Taxation of Government Consumption
Taxing of State and Local consumption and non-education salaries is approximately 9% of the FairTax base, but is it proper and constitutional? Jim Bennett and Hank Van Gieson go for Round 2 in the debate (see Round 1 from 2010). On this topic, AFFT’s Karen Walby submitted this to the Congressional record:
Public finance economists realize that the current system imposes taxes on government, albeit indirectly through the higher wages government must pay its employees, the payroll taxes it must pay, and the higher payments it makes to government contractors, than would otherwise be the case if there were no federal income tax system. They further realize that when you shift from an income tax to a consumption tax you must maintain the same “tax wedge” in government. Not doing so would distort the private marketplace, creating an incentive to consume through the medium of government. Federal taxation of units of government has already been upheld by the Supreme Court when it affirmed that the federal government could require all units of government to pay payroll taxes on wages paid to its employees.
FairTax.org acknowledges that increased revenue from taxing federal government consumption is exactly canceled by increased costs in the federal budget (as pointed out by the tax panel). What the tax panel neglected to point out is that this accounting method is used today by the Office of Management and Budget and Congressional Budget Office.
The FairTax taxes all consumption, including government consumption, once. Today, the income tax and payroll tax are imposed on government consumption by taxing government employees and government contractors, making government pay more than it would in the absence of these taxes. This tax revenue appears in the receipts column in the federal budget, and the added expense is counted in the federal budget as spending (exactly canceling each other out). Fortunately, at least in this respect, the federal budget is honestly presented.
This tax revenue currently “paid” by the federal government is part of the tax revenue that the FairTax replaces. The federal government could artificially reduce both spending and tax revenues by exempting its workers and contractors from both income and payroll taxes and lowering wages paid to employees and amounts paid to contractors accordingly. Similarly, the FairTax taxes government consumption and, like today, the expense and revenue would be reflected on the federal budget as such. If the FairTax were to exempt government from tax and if federal spending were held constant, then the purchasing power and size of the federal government as a share of the economy would be dramatically increased. Further, not taxing government consumption would artificially make government consumption appear cheaper and promote increased consumption via government. So, though a wash, there would be negative economic consequences if the FairTax did not continue the practice of taxing government consumption.
Hank has argued that taxing consumption is unnecessary to prevent government competition with the private sector due to Sec 704 and questions the constitutionality of it.
HR25, Sec. 704 took care of that problem by treating government agencies at any level that sell at least $2500 per quarter of goods or services as Government Enterprises. All Government Enterprises must collect and remit the 23% sales tax. There was no need to tax all government consumption. The playing field with the private sector was already level.
Furthermore, federal taxation of State and Local government consumption is unconstitutional. Sovereign powers do not tax each other, and the Supreme Court will throw out this feature under the long held doctrine of “intergovernmental tax immunity.” Your precedent for such taxation was also incorrect. The Supreme Court approved the Social Security plan because it allowed State and Local government employees a choice of whether or not to join the federal Social Security system. Many S/L government agencies decided to set up their own plan. HR25 wisely gives States a choice as to whether or not to act as the federal tax collector. A constitutional issue was thereby avoided. No such choice exists regarding the taxation of S/L government consumption.
Does Sec 704 make it unnecessary? What about the tax wedge? Should state and local government reflect the comparable costs of private providers, even if they’re not directly competing (applicable for outsourcing)? Would shifting that cost away from the state present a more accurate picture of state / local cost vs federal cost, or a less accurate one? No ear biting – Ding Ding Ding… Fight!