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Promote Sustainability by Rethinking the Income Tax?

Steve Puma | Thursday June 7th, 2007 | 24 Comments

fairtax.jpgAs a first-semester student in Presidio School of Management’s MBA in Sustainable Management program, I’ve been learning quite a bit about what sustainability really means, and what it will take for business and our economy to become sustainable. One topic that gets discussed quite a bit is how to encourage people and business to use natural resources more efficiently, while encouraging them to use more of the one resource that isn’t in short supply: human labor. Inevitably, the discussion turns to tax policy, specifically, how the US income tax system makes labor more expensive while discouraging savings and encouraging consumption. One professor suggested that a possible solution is to stop taxing labor and begin to tax things that we want less of, like carbon emissions.
This really caught my attention, because I have been a long-time advocate of the FairTax legislation, which would replace the Federal income tax and payroll taxes, and many other federal taxes with a consumption tax. It occurred to me that enacting the FairTax would, in addition to a myriad of other benefits, solve one piece of the puzzle, namely untaxing labor and making labor more attractive in the marketplace. I also realized that there are a number of other benefits of the FairTax which apply to sustainability, such as encouraging savings and discouraging consumption, encouraging purchases of used items (re-use), encouraging investment in education, and creating a safety net for the poor. In the remainder of this article, I will explain how the FairTax can be a positive tool in the effort to make the U.S. more sustainable.


I would like to start by stating a couple of things straight away: I am currently a volunteer community coordinator for American for Fair Taxation, the organization whose mission it is to get the FairTax bill passed, and, as such, I would not consider myself a disinterested observer by any means. I am very passionate about changing our tax system.
Secondly, I do not believe that the FairTax is some “magic bullet” that can solve all sustainability problems. I firmly believe that enacting the FairTax is the first step in moving towards a tax system that works positively for people and the environment. It will mostly affect labor and consumption. I believe that the next step would be to start implementing taxes on natural capital, so-called “eco-taxes“, so that the price of finished goods more accurately reflects their real cost to society and the environment. If eco-taxes were done right, the FairTax rate could be gradually reduced as these new systems are implemented, and the final price of goods could stay the same, and would accurately reflect their “true” price.
I also want to mention that the FairTax does not try to address waste in government spending. (It only removes the waste from income tax collection) It is designed to be “revenue-neutral”, so that it exactly replaces the current levels of government spending. What this means is that under the new system, all government expenditures would be fully funded, including Social Security and Medicare. While these are important issues that need to be addressed, the writers of the legislation felt that they would overly complicate things, and make it impossible to otherwise implement the needed tax reforms.
The FairTax legislation is a nonpartisan effort to create a simple, fair and transparent tax system which does not favor any particular ideology. Here is a particularly good explanation of the FairTax from Wikipedia.org:

The FairTax (H.R.25/S.1025) is a proposal in the United States Congress for changing tax laws to replace the Internal Revenue Service (IRS) and all federal income taxes (including AMT), payroll taxes (including Social Security and Medicare taxes), corporate taxes, capital gains taxes, gift taxes, and estate taxes with a national retail sales tax, to be levied once at the point of purchase on all new goods and services. The proposal also calls for a monthly tax rebate to households of citizens and legal resident aliens, to “untax” purchases up to the poverty level. The sales tax rate, as defined in the legislation, is 23% of the total register price (23¬¢ of every $1 – calculated the same way as income taxes), which is comparable to a 30% traditional state sales tax (30¬¢ on top of every $1). Because the U.S. tax system has a hidden effect on prices, it is expected that moving to the FairTax would decrease production costs from the removal of business taxes and compliance costs, which is predicted to offset a portion of the FairTax effect on prices.

Due to the rebate, the effective tax rate is progressive on consumption and could result in a tax burden of zero or less…the plan’s supporters argue that it would increase purchasing power, and decrease tax burdens by broadening the tax base and effectively taxing wealth. Many mainstream economists and tax experts believe consumption taxes, such as the FairTax, would have a positive impact on savings and investment (not taxed), ease of tax compliance, increased economic growth, incentives for international business to locate in the U.S., and increased U.S. international competitiveness (border tax adjustment in global trade).

The FairTax bill was first introduced into Congress in 1999, and has been re-introduced in each successive congress, substantially unaltered. The FairTax has been the most successful tax reform legislation to date, garnering 56 co-sponsors in the 108th Congress, 61 in the 109th, and 64 in the 110th Congress (2007).  By comparison, the Freedom Flat Tax bill, has only 4 cosponsors in the 110th Congress.  Very recently, several 2008 presidential candidates have expressed support for the FairTax.

I am sure you are painfully aware of the many problems with the IRS and the income and payroll tax system in general, so I will not bore you with a lengthy discussion of those. This article give a good overview of the costs of compliance inherent in the current system and this article talks about the origins of the income tax.

