Taxing Sales under the FairTax – What Rate Works?

Boston University ^ | September 2006 | Laurence J. Kotlikoff et al

[pigdog]

As specified in Congressional bill H.R. 25/S. 25, the FairTax is a proposal to replace the federal personal income tax, corporate income tax, payroll (FICA) tax, capital gains, alternative minimum, self-employment, and estate and gifts taxes with a single-rate federal retail sales tax. The FairTax also provides a prebate to each household based on its demographic composition. The prebate is set to ensure that households pay no taxes net on spending up to the poverty level.

Bill Gale (2005) and the President’s Advisory Panel on Federal Tax Reform (2005) suggest that the effective (tax inclusive) tax rate needed to implement H.R. 25 is far higher than the proposed 23% rate. This study, which builds on Gale’s (2005) analysis, shows that a 23% rate is eminently feasible and suggests why Gale and the Tax Panel reached the opposite conclusion.

This paper begins by projecting the FairTax’s 2007 tax base net of its rebate. Next it calculates the tax rate needed to maintain the real levels of federal and state spending under the FairTax. It then determines if an effective rate of 23% would be sufficient to fund 2007 estimated spending or if not, the amount by which non-Social Security federal expenditures would need to be reduced. Finally, it shows that the FairTax imposes no additional real fiscal burdens on state and local government, notwithstanding the requirement that such governments pay the FairTax when they purchase goods and services.

[groanup]

I call that instant inflation, you can call it something else if you want. The saved dollars are worth less.

Don't you think Kotlikoff, Gale, Jorgenson - anyone - who has studied that plan would have brought that up?

I say we get Paul Volcker back in the Fed and raise interest rates by 800% because ROB SAYS we are going to have inflation.

How does he know? Easy, he explains it.

Where is the economic paper? I mean your inflation numbers are big news and would have a drastic impact on the entire world. Shouldn't some economist somewhere have been able to noodle out your little equation?

[Principled]

You think that your effective tax rate on a $300,000 house will be 15%

Yes. I will finance my purchase.

[RobFromGa]

But HR25 has language in it that makes the repeal of 16 a prerequisite for implementation of the NRST.

This is not true, there is no such restriction in the bill just a suggestion.

The problem IS spending and that needs to be addressed first before putting Band-Aids on the tax code problem.

Amen to that.

[RobFromGa]

I'll ask you again: What do you think will happen to prices?

[Principled]

Well, under the income tax, what's the base?

Under the nrst, what's the base?

Which is larger?

Keep digging!

[groanup]

Did you report it?

No, I wanted everyone to see it. IMHO the worst offenders, by far, are the anti FT's. There is much more drive by idiocy there and you know who I'm talking about. At least some of you try to have discussions but far too many come in, hurl childish insults with third grade words, accuse us of being a cult and selling snake oil, and disappear. Then when they are challenged to debate they blow smoke.

[groanup]

Nice try. One way to avoid backing up your claim is throwing the question back at me, huh? Oh, well, the usual.

[RobFromGa]

Why, is the question too hard for you? Or is your answer about the same as mine, and you are just having a semantic argument with me?

What do you expect will happen to prices? I have been clear as can be about what I think will happen.

[Bloody Sam Roberts]

This is not true, there is no such restriction in the bill just a suggestion.

Indeed. I posted from memory after perusing the bill once. After looking it over again I see that you are correct.

[lewislynn]

There is no tax to pay on the sale of the non-existent service - hence the tax is 23% of $100, or $23.

Typical Principled logic. First you say there's no tax then you say the tax (that doesn't exist) is 23%...You are one confused individual.

[Principled]

What will happen to real prices? (As opposed to nominal prices)?

They'll not go up.

[groanup]

There you go again.

You said we would have instant inflation of 15 to 30%. I say that is earth shattering news. Do you have any idea what that would do to the dollar? Do you know what our trading partners would do? Our creditors, debtors? ANY holder of Treasury bonds or ANY bond period?

The question is, since it is so mind boggling one would think that economists who have studied the proposal would be in an uproar that such a bill sits in Congress.

Instead 75 economists have studied and endorsed the plan. Where are those studies that show these guys are idiots for endorsing 30% inflation?

You should make a point of contacting each and every one of them and warn them of this dire discovery you have made. Much as you did with Boortz and Jorgenson. I mean it's the least you can do to save the world.

Or you can just keep asking me what I think prices will do. Or, even better, you can go back through the threads where I have answered that question dozens of times.

[Principled]

Well, under the income tax, what's the base?

Under the nrst, what's the base?

Which is larger?

