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.

Dear ovrtaxt,

I think you may have missed my point.

I was pointing out that Little Miss Nanny is legally obligated to collect the 30% NRST, yet she will not.

She and the family are, under the NRST, evading taxation. Just as she and the family avoided taxation under the income tax.

The differences are 1) she must pay taxes on her purchases now; but 2) the couple previously paid taxes on the income used to pay her.

Thus, under the old law and the new, tax was to be paid twice.

Under the old law, tax should have been paid by the couple at the point of income, and the nanny should have paid tax, also at the point of income. But only one tax is paid.

Under the new law, tax, again, should be paid twice. The couple should pay tax in their transaction with the nanny, and the nanny should pay tax on her purchases. But, again, only one tax is paid.

Thus, the approximate level of tax evasion remains the same, the new NRST doesn't "capture" any part of the underground economy not captured by the previous income tax.

sitetest

Dear Your Nightmare,

"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."

Certainly, because the ultimate obligation to pay sales taxes rests with the purchaser (although the seller can also be dinged). That's why the state of Maryland occasionally audits folks who get big deliveries from North Carolina, because they've bought furniture and paid no sales tax, either to North Carolina, or to Maryland. And the state comes and demands a "use" tax, which serves in the place of the sales tax. The consumer is legally liable for it.

sitetest

... the employer shall remit the tax imposed ...

Does anybody really think that those same households that now employ underground nannies, housecleaners and gardeners and don't NOW pay FICA taxes, or withhold income tax from these employees' pay are going to become "in the game" taxable employers and pay the required tax under the FairTax scheme???

I didn't think so.

Again, this example illustrates how the tax base doesn't expand, but merely shifts.

Dear Dimples,

"In a more general sense, both tax schemes only collect tax at a single virtual toll booth:"

That's a really clear way to say it. I may borrow that. ;-)

"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 agree. Turning the tax collection methodology upside down doesn't change human nature.

"I believe the best working assumption to make now is that the magnitude of lost tax potential in each scheme is about the same."

That's my best guess, although I'm willing to go so far as to say that it's possible that an NRST might be a little more difficult to evade than an income tax, and thus, may net a little more from the "underground economy."

However, my understanding is that the 23% inclusive rate is based on the assumption that most of the "underground economy" transactions will be captured. Thus, if it turns out that you're right or I'm right, the rate will have to be higher. Which will encourage more evasion and avoidance.

As well, just how large a consumption tax can you have before you start to really affect consumption?

"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.)"

Yeah. That's actually one of my objections to the NRST. It's a huge change. A really, really huge change. To me, it seems like taking an ocean liner and turning it upside down. The basic structure of the boat will stay about the same, but you're gonna have a lot of ruined china (among other things).

The problem is that the entire society IS the experiment.

sitetest

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

In this particular example, yes. But every item or service is going to see a variable effect, depending on what happens to it before it's consumed. Items with many stages of production, such as computers or cars, will realize a greater price drop, while pure services such as the nanny will not. There are estimated effects for different industries on the FairTax site.

Dear ovrtaxt,

I'm not sure that I was addressing what you seem to think I was addressing.

I was only talking about compliance and the degree to which the NRST might be superior to the income tax in reducing tax evasion.

My own view is that it would not be substantially superior, and possibly not superior at all.

sitetest

In this particular example, yes.

And in every other example you can think of. You're mixing apples and ringshank nails. The Income Tax taxes income; the FairTax taxes consumption ... regardless of what industry, price, or other factors.

Anyway, what does price drop have to do with whether the dollars escape the tax authority? My response that you quoted addresses the claim that under the FairTax, the underground economy is supposed to grow the tax base thereby reducing the effective tax rate.

I will stipulate that yes, different aspects of the economy will be affected in different ways. More correctly, goods and services with high LABOR content will have the potential for the greatest price impacts since wage taxes and payroll taxes make up the lions share of tax collected under the current scheme.

But again, what does that have to do with whether there FairTax can eliminate the underground economy?

Here is my thoughts from a different thread re the Underground Economy:

Of course the illegal economy contribution is already included in the revenue neutral calulations, pigdog, you REALLY don't understand this plan very well considering how long you have been harping on it.

The Revenue Neutral calculations basically added up all the retail sales and services that would be taxable under the NRST, and divide them into the amount of government income that needs to be generated to replace the income and payroll and corporate taxes that would be lost. That yields the required FairTax rate to generate the same ("neutral") income.

The way they propose to start taxing the illegal underground economy is to start applying the taxes to the legal transactions that the drug dealers are making right NOW. Since they can't nail them at the income tax level they think it will be easier to nail people who are not reporting retail sales because it requires collusion between the illegal drug dealer and the honest retailers.

They do not expect to make what is now an illegal transaction, become suddenly legal by adding an additional 30% FairTax to the transaction.

ancient_geezer do you agree with this statement above?

