JORGENSON EXPLODES FAIRTAX MYTH (FR Exclusive)

U.S. Representative John Linder
1026 Longworth House Office Building
Washington, DC 20515
Phone: 770-232-3005
Fax: 770-232-2909
Copy: Neal Boortz, WSB Radio,
Dr. Dale Jorgenson, Harvard University

I wrote to you two days ago regarding what I consider to be serious misrepresentations of the Fair Tax plan contained in your book, “The FairTax Book”. On page 2, you state “Let’s agree up front that this book is about honesty” and I intend to hold you at your word. Since that time, I have been in contact with Dr. Jorgenson in an attempt to clarify his understanding of this Plan and his calculation of expected price declines.

On pp. 22-23, your book states: “An extensive study of tax costs was completed a few years ago by Dr. Dale Jorgenson, then chairman of the Harvard Economics Department. On average, Jorgenson concluded, 22 percent of the price paid for a consumer product represents embedded taxes.”

You then went on to show a Chart (Fig 5.1) which shows the expected price decline without embedded costs for various goods and services as prepared by Jorgenson during his study.

On page 55, you go on to explain that these embedded taxes are “in addition to the money taken out of your check in income and payroll taxes.”

On page 59, you again invoke Dr. Jorgenson’s study: “If you’re looking for scholarly support for the proposition that prices will fall once the embedded taxes are removed, we can check back with [Jorgenson’s] “The Economic Impact of the National Retail Sales Tax” and you quote his report:

Since producers would no longer pay taxes on profits or other forms of capital income under the NRST and workers would no longer pay taxes on wages, prices received by producers… would fall by an average of twenty percent”

In this statement, Jorgenson seems to say that one of the reasons for the price drop at the producer level was the elimination of the tax on wages paid to workers. So, naturally if the business is going to realize this benefit it must reduce the workers gross pay be the amount that is currently being paid in the form of income and payroll taxes. This only makes sense because how can the business reduce costs if it gives the worker tax savings to the worker?

Later on page 59, you state: “Once the FairTax takes effect, you’ll be receiving 100 percent of every paycheck, with no withholding of federal income taxes, Social security taxes, or Medicare taxes and you’ll be paying just about the same price for T-shirts and other consumer goods and services that you were paying before the FairTax.”

Dr. Jorgenson’s report clearly showed that under his study the worker would not get their complete paycheck, because if he/she did, there would be no cost savings to the business and therefore no price drop associated with worker taxes.

You continue this theme on page 83: “Remember that the poor, along with everyone else—will no longer have Social Security taxes or Medicare taxes removed from their paychecks. Whatever they earn, they get on payday. For most of those we categorize as poor, this would mean an immediate 25 to 30 percent increase in their take-home pay.”

On page 84, you make it clear though that even though the workers will keep all of their paychecks for a big raise, you still believe that because of “the disappearance of the embedded taxes, the total price paid for consumer goods will remain very nearly the same”.

By assuming these two things together, you are misrepresenting Jorgenson’s report and double-counting the tax savings, first by giving them to the worker as a pay raise, and then at the same time assuming that there was a cost savings to the business.

And then on page 111, you tie it all together with a Quick Review in which you erroneously assert that “Here’s what happens when we pass and implement the FairTax plan:”

“We all get virtual raises, since payroll taxes are no longer siphoned from our checks.

“The prices of consumer goods and services remain essentially the same, with the removal of the embedded taxes compensating for the added consumption tax.”

Dr. Jorgenson’s report seemed pretty clear to me, but I felt it was necessary to ask him directly what he meant so I sent him this e-mail:

I am a private US citizen who is concerned that the FairTax proponents are misrepresenting your conclusions. Would you please comment on the attached letter I sent to Mr. Boortz and Rep. Linder? I think that they are being dishonest to imply that the wage earner will keep his entire paycheck, while at the same time businesses will be able to reduce costs? Your March 1996 testimony stated, in part:

5.Since producers would no longer pay taxes on profits or other forms of capital income under the NRST and workers would no longer pay taxes on wages, prices received by producers, shown in the sixth chart, would fall by an average of twenty percent

Are you expecting business to reap a benefit from the taxes that that the worker no longer pays? It certainly sounds like that is part of where you see the business reducing its costs.

From: Dale Jorgenson [mailto:djorgenson@harvard.edu]
Sent: Wednesday, August 24, 2005 10:28 AM
To: Rob xxx
Re: Fair Tax- Is your 1995-6 Testimony being misrepresented by Boortz/Linder book?

A more reasonable interpretation of my 1996 testimony is that workers would keep that after-tax pay; producers' prices would fall, but retail prices would be increased by the national retail sales tax. Any gains by workers and investors would be the result of increase economic efficiency.

