Asymmetrical Information

He most certainly does. And after spending far too much time and money on so-called 'professional' tax services this year, I'm convinced that no one really understands the current tax code. But, this part is key..."Linder had better repeal the 16th Amendment, to make sure the income tax stays gone..." To be sure. Because, the Democrats in Congress will fight like mad, session after session to get it back. And what will prevent Progressive localities like Multnomah County (Portland, ahem) from inserting their own income tax provisions into the gap? In addition to weening America off federal income redistribution, there must be a strong, concerted effort to change the mentality that has been bred into the public's sensibilities that encourages them to believe it is somehow moral to be bled dry.

Sounds a lot like the FairTax proposal (www.fairtax.org). I haven't researched it, but perhaps Linder is advancing their proposal and George Will just didn't think to give them credit.

And a huge unmentioned benefit: the underground economy would now pay taxes. I'm talking about collecting taxes on (1) illegal drug sales, (2) off-the-books labor, and (3) undeclared tip income. These are areas which don't contribute to income taxes now.

I don't see why the federal government would be incapable of doing what state governments do: handing out different tax rates & kickbacks for a ton of specific industries & items. No difference, other than "get rid of progressive taxation."

Because the idea is to get rid of complexity. Once you allow deductions for various industries, you've just shot to hell any hope of getting rid of the lobbying business.

I'm not following how they're going to get rid of them completely - constitutional amendement? You could just as easily do that for the current tax system right now. Congress can always go back and change it later, and as long as there's no political hit to do so it'll happen.

I think the only way to collect tax on vice is to legalize vice crime. I could live with something like a National Sales Tax, but it would have to be graduated. Something like purchases under a thousand dollars taxed at 10%, under fifty thousand at 20%, and over 100 at 30%. These percentages are only meant to illustrate the idea, not to represent hard numbers that meet budget projections. There would still need to be an adjustment for something like a home purchase. I'm not comfortable taxing food and shelter either.

So the poor, who generally pay no income taxes and hardly have any money to save, now have almost a quarter of the income go to taxes. There's compassion for you...

Alex, you must have missed the up-front rebate on taxes on essentials up to the poverty level bit.

"And a huge unmentioned benefit: the underground economy would now pay taxes."

I'm not so sure. The danger is that the underground economy would change, but would still be there. I would expect a black market on all kinds of goods. A 23% sales tax would be a pretty huge incentive to find a way to buy without paying that sales tax.

On another note, I'm not sure I like the up-front rebate idea. Is there at least some sort of stepped-down rebate for people just above the poverty level?

I think I would prefer exempting groceries and medicine, like Minnesota does with their sales tax (Minn. also exempts clothing, which makes shopping at the Mall of America a great treat). Easier to manage, catches non-essential purchases by the poor (and the poor do purchase a lot of non-essentials), and should still end up being quite progressive. And, as an added benefit, in response to Megan's obesity post, would encourage grocery shopping rather than stopping at the nearest fast food drive-thru.

And a huge unmentioned benefit: the underground economy would now pay taxes.

You don't think that increasing the sales tax from the 4-8% range to 30% won't create a whole new round of underground transactions? Why wouldn't people with goods to sell respond to the new, vastly-increased incentive to sell without alerting the government?

As we calculate current sales taxes, the FairTax is 30%, not 23%. It's 23% according to how we calculating income tax (inclusive).

It's way too simplistic to think that simplifying the tax code will eliminate the lobbying business. Lobbyists are into everything at this point, this is just a piece of the pie.

Denise wrote:
On another note, I'm not sure I like the up-front rebate idea. Is there at least some sort of stepped-down rebate for people just above the poverty level?

The way I read it everyone gets the rebate. So, say the poverty level's $10,000 a year for a family of four and the tax rate is 24%. Every family of four, rich and poor alike, gets $200 a month (10000 * 24% / 12 months) from Uncle Sam to cover the sales tax on essentials. So those above the poverty level get the same $200 rebate.

Jim

I kind of like the way Texas handles it (sounds similar to Minn) 'essentials' aren't taxed. That doesn't mean ALL food, but things like milk, bread, juice, etc are tax-free, while my box of oreos are taxed.

Just be aware that the gov't will pick your pocket regardless of wether it's the front one or the back one. The front pocket is a bit easier to keep an eye on though.

Thanks, Jim, that helps; not sure it changes my preference though.

Along with repealing the 16th amendment, don't we need to add a new one? Where in the Constitution is the Congress empowered to levy a sales tax?

