Replies

yes, payroll and income taxes are both included in Jorgenson's (and now also Boortz's) estimation of embedded taxes.

OOPs, Jorgenson's response to you:

http://www.freerepublic.com/focus/f-news/1470200/posts

From: Dale Jorgenson [mailto:djorgenson@harvard.edu]
Sent: Wednesday, August 24, 2005 10:28 AM
To: Rob xxx
Re: Fair Tax- Is your 1995-6 Testimony being misrepresented by Boortz/Linder book?
August 24
Dear Rob,
A more reasonable interpretation of my 1996 testimony is that workers would keep that after-tax pay; producers' prices would fall, but retail prices would be increased by the national retail sales tax. Any gains by workers and investors would be the result of increase economic efficiency.

did NOT contain either employer nor employee side of payroll taxes as part of his analysis.

His 1996 Testimony was for replacement of income taxes only and had no element of payroll taxes included.

The proposed retail sales tax plan analyzed by Jorgenson was not the FairTax legislation at all as it left out major taxes that are replaced by implementation of the FairTax NRST. The tax proposal analysed was in regard to that of Dick Armey in 1995.

A point you have been informed of several times now and continue to repeat the same misinformation.

Jorgenson Testimony 1996

====== FULL TEXT ======

This statement was prepared for presentation at the Hearings on Replacing the Federal Income Tax, before the Committee on Ways and Means, U.S. House of Representatives, 104th Congress, Second Session.

THE ECONOMIC IMPACT
OF TAXING CONSUMPTION
by
Dr. Dale W. Jorgenson,
Harvard University

INTRODUCTION AND SUMMARY

[1] In this testimony I consider the economic impact of substituting a tax on consumption for corporate and individual income taxes at federal, state, and local levels, beginning January 1, 1996. I limit my analysis to a revenue neutral tax substitution -- one that would leave the government revenues unchanged. Finally I focus on the impact of fundamental tax reform on economic growth, leaving progressivity of the resulting combination of taxes and government expenditures to be determined by adjustment of expenditures. I have summarized my conclusions in a services of eight charts appended to the text of this prepared statement. These were generated by stimulating future U.S. economic growth with and without the change in tax policy. Further details are provided in an Appendix to this statement.

1. The revenue neutral substitution of a consumption tax for existing income taxes at both federal and state and local levels would behave an immediate and powerful impact on the level of economic activity. The first chart shows that U.S. gross domestic product (GDP) would increase initially by about thirteen percent; this increase would decline to around nine percent.
2. The imposition of a consumption tax would produce in a sharply higher tax rate on consumer goods and services. The second chart shows that the consumption tax rate required for replacing existing revenues from individual and corporate income taxes at both federal and state and local levels would be around fifteen percent. This would gradually rise over time reaching twenty-one.
3. As a consequence of the total transformation of the tax system, individuals would sharply curtail consumption of both goods and leisure. This would produce a dramatic jump in saving and a substantial rise in labor supply. These increases would subside only very gradually over time.
4. Taxation of consumption would induce a radical shift away from consumption toward investment. The third chart shows that real investment would leap upward by eighty percent! The fourth chart shows that real consumption would initially decline by around five percent, but consumption would grow rapidly and overtake the level under the income tax within two years.
5. Since producers would no longer pay taxes on profits or other forms of income from capital and workers would no longer pay taxes on wages, prices received by producers, shown in the fifth chart, would fall by an average of twenty percent with substantial relative gains for investment goods producers.
6. In the long run producer's prices, shown in the seventh chart, would fall by more than twenty-five percent relative to prices under an income tax. The shift toward investment and away from consumption would redistribute economic activity among industries. The eight chart shows that output would increase in all industries, but the rise in production of investment goods would be greatest.

IMPLEMENTATION OF A CONSUMPTION TAX

[2] In Hearings on Replacing the Federal Income Tax, held by the Committee on Ways and Means last June, testimony focused on alternative methods for implementing a consumption-base value added tax. This is economic jargon for a consumption tax, where value added is the sum of capital and labor incomes and subtracting investment form value added would produce a consumption tax base. An alternative and equivalent definition of this tax base is the difference between business receipts and purchases from other businesses, including investment goods. A third definition of the tax base is the total of retail sales to consumers.

[3] The three principal methods for implementation of a value added tax correspond to the three definitions of consumption as the tax base:

1. The invoice and credit method. Business invoices would include a credit against tax liabilities for value added taxes paid on goods and services received. This method is used in Canada and Europe. In Canada and many other countries the value added tax replaced an earlier and more complex system of retail and wholesale sales taxes. From the point of view of tax administration the invoice and credit method has the advantage that both purchases and sales generate records of the tax credits. The invoice and credit method would require substantial modification of collection procedures, but decades of experience have ironed out many of the bugs./1/
2. The subtraction method. Business purchases from other businesses, including investment goods, would be subtracted from business receipts, including proceeds from the sales of assets. This could be implemented within the framework of the existing tax system by integrating individual and corporate income taxes, as proposed by the U.S. Treasury (1992), and treating all businesses as partnerships or "subchapter S" corporations. The second step would be to allow expensing of investment in the year it is taken. Enforcement problems would be reduced by drastically simplifying the tax rules, /2/ but the principal method of enforcement, auditing of tax payer records by the Internal Revenue Service would remain.
3. National retail sales tax. Like existing state sales taxes, a national retail sales tax would be collected by retail establishments, including service providers and developers fro residential real estate fro sale to owner-occupiers. This would also require a new system for tax administration, possibly sub-contracting the actual collection to existing state agencies. The Internal Revenue Service could be reduced to an agency that would sub-contract collections. Alternatively the IRS could be abolished and an new agency created for this purpose. /3/ Enforcement procedures could be limited to those used by the states.

