Hot damn!
A chance to discuss policy with someone who won't start attacking and insulting me if I criticize someone's pet tax system!
My only pet requirement for any tax system is that once it is implemented, the government can't come back for more later. The leeching bastards have to STFU and live within their allowance, barring an emergency.
That would be nice, but preventing big-spending politicians from coming back later and ratcheting up tax rates would require some mighty tightened-up legislation. I wouldn't wait with bated breath for all these "profiles in courage" to come up with anything like that!
1) If presented honestly, the tax rate is actually about 30%, not 23%. The reason is that, in order to make it sound better, FairTax promoters decided to pitch the plan by disingenuously presenting the tax-inclusive rate, unlike the manner in which sales taxes are normally described. Let's say that something with no sales tax would cost you $100. The FairTax is designed to make it the case that AFTER you add the sales tax, the percentage of the after-tax price is 23%. Adding about $30 to the $100 pretax price does just that. To anyone else, that sounds like a 30% tax. But to a FairTax advocate, it's 23%!
Yeah, that's definitely a 30% sales tax. If anyone calls it 23%, they're just fucking around with reciprocals and being totally dishonest. Implementing such a huge mark-up all at once would be a giant jolt – like forcing the US economy to take the “ice bucket challenge”. My quick and dirty revenue calculation goes up to $3.8 trillion (versus only $2.9 trillion for a 23% tax) - but of course that's before deducting for exempt sales and “leakage”. I don't have a reliable way to estimate the latter (which you refer to as transactions “making a detour around the cash register”). But the incentive to cheat is obviously greater at 30% than at 23%. I suspect that, due to this leakage problem, the extra revenues generated by each percentage point increase in the tax diminish at higher rates.
See additional commentary below, but it certainly is the case that with this sort of tax it's very unrealistic (to say the least!) to expect revenues to be a linear function of the rate. The incentive to evade is just too high with a 30% sales tax rate. And, as you say, presenting this as a "23% tax" is just patently dishonest. Supporters don't do themselves or their credibility any favors by utilizing this sort of sleight of hand.
2) All of the studies I've seen on broad-based consumption taxes seem to suggest that revenue expectations fall far short of the back-of-the-envelope number you get if you simply figure the product of what is purported to be personal consumption expenditures and the tax rate applied to that base. I recall, for instance, that the aforementioned Robert Barro has written several times that a well-designed, broad-based consumption tax in the US could be expected to raise 0.5% of GDP for each percentage point of the tax rate. European experience with the portion of the VAT that's not exempted for necessities indicates the same thing after adjusting, of course, for Europe's lower levels of consumer spending relative to the US.
Then the Barro rule of thumb (assuming the 0.5% applies to the entire GDP, not just the consumption component) would suggest revenues of only $2.7 trillion from a 30% levy. But given the propensity for more leakage at higher rates, I don't think the relationship is a linear one. And I would question how instructive the European experience is, given the differences between VAT and sales taxes. The last time I checked, most European VAT rates were “only” 20% - or one-third less than the proposed FairTax.
Again, I don't think the relationship would be a linear one at all. Note additionally that in every case, European nations have chosen the VAT structure rather than a simple point-of-sale tax with a high rate. That's obviously because the VAT's design makes it risky to evade, since there is an electronic trail subject to audit should any business or service provider come under suspicion of under- or non-reporting.
Also, when the Bush Treasury Department hired some consultants to look into this idea and similar consumption tax plans back around 2005 (at more or less the same time they tried to promote Social Security privatization), they gave up on it after concluding that the tax-exclusive rate would have to be a little more than 30% just to replace the income tax, and to make it revenue-neutral, you would have to leave the payroll tax in place. The only economists I've seen dispute analyses such as these are people like Laurence Kotlikoff (a Boston University professor who moonlights as a well-paid shill for the FairTax).
The Treasury consultant studies sound credible, since their conclusions were probably not what the Bushies were hoping to hear. If going to 30% only lets us replace the income tax (and not eliminate the payroll tax), what's the point? We end up taxing BOTH income and consumption, instead of switching entirely to a levy on consumption only. And of course, the liberals wouldn't stand for it, since we would wind up with two “regressive” taxes and eliminate the one that soaks the rich.
