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Would the FairTax Raise or Lower Marginal and Average Tax Rates
National Bureau of Economic Research ^ | December 2005 | Laurence J. Kotlikoff

Posted on 12/16/2005 2:20:48 PM PST by ancient_geezer

Would the FairTax Raise or Lower Marginal and Average Tax Rates

  Laurence J. Kotlikoff, David Rapson

NBER Working Paper No. 11831
Issued in December 2005
NBER Program(s):   PE

---- Abstract -----

This paper compares marginal and average tax rates on working and saving under our current federal tax system with those that would arise under a federal retail sales tax, specifically the FairTax. The FairTax would replace the personal income, corporate income, payroll, and estate and gift taxes with a 23 percent effective retail sales tax plus a progressive rebate. The 23 percent rate generates more revenue than the taxes it replaces, but the rebate’s cost necessitates scaling back non-Social Security expenditures to their 2000 share of GDP. The FairTax’s effective marginal tax on labor supply is 23 percent. Its effective marginal tax on saving is zero. In contrast, for the stylized working households considered here, current effective marginal labor taxes are higher or much higher than 23 percent. Take our stylized 45 year-old, married couple earning $35,000 per year with two children. Given their federal tax bracket, the claw-back of the Earned Income Tax Credit, and the FICA tax, their marginal tax is 47.6 percent. The FairTax imposes a zero marginal tax on saving meaning that reducing this year’s consumption by a dollar permits one to increase the present value of future consumption by a dollar. In contrast, the existing federal tax system imposes very high marginal taxes on future consumption. For our stylized working households foregoing a dollar’s consumption this year to uniformly raise consumption in all future years raises the present value of future consumption by only 45.8 to 77.4 cents, i.e., the effective marginal tax rates on uniformly raising future consumption via saving facing our households ranges from 22.6 percent to 54.2 percent. The FairTax also reduces most of our stylized households’ remaining average lifetime tax rates ? and, often, by a lot. Consider our stylized 30 year-old, single household earning $50,000. The household’s average remaining lifetime tax rate under the current system is 21.1 percent. It’s 16.2 percent under the FairTax.



TOPICS: Business/Economy; Government
KEYWORDS: dontdrinkthekoolaid; fairtaxisnt; onlyflattaxisfairtax; taxes; taxreform
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Looks like a new economic report specifically about the FairTax legislation has been published.
1 posted on 12/16/2005 2:20:51 PM PST by ancient_geezer
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To: Taxman; pigdog; Principled; EternalVigilance; rwrcpa1; phil_will1; kevkrom; n-tres-ted; Zon; ...
A Taxreform bump for you all.

If anyone would like to be added to this ping list let me know.

John Linder in the House(HR25) & Saxby Chambliss Senate(S25) offer a comprehensive bill to kill all income and SS/Medicare payroll taxes outright and replace them with with a national retail sales tax administered by the states.

H.R.25,S.25
A bill to promote freedom, fairness, and economic opportunity by repealing the income tax and other taxes, abolishing the Internal Revenue Service, and enacting a national retail sales tax to be administered primarily by the States.

Refer for additional information:


2 posted on 12/16/2005 2:21:27 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: ancient_geezer
The FairTax’s effective marginal tax on labor supply is 23 percent.

Oh. The Fair Taxers won't like this! Someone is admitting that the FairTax is effectively a 23% income tax! This is because a sales tax and and income tax can be structured to be "economically equivalent".

3 posted on 12/16/2005 2:25:16 PM PST by SolidSupplySide
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To: SolidSupplySide
Someone is admitting that the FairTax is effectively a 23% income tax!

23% of GDP is a whole lot of money!

4 posted on 12/16/2005 2:28:01 PM PST by SolidSupplySide
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To: SolidSupplySide

This is because a sales tax and and income tax can be structured to be "economically equivalent".

Ahmmm, "economically equivalent" just means they bring in the same amount of revenue to the govenment.

Any tax system can be made economically equivalent to any other tax. It just needs to be designed to be revenue neutral.

5 posted on 12/16/2005 2:29:52 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: ancient_geezer
Ahmmm, "economically equivalent" just means they bring in the same amount of revenue to the govenment.

This is false. "Revenue neutral" means bringing in the same amount of revenue to the government. "Economically equivalent" means they impact the economy in the same exact way.

Any tax system can be made economically equivalent to any other tax. It just needs to be designed to be revenue neutral.

I suppose any kind of tax can be "revenue neutral". A city can reduce property tax and raise sales tax so that there is no change in revenue. But there will be economic effects of reducing property tax and raising the sales tax. Property ownership becomes more desirable. Economic activity becomes less desirable. Our "revenue neutral" changes in property tax and sales tax are not "economically equivalent".

6 posted on 12/16/2005 2:34:14 PM PST by SolidSupplySide
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To: SolidSupplySide
Is that supposed to have been a surprise? If I make $1 and spend $1 more under the FairTax, I pay 23% of that to the feds. If I decide to save it, the feds get nothing now.

On the other hand if I make $1 more now I pay $0.3265 more to the feds, plus my employer pays another $0.0765 for a total tax rate of 40.3% whether I spend or invest it.

