Taking on Woodall & Linbeck

December 11, 2012  ·  Filed under: Criticisms

Hank has asked that we provide some critical input on the attached study prior to taking on Rob Woodall and Leo Linbeck.

Forward:

The September 2006 Fairtax Rate study concluded that an inclusive sales tax rate of 23.82% would be revenue neutral. The study is fatally flawed for two reasons. (1) Including Government consumption in the base is inappropriate under our constitutional republic form of government, and (2) The failure to properly account for legal tax avoidance and illegal tax evasion. The following discussion explores both criticisms and addresses several related issues along the way that bear on my conclusion.

Give it a read and provide Hank some feedback. :)

https://docs.google.com/open?id=0B6dQ-sYtwh6lMWdlazM5VWtBNWM

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47 Responses to “Taking on Woodall & Linbeck”
  1. Hank’s gotten deeply into the weeds. A few issues.

    The appropriate comparison to make is not the FairTax v. perfection. No tax system ever will be perfect. It’s whether or not the FairTax is better than the income based system we have today. We have a tax code now that is such a complex mess even the IRS admits it can’t manage it correctly. The cost of compliance is astronomical and a big economic drag.

    The current code’s complexity creates huge uncertainty. The current “fiscal cliff” debate is a prime demonstration of how uncertainty paralyzes business investment and constrains economic and job growth. In fact, any income tax based system discourages growth. The maze of credits, deductions & loopholes distorts sound financial decisions. Business investment decisions are frequently warped and prolonged by tax implications.

    You can argue about what should be the appropriate “revenue neutral” rate all day long, but you could simply implement the Fair Tax and adjust the rate after real data becomes available. That would be pretty quick because govt inflows would be much more consistent from month to month than the current income tax based fluctuations. Think April 15. That introduces risk that we won’t forecast FairTax collections accurately, but risk is hardly absent from our current state of affairs as we run $1T+ yearly deficits.

    The underground economy is large, but no one is suggesting that the FairTax will produce tax revenue from illegal transactions themselves. What will happen is that the drug dealer, the hooker, the illegal alien who either don’t report income at all or don’t even exist from a legal standpoint today, will start paying sales tax on the everyday things they buy (e.g. a new Escalade, fancy clothes, new work boots). That’s tax revenue from a totally new source.

    Taxing services recognizes that we have an economy in which we produce more services than goods. Also, it makes the FairTax more progressive. Who consumes more services, rich people or poor people?

    Regarding intergovernmental taxes, it’s irrelevant. Neither governments nor businesses ultimately pay taxes. They’re only collection agents for the people who use them. People pay all the taxes.

    The FairTax may not be perfect, but it looks a lot better than what we have today. It encourages behavior that will positively impact our worldwide competitiveness and growth in the future. The way things are headed, we’ll need it. Let’s stop trying to reform the malignant beast we have today and do something genuinely different. Isn’t that REAL reform?

    Bill Fogarty  ·  Dec 11, 2012 at 8:55 pm  ·  Permalink
  2. Hi Bill,

    Thanks for your comments. I certainly agree that the income tax needs replacing. I just don’t agree that the Fairtax is a suitable replacement. And if you think I’m getting down into the weeds with this post, you might read my 15 point indictment of the Fairtax which I’d be glad to provide upon request.

    As for the Fairtax rate, I am simply questioning the AFFT paid for rate study that concluded that a 23% inclusive rate works and is revenue neutral.
    By taxing governments and failing to account for evasion, I can show that the exclusive rate would have to be 65%+ in order to be revenue neutral. Surely you wouldn’t want to implement the Fairtax and find out the rate the retail merchant has to add to his cost is 65%? Now is the time to get in the weeds and see what the legislation really says. The Pelosi approach is sheer insanity, imho.

    Taxing services is the fundamental problem with the Fairtax scheme. Six other nations have tried to implement a broad based national sales tax like the Fairtax. They all failed and switched to a VAT, a consumption tax in use in over 130 countries worldwide. Isn’t there a message there?

    Intergovernmental taxation is far from an irrelevant issue. It is one of the oldest and most difficult challenges our Courts have faced. Perhaps this extract written by then Justice O’Connor will explain what is at stake.

    “Federal taxation of state activities is inherently a threat to state sovereignty. As Chief Justice Marshall observed long ago, “the power to tax involves the power to destroy.” McCulloch v. Maryland, 4 Wheat. 316, 431 (1819). Justice Holmes later qualified this principle, observing that “[t]he power to tax is not the power to destroy while this Court sits” If this Court is the States’ sole protector against the threat of crushing taxation, it must take seriously its responsibility to sit in judgment of federal tax initiatives. I do not think that the Court has lived up to its constitutional role in this case. The Court has failed to enforce the constitutional safeguards of state autonomy and  self-sufficiency that may be found in the Tenth Amendment and the Guarantee Clause, as well as in the principles of federalism implicit in the Constitution.”

    Bill, we need tax reform, but the Fairtax is not the solution. 

    Hank Van Gieson  ·  Dec 12, 2012 at 1:46 am  ·  Permalink
  3. Bill,

    To reinforce Hank comment, “”Yes”, we all agree that the current tax is a disaster and must MUST GO. But many of you employ the faulty logic the erroneous rationale, that therefore we MUST adopt the FT. No, we can get rid of the IT and find something better than the IT – i.e., the FT is considerably worse than the IT, not in its complexity, but in it is outrageous expansion of Marxist wealth redistribution and in its disastrous impact on our 70%-retail-sales-sensitive economy.

    Consider the disastrous impact on our economy of a 60% revenue neutral rate.

    When the govts have to pay FT, yes they will/must [ass it on to theor citizens who would then pay not only much higher FT, but higher State & Local taxes

    The economic Kool-aid you note in your last paragraph, does not hold up against the reality of the disastrous financial of the FT. It sounds good when you say it fast, but does not hold up under thoughtful analysis. Its a glib marketing line.

