JORGENSON EXPLODES FAIRTAX MYTH (FR Exclusive)

U.S. Representative John Linder
1026 Longworth House Office Building
Washington, DC 20515
Phone: 770-232-3005
Fax: 770-232-2909
Copy: Neal Boortz, WSB Radio,
Dr. Dale Jorgenson, Harvard University

I wrote to you two days ago regarding what I consider to be serious misrepresentations of the Fair Tax plan contained in your book, “The FairTax Book”. On page 2, you state “Let’s agree up front that this book is about honesty” and I intend to hold you at your word. Since that time, I have been in contact with Dr. Jorgenson in an attempt to clarify his understanding of this Plan and his calculation of expected price declines.

On pp. 22-23, your book states: “An extensive study of tax costs was completed a few years ago by Dr. Dale Jorgenson, then chairman of the Harvard Economics Department. On average, Jorgenson concluded, 22 percent of the price paid for a consumer product represents embedded taxes.”

You then went on to show a Chart (Fig 5.1) which shows the expected price decline without embedded costs for various goods and services as prepared by Jorgenson during his study.

On page 55, you go on to explain that these embedded taxes are “in addition to the money taken out of your check in income and payroll taxes.”

On page 59, you again invoke Dr. Jorgenson’s study: “If you’re looking for scholarly support for the proposition that prices will fall once the embedded taxes are removed, we can check back with [Jorgenson’s] “The Economic Impact of the National Retail Sales Tax” and you quote his report:

Since producers would no longer pay taxes on profits or other forms of capital income under the NRST and workers would no longer pay taxes on wages, prices received by producers… would fall by an average of twenty percent”

In this statement, Jorgenson seems to say that one of the reasons for the price drop at the producer level was the elimination of the tax on wages paid to workers. So, naturally if the business is going to realize this benefit it must reduce the workers gross pay be the amount that is currently being paid in the form of income and payroll taxes. This only makes sense because how can the business reduce costs if it gives the worker tax savings to the worker?

Later on page 59, you state: “Once the FairTax takes effect, you’ll be receiving 100 percent of every paycheck, with no withholding of federal income taxes, Social security taxes, or Medicare taxes and you’ll be paying just about the same price for T-shirts and other consumer goods and services that you were paying before the FairTax.”

Dr. Jorgenson’s report clearly showed that under his study the worker would not get their complete paycheck, because if he/she did, there would be no cost savings to the business and therefore no price drop associated with worker taxes.

You continue this theme on page 83: “Remember that the poor, along with everyone else—will no longer have Social Security taxes or Medicare taxes removed from their paychecks. Whatever they earn, they get on payday. For most of those we categorize as poor, this would mean an immediate 25 to 30 percent increase in their take-home pay.”

On page 84, you make it clear though that even though the workers will keep all of their paychecks for a big raise, you still believe that because of “the disappearance of the embedded taxes, the total price paid for consumer goods will remain very nearly the same”.

By assuming these two things together, you are misrepresenting Jorgenson’s report and double-counting the tax savings, first by giving them to the worker as a pay raise, and then at the same time assuming that there was a cost savings to the business.

And then on page 111, you tie it all together with a Quick Review in which you erroneously assert that “Here’s what happens when we pass and implement the FairTax plan:”

“We all get virtual raises, since payroll taxes are no longer siphoned from our checks.

“The prices of consumer goods and services remain essentially the same, with the removal of the embedded taxes compensating for the added consumption tax.”

Dr. Jorgenson’s report seemed pretty clear to me, but I felt it was necessary to ask him directly what he meant so I sent him this e-mail:

I am a private US citizen who is concerned that the FairTax proponents are misrepresenting your conclusions. Would you please comment on the attached letter I sent to Mr. Boortz and Rep. Linder? I think that they are being dishonest to imply that the wage earner will keep his entire paycheck, while at the same time businesses will be able to reduce costs? Your March 1996 testimony stated, in part:

5.Since producers would no longer pay taxes on profits or other forms of capital income under the NRST and workers would no longer pay taxes on wages, prices received by producers, shown in the sixth chart, would fall by an average of twenty percent

Are you expecting business to reap a benefit from the taxes that that the worker no longer pays? It certainly sounds like that is part of where you see the business reducing its costs.

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?

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.

[He then went on to recommend his book called LIFTING THE BURDEN, about another tax reform plan he calls Efficient Taxation]

I wanted to be perfectly clear what he was saying, so I asked him to clarify his email:

Excuse me for my lack of understanding of your answer, when you say "workers would keep that after-tax pay" are you saying that if they are making $1000 a week now, and paying $200 payroll+income taxes now, that under the FairTax you were assuming that workers would get paid $800 and keep all of that? Or are you saying that you meant they would make $1000 under the FairTax?