7 posted on 12/16/2005 2:35:58 PM PST by KarlInOhio (In memory of Alvin Owen, Thsai-Shai Yang, Yen-I Yang and Yee Chen Lin:the victims of Tookie Williams)
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To: ancient_geezer
What happens to the present sales taxes we pay on purchases imposed by cities and counties?
8 posted on 12/16/2005 2:38:08 PM PST by Recon Dad (Force Recon Dad (and proud of it))
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To: SolidSupplySide

23% of GDP is a whole lot of money!

True, 23% of GDP may be a lot of money.

However neither Federal revenues, nor the FairTax is 23% of GDP. Both are lower than 23% of GDP.

A nice try as misdirection however.

9 posted on 12/16/2005 2:38:55 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: SolidSupplySide

"Revenue neutral" means bringing in the same amount of revenue to the government.

It means bring in the same amount of money to government as the tax law it replaces would.

If government gets the same amount of money as it would under the tax law it replaced, the economy gets the same as it would as well. That is revenue neutral and economically equivalent.

10 posted on 12/16/2005 2:45:28 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: ancient_geezer
However neither Federal revenues, nor the FairTax is 23% of GDP.

This is true. In recent years, federal revenues have be 21% of GDP.

See table 4

This is the amount that the FairTax is intended to generate. It is a little less than the 23% rate due to the quirky rebate scheme. (The rebate scheme serves no economic purpose. It exists only to make the rate progressive.)

Notice that in recent years that the federal share of GDP has decreased. That is the result of the Bush tax cuts. We are getting more revenue on a lower percentage because the economy has grown. FairTax proponents have not adjusted their claim to 21% of GDP. In effect, the adoption of the FairTax would be a tax increase over today's rates.

11 posted on 12/16/2005 2:50:54 PM PST by SolidSupplySide
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To: Recon Dad

Well...of course that would stay...as would some part of our income tax as well. Any money saved by disbanding the IRS would of course not be passed along to us in savings. Instead it will be spent by politicians to benefit the greater good. Of course the rate would need to increase over time. At least it would finally provide a way for our government to finally tax frequent flier miles.


12 posted on 12/16/2005 2:51:32 PM PST by willyd (No nation has ever taxed its citizens into prosperity)
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To: Recon Dad

What happens to the present sales taxes we pay on purchases imposed by cities and counties?

The FairTax legislation is a replacement for federal income and payroll taxes. As federal law, it cannot address state or local govenment.

As far as impact, the only factor changed is when federal tax dollars are taken from you, before you can spend today, or when you spend under the FairTax.

A retail sales tax gives you the first option of using your money, save and invest without tax, or spend and pay tax.

And income tax takes the dollar before you can save or invest.

13 posted on 12/16/2005 2:52:36 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: ancient_geezer
If government gets the same amount of money as it would under the tax law it replaced, the economy gets the same as it would as well. That is revenue neutral and economically equivalent.

You seem to be caught in static analysis. You cannot see that reducing property tax and increasing sales tax will affect the decisions of economic participants.

A flat income tax and a sales tax will certainly change the behaviors of economic participants over today's income and wealth tax. But in steady state, a flat income tax and a sales tax will affect economic participants in the same exact manner. The only difference is that a sales tax has destructive consequences at transition due to the necessary increase in money supply.

14 posted on 12/16/2005 2:54:33 PM PST by SolidSupplySide
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To: SolidSupplySide

Notice that in recent years that the federal share of GDP has decreased. That is the result of the Bush tax cuts. We are getting more revenue on a lower percentage because the economy has grown. FairTax proponents have not adjusted their claim to 21% of GDP. In effect, the adoption of the FairTax would be a tax increase over today's rates.

 

As the bill stands at present, you are correct. As the true revenue neutral rate should be closer to 19% taking the Bush tax cuts into account. Howerver, since the Bush tax cuts have not been made permenant and they all expire by 2010 the bill has not been adjusted for obvious reasons.

I would suggest you get on the ball and make sure those tax cuts are made permanent. To do so will drop the FairTax rate considerably.

 

The 23% rate is based on pre-1999 tax and NIPA/GDP data when the legislation was first introduced, refer to the CATO's description of Calculating the Tax Rate.

A more current calculation based on current tax law (Bush tax cuts in effect 2003) is provided below:

 

http://www.fairtaxvolunteer.org/smart/tax_system.html

 

