A Misleading Sales Pitch (Why the campaign for the Fair Tax will set back the cause of Tax Reform)

Here’s the pitch: The FairTax — a plan to replace the federal income tax and payroll tax with a national sales tax — will get rid of the IRS forever. It will let workers keep their entire paychecks and retirees keep their entire pensions. It will raise just as much money as the current tax code. It will promote economic growth. It won’t hurt the middle class, and it won’t cause prices to rise. It will even end our illegal-immigration problem.

These claims are drawn from the leading proponents of the plan: a group called Americans for Fair Taxation, former Republican presidential candidate Mike Huckabee, and the trio behind the book FairTax: The Truth. By painting an attractive picture of a prosperous America without an IRS, they have gotten many conservatives to become enthusiasts for their cause. Rising conservative star Marco Rubio, a Senate candidate in Florida, has endorsed the FairTax in the past (although more recently he has hedged on it). Republican congressman John Linder of Georgia, a FairTax co-author who just announced that he will not run for reelection, has made promoting it his principal mission in Congress. The Iowa Republican party has endorsed it. It seems to be gaining support among tea partiers.

The FairTax sounds too good to be true. It is. The campaign for the FairTax is deeply misleading, and much more likely to set back the cause of tax reform than to advance it.

The FairTaxers give a misleading answer to the first question everyone asks about their idea: How big will the tax be? The FairTaxers say they want a 23 percent sales tax. Most people will assume that a product that costs $100 before the tax is added would cost $123 with the tax. Actually, the tax would be $30 and the total price $130. They call it a “23 percent” rate because $30 is 23 percent of $130. Those FairTaxers who understand the numbers defend this way of calculating the tax rate because it makes it comparable to the income-tax rates they’re trying to replace. But it’s not the way any of the 45 states that have sales taxes calculate their rates. Whether or not the FairTaxers intend to mislead people by using the 23 percent figure, confusion is the effect.

It is not at all clear that this 30 percent sales tax would raise enough revenue to eliminate income and payroll taxes. Brookings Institution economist William Gale has estimated that to replace current federal tax revenues, the tax rate would have to be 44 percent (or 31 percent the way the FairTaxers calculate rates: A $100 product would cost $144 after tax). Gale’s calculation assumed that nobody would evade the sales tax and that Congress would not narrow the tax base by, for example, exempting medical services from the tax. Relaxing those assumptions increases the rate required even further.

Several groups of people would be adversely affected by the tax. Retirees, for example, have paid taxes on their wages during their working lives. After a FairTax was implemented, they would find themselves also having to pay higher taxes on everything they used their accumulated savings to buy. The value of non-retirees’ accumulated savings would drop, too.

The middle class would also pay higher taxes. Under the FairTax plan, the federal government would give all legal residents of the U.S. a “prebate” to cover sales taxes on all purchases up to the poverty line. That would protect the poor (except for illegal immigrants; higher prices are supposed to induce immigrants to come legally so they can get their prebate). And the rich would pay less than they do now, since returns to investment typically are a large share of their income, and these would go untaxed. So if revenues are to stay the same, the middle class will have to pay more. If the change in tax policy increases economic growth, this effect will be mitigated — but it will take a very long time for it to disappear under any plausible assumptions. Governor Huckabee’s claim that voters in all income groups would come out ahead while the federal government would raise the same amount of revenue as before is of course unsupportable.

FairTax proponents generally respond to these criticisms with what we would have to call flimflammery if we thought they understood the issues. Existing taxes are embedded in today’s consumer prices, they say, so getting rid of them would cause prices to drop. Adding sales taxes would be “a wash,” says Huckabee. So prices don’t go up, and workers get to keep their “entire paycheck.” Again, it sounds too good to be true.

And again, it is. If prices stay flat after a sales tax, workers can’t keep their “entire paychecks”: Wages have to fall. The paycheck you’re keeping would be smaller. (Think about it this way: If existing taxes are embedded in the cost of every product, they’re embedded in the cost of labor, too.) If wages don’t adjust downward, then unemployment has to rise. If the Federal Reserve increases the money supply to prevent this combination of falling wages and rising unemployment, then consumer prices will increase.