Another point, even though I haven't examined either Barro's or the Bush Treasury studies in detail: Current federal tax revenues are $3.2 trillion a year. The Barro rule of thumb suggests a 30% broad-based consumption tax would raise only $2.7 trillion, thereby widening the budget deficit by $500 billion. The Bush Treasury studies suggest such a tax would raise even less – around $2.2 trillion (since payroll taxes currently make up 1/3 of federal revenues).
Yes, that certainly does make one wonder where these people come up with the sort of magic supporting claims of "revenue-neutrality!"
3) Although one must always consider the dynamic effects of any tax policy change, I have serious concerns about major disruption of certain key industries. What would happen, for instance, if you suddenly slapped a new 30% sales tax on new cars and light trucks? Obviously, the market for vehicles would be hyperstimulated in the run-up period before the tax was implemented, but would be depressed for quite some time thereafter. Same thing for the housing industry, as the FairTax would apply to new homes (but not pre-owned ones).
Agreed. Again, it's like asking the US economy to take the ice bucket challenge. I'm not sure how we might cushion the shock either. And I have serious concerns about putting a permanent crimp into consumer spending, which has always been our leading growth engine since it accounts for 70% of GDP.
Indeed. And can you imagine what sort of effect would arise from immediately adding almost 30% to the cost of a new house? Lobbyists for the homebuilding industry and real estate agents would go apoplectic! The same obviously goes for the auto industry, as well as many others.
4) I think one reason the negative impact on revenues would be very high is that evasion would be at least as large a problem as it is today. Note that income tax collections fall well short of what analyses of effective tax rates, brackets, and US personal income as estimated by most economists would suggest. Although an aggregate estimate of unreported income is anybody's guess, I don't think many people doubt that it's several hundred billion dollars per year. And there's no reason to expect that it would be any less under the FairTax. Large portions of the incomes of small business owners and service providers would no doubt take a detour around the cash register if you imposed a 30% sales tax.
We already have a huge underground economy. The fact that so much under- and unreported income never gets taxed is one of the arguments for switching to the FairTax (or something like it). Supposedly all the income that currently escapes the tax net would be nicked when the earners spend it. But if you are right about leakage not being any less under a FairTax than it is under our existing tax system, there is little compliance advantage to switching. The IRS wouldn't be abolished - it would just need to be retrained to audit differently.
I don't see how it could possibly be any more difficult to evade taxation under the FairTax than under our present system. Indeed, it would generally be done in the same way -- by not reporting or underreporting sales or service fees. And since a lot of lower-income people pay marginal tax rates of less than 30%, the incentive to cheat under the FairTax might be even more tempting for many than it is today.
And, yes, there would still be the need for a revenue collection and enforcement regime, but I think it's fair to say that its operation would be less cumbersome and could be streamlined with any simpler tax system.
5) FairTax supporters are loathe to release any data supporting their claims involving "embedded taxes," and I think it's pretty easy to see why.
For starters, although this may in some instances, of course, depend on elasticity of certain labor markets, economists seem to be in virtually full agreement that the incidence of the employer portion of the payroll tax falls wholly, or at least almost wholly, on the employee, not the employer. If that's true, and I believe that it is, one may expect that in the event the payroll tax were completely eliminated, most workers' paychecks would settle at an amount approximately equal to their current gross pay, less both the employee's and employer's "side" of the former payroll tax. Thus the employer's cost of hiring a worker would remain constant across the transition.
You were doing fine until the last sentence. Rather than staying constant, don't you mean the employer's cost of hiring would go DOWN by the combined amount (15.3%) of the former payroll tax? If so, the next question is - would employers pass along the full amount of such savings in the form of lower prices, thereby cushioning the shock of the FairTax.
That is a very interesting question.
To start with, oops! Looks like I "misspoke." My statement to which you alluded does not make sense. In any event, I think this issue is a bit unclear, since I've always been very skeptical of a lot of tax incidence analyses. My understanding is that many who have written theses and dissertations covering this issue claim that the worker, not the employer, wholly or almost wholly bears the burden of the employer side of the tax. (But is this like some of those old neo-Keynesian macro models, which worked great on blackboards in economics classrooms of the 1960s and '70s, but not so well in the real world?) No one really knows. I think people who have looked at this examined changes in the rate, not the entire elimination of the payroll tax. What sort of shift would occur if the payroll tax were disappeared?
In any event, I think that after the smoke clears and some new equilibrium is reached, employers' costs of hiring would tend toward the status quo ante after employees and employers battle over the employers' side of the tax. The "truth" may be in the middle somewhere, I suspect.
