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.

A readability re-post of Sprite518 at #156:

To: RobFromGa

Ok I finally read what you wrote. LOL! Let me break it down for you since it’s obvious you went to a government school..

You Said: 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

Answer: Ok your key words, “he was NOT assuming that the worker would keep his current after-tax amount” That is not what the Doctor wrote, or well at least you posted. I have just copied and pasted what you said he wrote.

The Dr wrote, “I am saying that the worker “WOULD” continue to receive the after-tax amount of $800.” This is even better! Thanks for posting this. Since the Doctor was assuming employees would still be taxed like they are today. It makes the Fair Tax (HR 25) incredible knowing that we would take home what we make before taxes. This would be a huge pay raise for everyone. And if the doctor did not factor this then our buying power should increase. Thanks for posting this :-)

You said: 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.

Answer; If a company is paying an employee $30,000 a year, and the Fair Tax bill becomes law. That company would no longer have to worry about embedded taxes. So then why do you think the company would reduce the pay of the employee? How do you come up with that conclusion? LOL! Just think about it…. the company has no tax liability therefore it has more money now that it does under our current tax system. Embedded taxes are gone! How come you think the company would have less money?

You wrote: “ There would be no increase in take-home pay.“

Answer: Nothing could be further from the truth. Please read HR 25, or the Fair Tax Book. The Fair Tax eliminates ALL taxes and replaces it with a consumption tax only.

You also wrote earlier in the same post: “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?”

Answer: You came up with the wrong conclusion. If a business no longer has any tax liability, then why would they reduce an employees pay? The company just gained a lot of money since the embedded taxes have been eliminated?

You also wrote, “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. “

Answer: How in the heck do you come up with there would no cost savings? LOL! Now I see why you have all your numbers screwed up. You act as if the taxes that employee’s see they paid in their check is really being paid by the company and not the employee. LOL! No wonder why you are so confused! Now I understand Employers pay ½ of your Social Security, but companies are not paying your federal and state taxes. That is being paid by the employee. This is why we do our taxes each year. If the companies were paying our Federal and State taxes, then we would not have to fill out a 1040 every year. LOL!

156 posted on 08/25/2005 7:22:13 AM PDT by Sprite518

The poster you mention is certainly welcome to his opinion as are the economists mentioned. There are, however, more than the two assumptions you list. In fact, I'm not even sure that Jorgenson made the Assumption you ascribe to him but in any event those are the opinions of a single economists and in this thread the presumption seems to be anything but unanimous by the SQL crowd.

Your analysis of what was "wrong" with what "Boortz and the FairTax supporters" presented doesn't seem too overpowering. I don't see the great schism that you seem to think you do. I do see a difference of opionion as to how best to express the many benefits of the FiarTax and I don't doubt that, as more work is done over the next few months, the positions will become clarified. In the meangtime trying to paint them as somehow "wrong" is just plainly silly.

This sounds to me like the echo of the old static vs dynamic economy argument so I'm willing to see more information. In the meantime, it is clear to many of us that the FairTax is by far the best plan "out there". And don't forget that there are at least 75 economists of note who do not subscribe with Jorgensons simplifying assumption - if that's what it was - about wages; those 75 who signed the endorsement that went to all comngressmen and the President ... they agree that gross pay will be net pay.

Even in view of that there are other options than just the single #1 you mention. In any event the difference of opinion will certainly be ironed out before the FairTax become the tax law of the land - and I believe that it will be.

But back to your frequent and misleading multipost:

"The 11 cut-and-pastes you stitched together in your post (and aren’t YOU the guy continually criticizing ancient_geezer for HIS cut-and-pastes??) Fall into 2 categories - FUD (Fear, Uncertainty, and Doubt) and OOC (Out of Context quotation). The FUD Factor items are marked with a “*” and the OOC items with a “+”.