    Stephen Eldridge  ·  Dec 13, 2012 at 1:59 am  ·  Permalink
  4. I haven’t had a chance to go through Hank’s paper, but I noticed that Senator Chambliss and Congressman Woodall (who replace retiring Rep. Linder) have asked the Joint Committee on Taxation to score the FairTax. As far as I know, this has been the first request made to do so since 2000 or so. I hope Morph keeps an eye on this. I would be very interested to see what the JCT comes out with this time.

    http://www.gwinnettchamber.org/chambliss-woodall-call-for-fairtax-consideration-send-letter-to-joint-committee-on-taxation

    Hayden Kepner  ·  Jan 7, 2013 at 9:05 pm  ·  Permalink
  5. Bill Fogarty: You said that drug dealers will pay the sales tax when buying a new Escalade, fancy clothes and so on. I knew some drug dealers even though I don’t approve what they do, they never buy new cars. They buy junks and old cars. If they get busted with what they do, they will lose the old car, just a dime in the bucket. I had a 1983 Honda Accord for sale at $500. A drug dealer came over and bought the car. He had a large roll of cash and he gave me $500. No questions asked. The paper work was signed and that was it. Same thing with hookers. Illegal aliens don’t buy new cars from dealerships. When buying a new car, you have to prove you have a license. Every time, I bought a car from a dealership, I have to show a license. Most states don’t issue licenses to illegal aliens. Some are starting to issue but they can’t be used as IDs. Just for driving. As for taxing services, any service that is cash basis, no paper trail.

    Henry  ·  May 30, 2013 at 3:57 pm  ·  Permalink
  6. Hank,

    In replacing the income tax, the FairTax or any sales tax producing equal revenue to the income tax already accounts for evasion. In his 1996 book, “The Power to Destroy”‘ the late Senator Roth cites IRS releases that 17% of Americans liable for income taxes evaded or disregarded them.

    Unless you are assuming there will be an additional 15% evasion, your evasion estimate is covered by the existing evasion. If anything, 15% is too conservative a figure.

    The FT only replaces the present revenue, it doesn’t intend to make up for revenue lost from existing evasion. So, you don’t have to add 15% to whatever the actual FT rate may be.

    Thanks, Phelbers

    Phelbers  ·  Oct 12, 2013 at 3:45 am  ·  Permalink
  7. Phelbers,

    Nice try, but I don’t agree with your higher math. Yes, the Fairtax replaces the three taxes that already have some evasion built in as you wrote. But the Fairtax calculations did not include any evasion factor, and there will be an estimated 15% evasion. Call it additional evasion if you like, but the 23% is off by at least 15%. In other words, at 23% inclusive, the Fairtax is not revenue neutral. What say you?

    Hank Van Gieson  ·  Oct 12, 2013 at 11:27 am  ·  Permalink
  8. I’d disagree that the AFFT calculations did not include any evasion factor. They may not have explicitly included them, but the factor is automatic, and built-in with a revenue neutral calculation. The IT evaded dollars are still not made up for if the same total is received under a sales tax.

    Since 17% now evade the IT (I group all the taxes proposed for replacement for ease of dialogue under the IT term) the total take of the IT includes 17% evasion. Those evaded dollars are not now received by the Treasury. If that same total is received under a sales tax, the same evaded remainder will also not be received by the treasury under the sales tax.

    Surely there can be no disagreement on this point if senator Roth’s citation of the IRS disclosure is factual. (It was early in the book, page 75 or so as I recall).

    You would have to show that the AFFT specifically considered evasion as being eliminated under the sales tax, and that they deliberately reduced their percentage by 15%, to make your additional evasion figure valid.

    The Treasury will get some sales tax from the evaders when they buy new things such as food or other items from honest sellers, and to that extent, I agree with the AFFT. I do not agree that all evasion will be eliminated. There are other referenced state sales tax evasion studies somewhere in the archives of these pages that give evasion rates in the high teens. I’d have to do some digging to find them, but they indicate that the evasion rate will about be the same under a sales tax as they are under the IT. Your figure is probably too conservative, but good enough for our discussion, and I accept it.

    If it is the AFFT position that there will be no evasion under a sales tax, and they have deliberately reduced their percentage number on that specific basis, then I would fully agree and support your position here. Given the evasive responses of AFFT, it would be difficult at best to get any answer from them about this. But, since the total revenue neutral amount already automatically includes evasion, it’s too far a leap for me to add that additional negative on them just yet without confirmation of such a deception. I wouldn’t put it past them, but I’d have to see it first.

    I hope you can at least understand my point before rejecting it out of hand.

    Thanks, Phelbers

    Phelbers  ·  Oct 12, 2013 at 2:08 pm  ·  Permalink
  9. To: our dear old friend Phelbers,

    I am getting old and easily confused. I do not understand your argument yet and need your help to do so.

    Step 1. We have reviewed the BI reports and found no specific allowance for evasion (i.e., no increase in the FT RATE that compensates for evasion) and also found specific (laughable) excuses for making no explicit allowance for evasion. If necessary we will find these specific references. This leads us to the conclusion that the FT make NO specific allowance for evasion. Please confirm whether or not you agree.

    Step 2. It appears to me that you believe than an explicit allowance is NT needed. Please confirm and explain why it is NOT necessary and how will evasion be compensated for.

    Next, While you & HVG seem to agree that evasion will be 15%, I am amazed that you 2 can predict the unpredictable.

    Please confirm if you agree that the current tax collections are AFTER evasion and projected FT revenues (i.e., the current after-evasion total) is BEFORE any evasion so that ANY FT evasion will make FT revenues come up short of its target.

    I hope these answers will allow us to move forward to clarify this point.

    Stephen C. Eldridge  ·  Oct 12, 2013 at 9:06 pm  ·  Permalink
  10. Phelbers,

    I’m old enough to know what I don’t know, and I never reject anyone’s ideas out of hand. However, if you go into the research section and bring up the Sept, 2006 “What rate works” study, and turn to page 26, you will get confirmation that evasion was not included when determining the Fairtax rate. Yes, the revenue required was after evasion of current taxes, but there is no way that IT evasion could transfer to the Fairtax. The FT rate needs adjusting and I like 15% because that is what a 2006 study indicated.

    Hank Van Gieson  ·  Oct 13, 2013 at 12:03 am  ·  Permalink
  11. Hank,

    I see the wording you refer to.