The greatest benefits of moving away from an income and payroll tax based system lie in the effects on wage earners. Under the current system, employees have income and payroll taxes (social security and medicare) deducted from their paychecks, before they get a chance to decide what to do with that money. In addition, employers pay a share of payroll taxes which is equal to the amount that employees pay. Since this costs is borne fully by the employer, this
essentially a tax on labor. The effects of a labor tax are decreased employment, decreased pay and increased prices on goods. It should also be noted that payroll taxes disproportionately affect low- and middle- income workers, because the tax is only applied to the first $90,000 of wages. By eliminating the income and payroll taxes, real wages will increase, employment will increase as the cost of labor goes down, and consequently, the price of goods will decrease as well.
My personally favorite benefit of the FairTax is having more control over how much tax I pay and how much I can save. By eliminating the income and payroll taxes, and enacting a sales tax, I now have taken back control of my money from the government, who currently considers it “their” money first. Now, I don’t have to worry about 401(k)s, medical savings plans, etc., because everything is now pre-tax!! Now, if I want to save my money to buy a house, I can save as much as I want, and not have to pay any tax on it, at least until I buy the house (if it’s used, I won’t have to pay any tax…more on that later). If I simply want to pay less taxes, I can endeavor to purchase less. So, you can see how keeping the income tax in place is discouraging people to save, which, in turn, encourages them to consume more, and we all know that consuming more is a bad thing.
Encouraging people to reuse products instead of purchasing new products is a great way to reduce waste and also resource consumption and emissions, because reuse removes the demand for a new product and also keeps a previous product from being disposed of.  By only taxing new goods, and only taxing them once at the initial point of purchase, the FairTax will create a new incentive for consumers to purchase used goods, including houses which are not new construction.
When many people think about a sales tax, they assume that the sales tax will not be progressive, and will negatively affect the poor, since poor people spend a much higher percentage of their income on necessities.  This is not so under the FairTax plan, because each legal taxpayer in the U.S. will receive a monthly check, called the “prebate”, for the amount of tax they would pay on purchases up to the poverty level of spending.  This would protect all families from paying sales tax on the necessities of life.  Thus, a couple with two children receives a prebate of $6,297 per year, allowing them to consume $27,380 free of tax and reducing the effective tax rate on a family spending $54,760 to 11.5 percent. In contrast, all families today, even the poor, pay 15.3 percent in payroll taxes. The FairTax is the only tax reform plan that entirely eliminates taxes for the poor because it is the only tax reform plan that repeals the high and regressive payroll tax. In addition, taxpayers who earn well below the poverty level wage will see their effective tax rate drop, up to the point where they actually have a negative tax rate. This is commonly known as creating a “floor” for the worst off in our society, such as homeless persons, by providing them with a basic level of income.
The FairTax considers education to be an investment, and, as such, is not taxed. This makes it much easier for people to afford to pay for college, and, with the previously mentioned incentive to save, helps them to save for college as well.  In creating a sustainable world, we want to begin to use people more instead of natural resources, and I can think of no better way to do this than by having more people go to college.
On a final note, elimination of the IRS and the income tax, and implementing a consumption tax will have one very direct environmental impact: a massive reduction in the use of paper. Reportedly, the IRS sends out 8 billion pages of forms and instructions each year. Laid end to end, they would stretch 28 times around the earth. Nearly 300,000 trees are cut down yearly to produce the paper for all the IRS forms and instructions. A consumption tax, administered by the states, has a much smaller bureaucracy and a greatly reduced need for paper consumption.
There are so many benefits to a consumption tax over an income tax, and so many detriments to the IRS and our current tax system that I could go on indefinitely, which, I’m sure would bore the pants off of you! You may also find that a lot of my points may bring up more questions than they answer. I will gladly answer any and all questions which you may have.
I find that the income tax challenge seems as insurmountable as the sustainability challenge. I would like to put forth that they are actually the same struggle, the struggle for a fair and equitable world, with an economy that takes into account the real costs of production to the world when it prices its goods.
spuma@presidiomba.org
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Steve Puma is currently pursuing an MBA in Sustainable Management from Presidio School of Management while also working as an IT consultant in San Francisco. Steve’s interests include green building, New Urbanism, renewable energy and thinking about the big picture.
He is also a big supporter of the FairTax Act of 2007, which abolishes the IRS and replaces it with a national retail sales tax.


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  • jankdc

    Thanks for writing this piece. It helped summarize the fair tax website from an environmentalist point of view. One mainstream criticisms for a sales tax is that it would keep people from purchasing goods, causing a recession. How would you reply to that?

  • Steve Puma

    jankdc:

    As a matter of fact, the current research shows that there would be a boom in the economy if the FairTax was enacted. I am not an economist, so I can only give a very condensed notion of how this will work. For full details, you should check out the extensive research located on the FairTax.org website: http://www.fairtax.org/site/PageServer?pagename=about_research_economy

    These are the points that I see:

    -Workers would see their full paychecks, with no taxes taken out. Now, of course, the prices they will pay will have the FairTax added to them, but, because of the effect of embedded taxes in US goods, which can be up to 22% of the cost of US products, those prices will go down.

    The bottom line is that there will be a leveling out effect: Workers will have more money, but goods will cost either the same after tax, or slightly more than before.

    The key to this puzzle is waste: We will be removing trillions of dollars of compliance costs and uncollected taxes from the equation. Removing this huge piece will be a net benefit to the economy as a whole.

    -Removing payroll taxes results in higher employment. More workers=more people who can buy stuff.

    -Wage earners will now have an incentive to save, which ultimately means more purchasing power in the long run.

    -Trillions of dollars which are currently in offshore accounts to avoid US income taxes would no longer have a reason to stay offshore. The US becomes a magnet for investment.

    -US goods become much more competitive overseas and at home, due to the effect of embedded taxes in their prices. When European and other foreign goods leave their countries, the respective companies are refunded for the tax component. Not so with US goods. This means that US goods are less competitive both abroad and at home. The FairTax levels the playing field.

    There’s a lot more. I hope this helps.

  • http://tinyurl.com/7lssy Ian

    Here is why the FairTax will make a good U.S. tax system REPLACEMENT. The FairTax is:

    • SIMPLE, easy to understand
    ‚Ä¢ EFFICIENT, inexpensive to comply with and doesn’t cause less than
    optimal business decisions for tax minimization purposes
    • FAIR, loophole free and everyone pays their share
    • LOW TAX RATE, achieved by broad base with no exclusions
    ‚Ä¢ PREDICTABLE, doesn’t change, so financial planning is possible
    ‚Ä¢ UNINTRUSIVE, doesn’t intrude into our personal affairs or limit our liberty
    • VISIBLE, not hidden from the public in tax-inflated prices or otherwise
    • PRODUCTIVE, rewards, rather than penalizes, work and productivity

    Its benefits are as follows:

    FOR INDIVIDUALS:
    • No more tax on income Рmake as much as you wish
    • You receive your full paycheck Рno more deductions
    ‚Ä¢ You pay the tax when you buy “at retail” – not “used”
    • No more double taxation (e.g. like on current Capital Gains)

    ‚Ä¢ Reduction of “pre-FairTaxed” retail prices by 20%-30%
    • Adding back 29.9% FairTax maintains current price levels
    • FairTax would constitute 23% portion of new prices

    ‚Ä¢ Every household receives a monthly check, or “pre-bate”
    • Pre-bate equals payback for taxes on spending to poverty level
    ‚Ä¢ FairTax’s pre-bate ensures progressivity, poverty protection
    • Finally, citizens are knowledgeable of what their tax IS
    ‚Ä¢ Elimination of “parasitic” Income Tax industry

