Tuesday, December 18, 2007

Reject the Fair Tax

I want to disclaim at the beginning that I am no tax policy expert. Yet, I think that the concepts argued for and against the “fair tax” as proposed by Mike Huckabee are simple enough that most people should be able to understand them.

Mike Huckabee describes on his campaign web site his version of the Fair Tax:
When the FairTax becomes law, it will be like waving a magic wand releasing us from pain and unfairness.

The FairTax will replace the Internal Revenue Code with a consumption tax, like the taxes on retail sales forty-five states and the District of Columbia have now. All of us will get a monthly rebate that will reimburse us for taxes on purchases up to the poverty line, so that we're not taxed on necessities. That means people below the poverty line won't be taxed at all. We'll be taxed on what we decide to buy, not what we happen to earn. We won't be taxed on what we choose to save or the interest those savings earn. The tax will apply only to new goods, so we can reduce our taxes further by buying a used car or computer.

Our current progressive tax system penalizes us for working harder and becoming more successful. As we climb the ladder, the government lurks on each rung, hungry for a bigger bite out of our earnings. The FairTax is also progressive, but it doesn't punish the American dream of success, or the old-fashioned virtues of hard work and thrift, it rewards and encourages them. The FairTax isn't intended to raise any more or less money for the federal government to spend - it is revenue neutral.
There are a lot of different points to be made. Easily dismissed is the claim that the Fair Tax will release us from pain and unfairness. Such a silly claim gets at the unseriousness of the Huckabee campaign in general. More substantively, only six countries have ever adopted retail sales taxes at rates of 10% or more; none do now. 58 Fla. L. Rev. 1043, 1048; Joel Slemrod, Presentation to the President's Advisory Panel on Federal Tax Reform: The Costs of Tax Complexity (Mar. 3, 2005), available at http://www.taxreformpanel.gov/meetings/ docs/slemrod 03032005.ppt.

Huckabee next says that all will get a monthly rebate for purchases up to the poverty line. This argues against one of the main points that he promotes in arguing for the Fair Tax: administrative ease. Huckabee has argued for abolishing the IRS, but it seems that he would have to replace it with some other agency by which to mail out every American’s monthly rebate check. The type of money being passed through the mail would also invite all sorts of criminal behavior (remember how well the debit cards went after Katrina?).

Huckebee also says that the Fair Tax will create positive incentives for saving. That is probably true. Through a combination of zero tax on savings and the dramatic increase of goods after the Fair Tax is enacted, people are likely to refrain from spending. The Fair Tax creates the incentive to withhold income from being put back into the economy. How this will affect the economy only an economist could predict, but the incentives seem to lead to a slowing of the economy as people withhold their dollars from the marketplace. However, eventually, even savings will be taxed as they are spent. The savings argument is misleading because it really only marks a delay in taxation, not an abolition of the tax on savings.

Huckabee argues that both taxes are progressive. However, the Fair Tax is difficult to make progressive. Since the tax applies to all at the point of sale, regardless of economic status, it would generally appear to be either a flat or regressive tax. The single rate of taxation on purchases hits low-income people harder than high-income people because the purchases are a larger proportion of the low-income person’s wealth. Higher income people are able to save a larger portion of their earnings. Thus, even with the rebates he proposes, for anyone above the poverty line, the tax is regressive. To make it progressive, Congress would have to add in additional complexity Graduated tax rates, differential rates, or higher rates all would lead to increasingly complex taxpayer behavior and legislative and administrative responses. 88 Calif. L. Rev. 2095, 2141.

In sum, and these certainly aren’t all the points to be made about the Fair Tax system, the Fair Tax likely does little to improve the current tax system and likely does harm. It does little to improve the complexity or administrative burden. It only shifts the time of taxation from when it was produced to when it was consumed. Finally, it likely dulls economic growth by creating a disincentive to spend.

