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The Oxymoronic "Fair Tax"

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By Gus Van Horn from Gus Van Horn,cross-posted by MetaBlog

Back in 1996, I supported the candidacy of Steve Forbes, which centered around simplifying the income tax through a "flat tax". My rationale at the time was based partly on the notion that this simplification of the tax code would at least reduce the intrusiveness of the IRS and partly on the naive assumption that this would represent a first step by the Republicans towards reducing spending as well as taxes.

A decade later, I have been disabused of the notion that the Republicans really care about reducing the size of the welfare state. Nobody is talking about a flat tax anymore, but this might be due to the fact that, politicians being what they are, the bloom came off that rose when they realized that the idea was not popular enough to win an election. But at the same time, nobody is talking about spending cuts anymore, either.

The political debate has, thanks to the adoption of the welfare state by the Republicans, shifted away from rolling back the welfare state as have noted before. And yet, as I also noted, the Republicans continue to enjoy an undeserved reputation as defenders of economic freedom.

Furthermore, it remains easy to hate the IRS, so despite the electoral non-viability of the flat tax, some Republicans who want to run against the IRS have come up with a new gimmick: the "fair tax". Just the name should clue you in that the Republicans have no opposition on principle to taxation: What's "fair" about the government confiscating your money?

But this Wall Street Journal article shows that it's even worse than that. The idea is being sold with a mountain of lies, damn lies, and statistics. Worse still, it incorporates an element of wealth redistribution that would make any Democrat proud:

Rep. John Linder (R., Ga.) and Sen. Saxby Chambliss (R., Ga.) have introduced legislation (H.R. 25/S. 1025) to implement the FairTax. They assert that a rate of 23% would be sufficient to replace federal individual and corporate income taxes as well as payroll and estate taxes. Mr. Linder's Web site claims that U.S. gross domestic product will rise 10.5% the first year after enactment, exports will grow by 26%, and real investment spending will increase an astonishing 76%.

In reality, the FairTax rate is not 23%. Messrs. Linder and Chambliss get this figure by calculating the tax as if it were already incorporated into the price of goods and services. (This is known as the tax-inclusive rate.) ...

The distinction is confusing, but think of it this way. If a product costs $1 at retail, the FairTax adds 30%, for a total of $1.30. Since the 30-cent tax is 23% of $1.30, FairTax supporters say the rate is 23% rather than 30%.

This is only the beginning of the deceptions in the FairTax. Under the Linder-Chambliss bill, the federal government would have to pay taxes to itself on all of its purchases of goods and services. Thus if the Defense Department buys a tank that now costs $1 million, the manufacturer would have to add the FairTax and send it to the Treasury Department. The tank would then cost the federal government $300,000 more than it does today, but its tax collection will also be $300,000 higher.

...

Since sales taxes are regressive--taking more in percentage terms from the incomes of the poor and middle class than the rich--some provision is needed to prevent a vast increase in taxation on the nonwealthy. The FairTax does this by sending monthly checks to every household based on income. [bold added]

Not to defend income redistribution in any way, but wouldn't Americans still have to file reports subject to audit to make sure people were not lying about their income in order to get these rebate checks? This wouldn't even really get rid of the IRS as far as I can tell.

Oh, and there's more:

A 2000 estimate by Congress's Joint Committee on Taxation found the tax-inclusive rate would have to be 36% and the tax-exclusive rate would be 57%. In 2005, the U.S. Treasury Department calculated that a tax-exclusive rate of 34% would be needed just to replace the income tax, leaving the payroll tax in place. But if evasion [e.g., non-collection --ed] were high then the rate might have to rise to 49%. If the FairTax were only able to cover the limited sales tax base of a typical state, then a rate of 64% would be required (89% with high evasion).

As I noted, the public debate ceased being about reducing spending long ago: Just look at the emphasis of this article -- in a presumably pro-business publication -- on how impractical Linder and Chambliss's proposal is as federal income replacement! Granted, that is the focus, but the remarkable fact remains that it would take a 57% sales tax to replace the federal income tax. I can't believe something wasn't said about the need to cut spending!

The obscene amount of wealth our government seizes to finance the welfare state is, thanks to this debate, being made impossible not to notice. It will, however, be up to those of us who understand the nature of capitalism and who value our individual rights to interject that this is inexcusable and that Americans can and should change this by demanding, at least for a start, a reduction in size of the welfare state.

This is a chance -- no thanks to the "Fair tax' Republicans -- to bring the public debate on the welfare state back to where it belongs: on how to eliminate it.

