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MONEY finds flaw in 'FairTax' bestseller [FairTax myth busted by major magazine]
CNN ^ | 9/7/2005

Posted on 09/08/2005 4:48:28 AM PDT by Your Nightmare

A bestseller advocating radical tax reform contains a critical flaw that misleads readers, according to a report in the October issue of MONEY Magazine.

...

While consumers would pay a federal sales tax on purchased items, the authors argue that prices at the store would stay the same. The reason: everyone involved in the process of production would no longer be paying taxes, so they could charge less for their goods and labor.

If true, that would mean a dramatic increase in Americans' purchasing power.

But, according to the MONEY report, the book fails to make clear that, in order for pre-tax prices to fall so sharply, companies would also have to cut wages they pay.

"Sure, you'd get to 'keep 100 percent of your paycheck,' as Boortz and Linder repeatedly write, but it would be a smaller paycheck," MONEY senior editor Pat Regnier writes. "That's kind of a big thing to leave out."

(Excerpt) Read more at money.cnn.com ...


TOPICS: Business/Economy; Government
KEYWORDS: boortz; fairtax; taxreform
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1 posted on 09/08/2005 4:48:30 AM PDT by Your Nightmare
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To: lewislynn; Always Right; RobFromGa; sitetest; Dimples

Exposed hear on Free Republic first by RobFromGa.


2 posted on 09/08/2005 4:49:47 AM PDT by Your Nightmare
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To: Your Nightmare
Exposed hear on Free Republic first by RobFromGa.

I didn't here a thing...

3 posted on 09/08/2005 4:52:40 AM PDT by Prov1322 (Enjoy my wife's incredible artwork at www.watercolorARTwork.com! (This space no longer for rent))
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To: Your Nightmare

Money seems to have amnesia about the amount of taxes businesses pay for having employees. If you figure the book has bad math, Money just did them one better with lazy math.


4 posted on 09/08/2005 4:53:18 AM PDT by x5452
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To: Your Nightmare

So if my Fed taxes go up,that means my hourly wage MUST go up?


5 posted on 09/08/2005 4:56:25 AM PDT by Minnesoootan
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To: Your Nightmare

So if my Fed taxes go up,that means my hourly wage MUST go up?


6 posted on 09/08/2005 4:56:41 AM PDT by Minnesoootan
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To: Your Nightmare
But, according to the MONEY report, the book fails to make clear that, in order for pre-tax prices to fall so sharply, companies would also have to cut wages they pay.

Um NO. They would NOT have to cut wages at all. Since the money collected to pay taxes is money ON TOP of the money they all ready pay in production costs, their would be NO net increase in price of PRODUCTION. The Author at Money is deliberately MISLEADING or LYING about how this mechanism would work. The cost of goods would go UP because of the tax ADDED, HOWEVER the decision to PAY the tax would rest with the CONSUMER instead of forcibly removed from the WAGE EARNERS paychecks. There would be an off setting reduction in cost because all the hidden taxes that significantly the production costs would NOT have to be paid (Business taxes, fees etc) Once again we see the Dinosaurs grasping at any straw to avoid considering ANY changes to their corrupt failed Tax system. Guess it is MORE important to protect all the special tax privileges and shelters for the giant Corps and trust fund babies then to ACTUALLY have a Tax system that is FAIR.

7 posted on 09/08/2005 4:58:27 AM PDT by MNJohnnie ( Blaco say Wed Aug 31st, FEMA says Thur Sept 1st.. Who is lying?)
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To: Your Nightmare

Hogwash!!!!!!!!!!!!


8 posted on 09/08/2005 4:59:00 AM PDT by Red Badger (United States Marine Corps.....An army of WON!...........)
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To: Minnesoootan
So if my Fed taxes go up,that means my hourly wage MUST go up?

OUCH. Better put some ice on that Nightmare, this one is going to leave a mark.

9 posted on 09/08/2005 4:59:41 AM PDT by MNJohnnie ( Blaco say Wed Aug 31st, FEMA says Thur Sept 1st.. Who is lying?)
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To: MNJohnnie

"Money" is published by Time magazine. They have an agenda that doesn't include the Fair Tax.


10 posted on 09/08/2005 5:00:24 AM PDT by Wiser now (A bitter, sour old woman is the crowning work of the devil.)
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To: Your Nightmare

It's from CNN.

You've got to be kidding.


11 posted on 09/08/2005 5:02:38 AM PDT by ovrtaxt (Stop the looting! The IRS hates competition.)
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To: Your Nightmare

I'm sorry, but this dog won't hunt. If I keep 100% of my paycheck and pay tax only when I spend the money, then I will consider my purchases more carefully. If my employer gives me my entire check, instead of part to me and part to Uncle Sam, what's the difference? Where does all this 'smaller paycheck' stuff come from? If nothing else, the employer gets a break by not having to match my social security.I think there is some funny math here.


12 posted on 09/08/2005 5:03:18 AM PDT by bk1000 (A clear conscience is a sure sign of a poor memory)
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To: Wiser now
They have an agenda that doesn't include the Fair Tax.

So does the original poster. His posting history shows nothing but FairTax-bashing.

