The Cost on State and Local Government
Sometimes we discuss the debating point that a portion of the federal revenue is supposedly hidden in higher State and Local taxes. As we know, tax rates and even nominal dollars can be misleading. The true measure of a tax burden is the effect on your standard of living — the transfer of purchasing power from the individual to the government. I’ll argue here that State and Local governments will see little change in their real cost, making it no more hidden than today. Let’s go over some definitions first:
Real versus nominal value – In economics, nominal value refers to any price or value expressed in money of the day, as opposed to real value, which adjusts for the effect of inflation. Real values convert the nominal values as if prices were constant in each year. Any differences in real values are then attributed to the differences in the amount of goods that the money could buy in each year. Thus, the real values index the purchasing power of the money for each year.
Example (not compounded for simplicity and brevity):
Government collects $100 from a citizen earning $1000, taking 10%.
Now let’s consider 3 years of inflation at 3% a year, 9% total.
Government collects $109 from a citizen earning $1090, taking 10%.The nominal cost increase was $9, while the real cost increase was $0.
The real cost is $0 because the burden has remained consistent — no additional loss of purchasing power has occurred to the citizen and no gain in purchasing power has occurred to the government. Revenue was consistent with inflation and the real cost of government was unchanged. The government can’t buy more goods with the extra $9, and the citizen can’t buy less because he paid it — the inflation leaves both parties whole.
Income and sales taxes usually require no change to maintain real value as the tax base adjusts with the inflationary effects. However, some taxes do require periodic adjustment, such as land taxes. In that case, either the tax base is increased (reassessment of land value) or the tax rate is increased. Under a FairTax implementation, the States would need to do a one time readjustment of their tax base(s) or tax rate(s), convert to the FairTax system, or otherwise adjust their tax system in order to maintain the same real revenues (and real burden) due to the inflation (from accommodation).
Now let’s consider putting the FairTax into effect with a partial accommodation model assuming employees get gross pay and the rest is used for a 10% reduction in product cost, leaving a 17% exclusive price increase. The FairTax, like the current system, imposes a tax cost on government, which it does by taxing government purchases and payroll. Using the data from the BHI / Kotlikoff study, State and Local government consumption and investment is $1,659 billion. They also state that taxable spending is broken down to 59% for nonwages and 41% for wages. Given 17% inflation, which makes adjustments for purchasing power changes, $1,941 billion would maintain the same state and local burden on the citizens and collect the same real revenue. Less than $1,941 billion is a shift of purchasing power to the people (tax cut), more is a shift of purchasing power to the state (tax increase). The nominal increase of $282 billion would result in no change in real cost.
- $1,659 * .41 (% for wages) is $680 (wages and salaries)
- $680 * (7.65% employer payroll windfall) is $52
- $680 – $403 (tax free wages on education) $277 (taxable wages)
- $1,659 * .59 (% for nonwages) is $979 (nonwage consumption)
- $979 – $163 (tax free capital consumption) leaves $816
- $816 * 1.17 (17% price increase) adds $122 (nonwage taxes)
- $277 * 1.3 (30% on gross wages) adds $63 (wage taxes)
- $4 * 1.17 (17% price increase) is $5 (.25% State administration fee)
- $1,659 + $122 + $63 - $5 – $52 = $1,787 billion
The real cost of spending has decreased by $154 billion (8%) of almost 1.95 trillion, making the State and Local burden less than before.
This does not necessarily mean that the combined burden on the citizen is less — purchasing power changes should equal out under revenue neutrality. The offset would be reflected in the federal burden. Rate studies by William Gale and Diamond & Zodrow reflect this as they reduce the tax base on state and local education by an additional $300 billion, creating a higher FairTax rate and further reducing the real State and Local burden by $34 billion to $188 billion (9.6%).
So what does that mean for State and Local taxes?
The main tax bases used by State and Local government will not factor the inflationary effects from accommodation, resulting in a loss equal to the nominal cost increase – thus shifting purchasing power to the people from state and local government. In order to maintain real revenues, the state and local government will have to make adjustments to their tax system. State income taxes are applied on gross wages, which will not change. State sales taxes are applied on pre-tax retail prices, which will decrease by 10%. Unlike normal inflation, states and local governments will have to make a one time adjustment to their systems for the accommodation, which may include: raising tax rates, modifying the tax base, taxing the FairTax, conforming to the FairTax, land value reassessment, accepting some loss of real revenue, etc.
When the real value of the tax based is decrease by inflation, an adjustment may need to be made to collect the same real revenue in order to maintain the purchasing power of both the government and the citizen. The rate may be higher, the base broader, or the system changed altogether, but it comes down to the simple question of whether you have more, less, or the same dollar value in your pocket and the impact on your family. The state and local government should continue to impose approximately the same burden on you before and after the FairTax.
A more detailed economic analysis can be found in the BHI/Kotlikoff rate study. Section V discusses the State and Local government and the need to maintain real revenues.
Morph,
Nice post. One minor correct (I believe) in the inflation example you give. If the inflation rate is 3% per year, then after 3 years of inflation shouldn’t the amount collected by the government in taxes be $109.27 and the nominal cost increase $9.27? Each year the original $1000 increases by 10% over the previous year, so:
Year Amount Tax
0 $1000 $100
1 $1030 (1000.00+3%) $103
2 $1060.90 (1030.00+3%) $106.09
3 $1092.73 (1060.90+3%) $109.27
Doesn’t change your arguement. If you rounded to the nearest $ then ignore this comment.
John
Yes John, I did consider that and thought about putting non-compounded in there to clarify, I left it out for simplicity and space. Glad you picked up on it though.. you guys are paying attention.
I’ll add the clarification and I also have a correction that I need to add – made an error with government wages on education, so stay tuned.. I’ll update it in a couple hours.
Wouldn’t it be smarter to simply tax the land value — collect a significant share of the economic rent on land, whether it be owned by individuals, corporations, foreign investors, pension funds or REITS, and use THAT steady revenue stream to fund our common spending.
It would be fair. It would be simple. It would be efficient. It would be equitable. It would not be easily evaded. It would also have very desirable incentive effects: well-located land would not sit waiting for the speculator to be good and ready to sell; rather, it would be put to use now to meet human needs. Land on the fringe would not be prematurely developed (which we call sprawl and long commutes and new infrastructure needs).
And wouldn’t it be nice not to pay a tax on your wages OR on every penny you spend to meet your needs?
Every dollar we spend on good schools raises land values. It increases the amount that tenants pay landlords and which landlords mostly get to pocket. It increases the amount that buyers pay sellers, and which sellers mostly get to keep. It increases the amount that buyers must borrow from lenders, and must pay back, with interest, for 30 working years of their too-short lives.
There is a better way. Fund that from land rent. Recycle the land rent, rather than letting it be someone’s private treasure and then taxing wages or/and sales.
This is not a new idea. But it is a wise and just one.
Ok, I updated it. I had excluded education wages since they are untaxed, but forgot about their reduction of employer payroll taxes. So I had to add that back in to show the reduction. I also clarified, to John’s point above, that the first example is not compounded for simplicity and brevity. I also color coded the second example to try and make it easier to follow.