-- CAV149388620

http://ObjectivismOnline.com/archives/002764.html

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What would be nice about it is that 57% is a lot closer to what they actually take in one way or another then the 25 or 30% most people believe they pay. Interestingly, this excludes state and local taxes. What does that bring the percentage of actual theft to? 80% maybe. Plus inflation? Disgusting.

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Just looking at order of magnitudes, I believe the 57% number or some number that is higher. There are 2 reasons why: progressive taxation makes us think about marginal tax rates that are not representative of averages, and we forget the cumulative effect of corporate income taxes.

1. Aq has already pointed out the "other" taxes that we pay that aren't included in federal taxes, buthte other thing to consider is that the bulk of taxes are paid by rich and corporations at much higher marginal tax rates than the average income tax payor. Corporations pay taxes in the 30-40% range and they didn't get breaks this last round of cuts. I wrote about the fact that US corporations now are starting to look like some of the most highly taxed entities even when compared to European socialist countries.

2. Remember that corporate incomes taxes are built into the prices of products and they are stacked. That is, when company A sells its product to company B to company C, to company D, that the final price must include the corporate incomes taxes of all the companies that touched that article. It is not uncommon to have many layers (6+) of companies involved in this value chain in order to get a product from raw material to the store.

Add state/local income, state sales taxes, property taxes and I would not doubt that you could easily have to get to a 57% or great "final sales" tax to keep the revenue the same.

The "fair tax" will never fly, because it instantly makes more transparent just how much money the govt is taking from you. It's in politicians interest to keep that number as hidden as possible. Make it transparent and suddenly you'll get people questioning why it is so high.

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This wouldn't even really get rid of the IRS as far as I can tell.
From what I can tell, it repeals subtitle A,B,C of Title 26. This leaves in place a number of other taxes such as retail excise, manufacturing excise, wagering, environmental tax, alcohol, tobacco, firearms, "greenmail", structured settlements. There is a lot of the IRS code that remains untouched by this bill.
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Since sales taxes are regressive--taking more in percentage terms from the incomes of the poor and middle class than the rich--some provision is needed to prevent a vast increase in taxation on the nonwealthy. The FairTax does this by sending monthly checks to every household based on income. [bold added]

Not to defend income redistribution in any way, but wouldn't Americans still have to file reports subject to audit to make sure people were not lying about their income in order to get these rebate checks? This wouldn't even really get rid of the IRS as far as I can tell.

(The first paragraph is the article Gus Van Horn is quoting, the second is his analysis of that quote.)

The paragraph Gus Van Horn is quoting proves that the people writing the Wall Street Journal do not understand the fair tax proposal--and their misunderstanding has confused Gus Van Horn.

The monthly check would be sent out, all right--but it would be sent out to every household and be based SOLELY on the number of people living in the household. Yep, a billionaire family of four gets the same check as a dirt-poor family of four. The dependency on the size of the household is there becuase that is the key variable in figuring out the poverty level.

The purpose of this is to effectively exempt the poverty level of income from the tax. If the poverty level is 12,000 per year (it isn't but I chose that number to make the math easy for the illustration), that works out to 1000/month; you get sent a check for $230--it is the refund on the sales tax you would pay, if you were at maximum poverty level and spent all your income. Thus, the poor are exempt from this tax.

It should be noted that "how many people are in your household" is basically equivalent to the information you are required, under the US Constitution, to give to the census bureau. (The census asks for more; that's an over-reach on their part.)

Please note that Gus van Horn's conclusion--based on this faulty information--is incorrect. there would be NO so-called need for the federal government to determine your income under the "Fair Tax." Think about that.

Why do it this way instead of simply exempting "necessities?" Because if they wrote it to exempt food and shelter, caviar and filet mignon, to say nothing of multimillion dollar mansions, would be exempt--and people would find some way to make a loophole out of it. Also, there would be endless wrangling by lobbyists to get their specific service and/or product exempted. And one of the great big problems with the income tax (over and above the fact that it IS a tax!) is that it has become such a political football with everyone trying to get new exemptions, and the exemptions themselves being used for social engineering. The most influential group opposed to the "fair tax" is the lobbying firms (merchants of pull) whose specialty is to lobby Congress over tax law. They'd have to find honest work if this passed.

The distinction is confusing, but think of it this way. If a product costs $1 at retail, the FairTax adds 30%, for a total of $1.30. Since the 30-cent tax is 23% of $1.30, FairTax supporters say the rate is 23% rather than 30%.

(that's from the WSJ article)

The reason they quote it this way is that this way, it parallels the way income tax is quoted. Your tax is quoted as an inclusive percentage--a "30% tax rate" means you keep 70% and the government takes (steals) 30%. By quoting the "fair tax" this way, you see that out of every dollar you actually fork over at the cash register, 23% goes to the government.

