A Misleading Sales Pitch (Why the campaign for the Fair Tax will set back the cause of Tax Reform)

Here’s the pitch: The FairTax — a plan to replace the federal income tax and payroll tax with a national sales tax — will get rid of the IRS forever. It will let workers keep their entire paychecks and retirees keep their entire pensions. It will raise just as much money as the current tax code. It will promote economic growth. It won’t hurt the middle class, and it won’t cause prices to rise. It will even end our illegal-immigration problem.

These claims are drawn from the leading proponents of the plan: a group called Americans for Fair Taxation, former Republican presidential candidate Mike Huckabee, and the trio behind the book FairTax: The Truth. By painting an attractive picture of a prosperous America without an IRS, they have gotten many conservatives to become enthusiasts for their cause. Rising conservative star Marco Rubio, a Senate candidate in Florida, has endorsed the FairTax in the past (although more recently he has hedged on it). Republican congressman John Linder of Georgia, a FairTax co-author who just announced that he will not run for reelection, has made promoting it his principal mission in Congress. The Iowa Republican party has endorsed it. It seems to be gaining support among tea partiers.

The FairTax sounds too good to be true. It is. The campaign for the FairTax is deeply misleading, and much more likely to set back the cause of tax reform than to advance it.

The FairTaxers give a misleading answer to the first question everyone asks about their idea: How big will the tax be? The FairTaxers say they want a 23 percent sales tax. Most people will assume that a product that costs $100 before the tax is added would cost $123 with the tax. Actually, the tax would be $30 and the total price $130. They call it a “23 percent” rate because $30 is 23 percent of $130. Those FairTaxers who understand the numbers defend this way of calculating the tax rate because it makes it comparable to the income-tax rates they’re trying to replace. But it’s not the way any of the 45 states that have sales taxes calculate their rates. Whether or not the FairTaxers intend to mislead people by using the 23 percent figure, confusion is the effect.

It is not at all clear that this 30 percent sales tax would raise enough revenue to eliminate income and payroll taxes. Brookings Institution economist William Gale has estimated that to replace current federal tax revenues, the tax rate would have to be 44 percent (or 31 percent the way the FairTaxers calculate rates: A $100 product would cost $144 after tax). Gale’s calculation assumed that nobody would evade the sales tax and that Congress would not narrow the tax base by, for example, exempting medical services from the tax. Relaxing those assumptions increases the rate required even further.

Several groups of people would be adversely affected by the tax. Retirees, for example, have paid taxes on their wages during their working lives. After a FairTax was implemented, they would find themselves also having to pay higher taxes on everything they used their accumulated savings to buy. The value of non-retirees’ accumulated savings would drop, too.

The middle class would also pay higher taxes. Under the FairTax plan, the federal government would give all legal residents of the U.S. a “prebate” to cover sales taxes on all purchases up to the poverty line. That would protect the poor (except for illegal immigrants; higher prices are supposed to induce immigrants to come legally so they can get their prebate). And the rich would pay less than they do now, since returns to investment typically are a large share of their income, and these would go untaxed. So if revenues are to stay the same, the middle class will have to pay more. If the change in tax policy increases economic growth, this effect will be mitigated — but it will take a very long time for it to disappear under any plausible assumptions. Governor Huckabee’s claim that voters in all income groups would come out ahead while the federal government would raise the same amount of revenue as before is of course unsupportable.

FairTax proponents generally respond to these criticisms with what we would have to call flimflammery if we thought they understood the issues. Existing taxes are embedded in today’s consumer prices, they say, so getting rid of them would cause prices to drop. Adding sales taxes would be “a wash,” says Huckabee. So prices don’t go up, and workers get to keep their “entire paycheck.” Again, it sounds too good to be true.

And again, it is. If prices stay flat after a sales tax, workers can’t keep their “entire paychecks”: Wages have to fall. The paycheck you’re keeping would be smaller. (Think about it this way: If existing taxes are embedded in the cost of every product, they’re embedded in the cost of labor, too.) If wages don’t adjust downward, then unemployment has to rise. If the Federal Reserve increases the money supply to prevent this combination of falling wages and rising unemployment, then consumer prices will increase.

Most experts in tax administration also say that enforcing sales taxes gets hard quickly once the rates hit double digits. That’s one reason that many countries with broad-based consumption taxes levy value-added taxes, which are collected in smaller amounts at each step along the production and distribution chain, instead of sales taxes, which are collected in one big lump at the end. The fact that no country relies on sales taxes to the extent the FairTaxers advocate does not, however, faze them. Americans for Fair Taxation’s website discusses the issue thus: “Two of the largest economies in the world rely almost solely on sales taxes: Florida and Texas. Many civilizations in history have relied solely on transaction-based consumption taxes: a percentage of a grain shipment in exchange for a safe harbor.” Sales taxes in Florida and Texas are under 10 percent. Might imposing a 30 percent tax rate on the sales of a non-grain-based economy pose different issues? AFT doesn’t say.