Updated again… similar to education, added capital.
Morphh,
It doesn’t seem conceivable that two fair minded, unbiased Fairtax observers such as you and I could come to two such differing conclusions about the impact of the Fairtax on State and Local governments???
But, we have, so I’m going to try to explain why. My simply analysis assumed a 17% price increase and applied that increase to S/L purchases of goods and private services, and then calculated the net increase in payroll costs assuming burdened payroll amounts. My conclusion was that there would be a nominal increase in S/L consumption costs which would require the current S/L average sales tax of 6.5% to be increased to 8.5%.
You assumed a 17% inflation rate, and then proceeded to show that in real terms, the cost increases would be less than 17%, resulting in a tax cut for everyone. That result should not have been a surprise because you added over half a trillion in untaxed wages and capital to your equation. You also did not include the burdened amount of wages per the definition in HR25. Had you done so, the result would have been an increase in real costs which would have required a tax increase for everyone? Confusing?
I don’t believe we are dealing with the classic inflation here, but a unique, never before experienced retail price increase caused by a new federal government tax system. After all, producer costs would be lower and, according to LK, taxes are not included in the GDP so the GDP will contract by 10%, not the usual signs of inflation?
This might be a good time to also mention that the whole monetary accommodation thing probably doesn’t apply in the Fairtax case. Over $2 trillion in cash will flood the markets annually due to the elimination of income tax and payroll contributions as well as the $600 billion prebate. Am I to believe that the business checks currently sent to the federal Treasury to pay for the withholding is somehow not money. Why does Ben Bernanke have to worry about the money supply? It seems to me that the necessary cash/money to support a price increase is already in existence? Please explain why the Fed needs to get involved?
It seems to me that raising the State/Local tax rate would be a burden on all citizens. I don’t think you have adequately explained just how inflation factors would actually result in a tax rate reduction. Sorry, but it makes no sense to me.
I have written John Linder a letter asking him to clarify the burdened payroll language in HR25, and I hope he responds promptly?
Hank, My thought on burdened payroll is that regardless of whether it is wages, benefits, insurance, unemployment or workers compensation, it has to come out of the government’s base consumption today. It’s not an increase in consumption – it’s part of the current 100% (they pay these things today). So is it in the 41% or the 59%? Does it matter?… they’re both taxed – perhaps it matters a little bit as they have different offsets. If you want to increase the 41% and decrease the 59%, I don’t have an issue with that if you can give some figures for the difference.
Of course I included the tax free wages in the equation as it has to be included in a comparison with the real cost of today. They’re not tax free today, so we have to show this reduction to S/L cost.
I did not state that tax rates would reduce – I said the real tax cost/burden would reduce. Getting gross pay is not a windfall — you don’t get to keep it. FairTax people seem to get excited about gross wages, but it really doesn’t matter — it shouldn’t give you any more money. Net wages, gross wages, some other amount doesn’t matter – the government is still going to take the same real amount from you. If you get gross wages, that just means they’re going to take more nominal dollars from you. In this case, S/L government would have to raise their tax rate to do it (since their tax base wouldn’t auto-adjust), but no one is getting away with anything. The citizen is not going to get more money before/after and neither is the State. A windfall gain from gross wages is a illusion. The government is going to get its piece of pie. The slice of State/Local pie in relation to the whole pie is less, but the slice is bigger than before as the whole pie got 17% bigger.
If GDP does not include taxes, how can it decrease by 10%? The 10% reduction is mainly from the removal of taxes. I don’t know the reasoning for why the Fed would need to get involved.
Hank,
I think you’re misunderstanding what Kotlikoff stated. He said “raise tax rates” not raise taxes, there’s a difference as he states it is to “recapture the lost revenue” because “purchasing power is fully transferred to state and local taxpayers from state and local government”. “Despite suggestions to the contrary, implementation of the FairTax, including the requirement that state and local government pay the FairTax on their purchases, entails no reduction in state and local real spending, provided those governments adjust their revenue collection so as to continue to collect the same real revenues.”
Let’s step through it…
1) Do you understand and agree with the small example in the beginning of the post regarding a 10% tax?
2) Do you agree that it would be a tax decrease if the government received less than $109 and the individual kept more after the three years, likewise a tax increase if the government collected more than $109 and the individual had less?
3) A tax is primarily two parts: tax rate and tax base (tax base * tax rate = tax). Do you agree that changing either the tax base, the tax rate, or both can result in a increase or decrease in tax?
Morphh,
OK, you may be making progress in my continuing education. I’ve read and reread the Kotlikoff/BHI chapter 5 until I’m going blind. I can read, but I still can’t understand why raising the tax rate isn’t the same as raising taxes.
Tell you what, how about completing the following sentence in 20 words or less with no equations, no charts, just plain old English.
The Fairtax transfers purchasing power from State and Local governments to State and Local taxpayers by:—–
Another question that I was reminded of in researching the history of this issue is one that deals with monetary accommodation. Why does the Fed have to do anything about monetary accommodation when literally $trillions are dumped into the economy due to the increase in take home pay? That additional pay seems to me to be adequate to support the inflationary rise in prices?
Hank,
Completing the sentence: The Fairtax transfers purchasing power from State and Local governments to State and Local taxpayers by reducing the cost of production and thus decreasing the state and local sales tax base. Decreasing the tax base decreases taxes paid and increases taxpayer purchasing power.
You stated “I can read, but I still can’t understand why raising the tax rate isn’t the same as raising taxes.” It’s because the tax rate is only half of the equation (tax base * tax rate = taxes). Raising the tax rate doesn’t raise taxes if the tax base decreases to offset the change in the rate. Example ($10 * 10% = $1) or ($9 * 11% = $1)
Consider your property taxes when the county reassess your tax home value by 15%, raising your taxes but not your tax rate. They changed the tax base (home value) and you have less money in your pocket because of it. The FairTax decreases the sales tax base for state and local government (10% for example – reduction on product cost). So if they reassessed your home value for 10% less, it would be a tax decrease – you would have more money in your pocket. What if they decreased your home value by 10%, but raised your tax rate by 1% – giving you no more and no less $, giving the government no more and no less $?
This is what happens with the FairTax. The state sales tax base decreases from the reduction of production cost, meaning that the citizen now has more money (just like the home reassessment decreasing by 10%). For the state to collect the same amount of revenue, they have to raise tax rates (11%) or change their tax laws to restore the purchasing power. So the state is collecting the same amount and the individual is paying the same amount. The rest is just inflation as described in the first example based on the accommodation level.
As far as the monetary accommodation, I can’t say I fully understand those principles and why they would need to make an accommodation for the tax.
OK, Morphh,
I think I’ve got it, but let m,e play it back using some actual numbers.
The Fairtax lowers producer costs by 10% which results in a 10% revenue shortfall for the State/Local governments. If the States take no action, not only will my take home pay rise by the amount of my income tax withholding. payroll contributions, and the Family Consumption Allowance, but I would get an added benefit from lower State taxes. So, holding their tax base constant, States raise their tax rates by 10% , taxpayers lose that added benefit, and everyone is whole. In Florida, assuming the base is average, then the current 6% sales tax would rise to 6.6%. Am I correct so far?