13 posted on 09/08/2005 5:06:02 AM PDT by kevkrom ("Political looters" should be shot on sight)
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To: x5452
Money seems to have amnesia about the amount of taxes businesses pay for having employees. If you figure the book has bad math, Money just did them one better with lazy math.

Oddly, the math flaw was confirmed by the fair taxer researcher who came up with the 22% embedded taxes, Dr. Jorgenson. Boorts and Linder also agreed there was a flaw, and Boortz said he would correct it in later editions. I have done the math many times, it is flawed.

14 posted on 09/08/2005 5:06:18 AM PDT by Always Right
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To: MNJohnnie
The Author at Money is deliberately MISLEADING or LYING about how this mechanism would work.

The authored lied about nothing. The author was merely pointing out the gross misrepresentation that the fairtax orgnization and Boortz were saying. The author did not concluded wages would go down, merely pointed out that was the assumption used in the fairtax model by the expert who did all their research.

15 posted on 09/08/2005 5:09:06 AM PDT by Always Right
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To: Wiser now
"Money" is published by Time magazine. They have an agenda that doesn't include the Fair Tax.

Actually, it is a very evenhanded article which exposes the good points and the flaws of the fair tax.

16 posted on 09/08/2005 5:10:11 AM PDT by Always Right
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To: Your Nightmare
What The FairTax Book fails to mention is that prices can only fall this sharply if companies cut wages. I asked Jorgenson about this, and he agreed. Say your salary is $100,000 a year today, but you take home $80,000 after taxes. Your company is still paying that extra $20,000. In a FairTax world, it will save that money, and be able to lower its prices accordingly, only if it can reduce your salary to $80,000. In other words, your take-home pay is the same as before. Sure, you'd get to "keep 100 percent of your paycheck," as Boortz and Linder repeatedly write, but it would be a smaller paycheck. That's kind of a big thing to leave out.

Isn't this only true if the company still pays payroll tax? If they don't pay the payroll tax anymore why would they have to cut your salary?

17 posted on 09/08/2005 5:19:34 AM PDT by raybbr
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To: Your Nightmare
Money conveniently forgets that about 5.9% of an employees paycheck (real value) goes to cover just the administration of taxes, not even the taxes that have to be paid themselves.

Real and actual wages would rise, and by a cute trick of verbiage, Money hung itself right out in the wind.

18 posted on 09/08/2005 5:20:44 AM PDT by xcamel (Deep Red, stuck in a "bleu" state.)
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To: bk1000

My 2 cents, as an employer I would be more inclined to give my employees a raise not having to send matching SS & Medicare payments to the Treasury each month, not to mention a little more profit. Still have to rethink my purchases though.


19 posted on 09/08/2005 5:24:53 AM PDT by poobear (Imagine a world of liberal silence.)
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To: Your Nightmare

I don't understand how anyone can think that the "Fair Tax" is a magic cure for federal taxes. The government is still going to take as much taxes as it does now, just through a different mechanism. Over time, there would be thousands of rules and regulations, special "luxury" taxes, special statuses for certain shoppers (low income), etc, etc. You will still need to report to the government your income statements and sales taxes paid, etc.

The *only* way to stop the rise of tax rates is for the government to stop increasing spending. A good start to doing that is to have people receive their full salary and have to write quarterly estimated payments checks directly to the government. That will bring home the true amount of taxes being paid.


20 posted on 09/08/2005 5:28:21 AM PDT by mikegi
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To: Always Right
Actually, it is a very evenhanded article which exposes the good points and the flaws of the fair tax.

As much as I like the idea of ending the IRS's rein of tyranny over John Q. Taxpayer with the adoption of a consumption tax it'll never, ever happen. There simply is NO WAY the political elite are going to give up their single greatest power over the masses. A million people could picket on Capital Hill and absolutely nothing is going to happen. Mark my words. The point is moot.

21 posted on 09/08/2005 5:33:19 AM PDT by Thermalseeker
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To: raybbr
Isn't this only true if the company still pays payroll tax? If they don't pay the payroll tax anymore why would they have to cut your salary?

They don't have to cut salary. But when fair taxers claim prices will drop 20%, they are assuming that salaries are cut. And this has been confirmed by the fair tax modeler who did their research, and Boortz acknowledged it too.

22 posted on 09/08/2005 5:34:04 AM PDT by Always Right
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To: Your Nightmare
If the feds will get the same amount of money but there will be less time and money spent getting it too them, I can't see how there won't' be savings for the overall economy.

However, I also don't understand the claim that prices won't rise. I thought the idea was people could afford the price increase because the feds wouldn't be withoholding their salary and would be giving them "prebates".

23 posted on 09/08/2005 5:35:38 AM PDT by Tribune7
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To: poobear
My 2 cents, as an employer I would be more inclined to give my employees a raise not having to send matching SS & Medicare payments to the Treasury each month, not to mention a little more profit. Still have to rethink my purchases though.

That's fine, but the point being made by the article is that you can not decrease your prices by 20% like the fair taxers claim unless employers can cut wages.

24 posted on 09/08/2005 5:36:07 AM PDT by Always Right
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To: Tribune7
However, I also don't understand the claim that prices won't rise. I thought the idea was people could afford the price increase because the feds wouldn't be withoholding their salary and would be giving them "prebates".