In fact, once the wage and price issues are squared away, my biggest remaining concern with the FairTax is that the 30% tax rate will drive many retail transactions underground because of the very high tax rate, that is the big unknown. I am esp worried about this as it relates to personal services- which are transacted individual-to-individual.

I agree with your views. Illegal transactions will not be taxed; dollars flowing out of the underground are only taxed once (as they are today before they flow in;) dollars that flow underground are not taxed at all.

If aftertax income remains the same (as we believe it will) and aftertax prices remain the same (prices drop but tax is added back in at retail), there is no aggregate change in purchasing behavior. However, the ability to discount purchases by 30% (by not collecting or paying Sales Tax) is a powerful incentive to go underground for both the seller and the buyer. On an economy-wide basis, more choices are made about consumption based on price by more individuals than are made about jobs/income.

It seems there will be much more incentive and much more opportunity to cheat.

You are the definition of a "True Believer".

Thank you! I consider that to be a compliment regardless of how you intended it.

There are are a couple of things you, and anyone else interested, need to know about me. They are:

1. I consider the communist inspired progressive income tax to be the greatest evil ever perpetrated on the American people and fully intend to see it where it so properly belongs - on the ash heap of history!

2. The Fairtax bill currently before congress, warts and all, represents the best opportunity for doing that to come along in my lifetime and I WILL do whatever I can to see it become the law of the land regardless of who's toes I happen to step on in the process.

I WILL do whatever I can to see it become the law of the land regardless of who's toes I happen to step on in the process.

Stepping on toes is fine, but I would suggest that you'll have more success if you use a bit more honesty. And a willingness to listen to the opponents you are attempting to stomp and bludgeon into submission.

Or, are you planning on carrying out your plans without gaining the support of anyone not already sold on every aspect of the plan?

It seems there will be much more incentive and much more opportunity to cheat.
You got that right, but if you listen to the fairtaxers, if you're against the Fairtax it's because you work for the IRS, are an accountant, or you're a income tax cheat.

The truth is, if a person was intent on being a tax cheat there'd be no better oppotunity tha the Fairtax.

Here is a way to look at your example:

Level 1: Hot Dog Packer, manufactures hot dogs and sells to
Level 2: Fred's Hot Dogs, who buys the hot dogs and resells them without adding any value for 33% higher to
Level 3: John's Hot Dogs, buys the hot dogs and resells them without adding any additional value for 33% higher to
Level 4: George's Hot Dogs, buys the hot dogs and resells them without adding any additional value for 33% higher to
Level 5: Johnny's Really Good Dogs, who buys the hot dogs and sells them without adding any additional value to the end consumer for 33% more than he paid.

And remember that at each step of the way none of these companies has any inputs except for the hot dogs they buy-- no buildings, employees, phones, trucking charges, etc. Plus each of them is a C-Corp paying max corporate income taxes.

Try the examples with some real numbers (site_test has done this, he can probably show his example) and the accumulated tax numbers are much much lower. It is of course unreasonable just from a common sense point of view that these numbers could get as large as your example shows.

The pigdog example just shows that when you put garbage into a spreadsheet, garbage can come back out.

I would suggest that you'll have more success if you use a bit more honesty. And a willingness to listen to the opponents you are attempting to stomp and bludgeon into submission.

Thank you for the suggestion. I will try to comply but you should also know that I recognize this to be the deep end of the pool and I WILL NOT willing allow those on your side, who would perpetuate the tragedy we currently live with, to get away with the word/mind games they seem so fond of.

I have said this many times previously on this forum and will repeat it now for you!

For me, this is not, and never has been, about money. It IS, and always has been, about only one thing.

F R E E D O M ! ! !

if you're against the Fairtax it's because you work for the IRS, are an accountant, or you're a income tax cheat.

You left out troll, lovers of the Status Quo, Democrat, liberal, anti-Freedom, dishonest, Squirrels, NIghtmareTaxers, stuck in the mud, economic moron, joke, tax-lover, ridiculous, "lump of coal in our butts, so long its turned into a diamond", Marxists.

I recognize this to be the deep end of the pool and I WILL NOT willing allow those on your side, who would perpetuate the tragedy we currently live with, to get away with the word/mind games they seem so fond of.

Actually you should be pissed at Neal Boortz and John Linder for publishing a book that can't even get it right on the fundamental question of what will happen to earnings and prices when we institute the plan.

The Fairtax Plan is still a viable one to debate without the misrepresentations, and they have really hurt your efforts and those of hundreds of thousands who have worked in the trenches to elevate this to the national spotlight. To have to backtrack after getting the people all warmed up is a tragedy.

And if you are still denying that there is a major screw-up in the book, then you are hurting your cause.

Don't shoot me, I'm just pointing out the obvious.

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