Replies

?...Read it yourself. Your ommissions and deceptions of what the Fairtax does tax is bastardizing your own tag line.

I have read it and reread it. It appears that government employer may pay the sales tax on employees. I wonder if that is akin to the sales tax applied to a domestic servant that provides a service. If so I stand corrected and it's an honest mistake born of ignorance.

ancient_geezer, Principled, you two understand legalese better than I. It would be unwise for me to take just YN or ll's word on it. I'd like to here from the pro side not just the antis.

ancient_geezer, Principled, you two understand legalese better than I. It would be unwise for me to take just YN or ll's word on it. I'd like to here from the pro side not just the antis.

Who do you think explained it to them?

I have read it and reread it. It appears that government employer may pay the sales tax on employees.

It it is required to where that employee provides what is tatamount to an end (i.e consumed) service to government rather than a component of a service for fee to an end user as the case of a government enterprise where the FairTax is collected from the purchaser.

I wonder if that is akin to the sales tax applied to a domestic servant that provides a service. If so I stand corrected and it's an honest mistake born of ignorance.

The essential crux is that in most activities, government is a consumer not a producer and is tax the same as an individual would be in aquiring services for personal use as opposed to business use which ultimately provides a service from which the tax is collected from the end user.

A fairly comprehensive discussion of the issues involved in the NRST levy on government consumption (as an issue raised by the JCT that income taxes, flat taxes proposals & VATs tax government consumption but sales taxes without special provision to cover them do not.) can be found in this PDF:

==>Prepared for Americans For Fair Taxation
By David Burton and Dan R. Mastromarco
The Argus Group: February 4, 1998

This report responds to Ken Kies’ letter to Chairman Archer of January 12, 1998. In his letter Mr. Kies propounds several objections to the Americans for Fair Taxation (AFFT) FairTax plan (FairTax) as raised by the Joint Committee on Taxation (JCT) staff. This memorandum addresses those objections with respect to three basic issue areas. They are:

•the revenue neutral sales tax rate,
•compliance and evasion issues, and
•the economic impact of replacing the current tax system with a sales tax.

Page 14-16

C. Government Value Added Should be in the Tax Base The Same As It Is In the base of the Income and Flat Tax Schemes

In the absence of a special rule, a sales tax would fail to tax government value added at any stage. In the absence of a tax on government payroll, therefore, the tax base would be much smaller than under either the income tax or the flat tax schemes. Assuming spending were held constant, this would effectively increase the relative size of government by the proportion of revenues relative to wages and government purchases that are foregone. The JCT may be incorrectly and inadvertedly increasing the size of the government.

We anticipate that one possible source of confusion on the part of the JCT is the tax treatment of government output. How should such output be taxed, if at all?

The GDP includes, of course, both government value added and private value added. Government value added is included at “cost”, which is primarily the wages paid to its employees. The income tax taxes income whether the source is government or the private sector, and by doing so, taxes government output. While the government pays its employees a gross amount and then withholds the income tax from their paychecks, we could, of course, just pay government workers a lower tax-free wage. This would accomplish the same objective. However, we choose not to do this: with the result that we have higher spending (from paying pre-tax wages) and higher tax revenue (from the income tax on those wages).

And it is important to note that the flat tax does tax government (and non-profit) output because government (and non-profit) wages are included in the tax base. To be consistent, the AFFT FairTax does so as well.

A pure subtraction method VAT (aka a business transfer taxes) would not typically tax government value added. The Hall-Rabushka flat tax variant is an exception, however. Unlike a normal subtraction method VAT, the flat tax allows a deduction for wages and then taxes wages at the individual level. In doing so, it also provides the mechanism for taxing government wages (while a normal BTT only taxes business wages by taxing receipts and denying the deduction for wages). Thus, the flat tax base is much larger than the base of a normal BTT (i.e. larger by the size of the government wages).⁶²

So today, both the income tax and the flat tax tax government output.

However, a sales tax, in the absence of a special rule, would, like a pure BTT, not tax government value added by employee wages. In the absence of a tax on government payroll, therefore, the tax base would be much smaller than under either the income tax or the flat tax schemes. Assuming spending was held constant, this would effectively increase the relative size of government by the proportion of revenues relative to wages and government purchases that are foregone. The FairTax taxes government value added in order to maintain the relative size of the government to the private sector, rather than increasing the size of the government.

Another way of looking at this problem is to examine it from two different perspectives: incidence forwards and backwards.

If we assume that consumption taxes are fully incident on the factors of production, then the return to capital and the return to labor will decline by the amount of the tax. As noted earlier, under this incidence assumption, tax-inclusive prices would not be higher but the return to workers and capital would decline. Thus, in the absence of a special rule, government workers would experience a windfall. Their consumption prices would not go up and their wages would go up by the amount of the repealed income tax but, since government value added is not taxed, their wages would not appear to be subject to downward pressure.⁶³

Taking the alternate incidence assumption, namely that the FairTax would be fully passed forward and borne by consumers, government employees would pay the tax just like private sector workers, since tax-inclusive prices would be higher by the amount of the FairTax. Government workers would, of course, have higher pre-tax wages, but the costs of purchasing goods and services would be higher by the amount of the FairTax. However, the inequity in our alternative incidence assumption redounds to the beneficiaries of government who would now be consuming a level of government services that is enlarged by the removal of the wage taxes formally imposed. We collectively would be getting the benefit of government (the Armed Forces, the Consumer Product Safety Commission, National Public Radio, or the JCT on Taxation) free of tax. Those who disproportionately benefit from government would disproportionately benefit from this effective increase in government spending. Or, put another way, we would have legislated a huge increase in the size of the government that is paid for by the private sector.

Another way of addressing this problem is to simply take the National Income Product Accounts and start calculating the tax base under the various consumption taxes. If one goes through this exercise to demonstrate the oft-repeated equivalence of the various consumption tax plans, it becomes clear that in the absence of a special FairTax rule regarding government, the flat tax has a broader base because it taxes government wages. Similarly, a pure income tax is broader not only by the amount of unconsumed capital income but also by the government wages amount.⁶⁴

In the context of a sales tax, then, an employer payroll tax on government wages simply achieves parity with the income tax and the flat tax. Failure to impose this tax would exempt government value added from tax for the first time and constitute a dramatic incentive to consume through the medium of government. The JCT seemingly recognized this in their pamphlet “Impact on State and Local Governments and Tax-Exempt Organizations of Replacing the Federal Income Tax,” p. 57-58, May 1, 1996. A sales tax should also be imposed on government purchases from the private sector to fully reflect the opportunity cost of that purchase.

Government enterprises (e.g. Amtrak, the Post Office) are a separate case. They can easily be put on equal footing by taxing their sales and exempting their inputs as if they were a private enterprise. If government (and non-profit) enterprises are not subject to tax, they will have a huge relative price advantage over private companies through cross-subsidization.

62. Even a normal BTT, however, taxes government purchases of goods and services from the private sector since the private revenues from those sales are includible in the taxable base.

63. Eventually, with free market forces, private sector workers and perhaps political pressure would bid the government salaries down. However, given the rigidity of government pay scales and rules against exchange this may take many years (i.e. government wages may be “sticky”). In the interim, the relative size of government will have increased.

64. Since the sales tax does not tax the “return” to government investment (i.e. later government consumption scored as government capital consumption in NIPA), using a tax prepayment approach that is equivalent in present value terms to taxing the returns is appropriate.