The 11 items are:
1 - Garner (Zodrow, Gravelle, Gale)*
2 - Koltikoff+
3 - Response to Gale by Mastromarco/Burton+
4 - Mastromarco/Burton real estate +
5 - CBO Price Level*
6 - Slemrod/Bakija; Taxing Ourselves*
7 - Gravelle & Esenwein; CRS Overview*
8 - Wilkins; National Retail Federation*
9 - Zodrow; Transitional Issues*
10 - Bull & Lindsey; Monetary Implications*
11 - Hall; Price Level*

Let’s take the OOC items first -
Item 2 (Koltikoff) - in a two paragraph discussion of whether or not the FairTax is regressive in theory, the author made certain assumptions to illustrate a point. You merely took these assumptions and presented them as though they were a fact - his belief - he was presenting. They were assumptions to illustrate a point, not fact he was presenting.

Item 3 (Response to Gale) - You conveniently left out the portion where the responders point out that prices would drop with the assumption of the FairTax, and that Gale, in fact, was contradicting himself. Here’s a link to the entire response midway on page 14 (through midway on page 15) where it says:
” J. Gail Perspective: Consumer Pricing: Up, Down and Sideways Simultaneously”. Gale completely overlooks the fact that prices would drop with the onset of the FairTax as the responders point out. After this price drop, prices would then be raised up again to some degree by the sales tax which is the meaning of their statement “... prices will increase by the amount of the sales tax but returns to labor and capital will be higher.”

Item 4 (Real Estate Foundation) - The footnote you posted from this response also suffers from the same flaw in reasoning as Item 3 just above. Price will first decrease with the advent of the FairTax causing the after tax increase in wages mentioned as well as the increase of prices back in an upward direction from their decrease to the lowered level mentioned above

So much for your out of context quotations. Next we take up the FUD Factor Items:

Item 1 (Garner) with points from (Zodrow, Gravelle, Gale) - As with almost all of the liberal FairTax opponents, the discussion presents what amounts to a description of a VAT structure (calling it a “consumption” tax) and comparing that to a flawed description of the FairTax (which includes a discussion of exemptions/exceptions “required”). In addition the discussion goes on to the SQL “leap of Faith” (as do you) that prices MUST increase with the advent of the FairTax ... while showing no such convincing (or even fairly convincing beyond just stating it) evidence of why this would happen. Garner is obviously not too familiar with the FairTax as he describes a decline in bond values and the idea of corporations “losing” their depreciation - which of course is nonsense under the FairTax. He also uses heavily from well-known SQL sources such as Zodrow, Gravelle, and Gale which in and of itself should merit serious concern.

Item 5 (CBO) - Hardly a benefactor of the Status Quo (yeah, right) but also makes the “Leap of Faith” as in Item 1 that prices must increase with the advent of the FairTax. They do, of course, but only after first declining by the removal of the income tax component leaving them more or less the same overall. Despite that lapse, the opinion is offered that the Fed will step in to raise prices (without any clear or convincing indication of why this might be so; merely the claim that it is so).

Item 6 (Slemrod/Bakija) - Here, from a long time SQL advocate (Slemrod) we see the similar liberal “Leap of Faith” that the sky would fall in the opinion (offered again without any backup) that corporate earnings would fall by 20%. A slightly different twist is given in that the Fed rather than raising prices would now, God-like, merely “monitor” prices to decide if any action need be taken to PREVENT A PRICE RISE (rather than causing it as in Item 5. Perhaps rather than calling these sorts of SQL ploys a “Leap of Faith” (which of course they are), they should be called the Chicken Little Syndrome.

Item 7 (Gravelle & Esenwein - CRS) - Once again we see the Chicken Little Syndrome in full operation where any price reduction due to the FairTax is completely ignored and sweeping statements reflecting a great lack of understanding of the FairTax are made by claiming that the tax “must be paid” in an example industry having a 1-2% profit margin which “now owing a tax equal to 20% of receipts” - all the while ignoring the fact that the business does not pay the sales tax (at all, let alone out of its “profit margin”), but that the customer of the business pays the tax. In addition, the CRS folk seem to not understand that the FairTax is border-adjustable as well as the old unwarranted assumption about lower wages being required (for some reason). There are a good number of other flaws in the paper itself other than the selected snippet posted. We also see the use of the old chestnut of anonymous “... 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. You’d think that at least these “unnamed economists” would appreciate the credit (?) of being named.