    But, two items in that study have led me to believe that evasion was not disregarded. First, on page 26, just after the sentence I believe you refer, it states:

    “But the fact that we have not explicitly considered tax evasion does not mean that we have ignored it. On the contrary, we have implicitly incorporated a significant degree of tax evasion in our calculations simply by using National Income and Product Account-based projections of household consumption expenditures in forming the FairTax tax base (Easton, 2001).”

    That’s where I may have gotten the idea that evasion costs were ‘built-in’.

    And, on the first page, the fourth paragraph, first sentence states:

    “Implementing the FairTax rate of 23% would produce $2,586 billion in federal tax revenues which is $358 billion more than the $2,228 billion in tax revenues generated by the taxes it repeals.”

    That’s 14% more than was at that time taken by the ITs, and would roughly offset your referenced 2006 study’s 15% evasion.

    I’m not saying the rate determination study in not otherwise flawed, but there is some margin built in, and it may well indeed account for a good part of the cost of evasion. If I have missed what the extra $358 billion was intended for, I’m certainly open to what that may be.

    And keep in mind, I’m not trying to prove anyone wrong, just questioning what does not make sense to me at first glance. It would be just as bad to overstate the sales tax percentage as it is to understate it.

    Thanks, Phelbers

    Phelbers  ·  Oct 13, 2013 at 1:43 am  ·  Permalink
  12. Phelbers,

    As I recall, the additional revenue was needed to pay for the prebate, and had nothing to do with evasion or avoidance. And, here is an extract from a study I did some time ago that responds to the five reasons BHI gave for not directly addressing evasion in their 2006 rate study.

    “Discussion: This AFFT funded study seems to make a convincing case for their failure to include either illegal evasion or legal tax avoidance in the Fairtax rate calculations. But, most of the five claims do not stand up to critical examination. Here is the other side of the coin.
    (1) Major retail outlets will comply.
    Goods, maybe; Services, no. It may be true that 80% of goods are sold by the sixty recognized American “big box” chains and warehouse clubs. (See Wiki), but there are literally millions of large and small service providers. And, it is the taxation of services that has caused broad based, high rate, national sales taxes to fail due to evasion. According to Joel Slemrod in his notable book “Taxing Ourselves”, Iceland, Norway, South Africa, Sweden, Zimbabwe, and Slovenia all tried a broad based, high rate national sales tax similar to the Fairtax, failed, and switched to a VAT. It also would be a mistake to rule out even the “big boxes” from evasion. Without any kind of a dual reporting system, evasion will occur at higher rates. The consumer may pay the tax, but only the merchant knows if the tax was forwarded properly. Who has the cleverer CPA’s and accountants, Wal-Mart or the Treasury Department?

    (2) Federal Government Enforcement.
    Without a dual reporting system, there is no way the federal government can reasonably enforce a national sales tax on all services. At a 30% sales tax rate or higher, evasion becomes very attractive and well worth the risk of an audit. And, again, who has the best book keepers?
    (3) NIPA
    This argument has no merit! Fox Murray A National Retail Sales Tax: Consequences for the States” (pg289, footnote#4) “A national retail sales tax would not likely be any more effective in taxing the underground economy than alternative tax regimes. While those involved in underground activities may escape the income tax, the goods or services produced within the underground sector would similarly escape sales taxation. And while the evader would pay sales tax on purchases in the formal sector under a NRST, there would be no increase in collections relative to the income tax regime. Under the income tax, revenue would have been generated from the value-added chain of production in the formal sector, revenues that are lost in the switch to a sales tax. The net result is simply a change in the point of tax collection.” In addition, the NIPA managers when contacted directly discount claims of under reporting. Revenue from the underground will never be taxed by the Fairtax, and normal living expenditures of the participants in the underground economy are already accounted for by NIPA.
    (4) Federal Capital Gains.
    This argument implies that savings from the discounted federal debt would somehow be available as revenue to the federal Treasury. Not true. While the devaluation of debt might decrease the real burden of overall federal debt, there is no cash flow to act as revenue to offset any Fairtax evasion/avoidance.
    (5) Dynamic Versus Static Analysis
    Any dynamic analysis is only as good as the assumptions loaded into the model.

    Conclusion: The arguments presented in the study do not make a compelling case for ignoring the minimum of 15% likely evasion associated with such a high rate, broad based, national sales tax.”

    Phelbers, I stand by my claim that at least a 15% evasion factor should be incorporated in any FT rate study.

    Cheers!

    Hank Van Gieson  ·  Oct 13, 2013 at 3:05 am  ·  Permalink
  13. I’m not being obstinate, but I still have questions about the evasion issue.

    Of course most of the underground economy will not be taxed under a sales tax. Only the new things they buy from honest sellers would be taxed.

    But in the ‘what rate’ paper, isn’t the AFFT saying they ignore the underground evasion economy from their tax base calculation using NIPA data? If so, they never consider taxing the underground economy in the first place. The AFFT would in effect thus account for evasion if it is factual data.

    You say above that the NIPA data is bogus because the underground economy will never be Fair Taxed. But that begs the point if the underground economy is excluded from the tax base calculation. Or are you saying there will be another new additional 15% evasion rate over and above the expected existing 15% once the sales tax takes effect? That is, the AFFT only accounts for the present 15%, not the FairTax induced additional 15%?

    Do I misread this?

    Thanks, Phelbers

    Phelbers  ·  Oct 13, 2013 at 3:15 pm  ·  Permalink
  14. Phelbers,

    I’m not saying anything. It is the NIPA managers we talked to who rebutted the BHI/Kotlikoff/AFFT claim that the NIPA numbers under report actual consumption. Along with Fox Murray, there is agreement that the $2 trillion underground will never be taxed and the normal living expenditures of the underground “managers” are already accounted for in the GDP. Therefore, one of the five reasons given by AFFT for not addressing evasion is false. And, so are the rest as I reported.

    AFFT does not admit to any evasion–or legal tax avoidance for that matter. I still believe that there will be at least 15% illegal evasion and I base that estimate on the most recent “tax gap” study which showed evasion between 14% and 16%. I have no idea if evasion of a sales tax will be similar to income tax evasion, but 15% is as good as any for a starting point, imho.