Table two: national FairTax rate calculation: 2003
Line Description FairTax base Source
  Taxable item Billions  
1 Personal consumption expenditures $ 7,760.9 NIPA Table 1.1.5, line 2
2 Purchases of new single-family homes $ 310.6 NIPA Table 5.3.5, line 20
3 Purchases of new mobile homes $ 7.1 NIPA Table 5.4.5B, line 40
4 Improvements to single-family homes $ 132.0 NIPA Table 5.4.5B, line 42
5 Less: imputed rent on owner-occupied housing $ 859.6 NIPA Table 7.4.5, line 3
6 Less: imputed rent on farm housing $ 11.9 NIPA Table 7.4.5, line 5
7 Additional financial intermediation services $ 83.1 Financial & risk Intermediation greater than NIPA definition
8 Foreign travel by U.S. residents $ 39.6 One half of NIPA Table 2.5.5, line 110
9 Less: expenditures abroad by U.S. residents $ 6.6 NIPA Table 2.5.5, line 111
10 Less: food produced and consumed on farms $ 0.5 NIPA Table 2.5.5, line 6
11 State and local government consumption $ 1,058.5 NIPA Table 3.10.5, line 47
12 Gross purchases of new structures $ 213.4 NIPA Table 3.9.5, line 24
13 Gross purchases of equipment $ 51.5 NIPA Table 3.9.5, line 25
14 Federal government consumption $ 658.6 NIPA Table 3.10.5, line 12
15 Gross purchases of new structures $ 15.5 NIPA Table 3.9.5, line 9
16 Gross purchases of equipment and software $ 78.1 NIPA Table 3.9.5, line 10
17 Less: state and local government sales taxes $ 343.9 NIPA Table 3.3, line 7
18 Less: government education expenditures $ 414.7 Table 255, SAOUS 2003
19 Less: private education expenditures $ 151.7 NIPA Table 2.5.5, lines 105 & 106
20 Expenditures in U.S. by non-residents $ 86.7 NIPA Table 2.5.5, lines 112
21 Travel to U.S. by non-residents $ 33.3 One half, SAOUS 2003 Table 1280
22 National retail sales tax base $ 8,740.0  
Revenues to be replaced    
23 Income tax $ 927.7 Dept. of Treasury; derived from Table B-81 ERP 2004
24 Estate and gift tax $ 22.4 Dept. of Treasury; derived from Table B-81 ERP 2004
25 Payroll taxes $ 717.8 Dept. of Treasury; derived from Table B-81 ERP 2004
26 Excise taxes $ -  
27 Total $ 1,667.9  
Revenue-neutral rate calculation    
28 Tax exclusive rate (no rebate) 19.1%  
29 Tax inclusive rate (no rebate) 15.9%  
30 Base reduction equivalent for rebate $ 1,746.1 Total consumption allowance for 109 million rebate units
31 Net tax base $ 6,993.8  
32 Tax exclusive rate (with rebate) 23.8%  
33 Tax inclusive rate (with rebate) 19.3%

15 posted on 12/16/2005 3:02:31 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: willyd

Oh, and that's when we would be offered deductions!


16 posted on 12/16/2005 3:02:47 PM PST by Recon Dad (Force Recon Dad (and proud of it))
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To: ancient_geezer
As the bill stands at present, you are correct. As the true revenue neutral rate should be closer to 19% taking the Bush tax cuts into account.

Thank you for recognizing that the FairTax is not revenue neutral. It is a tax increase.

17 posted on 12/16/2005 3:05:29 PM PST by SolidSupplySide
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To: Recon Dad

Right...it's like a shell game...give me $30 and I give you back $5...now give me that $5 and I'll give you back $2...now give me that $2 and I will give that to someone else.


18 posted on 12/16/2005 3:09:02 PM PST by willyd (No nation has ever taxed its citizens into prosperity)
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To: SolidSupplySide; ancient_geezer

GDP includes busines investment and inventories. Neither are taxed under the NRST.

http://www.colorado.edu/Economics/courses/econ2020/section6/GDP-components.html


19 posted on 12/16/2005 3:09:35 PM PST by groanup (Shred for Ian)
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To: groanup
GDP includes busines investment and inventories. Neither are taxed under the NRST.

You are misinterpreting your link. GDP only includes economic activity, not assets such as inventories. Your link clearly shows that GDP includes CHANGES IN inventory. If businesses push more inventory out the door than it receives, that is an increase in GDP, and a sales tax will capture it.

A flat income tax does not tax inventories or business investment either. That's why I said a sales tax and a flat income tax are economically equivalent.

20 posted on 12/16/2005 3:14:32 PM PST by SolidSupplySide
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To: SolidSupplySide

You seem to be caught in static analysis. You cannot see that reducing property tax and increasing sales tax will affect the decisions of economic participants.

You misread the statement my friend.

If government gets the same amount of money under one tax law as it would under another tax law, that is economically equivalent.

For a given set of conditions if both systems return the equivalent revenues, they will do so in a dynamic sense as well.

By the way, what you are overlooking is the impact of decisions made by economic participants in the choices of investing vs spending. Today we are on the path of disaster where net savings is rapidly headed for a net debt scenario, a bubble economy looking to implode.

 

Savings

 

It is time to reverse that trend.

The only difference is that a sales tax has destructive consequences at transition due to the necessary increase in money supply.

That is foolishness. Since government takes no more from the money supply under the FairTax, than it would under an equivalent "Flat Tax" or even the income/payroll tax. After all, they all are supposed to be equivalent taxes according, at least to Flat Tax authors, your presumed necessary increase in money supply has no basis. The same money is available for expenditure on goods, services and investment in both cases. No adjustment is necessary.

21 posted on 12/16/2005 3:23:13 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: SolidSupplySide
...sales tax and a flat income tax are economically equivalent.

Correct. Actually I was misinterpreting your post.

22 posted on 12/16/2005 3:24:21 PM PST by groanup (Shred for Ian)
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To: SolidSupplySide

Thank you for recognizing that the FairTax is not revenue neutral. It is a tax increase.

It is as written, and revenue neutality will require a reduction in rate during Ways & Means Committee markup. I definitely grant that. The rate to be neutral with the temporary Bush tax reforms should be around 19%.

Interestingly most opponents would disagree with you saying that the FairTax does not collect enough and the rate is too low.