And that is the point being made. BOTH can not happen. Take home pay can not rise 25% at the same time price fall 22%. But that has been the story fair taxers have been telling.

25 posted on 09/08/2005 5:38:13 AM PDT by Always Right
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To: Always Right

No doubt. I would probably increase my prices, need to anyway. ;D!


26 posted on 09/08/2005 5:42:35 AM PDT by poobear (Imagine a world of liberal silence.)
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To: Your Nightmare

Perhaps an employee's gross paycheck would be smaller, but take home pay should remain about the same. A company has to pay matching funds and a staff to deduct and pay the taxes.

As far as the government still taking in as much in taxes, this may be the case, but it would then be our choice directly, and not only through elected representation. We could then have more than one way to show our disapproval of the use of tax dollars. When money is spent wrongly, we stop buying....


27 posted on 09/08/2005 5:45:28 AM PDT by Mikmur
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To: Your Nightmare

My car price has a lot of things in it when it comes from the manufacturer: materials, advertising, labor at x+1, company infrastructure, company fed/state/local taxes, and probably a few things in other categories that I've forgotten.

The labor cost has to be at level X+1 instead of at level X because I need a certain level of "take home pay" after my individual taxes are deducted and mailed to the fed/state/local gov'ts.

As you can see, the company has it's own taxes to pay and one could suppose that it pays me at X+1 level because of the taxes I pay.

Actually, it pays me at X+1 level because that's what they're willing to pay in the market for my labor. Also, that's what I'm willing to do that work at for that company.

There is no rule that says I have to back off my pay level demands just because I no longer pay income taxes. After all, my sales taxes just went up. I'd be foolish to back off my pay level demands.


28 posted on 09/08/2005 5:48:47 AM PDT by xzins (Retired Army Chaplain and Proud of It!)
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To: Always Right
But when fair taxers claim prices will drop 20%, they are assuming that salaries are cut.

I am in no way naive enough to think that if companies get a tax break that they will pass that on to the consumer.

In this current corporate world of "I'm going to take what I can" I don't ever expect the corporate weenies to say, "Oh gee. Our cost of doing business just dropped 20%. Let's drop prices." And, "Since our cost of doing business went down let's not cut wage because we really want to pass that gain along to our employees."

29 posted on 09/08/2005 5:53:34 AM PDT by raybbr
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To: Mikmur
We could then have more than one way to show our disapproval of the use of tax dollars. When money is spent wrongly, we stop buying....

I have a feeling that unless local and state taxes are reformed as well, those officials will use the loss of revenue (to them) as an excuse to raise taxes.

30 posted on 09/08/2005 5:56:13 AM PDT by raybbr
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To: MNJohnnie

This goes to the heart of what I've been trying to get an answer to since the book came out.

If I gross $ 1,000 per week, I presently take home about $ 750. My employer is required to pay what was withheld from my check ( $ 250 ) PLUS additional taxes of almost $ 80 to the government. If FAIR tax gets enacted, will I be paid:
a. $ 1,000
b. $ 750
c. $ 1,080

I just want an answer to that one question.


31 posted on 09/08/2005 5:57:55 AM PDT by GadareneDemoniac
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To: Prov1322
I didn't here a thing...
LOL! My bad. I was feeding my daughter when I wrote it.
32 posted on 09/08/2005 6:03:12 AM PDT by Your Nightmare
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To: GadareneDemoniac
will I be paid: a. $ 1,000 b. $ 750 c. $ 1,080 I just want an answer to that one question.

The answer is

d. What you are willing to work for.

33 posted on 09/08/2005 6:11:00 AM PDT by Tribune7
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To: whomever

Have any of you read the full, so called, fairtax plan?

I debated the plan on another website a few months ago. ANYone making under 200k would take it up the A$$.
You would pay an extra 23% on all goods and services. That means EVERYTHING! Food, elec.bill, doctors, plumber, attorney fees,the kid that mows your lawn, nothing would be excluded. The people that get screwed the worst are the retired elderly, those that make out better are homeless people and those making 200k or more.

I think the full plan can be viewed at fairtax.org.


34 posted on 09/08/2005 6:13:54 AM PDT by Beagle8U
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To: MNJohnnie; Red Badger; ovrtaxt; raybbr; xcamel; xzins; All
The claims made by the Americans for Fair Taxation and the FairTax supporters about a significant price drop are based exclusively on the research of Dr. Dale Jorgenson of Harvard. Dr. Jorgenson is the one who is contradicting the claims made about the FairTax, not Money or CNN. They are just reporting it.

Here's an explaination of how Boortz and the FairTax supporters misled people into thinking there would be a huge windfall from going to the FairTax. When studying the transition to a sales tax, economists assume that there will be one of two outcomes. They are:

In his study, Dr. Jorgenson made Assumption 2 - that take-home pay and consumer prices stay the same. This is not wrong, it is just one of the possible outcomes. What was wrong was how this was presented by Boortz and the FairTax supporters. They took the assumption that take-home pay would increase (from Assumption 1) and paired it with the assumption that consumer prices will stay the same (from Assumption 2). They mixed the best of both worlds and came up with a windfall, that take-home pay would increase while consumer prices stayed the same, that could not possibly happen. Much of the purported benefits of the FairTax come from this erroneous assumption made by Boortz and the FairTax supporters.