    Hank Van Gieson  ·  Oct 13, 2013 at 3:44 pm  ·  Permalink
  15. It is my understanding that the rate studies use actual income tax revenue, not projected revenue. To correct Hank, unless he’s speaking of some other instance I’m unaware of, the NIPA managers did not rebut that the NIPA numbers were under reported. They are under reported and I’m pretty sure they actually say so in the report. The question was to what degree – BHI/Kotlikoff/AFFT assumed a higher amount then what was actually included. If I recall, the managers verified that the NIPA figures assume something like 2.5% evasion (or maybe it was as high as 4%, can’t recall – but it was low). At the time BHI though it was higher. So it was the higher figure that was rebutted, not the fact that they do include evasion.

    I can also agree with an average of 15% evasion. However, what I think Hank and Stephen get wrong is how they apply the evasion to the tax base. They simply calculate the average evasion rate across then entire tax base without considering how an average is derived (mean, median, or mode) and how the high and low ends across the average apply to the tax base. The collection points are significantly reduced and larger retailers will account for little evasion as applied to the average. Evasion will occur in your small / medium businesses. In retail, about 97% of businesses accounts for only 14% of revenue. In services, about 99% of businesses accounts for only 20% of revenue. So when we apply our average evasion to this 97% and 99% (those bases which are susceptible to evasion and least enforcement), we see a reduction in total revenue of about 2% for retail and 3% for services. So 15% average evasion on the FairTax is within the allowances for the NIPA 2.5% evasion on the taxable base.

    Morphh  ·  Oct 13, 2013 at 7:50 pm  ·  Permalink
  16. Note that I updated my post above, so if you read it prior to me posting this message (in email or rss), you may want to reread it.

    Morphh  ·  Oct 13, 2013 at 9:15 pm  ·  Permalink
  17. Morphh,

    Read page 9 of the report and you will see that they used projected revenue for at least some of their study. And the NIPA managers were not quoted in the report, and, in fact, told us when interviewed that their data did not under report revenue due to any underground activity. Their position was that underground activity can never be taxed and that any routine purchases to support underground life style are already incorporated. This position is supported by the Fox Murray study found in your Research section. The repeated Fairtax claim that the $2 trillion in underground activity will be taxed is another Fairtax myth!

    As for your distribution of evasion according to sales, I find it hard to believe that 1% of service businesses account for 80% of sales. Unlike the “big box” impact on the sale of durable and non durable goods, there are millions of small to large service businesses, and it the service industry that caused broad based, high rate national sales taxes to fail in at least six nations worldwide. Please provide a link to your service industry data.

    Thanks!

    Hank

    Hank Van Gieson  ·  Oct 14, 2013 at 1:05 pm  ·  Permalink
  18. The NIPA figures were discussed in the AEI debate and it was stated that the evasion reflected from the data was approximately 2.5% and not the “significant” amount suggested by BHI.

    As for the 1% of services, which was more correctly 1.2% – this is from the Census Bureau’s Economic Census, but due to government shutdown – I can’t access it.

    Morphh  ·  Oct 14, 2013 at 3:18 pm  ·  Permalink
  19. From the “what rate” report, it looks to me as though the AFFT is saying, by using NIPA data, they exclude the underground economy in determining their taxable sales base. If the NIPA data indeed excludes the underground, then AFFT has accounted for evasion.

    However, Hank is saying that when he – or someone – interviewed NIPA, NIPA management told him – or whomever – that, no, NIPA includes every penny of the underground economy in their base calculation. Therefore, AFFT is reading into the NIPA assumptions something not there. So, AFFT accounts for ZERO evasion and expects to collect 100% from any and all would be evaders. (I don’t know for a fact that is the stated position of AFFT, as Hank states, that they will successfully get 100% of the underground economy to pay the FT – just on NEW items, food and such, they buy from HONEST retailers). Thus, Hank adds the full 15% to the FT percentage figure.

    An independent check of the actual retail sales, if such data is available, compared to NIPA figures might settle the matter.

    In a nutshell,

    AFFT: We use only the above ground NIPA sales data to determine the tax base. We therefore account for 100% of evasion. We don’t need to add any extra percentage to account for evasion.

    Hank: NIPA management says AFFT is wrong, the NIPA database does not exclude the underground economy in the slightest. Therefore, AFFT is in effect saying the FT will tax and collect all the sales tax from the underground, and Hank says the FT will not get a dime from the underground. AFFT must add 15% to its rate.

    Thanks, Phelbers

    Phelbers  ·  Oct 14, 2013 at 7:12 pm  ·  Permalink
  20. Phelbers, I couldn’t make much sense of your last post. See my post 15.

    15% evasion does not result in 15% added to the tax rate as the tax base is not uniform in the application of evasion – closer to a 3% rate increase if the figures from the Economic Census are correct.

    There are also other factors that can be figured in to evasion allowances. The rate was a static analysis, where most research suggests increased economic growth. So dynamic figures can make up for other revenue reductions.

    Morphh  ·  Oct 14, 2013 at 7:56 pm  ·  Permalink
  21. Phelbers,

    Hank didn’t say that at all. What I said was that NIPA and the Fox Murray report both say that the underground transactions will never be taxed (common sense), but the normal living expenses by “underground managers” are already included in the NIPA numbers. Therefore, no evasion figures are incorporated in the rate study due to NIPA under reporting.
    In other words, the reported $2 trillion in underground sales will never be taxed, but a small percentage of that number spent by underground operators for normal living expenses is and will be taxed. Today, the tax revenue comes indirectly from business profits from sales of products and services to anyone, including underground operators. Under the Fairtax, the tax revenue would come from the sales tax on the purchase of those same products and services. No real difference. Evasion is not included in the rate study, imho.

    Hank Van Gieson  ·  Oct 14, 2013 at 8:17 pm  ·  Permalink
  22. Morphh,

    My post 19 was meant to pin down Hanks assertion to the AFFT position that all evasion is accounted for vs. the AFFT position. Hank is adding 15% evasion tax rate percentage points (among his other additions) to the AFFT/HR 25 23% tax rate.

    I think you are saying that 15% of sales transactions are underground, but that these total only ~3% of the total dollar amount of sales. If so, is this 3% included in AFFT calculations? If it is not included, would Hank be correct in adding 3, not 15 percent to the 23%?