But, Morphh, what does any of this have to do with raising the dollars needed by the States to pay for the 17% increase in retail prices? Won’t the State of Florida have to tack on an additional 17% to their 6.6% rate, making the final rate 7.7%? Isn’t that what I have been claiming all along? States will have to raise their rates-or tax the tax, or reduce services in order to balance their budget. Where is the money???
Yes, Hank you’ve almost got it. Consider a non-accommodation, instead of a 10% reduction, you have a full reduction and the State would have to adjust. The same thing is happening with the 17% but it’s on the other side – inflation. You’re correct that they would have to tack on an additional 17% to their 6.6% rate (7.7%) or tax the tax (@ 6%).
Where I think you go astray is that this does not result in a tax increase by the State. Again we look at the tax base. A tax base needs to adjust for inflation, otherwise it will collect less real dollars each year. This normally happens automatically as retail prices and incomes increase and sometimes it doesn’t (home value reassessment). With the transition to the FairTax, the sales tax base of state and local government would not automatically adjust for the 17% increase in incomes and prices. This increases the purchasing power of the individual, and decreases the purchasing power of the state. Therefor, to retain real revenue, they have to make a one time adjustment to account for the inflation.
This goes back to the first example in the post. Both the individual and the state need to remain whole – with neither party gaining purchasing power via the other. To do this, the State and Local government have to adjust their tax to the new tax base in order to collect the same real revenue. In the post, I show that using the full adjustments results in the State and Local government taking 6% more, so the increase would not have to be the full amount but an adjustment would have to be made (maybe 7.2% for Florida), which would result in a real tax burden decrease by the State and local government.
Your last question “Where is the money???” is certainly valid. While the state does not increase taxes, there is certainly a transfer of purchasing power that has to take place from the individual to the state to maintain real revenue. Meaning, the State needs to take a piece of your income windfall. So this should be computed in your ultimate tax burden and purchasing power.
Morphh,
You have done an admirable job of trying to explain why the States won’t have to raise taxes in order to pay the federal sales tax on their consumption.
But, your statement that “the State needs to take a piece of your income windfall” is just the same as saying the States will have to raise taxes. You have made the case that I’m not going to get 100% of my gross pay as advertised by AFFT, but when State costs are added to the hopper, some of my “windfall” will go to the State through higher tax rates in order to pay the federal tax tab.
I guess we can move on, but I’m going to continue to claim that unless the Supreme Court finds federal taxation of State and Local consumption inappropriate or unconstitutional, then the State and Local governments will have to raise tax rates in order to pay the federal tax. Alternatively, the States could tax the tax, increase the tax base, or reduce services in order to balance their budget.
Hank,
You state “You have made the case that I’m not going to get 100% of my gross pay as advertised by AFFT, but when State costs are added to the hopper, some of my “windfall†will go to the State through higher tax rates in order to pay the federal tax tab”.
You do still get 100% of your gross (no taxes are withheld). You then spend your money and when you spend it on taxable goods, you pay taxes. As Morph explained the actual dollars you are paying to the Florida will change, but purchasing power should not.
John,
In 45 of the 50 States, you never were going to get 100% of your gross pay. But I think we all understood that State income taxes would likely still be withheld. The point I was trying to make was that after tax purchasing power is going to be further reduced due to higher State/Local sales tax rates. The issue we are addressing is the impact on S/L governments, and I still claim there is one. The price of almost everything S/L governments purchase is going up, and the money to pay the federal tax causing the higher prices will most likely be raised by higher taxes, although there are other options.
Sorry about the sloppy writing on my part!
Hank, I think you may be missing the bigger picture. You don’t get to keep any of the windfall. 100% of your paycheck is an illusion, an advertising gimmick. We know that it doesn’t matter if you get gross pay or net pay, it’s the same burden. You’re not 17% richer, and not poorer based on State adjustments. The only thing getting gross pay does is increase costs by 17%, including government – negating the entire thing. It goes right back to the government (Federal, State, and Local). It’s a matter of shifting purchasing power and the tax bases. But it should be computed to understand and compare.
Increasing the tax rate is not in order to pay the federal tax tab, not anymore than it is today. They’re not paying any more to the Fed under the FairTax, in fact, they’re paying less. As described in the post, it’s a tax decrease at the state level, even though they have to raise the tax rate because of the base change. So it would be incorrect in my view to suggest the States have to raise tax rates in order to pay the federal tax. This implies an additional FairTax cost at that level that doesn’t exist – the cost already exists and we have to adjust to maintain it.
Morphh,
O.K, although I don’t agree with some of your comments, I think I now have the “big picture”. Some or all of the “windfall pay increase” caused by eliminating the individual tax withholding will have to be recaptured by the States by raising rates sufficient to cover both the lost revenue from the producer price decline and the increased purchasing power needed to pay the federal tax on State consumption.
You are going to have to explain why you think the States would pay less, not more, under the Fairtax. The only federal tax the States pay now is the 7.65% payroll tax. Under the Fairtax, the States would have to pay for a 17% increase in the price of their consumption. How is that less?
All of which leads to a question about just how much of the “windfall” is going to be eaten up by higher retail prices and the increased State tax rate? Is the transfer of wealth from individuals to the States really a wash?
Using data from the Kotlikoff/BHI study, the Fox -Murray study and the Diamond- Jadrow study, (an approach that might cause any competent analyst gas pains?), the individual windfall including income tax, payroll tax, estate tax, and the Fairtax Family Consumption Allowance add to $2262 billion. (that is why I don’t think monetary accommodation matters?).
A 17% increase in the $9235B private consumption comes to $10804B, an increase of $1570B. Fox-Murray estimates that the added cost to the States of the Fairtax would be $346B. Total added costs would be $1916B, leaving $346 billion on the plus side of the “windfall”. Distributed over the 115 million family units, that comes to $3000 per family, and would support AFFT statements such as the Fairtax would be good for everyone, (on average).
However, what if the Diamond Jadrow study is correct and the exclusive rate turns out to be 38%, and retail prices rise by 24%.? Redoing the above estimates results in a net loss in individual purchasing power of $300 billion, or a net burden of $2600 per year per family. That wouldn’t support AFFT marketing claims.
Hank, I show in my original post line by line what the cost is to the state and how they would pay less by $118 billion in real dollars. One large factor is that over $500 billion is tax free. A nominal calculation is meaningless.
Morphh,
I’ve spent more than a little time trying to understand your analysis (again), and I have some disagreements.
Your total current State/Local spending of $1659 B looks to be too large by $163B. You added in a capital consumption allowance(?) which maybe shouldn’t be included? Next, you inflated the $1659 by 17% to $1941, calculated the increases and decreases for each sub item of education, investment, goods, services and the fee, and concluded that since the total of $1823B was less than the inflated cost of $1941B, the tax burden on S/L was $118B less under the Fairtax. I don’t agree!
By inflating the entire consumption and then determining the actual increased costs, what did you expect to find? Because the actuals included tax free spending, the actual cost had to be less than the inflated estimate.