Personally I recognize the rate as too high, and push for the lower rate since the legislation is to be revenue neutral by design and plan of its proponents and authors.

23 posted on 12/16/2005 3:30:12 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: ancient_geezer
If government gets the same amount of money under one tax law as it would under another tax law, that is economically equivalent.

No, if the government gets the same amount of revenue under two different tax schemes, they are REVENUE NEUTRAL.

For a given set of conditions if both systems return the equivalent revenues, they will do so in a dynamic sense as well.

Tax system 1:
0% rate on income $0-80,000
50% rate on income in excess of $80,000 Income = $100,000
Tax Revenue = $10,000

Tax system 2:
10% flat rate on income
Income = $100,000
Tax Revenue = $10,000

These two systems are revenue neutral in that they raise the same amount of revenue. But they are not economically equivalent. The worker under tax system 2 has more incentive to keep working because his next dollar of income is taxed at 10%. Under tax system 1, he would be taxed at 50%. They are revenue neutral but the dyanmics are different.

Do you see the difference between "revenue neutral" and "economically equivalent"?

A sales tax and a flat income tax (at the same rate with the same deductions) are "economically equivalent".

24 posted on 12/16/2005 3:33:29 PM PST by SolidSupplySide
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To: ancient_geezer
Interestingly most opponents would disagree with you saying that the FairTax does not collect enough and the rate is too low.

Well, I am ignoring the massive evasion a sales tax north of 10% would create. The underground economy would flourish under a sales tax that high. No jurisdiction in the world has sustained a sales tax rate more than 14-15% due to evasion. Because of the increase in the underground economy, the tax rate for a national sales tax would have to be greater than the theoretical one.

25 posted on 12/16/2005 3:37:15 PM PST by SolidSupplySide
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To: SolidSupplySide

"one tax law as it would under another tax law" = "under two different tax schemes"

I see you like to play word games.

A sales tax and a flat income tax (at the same rate with the same deductions) are "economically equivalent".

Only problem is no-one is proposing a flat income tax with the same taxbase as a retail sales tax replacing both income and payroll taxes.

No if you want to compare apples with apples and real proposals out there, I am interested in doing so. However, what I am not interested in is perpetuating the income tax in any form, whether it be flat or otherwise. We have already been there and done than and a century of experience tells us what a flat income tax becomes.

"A hand from Washington will be stretched out and placed upon every man's business; the eye of the federal inspector will be in every man's counting house....The law will of necessity have inquisical features, it will provide penalties, it will create complicated machinery. Under it men will be hauled into courts distant from their homes. Heavy fines imposed by distant and unfamiliar tribunals will constantly menace the tax payer. An army of federal inspectors, spies, and detectives will descend upon the state."
-- Virginian House Speaker Richard E. Byrd, 1910, predicting the consequences of an income tax.


26 posted on 12/16/2005 3:43:32 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: SolidSupplySide

Well, I am ignoring the massive evasion a sales tax north of 10% would create.

And ignoring the massive evasion an income/payroll tax system north of 40% does create. Once again you fail to compare apples with apples and oranges with oranges

27 posted on 12/16/2005 3:45:52 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: ancient_geezer
We have already been there and done than and a century of experience tells us what a flat income tax becomes.

There is also plenty of evidence from every single continent on what a sales tax becomes when its rate gets too high: A VAT!

28 posted on 12/16/2005 3:46:45 PM PST by SolidSupplySide
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To: ancient_geezer
And ignoring the massive evasion an income/payroll tax system north of 40% does create. Once again you fail to compare apples with apples and oranges with oranges

One of the benefits of income taxes is the cross-reporting which reduces evasion to a great degree. There is no cross-reporting in a sales tax. That's why they turn into VATs.

29 posted on 12/16/2005 3:48:21 PM PST by SolidSupplySide
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To: SolidSupplySide
23% of GDP is a whole lot of money!

Um yeah, government spends too much, we know. But given that government needs to exist and spend some amount, it needs a way to collect taxes. The income tax is a spectacularly bad way to do that; the FairTax, while not perfect, would be a substantial improvement.

30 posted on 12/16/2005 3:52:43 PM PST by ThinkDifferent (I am a leaf on the wind)
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To: SolidSupplySide

There is also plenty of evidence from every single continent on what a sales tax becomes when its rate gets too high: A VAT!

Not all sales taxes are equal my friend. The "sales tax" you refer to is the European business turnover tax that was replaced VATs. A sales tax on business purchases as opposed to retail only tax, as such taxes cascade throughout an economy causing extreme economic problems.

The dominate reason many other countries have gone to a VAT is it is a requirement for European Union membership in order to create a uniform tax sytem, a basis not related to "retail sales tax" evasion.