[He then went on to recommend his book called LIFTING THE BURDEN, about another tax reform plan he calls Efficient Taxation]

I wanted to be perfectly clear what he was saying, so I asked him to clarify his email:

Excuse me for my lack of understanding of your answer, when you say "workers would keep that after-tax pay" are you saying that if they are making $1000 a week now, and paying $200 payroll+income taxes now, that under the FairTax you were assuming that workers would get paid $800 and keep all of that? Or are you saying that you meant they would make $1000 under the FairTax?

I am saying that the worker would continue to receive the after-tax amount of $800. Prices received by producers would decline to cover the cost of after-tax wages to workers and after-tax dividends and interest to investors. However, taxes paid at the retail level would include the Fair Tax.

So, Dr. Jorgenson, whose report you are relying on to support your calculation of embedded taxes, is stating that in making those embedded tax calculations he was not assuming that the worker would keep his current after-tax amount, NOT that the worker would keep all of his current gross pay-check. By reducing the gross pay of the worker to the current after-tax amount, the producers would see a cost reduction that would allow them to reduce selling prices. There would be no increase in take-home pay.

I think you need to carefully review the misrepresentations in your book and offer a retraction and modify subsequent printings to remove these errors. You have spent a large amount of time on this plan, and it is still a viable option for debate even without the bug windfall pay raise for everyone. I would enjoy the opportunity to discuss this with you further if you have questions.

Dear Bigun,

Well, Dr. Jorgenson posits an approximately 20+% decline in the general price level. He is also positing a 20+% decline in gross wages, as the saved personal income, corporate income, and individual investor income taxes are passed through as savings to the consumer.

It appears that Dr. Jorgenson is saying that the price level decline will be roughly equal to the decline in gross wages.

Dr. Jorgenson does posit that the changes proposed will eventually result in additional economic growth - so, in a sense, that is a cost imposed by the current tax system.

But he is not arguing that the price decline will be paid for from "cascaded embedded taxes and tax costs" or whatever.

It's straight-up: Employees no longer pay income taxes, but they don't get those taxes back. Prices decline by the amount of those taxes. And then go back up after the application of the NSRT.

All we've done is play musical chairs with the taxes. Instead of paying them at the point of income generation, we pay them at the point of consumption. But from the change alone, folks don't gain any additional income or purchasing power. Eliminating "cascading embedded costs/taxes/delusions" isn't what gets us to a better world. At least not directly at all.

In fact, this model is much more sane than what had been proposed by many of the NSRTers here. It is clear how and why it will work.

As well, after clearing away the delusions of some, that folks would experience a net increase in purchasing power, virtually overnight, of 10%, 20%, or more, we can now debate the real merits and demerits of the system.

In terms of whether it would be better to give the taxes paid by or on behalf of workers back to the workers, or to use them to reduce the overall price levels, my own belief is that Dr. Jorgenson's path makes more sense.

I think it's problematic to achieve, but clearly the preferable method (if practically achievable).

I still don't think this is a good idea in an economy where the federal government absorbs 20% of GDP, and I'm adamantly opposed to its implementation PRIOR to the ratification of an amendment that spells out the repeal of the 16th amendment.

But Dr. Jorgenson's remarks, by vitiating the claims of some NSRTers here at FR, delivers the proposed system from the realm of lunacy to something worth debating, and perhaps trying to improve upon.

sitetest

I do not support a tax on the individual at the federal level in ANY manner

Interesting, the founders and authors of the Constitution, saw it differently. In fact that was the dominant factor in throwing out the Articles of Confederation and proposing the Constitution in its place.

Federalist #34:

``A CONCURRENT JURISDICTION in the article of taxation was the only admissible substitute for an entire subordination, in respect to this branch of power, of State authority to that of the Union.'' Any separation of the objects of revenue that could have been fallen upon, would have amounted to a sacrifice of the great INTERESTS of the Union to the POWER of the individual States. The convention thought the concurrent jurisdiction preferable to that subordination; and it is evident that it has at least the merit of reconciling an indefinite constitutional power of taxation in the Federal government with an adequate and independent power in the States to provide for their own necessities.

Federalist #39:

"The difference between a federal and national government, as it relates to the OPERATION OF THE GOVERNMENT, is supposed to consist in this, that in the former the powers operate on the political bodies composing the Confederacy, in their political capacities; in the latter, on the individual citizens composing the nation, in their individual capacities. On trying the Constitution by this criterion, it falls under the NATIONAL, not the FEDERAL character;"

Anti-Federalist Papers #3 NEW CONSTITUTION CREATES A NATIONAL GOVERNMENT;

There are but two modes by which men are connected in society, the one which operates on individuals, this always has been, and ought still to be called, national government; the other which binds States and governments together (not corporations, for there is no considerable nation on earth, despotic, monarchical, or republican, that does not contain many subordinate corporations with various constitutions) this last has heretofore been denominated a league or confederacy. The term federalists is therefore improperly applied to themselves, by the friends and supporters of the proposed constitution.

