but in response to a couple of comments above, I wanted to add a reminder that, contrary to the advertisements, the FairTax prebate does not eliminate all federal taxes for those below the poverty line.
Since households with incomes at or below the poverty line, as a rule, necessarily spend 100 percent of their incomes (i.e. the marginal propensity to consume), including the prebate, such households would, in fact, pay taxes under the FairTax. As we know, when the prebate itself is spent, 23 percent of such spending would be tax (inclusive). The end result is that, under the FairTax, those living at the poverty line would be paying approximately 5.3 percent of their annual incomes in federal taxes and those living below the poverty line would be paying an even higher percentage of their annual incomes in federal taxes.
So, on the one hand, relative to federal taxes, the total disconnect under discussion wouldn’t exist under the FairTax. On the other hand, FairTax advocates’ (e.g. AFFT, Neil Boortz) advertising about the proposed prebate’s effect on the tax burden of those living at or below the poverty line is untrue.
Helena, this is dependent on how poverty level is calculated. Will the Department of Health and Human Services include taxation or exclude it when determining the annual poverty level? If it includes the tax, than the prebate already includes the offsetting factor for taxing the prebate itself. If not, than you are correct. Unlike the CPI adjustment for COLA in Title III Sec 303, the poverty level indexing is not directly specified, although it would seem to be implied through prebate intent and the inclusive specification of the tax. I expect this indexing would be specified in a final version of the legislation.
Respectfully Morphh, I don’t believe that one can reasonably dismiss the reality of the federal tax that would be imposed on households living at or below the poverty level under the existing FairTax bill by simply “expecting” a modification to this legislation despite the fact that FairTax sponsors and their well known promoters deny this reality (and advertise to the contrary).
With regard to the possibility that the calculation of the poverty line could be adjusted to offset tax paid on the prebate (not contemplated among the sponsors), the poverty line would have to be increased by at least 23 percent (e.g. to recover $1058 [23 percent of the prebate] if the poverty line is $20,000, the poverty line would have to be increased to $24,600). As a result, the total cost of the prebate would be increased by at least 23 percent, and any argument that the FairTax proposal could be revenue-neutral would be demolished. In addition, for those at or below the poverty line, this idea might reduce the significance of the issue, but not eliminate it since a larger prebate would mean a larger amount of tax paid on that prebate (kind of a vicious mathematical cycle).
Incidentally, taxes paid on the prebate wouldn’t only impact those living in poverty. It would also likely increase the advertised rate on most of the rest of us–some more significantly than others.
So, getting back to the original topic–if there’s a case to be made that all households, no matter how poor, should pay some federal tax to be connected to the cost of the federal government, then FairTax proponents are good candidates for the job of making that case since the existing proposal accomplishes exactly that.
Helena, Why do you assume that the poverty level figure would not included the tax? No where is it stated or suggested that it would be excluded. On the contrary, promoters state the prebate is indexed and specify the prebate amount for non-accommodation, which inherently would include the tax in the prebate amount. DHHS adjusts poverty level to price inflation, which is what would happen in a partial or full accommodation model. It may not be specified in the Fair Tax Act as it’s already directed in the Omnibus Reconciliation Act.
In a non-accommodation model, DHHS would hold the poverty level constant, rather than decrease it (same as the CPI adjustment). In a full accommodation model as you described, it would be increased (rather than holding it constant). Since incomes would also increase, holding poverty level constant seems very unlikely. They’ll adjust the poverty level to the final retail price including tax. If prices go up 17%, poverty level will go up 17%. The increased government revenue received from the price increases covers the government expense from that same price increase - this is reported by both Gale and BHI. Price increases from tax accommodation do not change the tax rate.