Even some of the real advantages of the FairTax are overstated. Households would not have to prepare returns, and would thus enjoy more privacy. On the other hand, the federal government would still have to know people’s wages in order to determine how much they have earned in Social Security benefits. (Which leads to another problem, albeit a surmountable one. Those benefits are now linked to payroll taxes paid, which would of course end with the FairTax. As a result, people would have an incentive, for the first time, to make the federal government think they earned more than they actually did: They would accrue higher Social Security benefits while paying no extra taxes. Waitresses would start over-reporting their tips. The FairTax proposal has to take steps to combat this misreporting.)

And we haven’t even gotten to the politics of it. How likely is it that Congress and the president — any Congress, any president — will agree to create a new tax system that punishes the middle class and senior citizens? One that taxes people when they buy a home in which to live, but not when they buy a house as an investment? (This example comes from The FairTax Fantasy, a fairly comprehensive attack on the idea by Hank Adler and Hugh Hewitt.) That requires state and local governments to pay taxes to the federal government whenever they buy something — and thus, in all likelihood, to raise their own taxes? Let’s even stipulate that these are good ideas, and that the protests of the homebuilders and the charities at the loss of their popular deductions should be ignored. What are the odds that they will be?

AFT also advocates the repeal of the Sixteenth Amendment, which permits a federal income tax. Doing so would require the approval of 38 states’ legislatures. Good luck with that.

In their book FairTax, talk-show host Neal Boortz, Congressman Linder, and Linder aide Rob Woodall dismiss the notion that their campaign is quixotic by arguing that the American Revolution seemed that way too. Abandoning the FairTax as politically impractical, they say, would betray “the American spirit.” They add: “How sad it would be if the FairTax came so very close to reality, then failed legislatively because just a few people — people who could really have helped, people who could have made such a positive difference — just shrugged their shoulders and said, ‘Hey, it’s a good idea, but I don’t see it happening.’”

They need not worry about that scenario. The FairTax is not going to come close to reality. It is true that some things once considered unlikely have come to pass, but working to enact the FairTax is still a waste of time. The American spirit has historically included a fair amount of calculating of odds. And the vast majority of times that people have said, “That will never happen,” they were right.

But even if, per impossibile, the FairTax were enacted, its vulnerability to public sentiment would not end. One of the FairTaxers’ arguments against reform of the income tax is that no reform will stick. The income tax, they say, started as a simple flat tax, and look where we are now. Leaving aside the fact that it has proven quite possible to improve the income tax for long periods of time — most people don’t want to see a restoration of the pre-Reagan code — the same objection applies to the FairTax. Over time, wouldn’t it become just as riddled with exemptions and loopholes as the income tax is? Or as existing state sales taxes are? Or more so: How hard is it to imagine Congress adopting different tax rates for recyclable and non-recyclable products? And wouldn’t the FairTax be at least as easy for politicians to raise as the income tax?

AFT says no. “The FairTax is highly visible. And because there is only one tax rate, it will be very hard for Congress to adopt the typical divide-and-conquer, hide-and-disguise strategy employed today to ratchet up the burden gradually, by manipulating the income tax code.” But how visible would the FairTax really be? Each receipt would show how much the tax had raised the cost of a purchase, but most people would have no sense of how much they had given the federal government over the course of a year. Ask yourself whether you are better at estimating how much income and payroll tax you paid last year, or how much sales tax you paid.

The sound insight behind the FairTax is that the income tax pushes down the return on savings and thus creates a bias toward consumption today instead of consumption tomorrow. So taxing consumption instead of income, as the FairTax aims to do, makes a lot of sense. But there are many other ways to tax consumption. You could, for example, tax income but exempt savings. Other methods of taxing consumption pose far fewer economic, administrative, and political problems.

We do need to reform taxes — to make them simpler, more conducive to growth, and lighter on families. But if conservative politicians campaign for the FairTax, they will lose elections. If tax reformers define reform as the FairTax, there will be no tax reform. The nice thing to say would be that the people who came up with the FairTax and its marketing campaign need to go back to the drawing board. The truth is that they shouldn’t be allowed near drawing boards.

There is nothing fair about the Fair Tax. First you set the taxing event at the entrance of the “Pipeline of life’s accumulation” with the income tax. Everything that one earns goes through this taxing event before it can enter the pipeline of savings, retirement, property accumulation and all other capital accumulation for which one has a tax basis to keep from being taxed on that same money twice should one elect to sell the capital item, but would only be taxed on the gain.

