Sunday, December 2, 2007

More on "Fair Tax"

One of the comments on yesterday's entry made a good point (actually, several good points but I'm just going to highlight one of them).

The comment by Kipesquire points out that the claim by Fair Tax proponents that the Fair Tax would impose a federal sales tax of 23% is somewhat misleading. To their credit, the Fair Tax people at least acknowledge this point on their website (they don't acknowledge the regressivity point anywhere that I can see). Under the Fair Tax, if you spent $1 at a store, 23 cents of that dollar would be paid by the store to the federal government as tax. This is the basis for the Fair Tax people's statement that the Fair Tax rate would be 23%.

But as even they acknowledge, sales taxes are usually quoted on a "tax exclusive" basis; that is, they are quoted as a percentage of the cost of the underlying goods, not as a percentage of a price that includes the tax itself. What's really happening in this example is that you are spending 77 cents on some item and paying 23 cents in tax on that item. If you went to a store today and bought a 77-cent item and paid 23 cents in tax, we would normally say that the tax rate is 23/77 = 30%, not 23/100 = 23%. So it would be more straightforward (although less politically appealing) to present the "Fair Tax" as a 30% sales tax.

So when I said yesterday that my hypothetical couple Alice and Bob earned $100,000, saved $10,000, spent $90,000, and paid 23% of $90,000, or $20,700 in taxes, it's important to realize that the $20,700 is part of the $90,000 they spent. They got $69,300 worth of goods and paid $20,700 in taxes on those goods. On the more normal "tax exclusive" basis, one would say they paid a tax of $20,700/$69,300 = 29.87%. After their $6,297 rebate, their tax would be 20.78% of their spending. The richer C&D paid 29.70% of their spending (after rebate), and the even richer E&F paid 29.83% (after rebate).

Thus, under the Fair Tax, one's tax, quoted on a "tax exclusive" basis, would asymptotically approach 30% of one's spending, the more one spent.

But yesterday's main point was that it's extremely misleading to call a tax "progressive" when the rich would in all likelihood pay less of it as a percentage of their incomes. As noted yesterday, rich people can save a much higher percentage of their incomes than middle-class people. (Indeed, my hypothetical Alice and Bob's ability to save 10% of their $100,000 income while raising two kids is prodigious, given that real Americans often save less than nothing.) Because the "Fair Tax" would tax only spending, not savings (and it also taxes only consumer spending, not spending that represents business investment), rich people, as shown yesterday, could easily pay a lower percentage of their incomes in tax than middle-class people, thus piling up savings on which they could earn even more income on which to pay an even lower tax rate. I just can't trust people who fail to acknowledge this basic point.

5 comments:

Dutchman3 said...

Since you are a law Prof., maybe you could comment on whether or not it would be constitutional for the federal government to tax state and local governments operations? My understanding is that our republican form of government will not allow one sovereign power (federal) to tax the other sovereign power (state)under the doctrine of "intergovernmental tax immunity.

In the same vein, the current plan shifts almost 25% of the funding required to run the federal government to the state and local government agencies. Anyuone thaty thinks that the Fairtax is simple and transparent seems to not understand that point. And state and local taxes can be estimated to rise by 30% in order to pay the federal tax. Is that fair???

Dutchman3 said...

Since you are a law Prof., maybe you could comment on whether or not it would be constitutional for the federal government to tax state and local governments operations? My understanding is that our republican form of government will not allow one sovereign power (federal) to tax the other sovereign power (state)under the doctrine of "intergovernmental tax immunity.

In the same vein, the current plan shifts almost 25% of the funding required to run the federal government to the state and local government agencies. Anyuone thaty thinks that the Fairtax is simple and transparent seems to not understand that point. And state and local taxes can be estimated to rise by 30% in order to pay the federal tax. Is that fair???

Paul said...

The rich already find ways to not pay taxes, since "income" is taxed and not investments in aquiring capital. So the rich find their way anyway. I don't think they're is a reason to mistrust something that is so simply explained. I would be willing to try the Fair tax. I think it will help all of us in the long run, and at least its something different to do. Why not?

Paul said...

The rich already find ways to not pay taxes, since "income" is taxed and not investments in aquiring capital. So the rich find their way anyway. I don't think they're is a reason to mistrust something that is so simply explained. I would be willing to try the Fair tax. I think it will help all of us in the long run, and at least its something different to do. Why not?

Jim Bennett said...

Actually there was a study performed showing that the Fair Tax can rightfully claim to be progressive. See study by Economist David G. Tureck, together with Bachman, Haughton, Sanchez-Penalver and Ngo entitled "A Distributional Analysis of Adopting the Fair Tax: a Comparison of the Current Tax System and the Fair Tax Plan," the Beacon Hill Institute at Suffolk University, February 2007.

In this study, Tureck used real-world economic models to compare the progressivity of the Fair Tax with several existing taxes, giving each a score between zero and one. At 0.62 the Fair Tax came in just slightly behind Estate and Gift Taxes for progressivity and comfortably ahead of the Individual Income Tax, Corporate Tax and Payroll Tax.

I would refer you to that study, on whose basis the Fair Tax can rightly claim to be progressive.

~Jim Bennett
Summit, NJ