    Or are you saying Hank’s percentage is incorrect, and evasion is indeed covered by AFFT’s use of NIPA data?

    Thanks, Phelbers

    Phelbers  ·  Oct 14, 2013 at 8:22 pm  ·  Permalink
  23. Morphh/Phelbers,

    Guys, I think we are getting all snarled up over two simple and separate issues. First, the rate report claims that neither underground income nor the underground consumption it supports is reflected in the NIPA data. Therefore, the NIPA data under reports consumption. My point, supported by the Fox Murray report and an interview with the NIPA managers, is that the underground income will never be taxed, and the rate report is incorrect to state that underground consumption is not reported. NIPA managers stated that consumption by underground operators is included and therefore there is no under reporting in their data.

    A second and separate issue is the estimate of just how much evasion is liable to occur under the Fairtax. No one really knows, but at least six nations have abandoned their broad based, high rate national sales tax similar to the Fairtax due primarily to the difficulty in taxing services. Several economic experts note that at rates over 10%, the risk/reward ratio shifts in favor of risk. And, all bets are off at 30%, 42%, or whatever the actual Fairtax rate turns out to be. I use a 15% evasion factor because that is the income tax evasion rate according to the most recent study. Others have suggested 30% or more. I certainly do not know if sales tax evasion will be similar to income tax evasion, but I would point out that without a dual reporting system like that used for the income tax, sales tax evasion will be a major problem. And for those Fairtax advocates that keep shouting that it takes two to cheat, they are dead wrong. Consumers may pay the tax, but we can not know if the tax revenue was properly forwarded to the proper sales tax collection agency. It only takes one to cheat and that is the retail merchant!

    Hank Van Gieson  ·  Oct 14, 2013 at 9:53 pm  ·  Permalink
  24. I am not saying 15% of sales transactions are underground. I’m saying that if you add 15% evasion, as Hank does, it should not be applied uniformly across the entire tax base. 15% is an average – evasion in some sectors will be higher, some will be lower – the average is 15%. What sectors will be lower? Large business – big box retailers. These large businesses only make up about 3% of business, but amount to over 80% of the revenue. So, the vast majority of your revenue base will have very low evasion, but the vast majority of businesses will have average (15%) evasion. If 97% of businesses have an average 15% evasion and the other 3% has 1 or 2% evasion, then the tax base is only eroded by about 3%, not 15%.

    Thus, even assuming that AFFT uses Zero evasion and assuming Hank is correct and we’ll see 15% evasion, it will still only decreased the tax base about 3%. The tax rate would need to be increased by less then 1% to cover the loss, assuming other dynamic economic gains don’t eliminate that.

    However, we need not make that tax rate change. The NIPA data does include some evasion. It was reported at the AEI debate (I think by William Gale) that it only included about 2.5% evasion, not much and certainly not the significant amount suggested by BHI via the underground economy. But it’s enough… Based on that, the BHI rate study accounts for 2.5% evasion for that tax rate (along with pointing out other offsetting factors). So Hank’s 15% evasion can be accounted for in the BHI study, since it already accounts for about 2.5% erosion and 15% evasion would erode the tax base by about 2-3%.

    Morphh  ·  Oct 14, 2013 at 10:06 pm  ·  Permalink
  25. I made no claims as to the underground economy or underground consumption accounting for the 2.5% included in the NIPA. In fact, it can be discounted from those since they were directly discussed in the AEI debate with regard to BHI’s claim.

    If the average evasion is higher than 15% and other dynamic factors or offsetting gains don’t adjust revenue, then a tax rate increase would be needed to maintain revenue neutrality and avoid increasing a deficit. But as I described previously, the percentage of the evasion is often overstated as to the effect on the tax base, so the adjustment is likely to be small. Secondary reporting could be addressed similar to the VAT (I think Kotlikoff discussed this) – though it adds additional administration. So it’s one of those things that you’d have to see if the reduced evasion is worth the economic loss of additional administration, particularly for those that are generating the bulk of the revenues.

    Morphh  ·  Oct 14, 2013 at 10:30 pm  ·  Permalink
  26. Morphh,

    Forget secondary reporting for a retail sales tax. Can’t work! But I would be thrilled if you would just suggest that the Fairtax be dropped and a VAT put on the table. A VAT is far superior to a sales tax, both are a form of consumption tax, and the world has rejected national sales taxes in favor of a VAT. What is our problem with a VAT??

    Hank Van Gieson  ·  Oct 15, 2013 at 12:20 pm  ·  Permalink
  27. It is not clear to me that there is agreement here whether big-box sales are 80% of the tax base or 80% of goods sales only and thus a much smaller part of the total tax base. There may also be confusion in evasion percentage numbers – percentage of transactions evaded versus percentage of tax base evasion. There is also disagreement whether NIPA data allow for some degree of evasion.

    I believe Morphh is saying big-box sales are the 80% of the tax base, and there would be 15% evasion from the 20 percent non-big box sales and service tax base, or 3% total evasion. (15% of 20% = 3% of the total sales tax base). Further, he seems to say this level is covered by using NIPA data.

    If indeed 80% of ALL FT sales tax will come from tax-honest big-box stores then Hank is in effect saying some combination of:

    1) 75% of non-big box sales will be sales tax evaded (75% of 20% = 15% of total sales). This could be where the tax is charged but not remitted, a one-cheater fraud, or where the tax is not charged (a two-cheater fraud).

    or

    2) buyers will be driven from the non-big box sellers to the others who can sell cheaper by not charging the tax (a two-cheater evasion scheme) resulting in eventually a 15% total base evasion.

    Or Hank may be saying big-box is only 80% of goods sales but much less than 80% of the total goods / services retail tax base, and that there will be 15% evasion of the entire sales tax base.

    I tend to buy into Morphh’s argument if the big-box statistics he uses are for a total tax base 80-20 split, but I’m not sure we are all on the same page terminology-wise.

    Thanks, Phelbers

    Phelbers  ·  Oct 15, 2013 at 12:54 pm  ·  Permalink
  28. I have no problem with a VAT. It’s administrative costs are higher, but in most aspects, it is similar.