    • NO MORE IRS. NO MORE FILING OF TAX RETURNS by individuals
    • Those possessing illicit forms of income will ALSO pay the FairTax
    • Households have more disposable income to purchase goods
    • Savings is bolstered with reduction of interest rates

    FOR BUSINESSES:
    • Corporate income and payroll taxes revoked under FairTax
    ‚Ä¢ Business compensated for collecting tax at “cash register”
    • No more tax-related lawyers, lobbyists on company payrolls
    • No more embedded (hidden) income/payroll taxes in prices
    • Reduced costs. Competition Рnot tax policy Рdrives prices
    ‚Ä¢ Off-shore “tax haven” headquarters can now return to U.S
    ‚Ä¢ No more “favors” from politicians at expense of taxpayers
    • Resources go to R&D and study of competition Рnot taxes
    • Marketplace distortions eliminated for fair competition
    • US exports increase their share of foreign markets

    FOR THE COUNTRY:
    • 7% Р13% economic growth projected in the first year of the FairTax
    • Jobs return to the U.S.
    ‚Ä¢ Foreign corporations “set up shop” in the U.S.
    ‚Ä¢ Tax system trends are corrected to “enlarge the pie”
    ‚Ä¢ Larger economic “pie,” means thinner tax rate “slices”
    ‚Ä¢ Initial 23% portion of price is pressured downward as “pie” increases
    ‚Ä¢ No more “closed door” tax deals by politicians and business
    • FairTax sets new global standard. Other countries will follow

  • Katie Excoffier

    This really does seem like an effective way of encouraging reuse and discouraging waste. I have a few questions…
    I assume under this plan that service costs are not taxed, right? If I pay someone to fix my car, do I only pay taxes on the parts? If I pay someone to build a bookcase for me, do I only pay taxes on the wood? But if this same guy wants to build a bunch of bookcases in his shop and sell them, then do his customers have to pay tax on the whole purchase price (materials and labor)? If so, then does this discourage efficient production of new goods? Would people start buying their own materials and then pay someone tax-free to make the product for them?
    You said you pay taxes on new goods once, at the initial point of purchase, so on my bookcase example above, did the carpenter pay the tax on the wood when he first bought it, or do I pay taxes after he delivers it to me? What if I intend to paint the bookcase and resell it? Do I pay tax on the bookcase and the paint, and then the purchaser of my painted bookcase doesn’t pay tax? Will this lead to loopholes in the tax system whenever there is a supply chain involved? Who will control this?

  • Steve Puma

    Katie,

    I may not have been totally clear. Services are taxed, so you would pay tax on doctor visits, lawn maintenance, etc. The point is to not “choose winners…everything is taxed the same.

    I also did not mention that legal businesses would be able to purchase goods tax-free, as long as those goods were to be re-sold or used in the creation of goods to be re-sold. This is already commonly practiced by most businesses, in the case of state sales tax, so this would simply extend to federal sales tax.

    To do anything else would cause multiple-taxation, as would taxing re-sold goods.

    The FairTax also includes a provision that businesses can get a tax credit for current inventories when the tax is implemented, because those goods already have a tax component from the income tax, which would be double-taxation.

  • Lawnspar D

    Does the income tax really tax labor? It’s the earners that bear that tax not the employers isn’t it? Or are you saying that if there were no income tax, everyone’s wages would drop? (the gross wage, I mean. The after-tax wage might actually go up to something in between the original ‘take-home’ wage and whatever is coming out of the employer’s pocket). That would be interesting indeed….

  • Steve Puma

    To be very clear, there are 2 different taxes, the income tax, which only the employee pays, and the payroll tax, covering Social Security, etc., which is paid by both the employer and the employee.
    You may be unaware that every employer has to match the payroll tax for every employee. If you are self-employed, then you pay twice the employment tax, to cover both sides. So this is a direct tax on labor, and makes employing people more expensive.
    In addition, while the income tax itself is not a direct tax on labor to the employer, the cost of compliance involved with deducting taxes from every paycheck could also be considered a tax to the employer.
    The income tax, by taxing wage earners more the more they work, and only taking wage earners and not wealth and spending, is a disincentive to work and a disincentive to save for the wage-earner.
    Lastly, the government should not be in the business of keeping records of citizen’s financial life, in order to collect taxes. The FairTax removes all of this spying by the government.

  • Fiona

    If there were a national sales tax… perhaps it could actually be included in the displayed price of items so that you’re not constantly guessing about the price…. ie that a 99 cent product actually costs $1.08… I guess that’s wishful thinking as the states would keep doing it… god that annoys me!

  • Steve Puma

    Fiona,
    Reason why the FairTax doesn’t do that is that they want you to know exactly how much your government is costing you, and to be aware of it every time you shop.
    If it is hidden in the price, the we will have the same problem of lack of transparency which we have now.
    One of the ultimate goals of the FairTax is to wrest control of the government from the lobbyists and give it back to the taxpayers. This should also reduce government spending, by making people more aware.

  • http://tinyurl.com/7lssy Ian

    Here is a concise view of why the FairTax will make a good U.S. tax system REPLACEMENT. The FairTax is:

    • SIMPLE, easy to understand
    ‚Ä¢ EFFICIENT, inexpensive to comply with and doesn’t cause less-than-optimal business decisions for tax minimization purposes
    • FAIR, loophole free and everyone pays their share
    • LOW TAX RATE, achieved by broad base with no exclusions
    ‚Ä¢ PREDICTABLE, doesn’t change, so financial planning is possible
    ‚Ä¢ UNINTRUSIVE, doesn’t intrude into our personal affairs or limit our liberty
    • VISIBLE, not hidden from the public in tax-inflated prices or otherwise
    • PRODUCTIVE, rewards, rather than penalizes, work and productivity

    Its benefits are as follows:

    FOR INDIVIDUALS:
    • No more tax on income Рmake as much as you wish
    • You receive your full paycheck Рno more deductions
    ‚Ä¢ You pay the tax when you buy “at retail” – not “used”
    • No more double taxation (e.g. like on current Capital Gains)
    ‚Ä¢ Reduction of “pre-FairTaxed” retail prices by 20%-30%
    • Adding back 29.9% FairTax maintains current price levels
    • FairTax would constitute 23% portion of new prices
    ‚Ä¢ Every household receives a monthly check, or “pre-bate”
    • Pre-bate equals payback for taxes on spending to poverty level
    ‚Ä¢ FairTax’s pre-bate ensures progressivity, poverty protection
    • Finally, citizens are knowledgeable of what their tax IS
    ‚Ä¢ Elimination of “parasitic” Income Tax industry
    • NO MORE IRS. NO MORE FILING OF TAX RETURNS by individuals
    • Those possessing illicit forms of income will ALSO pay the FairTax
    • Households have more disposable income to purchase goods
    • Savings is bolstered with reduction of interest rates

    FOR BUSINESSES:
    • Corporate income and payroll taxes revoked under FairTax
    ‚Ä¢ Business compensated for collecting tax at “cash register”
    • No more tax-related lawyers, lobbyists on company payrolls
    • No more embedded (hidden) income/payroll taxes in prices
    • Reduced costs. Competition Рnot tax policy Рdrives prices
    ‚Ä¢ Off-shore “tax haven” headquarters can now return to U.S
    ‚Ä¢ No more “favors” from politicians at expense of taxpayers
    • Resources go to R&D and study of competition Рnot taxes
    • Marketplace distortions eliminated for fair competition
    • US exports increase their share of foreign markets

    FOR THE COUNTRY:
    • 7% Р13% economic growth projected in the first year of the FairTax
    • Jobs return to the U.S.
    ‚Ä¢ Foreign corporations “set up shop” in the U.S.
    ‚Ä¢ Tax system trends are corrected to “enlarge the pie”
    ‚Ä¢ Larger economic “pie,” means thinner tax rate “slices”
    ‚Ä¢ Initial 23% portion of price is pressured downward as “pie” increases
    ‚Ä¢ No more “closed door” tax deals by politicians and business
    • FairTax sets new global standard. Other countries will follow

  • FairTax Critic

    Steve —
    Dig a little deeper.
    1. The FairTax rate will probably need to be 50%-60% (at the federal level; 10%-20% higher when you add state/local taxes.) Even Kotlikoff (a FairTax supporter) claims the sustainable rate would need to be at least 36%, and this rate does not factor in any tax avoidance (see below) or state and local taxes.
    2. There will massive (legal) tax avoidance. Or, as you put it, people will have control over how much taxes they pay. I suspect they will choose to pay as little as possible. Thus, who is going to buy a brand new home and pay the tax associated with that home? Answer: Nobody will. What will that do to the required tax rate? What will that do to the construction industry?
    3. Yes, the FairTax is regressive. All the pre-bate does is (a) increase the required tax rate, since the government now needs more money to pay for the rebate, and (b) push the brunt of the tax burden up a notch onto the backs of the middle class, who consume a much higher percentage of their incomes on goods and services than do the wealthy.
    I, too, would very much like to see sustainable tax reform, but not the FairTax.

  • Detchoo

    Plus likely causes massive black market in goods from Canada/Mexico

  • http://tinyurl.com/7lssy Ian

    Critic –
    http://www.fairtax.org/PDF/FairTax-Fundamentals_and_facts-070122.pdf
    “The FairTax rate of $0.23 out of every retail dollar spent on new goods or services works.
    The Beacon Hill Institute at Suffolk University and Laurence Kotlikoff, Professor of Economics
    and noted public finance expert at Boston University, recently teamed up to provide a sound
    methodology for estimating the FairTax base and computing the FairTax rate.1 Their report:
    • Demonstrates that the 23 percent rate (as compared to current rate terminology for the
    taxes the FairTax replaces) specified by the Fair Tax Act (HR 25) is eminently feasible.
    ‚Ä¢ Suggests what led Gale2 and the President’s Advisory Panel on Federal Tax Reform3 to
    reach the opposite – and incorrect – conclusion.”
    Perhaps you might find it enlightening to read Dr. Kotlikoff in his own words:
    http://people.bu.edu/kotlikoff/

  • Steve Puma

    I need to address some of these misconceptions head on.

    As Ian stated, you need to read exactly what Kotlikoff said, and he never suggested a higher rate for the FairTax than what is stated.

    The misunderstanding either comes from a misqote of the Federal Commission on Tax Reform, or a misunderstanding of inclusive vs. exclusive tax rates.

    Research has shown that tax avoidance and tax evasion under the FairTax will be much LOWER than under the current system, not higher. It is much easier to cheat under the current system than with a consumption tax, because there are significantly less collection points under the FairTax, it takes two people to cheat under the FairTax, whereas under the current system it only takes one, and the tax base is much broader under the FairTax, making cheating much less significant.

    By the way, states have been successfully managing sales tax systems for many years, with no ill effects to their economies. Two of the largest economies in the world, Texas and Florida, operate exclusively on sales tax revenues.

    We already have MASSIVE tax evasion and avoidance in the country. The IRS is unable to collect HUNDREDS OF BILLIONS of dollars, and the system costs us trillions of dollars in compliance costs. No tax system is perfect, but The FairTax has been show to have significantly lower rates of cheating and avoidance.

    By the way…there is a big difference between avoidance and evasion. Being able to choose between saving and spending is legal and should be encouraged. The FairTax rate has already be calculated to account for this. Tax evasion is illegal, and will decrease under the FairTax.

    As for people not buying houses because of the FairTax…that is ridiculous. It has been proven that the FairTax would be a huge benefit to home ownership. Existing housing accounts for 3/4 of home sales, and proceeds from these sales are usually a prerequisite for new home sales. The FairTax makes saving for and buying existing homes much easier, which will also make buying new homes much easier.

    The FairTax also removes the tax component from the cost of building a new home, so prices of new homes will fall as well.

    Please refer to the following papers:

    http://www.fairtax.org/PDF/TheFairTaxTreatmentOfHousing.pdf

    This one is on why residential realtors support the FairTax:
    http://www.fairtax.org/PDF/WhyResidentialRealtorsSupportTheFairTax.pdf

    And this one is on why the FairTax beats the mortgage interest deduction:
    http://www.fairtax.org/PDF/PromotingHomeOwnership.pdf

    Your statement about the FairTax having a higher rate because of the prebate is true but irrelevant.