My study of some years ago had identical cost increases for each of the sub items except I forgot the fee. I’m in agreement that the after tax consumption by S/L governments would be $1823B. However, I compared that number to my baseline current estimate of $1496B, ($1333 + $163), and found that the total increase in S/L spending would be $327B. That is almost identical to the increase reported in the Fox-Murray report.
I have been writing that there would be an impact on S/L governments which would require increased tax rates or other possible solutions. You have been correcting me by insisting that not only would the S/L tax burden be less, but the solution would be simply to shift some of the windfall from taxpayers to the government, thus leaving everyone whole. Frankly, I think what we have here is a typical distinction without a difference? And it does lead to another question as to whether or not taxpayers would have sufficient added income to handle the increased retail costs.
You may have noticed the latest Fairtax Friday survey question about the importance of taking home 100% of gross pay? I think it’s very important but for reasons AFFT may not agree with. AFFT has been saying that the increased pay would save homeowners from bankruptcy, increase savings, etc. etc. I think the increased pay would not even offset the retail price increase, and if it were not for the FCA, everyone would be in deep trouble economically.
Hank, I’ll double check what I included in the math, but we do have to compare the real value, not the nominal value. I completely agree that the nominal value will increase, but that doesn’t tell your the impact on purchasing power. It may be easier if we used a non-accommodation model for the calculation. What you were writing was that S/L government taxes would increase, not tax rates, which I think we’ve clarified the distinction. Also, my premise was that the State’s tax base decreased, so people would be paying less even in nominal dollars. Inflation is another matter and completely dependent on the accommodation.. either the tax base includes inflation or it doesn’t. Not adjusting for it would be giving a windfall to the individual from the S/L government. It may take me a little time to reread the Kotlikoff and Murry/Fox papers – then I’ll comment on the accuracy of figures.
Morphh, Good idea. While you are rechecking the data, lets try to agree on what “real” means. For instance, I expect retail prices to rise by a nominal 17%, but if income rises by at least that much, then real prices would be unchanged. (We need to take care to understand what happens to those lower income workers that don’t get as large a pay raise due to not paying any income tax currently.)
Now as to State revenues, the reduction in the tax base by 10% due to eliminating business tax costs means that nominal tax collections are reduced by 10%, but by raising the State tax rates, real revenue can remain the same. The same result could be accomplished by widening the tax base or taxing the tax.
Have I got it about right?
Hank, that all sounds correct to me. I’ll add that inflation through accommodation measures will affect retired seniors more than workers, as inflation decreases the value of savings.
I updated the figures. Here are the old figures, just so we have them as reference.
The change was based on Stephen Eldridge’s comments to me in an e-mail “line 4 you start after the 163 above. The 59% & 41% ratio must be adjusted. You took the 403 teacher salaries out of about 680 in total salaries (41% of 1,659). Of the remaining 1,093, 816 is non-salaries and 277 is salaries.”
Thinking about this a little more, there are a few flaws in in the new bit I added under “So what does that mean for State and Local taxes?”. It makes no assumption on the percentile of state and local workers on income taxes, it does not adjust current taxes upward by 1.17 for purchasing power changes in order to present an apples to apples comparison, and the 15% figure does not account for income taxes paid on state and local pensions.
I’ll try to work on these later this morning.
Ok, so I’m thinking that I can assume that state and local employees are not part of the top 5%, so they make less than $159,000. This reduces the base of income tax revenue by 59% from $1,101 billion to $341 billion * 15% (size of state and local workforce) = $51 billion (income tax revenue paid by state and local workers). $65 billion in payroll taxes puts my estimate at $116 billion for those two areas.
If you know of a paper that describes the actual income tax revenue paid to the Fed of state and local employees, please let me know.
$116 billion need then be multiplied by 1.17 to present an apples to apples comparison based on purchasing power changes, which puts the comparative number at $135 billion in real dollars.
What is the bigger question to me is how much income tax is paid on retirement pensions, which would be outside of the 15% employed by state and local government. The percentage of revenue used by a state to fund pensions seems significant as a total of state revenue. Here are some papers on it http://www.kellogg.northwestern.edu/faculty/rauh/
I’ve removed the newly added bit of comparison on taxes paid until we can figure it out a bit more regarding the current tax revenue paid in by State and Local government employees and pension recipients.
Morph,
I’ve read and reread the 25 posts plus the original article, and I still don’t get it. So at the risk of getting up your dander, I’m starting all over. My new analysis doesn’t require anyone to understand real versus nominal, doesn’t require any higher math, and doesn’t use words over two syllables. Here it is:
From the 2007 Kotlikoff/BHI “What Rate Works” study, State and Local taxable spending was $1093 billion. The 23% sales tax reduces spending power by $251 billion. 41% of S/L spending is for pay, so 1093 x .41 x .0765 = 34B in S/L FICA payments. Getting rid of their FICA share of $34B reduces the sales tax burden to $217B. That is 19.9% of spending. All S/L taxes have to rise by 19.9% in order to pay the federal tax bill.
What am I missing?
Whoops,
Remember, no one is perfect?!? The last sentence should read “All S/L taxes have to rise by 16.3% in order to pay the federal tax bill (and keep spending at the same level).
Sorry! I used taxable spending instead of total spending. Getting old!
Hank, you’re mixing accommodation models. If it reduces spending by $251 billion (non-accommodation), it assumes a couple more things that you left out. State employees take home net pay, which means the state gets to keep the full federal income taxes and the employee half of payroll. This model also assumes prices remain the same as costs decrease, so there is no additional cost on consumption.
Morphh,
Accommodation is a four syllable word and played no part in my analysis. The reduced spending is due to the increased tax burden, so the States have to raise their taxes to make up the shortfall. To my way of thinking, everyone gets their gross pay, not net, and prices can increase 17%. Doesn’t matter because I’ve already accounted for the sales tax impact by raising S/L taxes.
As for accommodation, since you raised the subject, why does the Fed have to do anything? Between the employees increased take home pay and the prebate, over $2 trillion in cash would be available to be spent. That $2 billion can easily support a 17% retail price increase with no action by the Fed. I think the accommodation issue is a red herring, but at my age, I could be wrong.
If you’re raising prices by 17%, then employees take home gross – they have more income. The state, like retail goods, must also rise by 17%. This is inflation. You’re gross pay is not a pay increase. The cost of life, including state taxes, will be raised by the same amount, leaving all parties whole. If your pay went up 17%, but your state taxes didn’t, then you would receive a windfall gain, essentially a huge tax cut as a percentage of your purchasing power. The state must raise the same amount of revenue based on the inflation. In most cases, the state doesn’t have to change anything because inflation is built into their tax system, but in this case it’s not, so they would make a one time adjustment to get the same revenue.
Also note that if you’re raising prices by 17%, then the tax doesn’t reduces spending power by 23%, since costs reduced by 10%, your purchasing power is only reduced by the remaining 13% or $142 billion.
Hank, I use accommodation in the generic sense of prices / pay allocation. The Fed increasing or decreasing the money supply for such changes is a side discussion.