In particular, what about Article I Section 9:

"No tax or duty shall be laid on articles exported from any state."

the comment about taxing the underground economy is referring to the fact that when you shift from income to consumption, illicit income no longer is tax free.

you will still not be paying tax on your crack, but your dealer will be paying tax on his income just like anyone else, based on what he buys from mainstream retailers.

you do lose some revenue to black markets for goods, but these losses tend to be rather small (large losses are easy to track down, its typically small operatons that would evade) and should be vastly overwhelmed by the reduction in income evasion and the improved GDP growth thanks to a more efficient market

Kevin Drum, Mark Kleiman, Angrybear et al. have figured out that George Will flunked 1st grade math - assuming he believes what he wrote.

The income tax is a great damper on the overall economy. You can't ask government to give up so much intrusive power. Leftists particularly will be furious!

Most of the objections raised in these comments are answered on the Fair Tax FAQ page:

http://www.fairtaxvolunteer.org/smart/faq.html

It is a revolutionary plan, and it would be great for the economy.

Only new items are taxed, so you can sell your car, house, whatever without collecting tax. 16th ammendment is repealed. All families get the poverty level rebate. Corporations don't pay income tax so the theory is that through competition prices would drop.

Taxing food and shelter is fair - if you eat out a lot or buy expensive food, you pay more. If you buy a $1 million dollar house you pay more.

All in all, it looks like an excellent plan.

Here is another take on the plan. Doesn't sound nearly as nice as Mr. Will's column.

http://www.nationalreview.com/nrof_bartlett/bartlett200408090847.asp

There have been quite a few Fair Tax proposals, starting, I think with a proposal a couple economists (Hall and Rabushka) made in the WSJ about 20 years ago. They generally are flat rate consumption taxes of some flavor. Although past results do not always forecast future returns, I suspect the next 20 years will contain as much talk and as little change as the past 20.

I'd love to be wrong.

One side-effect would be an increase in bartering, though you can only go so far with that. I may be able to trade a load of gravel for some dental work, but only if my dentist wants a load of gravel.

Someone add some reasonable provision to this that handles the case of the person who has accumulated, say, $100K in savings outside of any of the tax-defered accounts. They've paid income tax on the whole nut; how do you keep from hitting them with another 23% tax?

The income tax is a great damper on the overall economy. You can't ask government to give up so much intrusive power. Leftists particularly will be furious!

Why the inflammatory rhetoric?

As an avowed leftist, I'm more than happy to consider any proposal that might result in an improvement of our current system. Dear god, if you think "intrusive power" is what the left is all about, you have some serious studying to do about the meaning of the word "liberal".

Anyhow, a proposal like the FairTax is something I've been thinking about and/or willing to consider for an awfully long time. It certainly does have some appeal. However, there are some bits I don't think have been thought through well enough:

1) The idea is usually to avoid regressive taxation by handing out refunds. Households would have to document their existence and number of dependents in a filing ... which starts to look an awful lot like a 1040. Maybe simpler, but you'll still need an annual document from every household in the country. So, you abolish the IRS only to replace it with another paper bureaucracy nearly as big.

2) Taxing goods and services ... so now, every business in the country needs to document exactly how much they sell in goods and services and return that much tax to the government. This is much, much worse of a paperwork nightmare. State sales taxes generally tax goods, but not services. So now all of the couriers, lawn guys, web designers, etc. need to track every sale and file taxes for them. And this will have to be enforced with another audit bureaucracy, because as other posters have pointed out, the incentive to cheat and sell sans tax will be immense.

You end up with a massive tax bureaucracy that I'm not convinced will be any smaller than the IRS. The costs of filing all that paperwork will still exist, but now on the business/sales end. Businesses will have to increase prices to cover the new expense.

3) Double-taxation of retirement savings. A couple generations of people have been saving up a lot of their after-tax dollars for retirement. Now, when they pull it out, they'll pay taxes again on it when they spend it. That's not particularly nice for all the people who took responsible care

4) Multiple taxation of many products; the B2B assembly line. Most businesses that sell products these days only do final assembly ... the components of the products go back many steps in a production chain, travelling from one business to another in a very deep web of B2B transactions. If you do a "sales tax" on each step of that web, you're accumulating that 23% (or whatever) on each many, many steps in the production chain. Imagine your iPod ... 23% on the ipod, which has a screen that was taxed at 23%, made in part from a sheet of plastic taxed at 23%, made from plastic resin bricks taxed at 23%, made from refined oil stocks taxed at 23%.... that's a cumulative 182% tax on a five-step manufacturing chain, not including tax on the markup!

... unless you only tax sales "to consumers", and exempt all B2B sales. But then you have to define exactly what that means, and what's to prevent people from setting up little virtual sole proprietorships just so they can have a B2B sales tax exemption? (People do this now at the state level all the time) Administrating that issue on a national level will require another huge bureaucracy, with more filing of paperwork to prove legitimate cause for B2B exemption for every damn sale. And don't you think lobbyists would work their butts off to game that system just like the current one?