While Dr. Jorgenson's use of Assumption 2 was not wrong, most economists believe that, because wages are difficult to lower (economists call this "sticky wages"), Assumption 1 is the most likely outcome from a transition to a sales tax.

Below is a compilation of quotes from various economists (including, ironically, the authors of the FairTax bill) that explain these assumptions in greater detail:


Consumption Taxes: Macroeconomic Effects and Policy Issues

by C. Alan Garner
Federal Reserve Bank of Kansas City
in Economic Review - Second Quarter 2005

Wages and prices. Replacing the income tax with a flat tax poses smaller challenges for wage and price adjustment than either a national sales tax or a VAT. Because the structure of the flat tax is similar to the current income tax, large adjustments in consumer prices or wages would probably not be necessary After-tax and before-tax wages would be similar before and after the tax reform, and nominal prices would be roughly unchanged (Zodrow 2002).

A national sales tax or a VAT, in contrast, would require the average price of consumer goods and services to rise relative to production costs and wages.15 A national retail sales tax is the simplest case to understand because the tax is imposed entirely at the retail level. Consumers would pay a substantially higher price for goods and services after adding in sales taxes at a rate that could easily be 30 percent or higher. Because wages are a large fraction of production costs, the price paid by consumers would increase relative to the wage rate received by workers. However, in the case of a revenue-neutral tax reform, the decline in the income-related taxes paid by households would offset the rise in consumption taxes, leaving households with the means to purchase the higher-priced goods and services. Under a VAT, consumer prices would increase relative to wages because of taxes imposed at various stages in the production process rather than just the final retail sale.

An important question from the standpoint of short-run macroeconomic adjustment is how the increase in consumer prices relative to wages occurs. One possibility is that the after-tax consumer price level would rise by the full amount of the consumption tax while wages remain constant. Another possibility is the after-tax consumer price level would be constant while wages decrease. Most discussions of transitional tax-reform issues assume the first case.16 When a VAT has been introduced abroad, authorities typically permitted an upward adjustment in the after-tax consumer price level, although efforts were generally undertaken to ensure that this one-time adjustment did nor become a sustained inflationary process (Tait).

Alternatively, the necessary increase in consumer prices relative to wages could be accomplished by holding the price level constant and reducing the wage level. Many economist, however, believe that wages are "sticky" in the downward direction. Workers are reluctant to take a wage cut, and efforts to reduce the wage rate might cause many workers to leave their jobs. The result could be a large temporary increase in the unemployment rate and lower levels of spending and output. Gravelle cites simulations with large-scale econometric models that do not assume the economy always operates at full employment. In three of the four simulations cited, real output decreased initially in response to fundamental tax reform. Although other economists have criticized such models and might not accept their conclusions, the simulations emphasize the need for further research on the short-run employment and output effects of fundamental tax reform.

Moreover, replacing all federal income taxes with a national sales tax or VAT would require much larger price and wage adjustments than other countries experienced when adopting VATs. Foreign VAT rates have typically been no more than 10 percent because the countries kept other revenue sources, such as an income tax. In most cases, the country also eliminated other consumption-type taxes, which offset some of the upward price-level pressures. Thus, the price adjustments required by fundamental U.S. tax reform would be outside the range of historical experience.

  1. This discussion focuses on fundamental tax reform in which a national sales tax or VAT replaces all federal income and payroll taxes. The adjustment issues would be smaller if a low consumption-tax rate were enacted to replace a small part of the current tax system or to supplement existing revenue sources.
  2. The increase in consumer prices could account for part of the decline in the real value of existing assets during the transition to a consumption tax. Nominal assets such as bonds and bank accounts would lose real value as the price level rose. With no increase in consumer prices, the decline in the real value of existing assets would occur through other channels. For example, the decrease in wealth would fall on equity owners as corporations lost expected depreciation allowances and the prices of tax-free investment goods declined relative to taxable consumer goods and services (Zodrow 2002). In practice, the increase in the price of consumer goods and services relative to wages could occur through a combination of consumer price increases and nominal wage decreases.

Statement of Laurence J. Kotlikoff,

Professor of Economics, Boston University, and Research Associate, National Bureau of Economic Research

Testimony Before the House Committee on Ways and Means - Hearing on Fundamental Tax Reform
April 11, 2000

This sentence and the one preceding it assume the price level will rise with the adoption of the Fair Tax. If the Federal Reserve used its monetary policy to maintain the consumer price level, the adoption of the Fair Tax would entail a decline in the level of producer prices and, thus, the nominal wages and capital income received by productive factors.

Response to William Gale

by Dan Mastromarco and David Burton
[authors of the FairTax]
Memorandum, March 16, 1998

Federal income and payroll taxes either are or are not incorporated into the prices of goods and services. If they are embedded in prices, their removal will reduce prices. If they are not, then their removal will not reduce prices but instead returns to labor and capital will go up. If returns to labor go up, people will see their after-tax wages increase and asset values will increase since the present discounted value of the new, higher returns will be higher.

The replacement sales tax could be incident on the factors of production or it could be incident on consumers through higher prices. It cannot be both. If it is incident on the factors of production, then wages and the return to capital will fall but sales tax inclusive prices will not be any higher, on average, than they are today. If the sales tax is fully incident on consumers, then prices will increase by the amount of the sales tax but returns to labor and capital will be higher.