The FairTax covers taxes up to the poverty level. Using a family of four example with poverty level figures at $28,000 ($21,560 untaxed). A family that earns $21,560 (the cost of untaxed poverty level spending) will receive a prebate of $6,440, which brings them to $28,000 - the amount needed for poverty level spending (including taxing the prebate). They will pay no tax on these goods and services. If a family of four earns $28,000 and receives the $6,440 prebate, they end up paying $1,481 when you tax the rebate (or 5.29%). However, this is not poverty level spending - they’re spending $6,440 over poverty level ($34,440), so therefor the $6,440 is taxed at 23% as expected when spending above poverty level.
What it seems like you’re suggesting is that poverty level spending set at $28,000 does not include the tax. The family receiving $6,440 therefore is $1,481 under poverty level spending as the prebate gets taxed. This would suggest that in a full accommodation model, where prices increase by 30%, the poverty level remains the same and conversely that under non-accommodation, the prebate would be decreased as poverty level is adjusted downward with production costs. This is contrary to what is stated by FairTax sponsors and well-known promoters.
The answer to the discussion about the adequacy of the initial base poverty calculation for the prebate lies in the methodology set forth at Sections 652 and 673(2) of the Omnibus Reconciliation Act of 1981 and the regulations promulgated by HHS under those federal statutes. Those statutes are incorporated by reference at Article II, Section 303(a)(1) of the Fair Tax bill.
Anyone who cares to digest those sections of the federal statute for us would be doing this group a favor. The magnitude of the favor is highlighted by the general complexity of federal statutes and regulations - except, of course, for the Fair Tax bill.
~Jim Bennett
Summit, NJ
There is something very suspicious about the “poverty level” spending for the FairTax rebate. According to Morph, the povery level for a family of four is $28,000.
I don’t see how this could possibly includes heath care expenditure. The average health insuranc premiums for a family of four is $12,000 per year. When you add co-pays and deductibles to that number, it easily exceeds $15,000. So, after health care costs (assuming you can get and afford insurance), the family of four is left with a whopping $13,000, for food, clothing, shelter and transportation.
So, the calculation for the prebate must assume that the state picks up the tab for health care for the poor, which, of course, means that the fellow taxpayer must pay not only for poor folks health care but the FairTax on that health care as well.
So, if you assume that health care is one of the “basic necessities of life,” the taxes on which are supposed to be covered by the pre-bate, I think the FairTax folks have miscalculated again.
I don’t see that the individual purchasing full health care coverage is a common basic necessity for those at poverty level. The government provides health care to low income families through Medicaid and provides for the elderly through Medicare. Such expenses are covered by social programs and philanthropy, so they should not be included as a general expense to the individual to live at poverty level. Even without such programs, most would live perfectly fine without full coverage using just high deductible insurance for major events. So I disagree with the base assumption that such should be included. The federal government paying taxes to itself doesn’t cost anything additional - left hand to right hand.
Morph — Medicaid (and similar programs) is paid largely, if not mostly, by state governments. So when a state (or county) pays for medical services for the poor, it would need to pay the FairTax to the federal government on those services, which in turn will come out of the pockets of the taxpayers in that state.
Also, while those living in the poverty level who don’t have any assets and thus qualify for Medicaid might not have to pay for health care out of their own pocket, a middle class family who’s primary breadwinner loses his or her job will not qualify for Medicaid, unless it becomes impoverished. Thus, they will still need to pay for health care coverage out of their own pockets (as well as all of the other costs of a middle class lifestyle.) Moroever, since their employer wont’ be subsidizing it anymre, they’ll need to foot the entire bill (plus the FairTax).
The claim that the prebate will cover the tax on the “basic necessisites of life” implies that if you lose your job and just cut back a little you won’t owe any net tax liability. In reality, if you lose your job under the FairTax, you are totally screwed, because there are things you will need to keep spending money on (health care, insurance, utilies, rent, food, medicine) that someone who lives in poverty doesn’t need to pay for (or, at least, gets substantial assistance). The prebate isn’t going to be enough to pay the tax on everything. In fact the prebate will probably get used up paying the tax on health care costs alone.
In contrast, under our current system, as bad as it is, if you lose your job at least you won’t need to pay any federal taxes until you start working again.