Item 8 (Wilkins - National Retail Federation) - This is a study originally commissioned by the NRF from Coopers & Lybrand (who had, as I recall, Wilkins as the leader of the group doing the “investigation”). It is of the Chicken Little/Leap of Faith persuasion and is impossible to tell much about - aside from the lack of veracity - since, despite requests, it was never published so others could investigate its pronouncements. This link:
http://www.fairtaxvolunteer.org/smart/PwCRebuttal.pdf
has a refutation of the Wilkins/PwC/NRF “study”. A HIGHLY RECOMMENDED READ!!

Item 9 (Zodrow - Transitional Issues) - this is merely George once again “doing his thing”. He pretty much makes the usual Chicken Little observations, but is at least honest enough to mention that the “... opinion on this issue is certainly not unanimous.“ And goes on to cite the Jorgenson 25% or so price decline. Kudos, George, for inserting a bit of much needed honesty into the discussion. Makes the Leap of Faith about the Fed being magical and omniscient.

Item 10 (Bull & Lindsey - Monetary Influences) - Makes the Leap of Faith about the wage decline without even considering the removal of the cascaded income tax in prices. This may be one of the reasons that Lindsey is no longer a Presidential Advisor on the economy.

Item 11 (Hall - Price Level) - Why is it not surprising that someone largely thought of as an author of the Flat Tax be strongly in favor of that over the FairTax (which he nowhere demonstrates an understand of aside from the requisite Leap of Faith that wages will be lowered and prices raised (the Chicken Little Syndrome again) while ignoring any price reductions offered by the advent of the FairTax.

So, let me see now if I have this straight ... the FairTax supporters may not use the economic data which is presented in good detail on the Americans For Fair Taxation website (because you say so) while you are quite free to use all of the snippets you can gather up from the known SQL defenders (who seldom, if ever, admit to being so - just like you) even if they are only op/ed pieces with little or no economic detail? By George, I think I’ve got it!!! "

To be correct we should note that the study in #8 is now "available", but only if you wish to buy it - which I certainly do not since it's been heavily rebutted.

That "stuff" is no better now than then - but nice try to try to trick the unwary!

The example given by s-test which has illegal aliens paid by someone with after tax income is well off-point since that money has been taxed by an income tax from the legal economy regardless of whether the after tax money is spent for day labororers, jellybeans, or stuffed in a mattress. It does not derive a cent of tax contribution directly from the illegal economy.

Such an example also pre-supposes that the person with the legal income actually PAYS income tax (not everyone does) so it would be necessary to offer some convincing data about the taxes paid (by those hiring day laborers) since many pay at a rate of, say 15%, which is still less that the tax contribution derived by the FairTax,

The FairTax in a similar situation is quite different (assuming in both examples the illegal income is not taxed) in that the illegal income will be taxed and at a rate of 23% when spent for taxable items.

I also find no justification for your uncorroborated assumption that "... the magnitude of lost tax potential in each scheme is about the same ..." since it clearly is not as the legal income is taxed regardless of what it is spent for (or even if it is spent) while converting it to illegal income by hiring illegals yields no further tax revenues at all at present but clearly does with the FairTax - at a 23% rate. The illegal economy will clearly yield greatly more tax revenue under the FairTax for that reason.

With the case of drug dealings this is even more clear since a great amount of the money spent for drugs presently is stolen money - completely untaxed with no income tax paid at all (and the same comments as with the above example apply to any legal income involved). The FairTax will also yield considerable larger tax contributions fom this part of the illegal economy when spent for consumption.

No "experiment" is necessary to divine the benefit of the FairTax on this matter - it is quite obviously highly favorable to the FairTax.

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