You should note that retail sales taxes were expressly not replaced by the VAT in the EU where VAT became the tax system of choice:

 

http://europa.eu.int/eur-lex/en/consleg/pdf/1967/en_1967L0227_do_001.pdf

FIRST COUNCIL DIRECTIVE
of 11 April 1967
on the harmonisation of legislation of Member States concerning
turnover taxes
(67/227/EEC)
THE COUNCIL OF THE EUROPEAN ECONOMIC COMMUNITY,

Having regard to the Treaty establishing the European Economic Community,and in particular Articles99 and 100 thereof;

Having regard to the proposal from the Commission;
Having regard to the Opinion of the European Parliament;
Having regard to the Opinion of the Economic and Social Committee;

Whereas the main objective of the Treaty is to establish,within the framework of an economic union,a common market within which there is healthy competition and whose characteristics are similar to those of a domestic market;

Whereas the attainment of this objective presupposes the prior application in Member States of legislation concerning turnover taxes such as will not distort conditions of competition or hinder the free movement of goods and services within the common market;

Whereas the legislation at present in force does not meet these requirements;

Whereas it is therefore in the interest of the commom market to achieve such harmonisation of legislation concerning turnover taxes as will eliminate, as far as possible, factors which may distort conditions of competition, whether at national or Community level,and make it possible subsequently to achieve the aim of abolishing the imposition of tax on importation and the remission of tax on exportation in trade between Member States;

Whereas, in the light of the studies made, it has become clear that such harmonisation must result in the abolition of cumulative multi-stage taxes and in the adoption by all Member States of a common system of value added tax;

Whereas a system of value added tax achieves the highest degree of simplicity and of neutrality when the tax is levied in as general a manner as possible and when its scope covers all stages of production and distribution and the provision of services;whereas it is therefore in the interest of the common market and of Member States to adopt a common system which shall also apply to the retail trade;

Whereas,however,the application of that tax to retail trade might in some Member States meet with practical and political difficulties; whereas,therefore,Member States should be permitted,subject to prior consultation,to apply the commom system only up to and including the wholesale trade stage,and to apply,as appropriate,a separate complementary tax at the retail trade stage,or at the preceding stage;

Whereas it is necessary to proceed by stages,since the harmonisation of turnover taxes will lead in Member States to substantial alterations in tax structure and will have appreciable consequences in the budgetary,economic and social fields;

*** SNIP ***

 

In fact, the original reason for a VAT was due to the cascading effect of transaction/turnover taxes on all business operations (a VAT without purchase credits) that created devastatingly high tax burdens on business and economies. The creation of the VAT had little if anything to due with evasion rates of retail sales taxes.

http://www.uq.edu.au/economics/johnquiggin/news/GST9806.html

"The VAT was introduced in France in 1954, to replace a system which relied a highly distortionary turnover tax on sales to supplement a rather ineffectual income tax system. The problem with a turnover tax is the 'cascade' effect arising from the fact that goods are taxed every time they change hands. The effective rate of tax on a good therefore depends on the length of the marketing chain from producer to final consumer. At even modest rates, cascade taxes are highly distorting. The VAT solves this problem elegantly, by allowing firms to credit the tax already paid on their inputs against the tax imposed on their sales. The net tax payable is therefore a fixed proportion of value-added. ..."

"Like the metric system, the VAT was adopted by other European countries, and the use of a VAT was made a condition of membership of the European Union. Once again, the English-speaking countries had less need to make the change, and were slower to do so. Their income tax systems were more effective, and their wholesale and retail sales taxes were less distorting than cascade taxes. ..."


31 posted on 12/16/2005 3:55:32 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: SolidSupplySide

There is also plenty of evidence from every single continent on what a sales tax becomes when its rate gets too high: A VAT!

And what do you say of a tax system that its authors note is a VAT with income tax from its very design?

 

http://waysandmeans.house.gov/fullcomm/106cong/4-11-00/4-11kotl.htm

"Robert Hall, one of the originators of the proposal(Flat Tax), who describes his Flat Tax as, effectively, a Value Added Tax. A value added tax taxes output less investment (because firms get to deduct their investment.)"

"The Flat Tax differs from a VAT in only two respects. First, it asks workers, rather than firm managers, to mail in the check for the tax payment on that portion of output paid to them as wages. Second, it provides a subsidy to workers with low wages."

 

The Flat Tax; Chapter 3, by Robert Hall and Alvin Rabushka

  • Here is the logic of our system, stripped to basics: We want to tax consumption. The public does one of two things with its income—spends it or invests it. We can measure consumption as income minus investment. A really simple tax would just have each firm pay tax on the total amount of income generated by the firm less that firm’s investment in plant and equipment. The value-added tax works just that way. But a value-added tax is unfair because it is not progressive. That’s why we break the tax in two. The firm pays tax on all the income generated at the firm except the income paid to its workers. The workers pay tax on what they earn, and the tax they pay is progressive.
  • To measure the total amount of income generated at a business, the best approach is to take the total receipts of the firm over the year and subtract the payments the firm has made to its workers and suppliers. This approach guarantees a comprehensive tax base. The successful value-added taxes in Europe work this way.
  • The other piece is the wage tax. Each family pays 19 percent of its wage, salary, and pension income over a family allowance (the allowance makes the system progressive). The base for the compensation tax is total wages, salaries, and retirement benefits less the total amount of family allowances.

32 posted on 12/16/2005 4:01:58 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: SolidSupplySide
a sales tax and a flat income tax are economically equivalent.

Actually that is arguable. In most analyses I have seen the sales tax would create a boom economically. Jorgensen put the GDP spike at upwards of 10%. The "tax haven" effect is enormous as well. Jobs, jobs jobs.

The flat tax would be simulitive also, assuming the rate is low enough, but nowhere near the amount the fair tax would be.