I agree that this IS done in a confusing way and frankly I think it was a mistake for them to do so--it just gives the opponents something to hit them on. But they did have their reasons.

My personal opinion: The "fair tax" would turn the US into the world's biggest tax haven. Corporations that used to be based here, driven offshore by our double-taxing their foreign profits (we are the only industrial country to do so, to my knowlege), would come back, and not have their profits taxed at all. That would lead to unbelievable growth. The IRS would no longer be snooping around in your life, no more than the states (that do not have income tax) do, at the cash register (though they would continue to collect those excises). This is a HUGE improvement over the current situation.

But of course I have to say this: yes, it is still a tax, and it is still therefore immoral.

I also think it will be very hard to pass. I won't quite say "impossible" because there is a big grass roots movement. But I notice that the most damning arguments against it are basically based on misunderstandings of it. In some cases I am sure those misunderstandings are quite willful. (I specifically do NOT accuse the present company of this!)

A recent WSJ article (I do not know if it is the same one Gus Van Horn quoted; I do know the author was Bartlett) claims that the fair tax is a scheme by the Scientologists, and that is untrue. (Scientologists were pushing a different scheme (cats.org) but I am told--not verified by me--that they are no longer involved with that.) That claim is of course the fallacy of "guilt by association" and simply a smear.

Edited by Steve D'Ippolito
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From what I can tell, it repeals subtitle A,B,C of Title 26. This leaves in place a number of other taxes such as retail excise, manufacturing excise, wagering, environmental tax, alcohol, tobacco, firearms, "greenmail", structured settlements. There is a lot of the IRS code that remains untouched by this bill.

True. What it does do is take the IRS (or whatever they choose to rename it) out of the lives of anyone who is not actually running a business. And businesses would no longer have to file ANY sort of corporate income tax.

One other thing that does disappear is the "payroll tax" (and its evil twin the self-employment tax) that funds Social Security, Medicaid, and Medicare. That is about 15 percent of the first ~$90,000 of income (a regressive tax!) although half of it is supposedly paid by your employer (i.e., comes out of your hide without you even seeing it on a piece of paper titled "paystub").

One big benefit of the "fair tax" if it is ever enacted, is that ANY tax hike will immediately result in a jump in the price of goods you buy the next day. Did I say benefit? Yes, because everyone will be made unhappy by the tax hike right away. Therefore the political cost of a tax hike becomes a lot higher. One of the reasons we are in the mess we are in right now is that almost half of the voters pay no income tax whatsoever. Therefore anyone arguing for tax cuts is going to get, at best, less than half of the votes for doing so (and in practice a lot less than half because of altruism).

One thing I do not like about the proposal is that the tax will be "hidden" in the price of the product. I think it should be added on at the cash register every time, and slap the consumer across the face every time. (But then the "inclusive" rate quoted would be an even worse "misrepresentation" than it already is.)

One benefit I have NEVER seen anyone discuss is that the special, priveleged status of employer paid, one-size-fits-all medical insurance, disappears. That is a huge distortion of the health care market, and it's suddenly gone.

Also imagine suddenly being able to draw on your 401k account any time you want, and not having to wait on some arbitrary age the IRS decides is a "retirement age"--it's no longer taxable until you spend the money.

IF (a big if) this becomes law it will be an interesting transition! I suspect there will be some folks who are worse off for a while--but the economy will boom and five years later they will be much better off.

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Great posts Steve.

Despite its shortcomings, the Fair Tax really does appear to be a significant improvement over the current tax structure. This is of course presupposing that the bill actually eliminates all of the other forms of taxation (e.g. income tax, payroll tax and the like) that it is supposed to.

However, I still think that Walter Williams raises a good point concerning the Fair Tax. That is, even with the transition to a Fair Tax structure, there still needs to be precautions to prevent the government from engaging in massive deficit spending or inflating the currency.

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However, I still think that Walter Williams raises a good point concerning the Fair Tax. That is, even with the transition to a Fair Tax structure, there still needs to be precautions to prevent the government from engaging in massive deficit spending or inflating the currency.

Quite true.

I have confirmed one thing--the article Gus Van Horn quotes is indeed the same article that tried to smear the "Fair Tax" as a plot by Scientology. Therefore I would as a rule not believe ANYTHING that article says until proven otherwise.

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Wouldn't such a tax cause enormous inflation when it first came into existence? Basically, you suddenly start earning a lot more (because you're not paying income taxes anymore) yet everything also costs you a lot more: net effect is that the purchasing power of a single dollar, at least in practice, goes down tremendously...

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Wouldn't such a tax cause enormous inflation when it first came into existence? Basically, you suddenly start earning a lot more (because you're not paying income taxes anymore) yet everything also costs you a lot more: net effect is that the purchasing power of a single dollar, at least in practice, goes down tremendously...