    I think we all agree that the better-off in our society should pay slightly more to provide benefits for the less fortunate in our society. That is the hallmark of a good society.

    Our current system take this idea to a ridiculous level, by providing tax incentives not only for the poor, but for every special interest group under the sun. It is so complictaed that those of us who are bearing the burden are hardly aware of it!!!

    The FairTax provides the best of both worlds. If you compare the effective tax rates when you include the prebate, you will find that the tax rate starts at 0% or below for the poorest people, and gradually increases with an increases in earnings (since spedning increases with earnings), but never goes above 23%. This is eminnently fair and equitable.

    And I don’t want to hear that the wealthy will not pay their fair share. The wealthy certainly spend a lot of money in this country, and if you don’t believe me, just come to where I live, Contra Costa County California, and I will show you endless examples of conspicuous consumption. I only have to mention the words BMW, Mercedes, Rolex, Porche, Tiffany, etc. and you will understand what I mean. Try going into an Andronico’s market sometime and see how much people are willing to spend on food….I think the wealthy will pay more than their fair share.

    And so will illegal immigrants, tourists and criminals, who currently pay nothing into the tax system.

  • Alex

    Steve,
    The Fair tax sounds good but I wanted to point out that in your last response you state that illegal immigrants don’t pay taxes. I happen to have a good share of friends who are here illegally and do in fact pay taxes. Please follow this link to a New York times article that reports on this very issue.
    http://www.nytimes.com/2005/04/05/business/05immigration.html?ex=1270353600&en=78c87ac4641dc383&ei=5090

  • Steve Puma

    Alex,
    Thank you for posting that. I actually was unaware of this.
    Ironically, this is just another example of how the payroll tax skews the system.
    I would like to modify my comments to say “And so will tourists, criminals and others who currently pay nothing into the tax system.”

  • FairTax Critic

    Steve —
    Without meaning to be sarcastic, you are proving my point when I say you need to dig a little deeper.
    1. The Beacon Hill/Kotlikoff study was paid for by Americans for Fair Taxation (the primary group behind the FairTax), which doesn’t mean the study is wrong, but that you have to be skeptical of its conclusions.
    2. Even accepting the study as accurate, if you read it carefully you will see that for the year 2007 (the only year studied) a tax rate of 31.8% would leave the federal government with a $473 billion deficit. So, it’s not exactly sustainable. In a later paper, Beacon Hill/Kotlikoff stated that the sustainable rate would be areound 36%. (By the way, I am using tax-exclusive numbers. These are the percentages that will need to be added on top of the price the merchant charges to pay his expenses and earn a profit.)
    3. Even these numbers are suspect. First, they do not take tax evasion and tax avoidance into account. Second, they do not take state and local taxes into account. (State and local taxes are generally about 1/3 of federal taxes; if states get rid of their income taxes and adopt mini-FairTaxes, as they surely would if the FairTax is adopted, the state and local tax will increase the overall tax by about 1/3. So, if the Fairtax is 45% at the federal level, it will increase to around 60% when state and local taxes are added in.)
    4. It does not take two people to cheat under the FairTax; it takes only one. For example, I’m a landlord. I charge you rent, plus the FairTax. I pocket the FairTax (instead of forwarding it to the government). I’m also a lawyer. When I bill you and include the FairTax, how are you going to know that I sent the tax on to the government? Also, if I buy a new car and call it a business expense (so that it is tax-free), how is the government going to prove differently. (No IRS; the burden of proof will be on state taxing authorities.) Under our current system, most income is reported twice — i.e., by our employers and by the employees; by banks and brokerage houses as well as by recipients of interest and dividends. So the vast majority of tax obligations can be easily verified. Most tax-evasion comes in instances where there is not double reporting (i.e., privately owned businesses.) Under the FairTax, there will be no double-reporting at all. Thus, I’m afraid that tax avoidance will increase, rather than decrease under the FairTax.
    5. By the way, you should look at William Gale’s study, the Joint Committee on Taxation’s studies, the ITEP study, and the President’s Tax Reform Commission’s study; each of which concluded the FairTax would need to be much higher than AFFT claims it to be.
    6. If you think that people will not legally avoid paying a 50%-80% tax (or, even a 30% rate) by shifting their purchases to used cars (instead of new cars), existing homes (instead of new homes) and foreign travel (rather than domestic travel), then I’m afraid you don’t know much about human behavior. Of course they will seek to minimize their tax obligations (just as they do now) and that tax avoidance is NOT factored into the Beacon Hill/Kotlikoff study. The other studies I mentioned assume a modest amount of tax avoidance and tax evasion, like around 10% or so (which is much less than under our current system) but acknowledge that actual tax avoidance and evasion will probably be much higher.
    7. Yes, SOME rich folks will still buy new BMW’s ect., but they still consume a much lower portion of their incomes than do the middle class, so the middle class will bear the brunt of the tax.
    8. If you think the embedded taxes will be removed from the cost of building a new home (or anything else), you should re-read the Beacon Hill/Kotlikoff study who explicitly state that prices will NOT drop by the so-called embedded taxes, and, instead, will rise by the amount of the tax. (By the way, they think this is a good thing.) Alternatively, check with Dale Jorgenson, the Harvard economist that AFFT and Boortz tout as having “proved” the embedded taxes will disappear. He’s OPPOSES the FairTax (something they won’t tell you), agrees with Gale about the required tax rate (i.e., 50%-60%) and points out that the only way for the embedded taxes to disappear from the price of goods is if all our our salaries are immediately lowered by the amounts we currently pay in taxes.
    9. Illegals, tourists and criminals already pay taxes when they buy things. (that’s what the so-called “embedded taxes” are.) For example, when a drug dealer buys a new Cadillac, the Cadillac dealer, salesperson and manufacturer all pay income taxes associated with that sale. Under the FairTax, the Cadillac dealer will collect the tax from the drug dealer and remit it to the government. So, the result is the same. The transaction will create tax revenue to the government. (When the drug dealer sales his drugs, he’s not going to pay income tax on the sale, nor will he collect the FairTax from his customers. So that transaction will not yield any tax revenue.)
    Steve, I’m not trying to imply that you are stupid or ignorant or anything else. I’m glad you’re for tax reform and I wish you well on you MBA. I’m just pointing out that the folks that push the FairTax (i.e., Boortz, AFFT, etc.) have an unfortunate tendancy to stretch the truth (to put it mildly) and skip over or dismiss valid criticism of it. The result is that most people who hear about the FairTax get a completely false impression of what it will actually be and do.