[4] All three alternative methods for implementing a consumption tax could be based on the same definition of the tax base. This greatly simplifies the tax economist's task, since the economic impact would be the same for all three approaches. This leaves important issues to be resolved by other tax professionals, including, especially, tax lawyers who would write the legislation and the implementing regulations and tax accountants who would translate the laws and regulations into accounting practice and advise economic decision-makers about their implications.

[5] From the economic point of view the definition of consumption is straightforward; a useful and commonly accepted point of departure is Personal Consumption Expenditures (PCE) as defined in the U.S. national income and product accounts. However, the taxation of services poses important administrative problems reviewed in a U.S. Treasury (1984) monograph on the value added tax. First PCE includes the rental equivalent value of the services of owner-occupied housing, but does not include the services of consumer's durables. Both are substantial in magnitude, but could be taxed by the "prepayment method" described by the Hon. David Bradford(1986). In this approach taxes on services would be prepaid by including investment rather than consumption in the tax base.

[6] The prepayment of taxes on services of owner-occupied housing would remove an important political obstacle to substitution of a consumption tax for existing income taxes. At the time the substitution takes place all owner-occupiers would be treated as having been prepaid all future taxes in the services of their dwellings. This is equivalent to excluding not only mortgage interest from the tax base, but also returns to equity, which might be taxed upon the sale of residence with no corresponding purchase of residential property of equal or greater value.

Of course, this presumes that homeowners would refinance to take advantage of the altered tax treatment of mortgage lenders.

[7] It is essential to include housing and consumer's durables in the tax base in order to reap the substantial economic benefits of putting household and business capital on the same footing./4/

This raises politically sensitive issues and it is important to be clear about the implications of prepayment as the debate proceeds. Under the prepayment method purchases of consumers' durables by households for their own use would be subject to tax. These would include automobiles, appliances, home furnishings, and so on. In addition, new construction of owner-occupied housing would be subject to tax, as would sales of existing renter-occupied housing to owner-occupiers. Together with the exclusion of rental values of existing owner-occupied housing, this would maintain the asset values for housing.

[8] Other purchases of services that would be especially problematical under a consumption tax include services provided by nonprofit institutions, such as schools and colleges, hospitals, and religious and eleemosynary institutions. The traditional, tax-favored status of these forms of consumption would be defended tenaciously by recipients of the services and even more tenaciously by the providers. The argument can be made that educational services represent investment in human capital rather than consumption.

[9] Finally, any definition of a consumption tax base will have to distinguish between consumption for personal and business purposes. On going disputes over home offices, business-provided automobiles, equipment, and clothing, and business-related lodging, entertainment and meals would continue to plague tax officials, the entertainment and hospitality industries, and holders of expense accounts. In short, substitution of a consumption tax for the federal income tax system would not eliminate all the practical issues that arise from the necessity of distinguishing between business and personal activities in defining consumption. However, these issues are common to both income and consumption taxes.

CONCLUSION

[10] Under any one of the three approaches to implementation of a value added tax, substitution of a consumption tax for existing individual and corporate income taxes would be the most drastic change in federal tax policy since the introduction of the income tax in 1913. It is not surprising that the economic impact summarized above would be truly staggering in magnitude. It is easy to foresee that as Americans become more fully apprised of the manifold ramifications of fundamental tax reform the Gucci Gulch/5/ will be transformed into the political equivalent of the Grand Canyon.

[11] The coming debate over tax reform is both a challenge and an opportunity for economists. It is a challenge because the impact of fundamental tax reform would involve almost every aspect of economic life. Economists who have spent their lives pre-occupied by the latest debating points in journals read only by other economists will suddenly find that the fine points that dominate scholarly discussion will be subjected to the refiner's fire of public scrutiny.

[12] The debate will be an opportunity of economists because economic research has generated a wealth of information about the impacts of tax policy. Provided that the economic debate can be properly focused, economists and policy makers will learn a great deal about the U.S. economy and its potential for achieving a higher level of performance. I am personally very gratified that the Joint Committee on Taxation under the leadership of Chief of Staff Kenneth Kies has taken the initiative in channeling the professional discussion. In my remaining testimony I will outline my own recommendations for the initial ground rules.

