Friday, January 11, 2008

Kling on the Fair Tax

Arnold Kling at TCS Daily looks at the Fair Tax, which proposes to replace the Federal Income tax with a consumption based national sales tax. Kling has proposed a similar idea himself in the past, but has some issues with the proposal as it stands today. One thing proponents like to tout is that you get your entire paycheck with no taxes taken out, which sounds like a good deal until you dig into a bit further.

First, the advatanges of such a plan, as Kling sees it:

"Potential advantages include reduced complexity, weaker incentives to lobby for tax breaks, and stronger incentives to save. Potential drawbacks include difficulty raising revenue and major shifts in the tax burden relative to the current system."

The Fair Tax proposal is to tax all purchases, even those made by government agencies, at a rate the proponents claim is 23%* (see Kling's note below), with the exception of educational costs. There is also a exception for repurchased goods, even big ticket items such as houses and cars, so only newly produced items and services would be subject to the tax. The tax would replace all Federal taxes, including the payroll taxes for Social Security and Medicare. The personal tax exemption would be $2352 for adults and $732 for children. One thing he doesn't examine is that the plan calls for the government would send a check to those making under a certain income figure (or maybe it was everyone) to defray living costs - but I haven't seen how that would be implemented.

"(*The FairTaxers quote a 23 percent rate. If a boombox costs $100 and I pay a $30 sales tax, then to me that is a 30 percent tax. What the FairTaxers are saying is that if I have to lay out $130 for the boombox and $30 of that is taxes, then I am paying $30/$130 = 23 percent in taxes. This is consistent with the way we think of income taxes--if you earn $130 in income and pay $30 in taxes, then you think of your tax rate as 23 percent. However, it is not the way we typically think of sales taxes.)"

Kling compares the Fair Tax with his own proposal and finds it wanting in several regards, but suffice it to say that it is lacking - for example, the exemptions from his own plan for a family of four would be $20,000 versus $6288 under the Fair Tax, and he also believes proponents are ignoring the transistion costs, which might puts the real rate as high as 45%. But one biggie he points out is that the vast majority of the current income tax revenues come from the upper end of the income distribution; the top 10% of income earners, those making over $104,000 a year, contribute 70% of the income tax revenues. As he puts it:

"The problem with a consumption tax is that the top 5 percent of earners do not consume at the same rate that they earn income. As a result, the government cannot abolish the income tax without sacrificing hundreds of billions in revenue from the subset of high earners who also are high savers. To make up for this loss, the middle class has to be socked with either higher taxes or fewer entitlements."

A while back the Skeptical Optimist looked at the proposal and pointed out another huge issue: if I have money in my savings account that I've already been taxed on from the current income tax regime, why should I pay another tax when I spend it after the Fair Tax is implemented? I've seen no good answer from the Fair Tax proponents on this one.

Kling goes on to make a more practical middle proposal, one in which you flatten the income tax to three rates: zero for those earning under $100,000, 10% for those between $100-150,000, and 35% over that figure, abolishing the payroll tax and institute a national sales tax at a rate of around 20%, with all future tax adjustments being address on the sales poriton only. This would certainly make tax payers sensitve to the cost of new govenrment programs (as well as the politicians elected by the taxpayers).

Interesting discussion, but I'm still not sold - either way, both systems are fairly complicated, and the transition is likely to be messy. I'm still drawn to a much more appealing proposal that has been empirically shown to work to unleash the engine of economic growth - the Flat Tax.


Mark said...

The problem with a consumption tax is that its insane, not that the top 5 percent do this or that.

But unless there is some alternate universe, where math has no meaning, then Fairtax has fatal flaws.

I don't think the fairtax slows down at stupid. I can't imagine why its not laughed off the stage.

I guess it sounds so darn good, unless you use math and logic to study it.

For one thing — Fairtax pretends to tax the federal government, to pay the federal government, about 300 billion dollars.

Boortz writes “the federal government itself becomes a major taxpayer” Page 148.

Can the federal government can really pay the federal government 300 billion dollars.

Its like me saying I will tax myself 10,000 dollars a day. Oh, I can write a check for 10K, I can even deposit my own check in my own account.

But at the end of the month, I dont have 300,000.

Incredibly, Fairtax thinks they will have 300,000. Well — they pretend they have 300 billion, just from taxing themselves, along with everything else.

For example, when the Fairtax makes the US Navy pay 4 billion in “sales tax” on a 12 billion dollar aircraft carrier — the Navy can write the check, The Treasury can even deposit the check.

But the Treasury isnt a dime ahead. The treasury had to issue the money to cover the check it cashed.

But Fairtax acts as if they are getting 4 billion into the treasury from the Navy. Fairtax advocates think they are ahead 296 other billions from taxing government overall. But they aren't.

As a result, the Fairtax budget would be 300 billion dollars shy -- and the rate would have to go up on the fairtax to cover that. So the rate would have to at least be 35% for that one fallacy.

Another major fallacy — Fairtax pretends it will be able to tax health care. Fairtax looks to tax the 2 trillion dollar health care industry — to the tune of 460 Billion.

If Fair tax CAN NOT tax health care for political reasons — they lose 460 Billion more in revenue, and the tax rate has to go up to 50-55% percent.

Lets see if the Fairtax can really tax health care and get 460 billion from these people.

Will Fairtax get away with taxing health care?

Depends. Depends what a cancer patients does when just ONE patient gets a tax bill of 40,000 dollars on their surgery, chemo, and hospital bill. Will they go ahead an pay it?

Or scream like bloody murder?

Keep in mind, there are 15 million people dealing with cancer at any one time.

Even if they cancer victims have insurance — insurance doesnt cover this extra 35% tax. So if you survive cancer and your insurance pays the doctor and hosptial 100K, you still owe the 35,000 for the tax.

The Fairtax would be the new -- and absurdly high -- co-pay.

What do you think nursing home patient will say, or the famlies, they see a 25,000 tax, per year, on their nursing home care?

Will they just pay it? Or scream like bloody murder?

What would the parents of an 8 year old leukemia victim say, when they see a “sales tax” bill of 70,000 dollars, on their effort to keep their child alive. Suppose further that the parents only make 35,000 a year.

Will they just pay it -- using magic -- or will they phone their congressmen? Their Senator?

What will millions of people say when they see their bills — second opinions are taxed — lab tests — taxed — ER visits — taxed. Dental care -taxed. Doctor visits — taxed. Knee replacement — taxed. Child birth — taxed.

The outcry from these folks will be like nothing US history has ever seen before.

Congress would quickly exempt health care expenses from a high sales tax.

If any Congressman dared to suggest the parents of a cancer victim should pay a sales tax — they wont be a congressmen very long.

So the rate would have to be adjusted up — to 55-65%

My point is — you wont be ABLE to tax health care. And you CAN'T tax the federal government.

The Fairtax budget would be 800 billion dollars shy --

And we havent even discussed other huge markets which will demand exemptions. Renters -- Car sales, new home sales -- new moblie homes.

Of the 40 million renters in the USA - I bet not 12 individual renters know their taxes would skyrocket the moment this bill is passed. And wow, will they have a few words.

ALready, you have nearly a trillion dollar shortfall. And there are other fallacies, but no time to explain them too.

Fair tax can’t work. And Im really sorry that it can't.

Kalthalior said...

I have to agree with you the Fair Tax, as proposed, appears to me to be unworkable. The whole prebate thing doesn't seem to make a great deal of sense, along with the issues concerning the government payment of taxes to itself.

I'd much rather see a Flat tax, emprically shown to work effectivley in many other nations and generate far better returns in terms of economic growth.