Ultimately, the percieved benefits in "simplicity" of a national sales tax probably evaporate in reality.

The plain fact is that running a country of three hundred million people is incredibly complex, and ludicrously expensive. The money has to come from somewhere, and there will always be bureaucracy and corruption.

We should always be fighting to reduce bureaucracy and waste, but there is no magic bullet, folks.

Everybody has forgotten what Henry George had to say. Taxes distort the economy. Consumers are influenced by the price increases and consume less of whatever is being taxed. This is nice if you want them to use less of it. Vice taxes and fuel taxes are wonderful things, worth enforcing. The most important tax, however, should be on land and/or the raw materials that come from the land. When land is taxed, people will use it more efficiently. Cities will again be used properly, no longer as oceans of parking lots, empty warehouses and rusting industrial detritus.

It's a 30% sales tax, not 23%. Brittain33 had it right many comments ago. When you buy a $100 item, $30 tax is added on. John Linder is afraid to tell the truth so he divides the tax ($30) by the total ($130) instead of the original price.

Speaking as someone who lives in a jurisdiction with both a federal and provincial sales tax (each of which operate under different rules), IdahoEv correctly identifies some of the administrative issues involved. In practice though, they aren't all that onerous compared to an income tax system, particulalry if the system is well-designed and exemptions are kept to a minimum.

I'm not sure this would have much of an impact on a black market. Vendors already have an incentive to sell off the books to avoid paying income tax. If anything, I would expect this incentive to go down under a sales tax system. Buyers would now be saving the tax, not the sellers. Sellers could perhaps increase their customer base if they did not charge the tax but I would think that this would be limited by the fact that they would need to keep quiet about it.

Not mentioned yet is the reality that the gap between spending and income rises dramatically as you go up the income scale. At some point the progressivity of the rebate will be countered by the regressivity of this spending gap (the very wealthy tend to invest far more of their income, which would go untaxed). So while the "Fair Tax" would be sharply progressive with respect to income and spending at the low end and progressive (converging on flat) against spending alone at the high end, it would actually be regressive against income at the high end.

Net effect, steep progressivity at the low end reduces upward mobility, and regressivity at the high end increases upward mobility. It seems to me that this would create an "income divide" lifting folks from the upper middle class into a self-perpetuating aristocracy who can continue to amass untaxed wealth at the top and dragging the lower-middle class down into an underclass whose above-poverty income gets eaten up by taxes at comparatively high rates. Granted, spending habits will change as a result of the perceived price increases, but that just shifts where the income divide falls, it doesn't eliminate it. That this tax is being championed by wealthy men who already have high rates of investment means this facet of the plan deserves a great deal of scrutiny.

And IdahoEv, the "Fair Tax" plan does exempt business to business sales. The tax falls exclusively on consumers. It also, as has been pointed out, exempts used items, meaning goods will effectively depreciate sharply when bought new. Imagine if, in addition to current rates of depreciation, your new car dropped in effective value by an additional 23% when you drove it off the lot. What would this do to new car sales? What would this do to new home construction? I'd love to hear an economist address these questions.

I'm all for exploring alternative tax systems, particularly simplification of the tax code, but not at the expense of broadly progressive taxation. Rewarding the wealthy for being wealthy at the expense of the middle class is simply bad policy, as is forcing the poor to dig out of an even deeper hole to acheive the American Dream.

Oh, and I'd be interested to know how much of the "compliance costs" Will and other consumption tax proponents talk about consists of low-income folks getting suckered into "rapid refund"-style loans and corporations paying millions of dollars for tax-evasion schemes that simultaneously depress revenue collection and inflate "compliance costs" (which would be a misnomer in this case, but I suspect that isn't stopping anti-tax crusaders).

Before you get enthusiastic about a national sales tax, consider a few points:

First, it appears that 23% is not sufficient to provide the revenue. 60% is more like it. See
http://www.brookings.org/views/papers/gale/20040812.htm, A Note on the Required Tax Rate in a National Retail Sales Tax: Preliminary Estimates for 2005-2014.

This assumes that all of us would receive a grant equal to the poverty threshold times the sales tax rate.

How would you feel about paying a 60% sales tax on that new house? (How do you think the FIRE [finance, insurance, real estate] sector is going to feel about financing that 60% sales tax?)

How would you feel about paying a 60% sales tax on a new car, particularly knowing that it drops in value as soon as you drive it off the lot? (How do you think GMAC would feel about financing that 60% sales tax?) How much would the tax rate have to go up to exempt car purchases?