[lucysmom]

This rule is to prevent gov't from choosing to simply hire more people instead of contracting to private companies. Without the rule, gov't could hire for much less than it can contract work out.

Excuse me - because government employees are paid with my tax dollars, why would I support a scheme that would cost me more for the same employees? That doesn't sound like an efficient use of my tax dollars.

[Principled]

You misunderstand.

If there were no tax on gov't wages, gov't would choose to hire employees instead of contract to private.

Are you on this board telling people you want private contractors to be put out of business in favor of having government doing everything?

[lewislynn]

This rule is to prevent gov't from choosing to simply hire more people instead of contracting to private companies. Without the rule, gov't could hire for much less than it can contract work out.

IOW for Parity.

So how does the government paying/remitting 23% tax on service wages (as you and pigdog suggest to be the case)VS private sector paying/remitting 30% tax on service wages solve that potential parity problem again?

The disparity of the rates is 30%. The private sector tax is 30% MORE than the 23% government tax rate you tout, yet you claim it to be for parity.

BTW, what "rule" are you talking about?

[Principled]

Nowhere did I claim parity. You made that up.

[lucysmom]

Are you on this board telling people you want private contractors to be put out of business in favor of having government doing everything?

There is a time when hiring contractors makes sense and a time when it doesn't. Government shouldn't get into the business of manufacturing supplies or equipment, for instance.

But, I see no good reason for taxing government for hiring a janitor simply to provide a market for for companies doing that work as contractors, particularly if it ends up costing me more. That is not the best use of tax money, it promotes what the FairTaxers say they want to end - private sector influence in the pursuit of government favors, in this case contracts. Nor is it always more efficient.

Here's a real life example; I worked for a company that decided to dispense with in-house computer support and contract out, the support people were still located on site, but worked for the contractor. Before support was contracted out, when we had a problem we just walked across the floor, described the problem to the support person and he fixed it, usually within minutes. Once the contractor was in place, we had to submit a work order, that then had to be approved by the department head, who would then pass it on to the support person's supervisor who would pass it on to the support person. Talk about inefficient! The result was more forms to fill out and lost productive time.

When we needed to purchase new computers for the department, the contractor sent a guy out from Texas to spend a week in our department, observe and make recommendations. He was a nice guy, we enjoyed his presence in our department, he had no experience with what we did or the computers we used. Basically it was a waste of our productive time, and the company's money.

The private sector goes in cycles, a company may decide to contract out rather than hire in-house employees to save money. After a while, they decide its more cost effective and efficient to fire the contractor and hire in-house employees. If there were a clear advantage either way, I doubt it would cycle.

Actually, using my tax dollars to provide work for government contractors sounds kind of like pork.

[Dimples]

You might have missed this earlier in the thread where we discussed the inflationary aspects of the FairTax. Kotlikoff does indeed bring it up in the very paper referenced by this thread:

"The first is the major capital gain that the federal government stands to accrue if, as seems likely, the Federal Reserve fully accommodates the introduction of the FairTax and permits consumer prices to rise by roughly 30%. This would reduce the real value of nominal U.S. government debt in the hands of the public (many of whom are foreigners) by about $1 trillion."

While Kotlikoff presents inflation as a "capital gain" to government, note that there is an equal "capital loss" by holders of government debt assets (whether foreign OR domestic)... got any T-Notes??, ... got any money funds? ... got any low risk or tax-free Mutual Funds?

The gain/loss (inflation) phenomenon is not simply limited to government debt. It's also affects the real value of ALL capital assets.

What Rob (and several other of us) have been saying about the devaluation of capital assets and the resulting impact on holders of those assets is spot on. And, apparently, the "poster economist" for the FairTax, Kotlikoff, also believes it will happen, but, because of his underlying agenda, he fails to complete the impact of the inflation picture.

[Principled]

But, I see no good reason for taxing government for hiring a janitor simply to provide a market for for companies doing that work as contractors, particularly if it ends up costing me more.

I'm not convinced it will cost you more.

THere's this unresolved issue - yes we all agree than retail prices can come down 9% as a result of:
-eliminated ER fica
-eliminated income taxes
-eliminated compliance costs

But much remains to be discovered. The amount of compliance cost used is low - but the biggest cost to us is the cost of drag on the economy. That is what the anti crowd refuses to even recognize the existence of.

To this point, the only way to have a discussion is to stipulate to 9% coming off retail prices when the nrst is passed.

At that amount, purchasing power to individuals grows. But the amount that I believe will come off prices after 12 months is twice the 9% figure .

If you prefer government over private industry for everything, you're in the wrong country.