Criticism of the Sales Tax for Residential Real Estate Isn't Built on a Solid Foundation

by Dan R. Mastromarco and David R. Burton
[authors of the FairTax]
Tax Notes, June 29, 1998, p. 1779

Footnote #13: The degree to which after-tax wages will increase is a function of the incidence of both the sales tax and the repealed taxes. If the income tax and payroll taxes are incident on income recipients and the sales tax is incident on consumers, then after-tax wages and returns will go up quite considerably as will tax inclusive prices. If the sales tax is incident on the factors of production, then after-tax wages and the after-tax return to capital will not go up to any considerable degree (at first) but producer prices will fall and retail prices, even including the sales tax, will remain roughly comparable. The real purchasing power of wages will undoubtedly increase considerably over time because of a larger capital stock (increasing productivity), microeconomic efficiencies caused by a more efficient allocation of scarce resources, and higher productivity from lower compliance costs.

The Price Level

Switching to an indirect tax such as a valued-added tax (VAT) or national sales tax will probably cause a one-time jump in the price level, with no permanent change in the inflation rate. By contrast, any consumption-based tax that levies taxes directly on households will probably have little or no effect on the price level.

A VAT or sales tax is likely to boost the price level because each one collects the tax on labor income from the firm or retailer. That treatment represents a change from the current income tax system, which collects tax on labor income directly from the worker. Because the cost of labor to the firm would include the new tax, real compensation paid to workers would initially have to fall to match the value of their so-called "marginal product" and keep them fully employed.

Real compensation can fall in two ways: nominal compensation can drop or the price level can rise. What happens will ultimately depend on the Federal Reserve. If it fixes the price level, nominal compensation will have to fall--an event that workers might accept because they would no longer have to pay income tax and hence would take home about the same pay as now. Most analysts note, however, that workers have resisted cuts in nominal compensation in the past. Those analysts expect that firms fearing morale problems or facing union contracts will hesitate to make such cuts. In that case, nominal compensation may fall slowly to its new level, leading to higher unemployment rates in the interim. To prevent that outcome, the Federal Reserve is expected to allow the price level to rise. For example, a VAT or sales tax of 10 percent would lead to a one-time jump of 10 percent in the price of consumer products.

Further price increases may ensue if compensation is indexed to inflation. In that case, the price rise will cause a corresponding rise in compensation, and real compensation will not drop enough to maintain full employment, requiring a further price rise--that is, a wage-price spiral. That problem occurred in the United Kingdom when it adopted a VAT in 1979, although the extent of indexing there was greater than it is in the United States.

Source: U.S. Congressional Budget Office. (1997). The Economic Effects of Comprehensive Tax Reform. Washington DC: Government Printing Office.
Setting aside for a moment temporary inflexibilites in contracts for wages, bonds, and so forth (we address these later), whether ther overall level of prices changes or not does not materially affect this story.16 Even if prices do not rise at all, moving to a consumption tax would cause the purchasing power of both wages and existing wealth to decline by an average of 20 percent relative to a situation with no taxes. Nominal wages would be forced down because firms would be earning 20 percent less, after taxes, from the output produced by workers. The nominal value of existing capital assets - in the form of, for example, share prices - which constitute much of old wealth, would also decline because the output they produce provides 20 percent less in after-tax revenues.
  1. Whether in fact consumer prices would rise in the event of tax reform depends on the monetary policy set by the Federal Reserve Board.

Source: Slemrod, Joel and Jon Bakija, Taxing Ourselves: A Citizen's Guide to the Great Debate over Tax Reform, MIT Press: Cambridge, 2004.

Transition Costs and Macroeconomic Adjustments

One of the most difficult issues to address in considering a shift to consumption taxes is the transition from the current system to the new tax regime.5 While all shifts to a consumption tax cause some common transitional disturbances and windfall gains and losses, the most serious problems arise from a shift to a national retail sales tax or to a value added tax. In these cases, a tax formerly largely collected from individuals is now collected at the firm level -- either from retailers on total sales or from both final and intermediate producers' value added. Flat taxes avoid this problem but can result in confiscatory taxes on existing assets.

Price Accommodation and Short-run Contractions Under a Retail Sales Tax or VAT

Holding prices fixed, these firms would need to reduce payments to workers to retain profit levels. In fact, many firms would not have enough of a profit margin to pay the tax without something else -- either prices or wages -- adjusting. Consider, for example, a grocery retailer that may have a 1% or 2% profit margin now owing a tax equal to 20% of receipts. This firm simply does not have the cash to pay the tax. If it is difficult to lower wages (and presumably it would be), a significant one-time price inflation, to allow these costs to be passed forward in prices instead, would be required to avoid a potentially serious economic contraction. Note that the price increase, were it possible to implement correctly and precisely, would solve the transition problem because although prices would rise, individuals would have more income to purchase the higher priced goods -- and demand would not fall. It is difficult, however, for the monetary authorities to engineer such a large price change. Moreover, even with the monetary expansion in place to do so, the imposition of such a tax would be disruptive if firms are reluctant to immediately raise prices, again leading to an economic contraction. That is, firms could contract their business, or even close down, until output had contracted enough to raise prices.