Then, just about the time that you reach the age where you will no longer be a wage earner and will no longer be adding to your pipeline of accumulation, but will instead begin to live off of your savings, retirement and capital accumulation some smart guy comes along and says hey, I’ve got a great idea; lets move the taxing event from the entrance of your pipeline of accumulation to the exit of that pipeline! We won’t tax you when you earn the money, we will tax you when you spend it. You can fill your pipeline of accumulated savings with all that you can earn before paying tax on it. We will call it the Fair Tax!

But wait, you might say,”I am no longer earning or accumulating wealth. I was taught that I should save for my retirement so that I could support myself and would not be a burden on society. I made many sacrifices throughout my life to accomplish that goal and now you tell me that you want to change the rules of the game and move the taxing event to the other end of the ‘pipeline’, so that everything that I have already paid taxes on over my entire life, which I was able to save, will now be taxed a second time when I spend it!!? And you will call this a FAIR TAX?”

You might ask yourself, “What the hell is fair about that?”

Proponents of the Fair Tax try to argue that, “Prices will go down, etc.”

I say Bull S**t. That doesn’t change the fact that current earners will be buying goods and services and saving, with untaxed dollars, and those that sacrificed and did things right and managed, by acting responsibly, to reach retirement age with accumulated capital through sacrifice will be competing for those same goods and services with dollars that have already been taxed!

For the retired or soon to be retired person, there is nothing fair about the Fair Tax until they can figure out a way to provide a credit against the tax for accumulated capital which has already been subject to tax.

To change the rules of the game in this drastic manner without accommodating the responsible people who saved to accomplish the admirable goal of self-sufficency, would be akin to waiting until a football team had moved the ball to within one foot of the goal line and then unilaterally declaring that the rules have just changed and they must cross the center of the field to score and no adjustment will be made for yardage they have already gained. Except, I suspect, those so affected by the Fair Tax, will take this “stick in the eye” a lot more seriously than any football game!

Once again Ramesh proves not to have a clue. The overall tax burden will be lower under the Fair Tax. Currently under the income tax retirees are taxed on their savings and any capital gains. These forms of income taxes will be eliminated by The Fair Tax. They will consequently have more purchasing power and be able to save and invest more than with the income tax.

You are wrong. Retirees are not taxed on their savings. They are taxed only on the earnings of their savings.

Under the Fair Tax proposal, they would be taxed on their entire savings, (savings plus earnings) should they decide to cash in their savings and use it to buy something. As a consequence, they will have paid tax twice on their savings, first when they earned it, and second when they spend it. Some Fair Tax that is!

It was the combination of the 16th and 17th Amendments that broke the chains on the federal government. The 16th:

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

allowed the feds to tax individuals directly, without having to go thru the states.

The 17th, direct election of Senators (who were previously appointed by the state legislatures), took away the ability of the state legislators to stop federal encroachments on their power.

Do you think a Senate, appointed by state legislators, is going to allow unnecessary budget items that have to be paid for by the states, from out of STATE revenue?

Americans For Fair Taxation has been aware since 1995. The purpose of House Joint Resolution 16 is to repeal the 16th Amendment. If you took of your blinders you would realize The Fair Tax Act(HR25/S296) has a provision in their bill recognizing the need to repeal the 16th Amendment.

And, should that provision not be ratified, then what? So-called Fair Tax and Income tax both?

The bureaucracy will be much smaller. The IRS consisting of approximately 100,000 agents will be replaced with an agency requiring about 5,000 agents.

Any idea on how many began with the IRS? Can you name any bureaucracy that has not grown?

You really need to read the bill. There will not be any taxes on business to business transactions.

I printed it all out long ago and did read it, all 133 pages of it. I wonder if any supporters actually read the bill or rely more on Boortz's book.

The wealthy will no longer have their investments taxed thereby increasing their purchasing power.

The wealthy are the least of my worries. It is John Q. Public that will see he now must pay 30 cents on the dollar in tax that I see running to buy used over new items.

The author hasn't a clue and obviously hasn't spent one second reading the bill.

From where I sit, it appears like people more follow Boortz's book than the actual bill. The problems in this bill are way too apparent and clear for them to be so easily missed by supporters.

I am constantly amazed to see those who readily see big problems in the healthcare takeover, but who, out of hatred for the IRS or whatever, ignore glaring problems within this bill.

As I have long maintained, we do not tame the beast by changing how we feed the beast. The beast being out of control government spending.

Put down Boortz's book and actually read the entire bill.