Beyond its inherent political impracticability, the Fair Tax should be rejected. The better alternative, and the more realistic one, is the one Mitt Romney has proposed: lower marginal rates, end the death tax, end taxes on savings, and lower corporate taxes. These things combined will do more for the economy and the nation than the enactment of the Fair Tax.

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7 Comments:

Blogger Ian said...

All presidential candidates, of both parties, having a shot at the nomination - with the exception of Mike Huckabee - support the status quo income tax machinery that is easily abused, depending upon which party is in power.

Huck's FairTax plan dismantles that machinery and stops hiding business's tax costs in prices to consumers (by ending tax on business income and payrolls) - which also places our products at a substantial global disadvantage. It scraps the tax code, and ends tax-favor bartering between 35,000 lobbyists (53% of all lobbyists) and 535 members of Congress.

FairTax returns the primary function of taxation to revenue collection. However, it does so without unnecessary government invasion of American families, in violation of citizens' 4th Amendment rights "...to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures..."

But is FairTax actually "fairer"? To provide substantive answers, Prof.'s Kotlikoff and Rapson (10/06) have concluded,

"...the FairTax imposes much lower average taxes on working-age households than does the current system. The FairTax broadens the tax base from what is now primarily a system of labor income taxation to a system that taxes, albeit indirectly, both labor income and existing wealth. By including existing wealth in the effective tax base, much of which is owned by rich and middle-class elderly households, the FairTax is able to tax labor income at a lower effective rate and, thereby, lower the average lifetime tax rates facing working-age Americans.

"Consider, as an example, a single household age 30 earning $50,000. The household’s average tax rate under the current system is 21.1 percent. It’s 13.5 percent under the FairTax. Since the FairTax would preserve the purchasing power of Social Security benefits and also provide a tax rebate, older low-income workers who will live primarily or exclusively on Social Security would be better off. As an example, the average remaining lifetime tax rate for an age 60 married couple with $20,000 of earnings falls from its current value of 7.2 percent to -11.0 percent under the FairTax. As another example, compare the current 24.0 percent remaining lifetime average tax rate of a married age 45 couple with $100,000 in earnings to the 14.7 percent rate that arises under the FairTax."

Further, per Jokischa and Kotlikoff (2005) ...

"...once one moves to generations postdating the baby boomers there are positive welfare gains for all income groups in each cohort. Under a 23 percent FairTax policy, the poorest members of the generation born in 1990 enjoy a 13.5 percent welfare gain. Their middle-class and rich contemporaries experience 5 and 2 percent welfare gains, respectively. The welfare gains are largest for future generations. Take the cohort born in 2030. The poorest members of this cohort enjoy a huge 26 percent improvement in their well-being. For middle class members of this birth group, there's a 12 percent welfare gain. And for the richest members of the group, the gain is 5 percent."

We, as FairTax advocates, believe that government should serve We, the People, with a fair tax system that will not enable politicians to pit poor against rich (creating barriers to achieve wealth, adding tax penalty to the sacrifices made for personal success). Nor do we want politicians to continue using business as a tool to hide taxes from consumers, often villifying business, which discourages entrepreneuship, personal achievement, economic growth. Liberty and happiness depends on restoring the fruits of labor to those who produce them. We believe that the tax function should align with economic growth, not against it, that government should be paid for in the same manner as working Americans - when, and because, something is sold!

Many of us have joined FairTax.org in order to build a national movement to free ourselves, our family pocketbooks, and our businesses from confiscation of income, and punishment of productivity. And this we say to our federal representatives,

"Either scrap the code and enact the FairTax, or we intend on replacing you with someone who will."

11:33 PM  
Blogger Spudfunkel said...

How does it help our economy to put every single employee of the IRS (all 115,000 of them) out of a job? Not to mention the majority of our nation's tax attorneys and accountants, which represent a highly-educated, highly-trained, highly-specialized class of professionals that would have literally no other employment opportunity. Several Fortune 500 companies, such as H&R Block and Jackson-Hewitt, would also be forced to close.