These disruptions are not minor in nature -- imagine the difficulties of engineering and absorbing a one-time price increase that is likely to be close to 20% (the level, approximately, that might realistically be needed to replace the income tax).6 Even if such an inflation could be managed, there are always concerns that any large inflation could create inflationary expectations -- it's hard to manage a single one-year price increase. In fact, economists who judge a consumption tax to be superior to an income tax may nevertheless be skeptical about the advisability of making the change because of these transition effects.

  1. See CRS Report 98-901, Short-Run Macroeconomic Effects of Fundamental Tax Reform, by Jane G. Gravelle and G. Thomas Woodward for a more detailed discussion of these issues.
  2. The rate would depend on whether and the extent of any family exemption. A 20% tax exclusive rate would correspond to a tax inclusive rate between 16% and 17%.
  3. 7 U.S. Congress, Joint Committee on Taxation, Tax Modeling Project and 1997 Symposium Papers, committee print, 105th Cong., 1st sess., Nov. 20, 1997, JCS-21-97 (Washington: GPO, 1997), p. 24.
Source: CRS Report for Congress: The Flat Tax, Value-Added Tax, and National Retail Sales Tax: Overview of the Issues. Esenwein, Gregg A. and Jane Gravelle.

Prices.

Prices for consumer goods and services quickly rise by the amount of the tax, and then some. The portion of the price increase in excess of the tax is due in part to the higher cost of imports (from the weaker dollar) coupled with the ability of some domestic producers of competing goods to hike their price to that of imports. Consumer prices similarly rise 25 percent -- roughly the nominal rate of sales tax, unadjusted for any exemptions or transition rules -- by 2002 and gradually drop from that peak to a level that remains about 18 percent above the pre-change baseline.

Examined on a year-over-year basis, these price increases generally amount to a large, one-time hike in prices as the NRST is imposed, with some moderation of this increase in the longer run. Due to a weaker dollar, merchandise import prices increase by nearly 4 percent shortly after the NRST is imposed and are 6.5 percent over baseline levels in 2010. Merchandise export prices are also above baseline levels. In 2001 and 2002 they are nearly 3 percent above the baseline. However, due to lower interest rates, which reduce business costs, export prices are only slightly greater than baseline levels for most of the remainder of the forecast period. The overall impact on prices is measured by the change in the GDP deflator, which initially rises 20 percent above the baseline price level before settling back to a 13 percent price rise relative to the baseline.

The notion espoused by some that pre-tax prices would drop some 20-30 percent under a NRST (so that after-tax prices would not rise and may even decline) is a peculiar one. This could only happen if all of the personal income tax, the corporation income tax and payroll taxes are currently embodied in retail prices. Tax incidence -- that is, who actually bears the ultimate tax burden -- is an elusive question that has been the focus of many economic papers, because the answer is not clear. However, the general consensus among economists is that perhaps a portion of the corporate income tax may be passed on to consumers in the form of higher prices, but that the majority is ultimately paid by corporate owners in the form of lower after-tax profits and by employees in the form of lower compensation. Most economists concede that personal income taxes and payroll taxes are ultimately borne by labor and are not passed on to consumers in the form of higher prices.

Source: Statement of John G. Wilkins, Managing Director, Barcroft Consulting Group, on behalf of National Retail Federation. Testimony Before the House Committee on Ways and Means. Hearing on Fundamental Tax Reform. April 11, 2000.

Transitional Issues in Tax Reform

Price Level Effects

Because the flat tax is similar in structure to the existing income tax system, its implementation would have relatively little effect on the absolute price level. Both before- and after-tax wages would be roughly similar before and after reform, so that nominal prices remain roughly constant.

In contrast, the effect of implementing an NRST on the absolute price level is less certain. One possibility is that the tax could be fully shifted forward in the form of higher prices for consumption goods, with no change in the price of investment goods, which are untaxed under the NRST. At the other end of the spectrum of possible responses, nominal prices could remain constant. Under this scenario, before-tax real wages would have to fall roughly to the level of prereform after-tax real wages in response to the elimination of the income tax. Intermediate responses between the "full price adjustment" and "no price adjustment" scenarios are of course also possible.

Choosing between these various scenarios requires making necessarily speculative assumptions about the response of the monetary authorities to the imposition of the NRST. However, most analysts assume that the monetary response would be sufficiently accommodating that the full price adjustment scenario would obtain.

The primary rationale underlying this assumption is the view that the downward flexibility of nominal wages is quite limited, in part because most wage contracts and agreements are specified in nominal terms. Thus, a tax reform that required wage reductions to reach a new equilibrium would be quite costly as these wage reductions would initially be distributed unevenly across industries. This in turn might result in considerable unemployment in sectors characterized by rigid wages, as well as misallocations of labor, at least in the short run. Proponents of the full price adjustment view assume that monetary policy would be expansionary to avoid these costs.