Federalist #45:

"The change relating to taxation may be regarded as the most important; and yet the present [Continental] sic Congress have as complete authority to REQUIRE of the States indefinite supplies of money for the common defense and general welfare, as the future [Constitutional] Congress will have to require them of individual citizens;

If the federal government cannot support a task by tariffs on imports and business tax, then cease that task.

Who do you think pays for tariffs and business taxes? Clue: it isn't the nation importing goods or business providing goods and services we pay for as consumers.

Furthermore why would we want to put our nation's financing at the mercy of foreign nation's export policies? Imagine China threatening not to provide exports and affecting government revenues, holding us hostage to their good graces :O/

Federalist #35:

"if the jurisdiction of the national government, in the article of revenue, should be restricted to particular objects, it would naturally occasion an undue proportion of the public burdens to fall upon those objects. Two evils would spring from this source: the oppression of particular branches of industry; and an unequal distribution of the taxes, as well among the several States as among the citizens of the same State."
"The maxim that the consumer is the payer, is so much oftener true than the reverse of the proposition, "

"When they are paid by the merchant they operate as an additional tax upon the importing State, whose citizens pay their proportion of them in the character of consumers. "
"Suppose, as has been contended for, the federal power of taxation were to be confined to duties on imports, it is evident that the government, for want of being able to command other resources, would frequently be tempted to extend these duties to an injurious excess. There are persons who imagine that they can never be carried to too great a length; since the higher they are, the more it is alleged they will tend to discourage an extravagant consumption, to produce a favorable balance of trade, and to promote domestic manufactures. But all extremes are pernicious in various ways. Exorbitant duties on imported articles would beget a general spirit of smuggling; which is always prejudicial to the fair trader, and eventually to the revenue itself: they tend to render other classes of the community tributary, in an improper degree, to the manufacturing classes, to whom they give a premature monopoly of the markets; they sometimes force industry out of its more natural channels into others in which it flows with less advantage; and in the last place, they oppress the merchant, who is often obliged to pay them himself without any retribution from the consumer. When the demand is equal to the quantity of goods at market, the consumer generally pays the duty; but when the markets happen to be overstocked, a great proportion falls upon the merchant, and sometimes not only exhausts his profits, but breaks in upon his capital."

Federalist #30:

"The more intelligent adversaries of the new Constitution ...qualify ... by a distinction between what they call INTERNAL and EXTERNAL taxation. The former they would reserve to the State governments; the latter, which they explain into commercial imposts, or rather duties on imported articles, they declare themselves willing to concede to the federal head. This distinction, however, would violate the maxim of good sense and sound policy, which dictates that every POWER ought to be in proportion to its OBJECT; and would still leave the general government in a kind of tutelage to the State governments, inconsistent with every idea of vigor or efficiency. Who can pretend that commercial imposts are, or would be, alone equal to the present and future exigencies of the Union? Taking into the account the existing debt, foreign and domestic, upon any plan of extinguishment which a man moderately impressed with the importance of public justice and public credit could approve, in addition to the establishments which all parties will acknowledge to be necessary, we could not reasonably flatter ourselves, that this resource alone, upon the most improved scale, would even suffice for its present necessities.
"To say that deficiencies may be provided for by requisitions upon the States, is on the one hand to acknowledge that this system cannot be depended upon, and on the other hand to depend upon it for every thing beyond a certain limit. "

James Madison, Elliots Debates Vol 3 p128:

"If a government depends on other governments for its revenues -- if it must depend on the voluntary contributions of its members -- its [*129] existence must be precarious."

Dear Always Right,

"I don't see how rents go down."

Yeah, that one's really problematic.

As the landlord likely derives his income partially, mostly, or even completely tax-free, he has little in tax savings directly to reduce the rent. The largest costs he has are typically the cost of the capital (whether he borrowed the money, or paid cash for the property) and the property taxes and insurance.

I know that a lot of NSRTers claim interest rates will plummet, but frankly, that strikes me as being as plausible that we are all about to get a 25% raise. * chuckle *

I'm skeptical that property taxes will decline. Perhaps eventually there will be a small decline in insurance costs.

I can see that there could be modest declines of a few percent. After all, the landlord can do all the maintenance on a pre-NSRT basis, and that saves 23% of a modest part of his costs.

However, I don't see rents not soaring by 20% - 25% after applying the NSRT.

It's interesting to think about the different effects to the economy, and to individual groups of folks within society, depending on where you send things: whether you send the saved taxes back home with the worker; or whether you send the to the consumer.

Many transactions that are currently tax-free or deferred will become sources of screwing someone. My own example is health insurance, especially the part that is employer-paid.

In order to maintain the ability of the employer to reduce prices by reducing payroll costs (and to do that in proportion, one to the other), the employer cannot take the burden of the 30% tax on the health insurance. For folks with high-cost health insurance that is largely or completely employer-paid, this will represent a significant bite.

sitetest

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