And all of this comes for the reward of a system of taxation that disincentivizes consumer spending, the very lifeblood of our economy. FairTax is designed to promote savings and investment. And since personal savings accounts are used by banks to make their own investments, FairTax essentially just promotes investment. More people will be buying mutual funds, shares of stock and debt equity on the open market. Bully. However, those same people will be less likely to purchase the products and services offered by these companies because they are directly taxed (at a level 3-100 times higher than they have ever before seen) on those purchases. Regardless of the amount of money invested in the market, companies cannot sustain themselves without revenue received from consumer spending. Those investments everyone will be making will ultimately lose money.

And if you try to argue that the higher taxes will be offset by the fact that Americans will be taking home most of their paycheck, I'm sure the laws of inflation will have a few things to retort. Flooding the economy with disposable income is a fantastic way to drive up prices across the board, as well as weaken the dollar even further on the currency market.

By the way, what would happen to the corporate and estate tax system? Do corporations only get taxed for what they spend? Are they exempt altogether? And cities and states won't stop taxing their residents' income. What about FICA and Social Security? My paycheck is still going to get hit pretty hard every month. Now I've got a 23% surtax on my groceries, too. Thanks, Mike.

I am not rabidly anti-Huckabee. I agree with him on many social issues. But this FairTax idea is beyond ludicrous. It's because of this alone that I would happily vote for Barack Obama or (gulp) John Edwards if Huckabee ever won the GOP nomination.

Oh, yeah, go Mitt.

3:06 PM  
Anonymous Anonymous said...

A consumption tax makes more sense because if the government ever wants/needs to generate more revenue... they wouldn't have to raise the tax rate, but instead do things to stimulate the economy. More consumer spending will mean more government revenue. if they ever get to a point of surplus, they can lower the tax rate which might stimulate the economy even more... it's a win-win.

8:39 PM  
Blogger D said...

You're correct to reject the Fair Tax, but it seems you reject it for the wrong reasons. The Fair Tax is one of many attempts to impose a tax on consumption, the principal objective of which is to eliminate the disparate treatment of consumption and investment.

To understand precisely how this disparate treatment occurs, and to understand why it is unfair, an illustration is useful.
Suppose the existence of two taxpayers, Investor and Consumer. Investor earns 100 dollars of ordinary income and, choosing to defer consumption, invests it for 24 years at 9% interest. Unmolested by taxes, Investor’s 100 dollars will grow to be 800 dollars in year 24. Also in year 24, Consumer earns 800 dollars, all of which is spent on consumption.
Let us now consider the treatment of Investor and Consumer under the hybrid income tax. Initially, Investor’s 100 dollars of ordinary income is taxed at 33% leaving only 67 dollars to be invested. Further, the annual rate of return that Investor will receive is reduced from 9% to 6% because of the 33% tax imposed on interest under U.S law. The result is that in year 24, Investor is left with only 267 dollars to consume. This is an effective tax rate of 67%. Consumer, who earned 800 dollars in year 24, is taxed at an effective rate of 33% and is left with 533 dollars to consume. Thus, in year 24 Investor is subject to an effective tax rate double that of Consumer. John Stuart mill called this result the “double tax” on savings: taxpayers are taxed twice on what they invest and only once on what they consume.

Fair Tax attempts to cure this problem. However, many of the claims made by Fair Tax advocates appear exceedingly far-fetched.

Eliminate the IRS? Some agency will be needed to administer and enforce the Fair Tax just as the IRS is needed to administer and enforce the current income tax.

Retail sales tax (RST) as low as 23%? The president's advisory panel on federal tax reform, as well as the Treasury claim that a much much higher. With administration expense estimates for the prebate system as high as 780 billion dollars the RST rate would necessarily be increased. Treasury estimates raised the proposed 23% rate to as much as 34%. This rate could be raised even higher if any of the 45 states already having an RST in place elect supplement the existing RST with the Fait Tax RST. Given an average state sales tax of 6.5%, this would bring the retail sales tax to nearly 40%. Further, the absence of a tax on used goods could create an underground economy. In order to compensate for the resultant lost revenue, the RST rate would need to be raised even higher. Treasury estimates would raise the rate to as high as 49%. When the Treasury made greater assumption regarding rates of tax evasion, the predicted RST rate necessary to remain revenue neutral was pushed higher still.

