The Political Basis for the FairTax

American Thinker ^ | 05/22/2011 | Robert E. Dell and David G. Tuerck

[SeekAndFind]

As the current debate over fiscal reform suggests, very few proposals for fundamental changes in tax policy have the potential to command support across the ideological spectrum.  The "FairTax" is the great exception.  Correctly understood, the Fair Tax Act (HR 25, S13 with 67 cosponsors), which would replace almost all federal taxes with a direct tax on consumption, should appeal to conservatives, progressives, and libertarians alike. 

Let's start with conservatives.  The FairTax enjoys more support from this quarter than any other tax reform proposal, including the flat tax and the reforms outlined in Congressman Paul Ryan's Path to Prosperity.  The latter two reforms provide for large personal exemptions and do not specifically tax imports.  By taxing a wider base with a lower comprehensive average marginal rate, on the other hand, the FairTax encourages more new hiring and faster economic growth.  Several dynamic simulation studies suggest U.S. GDP could be 10% higher in a few years under the FairTax than under the current tax code.

But the FairTax should appeal to progressives as well.  It eliminates subsidies to Cadillac health plans and millionaire mansions, along with the regressive Social Security tax.  It makes the wealthy pay taxes on their consumption while permitting the poor to consume tax free.  It eliminates every vestige of corporate welfare that is embodied in today's tax code.

A 2006 study by Kotlikoff and Rapson comparing remaining lifetime tax rates under the current system versus the FairTax for households of varying age and income levels showed the reduction in tax rates to be greatest for the lowest earning households.  For example, a single woman aged 60 making $25,000 per year and facing an effective tax rate of 14.1% under the current system would instead have a negative 6.2% rate under the FairTax, due largely to the effects of the FairTax prebate (a government subsidy financed through the tax itself) and elimination of the payroll tax.  The FairTax is arguably more progressive than the current system, the flat tax or the Ryan plan.

A study by the Beacon Hill Institute concluded that if we group taxpayers by expenditure per capita, the average taxpayer in the top decile loses under the FairTax (with lower levels of after-tax consumption than under the current system).  The relative treatment of the lifetime poor versus the lifetime rich under the FairTax, once understood, make the tax cuts for the rich argument against the FairTax ring hollow.

A tax is more truly progressive if its burden falls most on the people who consume the most.  Progressive economists such as Robert Frank have argued that rising income inequality due to disproportionate growth in the incomes of the statistical top 1% of income earners is not an egalitarian concern per se.  The problem is that the spending habits of the increasingly rich create "expenditure cascades" that make it harder for middle-class families to make ends meet and increase their sense of relative material inadequacy.  The FairTax is an answer to this problem.

Libertarians, for their part, should celebrate the end of income tax withholding.  As FairTax proponents Neal Boortz and John Linder have put it: "[I]ncome taxes are seized. Consumption taxes are paid."  Equally celebrated should be the end of the practice of ratcheting up the tax rates on top earners in the pursuit of new revenues and of selling tax expenditures to special interests for votes or campaign support.  The FairTax calls for one universally transparent rate to be paid by everyone on all final consumption.  Thus, everyone acquires an economic interest in all government spending decisions and the tax code disappears as a playground for special pleaders.  There should be a natural convergence of conservative, progressive, and libertarian pundits who oppose the blatant cronyism that goes on now.

No tax system is perfect.  Substantive criticism of the FairTax has centered on transitional issues and the rate necessary for revenue neutrality.  But much of the detractive criticism amounts to pointing out small holes in a barn door without acknowledging the utility of the barn to the horses inside.  The main objective of any tax system should be to keep marginal rates low, since, as marginal rates rise, wealth destruction rises disproportionately.

Conservatives worry about a FairTax political bait and switch; the Wall Street Journal editorial board has expressed such skepticism.  If the Sixteenth Amendment to the constitution is not repealed (as is called for in the FairTax legislation), the country could end up with both an income and a sales tax.  But the legislation also contains a provision that would repeal the FairTax and reinstate the income tax if the Sixteenth Amendment is not repealed within seven years to prevent both from being in existence at the same time.  The best insurance against such an outcome, however, is a broad, bipartisan understanding of the virtues of the FairTax.

The Ryan plan and the flat tax are no less susceptible to political demagoguery than the FairTax.  Political candidates able to deliver a clear and consistent defense of the FairTax, such as Saxby Chambliss (R-GA) and Marco Rubio (R-FL), have successfully overcome attack ads and advanced their careers in the process.