Most experts in tax administration also say that enforcing sales taxes gets hard quickly once the rates hit double digits. That’s one reason that many countries with broad-based consumption taxes levy value-added taxes, which are collected in smaller amounts at each step along the production and distribution chain, instead of sales taxes, which are collected in one big lump at the end. The fact that no country relies on sales taxes to the extent the FairTaxers advocate does not, however, faze them. Americans for Fair Taxation’s website discusses the issue thus: “Two of the largest economies in the world rely almost solely on sales taxes: Florida and Texas. Many civilizations in history have relied solely on transaction-based consumption taxes: a percentage of a grain shipment in exchange for a safe harbor.” Sales taxes in Florida and Texas are under 10 percent. Might imposing a 30 percent tax rate on the sales of a non-grain-based economy pose different issues? AFT doesn’t say.

Even some of the real advantages of the FairTax are overstated. Households would not have to prepare returns, and would thus enjoy more privacy. On the other hand, the federal government would still have to know people’s wages in order to determine how much they have earned in Social Security benefits. (Which leads to another problem, albeit a surmountable one. Those benefits are now linked to payroll taxes paid, which would of course end with the FairTax. As a result, people would have an incentive, for the first time, to make the federal government think they earned more than they actually did: They would accrue higher Social Security benefits while paying no extra taxes. Waitresses would start over-reporting their tips. The FairTax proposal has to take steps to combat this misreporting.)

And we haven’t even gotten to the politics of it. How likely is it that Congress and the president — any Congress, any president — will agree to create a new tax system that punishes the middle class and senior citizens? One that taxes people when they buy a home in which to live, but not when they buy a house as an investment? (This example comes from The FairTax Fantasy, a fairly comprehensive attack on the idea by Hank Adler and Hugh Hewitt.) That requires state and local governments to pay taxes to the federal government whenever they buy something — and thus, in all likelihood, to raise their own taxes? Let’s even stipulate that these are good ideas, and that the protests of the homebuilders and the charities at the loss of their popular deductions should be ignored. What are the odds that they will be?

AFT also advocates the repeal of the Sixteenth Amendment, which permits a federal income tax. Doing so would require the approval of 38 states’ legislatures. Good luck with that.

In their book FairTax, talk-show host Neal Boortz, Congressman Linder, and Linder aide Rob Woodall dismiss the notion that their campaign is quixotic by arguing that the American Revolution seemed that way too. Abandoning the FairTax as politically impractical, they say, would betray “the American spirit.” They add: “How sad it would be if the FairTax came so very close to reality, then failed legislatively because just a few people — people who could really have helped, people who could have made such a positive difference — just shrugged their shoulders and said, ‘Hey, it’s a good idea, but I don’t see it happening.’”

They need not worry about that scenario. The FairTax is not going to come close to reality. It is true that some things once considered unlikely have come to pass, but working to enact the FairTax is still a waste of time. The American spirit has historically included a fair amount of calculating of odds. And the vast majority of times that people have said, “That will never happen,” they were right.

But even if, per impossibile, the FairTax were enacted, its vulnerability to public sentiment would not end. One of the FairTaxers’ arguments against reform of the income tax is that no reform will stick. The income tax, they say, started as a simple flat tax, and look where we are now. Leaving aside the fact that it has proven quite possible to improve the income tax for long periods of time — most people don’t want to see a restoration of the pre-Reagan code — the same objection applies to the FairTax. Over time, wouldn’t it become just as riddled with exemptions and loopholes as the income tax is? Or as existing state sales taxes are? Or more so: How hard is it to imagine Congress adopting different tax rates for recyclable and non-recyclable products? And wouldn’t the FairTax be at least as easy for politicians to raise as the income tax?