Most observers fall into the full price adjustment camp. For example, McLure (1996, p. 23) concludes that it would be "hard to imagine the monetary authorities not accommodating such an increase in prices." Gravelle (1995, p. 59) argues that full price adjustment is likely because a "national sales tax would tend to produce an economic contraction if no price accommodation is made." In its analysis of the distributional implications of implementing consumption taxes, the Joint Committee of Taxation (1993, p. 59) concludes that, "Unless there are convincing reasons to assume otherwise, the JCT staff assumes the Federal Reserve will accommodate the policy change and allow prices to rise." Finally, Bradford (1996a, p. 135), in discussing the same issue in the context of a value-added tax, observes that, "It is commonly believed that introducing a value-added tax of the consumption type will bring with it a monetary policy adjustment that would result in a one-time increase in the price level ;and no change in payments to workers in nominal terms."

Nevertheless, opinion on this issue is certainly no unanimous. For example, the alternative assumption [that wages will fall] is implicitly made by Jorgenson and Wilcoxen, who argue that implementing a national sales tax would reduce producer prices on average by 25 percent. Auerbach (1996) takes a compromise position by assuming partial price adjustment. In addition, European experience with the introduction of the VAT is mixed, generally suggesting partial price adjustment. On the other hand, Besley and Rosen (1999) find full (or even more than 100 percent) forward shifting of state sales taxes in the United States.

Source: Zodrow, George R. (2002). "Transitional Issues in Tax Reform." In United States Tax Reform in the 21st Century, George Zodrow and Peter Mieszkowski, Editors. Cambridge University Press.

Monetary Implications of Tax Reforms

Does it matter how the central bank responds when the tax system is reformed? Some economists would argue that in a very general sense it does not. Many would argue that the central bank's response would have little long-run effect, because what really matters is the productive capacity of the economy and because there could be no money illusion in the long run.

And, in the short run, the standard relation between prices and money makes it clear that, under limiting assumptions, the central bank need not change monetary policy. Consider the transition from our present tax system to a consumption tax. Ignoring any incentive effects caused by the tax reform, velocity and output are unchanged. With a revenue-neutral tax reform, aggregate after-tax income is unchanged, so there need be no demand-driven effects on consumer prices. Under these conditions, v, y, and q remain unchanged as a result of the tax reform, and thus maintenance of the status quo implies that the central bank need not change its policy. Assuming that output is constant, the central bank could eliminate any transitory price changes in the long run by leaving monetary policy unchanged.

But things may not be that simple. The implied changes to wages and producer prices require a degree of flexibility in the economy that many might find unlikely. Specifically, for the consumer price to stay constant, the producer price must fall by the amount of the tax. And because a drop in the producer price means that the business revenue produced by hiring another worker drops, the before-tax wage must drop by a corresponding amount. Many have argued that such price and wage changes are implausible and that the central bank should "accommodate" a transitory change in the consumer price level by adjusting monetary policy so that it is consistent with constant producer prices and wages.

Source: Bull, Nicholas, and Lawrence B. Lindsey. 1996. "Monetary Implications of Tax Reforms." National Tax Journal 49.3 (September): 359-79.

The Price Level

When Britain adopted consumption taxation in 1979, the price level rose by the amount of the new tax. This jump in prices caused substantial disruption in the economy, partly because it stimulated further rounds of wage and price increases through indexation formulas that failed to exclude consumption taxes from the measured cost of living. Standard macroeconomic analysis suggests that the underlying cause of such a price effect is the contractual determination of wages in money terms. Under an income tax, the wage is set in pretax terms. Workers finance consumption out of what remains of their wages after paying taxes. Under a sales tax or a value-added tax (VAT), the wage is set on an after-tax basis. Workers use their entire wages for consumption and pay their consumption taxes as they consume. When an income tax is replaced by a sales tax or VAT, the wage bargain should be revised to lower the purchasing power of wages or by raising the prices of consumption goods. As a practical matter, the second always occurs.

One of the advantages of a flat tax or a personal cash-flow consumption tax is that both leave the wage bargain in pretax form. There is no disruptive jump in the price level. Unlike other effects I have discussed, the increase in the price level is not intrinsic to a consumption tax, but is the result of a particular choice about how to administer the tax.

Source: Potential Disruption from the Move to a Consumption Tax, by Robert E. Hall. The American Economic Review.

35 posted on 09/08/2005 6:14:01 AM PDT by Your Nightmare
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To: GadareneDemoniac
If I gross $ 1,000 per week, I presently take home about $ 750. My employer is required to pay what was withheld from my check ( $ 250 ) PLUS additional taxes of almost $ 80 to the government. If FAIR tax gets enacted, will I be paid: a. $ 1,000 b. $ 750 c. $ 1,080 I just want an answer to that one question.

You'll have to ask your employer. The model Jorgensen used assumed (for simplicity, most likely) that the take-home pay would remain constant, and the former taxes would be kept by the employer. Again, this was for modelling simplicity -- it does not require that this happen in reality.

It is very unlikely to happen, actually, as it would require mass violations of existing employment contracts/agreements. If my gross salary is contracted at $50,000 (before taxes), then my employer would be violating our contract if he only gave me the $38,000 or so I'm currently getting as "take-home" pay.

