Saturday, December 1, 2007

The "Fair" Tax

Republican Presidential candidate Mike Huckabee recently endorsed the "Fair Tax." The "Fair Tax," which you can read in detail about here, is a proposal to repeal federal income tax, payroll tax, estate tax, and a bunch of other taxes, and replace them all with a 23% federal sales tax. The IRS could be abolished, and people would pay taxes only on what they spend, not on what they save.

Everyone would also get a "prebate" of the tax equal to the amount of tax that a poverty-level household would pay. The prebate is determined solely by household size, not by income -- for example, every married couple with two children would get an annual prebate of $6,297. The alleged advantage of the prebate is that it would, supposedly, make the Fair Tax progressive -- poor people would pay hardly anything, and middle-class people would pay a lower percentage of their spending in tax than rich people.

I'm not really expert enough to evaluate the Fair Tax in all its detail, but I can tell you one thing: the whole concept is based on a big, fat lie. The Fair Tax website prominently states and many times repeats that the Fair Tax is "progressive." Nonsense.

The website makes this claim because, under the Fair Tax, the wealthier you are, the more tax you would pay, when the tax is considered as a percentage of your spending. But they hide the fact that they wealthier would be likely to pay less when the tax is considered as a percentage of income.

The wealthy generally spend less of their income than the poor or middle class, and the Fair Tax taxes only spending, not saving. Therefore, under the Fair Tax, the wealthy would likely pay less tax as a percentage of income. Maybe a lot less.

Let's do an example. Alice and Bob are a two-earner couple with two children. Between them, they make $100,000 per year. Because raising kids is expensive, they have to spend most of their income. Let's imagine they manage to save $10,000 and spend $90,000. They pay 23% x $90,000 = $20,700 in tax. After their rebate of $6,297, their net tax is $14,403. That's 16.00% of their spending, and it's 14.40% of their income.

Now, Carol and David are also married with two kids, but Carol is a partner at an investment bank and makes $10,000,000 per year. David doesn't work. Living rich is expensive, but they've got so much money they manage to save $5,000,000 of their income and they spend $5,000,000 (I could live pretty well spending $5,000,000 per year, couldn't you?). They pay a tax of 23% x $5,000,000 = $1,150,000. The get the same $6,297 rebate (a trivial sum for them), after which their net tax is $1,143,703.

Now, the Fair Tax people want you to focus on how much tax Carol and David pay as a percentage of their spending. And yes, as a percentage of spending, Carol and David pay 22.87% -- notably higher than Alice and Bob. But look at their tax as a percentage of income. Because they can save half their income, Carol and David's tax is just 11.44% of their income! That's substantially lower than Alice and Bob's tax as a percentage of income.

And if Ellen and Frank, another married couple with two kids, are super-rich, make $100,000,000, and spend $25,000,000 (saving $75,000,000), they'd pay 23% x $25,000,000 = $5,750,000 in tax, or $5,743,703 after their rebate. That's 22.97% of their spending but just 5.74% of their income!

So it seems to me that the "Fair Tax" is likely to be highly regressive. The Fair Tax website touts the tax as progressive many times based on tax paid as a percent of spending. But I don't see a word about tax paid as a percent of income.

In my opinion, that's fundamentally dishonest. It causes me to distrust the whole website. When people are promoting a highly regressive tax as progressive, I would say, stop right there. The whole thing is immediately suspect.


Anonymous said...

Interesting. I saw a Huckabee tv ad about "putting the IRS out of business" and I didn't know what that referred to.

KipEsquire said...

Let's begin at the beginning: The tax is 30%, not the 23% lie that its proponents keep trying to foist on the uninformed (i.e., "0.3/1.3=0.23" is a 30% tax, not a 23% tax).

Second, for the program to be revenue-neutral the tax would actually have to be around 44% -- assuming:

--zero tax avoidance/evasion;

--the (unlikely) constitutionality of trying to apply the federal sales tax to purchases by state and local governments;

--the taxation of financial services, including, e.g., the interest you pay on your mortgage (since the bank "sold you" financial services).

All in, a more realistic revenue-neutral tax rate has been estimated, by non-partisans, to be as high as 82% Splendid.

Third, how is that "prebate" to be administered without an IRS? And who would dare suggest that politics wouldn't enter into it (cf., DOMA's proscription against joint tax returns for same-sex couples)?

Finally, who is naive enough to believe that we could go from a federal income tax today to a federal sales tax tomorrow and not end up having both the day after tomorrow?

Bottom line: The devil you know...

Anonymous said...

Well it seems there's a slim chance Congress would ever get behind this plan. Also, don't you think it would be bad for the economy? If items cost 30% more in the stores I think people will buy much less due to sticker shock, even if they supposedly will have more money to spend. And will mortage, rent, and health insurance be taxed?
This would sure put a lot of tax lawyers out of business.

Anonymous said...

First off, your argument is very flawed. The "super" rich don't usually "earn" 100,000,000 per year but are most likely worth 100,000,000 and pay no taxes on that since they are taking no income! That's right. They most likely take a 0 salary and receive payment in stock options if they even work at all. That being said, 30% income tax on $0 is...well..$0 dollars. If we are lucky they pay the 15% capital gains on sale of property / stock or receiving dividents. But that's pretty much as high as most "super" rich pay. Meanwhile, the middle class is paying 20-30% of their income now and the "super" poor pay very little. So, what we have currently is a nice little bell curve, kicking the hard working, tax paying citizens of the country every year, which most politicians are not willing to admit.