Morphh,
No, State spending power is reduced by more than 13% because they don’t save on tax costs as much as a business that pays income taxes and payroll contributions. Where we assume businesses reduce costs by 10%, the State government can only reduce costs by 3.1% or so. What cost savings do the State have other than their FICA share? (.0765x.41=.031)
Hank, true but they also get breaks that business don’t get, like exempting a large portion of its workforce and not charging the FairTax on their services. I’m not sure it’s a matter of their cost but the cost of goods they consume. The goods they buy will be 17% more expensive than today, thus the change of purchasing power should be equal to the difference between today, along with taking into account the cost of goods and revenue changes, but it’s a different way to look at it, so I’ll have to compute on that.
Here is an example regarding the decreased tax base, which is the reverse of the inflation. Let’s say that prices stay the same. The state will have to raise its tax rate, but not raise taxes. If today they earn 5% on $100, they take home $5. Since a state sales tax is on the pretax price, the cost of the good would drop to $77. At the same 5% rate, the state just lost money – they now collect $3.85. So the state would have to either, tax the FairTax to get the same $5 or raise their tax rate to 6.5%. Neither of these are a tax increase – it’s a rate increase to collect the same amount of revenue – $5. This is what is happening – critics see the tax rate increase and equate it with a tax increase, which is not the case because the tax base changed. Your tax burden is the loss of purchasing power from your pocket, not the rate – be it 5% or 6.5%, it’s the same $5.
Morphh,
Back to simple basics. Do you agree that 23% of $1093B is $251 B? Do you agree that if S/L payroll was 41% of taxable services in 2007, then getting rid of the government share of FICA would have saved $34B? Wouldn’t the net cost increase for federal sales taxes have been $217B in 2007? Wasn’t that 16.3% of all S/L consumption in 2007? Doesn’t that mean that if governments retained their level of spending ($1333), that all taxes would have had to increase by 16.3% in 2007?
Provided that S/L taxes were increased by 16.3%, the new federal sales tax bill would have been paid and spending could have remained the same. Now, you can point out that the producer costs were forecast to drop by 10%, and the S/L governments would have collected too much revenue. That is theoretically true, but as Karen Walby wrote, “prices are sticky downward.” While the tax bill was an immediate cost, the producer cost reduction would take months if not years to stabilize. The 50 State Treasurers would have to be insane to count on the 10% cost reduction from square one. After a year or so, if costs did decline, an adjustment to the 16.3% tax increase could be warranted.
Morphh, I know this is simple squared, but I fail to understand how anyone can make a case that the Fairtax does not significantly impact State and Local governments. S/L governments will have to raise taxes, reduce services, or “tax the tax” in order to continue to operate at the same pre-Fairtax level of spending.
A 16.3% percent tax rate increase would be warranted, because you have 17% inflation, but that does not mean it is a tax increase. That’s the problem – you’re doing half the equation. I don’t know how to make the math any simpler, but if prices and wages rise by 17%, then taxes too will rise by 17%. This does not mean the real cost of goods or taxes is higher. That is the meaning of purchasing power and the direct meaning or real vs nominal. If you get a 17% raise, then the cost to you, the purchasing power you loose to the state and the goods, remains the same. The cost in purchasing power is not increased.
Here is another example.
To maintain that the State can buy 10 widgets and the citizen can buy 100 widgets, the State must increase its nominal revenue by 17% so that real revenue and the tax burden can remain consistent.
Morphh,
“if prices and wages rise by 17%, then taxes too will rise by 17%. This does not mean the real cost of goods or taxes is higher.”
I certainly agree with you. But prices and wages are not going to rise 17% for all of us.
(1) Prices will be initially 23% higher, and may eventually drop to only 17% higher, but being “sticky downward”, it is going to take months or years for producer costs to stabilize at 10% lower. And, perhaps never depending on supply and demand. For sure, it isn’t going to happen overnight! Also for sure, goods and services will have an inclusive 23% sales tax added on day one, except for existing inventory.
(2) Wages will adjust overnight, but the only adjustment retired middle class seniors will see is the prebate. And, the prebate isn’t going to offset the 23% federal sales tax plus the estimated 1% increase in State and Local income, sales, and property tax rates. Retired middle class ($30K-$100K) seniors are going to take it in the neck!
Morphh. pretend you are a State Treasurer, and you have been advised that on Jan 1, roughly 82% of all your State government spending is going to be taxed at an inclusive 23% rate. You also will not have to pay the 7.65% FICA on your employees. After deducting the FICA savings, you figure that you will have to raise all sales and income tax rates by 16% in order to be able to spend your annual budgeted amount plus pay for the federal sales tax. What do you do? Taxing the tax is a poor choice and violates one of the federal goals of the sales tax. Reducing services will get you fired, and raising taxes may be just as bad for your job security. What a Hobson’s choice.
I believe that you will raise all State tax rates by a full 1%, and try to get the State legislature to approve a retroactive implementation ASAP. As producer costs drop, you may be able to lower your tax rates, but it is going to take some time.
Morphh, the widget exercise makes some sense from a theoretical perspective, but that State Treasurur can’t deal in theory or widgets. As a practical matter, the Federal sales tax is going to impact S/L government spending and taxes. There is no free lunch.
(1) The FairTax provides an inventory credit, so that this can happen more quickly.
(2) This is not an argument on the cost of State and local government – different debate.
(3) Since the FairTax is intended to be inclusive, I’d guess the state would probably just include the FairTax as part of the good cost, just as income taxes are today. It does not violate the Federal goals, since the Federal goal only applies to itself and has no control over what a state taxes. It is inline with the other changes to goods and services for the transition. Problem with this method though is that if the Fed raises or lowers the tax rate in the future, it effects the state revenue positively or negatively. So maybe you’re right on the path they’ll choose by adding 1%.
The State Treasurer has to deal in theory and widgets – that’s part of their job. What is practical is that the citizens don’t get a windfall – as you say, there is no free lunch. I never said it wouldn’t impact the state and local government – they will have to make adjustments and I agree this could be a perception challenge for states. My argument was that the adjustment is not a tax increase and such is not “hiding” the FairTax via increased state revenue, which is what you continually repeat. If they don’t make such an adjustment, the citizens (as a whole) get a tax decrease.
Morphh,
If those adjustments aren’t tax increases, what are they? What is the perception challenge you wrote about? The citizens won’t get a tax decrease, their taxes remain the same unless the State makes “adjustments. If their tax rates remain the same, then they would see a decrease in State services because the States are then short over $200 billion in revenue which went to pay the federal tax.
Are you shitting me? Seriously!? I give up.
Morphh,
I’m certainly fine with that, but I will continue to claim that federal taxation of S/L consumption is not only unconstitutional, but also hides 10-15% of the federal revenue raised in higher S/L taxes. Or alternatively, cascading taxes or reduced services. And if you don’t agree with the term “hiding”, then please explain just how we will know how much of our S/L taxes is going to the federal government?
How much of your state revenue goes to the federal government today via wages for employee income and payroll taxes? As shown in my post, the FairTax places a lower burden on the state, meaning the FairTax revenue needed by the state is less then the income and payroll tax revenue, but you have to adjust for inflation.
