Supporters of the FairTax propose to replace all federal taxes -- the income tax, the payroll tax, the capital gains tax, corporate income taxes, etc. -- with a simple, broad-based, 30% consumption tax.
Of course, a consumption tax is highly regressive relative to the current tax system. So, to soften the blow to lower income households that must spend a very high percentage of their gross income on necessities such as food, rent, clothing, health care, etc., the FairTax features what is called a "prebate," or an annual cash payment to all households based on family size.
Would this be good for most American families? Let's take a quick look at typical examples throughout the income distribution.
Consider a lower-income family in the bottom two quintiles of the distribution. Typically, they pay the payroll tax (if not unemployed or retired) and little else at the federal level. At first glance, one may reasonably assume they'd be quite a bit worse off under the FairTax, since they are more or less forced to consume a very high percentage of household income. However, the "prebate" may very well offer them enough resources that they'd end up better off than before. I think it's probably a close call in the aggregate, and for individual cases depends on factors such as family size, consumption habits, income, and employment status.
Travel just a little bit higher in the distribution and consider households with incomes about one standard deviation below and above the mean. Here the prebate is of less import, since it amounts to a lower percentage of household income, but it's till far from trivial. Working individuals and families in this range pay a fair portion of their income in payroll and income taxes. Consumption as a percentage of income for this group is still pretty high, since they aren't far enough up in the distribution that MPC begins to decline. Although the "prebate" would be a far less decisive factor for this group than for lower-income folks, I think it would be a decider for a rather large number of people who would, on net, be better off under the FairTax.
Go up just a little higher on the scale and consider middle-class and upper middle class individuals and families in the $100K to $300K income range. Here, MPC begins to decline just a bit, while marginal income tax rates rise substantially. There's little doubt that the vast majority of households in this group would get a net tax cut under the FairTax, in most cases a fairly substantial one. And when you go above $300K in annual income, it just keeps getting better and better!
And that's not all! An "uninformed" person might think at first blush that if a 30% consumption tax on everything suddenly replaced all other taxes, he would pay close to the same amount of total tax that he does now by way of income and payroll taxes, or possibly even more.
But that's not how things work in the FairTax world!
Supporters claim that if you remove currently "embedded" taxes that factor into the cost of goods and services, you can add back in the 30% FairTax and the price level, on average, remains the same! (Yes, seriously. If you don't believe me, just look at their promotional websites and literature.)
Consider something now priced at $100. Then suppose that federal taxes levied on the producer were eliminated. FairTax supporters claim that the consequent removal of "embedded" taxes would then allow the price to drop to $77 without penalty to the seller. Then the $30 sales tax (FairTax) could be added back in, thus keeping the price level where it was before.
If all of that is true, virtually everyone in the middle class and working class would be much, much better off under the FairTax. Remember, since the income and payroll taxes would disappear, the worker's take-home paycheck would rise substantially. So, no one would any longer have to pay income and payroll taxes, since they would all be replaced with the consumption tax. But in the FairTax fantasy world, people wouldn't have to pay that either, since prices won't go up on net after all the "embedded taxes" mysteriously disappear. Pretty cool, huh!
(By now, you must surely think this whole thing is beginning to look like a game of three-card Monte.)
So, let's drill down just a little into this "embedded taxes" business. Just what are "embedded taxes," and for that matter, who actually ends up paying the tax? (You certainly aren't likely to get a straight answer if you ask a FairTax supporter. Ask them to back this up and they suddenly turn mute.)
But federal embedded taxes for a typical company can only consist, to any significant degree, of the employer's portion of the payroll tax and corporate income taxes.
Let's take care of that first item straight away. Economists are in virtually unanimous agreement that the incidence of the payroll tax (including the "employer's" portion) lands solely on the employee. Here's a good concise explanation:
http://www.economonitor.com/dolaneco...permanent-fix/
That leaves the corporate income tax. Economists have long disagreed on corporate tax incidence. Decades ago, it was widely believed that the incidence primarily landed upon shareholders. Then, with globalization and much greater mobility of capital, analysts came around to the point of view that the incidence had been mostly shifted to employees (not customers). So, if in fact relatively little corporate tax incidence now lands upon consumers, one should expect that prices should not fall materially if the tax is eliminated. (However, to the extent that some monies which would otherwise be paid in corporate taxes might end up in workers' paychecks (and they are, after all, also consumers!), a number of people might benefit.
Still, consider the fact that
total corporate income taxes only account for about 10% of federal revenue, while the FairTax obviously would be called upon to raise
all federal revenue. Thus it is easy to see that the removal of
all embedded taxes cannot possibly amount to more than a very small percentage of the new 30% consumption tax.
The 23% embedded taxes stuff was just pulled out of thin air so that supporters could claim this whole thing is a huge free lunch for almost everybody. No credible, objective economist or tax policy analyst could possibly buy into this preposterously ridiculous nonsense.
The FairTax, in summary, would probably be neutral to slightly positive for most households in the lower to middle income ranges, a significant positive for those in the top one-third of the distribution, and a huge positive for the finances of those in the top 10%. And the more you make, the better it is for you!
So how in the world do these people claim revenue-neutrality? Who actually pays the tax, and how in the world do these people think they can claim anything remotely close to revenue-neutrality? Where do they think the money is going to come from? That's a good question!
So far, the FairTax people have not said that they're going to set up a suite of offices in the Marriner S. Eccles Building so they can just conjure money out of thin air like their neighbors. Maybe that's next!
The math doesn't work and the logic doesn't work, so consequently the whole idea doesn't work.
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