AFT says no. “The FairTax is highly visible. And because there is only one tax rate, it will be very hard for Congress to adopt the typical divide-and-conquer, hide-and-disguise strategy employed today to ratchet up the burden gradually, by manipulating the income tax code.” But how visible would the FairTax really be? Each receipt would show how much the tax had raised the cost of a purchase, but most people would have no sense of how much they had given the federal government over the course of a year. Ask yourself whether you are better at estimating how much income and payroll tax you paid last year, or how much sales tax you paid.

The sound insight behind the FairTax is that the income tax pushes down the return on savings and thus creates a bias toward consumption today instead of consumption tomorrow. So taxing consumption instead of income, as the FairTax aims to do, makes a lot of sense. But there are many other ways to tax consumption. You could, for example, tax income but exempt savings. Other methods of taxing consumption pose far fewer economic, administrative, and political problems.

We do need to reform taxes — to make them simpler, more conducive to growth, and lighter on families. But if conservative politicians campaign for the FairTax, they will lose elections. If tax reformers define reform as the FairTax, there will be no tax reform. The nice thing to say would be that the people who came up with the FairTax and its marketing campaign need to go back to the drawing board. The truth is that they shouldn’t be allowed near drawing boards.

You’re already being taxed on savings and capital gains! The Fair Tax will eliminate this taxation and therefore will be able to acquire more wealth via investments and increase savings!

I reiterate, I am not being taxed on savings. That event happened when I earned the money to save. I am only taxed on the earnings generated by the savings. Under the concept of the Fair Tax when I cash in my savings and spend it. Same for capital gains. If I have spent $1 million on land for my ranch and I sell it for $1.2 million, I will pay tax on $200K, and can spend the money with no further consiquences. At 28% capital gain rate my tax would be $56K. Under the Fair tax, when I have spent the $1.2 mil., I will have paid a tax of $276K, not to mention that tax has already been paid on the $1Mil. when it was earned.

The thing I think you fail to grasp is, retirees are not in the mode of acquiring more wealth that would no longer be taxed, but are instead in the mode of spending the wealth that they have acquired and paid tax on. You propose to increase their burden by 23%.

As for your attempt to appeal to my conscience:

“Are you willing to sacrifice the opportunity for future generations not to have their wealth taxed to avoid your perceived double taxation?”

First, double taxation is not a perception with the Fair Tax with regard to accumulated capital, it is a fact.

As for the future generations, especially the idiots that voted this communist into office, I am not prepared to wreck the security of my family to right their ship. I am obligated to not support anything that will put them further into debt on the spending side of the equation and will act accordingly. I would gladly sacrifice social security, which I never expected to collect anyway, and Medicare, which has done nothing but screw up my hospitalization plan that I already had in place (it used to pay virtually all claims after deductible and now pays nothing if Medicare elects to deny their portion).

The solution to their problem (future generations) is: Abolish the income tax, rein the federal government back into the restraints of the Constitution, seat Senators through the respective state legislatures and never let the federal government out of that box again! See Papabear post # 29.

Taxes are not for controlling spending, that is a strawman.

Someone should have told that to founding father and first Secretary of the Treasury Alexander Hamilton before he wrote Federalist Paper #21. To quote an excerpt:

"It is a signal advantage of taxes on articles of consumption, that they contain in their own nature a security against excess. They prescribe their own limit; which cannot be exceeded without defeating the end proposed, that is, an extension of the revenue. When applied to this object, the saying is as just as it is witty, that, "in political arithmetic, two and two do not always make four." If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great as when they are confined within proper and moderate bounds. This forms a complete barrier against any material oppression of the citizens by taxes of this class, and is itself a natural limitation of the power of imposing them."

I’d rather see the IRS gone and a flat tax instead.

We already had a flat tax on income. It's the current income tax code. People were taxed 1% on the first $20,000 of income and 7% on income over $500,000 when the 16th Amendment was enacted in 1913. Less than 1% of the population earned more than $500,000 which means more than 99% were taxed 1%. It was essentially a flat tax on income. Another flat tax on income would morph into the same multi tiered, convoluted, increasingly intrusive and heavy progressive income tax we have today only faster thanks to the thousands of lobbyists that didn't exist in 1913.