Sorry Hank, these things are clear to me and I can’t understand why it’s not simply understood. I don’t know if you’re intentionally trying to be difficult and critical in the face of truth, or if you really don’t understand these concepts.
I can pull up numerous threads where you state the measure of a tax is purchasing power. The value of the dollar changes daily. A tax rate can be increased or decreased as it’s half of the equation measured in relation to a tax base. So it confuses me to see you arguing a static dollar value, ignoring any inflation, and presenting a tax rate as an increase while ignoring its tax base. Then you state that you’re going to continue to say something that is clearly false. I don’t believe you would intentionally lie, and I don’t think it’s overly complex, so I’ll try to press on to get you to understand. I ask though that you really think about what I’m saying and the examples I’m giving. I feel like you’re going in circles and it’s taking time away from my family (as my wife keeps telling me).
Every state gains more revenue each year via inflation. This is not a tax increase every year. The state is subject to the same inflation as the rest of the country and revenue has to keep up with inflation. This is easily done via a tax base that automatically adjusts for inflation. Some are more difficult, like land taxes. The FairTax change is an adjustment for inflation, that’s it. If they adjust for inflation, they’ll actually end up with increased revenue by 8%, because the revenue needed by the state to cover federal tax costs decreases under the FairTax.
Why does a company need to raise prices by 17%? What was going to the fed via income taxes becomes a windfall to the citizen. That windfall has a cost, increased prices since the business now has to offset the fed taxes. The citizen then pays for these fed taxes with the windfall gains. From one hand to another. Translate this to the State. The state also has the same situation. The State employees get gross, which must be paid for by an increase in revenue. Again, it comes from the overall citizen windfall – the 17% increase. Just like the prices of goods and services, the state will increase revenue by the same amount – it’s the effects of inflation. Did prices go up 17% yes, did State revenue go up 17% yes, does federal revenue go up 17% yes, does individual income go up by 17% yes. Yes yes yes, everything increases. Is it a tax increase? What is the change in purchasing power? None
Hank, sorry for the overly aggressive tone – wasn’t having a very good day yesterday. Didn’t mean to take it out on you.
Morphh,
No apology needed, you run a fair and balanced blog which I greatly appreciate. Let me assure you that I am not being intentionally difficult, and I really am having trouble understanding the widget example. Thanks for keeping at it because I think I have finally figured out why we differ.
You wrote: “The State employees get gross, which must be paid for by an increase in revenue. Again, it comes from the overall citizen windfall – the 17% increase. Just like the prices of goods and services, the state will increase revenue by the same amount – it’s the effects of inflation. Did prices go up 17% yes, did State revenue go up 17% yes, does federal revenue go up 17% yes, does individual income go up by 17% yes. Yes yes yes, everything increases. Is it a tax increase? What is the change in purchasing power? None”
My answer to the questions is Yes, No, I guess so, It depends. Let’s take one at a time.
Retail prices do increase 17% over time, but initially will go up 23% after the investment credit is used up. (matter of days or weeks depending on the product). Prices are sticky downward, and competition will eventually reduce most prices.
State revenue goes down if the rate remains the same. A year or so ago, I recall that you agreed that the States would not “tax the tax” when we were discussing the HR25 mandated sales receipt. Line 1 is cost, and that is the line the State sales tax will be applied to, not line 3 which is the tax inclusive price. If costs are going down 10%, then the State sales tax base goes down by 10%. The rate has to be increased accordingly.
I’m not smart enough to know if federal revenue increased by 17%, but isn’t the goal to be revenue neutral? Am I stuck on nominal versus real here?
I totally disagree that everyone will see a 17% rise in individual income. The only rise in income that most middle class retirees will see is the prebate, and that darn sure isn’t a 17% gain. For instance, a retired couple living on $50K from SS plus investments pay zero federal tax today. Under the Fairtax, the only increase in income would be the prebate of $5,000, which is a 10% pay raise, not 17%.
Bottom line is that I still believe that States will have to raise their rates to reflect the lower base and the new net $217 billion cost of the federal sales tax , and that isn’t a zero sum game.
I don’t want to debate how prices will fluctuate in the initial weeks – it’s irrelevant to the big picture. The point is prices go up because employees are given a windfall.
State revenue goes up when you adjust for inflation. Of course, it won’t go up if you keep it static, which is the problem.
I didn’t say everyone would receive a 17% rise in individual income. Again, we’re talking in general – it’s a displacement of cost, so one has to essentially equal the other. If prices rise by 17%, then overall incomes were raised by approximately the same amount. Different groups will have different results, but that’s not what we’re discussing – stay focused.
The goal is to be revenue neutral in real dollars. Nominal dollars can change where $1 today is not equal to $1 tomorrow. If you raise prices by 17%, then Federal revenue will also increase by 17%. The rate calculation research assumes costs go down and prices don’t change, which is why you would see a $1 for $1 comparison of revenue neutrality there. However, if they gave employees gross, then the revenue would also follow. All studies show this has little effect on tax burden as a whole, though it will effect different groups, such as retirees differently. Essentially, the citizens get a raise, which is instantly consumed in higher prices and taxes (to include state taxes), but purchasing power will remain consistent.
The states will have to raise their rates, but that is not a raise in taxes – it’s a change in inflation. You have to understand real vs nominal. Inflation effects are a must to understand what we’re talking about. You can’t raise income and prices in a vacuum – there is no windfall. Taxes will increase by the same amount to keep the burden consistent.
Perhaps it would be simpler to follow if we work under the assumption that prices remain the same and employees get net pay. Then there is no inflation or real / nominal effects to take into account.
I’m trying to do this quickly, so forgive a math error.
Today the state collects revenue that pays for
* Employee income taxes & employee payroll taxes
Total employee wages and salaries is $680. $979 is untaxed consumption for a total of $1659.
Since after tax prices remain the same, $816 of the consumption is irrelevant. $163 is untaxed, so we can decrease it by 23% to $125. So total cost for the state on consumption is $816+$125 = $941, a savings of $38 billion.
So now to income, which is more tricky. Since we don’t know how much income tax is paid, I’m going to do something super generous. Let’s assume state employees pay zero income tax. We’ll only consider the state as having to generate revenue for payroll taxes, which we’ll put at 15.3%. So let’s say the state today pays $104 billion.
The state spends $680 today, but $403 of that is untaxed under the FairTax, so we can decrease that by 15.3% to $341. This leaves the remaining wages of $277 as taxed. We’ll decrease it by 15.3% to $235 and then multiply 1.3 (30%) = $305 billion. So let’s add it up.
$305 + $341 + $941 = $1,587 total spending under the FairTax
In today’s dollars, that’s $72 billion less.
This might be boggling your mind right now.. The state only paid $104 billion in income tax costs under the current system, but under the FairTax it has to pay $70 billion on wages and $187 billion (23% of $816) in consumption for a total of $291 billion. That’s almost 3x as much!
But here is the issue, prices dropped for a reason. The cost of the goods contained embedded income tax costs which were removed. So under the current system, we made the assumption that $104 of their revenue was paid to the Fed in taxes, but we neglected to factor how much of their consumption cost was due to federal taxes. Thus, to keep it consistent with prices, we’ll assume that 23% of their consumption cost was due to embedded tax costs which is $979 * .23 or $225, for a total of $329 billion.