I am saying that the worker would continue to receive the after-tax amount of $800. Prices received by producers would decline to cover the cost of after-tax wages to workers and after-tax dividends and interest to investors. However, taxes paid at the retail level would include the Fair Tax.

So, Dr. Jorgenson, whose report you are relying on to support your calculation of embedded taxes, is stating that in making those embedded tax calculations he was not assuming that the worker would keep his current after-tax amount, NOT that the worker would keep all of his current gross pay-check. By reducing the gross pay of the worker to the current after-tax amount, the producers would see a cost reduction that would allow them to reduce selling prices. There would be no increase in take-home pay.

I think you need to carefully review the misrepresentations in your book and offer a retraction and modify subsequent printings to remove these errors. You have spent a large amount of time on this plan, and it is still a viable option for debate even without the bug windfall pay raise for everyone. I would enjoy the opportunity to discuss this with you further if you have questions.

I sense desperation in your posts lately. I'm worried about you.

Desperation? ME? LOL! YOU are delusional on top of everything else!

I post a book title in response to the request of another poster, without ANY editorial comment and without once posting to anyone named "Your Nightmare" I might add, since I happen to believe that most folks are capable of reading something and deciding for themselves what it says. YOU however, at the very appearance of the title, launch your trashing effort and I'M the one who is desperate???

LOL! You REALLY are phunny!

An honest question. What do you think would happen if a plan like Bush's "guest workers" idea were implemented? Would they get the FCA?

Good question. I suppose it would really depend on the plan -- I haven't looked into that much, but it comes down to whether or not they'll be given a status equal to legal residents. If so, they'd probably be eligible for the FCA, though that would probably require amending the tax code accordingly as well. A "compromise" position might be to give "undocumented workers" (i.e. illegal immigrants with a job) the right to stay for a certain length of time, but not to be eligible for the FCA.

Too many variables for a guess with any kind of conviction, I guess.

Prior to the tax removal, my 90 dollar income would not pay for the 100 dollar car. After the tax removal, my 90 dollar income might pay for the car if the company responds to tax cessation by reducing it's price to 90 dollars.

pigdog's response:

That's quite a good observation that some of the Status Quo folks on the thread certainly miss.
Quite right.

Quite wrong.

Someone missed something alright. Both of you... You both missed the 30% tax on the $90.00 price making the total cost what was $100.00 after tax would now be $116.88 after tax.

I notice you use the term "accumulated tax costs." Pigdog claims these are "cascading" taxes. What's your opinion on that?

The term is immaterial. These costs do cascade through the economy (as they are passed to the next level in the form of a higher price,) and they do accumulate (as they add up, ultimately to paid by the consumer at the final retail stage.) Call them whatever you want.

The real issue is their cumulative magnitude ... While we agree that they exist, IMHO, the FairTax proponents overstate the actual magnitude of these costs.

A business can give it's employees a 25% take-home pay raise if they want, but they can't also save money on the elimination of the embedded worker payroll taxes. Put another way, You can't have your cake, and eat it too.

I am not understanding this statement the business is not giving you a 25% take home pay raise they just are not taking out taxes you still make the same amount of pay hourly.

Your example is a good one. In a more general sense, both tax schemes only collect tax at a single virtual toll booth: the current scheme collects tax at the point where money is tagged as income AND is transfered through an entity that is "in the game" (not underground); the FairTax proposes to collect the tax where the money is tagged as consumption and is passed to an entity that is "in the game."

Both schemes have underground potential. Some money in either scheme will never pass through an "in the game" tollbooth. Only money transferring into the underground is taxed by the income tax and only mony transferring out of the underground it taxed under the FairTax. Money that stays IN the underground is not taxed under either scheme.

Unfortunately, it is impossible to predict how the underground will evolve to thwart any new scheme of taxation, just rest assured that it will. I believe the best working assumption to make now is that the magnitude of lost tax potential in each scheme is about the same. I can't prove that, but no one else can prove that any new scheme will be significantly better (or worse.) You just can't run the experiment (a problem with most predicive economics.)

Under the new law, Little Miss Nanny should be charging the 30% NSRT on her services to my friends, taking here income, and then spending it personally and paying the NSRT on her purchases. Thus, we're missing half the taxation that should be going on, here.

What!?!? An under the table nanny is going to start charging 30% more? Are you kidding?

What makes you think your friends who hire her are going to be stupid enough to pay her? Unless she produces a receipt, which she won't do unless she has a real business, which puts her on the radar of the state collection agency, she won't be raising her prices. That's a silly example. This is the open market, remember?