There's a reason why Karl Marx included a heavy progressive tax on income as a plank in his Communist manifesto. He understood gradually increasing the tax on productivity will discourage people from being productive and then they will turn to the state for their subsistence.

I'd prefer Flat Tax. Even Fair Tax has too much bureaucracy and exceptions. Flat Tax is much simpler. A simple personal deduction for yourself and dependencies and then one single rate after that. Eliminate all other taxes. Abolish the IRS. But first: CUT GOVERNMENT SPENDING!!! Any and all tax reforms will be meaningless without that first step.

I mostly agree. The government should be constitutionally limited to only 4 sources of revenue: A 10% income tax, a land tax (acreage only, not buildings); loser pays civil trials; and perhaps some infrastructure usage fees.

I don't like the Fair Tax, it hurts cost of production and encourages smuggling from foreign countries.

“The splitting hairs argument only weakens your position. That is money that would otherwise be saved for your retirement. The Fair Tax will remove that tax.”

I don’t know how you define splitting hairs. The principal, or actual savings portion of a savings account is signifacantly more substantial than the current period’s earnings.

And again, I am not saving money for my retirement. I am spending money from my retirement.

So you now tell me: “Wrong again. You won’t be taxed on used items, nor will you be taxed on necessities up to the poverty level. You are taxed multiple times with every purchase due to corporate income taxes included in the price at each stage of production.”

So here is your advice?: Either pay a second tax on the money you have already paid tax on, cause we are changing the rules or buy all of your stuff second hand and /or live under the poverty level.

That’s very nice of you.

My response: F. Y.

As for the so called Corporate Income Tax that you claim is imbedded in the cost of all products, I believe this is a dream fostered on the public. Having spent over twenty years in the tax department of a major corporation I can tell you that the goal of the corporation was always net book income. Corporate taxes are paid on Net Taxable Income. Anything that adds to the bottom line of a corporation is a resource to pay those taxes. Corporations pay a lot of money to tax professionals in an effort to defer taxes on book income, through timing differences, such as depreciation and depletion but the market is the detemining factor in the price of goods and services. I will grant that payroll and excises taxes are imbedded factors, but not income tax, which is a tax paid on profit.

I reiterate, I am not being taxed on savings.

Your reiterations don't change the fact the money going to Uncle Sam will remain in your savings account for you to spend under The Fair Tax.

The thing I think you fail to grasp is, retirees are not in the mode of acquiring more wealth that would no longer be taxed, but are instead in the mode of spending the wealth that they have acquired and paid tax on. You propose to increase their burden by 23%.

Oh really? You better tell that to my 84 year old father and my brother who are both retired and still invest. My father has been doing so for many years and has accrued a done well over many years. He would have amassed more if his capital gains weren't taxed.

I am not prepared to wreck the security of my family to right their ship. I am obligated to not support anything that will put them further into debt on the spending side of the equation and will act accordingly.

The income tax has been wrecking people's security for decades and is doing so now at an increasing rate. The Fair Tax will reduce their overall tax burden, ensure they are not paying taxes for corporations via embedded taxes and restore more power to them by giving them more choice as to when and how often they are taxed.

The solution to their problem (future generations) is: Abolish the income tax, rein the federal government back into the restraints of the Constitution, seat Senators through the respective state legislatures and never let the federal government out of that box again!

The first part of your statement just described the effects of The Fair Tax! The latter part cannot be accomplished by any tax code. That is a separate issue.

"I’d rather see the IRS gone and a flat tax instead." The IRS would still have to be there to verify or audit returns for income so they would not be gone. The income tax started as a single rate and grew into the monstronsity that we have now. The FT is uncomplicated unless you try to make it complicated. One rate. New goods and services only. Paid at the register. Perfect? No. Cheating? Sure, but I doubt that it would be close to what we have now. My fundamental objection to the Income Tax is that it is fundamentally unamerican and unfair.