Of course, this is going to be off by a good factor because I’m making a wild assumption that the State has no income tax cost for the sake of simplicity and I’m sure adjustments could be made, but perhaps this brief example using non-inflationary figures helps understanding. Or maybe it just confuses more.. haha
Morphh,
But you haven’t answered the key question. Are you in the “tax the tax” camp or are you in the “tax the cost” camp? Doesn’t it matter?
No, I don’t care one way or another. It’s the same cost.
Morphh,
Now I am about to give up. How can you possibly claim that the pretax cost is the same as the after tax price?
Between a 10% rate taxing the tax or a 11.7% rate that doesn’t – I don’t care. They’re both the same $ amount and they both account for inflation. To quote from the example in 36.
Both situations collect $117. Collecting $100 is not an option under 17% inflation, unless the state wants to give the citizens a huge tax cut.
Morphh,
O.K., I’m going to take it that you are figuring on the States taxing the tax. Nothing in HR25 would prevent that from happening except one of the stated goals for federal taxation is to prevent cascading taxation. We will have to wait and see. I now understand how the numbers work if you cascade the taxes.
What I don’t understand is the other side of that coin. If the States just tax the pretax cost, then their tax base will eventually decline by 10%. They will take in 10% less revenue at the same rate. Meanwhile, the State is going to have to pay for stuff that costs 17% more and send over $200 billion in sales taxes off to Washington. How do they do that without raising the rates on everyone for everything ? Isn’t that an added tax burden on residents of a State?
They do have to raise the rates on everyone, but that’s not an added tax burden. If they didn’t raise the rates, it would be a tax cut as a percentage of your income.
Let’s say the State takes 10% of your income. Maintaining the same tax burden would mean they continue to take 10% of your income. If they take less then 10%, then it’s a tax cut, if they take more than 10%, it’s a tax hike.
So if average income goes up 17%, state revenue will also increase by 17% because revenue is 10% of total income. If state revenue didn’t go up, your purchasing power would increase, because your income went up but taxes didn’t. They would get less then 10% of your income.
Hopefully you’re with me so far.
So what happens here is that the state is no longer getting 10% of your income. Due to 17% general inflation of income and a 10% reduction in tax base, they’re now only collecting 7.5% of your income. This presents a shortfall for the State. They need 10% of your income to cover the budget, which includes higher consumption costs. If they get 10% of your income, they’re fine.. they actually achieve a surplus.
To get 10% of your income, they could increase their tax base (tax the FairTax cost) or they could raise tax rates on the reduced base where it can take in 10%. Doing this would maintain the state gets 10% of your income. Not doing this would give you a tax cut – your burden would be 2.5% less as measured by purchasing power.
Hank, did my last post make sense?
Morphh,
Forgive the delay, but I am really trying to understand your logic. I promise a response sooner rather than later. Meanwhile, I’m drafting a book named in your honor “When is a tax increase not a tax increase?” LOL!
Morphh,
O.K., rainy day, no golf, and time to read and think about your paper. I’m still not with you. For openers, why do you believe that average income will go up 17%. Are you claiming that the prebate represents a 17% rise in gross income? If so, how did you come to that percentage? Or, did you assume that workers would get the prebate and the employer share of FICA? That isn’t going to happen, imho.
So, lets start with a rational discussion of why you think incomes will rise 17%. Otherwise, if income remains the same and the State raises the rate, that sure sounds like a tax increase, doesn’t it?
The 17% average income increase is by employees getting gross wages. It has little to do with the prebate and does not include employer share of payroll. It’s the average difference between net pay and gross pay – that additional money which you can now spend. It is equivalent to the cost of the tax system on those taxes, which is why prices rise by 17% when you give employees gross pay.
O.K., but what you are talking about isn’t income, but purchasing power. States that tax income won’t get one penny more in revenue from income taxes under the Fairtax. Gross income remains the same, (except for the prebate). My point remains that average income isn’t going to rise by 17%. Income is fixed as far as I can tell. The State revenue from income taxes will be unchanged unless the States increase the rate. And, that is a tax increase, imho!
It is income – net vs gross. Gross is fixed, but you don’t spend gross today – you spend net. And what is income but what you can purchase and there is certainly a difference with regard to what you can buy between the two. It is essentially a raise – you can buy more stuff. Call it what you will, but it is a 17% increase in what people can spend on goods and services. To anyone else that’s not trying to be difficult, that’s not fixed. And it’s not fixed to the economy – it’s inflation. An increase in purchasing power doesn’t happen in a vacuum – you’re not suddenly wealthy. Your increase in purchasing power is a loss to the government’s purchasing power.
You’re correct that the tax base does not increase for the State, but that’s the issue. We’re dealing with 17% inflation, but the tax base is remaining fixed. This is the root of the problem. Measure purchasing power. We have to adjust the tax base for inflation or otherwise raise the rates for inflation. It’s not a tax increase because your purchasing power is remaining consistent, as does the State. Kotlikoff stated the same thing in the other thread. This is basic economics. Do the math Hank and stop with this nonsense and word games.
You have a new net income, the state needs to take a percentage of that new income to maintain the same real revenue and for you to maintain the same loss to the state as a percentage of your purchasing power.
Hank, a more detailed and technical explanation can be found in Section V of the BHI/Kotlikoff rate study. It discusses this exact thing and comes to the same answer.
Here is a portion of that Section:
Morphh,
I have read and reread that section a hundred times, and it still says to me that the States are going to have to adjust their tax structure in order to prevent us peons from getting a tax decrease. So, if the States choose not to “tax the tax”, then their sales tax base will decline by an average of 10%. The retail prices of State purchases are going up 17%, offset by the FICA savings. There seems to be a net 20% State revenue shortfall which will certainly require some adjustments. State tax rates are going to have to go up a percent or two in order to make the States whole. And, if you consider the individual tax burden from just the State perspective, I don’t see how the individual comes out whole. But if you are taking the broader view of federal and State tax burdens, I suppose individuals might be O.K.
Now, back to the basic question. As I recall, you informed me that I was lying if I continued to claim that “15% of federal revenue would be hidden in higher S/L taxes”. I’d be happy to replace the word “hidden” as too pejorative. What is really happening is that there is a federal tax transfer to the States. So, how would you phrase that transfer?
Of course it’s a hidden tax. How many FairTax supporters do you think realize that state and local government purchases will be subject to the FairTax?
About the same number that realize that they’ll need to start paying 100% of their health insurance premiums because businesses will no longer be able to deduct the cost of health insurance, and that the entire premium will be subject to the FairTax.
It’s not any more hidden than it is today – in fact I’d argue that it’s less hidden by proof of this discussion. It may be true that 15% of Federal revenue is hidden in State taxation under the FairTax, but that’s not any more than is hidden there today. What you seem to suggest in your statements is that the real burden on states is higher and some additional 15% is hidden by taxing the states that doesn’t exist today, and that’s just false. There is no federal transfer to the states. In fact, it would be less than today as I show above. Today there is cost to the State of the federal tax system. The cost of the current tax system (the revenue needed by the state to pay for costs associated with income taxation) is more today than the cost of the FairTax would be to the State after the adjustments are made (see post 46).