Second, if all that is okay with you (hey, it could reduce the sales of SUV's and gasoline significantly!), go take a look at http://www.itepnet.org/sale0904.pdf, The Effects of Replacing Most Federal Taxes with a National Sales Tax: A State-by-State Distributional Analysis, which shows, for each income quintile for every state, how much more (or less) each household would pay under such a scenario. The folks in the bottom 4 quintiles will see their federal taxes go up by $3000 to almost $5000; those in the top percentile will see tax decreases of $113,000 to $450,000 per year. As David Cay Johnston (Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Super Rich--and CheatEverybody Else) points out, those top 1% folks have the ear of our elected representatives, who depend on their campaign contributions, and whose welfare is of great interest to those reps. So despite its horrendous effects this might have a real chance of happening.

Third, many states are dependent on sales taxes -- there are counties in Alabama where the sales tax is as high as 11%, even on items like milk and bread.

I'm with jj (above) -- we need to pay attention to what Henry George had to say. Our taxes should fall on land values and natural resources, where they won't distort the economy, not on transactions, or buildings or wages. If we want to see more jobs and better paying jobs, and genuine opportunity for all, that is the kind of tax system we should be using. (Check out henrygeorge.org if you need an education in economics. Very approachable and clear!)

... and how would you feel about *every* retailer being a tax collector, and all the opportunities for tax money to disappear into the ether with cash purchases.

The IRS can't do much with cash businesses now. How much worse would it become were every retailer supposed to be a tax collector? Who is going to pursue all those retailers, and how?

Ebay would have to do some major reprogramming!

Big brother would be everywhere. Not a prospect most of us relish.

Land, on the other hand, is very difficult to hide, and impossible to move off shore. We all need it, at least a tiny bit of it, and it only seems fair for us to pay the commons regularly for the exclusive use of the bit we call our own, instead of paying the last holder big bucks and the bank for the next 30 years. We could leave our kids -- all of them -- a much better world if we pursue land values and other natural and societally-produced goodies as the base of our system of taxes.

I may have missed some comments but I haven't seen anyone address the fact that a national sales tax IS regressive compared to the present system.

This is because the percentage of income actually spent on goods declines as income rises all other things being equal. Witness Warren Buffett, a multi-billionaire living in a relatively modest home in Omaha, NE. His tax burden would obviously drop precipitously with a national sales tax.

An extreme example but you get the idea. The tax burden would be shifted downward to lower income families compared to an income tax.

I'm not saying that's good or bad, just that it might be considered an unintended consequence.

Not mentioned is that the 23% tax requires a drastic cutback of government spending. That is not a replacement tax which would be an over 30% sales tax.

This proposal will continue to be pushed by the economic self-interest of the financially well-off. People spend less and less of their income subject to the this tax as income rises.

The big ideas for taxes really should be to put the corporate taxes back to the 60's without loopholes, put a simpified income tax back to the Reagan years without loopholes, have payroll taxes exempt the first $4,000 and have no upper cap, have a death tax of 50% on estates over a million that goes toward Social Security, repeal the tax-exemption of churchs, foundations, and charities after the first million in property or income but make individual donations 50% deductable, value working wages over dividend clippers by having the dividend income taxed at 10% more than the individuals income tax bracket, encourage job creation by having the only tax credits and breaks be for research and devlopment and new job creation.

(guess I'm not a neo-libertarian)
Gary

I'm still waiting for any FairTax proponent to respond to Claire Wolfe and Aaron Zelman

Hey, Wyn, thanks for that PDF! It shows in hard numbers what I have understood intuitively about this tax. Every time I bring up the top-end regressivity issue, Fair Tax proponents simply argue that it is invalid to measure regressivity against income if the tax base is spending. They have so far been incapable of refuting my simple, non-economist's common sense take on the plan, preferring instead to deny the very basis of comparison with the current income tax.

Also, the part of that PDF that blew my mind, and I'd like to get some confirmation that this is true (emphasis mine):

The fact that the sales tax, even by its proponents’ own figures, entails a 30 percent tax rate is only the beginning of the math problems. Allegedly, almost a third of the projected sales-tax revenues are supposed to come from taxes that the government will pay to itself. Build a road, pay yourself a tax. Buy some planes for the Air Force, pay yourself some more. And so on. Unfortunately, that can’t work. Without these phantom governmental tax payments, the sales tax rate would have to jump to 42 percent to break even.

My head nearly exploded on reading this. This would explain the "revenue neutral" line the Fair Tax folks keep feeding us. Have you seen any other analyses that would independently confirm this Enron-style tax accounting?

If you have any more such links, please post them! Hard data is really difficult to come by, since the vast majority of info out there is from pro-FT sites, and in my experience they avoid hard data like the plague, except for cherry-picked data points like the ubiquitous family of four earning ~$40k. I've been trying to get people to pay attention to these tax issues for some time now, and every little bit of information helps.

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