What!?!? An under the table nanny is going to start charging 30% more? Are you kidding? What makes you think your friends who hire her are going to be stupid enough to pay her? Unless she produces a receipt, which she won't do unless she has a real business, which puts her on the radar of the state collection agency, she won't be raising her prices. That's a silly example. This is the open market, remember?

Actually, the nanny isn't liable for the tax. The bill defines "any household employing domestic servants" as a taxable employer and further states that "in the case of wages or salary paid by a taxable employer which are taxable services, the employer shall remit the tax imposed." Sitetest's friends would be liable and would have to remit the tax.

The term is immaterial.

I believe the term is material. "Accumulating" is an additive process, "cascading" is a multiplicative process. A tax that accumulates adds up as the product goes from level to level but the effective tax rate on the base does not change because the tax isn't taxing the tax from previous levels. A cascading tax does tax the tax from previous levels (e.g., a sales tax is imposed on the manufacturer and again on the distributor) so the effective tax rate increases from level to level.

So then you'd agree that there exist certain untaxed consumption transactions under the FairTax scheme (a different underground, if you will.) Presuming you're right and the nanny DOESN'T raise her prices and act as an "in the game" tax collector, the flow of money from above ground employer to homeowner to underground nanny to above ground retailer only taxes each dollar once: at the above ground retailer.

In the current scheme, the same flow only taxes the money once: at the employer through withholding.

While the FairTax does collect tax from different entities at different points, and some tax from money that escaped taxation in the prior current scheme, other monies, now taxed, escape. It is certainly not clear that the the tax base is significantly larger, but it is different.

Keep it up and it IS really quite entertaining!

You really must wear industrial-strength XXXL blinders. You want to get the FairTax passed so bad, you want to skip right past the honest debate steps and get right to the congratulary backslaps and attaboys.

It doesn't work that way. The fact that you continue to name-call and heap verbal sewage on anyone who dares to question any aspect of your plan, even when such flaws are obvious and bleeding from the neck, shows that you don't want to discuss this civilly. You just want to ram it down our throats. And you think we are squirming?

And thanks to both you and pigdog for providing such a good consistent example of what a FairTax kool-aid drinker behaves like thread after thread after thread. There are others but none with quite the staying power, but others are close. You are the definition of a "True Believer".

the business is not giving you a 25% take home pay raise they just are not taking out taxes you still make the same amount of pay hourly.

The key word is "take-home". Let me try to explain. If they don't take out the taxes your gross pay is the same, but the take-home pay is higher by the amount of the taxes. The business has two choices (actually a range of choices between these two extremes):

A. they can keep paying you $8 per hour and now give you the whole $8 (instead of giving you $6.50 and the govt approx $1.50 as before). In this case the business hasn't saved anything on your income and payroll taxes, so they will be able to only reduce prices by at most 10% (the money they save on your half of FICA, plus a few percent for other things beyond the scope of this post). So, the prices you pay at retail will not go down, and when they tack on the 30% FairTax you will pay about 17% more for everything you buy on average.

B. they can reduce your gross pay to the $6.50 you were "taking-home" before. In this case the business HAS saved on your income and payroll taxes, so they will be able to reduce prices by perhaps 23%. So, the prices you pay at retail will go down about 23% on average, and when they tack on the 30% FairTax you will pay about the same as now for everything you buy on average.

See the example in the letter here for more clarification:

A difference without a distinction. With a Tax-revenue-neutral constraint (ie. the Feds collect the same amount of money from either tax scheme) it makes no difference whether you pay that tax a little bit at a time at each level or all at once at the end. The distribution of burden will change as some pay more and some pay less, but, in aggregate, the same tax is due at the end.

Folks here tend to throw terminology into a discussion rather loosely. Taxes in the current scheme both cascade and accumulate. Taxes in the FairTax do neither. In the end the same amount of tax dollars wind up in the Treasury. They just get there through different routes.

...the effective tax rate on the base does not change...

your point??? what do you mean by "base"?? ... the original dollar cost in the example? the taxpayer? great example of throwing in an undefined term.

Ultimately, extracting $2,000 Billion dollars from a $10,000 Billion economy requires levying an average transaction tax of 20%. If you tax less than the full base (base being defined as the total magnitude of all economic transactions -- GDP), you have to raise the rate. It doesn't matter, from the perspective of the total tax burden whether you pay it up front or in arears.

Having said that, there are secondary effects that may make one scheme preferable over others: growth impacts, ease of collections, transparency, distribution of burden, etc., but none of these are germine to this thread. The topic here is whether the FairTax can really raise your effective wages AND lower effective prices AND generate the same amount of tax revenue.

It can't.

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