33 posted on 12/16/2005 4:02:45 PM PST by groanup (Shred for Ian)
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To: SolidSupplySide
"One of the benefits of income taxes is the cross-reporting which reduces evasion to a great degree."

It is also a system that penalizes hard work and investment, eviscerates the 4th Amendment, results in lien and levy of private property for failure to pay, results in countless hours of lost productivity, instills fear and loathing into otherwise perfectly rational adults. The Founding Fathers are spinning in their graves. Why do you defend the indefensible?
34 posted on 12/16/2005 4:05:55 PM PST by Conservative Goddess (Politiae legibus, non leges politiis, adaptandae)
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To: groanup
Actually that is arguable. In most analyses I have seen the sales tax would create a boom economically. Jorgensen put the GDP spike at upwards of 10%. The "tax haven" effect is enormous as well. Jobs, jobs jobs.

I see that you employee an appeal to authority by referencing Dr. Jorgensen. Perhaps you should read what he writes. On pages 22-23, Jorgenson declares a flat income tax and a sales tax as being equivalent.

35 posted on 12/16/2005 4:15:34 PM PST by SolidSupplySide
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To: SolidSupplySide; groanup

a flat income tax and a sales tax as being equivalent.

Yep as they generate the same revenue to government.

But as he shows in that same paper, their respective effects on the economy are quite different:

 

http://www.economics.harvard.edu/faculty/jorgenson/papers/baker.pdf

Revised April 12, 1999.
THE ECONOMIC IMPACT OF FUNDAMENTAL TAX REFORM
by
Dale W. Jorgenson Harvard University
and
Peter J. Wilcoxen University of Texas, Austin

This paper was prepared for presentation at the
Baker Institute Conference
on Tax Policy Reform
Rice University Houston,
Texas November 6, 1998


 

We have simulated the impact of implementing two different versions of a consumption tax at the beginning of 1996. The first is the Armey-Shelby Flat Tax. The Armey-Shelby proposal levies taxes on the difference between business receipts and the sum of business purchases and business payrolls. Labor income is taxed at the individual level. An important feature of the proposal is the system of personal exemptions at the individual level that we have described.

The second proposal we have considered is the National Retail Sales Tax. The tax base is the same as in our simulations of the Flat Tax. However, the method of tax collection is different. The Arrney-Shelby Flat Tax preserves the existing structures of the corporate and individual income taxes, but alters the tax base. The National Retail Sales Tax eliminates corporate and individual income taxes; retail establishments would collect the taxes. This would require a broad definition of these establishments to include real estate developers and providers of services, such as medical, legal, and personal services. Most important, no personal exemptions are provided.


PDF page 25-27:

2. Figure 4 compares the consumption tax rates for revenue-neutral substitution of the Armey-Shelby Flat Tax (FT) and the National Retail Sales Tax (ST) for existing income taxes. The Flat Tax rate is 25.1 percent in the year 1996 and remains virtually constant through the year 2020. The National Retail Sales Tax rate rises from only 15.7 percent in 1996 to 21.4 percent in the year 2020. Only the Flat Tax includes a system of personal exemptions, so that the tax rate is considerably higher, especially at the initiation of the tax reform. Second, the consumption tax base for the Flat Tax grows at nearly the same rate as government expenditures, while the tax base for the Sales Tax grows more slowly, reflecting the increased importance of investment.

3. Figure 5 compares the impacts of the Flat Tax and the Sales Tax on GDP. Under the Flat Tax the GDP is only 0.6 percent higher than the Base Case in 1996; the impact of this tax reform on GDP gradually rises, reaching 1.3 percent in 2020. Under the Sales Tax the GDP jumps by 13.2 percent in 1996, but the impact gradually diminishes over time, falling to 9.0 percent in the year 2020. The short-run differences between these two tax reforms are due mainly to the impacts on labor supply, while the long run differences also reflect the impacts on capital accumulation.

4. Figure 6 compares the impacts of the two tax reform proposals on consumption. The impact of the Flat Tax in 1996 is to increase consumption by 3.5 percent, relative to the Base Case. This impact gradually diminishes over time, falling to 1.3 percent by 2020. While it may seem paradoxical that consumption increases with a rise in the consumption tax, the marginal tax rate for low-income taxpayers is reduced to zero, stimulating consumption. By contrast the Sales Tax curtails consumption sharply in 1996, resulting in a decline of 5.6 percent, relative to the Base Case. However, the level of consumption overtakes the Base Case level in 1998 and rises to 5.5 percent above the Base Case in 2020.

5. Figure 7 compares the impact of the two tax reform proposals on investment. The impact of the Flat Tax in 1996 is to depress investment by 8.6 percent, relative to the Base Case. Investment recovers over time, eventually reaching a level that is only 1.7 percent below the Base Case in the year 2020. Substitution of the Sales Tax for existing income taxes generates a dramatic investment boom. The impact in 1996 is a whopping 78.5 percent increase in the level of investment that gradually gives way by the year 2000 to a substantial increase of 16.5 percent, relative to the Base Case.