“I don’t like the Fair Tax, it hurts cost of production and encourages smuggling from foreign countries.”

Would you be so kind as to explain why you believe that? Everything that I have read about the FairTax says the opposite.

The tax is collected at the register so how would smuggled goods hurt anything?

The removal of taxes on business would make the US a haven for business and manufacturing. I don’t see how removing the cost of taxes is going to hurt the cost of production.

And opening up a new bureaucracy to handle the rebates every month is what?

Oh sure, it may begin smaller, but what bureaucracy hasn't grown when government is involved?

And on those rebates, what makes you think poor families can afford 30 cents on the dollar for their milk and groceries, while they wait on their monthly rebate checks?

What is the expense of sending out and managing those monthly rebate checks?

And, no cheating? There is no such thing as anything uncheatable.

It's a pipe dream at best.

No new bureaucracy is needed, large or small. The SS administration is already cutting checks so this will not be a huge task.

The IRS will be gone. Any small positions will be minor and no where near as oppressive and intrusive.

The PREbates come at the beginning of the month.

I didn’t say there won’t be any cheating. There will always be those who cheat. This system will make that cheating more difficult and minor compared to what is going on now. The FairTax expands the tax base and the base of tax payers. Right now, almost half of the people do not pay an income tax, nor does the criminal element, illegals, and tourists. They will all pay under the FT.

What do you see so worthwhile in keeping the present system?

I think what scares the daylights out of the people insider the Beltway about FairTax comes to these points:

1) It would drastically reduce the size and power of one of the most powerful agencies in the US government, the Internal Revenue Service division of the Department of Treasury.
2) It would eliminate the most insidious form of corruption: the "tweaking" of the Internal Revenue Code with influence from tax lobbyists and Congress with wording that could literally affect as little as ONE taxpayer! That means no more using the tax code to affect economic outcomes.

In short, the passage of FairTax and the repeal of the 16th Amendment would be the more dramatic change of power in government since the American Revolution itself.

And, the SS Administration will continue cutting checks, no? So, do you propose just tripling their workload?

And, why PREbates at all? Or, did you miss that if an individual does not file the necessary papers every month, they do not receive such?

There is nothing I like about he IRS currently. However, I can’t see junmping out of hte frying pan and into the fire just because someone else has a long standing grudge against them.

And again, you forget that the so-called ‘Fair’ tax is only on new items.

What stops people who hate paying taxes, like most all of us, from walking away from purchases of new items and going for used cars, homes or what have you?

Sounds too like there will be a very lucrative black market.

Your so-called “fair’ tax is billed as “revenue nuetral,” meaning it is expected to bring in no more taxes than is currently paid in.

So, what’s the advantage?

The workload will not triple. The hardest part will be to enter the database of eligible households. After that, push a few buttons to issue the checks. It’s not like someone will be writing the checks by hand.

I didn’t miss that at all. That you have to register is the beauty of it. if you don’t want to be on the list, you’re not on the list. And you don’t file every month. You file once and then only if there is a change in the number of your household residents.

A grudge. That’s what you think this is, a grudge? The IRS is one of the most evil, intrusive, unamerican things that our ‘representatives’ ever imposed on us. The Founders would have sent them packing with hot tar and feathers attached.

In my post at #49, I clearly stated that the tax is only on new products and services. I missed nothing. Some people will only buy new as they do now. Some will only buy used as they do now. Some will change their buying patterns. So what?

What evidence do you have for a black market?

The prebate and the revenue neutral components are to help ensure passage of the law. If the poorest are hit harder then others, it will be demagogued. If the revenue is not there, it will be demagogued.

Remember, this is a revenue bill, not a spending bill. They are separate by design and law. The advantages of this plan are that the base is widened, we have our whole paycheck (except state and voluntary deductions) and we decide if and when we pay takes. We also restore our privacy and take a step to returning to ‘innocent until proven guilty’. That concept has been totally trashed by the IRS.

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