That is something I've been trying to figure out as well. I've heard people say that your (nominal) income would drop (no effect on your net) and prices would stay the same, I've heard that it would be more like what you say. I think it might be somewhere in between. I cannot imagine the unions standing for having even nominal pay cut. Some independent businessment (i.e., doctors, lawyers) might actually go ahead and reduce their hourly rates since they no longer have to pay taxes.

Remember too that one thing that *would* disappear and almost certainly *never* be added to anyone's paycheck is the 7.5% "employer's share" of the payrol tax (social security, medicare, medicaid). Any company whose major cost is labor could lower their prices to that extent (before adding the tax back on). Also, their costs of complying with the corporate income tax vanish. More price reductions. My admittedly totally wild-ass guess is pre-tax prices would drop about 15%, then divide by .77 (since the 23% rate is inclusive) to add in the tax, to get a nominal price hike of 10.3% on average. This is not a good thing but is completely overwhelmed by the fact that you will get to keep "your share" of FICA and your withheld income tax. For some people the total of these can be 25% of your paycheck, but what would would see is 75% of your paycheck increase to 100%, meaning your take home pay would increase 33%.

This increase in your purchasing power is paid for by the cessation of costs of compliance with the income tax--a net $600B drain on the economy every year.

In any case, I don't think your scenario would be truly inflationary. Nominal prices would go up but you could afford the same amount of stuff as you had before. It would probably be considered a statistical glitch, much like the five quarter fiscal year we had when the government went from the fiscal year starting in July to having it start in October.

I will add another thought to this. Under this tax, investments are not taxed at all--you don't have to pay capital gains when your stock (option/futures contract/whatever) doubles in price and you sell it; you can simply plow all that money back into your next purchase. One thing that has deterred me from starting a business is I simply do not have the willpower to plow through all the damned paperwork mandated by the IRS; I imagine a lot of people otherwise inclined to start informal businesses (sole proprietorships) would find it ten times easier to proceed if it were gone.

The other thread referenced by softwareNerd has a lot of good discussion in it, both about the specifics of the plan AND whether or not it is principled to support it. If you are willing to spend some (alas, after-tax) dollars you can also buy the fair tax book by Boortz and Linder.

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I'm pretty sure inflation does not work that way. (in the same way that windmills don't cool you down) Inflation is an increase in the money supply without a corresponding increase in goods/services. As I understand it, it can only happen by printing more money. If the government were to keep less of our money, or to take it from different people, or to eliminate the IRS and thus spend it elsewhere, this does not alter the money supply - it simply puts the money to different uses and in different hands.

Any economics experts out there?

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I'm pretty sure inflation does not work that way. (in the same way that windmills don't cool you down) Inflation is an increase in the money supply without a corresponding increase in goods/services. As I understand it, it can only happen by printing more money. If the government were to keep less of our money, or to take it from different people, or to eliminate the IRS and thus spend it elsewhere, this does not alter the money supply - it simply puts the money to different uses and in different hands.

Any economics experts out there?

That's basically what I was trying to say previously. I do think though that the government tries to measure inflation by looking at prices. (Provided you keep in mind that chronic rising prices are a symptom of inflation, this isn't necessarily invalid.) If those prices go up because of enactment of the fair tax, it will look like inflation to the government (due to its methodology) but not really be due to an expansion of the money supply, nor will it be harmful because the overwhelming majority's usuable income will go up at the same time.

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I'm pretty sure inflation does not work that way. (in the same way that windmills don't cool you down) Inflation is an increase in the money supply without a corresponding increase in goods/services. As I understand it, it can only happen by printing more money. If the government were to keep less of our money, or to take it from different people, or to eliminate the IRS and thus spend it elsewhere, this does not alter the money supply - it simply puts the money to different uses and in different hands.

Any economics experts out there?

I'm not an expert, but I think you're right. Because of the shift in dollars there would probably be localized inflation on certain consumer goods which had a rise in demand, while that money which was spent elsewhere, before the tax was instituted might experience a drop. If the total money=the total goods, without altering money or goods, the overall general value shouldn't fluctuate much.

In a slightly more longterm view there could even be deflation due to "overproduction", like the 1800's, if it is a more friendly environment to business and investing. Of course, I'm sure we can count on the fed soaking all that up.

And I concur with Steve as to the difficulty of starting a business currently. The complexity of the tax code with regard to payroll, etc is so complicated as to almost require an accountant. Which, then you have to trust someone else with lots of your money and your legal compliance. Not a comforting feeling. If they could do away with all that nonsense I would do a back flip of joy.

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