6. Figure 8 compares the impacts of the tax reforms on exports, while Figure 9 compares the impacts on imports. It is important to keep in mind that net foreign investment, the difference between exports and imports in nominal terms, is exogenous in our simulations, while the exchange rate is endogenous. The Flat Tax results in a very modest decline in exports of 0.5 percent in 1996, relative to the Base Case, but exports recover rapidly and exceed Base Case levels in 1997, rising eventually to 4.6 percent above these levels in 2020. Imports initially rise by 2.0 percent, relative to the Base Case, in 1996, but this impact declines to only 0.3 percent by 2020. The Sales Tax generates a substantial export boom; the level jumps to 29.2 percent about the Base Case level in 1996, but declines by 2020, reaching 18.9 percent of this level. Imports in 1996 exceed the Base Case level by 2.5 percent, but fall to 1.3 percent below this level in 2020.


7. The inter-temporal price system provides the mechanism for re-allocations of resources in our simulations. Figures 10 and 11 give the impacts of the tax reforms on the prices of investment goods and consumption goods and services. Under the Flat Tax the price of investment goods drops by more that 6.8 per cent in 1996 and the price decline continues, falling only modestly to a little over six percent by 2020. The Sales Tax produces a reduction in investment goods prices exceeding twenty percent in 1996, rising gradually to between twenty-five and thirty percent over the period 2000-2020. Under the Flat Tax prices of consumption goods and services decline by more that 4: 5 percent in 1996, but this price reduction falls over time to around three percent in 2020. The Sales Tax reduces the price of consumption by a little over three percent in 1996, but this price decline increases to more than ten percent by 2020.

8. The implied subsidy to leisure time is equal to the marginal tax rate on labor income and would drop to zero when the individual income tax is abolished. Individuals sharply curtail consumption of both goods and leisure under the Sales Tax. Figure 12 shows that labor supply (and demand) jumps initially by thirty percent in 1996. This labor supply response recedes to a level of around fifeen percent by 2020. By contrast the Flat Tax generates an increase in both consumption and labor supply. The labor supply response is only two percent in 1996, but gradually rises to more than five percent by 2020.

9. Since producers would no longer pay taxes on profits or other forms of income from capital and workers would would no longer pay taxes on wages, prices received by producers under the Sales Tax, shown in Figure 13, would fall by an average of twenty percent in 1996. Figure 14 shows that prices received by producers would fall by an average of twenty-five percent by 2020. The impact of the Flat Tax on prices received by producers is much less dramatic. Prices decline in the range of six to eight percent for most industries in 1996 and five to seven percent by 2020.


36 posted on 12/16/2005 4:25:03 PM PST by ancient_geezer (Don't reform it, Replace it!!)
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To: SolidSupplySide
on pages 22-23, Jorgenson declares a flat income tax and a sales tax as being equivalent.

Maybe so. But you shouldn't have stopped reading on page 23.

On page 24 he puts the GDP increase under a flat tax at 1.3% while under a National Retail Sales it jumps by 13%. If that is economic equivalency I'm Alan Greenspan.

37 posted on 12/16/2005 4:28:02 PM PST by groanup (Shred for Ian)
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To: ancient_geezer

Thanks. You beat me by three minutes. :-)


38 posted on 12/16/2005 4:29:59 PM PST by groanup (Shred for Ian)
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To: ancient_geezer

This is a useful report, and it's very good that it's coming out at this time. The points made in the abstract will catch the eye of Secretary Snow, who is working on recommendations for tax reform to be given to the president in January. Those reductions in marginal tax rates for common households are highly significant to accumulation of capital by those working to raise their standards of living (i.e., just about everybody).


39 posted on 12/16/2005 5:51:09 PM PST by n-tres-ted (Remember November!)
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To: SolidSupplySide

"One of the benefits of income taxes is the cross-reporting which reduces evasion to a great degree."

Really ? One shudders to think how bad it would be if not for all those 4th-Amendment-violating cross-checks. The current IRS "tax gap" is $350B -- more than 40%. And that doesn't even count criminal activity.

On the other hand, 85% of retail purchases are made through 15% of businesses. These are the Wal-Marts, etc. which are not going to assist consumers in evasion of a Sales Tax. They have too much to lose. So even if the other 15% of purchases all evaded the FairTax, it would be much less than under the current income & payroll taxes.

Keep in mind, the current tax system requires only a single person to fail to evade it -- they just don't report it. That would be the self-employed in any number of businesses. Under the FairTax, it requires at least two people -- the seller and the buyer.


40 posted on 12/16/2005 6:11:10 PM PST by Kellis91789 (Rome didn't build a great Empire by having meetings. It did it by killing all who opposed it.)
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To: n-tres-ted
Apart from the prior discussion regarding economic equivalence; and, recognizing that tax reform must (at some point) be joined by governmental spending reform, there are a number of very attractive elements to the Fair Tax plan as outlined in HB25 and SB25.
First, federal revenue will be determined by spending on NEW goods and services. The underlying notion is that the sale of a new item with an inclusive tax (regardless of rate) then represents that total value to the economy.
Second, a large portion of those folks currently evading federal income taxes in a variety of ways get to, finally, pay at least a portion of their assigned share, assuming they buy goods and services. This group includes drug dealers, extortionists, con men of many stripes, and so on.
Third, the Fair Tax supports the benevolent greed of commercial enterprises. The plan, as proposed, will require all commercial entities to report closing book value inventory numbers on the date of conversion. This dollar amount is 'grandfathered' into the new system, and once sales pass that number, all further sales are subject to the Fair Tax. Further, it should be relatively quick to see net costs for new goods and services approximate current net costs, because the income tax implications of the current commercial economic model are removed.
Fourth, by taxing goods and services, removing the current withholding process, and applying only to new goods, I (and all of you) have greater control over not only income, but the timing of tax payments.
There are a couple of downsides...most notably, there may be requirement for Constitutional amendment to truly abolish the government's ability to tax income. And, second, there is not enough 'stomach' in Washington, right now, to make this all happen.
While I greatly admire and mostly support President Bush, as quickly as he caved on Social Security privatization, I can't expect that he'll take on this fight.
And, of course, the current lobby industry in Washington would be decimated by a plan such as this one (or the Flat Tax) as they would not be as able to push for favorable treatment of their paying constituents.