36 posted on 09/08/2005 6:14:02 AM PDT by kevkrom ("Political looters" should be shot on sight)
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To: Minnesoootan
So if my Fed taxes go up,that means my hourly wage MUST go up?
No, and I don't understand why you are asking.
37 posted on 09/08/2005 6:15:59 AM PDT by Your Nightmare
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To: MNJohnnie
They would NOT have to cut wages at all. Since the money collected to pay taxes is money ON TOP of the money they all ready pay in production costs, their would be NO net increase in price of PRODUCTION.
The amount of business income and employer payroll taxes paid by business are nowhere near enough to reduce price the amount claimed by Boortz. The level of price drop can only happen if wages are cut (which can't happen).
38 posted on 09/08/2005 6:19:17 AM PDT by Your Nightmare
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To: MNJohnnie
OUCH. Better put some ice on that Nightmare, this one is going to leave a mark.
???
39 posted on 09/08/2005 6:19:50 AM PDT by Your Nightmare
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To: GadareneDemoniac
I just want an answer to that one question.

You would get to take home $1000, but prices would go up 20% or more. The point being, when the fair taxers did their economic modeling, they ASSUMED you would take a pay cut to $750. Therefore, their claims are misleading.

40 posted on 09/08/2005 6:20:16 AM PDT by Always Right
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To: Beagle8U
Have any of you read the full, so called, fairtax plan? I debated the plan on another website a few months ago. ANYone making under 200k would take it up the A$$.

It's obvious that you have either failed to read, or comprehend, the plan. Because of the "prebate" (FCA), the NRST would actually be progressive based on spending (not income) -- retail spending at the poverty line would yield and effective tax rate of 0%, twice the poverty line would yield an effective rate of the NRST rate times one-half, etc., according to the formula:

Where:
41 posted on 09/08/2005 6:21:17 AM PDT by kevkrom ("Political looters" should be shot on sight)
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To: kevkrom
They have an agenda that doesn't include the Fair Tax.
So does the original poster. His posting history shows nothing but FairTax-bashing.
My agenda includes the Flat Tax. It's a workable consumption tax that isn't being promoted with lies.
42 posted on 09/08/2005 6:23:20 AM PDT by Your Nightmare
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To: Your Nightmare
My agenda includes the Flat Tax. It's a workable consumption tax that isn't being promoted with lies.

You mean, other than trying to sell an income tax (including retaining the VAT-like effects of corporate income taxation) as a "workable consumption tax"?

43 posted on 09/08/2005 6:30:52 AM PDT by kevkrom ("Political looters" should be shot on sight)
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To: Your Nightmare

Part of the price of doing business might be some federal taxes. These particular costs would go away under the NRST since the sales tax would be on the end consumer and not on the producers.....as I understand it.

This would lower prices a bit, but if one is going to say prices will fall because the labor cost will fall due to having not to pay the higher wage the income tax requires, then it is only fair to say that the worker's wage will fall. You can't take it away and let it stay at the same time.

Nonetheless, I still like the idea of getting the IRS out of individual's lives, I like the idea of getting rid of the mountains of tax code that can be used to criminalize anyone, and I agree that the huge service industry built around the income tax is an unnecessary drain on resources.


44 posted on 09/08/2005 6:34:54 AM PDT by xzins (Retired Army Chaplain and Proud of It!)
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To: kevkrom

The "so called" poverty level is what screws up the math on how it effects everyone.

My Mother is 80 yrs. old, gets about 18k in SS and a small retirement. She pays zero in taxes now, but it takes every dime of her 18k just to scrape by now. After the pre-bate is figured in, she would be taxed 23% on aprox 6k. thats money she dont have.

Also; anyone that has saved some of their "aftertax" money now, would get to pay taxs AGAIN when they spend it.


45 posted on 09/08/2005 6:35:23 AM PDT by Beagle8U
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To: Beagle8U
Also; anyone that has saved some of their "aftertax" money now, would get to pay taxs AGAIN when they spend it.

The fairtax has its winners and losers, and retirees fall in the loser category on this one. That maybe the toughest sale of all for the fairtax.

46 posted on 09/08/2005 6:39:55 AM PDT by Always Right
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To: Your Nightmare
My comment on all this: Economists are not employers. They are monetary navel gazers, and most always wrong.
47 posted on 09/08/2005 6:45:18 AM PDT by xcamel (Deep Red, stuck in a "bleu" state.)
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To: mikegi
The *only* way to stop the rise of tax rates is for the government to stop increasing spending. A good start to doing that is to have people receive their full salary and have to write quarterly estimated payments checks directly to the government.

Better yet would be to have them put their annual tax check in a drop box... located right in front of the voting booth.

48 posted on 09/08/2005 6:51:51 AM PDT by steve-b (A desire not to butt into other people's business is eighty percent of all human wisdom)
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To: raybbr
I don't ever expect the corporate weenies to say, "Oh gee. Our cost of doing business just dropped 20%. Let's drop prices."

Ever hear of a concept known as "competition"?

49 posted on 09/08/2005 6:53:21 AM PDT by steve-b (A desire not to butt into other people's business is eighty percent of all human wisdom)
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To: MNJohnnie
forcibly removed from the WAGE EARNERS paychecks

Yes, and therein lies the rub. All of the tax accountant and lawyer sympathizers conveniently ignore this little tid bit of freedom. Although I don't buy into the lower wages mantra, I would gladly take a pay cut to exercise the freedom of voluntary taxes.

50 posted on 09/08/2005 6:53:39 AM PDT by numberonepal (Don't Even Think About Treading On Me)
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