Then, just about the time that you reach the age where you will no longer be a wage earner and will no longer be adding to your pipeline of accumulation, but will instead begin to live off of your savings, retirement and capital accumulation some smart guy comes along and says hey, I’ve got a great idea; lets move the taxing event from the entrance of your pipeline of accumulation to the exit of that pipeline!

You're already being taxed on savings and capital gains! The Fair Tax will eliminate this taxation and therefore will be able to acquire more wealth via investments and increase savings!

Ignoring that fact, Are you willing to sacrifice the opportunity for future generations not to have their wealth taxed to avoid your perceived double taxation?

You are wrong. Retirees are not taxed on their savings.

They are taxed only on the earnings of their savings.

The splitting hairs argument only weakens your position. That is money that would otherwise be saved for your retirement. The Fair Tax will remove that tax.

Under the Fair Tax proposal, they would be taxed on their entire savings, (savings plus earnings) should they decide to cash in their savings and use it to buy something.

Wrong again. You won't be taxed on used items, nor will you be taxed on necessities up to the poverty level. You are taxed multiple times with every purchase due to corporate income taxes included in the price at each stage of production. There will no longer be multiple taxation when The Fair Tax eliminates those embedded corporate income taxes.

And, should that provision not be ratified, then what? So-called Fair Tax and Income tax both?

Per the Fair Tax Act(HR25/S296)

SEC. 401. ELIMINATION OF SALES TAX IF SIXTEENTH AMENDMENT NOT REPEALED.

If the Sixteenth Amendment to the Constitution of the United States is not repealed before the end of the 7-year period beginning on the date of the enactment of this Act, then all provisions of, and amendments made by, this Act shall not apply to any use or consumption in any year beginning after December 31 of the calendar year in which or with which such period ends, except that the Sales Tax Bureau of the Department of the Treasury shall not be terminated until 6 months after such December 31.

Any idea on how many began with the IRS? Can you name any bureaucracy that has not grown?

Are you aware the number of collection points will be reduced from 140 million(individuals and businesses) down to 40 million(businesses only)? The federal agency in charge under The Fair Tax will only grow if the number of collection points increases. That will happen at a much slower pace than the increase of individuals that has occurred with the income tax.

It is John Q. Public that will see he now must pay 30 cents on the dollar in tax that I see running to buy used over new items.

There will not be anymore tax collected under the Fair Tax than the embedded corporate taxes and associated compliance costs included in the price of all goods and services today. The total is nearly 23%. A $100 item actually costs $77 with $23 in taxes. That is the tax inclusive rate. The Fair Tax will eliminate those embedded taxes by eliminating corporate income taxes and apply that rate only at the final point of sale. That is the tax exclusive rate. Do the math: 23/77=30%. The amount of dollars collected will be the same($23)regardless of the rate quoted.

As I have long maintained, we do not tame the beast by changing how we feed the beast. The beast being out of control government spending.

No form of taxes can completely control spending. It's not designed primarily for that purpose however The Fair Tax will control spending to some extent. Increased spending would require Congress to raise the rate. Raising the consumption rate would result in a decrease of purchases. Fewer purchases would cause a corresponding drop in tax collection. Less taxes collected would give Congress less money to spend thereby forcing them to reduce spending or lower the tax rate to maximize collection.

I like the Fair Tax. I think it is moral and fair. The economics will sort itself -- as long as the foundation is fair and moral, I think the economics will end up being acceptable. I consider a progressive income tax to be unfair, immoral, and economically destructive.

I completely agree with you. I am sure there will be problems that we can sort out. Personally, I would get rid of the prebate concept and lower the overall rate. But that's just me. Beyond that the people that constantly say nothing can be changed are inevitably wrong. Wilson got the permanent income tax yoke around our throats. What is done can be undone. Indeed history tells us that is always the case. The marxist income tax must be eliminated to protect the freedom of our citizens. The Constitution must be amended to prevent the government hitting the citizens with both a sales tax and an income tax. While we are at it we need to amend the constitution to prevent states and localities from taxing property. It is time to reign in the bloated, arrogant and abusive government.

Taxes are not for controlling spending, that is a strawman. But, taxes continue to feed spending.

And, pray tell, what occurs during the 7 years we wait for ratification of repealing the 16th Amendment and Fair Tax is instituted?

When was that ratification clause added? It’s not in the original.

I didn’t say it before, but I will now, you ignored very relevant points of trouble with this and addrssed more minor points.

Typical of Fair Taxers and Ron Paulies (not saying you are a Paulie).

There are several problems I did not even address.

I’d rather see the IRS gone and a flat tax instead.

The simpler the better and Fair Tax is far from simple.

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