    Morphh  ·  Oct 15, 2013 at 12:56 pm  ·  Permalink
  29. Phelbers,

    I don’t know what Morphh is using for data, but my data says that “big boxes” are 80% of sales of durable and non durable goods. And, our economy is more than 50% service oriented. You run the math, but 80% of 40% is 32% according to my calculator. More importantly, the assumption that the big boxes would never cheat is flawed, imho. Who has the smarter accountants–Wal-Mart or the new Fairtax SSA?? And, one other evasion factor we haven’t mentioned is the real possibility that State Treasurers may decide that their State needs the revenue more than the Federal government and would prefer not to wash the cash through the Fed. All in all, none of us can predict with any certainty what evasion might be, but based on world wide experience with national sales taxes, I still vote for at least 15% of the taxable base. Using the 2006 rate report, that means that the adjusted tax base at that time would have been $9650B, and the exclusive rate would have been 41%.

    Hank Van Gieson  ·  Oct 15, 2013 at 2:39 pm  ·  Permalink
  30. According to the same sources, services are also similarly split. Hank, big box retailers would not be looking at evasion, but avoidance and there is only so much you can do with the FairTax (unlike our income tax).

    Morphh  ·  Oct 15, 2013 at 3:13 pm  ·  Permalink
  31. You can’t discuss the issue without first agreeing on the underlying data. Both 40 and 80 percent can’t be true.

    There may be an easy way to reduce evasion for the prebate level of spending.

    It would be to make the prebate in the form of a charge card good for the FairTax portion of the sale only, not in the from of spendable cash. (I have advocated this from day one, both in the blogs and to my Representatives without so much as a ho-hum in response).

    That way, at least for all retail up to the poverty level of spending, whenever the tax charge card was used, a record would electronically immediately go to the Sales Tax Bureau. Both the buyer and seller would be made known to the STB, because a seller would have to have registered with the STB to be able to take the FT charge card. And, each time the buyer used their card, there would be an instant deduction from it.

    I suppose there could be fake readers at crooked retailers who would make phony swipes of the card to fool honest shoppers, but “secret shoppers”, STB shills, would quickly detect them.

    Since no cash or cash equivalent prebate dollars would enter the system, no prebate money would not find its way into the evasion sector.

    I believe there would be a natural tendency to use the FT charge card until exhausted (except maybe by the Amish) even for the wealthy, but especially by most buyers. The card would be utterly useless for purchases, only valid for the tax part of a sale, and non-transferable.

    Only evaders would prefer a cash prebate. A charge card good for tax only would also prevent squandering the prebate on beer, Pepsi, cigarettes, and lottery tickets.

    And a charge card might reduce fraud somewhat.

    Thanks, Phelbers

    Phelbers  ·  Oct 15, 2013 at 7:53 pm  ·  Permalink
  32. Back in 2007, Jane Gravelle of the Congressional Research Service did some research on non-compliance rates under various sales tax/VAT regimes.

    http://www.aei.org/files/2007/02/28/20070302_GravellePresentation.pdf

    It’s not real clear, but, if I understand it correctly, the non-compliance rate in the UK with a VAT of around 20% was about 15%. VATs are believed to be more efficient that a sales tax (like the FairTax) and have less incentive or opportunity to cheat. So, if the UK has a non-compliance rate of 15% with a VAT of only 20%, you can just imagine what the non-compliance rate would be under the FaiirTax (which, of course) would be in addition to state sales taxes.

    Hayden Kepner  ·  Oct 15, 2013 at 10:02 pm  ·  Permalink
  33. Hayden, thanks for the link.

    Your referenced table says 15% evasion for a UK 28% VAT. So Hank’s 15% is in line with these data, if I guess we assume the table means 15% of the tax dollars, not 15% of non-big-box transactions, as Morphh seems to be saying.

    We still need common definitions and agreement for percentage references and tax base distributions to be conversing meaningfully.

    Thanks, Phelbers

    Phelbers  ·  Oct 15, 2013 at 11:20 pm  ·  Permalink
  34. Hank,

    On. Another point in your article, Oliver Wendell Holmes Jr. did more to destroy the US with the power of taxation than all others combined. He is the most two-faced snake in the grass liar to ever disgrace the Supreme Court. The quote you post is about as opposite to his rulings as could be.

    In US vs Sullivan, he held for the Court that any person shall be compelled to be a witness against himself in any criminal case by compelling tax returns, which of course are written testimony of a witness (the filer). He reversed lower court decisions that held correctly that the Fifth Amendment prevents the government from compelling written testimony in the form of a tax return that the government could then use against the filer in any criminal case, just as the government now does.

    Holmes held that it would be “extreme if not extravagant” to say the Fifth Amendment “authorized” a person to refuse to give testimony in the form of a tax return simply because he may have earned it illegally.

    Holmes plain lied, Bill Clinton style, using flowery logical fallacy to distract the reader with the straw man “authorize”. He never mentions that the Fifth Amendment authorizes nothing at all, but is only a prohibition against government. By tearing down the “authorize” straw man, he purports to have defeated the defendant’s true argument that the Fifth makes it unconstitutional for government to compel testimony.

    And we now have a Chief Justice who lionizes the miserable scoundrel Holmes, citing Holme’s preposterous dictum that all deference must be given to uphold the legislation over the Constitution. We wouldn’t be talking about the Fair Tax now if we had had an honest man in the Court instead of Holmes and his lackys, because we wouldn’t have the miserable income tax to replace.

    Thanks, Phelbers

    Phelbers  ·  Oct 16, 2013 at 3:34 am  ·  Permalink
  35. Phelbers,

    I have no idea what your Oliver Wendall Holmes rant is all about? I wonder if you are referring to my quote from John Marshall? What am I missing?