  • Saulson

    FairTaxCritic… excellent observations and debate. I’m curious, if the FairTax idea is as troubled as you describe, what’s the motivation for those who back it?
    I mean, is there anything cynical going on in your opinion? Speaking strictly from the point of view of personal motivation, who would benefit from the fair tax?

  • FairTax Critic

    Saulson —
    I obviously can’t speak for everyone, but I’ve had dozens of conversations over the years with FairTax supporters and this is how I would characterize them.
    The overwhelming majority are motivated to improve our tax system. I think we can all agree that the current income tax system is riddled with inefficiencies, unnecesary complexities and unfairness (however you define that). Plus, there is the nagging feeling that some people are getting away without paying what they justly owe.
    Accordingly, most FairTax supporters believe that a consumption tax (a) will increase economic efficiency, (b) be less complex, time-consuming and costly to comply with, and (c) will have greater over-all compliance. Plus, there is the assumption that a consumption tax will expand the tax base and thus bring down over all tax rates. I basically agree with the first three propositions; I don’t really agree with the last one.
    Two other possible benefits of a consumption tax, are (a) it will force retired folks to pay a greater percentage of the cost of their Social Security and Medicare benefits than our current system (which forces younger, working families to bear the brunt of the cost of SS and Medicare, and (b) be an implicit tax on wealth since their will be an immediate, inflationary effect of the FairTax, which will decrease the value of savings.
    These last two items are more controversial, and certainly are not highlighted by most of the FairTax’s most vocal supporters. (Dr. Kotlikoff of Boston University is a notable exception. He will highlight those items as benefits of the FairTax.)
    So, there is economic rationale to support a consumption tax, including the FairTax. What bugs me about the FairTax, is that there are also obvious problems with it (as there would be with any tax reform plan), but the FairTax proponents will not admit to, let alone discuss, those problems. Accordingly, we can’t have a really fair debate on the plusses and minuses of the FairTax vis-a-vis other tax reform ideas. (One place where there is actual debate allowed and encouraged about the FairTax is fairtaxblog.com.) So, most people who hear about and support the FairTax are simply not aware of its faults.
    As to the motivations of the FairTax proponents (as opposed to the supporters), I can’t really say. I think the folks behind AFFT are genuinely motivated by a desire for tax reform, and since this is their “baby” they have a hard time admitting to its problems. (Just as Democrats, for example, had a hard time for years admitting to all the problems with Welfare. Great in theory; terrible in practice.) Certain talk-show hosts and politicians found that they could promote themselves by pushing “tax reform” which has a populist ring to it (as long as nobody looks too hard at the facts). As long as they could convince enouth people the tax rate would be 23%, that prices would not rise, and that everyone would get free money from the government in the form of the “prebate,” they automatically got a number of committed supporters. Thus, they could ride the FairTax to promote their own careers. They are also the ones who fight hardest to keep any real debate on the FairTax to take place, because they know they would lose their gravy train of supporters if the true facts about the FairTax were learned.
    Well, enough of the soapbox. This is just a pet peeve of mine that I’ve had for a long time. I’m all for tax reform; but I’m also for honesty.

  • http://tinyurl.com/7lssy Ian

    Critic,

    If you’d like to consider comparable “sales tax” rates, calculate what people’s income tax rate would be, externalized.
    Read AFFT’s rebuttal of the Tax Panel:
    “The panel failed the American people in the two most fundamental tasks: 1) They failed to define true criteria by which reform should be evaluated; and 2) They failed to grade tax reform plans against those criteria.

    “Instead of the fundamental reforms the panel was charged with developing, they recommended changes that further complicate an already overly complex and impenetrable tax system, that is also too expensive to operate and an unfair burden to taxpayers. This panel failed to address:
    • The estimated $265 billion in current tax compliance costs
    • The routine lobbyist/legislative manipulations of the tax code that ill-serve the national interests
    • The embedded corporate income and payroll tax costs that are hidden from the consuming public
    ‚Ä¢ The truly dramatic advantages of switching to a transparent and simple national retail consumption tax, as detailed by HR 25, the FairTax.”

    More here: Gale Rebuttal
    Perhaps you’d also find it interesting to also listen to Kotlikoff’s opinion of Gale’s work?

    Kotlikoff Tax Foundation Podcast
    Why does it seem that the media (meaning either those with a liberal agenda of “big gov’t,” or those who want “no gov’t”!) want to “sanctify” Gale’s work – the basis for the calculations of which has never been suitably forwarded to Kotlikoff?
    . . . like the tax commission was comprised, and presided over, by other than POLITICIANS who derive their presently tyrannical power over the lives of American families thru confiscation of the fruits of their labor, using the tax code to socially-engineer society (and creating dependent constituencies) thru the granting of tax favors.
    There is no rational defense for continuing a tax on income in light of the research that Americans for Fair Taxation have championed.

    A look at Gale’s “A Note on the Required Tax Rate in a National Retail Sales Tax: Preliminary Estimates for 2005-2014 The Brookings Institution, August 12, 2004

    In another audio interview (I’ve lost track of), Kotlikoff states that Gale’s people did NOT fulfill his request to submit their complete basis for calculations. Curiously, one cannot find Gale’s 1999 paper – to which Gale refers – at the link on the Brookings Institute’s site.

    When one “digs deeper” (contrary to the “hole digging” recommended in previous posts) one can begin to see the inverse relationship between the health of the American economy, and the rise of the debt-driven society (credit cards anyone? don’t you just love Chase’s new “I wanna be free” credit-card-hawking ad campaign? truly Orwellian).

    Deprive American families of their earnings, make them have to jump thru “Return filing” hoops to get their own money back, include penalties and MORE INTEREST (on top of the “opportunity cost” of NOT being paid interest on their withheld funds) and what have you got?? Write the tax code so that brokers need not report to the government the “cost” of a citizen’s stock transaction, merely the ENTIRE GAIN, paving the way for the governments “collection SERVICE” (to serve themselves by) send(ing) out notices dunning disorganized, late filers for the whole amount as taxable – putting them to MORE work jumping through exhausting hoops? And the volume of abuse is untolled. Sheer madness.