All in all, after looking at Forbes' Flat Tax Plan and Lindner's Fair Tax Plan, I believe the best bet for current and future generations is the Fair Tax, but either must be coupled with sane spending reform (line item veto, balanced budget amendment, review of current 'entitlement' programs in terms of their constitutionality, etc.).

Thanks for reading. And, while this is my first post, I've been a lurker around here for many months. I am impressed by the quality of the writing, and the great sense of humor in many of these threads.
41 posted on 12/16/2005 6:33:03 PM PST by PubliusMM (Just doin' my best to stay free and secure. God Bless our military personnel.)
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To: PubliusMM
Your post is most certainly welcome and, for me, a shot in the arm for the fair tax. There are those who will take issue with your analysis but I find it very informed and thoughtful. Welcome to the debate.

When you get slammed by the anti FT's just remember, they have an agenda which includes making us all slaves to their scheme of tax, bribe, legislate and intimidate.

Welcome,

groanup

42 posted on 12/16/2005 8:17:16 PM PST by groanup (Shred for Ian)
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To: PubliusMM

Oh, and welcome to Free Republic.


43 posted on 12/16/2005 8:19:34 PM PST by groanup (Shred for Ian)
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To: groanup
When you get slammed by the anti FT's just remember, they have an agenda which includes making us all slaves to their scheme of tax, bribe, legislate and intimidate.

What a total crock.

44 posted on 12/17/2005 8:13:24 PM PST by RobFromGa (Polls are for people who can't think for themselves.)
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To: RobFromGa

Who pissed in your potato salad tonight?


45 posted on 12/17/2005 8:43:00 PM PST by groanup (Shred for Ian)
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To: groanup

I have no idea what you are talking about.


46 posted on 12/18/2005 3:49:57 AM PST by RobFromGa (Polls are for people who can't think for themselves.)
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To: ancient_geezer

Is this the new paper where Kotlikoff admits that the FairTax rate would have to be higher than 23% inclusive?


47 posted on 12/18/2005 7:55:44 AM PST by Your Nightmare
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To: SolidSupplySide
The 23 percent rate generates more revenue than the taxes it replaces, but the rebate’s cost necessitates scaling back non-Social Security expenditures to their 2000 share of GDP.
This is a very interesting sentence. Basically, the FairTax generates more revenue but increases expenditures (to pay for the "rebate") more than the increase in revenue.
48 posted on 12/18/2005 8:22:01 AM PST by Your Nightmare
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To: PubliusMM
Further, it should be relatively quick to see net costs for new goods and services approximate current net costs, because the income tax implications of the current commercial economic model are removed.
Relatively speaking almost nothing is manufactured here anymore, and more and more "services" are being outsourced offshore...There would be little pretax reduction along with huge 30% after tax increases in prices on day one.

If a domestic manufacturer/business strips away "the income tax implications of the current commercial economic model" s/he would then have to deal with the 30% sales tax implications (price increases) at the other end...simply manufacturing something cheaper only to be heavily taxed at the other end is hardly a solution.

I have a service business. Here's what I know based on the law. From day one I would have to remit "23% of the gross payments" to the government and then I'd have to pay another 23% of what's left when I want to spend it on new stuff.(Silly me, I choose to not alter my lifestyle because you're too lazy to fill out a tax return)...

If I don't increase my prices the amount of the tax I'd come up short of income no matter how many drug dealers pay sales taxes.

49 posted on 12/18/2005 9:28:50 AM PST by lewislynn (Fairtax= lies, hope, wishful thinking and conjecture.)
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To: Your Nightmare

Is this the new paper where Kotlikoff admits that the FairTax rate would have to be higher than 23% inclusive?

Blowing smoke again I see.

You are aware the feds are running a deficit now are you not? But then a revenue neutral tax bill is not required to remove deficits.

"The 23 percent rate generates more revenue than the taxes it replaces, but the rebate’s cost necessitates scaling back non-Social Security expenditures to their 2000 share of GDP."

Of course to pay for the full budget, clearing deficits as well as meet the revenue neutral targets, requires scaling back to the same share of GDP as it was in 2000 when when the 23% was established.

"Revenue Neutral" does nothing to change deficit by definition.

Sorry, but Kotlikoff papers usually target paying deficits as well as meeting the minimal revenue neutral requirments that is all that is required for the legislation.

Nice try at obfuscation though.

By the way, if you don't want to pay the NBER download fee for the paper, I am told that Kotlikoff will be making the full text available to AFT so they can put it up on their website before the end of the year.

50 posted on 12/18/2005 10:10:06 AM PST by ancient_geezer (Don't reform it, Replace it!!)
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