The Fed matches 50% or more (depending on state wealth) of Medicaid. You would rather have no income under the current system, than receive something (monthly prebate) under the FairTax? The reason you wouldn’t pay taxes on under the current system is because you either have no income to tax or they’ve already taxed you on it (taxed at whatever income bracket you were in). You have no ability to cut back your tax costs when you realize the unfortunate. “Basic necessities” is a proponent buzz-word, nothing in the bill. The rebate allows you to spend up to the poverty level tax free. As Helen stated, the FairTax prebate actaully doubles poverty level for a family due to the marriage adjustment. To that point, the DHHS poverty level is really $14,000. If you have an issue with their definition of poverty - take it up with DHHS. These figures are used in many government programs. This is not a FairTax problem. The purpose of the prebate is that we don’t have to define what each person deems a necessity (otherwise we would just untax health care or food). This is by design. This will be all moot soon anyway since we’re headed toward socialized federal health care.
“This will be all moot soon anyway since we’re headed toward socialized federal health care.”
And not a minute too soon!
[Morphh releases a painful groan...]
The principles of the FairTax suggest that the system should not be used as a back-end method for the welfare of social programs. If congress wants a health care subsidy, they should develop a separate program outside of the tax code. As you describe, one method may be through a supplement to poverty level which includes basic health care costs, which would result in a larger prebate - there in lies the rub. Unfortunately, the prebate might be one of the most direct and efficient wealth redistribution mechanism ever created, but at least it will be transparent and applied uniformly.
Morphh,
If you are going to allow “painful groans” on this blog, then I refer you to the “Kepner Debates Boortz, Item #115″, and would have to say that your explanation (?) is worth several painful groans. The 10% business cost savings due to eliminating the income/payroll taxes have absolutely nothing to do with whatever tax system replaces the income tax. The cost savings are simply the result of bagging current law, and will remain constant no matter what follows. We agreed that the best one can hope for is around 10% in cost savings, 4% from payroll, 3% from income tax, and 3% from compliance costs, a very generous estimate in light of the many competing interests for the cost savings.
That is why I believe that using the Rice study, costs will go down 10% and the 39% added exclusive tax would result in a 25% average increase in retail prices. (1.00 x .9 x 1.39 = 1.25)
What possible explanation can you provide for believeing that the cost savings will somehow vary with the varying Fairtax rate. The two are not related! Retail prices will certainly vary with the Fairtax rate, but not cost savings, imho.
My explanation is that the FairTax rate is essentially a mirror of the taxes being replaced. I find it difficult to disconnect the rate from the cost savings, as the cost savings equals the taxes being replaced.
Hank,
There is significant correlation between the 22% embedded tax and 23% fairtax rate. I’ve been unsuccessful in my attempt to determine exactly what numbers Jorgenson used for the 22% (in the paper I saw there was only a chart, i.e. no underlying data), but it’s not unreasonable to think the same sort of methodology was used in both cases, i.e. take federal tax dollars as a percentage of some base.
We know that federal government takes about 18% of GDP (inclusively). If we consumed 100% of that GDP and that consumption was fully taxed, the fairtax rate would necessarily be 18%. If the fairtax base was 50% of GDP, the rate would be 36% (inclusively). That’s why, imho, the debate about rate can be posed as “What percentage of GDP is the fairtax base?” Once that is know, the rate is a simple mathematical equation. Let P = percent of GDP that is the fairtax base, then fairtax rate = 0.18/P.
How is it possible that the added tax cost of all goods and services of the federal government right now is 22%, but one would have to take 40% (or higher) of the same goods and services to get the same revenue? I’m not claiming the bases are identical, but they are related.
Morphh,
Assume for a moment that the income and payroll taxes were eliminated. I believe that you and I agree that businesses would save around 10% of their costs on average, and might dedicate those cost savings to retail price reductions, although there are many other competing demands for those cost savings. (I’m also aware that many on this blog simply feel that prices will rise by the amount of the sales tax, whatever that turns out to be.)