  • Steve Puma

    It has taked me a while to compile an accurate reponse to FairTaxCritic’s original post, which I found strangely difficult to respond to because it is worded in such a way as to bring into question many facts about the FairTax.

    His post is pure propaganda, and he has twisted around facts and figures to make the points which he wants to make, and discredit the FairTax.

    The bottom line is that the FairTax has no agenda, except to make our lives easier and our economy better. Here are FairTaxCritic’s comments in italics, and my responses in bold.:


    1. The Beacon Hill/Kotlikoff study was paid for by Americans for Fair Taxation (the primary group behind the FairTax), which doesn’t mean the study is wrong, but that you have to be skeptical of its conclusions.


    – Kotlikoff is the top economist at Boston University and Beacon Hill is a very reputable organization. They don’t have a record of being paid off and all the research is subject to peer review. Also, a large portion of research is commissioned. So skepticism is fine but a study published in prestigious peer reviewed journal is not to be dismissed without reason. The study continually referred to is at http://www.fairtax.org/PDF/Tax%20Notes%20article%20on%20FT%20rate.pdf.

    2. Even accepting the study as accurate, if you read it carefully you will see that for the year 2007 (the only year studied) a tax rate of 31.8% would leave the federal government with a $473 billion deficit. So, it’s not exactly sustainable. In a later paper, Beacon Hill/Kotlikoff stated that the sustainable rate would be areound 36%. (By the way, I am using tax-exclusive numbers. These are the percentages that will need to be added on top of the price the merchant charges to pay his expenses and earn a profit.)


    – To start off the study states that it is calculated statically, meaning there is no economic growth being factored into people spending or government collections. As even opponents of the FairTax admit the economy will grow substantially and much research has come to the same conclusion, the concern is invalid. The study actually states that 3% of economic growth would make the FairTax revenue neutral at the flat 23% rate. To actually quote the study instead of making false claims, it says, “Those calculations ignore: 1) general equilibrium feedback (supply-side and demand-side) effects that could significantly raise the FairTax base (see, for example, Kotlikoff and Jokisch, 2005, or Tuerck et al., 2006b); 2) the possibility that tax evasion would exceed the considerable amount of evasion automatically incorporated in our calculations given our use of National Income and Product Accounts (NIPA) data, which undercount consumption expenditures due to evasion under the current tax system; and 3) the roughly $1 trillion real capital gain the federal government would secure on its outstanding nominal debt, were consumer prices to rise by the full amount of the FairTax.” The other paper he mentions was not a paper on the rate but economic impact. They studied only a part of the US economy and put together a model that had a 26% inclusive tax rate. In that paper Kotlikoff even says,” our highly stylized model is not the U.S. economy.” The 23% rate study was based on a comprehensive, state of the art model of the whole economy.


    3. Even these numbers are suspect. First, they do not take tax evasion and tax avoidance into account. Second, they do not take state and local taxes into account. (State and local taxes are generally about 1/3 of federal taxes; if states get rid of their income taxes and adopt mini-FairTaxes, as they surely would if the FairTax is adopted, the state and local tax will increase the overall tax by about 1/3. So, if the Fairtax is 45% at the federal level, it will increase to around 60% when state and local taxes are added in.)


    – Apparently FairTaxCritic didn’t look at large portions of the study (see above) because it starts off by saying the very high evasion numbers of today’s system are actually figured into the study. They are actually predicted to drop under the FairTax due to an 80% reduction in compliance and enforcement points. Also whole sections of the study went over state and local government taxation and how the FairTax would burden them more than the current system.


    4. It does not take two people to cheat under the FairTax; it takes only one. For example, I’m a landlord. I charge you rent, plus the FairTax. I pocket the FairTax (instead of forwarding it to the government). I’m also a lawyer. When I bill you and include the FairTax, how are you going to know that I sent the tax on to the government? Also, if I buy a new car and call it a business expense (so that it is tax-free), how is the government going to prove differently. (No IRS; the burden of proof will be on state taxing authorities.) Under our current system, most income is reported twice — i.e., by our employers and by the employees; by banks and brokerage houses as well as by recipients of interest and dividends. So the vast majority of tax obligations can be easily verified. Most tax-evasion comes in instances where there is not double reporting ( i.e., privately owned businesses.) Under the FairTax, there will be no double-reporting at all. Thus, I’m afraid that tax avoidance will increase, rather than decrease under the FairTax.


    – Question(s) 1, you don’t know now under sales taxes. Question 2, states collect sales taxes, even on services, very well now. Question 3, most states exempt agriculture and non-profits from sales tax now and enforce it with exemption IDs, etc. The same for FairTax.


    5. By the way, you should look at William Gale’s study, the Joint Committee on Taxation’s studies, the ITEP study, and the President’s Tax Reform Commission’s study; each of which concluded the FairTax would need to be much higher than AFFT claims it to be.


    – Gales study was extremely flawed and none of the others even looked at the actual FairTax. They invented their own tax plan and said it wouldn’t work. See the FairTax.org rebuttal section for specifics.


    6. If you think that people will not legally avoid paying a 50%-80% tax (or, even a 30% rate) by shifting their purchases to used cars (instead of new cars), existing homes (instead of new homes) and foreign travel (rather than domestic travel), then I’m afraid you don’t know much about human behavior. Of course they will seek to minimize their tax obligations (just as they do now) and that tax avoidance is NOT factored into the Beacon Hill/Kotlikoff study. The other studies I mentioned assume a modest amount of tax avoidance and tax evasion, like around 10% or so (which is much less than under our current system) but acknowledge that actual tax avoidance and evasion will probably be much higher.


    – Again, the rate is 23% inclusive (or 30% exclusive) and the huge non compliance of our current system was factored into the rate study as it clearly states. Research is being wrapped up right now that shows the FairTax has lower evasion than the current system. People will still buy new things for the same reasons they do now except under the FairTax they do it with their paycheck free of federal withholding and with less expensive goods due to no embedded taxes.


    7. Yes, SOME rich folks will still buy new BMW’s ect., but they still consume a much lower portion of their incomes than do the middle class, so the middle class will bear the brunt of the tax.