    Hank Van Gieson  ·  Oct 16, 2013 at 10:18 am  ·  Permalink
  36. The evasion on a European VAT, those reviewed by Jane Gravelle, is not a good reference. For one, we don’t know if the large retailer has the same market over there – the ability to reduce those collection points and focus revenue. Secondly, the revenue collection and liability is important for the type of tax. While a VAT has more reporting, it is also layered. It greatly increases the collection points and significantly reduces the 80/20 gains, since the 80 is not limited to the large retailer’s evasion, but every layer under it. We could have the same 80/20 in Europe and evasion from the large retailers could be 0%, but it would still have a major effect on the tax base because the large retailer is only responsible for the “Value Added” (which is usually low margin), not the entire tax. It can flip the 80/20 on its head. So if the tax has 15% evasion before it gets into to the big box through the layers, then having 0 evasion at the retail level is somewhat moot – it just changes the average slightly. This is unlike the FairTax, where the full responsibility, collection, and remittence is on the big box retailer. The manufacturers and suppliers have no tax liability.

    It’s not clear if the VAT’s reporting requirements result in an economic gain or loss, but it is believed that it reduces the average evasion rate. These same reporting requirements could be added to the FairTax without the addition of evasion layers and expanding collection points.

    Morphh  ·  Oct 16, 2013 at 2:23 pm  ·  Permalink
  37. Hank,

    I see that the Holmes quote is in your post #2 to Bill above, not in your paper. That’s what I was referring to.

    Phelbers

    Phelbers  ·  Oct 16, 2013 at 4:37 pm  ·  Permalink
  38. Morphh,

    I think the statistics on evasion are as a percentage of the total taxable base.

    When they say the UK VAT evasion rate is 15%, it means 15% of what the total VAT tax would be with no evasion, not what percentage of tax added exchanges take place. The tax bureau gets only 85% of what it would get in a perfect scenario.

    Thanks, Phelbers

    Phelbers  ·  Oct 17, 2013 at 5:29 pm  ·  Permalink
  39. Phelbers,
    I expect so. As I outlined in 36, the European VAT doesn’t have a large distinction between those with a high evasion and low evasion, since it’s all layered (value added) – so their average is more directly applied to the total tax base.

    Example – Assume that 98% of all business is small / medium with high/normal evasion. Let’s also assume that the average is 20% evasion.

    For simplicity, let’s say the other 2% is large business and has 0% evasion.

    In Europe, the VAT layers the tax at each level on the “value added”. Thus liability for the tax could be spread across 100%. By the time the retailer sells the product, it already has a large amount of evasion (not compounded as a percentage – but average). So under the VAT that 98% of business is probably responsible for something like 80% of the Government’s revenue. If we do our math. 80*.20 = 16%

    * This leaves the European VAT in our example with a 16% reduction across the entire tax base.

    Now we have the FairTax. Only the final retailer is responsible for tax liability, while all manufactures and supplies have no tax liability. Now your 98% of business only accounts for 20% of government revenue, while the very large retailers account for 80% of final sales. 20*.20 = 4%

    * This leaves the U.S. FairTax with a 4% reduction across the entire tax base.

    Now, we can plug different evasion factors in, but the point is there is a huge difference between how the average evasion is applied to the revenue. The European VAT having 15% evasion as applied to the total tax base is consistent with that model (as it’s layered) – it doesn’t mean that same model applies to the FairTax. It’s useful as an example of average evasion on consumption taxes – how much will the average business cheat (i.e. as applied to business – our mode average was 20% for all business or 19.6% means) but things change when you apply that average to those generating government revenue. The average base erosion for the VAT changes to 16% and 4% for the FairTax.

    Morphh  ·  Oct 17, 2013 at 6:59 pm  ·  Permalink
  40. Morphh,

    I understand the analysis, but I think there is still a difference in understanding between how you and Hank are discussing evasion.

    It may prove advantageous from enforcement purposes to talk in terms of percentages of businesses that evade versus the percentage of total tax dollars evaded. But, Hank insists that the total percentage of revenue evaded will be 15%, and you seem to counter that 15% of businesses will evade, resulting in only 4% of revenue loss.

    If your 80-20 percent big-box / other retail sales is accurate for ALL sales, including services, I agree with 4%. Hank is apparently not accepting that, but insisting that this 80-20 split is actually 40 big-box goods, 10 other goods, and 50% services (other than big-box and thus high evasion) services.

    I think I’d have to see some reliable resources/references for the goods and services breakdowns to come to a conclusion. The same Gravelle table show that the NIPA data include 8.9% evasion – something Hank also disagrees with?

    One other point is that many or most of the European nations have large VATs AND large income taxes, which may increase their tolerance for VAT evasion. France, for example, gets only 50% of its revenue from VAT.

    Thanks, Phelbers

    Phelbers  ·  Oct 18, 2013 at 8:35 pm  ·  Permalink
  41. Phelbers,
    To clarify, I’m not countering that 15% of businesses will evade. 100% of businesses may evade, but I counter that 98% of them would evade at the estimated average of 15%, while the revenue generating 2% would evade very little. The service sector is in the same category as retail goods.

    Here is a quote from “FairTax: The Truth: Answering the Critics”, which bases this information on the 2002 Economic Census.

    “[W]hen you look at who’ll be collecting this tax, the chances of drumming up a conspiracy suddenly look even worse. In America, .03 percent of all of America’s companies—688 companies, to be exact—sell 48.5 percent of all of the merchandise. Those companies aren’t going to help you cheat; there’s simply too much at stake. Data also shows that 3.6 percent of all of America’s companies—92,334 firms—collectively make 85.7 percent of all sales…
    When it comes to the services sector, the fact is that 1.2 percent of all businesses make approximately 80 percent of the sales in the services sector. They have too much to lose to risk helping you cheat. Even if the FairTax were paid only by these few companies, we would still have a better collection rate than the IRS currently has with the income tax.”

    So they’re saying that 80% of service sector revenue is generated by 1.2% of business, while 20% is generated by the other 98.8% of business. I don’t know if the 85.7% figure is just for retail goods, or if it includes the service sector, since they say “all sales”.

    I’ve sent an email to AFFT’s Karen Walby to see if she has updated figures from the latest Economic Census. I’ve also asked her to verify the evasion figures in the NIPA data.

    Morphh  ·  Oct 18, 2013 at 9:03 pm  ·  Permalink
  42. Morphh,

    Thanks for displaying that quote from the second Fairtax book. It confirms the failure of the authors to properly address tax reform. It does not take two to cheat, just the retail merchant. You may pay the sales tax but you have no idea whether or not the merchant forwarded the tax revenue to the proper agency. Without a dual reporting system such as used by the IRS today, evasion at the high rates proposed by HR25 will run rampant. I like 15% minimum until proven otherwise. Unfortunately, we may never know who was right because HR25 is going nowhere, imho.