Now, please tell me why the amount/percentage of those business cost savings will change depending on the Fairtax rate? Am I to believe that if the Fairtax rate goes up or down, those savings will increase or decrease? Makes no sense to me, but I could be the only one on this blog that doesn’t get it?
Andrew,
I see little or no correlation between Jorgenson’s embedded cost of the tax system, and the Fairtax rate. One deals with producer costs, while the other deals with what rate might produce revenue neutrality. I also don’t know for sure how Jorgenson went about deriving his average 22% costs across around 15 industry segments, but my best guess is that he ranked the cost savings largely in terms of material costs versus labor costs. Notice that the service industry has a higher than average cost saving. Might be a clue?
I like your method of determining the sales tax rate as a function of GDP. Turns out we do know from the BHI/Kotlikoff 2006 study that the Fairtax consumption base used was 81% of the GDP in 2007. Using your logic and the fairly stable historic average that government spending is 18% of GDP, I could conclude that the Fairtax rate should have been .18/.81= 22.2%. But Kotlikoff also pointed out that the taxes to be replaced by the Fairtax represented only 16.4% of GDP in 2007. So, the rate should have been 20.2%???. Something seems to be amiss. Could it be the prebate? When included in the taxes to be replaced amount, the taxes as a percent of GDP jumps to 19.5%, and the rate would be 24%, pretty close to the 23.8% BHI came up with.
And if you really want to get carried away, how about taking the 2008 budget of $3 trillion, add $600 billion for the prebate, ignore the inventory tax credits, and assume a GDP of $15 trillion. The taxable consumption base would be $12 trillion, and the rate would have to be around 30% inclusive, 42% exclusive.
So what?
Hank,
Just to be clear, the 30% inclusive calculation you made is not for revenue neutrality, i.e. it’s not the fairtax. It is instead for an NSRT that still offers a prebate, but eliminates deficit spending. I’m sure you know this, but just in case anyone gets confused.
“One deals with producer costs, while the other deals with what rate might produce revenue neutrality.” The producer costs being dealt with are specifically the revenue that is trying to be kept neutral. In other words, those costs are the taxes.
“So what?” My overall point is that to meet the goal of revenue neutrality, the rate cannot take more than 18% of GDP with certain exceptions: the prebate needs a bigger percentage, economic growth will need a smaller percentage, evasion will need a bigger percentage, compliance cost removal need a smaller percentage, avoidance could go either way depending on the “real” price change (add in the prebate plus evasion minus compliance cost removal minus economic growth and whatever avoidance feeds into itself).
We must start publicizing how the current broken income tax system has contributed and encouraged the recent financial crisis. Getting the FairTax implemented will require political will and momentum: this crisis gives us an issue to seize to our advantage. The current tax code encourages excessive personal and corporate leverage (without the personal mortgage interest deduction or the corporate interest deduction systemic leverage would not have been so excessive) and discourages savings on a personal and national level (hurting household and national balance sheets). Linking the tax code to the current crisis will add a much needed urgency and momentum to the FairTax cause. Individuals are hurting, and in times of economic distress there is no better remedy than giving the People more control of their own finances; this is exactly what FairTax does.
Loose monentary policy created the environment that lead to this crisis, but tax policy (along with non-market based decision making at the GSEs and the FHLBs) stoked the fire and transformed monetary stimulus into excessive individual, financial institution, and corporate leverage. An immediate move to the FairTax would, in a single move, repair our nation’s waning economic competitiveness, out of control fiscal situation, and misguided leverage-encouraging policies. A move to FairTax will instantly decrease the risk-premium on risk assets, providing a much needed, permanent boost to the financial markets. Combined with more urgent bank consolidation and ratings agency reform, this crisis can be resolved in rapid order, which will benefit all Americans. The fact that policy-makers do not even understand that the current tax code encourages leverage and was the enabler of this crisis, shows how unintended the incentives stemming from a non-transparent, complicated income tax system rife with credits and deductions can become.