    – If the FairTax didn’t have the prebate or repeal regressive payroll taxes the statements might be true. The middle class will not bear the brunt as research has shown (http://www.fairtax.org/PDF/Comparing%20AverageandMarginalTaxRates-110206.pdf) The FairTax doesn’t shift tax burdens and doesn’t have special loopholes for expensive accountants.


    8. If you think the embedded taxes will be removed from the cost of building a new home (or anything else), you should re-read the Beacon Hill/Kotlikoff study who explicitly state that prices will NOT drop by the so-called embedded taxes, and, instead, will rise by the amount of the tax. (By the way, they think this is a good thing.) Alternatively, check with Dale Jorgenson, the Harvard economist that AFFT and Boortz tout as having “proved” the embedded taxes will disappear. He’s OPPOSES the FairTax (something they won’t tell you), agrees with Gale about the required tax rate ( i.e., 50%-60%) and points out that the only way for the embedded taxes to disappear from the price of goods is if all our our salaries are immediately lowered by the amounts we currently pay in taxes.


    – Price wars for market share will not stop because FairTaxCritic says they will. The study did not factor price drops, true, and so far he’s twisted everything he’s cited in the research. In the third paragraph it says, “Focusing on real rather than nominal neutrality has the decided advantage that one can determine the revenue-neutral FairTax tax rate without having to pin down what happens to the price level.” Dr. Jorgenson said embedded taxes were X, he didn’t say all costs would come out in price. Neither does Americans for FairTaxation. The FairTax.org FAQs and the Ask the Expert section clearly state that. I have not heard that the Dr. opposes the FairTax. Linking to something where he says he does would help the believability of that statement.


    9. Illegals, tourists and criminals already pay taxes when they buy things. (that’s what the so-called “embedded taxes” are.) For example, when a drug dealer buys a new Cadillac, the Cadillac dealer, salesperson and manufacturer all pay income taxes associated with that sale. Under the FairTax, the Cadillac dealer will collect the tax from the drug dealer and remit it to the government. So, the result is the same. The transaction will create tax revenue to the government. (When the drug dealer sales his drugs, he’s not going to pay income tax on the sale, nor will he collect the FairTax from his customers. So that transaction will not yield any tax revenue.)


    -This is looking at the issue too simplistically. When money goes ‚Äòunderground’ (both wages and purchases) the FairTax taxes it much more quickly than the current system due to it being a cash register collected tax, not a reporting based tax. Also, these folks are paying some embedded but not the other federal taxes we pay so the FairTax evens the playing field.

    While I appreciate and encourage healthy debate on the FairTax, I deplore misinformation and propaganda.

  • Detonno

    Less new homes is probably a good thing – given that most new homes are schlock. It might encourage much higher quality building, and legitimate neighborhoods.

  • http://snipurl.com/meltdowninprogress Ian

    Just another tidbit, concerning this recurrent complaint about FairTax (so-called) “regressivity”:
    The effective tax rate percentages, that different income groups would pay under the FairTax, are calculated by crediting the monthly “prebate” (advance rebate of projected tax on necessities) against total monthly spending of citizen families (1 member and greater, Dept. of Commerce poverty-level data; a single person receiving ~$200/mo, a family of four, ~$500/mo, in addition to working earners receiving paychecks with no Federal deductions) – thus most citizens will never pay the full FairTax rate. Prof.’s Kotlikoff and Rapson (2006) concluded,

    “…the FairTax imposes much lower average taxes on working-age households than does the current system. The FairTax broadens the tax base from what is now primarily a system of labor income taxation to a system that taxes, albeit indirectly, both labor income and existing wealth. By including existing wealth in the effective tax base, much of which is owned by rich and middle-class elderly households, the FairTax is able to tax labor income at a lower effective rate and, thereby, lower the average lifetime tax rates facing working-age Americans.
    “Consider, as an example, a single household age 30 earning $50,000. The household’s average tax rate under the current system is 21.1 percent. It’s 13.5 percent under the FairTax. Since the FairTax would preserve the purchasing power of Social Security benefits and also provide a tax rebate, older low-income workers who will live primarily or exclusively on Social Security would be better off. As an example, the average remaining lifetime tax rate for an age 60 married couple with $20,000 of earnings falls from its current value of 7.2 percent to -11.0 percent under the FairTax. As another example, compare the current 24.0 percent remaining lifetime average tax rate of a married age 45 couple with $100,000 in earnings to the 14.7 percent rate that arises under the FairTax.”

    Further, per Jokischa and Kotlikoff (2005)

    “…once one moves to generations postdating the baby boomers there are positive welfare gains for all income groups in each cohort. Under a 23 percent FairTax policy, the poorest members of the generation born in 1990 enjoy a 13.5 percent welfare gain. Their middle-class and rich contemporaries experience 5 and 2 percent welfare gains, respectively. The welfare gains are largest for future generations. Take the cohort born in 2030. The poorest members of this cohort enjoy a huge 26 percent improvement in their well-being. For middle class members of this birth group, there’s a 12 percent welfare gain. And for the richest members of the group, the gain is 5 percent.”

    As things stand at present, Americans labor under nothing less than “tax slavery,” having our wages confiscated every working hour, as reflected in our paychecks every two weeks.
    Many of us have joined FairTax.org in order to build a national movement to free ourselves, our family pocketbooks, and our businesses from confiscation of income, and punishment of productivity. And this we say to our federal representatives, “Either scrap the code and enact the FairTax, or we intend on replacing you with someone who will.”
    (Permission is granted to reproduce in whole or part. – Ian)

  • http://fairtax.org Brian Pearson

    I believe Americans for Fair Taxation may be underestimating the impact of the tax on the underground economy. The size of underground economy is estimated to be between $1 trillion and $3 trillion. Also, most of that economy consists of illegal aliens; only citizens can apply for prebates. That makes the tax regressive for such people, whereas the prebate makes the tax progressive for citizens.
    Previously mentioned, but worth repeating, is the fact that there are trillions of dollars now sheltered from the income tax in offshore accounts. And, once the reason for those shelters is gone, that money will be repatriated. I don’t know of anyone who can guess at the impact of that, but it would represent huge infusion of capital, probably in stocks.