Income tax reform is badly needed. Fair Tax isn't the way to do it.

12:32 PM  
Blogger Ian said...

Economic dislocations are the problem with an income tax system that is highly manipulable - subject to influence by lobbyists and continual revision by politicians, taxes business resources and payroll whose costs cannot be extracted from export prices and results in higher domestic price tags for consumers.

Clearly, the answer is in front of us - the FairTax; that's right, the same plan ardently advocated by Gov. Huckabee and demagogued by people like Bruce Bartlett.

Mr. Huckabee's advocacy of the FairTax is the single most important policy position in this election. The research makes a compelling case for every American wage-earner to get involved in voicing their support for the FairTax Act of 2007 (HR 25 / S 1025) that's been reintroduced into every session of Congress since 1999, and with growing numbers of co-sponsors:

The FairTax rate of 23 percent on a total taxable consumption base of $11.244 trillion will generate $2.586 trillion dollars – $358 billion more than the taxes it replaces. [BHKPT]

The FairTax has the broadest base and the lowest rate of any single-rate tax reform plan. [THBP]

Real wages are 10.3 percent, 9.5 percent, and 9.2 percent higher in years 1, 10, and 25, respectively than would otherwise be the case. [THBNP]

The economy as measured by GDP is 2.4 percent higher in the first year and 11.3 percent higher by the 10th year than it would otherwise be. [ALM]

Consumption benefits [ALM]:

• Disposable personal income is higher than if the current tax system remains in place: 1.7 percent in year 1, 8.7 percent in year 5, and 11.8 percent in year 10.

• Consumption increases by 2.4 percent more in the first year, which grows to 11.7 percent more by the tenth year than it would be if the current system were to remain in place.

• The increase in consumption is fueled by the 1.7 percent increase in disposable (after-tax) personal income that accompanies the rise in incomes from capital and labor once the FairTax is enacted.

• By the 10th year, consumption increases by 11.7 percent over what it would be if the current tax system remained in place, and disposable income is up by 11.8 percent.

Over time, the FairTax benefits all income groups. Of 42 household types (classified by income, marital status, age), all have lower average remaining lifetime tax rates under the FairTax than they would experience under the current tax system. [KR]

Implementing the FairTax at a 23 percent rate gives the poorest members of the generation born in 1990 a 13.5 percent improvement in economic well-being; their middle class and rich contemporaries experience a 5 percent and 2 percent improvement, respectively. [JK]

Based on standard measures of tax burden, the FairTax is more progressive than the individual income tax, payroll tax, and the corporate income tax. [THBPN]

Charitable giving increases by $2.1 billion (about 1 percent) in the first year over what it would be if the current system remained in place, by 2.4 percent in year 10, and by 5 percent in year 20. [THPDB]

On average, states could cut their sales tax rates by more than half, or 3.2 percentage points from 5.4 to 2.2 percent, if they conformed their state sales tax bases to the FairTax base. [TBJ]

The FairTax provides the equivalent of a supercharged mortgage interest deduction, reducing the true cost of buying a home by 19 percent. [WM]

ALERT: Kotlikoff refutes Bruce Bartlett's shabby critiques of the FairTax.

1:36 PM  
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7:42 AM  
Anonymous Anonymous said...

QUOTE: "More substantively, only six countries have ever adopted retail sales taxes at rates of 10% or more; none do now"

HUH?

Here in the UK, sales tax is 17.5%. In other European countries, it climbs to as high as 25%.

What are you smokin'?

As for the '23%/34%' debate, you need to understand the basic principles of mathematics to appreciate that "net plus tax" is different from "tax inclusive".

7:32 AM  

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