    What I do know for sure is that 135 nations worldwide use a VAT , not a national sales tax. Six nations worldwide have tried a broad based high rate sales tax such as the Fairtax and all six switched to a VAT. Don’t you begin to see a message there?

    I am all for getting rid of the income tax and the IRS, but the Fairtax is not the way to go. A flat tax may be preferred by some, but if you really want to get rid of the IRS, why not support a 10-15% VAT and replace just the Corporate and individual income tax?

    Hank Van Gieson  ·  Oct 19, 2013 at 2:48 pm  ·  Permalink
  43. Hank,

    If HR 25 placed liability on the seller, or even the distributor or manufacturer, not the buyer as it now does, the HR 25 FairTax would be essentially a single point VAT with a prebate. It would give us a consumption tax, paid for by the ultimate consumer, but collected and administered much as is the present buyer-benevolent (in terms of administration) gasoline tax.

    The multilayered VAT, as well as the HR25 buyer-liable sales tax would both magnify and increase tremendously the size and meddlesomeness of the IRS, not get rid of it as you and AFFT suggest. The multilayered VAT allows for evasion at each step of the imposition rather than a single point, as with a reasonable sales tax or gasoline style excise-like consumption tax with a charge-card, good-for-tax-only prebate.

    Thanks, Phelbers

    Phelbers  ·  Oct 20, 2013 at 3:09 pm  ·  Permalink
  44. Hank,

    One other thought.

    Since you so favor a VAT, you should strongly favor the FairTax, or a sales tax, not oppose it. As you point out, all those countries who tried a sales tax quickly switched to a VAT. So the best way to get a VAT would be via a sure-to-fail sales tax.

    Thanks, Phelbers

    Phelbers  ·  Oct 20, 2013 at 3:17 pm  ·  Permalink
  45. Phelbers,

    I’m not sure you really understand a VAT and the reason why evasion at higher rates is so low. My understanding is that the “self policing” nature of a VAT can and does work. At each level of production, the seller provides the buyer a certificate showing the tax paid by the seller. If the seller does not pay the tax, then the tax due from both levels falls on the buyer. The end result is that sellers that try to game the system are quickly eliminated from the process. Doesn’t take a huge bunch of IRS auditors to keep evasion low. And, any cheating that does occur involves just a fractional part of the whole manufacturing process. Cheating with a retail sales tax involves the end product and that can be significant.

    A better way to get a VAT would be to pass legislation creating one, not passing the very foolish Fairtax and waiting for it to fail. And, the VAT I favor replaces just the corporate and individual income tax, nothing else.

    Hank Van Gieson  ·  Oct 20, 2013 at 11:32 pm  ·  Permalink
  46. Hank,

    If the Gravelle tables from Hayden’s link are factual, the 15% evasion for the UK 28% VAT disabuses the notion that a VAT is substantially better than other tax schemes, at least evasion wise. The latest figure for our income tax is 19% evasion. I don’t think the sales tax plan should be rejected based on evasion estimates.

    Also, I believe your strongest objection to a sales tax is that your SS and or other pensions would be taxed. The prebate would cover much of SS, and I favor extending prebate credit for all of it (the flagging FairTax will have to do this and eliminate the transition “double taxing” of already taxed savings to gain any favor with voters).

    I personally have no objection to having some skin in the game tax wise for purchases over the poverty level. I would strongly favor elimination of all present income taxes requiring persons to be witnesses against themselves in any criminal case (filing returns).

    The sales to VAT suggestion was meant tongue-in-cheek, even though there may well be some truth in it!

    Thanks, Phelbers

    Phelbers  ·  Oct 21, 2013 at 3:18 am  ·  Permalink
  47. Phelbers,

    According to WIKI, the UK VAT is not the only, or the largest source of revenue, ranked behind the income tax. The Standard rate is 20% and many goods and services are at the reduced rate of 5%. The list of zero rate stuff is longer than the Standard rate stuff. My guess is that the average VAT rate is in the area of 10%. I don’t know where Jane came up with 28% or whatever Hayden’s link indicated. WIKI also reports that evasion is 16% which would seem to support my claim that there will be evasion under the Fairtax and it was not included in the 2006 rate report. None of these statistics are representative of the evasion that might occur with a sales tax rate of 42%, the real rate retailers have to add to costs to accomplish the revenue neutral goal. Stay tuned!

    My strongest objection to the Fairtax is not the unfair taxation of retirees pensions. My objections to HR25 include the inappropriate federal taxation of State and Local government operations, the prebate and the resulting creation of a group of tens of millions of lower income workers that would pay no net federal tax due to the prebate, yet would still receive full government retirement benefits without having paid one dime, the destruction of the SS concept, the impact on the new housing market, and yes, the fact that retirees would see their after tax savings reduced in value by up to 30% overnight as well as their savings double taxed when spent.

    But that is not what the thrust of this thread should be. My claim is that evasion was not included in the Fairtax rate and should have been. Here are the reasons AFFT/BHI gave for not including an evasion factor in their study:

    (1) The overwhelming majority of purchases of goods and services occur in major retail outlets that will surely comply with the Fairtax.
    (2) The federal government would be able to concentrate its entire tax enforcement efforts on a single tax–the Fairtax.
    (3) The National Income and Product Accounts (NIPA) used to form the Fairtax base understate household consumption because they make no adjustment for either underground income or the underground consumption it supports.
    (4) Omission of tax evasion is offset by the major capital gain the federal government stands to accrue, assuming retail prices rise by 30%, which in turn would reduce the real value of government debt in the hands of the public by about $1 trillion. Although this is a one-time windfall, it is a very large one.
    (5) Omission of evasion is also offset by the fact that the rate study was a static analysis, and failed to incorporate the significant dynamic expansion of the base that would likely arise over time.”

    I would be happy to discuss any and all of these with you.

    Hank Van Gieson  ·  Oct 22, 2013 at 8:55 pm  ·  Permalink

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