Concerning possible effects on prices, it should be expected that market forces should exert some slight downward effect on prices in the event that some of the savings here accrue to employers. As stated earlier, "embedded taxes," although obviously a very small fraction of what FairTax aficionados claim, are not a flat zero.
Although it's been a while since I was involved with VC and private equity deals, I believe the average taxable profit margin across a broad range of industries is more like 6% rather than 10%. Of course, it's higher in a few industries and much lower in others. As a very rough guess, and assuming a 17% average corporate effective tax rate, I doubt seriously that "embedded" corporate income taxes amount to more than about 1% of gross sales. And that doesn't take into account the obvious fact that costs attributable to "embedded taxes" borne by many service providers are little, if any, greater than zero.
Your numbers are anecdotal. I think we could extract more accurate percentages by looking at national income and actual corporate tax data. I'm too lazy to attempt this but I think it is easily doable and would yield a more reliable estimate. I do agree that the savings from eliminating these “embedded” corporate income taxes would be small.
If there are significant savings to be reaped (and potentially passed along in terms of lower prices), they would come from eliminating: 1) payroll taxes 2) personal income taxes and 3) the high costs of complying with our existing Rube Goldberg tax code. Arguably these benefits could percolate through the entire economy. A business would save not only on its own reduced costs but also on lower costs for parts and materials it purchases from other firms enjoying similar savings. Trying to predict and quantify all of this with any degree of accuracy looks like a dubious undertaking, however.
Although I think it's fair to say that we can establish a reasonable range of estimates, I certainly agree that quantifying all this with any degree of precision would be a very nebulous undertaking, to say the least. But I do think it should be abundantly clear that the elimination of "embedded taxes" could not possibly balance more than a very small percentage of the 30% FairTax rate.
Another thing to remember here is that the FairTax features a "prebate," which FairTax supporters describe as a payment to every household designed to reimburse lower-income families for the tax levied on basic necessities such as food and clothing. (I suppose we're supposed to forget the obvious fact that they also claim that prices won't go up after the 30% tax is added on, since all those "embedded taxes" now disappear, and that the "prebate" should therefore be completely unnecessary!)
I'm too lazy to go look it up in one of their tables, but I think the annual "prebate" averages something like $6K for a typical family, and varies according to the number in your household. That suggests that the prebate alone would run somewhere around 3.5% or 4% of GDP.
So the “prebate” would be tantamount to rebating between ¼ and 1/3 of the estimated FairTax gross revenue intake. It also means employers would still have the burden of filing payroll information with the IRS so the feds would know who qualifies for it.
Yes, the authorities would have to compile and maintain all sorts of data. Another point I would make here is that since the "prebate" is adjusted for family size, lower-income households would receive at least a modicum of additional incentive to irresponsibly have more kids they can't afford.
Assuming that the estimates offered by Robert Barro and others are in the ballpark, one may reasonably expect that the FairTax, as presented by its supporters, would raise about 15% of GDP, and perhaps 11 or 11.5% after subtracting the "prebate."
For an $18 trillion economy, that translates into $2.7 trillion gross and at best $2.1 trillion after deducting the prebate.
Doesn't sound very "revenue-neutral" to me!
Nope. Methinks it would blow up the deficit. Even more so if its implementation tipped us into a recession.
Aside from the fact that it's a very long way from revenue-neutral, the most obvious feature of the FairTax is that it would deliver far and away the greatest portion of tax savings to wealthy households and high-income earners. In these days of growing inequality and wealth envy, that alone makes it as much a political non-starter as could be imagined.
Hey, that's a lot of bandwidth wasted on dissecting something that's never going to happen!Yup! Rather a lot of bandwidth for something that's never going to happen.
Next! Originally Posted by lustylad
However, the FiirTax still rears its head from time to time when some obscure congressperson wants to create a splash and attract some attention. At first blush, it sounds good to people who haven't thought through the issues.
Although I would love to see real tax reform, I think it's helpful for promoters of various plans to refrain from pitching their ideas in manifestly dishonest fashion. It's high time for people to recognize ridiculous nonsense such as that peddled by the FairTax books and websites.
"Next!," you say?
Well, I don't think we've heard the last from Rand Paul. He will likely remain active in the political arena for some time to come, and no doubt will be tossing out a few ideas -- whether good, bad, or ugly -- that are worthy of discussion.