In 2005 eighty academic and business economists formally endorsed the FairTax.  It is entirely conceivable that libertarian philosopher Robert Nozick and his longtime intellectual rival, egalitarian philosopher John Rawls, if they were alive today, could shake hands on the FairTax.  The philosophical differences between the average Democrat and the average Republican are trivial by comparison.

Robert Dell (robdell@comcast.net) resides in Atlanta and is coauthor of the forthcoming book, Back from Serfdom.  David Tuerck serves as executive director of the Beacon Hill Institute and professor and chairman of the Department of Economics at Suffolk University in Boston.

[rbb]

This seems as good a place as any to ask:

In reading minimum wage threads, I often find people saying that minimum wage was not designed or intended for someone to live on.

In reading tax threads, I often find people saying that nearly half pay no (federal income) taxes, and/or that the bottom half doesn’t pay enough taxes.

So how much, exactly, should someone earning minimum wage pay in taxes? (How much is ‘not enough’ and how much is enough?)

[rbb]

More broadly, people correctly have an aversion to taxes, which for some people distorts their judgment. This distortion of judgment I call Tax Derangement Syndrome, and occurs when people are so driven to avoid taxes that they make financial decisions which are suboptimal.

It’s a lot like people going out of their way to avoid a toll by driving an alternate route...and spending more (gas and time) in the process.

The FairTax, by nature of its ubiquity and its high rate, will drive many to seek to avoid it, resulting in inefficiency (on the part of the avoiders) and loss of tax revenue.

[rbb]

Prices ain’t gonna fall, and not everyone can make more money.\, which means spending has to fall.

[rbb]

If the wealthy were to reduce taxable consumption, that would be great for capital formation and business startups. Except that with consumption taking a hit, there might not be a sufficiently large market for all that new business.

[Kellis91789]

“Prices ain’t gonna fall, and not everyone can make more money.”

Are you sure about that ? As demand falls, you think producers are going to just sit back and sell nothing rather than lower prices ? Economics doesn’t work that way. When the government subsidizes something, it is giving buyers more money to buy something, which causes demand to increase, which causes the price to increase. People should not be confused that the “war on poverty” has been a failure, and resulted in a wider income gap. It is perfectly logical — the “wealthy” producers see the higher demand of the subsidized “poor” and raise prices accordingly. The have higher profits, which are then taken back by the government to redistribute to the “poor”. The “poor” are not really better off, and in fact they look even worse off than before in any income comparison to the “wealthy” producers.

[Kellis91789]

“If the wealthy were to reduce taxable consumption, that would be great for capital formation and business startups.”

But they won’t reduce consumption, they’ll simply consume outside the FairTax zone. Instead of maintaining a household with staff, vehicles, parties, etc. in the USA, their main home will be outside the USA and they’ll simply visit often enough to make those business decision that can’t be made remotely — of which there are very few.

Even if they stayed here and simply saved their money, the additional capital available may grow the economy some, but not enough to make up for the loss in FairTax revenue. The top 1% of Americans earn $2.5T and spend $2T each year, and the FairTax assumes it will collect virtually the entire 23% tax on that spending. If they save rather than spend, then the FairTax receipts are immediately short almost $500B/yr.

[Kellis91789]

The question I’d like answered is why even a minimum wage earner doesn’t pay 10% in income tax. Is a dime out of every dollar earned too much to pay for the Federal government ?

Because the dirty little secret is that if everyone paid 10%, we could eliminate the corporate income tax — making America the best place to operate a business — and income tax revenues would actually be HIGHER than they are now. Total income tax revenues including the corporate tax revenues are generally around 9.9% of all personal income. $1.3T out of $13T personal income according to the IRS and the Bureau of Economic Analysis.

When people claim we need the “rich” to pay a 35% tax rate, what they are really saying is that they need 35% from the high earners so that half the people can pay nothing and the bottom fifth can actually get “income tax” refunds for income taxes they never paid.

[Kellis91789]

Yes, that happens. It is analogous to the man who sells his prized classic car for less than it’s worth just so his wife won’t get it in the divorce. Some call it spite, and some call it principle. It’s a reaction to a feeling of betrayal. It’s their choice to do what they want with their money, and they’d rather blow it than see somebody get it who doesn’t deserve it. The FairTax assumes those people will just sit back and pay and pay and pay even though those people have legal alternatives to skip paying the tax.