[13] The first issue in the debate will be the economic impact of the federal deficit. Nearly two decades of economic disputation over this issue has failed to produce any resolution. No doubt the dispute will continue well into the next century and preoccupy the next generation of fiscal economists, as it has the previous generation. An effective rhetorical device for insulating the discussion of fundamental tax reform from the budget debate is to limit consideration to revenue neutral proposals. This device was critical to the eventual enactment of the Tax Reform Act of 1986 and is, I believe, essential to progress in fundamental tax reform.

[14] The second issue to be debated is fiscal federalism or the role of state and local governments. Since state and local income taxes usually employ the same tax bases as the corresponding federal taxes, it is reasonable to assume that substitution of consumption for income taxes at the federal level would be followed by similar substitutions at the state and local level. Since and important advantage of a fundamental tax reform is the the possibility, at least at the outset, of radically simplifying tax rules, it does not make much sense to assume that existing rules would continue to govern state and local taxes, even if the federal income tax were abolished.

[15] The central issue in evaluating the economic impact of fundamental tax reform is its impact on economic growth. A serious barrier to focusing attention on growth is that the main apparatus for policy evaluation employed by both the Congress and the Administration consists of distributional tables for policy impacts. So far as I am aware, the methodology I have employed in preparing this testimony - comparing time paths of U.S. economic growth with and without a change in tax policy -- has never been used by either the Joint Tax Committee or the Office of Tax Analysis of the U.S. Treasury. Public discussion of tax reform will be crippled until this analytical gap is overcome.

FOOTNOTES

/1/ The advantages and disadvantages of the invoice and credit method for implementing the value added tax are discussed by the U.S. Treasury (1984).

/2/ A subtraction method value added tax has been proposed by Ranking Minority Member Sam Gibbons of the Committee on Ways and Means. If no business receipts were excluded and no deductions and tax credits were permitted, the tax return could be reduced to the now familiar post card size, as in the Flat Tax proposal of Majority Leader Dick Armey and Senator Richard Shelby(1995), Economists will recognize the Flat Tax proposal as a variant of the consumption-base value added tax proposed by Robert Hall and Alvin Rabushka (1995).

/3/ A national retail sales tax has been proposed by Chairman Bill Archer of the Committee on Ways and Means and Senator Richard Lugar

/4/ See for example, my testimony before the Committee on Ways and Means of June 6, 1995.

/5/ Few readers of this testimony will be unaware of this colloquial expression for the corridor outside the hearing room of he Committee of Ways and Means. The expression appeared in the title of the definitive account of the Tax Reform Act of 1986 by Jefferey H. Birnbaum and Alan S. Murray (1987).

APPENDIX

The simulations of U.S. economic growth summarized in the charts appended to this testimony are based on an intertemportal equilibrium model of the U.S. Economy that I have constructed with Peter J. Wilcoxen. The details of the model and more than a dozen applications are summarized in our survey paper, "Energy, the Environment, and Economic Growth," published in 1993. The model of U.S. economic growth is disaggregate4d to the thirty-five industries listed in the final four charts in my testimony. In addition the model distinguishes among 1344 types of households, disaggregated by family size, age and gender of household head, region of residence, race, and urban versus rural location. The model is built around sub-models of investment and saving based on rational expectations. The price of investment goods in every period is based on expectations of future capital service prices and discount rates that are fulfilled by the solution of the model.

In order to analyze the economic impact of changes in tax policy, we simulate the growth of the U.S. economy with and without changes in these policies. The first an most difficult step is to generate a simulation based on current tax policy. We call this the BASE CASE. We then produce and alternative simulation based on a consumption tax. This represents the alternative case. Finally we compare the base case with the ALTERNATIVE CASE in order to assess the effects of the substitution of a consumption tax for the existing income tax system. The most difficult part of tax policy evaluation is to project U.S. economic growth under the existing tax system. For this purpose I have introduced the characteristic features of U.S. tax law into the cost of capital, distinguishing among assets employed in three different legal forms of organization -- households and nonprofit institutions, non-corporate business, and corporations. Income from corporate business is subject to the corporate income tax, while distributions to households are subject to the individual income tax. Income from unincorporated businesses -- partnerships and sole proprietorships -- are taxed only at the individual level, while income from equity in household assets is not subject to the income tax.

REFERENCE

Armey, Dick, "Freedom and Fairness Restoration Act," Washington, D.C. 104th Congress, First Session, 1995.

Birnbaum, Jefferey H., and Alan S. Murray, Showdown at Gucci Gulch: Lawmakers, Lobbyists, and the Unlikely Triumph of Tax Reform, New York Random House, 1987.

Bradford David, Untangling the Income Tax, Cambridge, Harvard University Press, 1986.

Jorgenson, Dale., and Kun-Young Yun, Tax Reform and the Cost of Capital, New York, Oxford University Press, 1991

U.S. Department of the Treasury, Tax Reform for Fairness, Simplicity, and Economic Growth, Washington, U.S. Government Printing Office, 1984.

_____, Taxing Business Income Once, Washington, U.S. Government Printing Office, 1992.

[CHARTS OMITTED]