So I guess what you could say is 15% of federal revenue is generated through state taxation and due to citizens taking home gross pay, they will have to adjust their tax base or rates to collect the same percentage of their citizen’s purchasing power. If the State takes 10% of your spendable income today, they need to take 10% of your spendable income under the FairTax. Because your spendable income increases, but the tax base doesn’t, they have to adjust the base or the rate to maintain 10% – purchasing power remains consistent.
Morphh,
You were correct to suggest that #46 might confuse more–haha.
Look, I understand your thought process, but disagree that simply taking the same percent of my new and increased purchasing power will balance the books. As a retiree, my increased purchasing power consists of our $5000 prebate. And, that represents a 10% increase in our gross income which was $50,000. A 10% increase doesn’t begin to offset the 17% increase in retail prices, plus a 2% increase in my State and Local tax rates. How many times are you going to suggest that our gross income increase will offset taxes and prices? For many of us, it isn’t going to compute. I’ve already shown that taxing just 75% of our gross would result in our paying $4,000 more in sales taxes than we pay in federal taxes today. How much more in State and Local taxes do you think we can stand?
The State is going to experience a 10% reduction in their sales tax base, and a 17% increase in retail prices, offset by the 7.65% FICA savings of an estimated $36 billion. The net revenue shortfall is 20%, and I still don’t know how that shortfall can be eliminated without calling for a tax increase. Just show me the source of the money!
Hank, what you describe is an argument against inflation and how it adversely effects retired folks on fixed incomes. I certainly agree with you there. How the proposal effects different income groups is not what we’re discussing though. We’re discussing if this change results in a tax burden increase on the State, which it does not. We’re also discussing if the change in tax rate or base by the State is because the FairTax is hiding a larger share in state taxes, again which it does not.
What you describe as hurting you is the result of inflation. The fact that the fed and state has to keep up with inflation does not equal an increase overall, but it does effect different demographics differently. What is the source of the money? It comes from the increase in spendable income by the citizens. This is where we get into the accommodation by the Federal Reserve. The increase of prices, wages, and taxes comes from the expansion of the money supply. The more the Fed accommodates the tax, the more it effects retirees as this devalues their savings and fixed incomes. Now, certain aspects of retirement income will be adjusted, such as SS, government pensions and prebate, but other private investments may not.
I’m going to try and do another widget example. How to explain this – I’m not an algebra teacher.. haha
Ok, please take the time to read this well because it took me over an hour to get it out in what I hope is a simple explanation of the process.
Morphh,
It really isn’t nice to ask a senile, old man to wrap his thoughts around 10,000 widgets. If restoring widget count for all parties represents neither a tax increase or decrease, so be it.
A few questions. (1) From the State tax perspective, don’t all those widgets cost 90 cents rather than 1 dollar? (2) Why does restoring the State’s original prefairtax widget count make sense when in fact, the States need to be able to buy more widgets to pay for a new budget line item called the Fairtax? (3) Does any of the widget counting change the fact that 15% of the federal revenue is going to be raised through State and Local government consumption taxes?
Hank,
10,000 widgets is a measure of purchasing power, which you have repeatedly stated yourself is the true measure of tax burden when comparing systems.
(1). I stated in the post that I ignore the +/- of corporate taxes, since we don’t include them in the income tax portion. You’re confused enough as it is without adding in cost decreases. It works out the same in either case (30% tax on 90 works the same as a 17% tax on 100 for this purpose – the 10% cancels out). If I can get you to understand the basics, we can add in those other variables.
(2). The number of widgets doesn’t increase. A widget is a physical item, not elastic currency. The state doesn’t need to buy a larger number of police cars (widgets) for example. It needs more currency to buy the same number of cars as it did before. As for the line item, I included a 17% cost increase (paid to the Fed) on all State revenue in this example, which is higher than the actual FairTax cost after exemptions. So it includes the budget line item, which is in fact not new but a replacement of the existing income tax cost.
(3). No, but you make the incorrect determination that the 15% is a new or higher cost – it’s not. 16.3% of the federal revenue today is raised through State and Local government employee taxation and indirect consumption costs seen if you remove the income tax system. The overall cost to the State decreases by 8% as shown in the original post.
Morphh,
O.K., I think I am now a master of widgets. After all this, I conclude that it would be correct to claim that “15% of the federal revenue collected is included in State and Local taxes.” Fairtax claims regarding “transparency” are somewhat overstated. You can stare at your sales receipt all day, and you still won’t really know how much federal tax you paid.
Morphh, I really do appreciate all the effort you put into this and prior discussions about the impact of the Fairtax on State and Local Governments. Provided the Supreme Court upholds the Constitution, this may never become an issue. Federal taxation of S/L government consumption is clearly unconstitutional under our constitutional republic form of government. Stay tuned!
I’m so glad that some of this is making sense. I can’t argue with your stated points – true and true. Though I do personally think the cost of state government should reflect what it would cost a private organization to provide a similar service, so I partly see this as a true cost of State services, but I understand what your saying. It would be interesting if the state added it, not as an adjustment on their existing sales tax, but as a separate surcharge, so people could clearly see the cost relayed to the Fed. The State need not hide it if they so choose.
Another alternative for the adjustment would be to model the FairTax. If they broadened their base (tax services and remove exemptions), they could probably cut their rate by more than half. The state could tack on a few percent to the FairTax and augment the prebate. Makes sense if they’re already doing the collection and enforcement for it – why administer two tax systems.
Morphh,
Well, since you raised the subject of “conforming States”, here are my thoughts. The biggest issue the Fairtax faces is to get the States to go along with a national consumption tax. And, I am not aware of any effort made by AFFT to address this issue. Here is an extract from the National Governors Association (NGA) 2010 Tax Policy paper:
“The nation’s Governors oppose a national sales or transactional value-added tax. Such taxes would intrude into a tax area that has traditionally been reserved for and relied on by state and local governments. If enacted, either of these taxes would seriously threaten the ability of state and local governments to maintain their tax base.”
Seems pretty clear and unambiguous to me. State sales taxes have evolved over decades, and no two States are alike in what they tax, or what rate they use. To assume that any State would go through the legislative hoops needed to “conform” to the federal Fairtax system would be very optimistic. And, it seems to me that getting 38 States to ratify a Constitutional Amendment repealing the 16th Amendment would be an equally daunting task.
The highest priority task facing AFFT ought to be sitting down with the Governors and staff and working out some sort of compromise. Failing that, the Fairtax and HR25 are going nowhere. Perhaps a federal VAT would find some support from the States due to the nature of the collection process. At least the VAT wouldn’t have to appear on the retail sales receipt in competition with the State sales tax. Just a thought.
If anyone wants to read the entire NGA Tax Policy paper, click on this link.
http://www.nga.org/cms/home/federal-relations/nga-policy-positions/page-ec-policies/col2-content/main-content-list/title_federal-tax-policy.html
Indeed. One note, a VAT would still be required on the sales receipt so it would likely face the same struggles.