While consumption might tick down in the short term, hurting GDP and FairTax receipts, less consumption and more savings is a desirable macroeconomic policy goal at this stage of the United States’ demographic and economic development. Longer term, FairTax will minimize the volatility and pain of the boom-bust economic cycle, which in almost every case has been driven by or accompanied by a credit crisis and credit-fuelled boom in certain sectors of the economy (this time is more painful because the over-leverage is on the consumer and on the financial institutions instead of on telecom and energy trading companies). Moving to FairTax will permanently erase the Federal government subsidy on excessive leverage and thereby limit the inherent volatility in the economy.
Well said CF, I agree 100%. I would even go a step farther, initiate the Fair Tax at a 15% inclusive rate for the first year or two to get the economy going again, then worry about becoming revenue neutral. This would be a real stimulus package that would actually work.
26. I agree; well said CF. The ultimate stimulus package woud be the adoption of the FairTax. Every working person would get 100% of their earnings. Every citizen would be doing what the government is doing now, thrrowing money at every economic problem they have. Each of us, looking after our own families would do a better job than Congress can. Son or daughter going to college in 3-5 years? Better save. Are you getting too many contracts for your present staff? Better buy a truck and hire two more people. Want to sell the house when the housing prices turn around? Better fix up hte house. Shall we get a new or older home? Car is getting undependable? Should I get a new or used car?
Adopting the FairTax would not only abolish the income tax. It would allow us to answer these questions according to our needs and our own financial circumstances. We wouldn’t be penalized for savings or investments. We would pay a federal sales tax on a new house or car, but there would be no federal tax on used cars or homes. The money going into the economy would be earned money that would add value to the economy. It would not be confiscated (Tax) money from hard working americans!
Yes, the FairTax frees people. We don’t have personal freedom unless we have economic freedom. Our founding fathers knew this. That’s why they protested a few pennies’ tax on tea. We forgot that for awhile. During the past 75 years, we have tolerated ever more federal control over our finances and, therefore, our lives. It’s time that we took the control back by adopting the FairTax. Ted
After following the whole thread, I am glad to see people finally getting away from minutia, and focusing on the big picture. Whether the FairTax rate is really 22% or 24% isn’t really important. After all, if we are revenue-neutral, the federal government is already taking that amount of money from the private sector through some form of taxation.
The important point is the shifting of power from a cabal of government bureaucracies and self-serving politicians back to the public. If history teaches us nothing else, we should have learned that a centrally-controlled economy will inevitably failure. Whether by malfeasance, corruption, or simply because no “select group” is capable of effectively dealing with, and predicting, the billions of micro-economic decisions necessary for the efficient allocation of goods and services.
The FairTax, even as envisioned by the most pessimistic of critics, will still serve the public better then the socialism-lite being promoted in Washington and by the “enlightened intelligentsia”.
The real challenge for FairTax supporters is to educate the public on the failings of the current system, particularly with respect to the current crisis, expose the duplicitousness of those wanting to implement systems of even greater centralized control, and demonstrate the effectiveness of the FairTax in dealing with the real problems people are facing today, and can expect to face in the future.
Steve,
Having just reread “Atlas Shrugged” for the umpteenth time, I agree with much of what you wrote. A centrally managed economy just doesn’t work. As John Galt said when asked by senior government officials what help he needed to get things back on track, his answer was “Get the hell out of the way!”
I might add that your willingness to accept higher sales tax rates based on the revenue neutral argument may be flawed. Keep in mind that the Fairtax plan includes a $600 billion cash grant entitlement called a prebate, a $600 billion one time inventory tax credit, and an estimated $100 billion in a one time pension adjustment for all government retirees per HR25, Title III, Sec. 303. These costs are over and above just replacing the revenues needed to fund the government. The Fairtax really isn’t revenue neutral, but requires huge additional outlays in order for it to be “Fair”, imho.