I came across a piece entitled "Why Democrats should love the FairTax," written by Laurence J. Kotlikoff, a professor of economics at Boston University, an economic adviser to Mike Gravel and a consultant to FairTax.org.
I continue to be amazed how even economists, who should know better -- far better -- than to even think about a sales tax as a solution to anything, can be in favor of such an alternative.
Why Democrats should love the FairTax
What if Mr. Megabucks sits and counts his money? With a direct wealth tax Mr. Megabucks pays $15 million immediately and is left with $50 million in purchasing power. Under the FairTax, Mr. Megabuck is in the same boat. Retail prices rise by 30 percent and Mr. Megabucks finds that his $65 million can only buy $50 million in real goods and services; Mr. Megabucks has the same number of dollars, but 23 percent less purchasing power. This equivalence is no coincidence; taxing consumption is mathematically identical to taxing the resources used to buy consumption - current wealth holdings plus wages as they are earned. The beauty of the FairTax is that taxing wealth at a 23 percent rate generates enough revenue to reduce workers' marginal tax brackets to 23 percent. This is dramatically lower than the 30 percent to 45 percent marginal tax bracket confronting most workers under our combined income and payroll taxes. - Laurence Kotlikoff
Is Dr. Kotlikoff proposing an annual 30% tax on Mr. Megabucks' portfolio, without regard for what its contents are? Is he proposing an annual tax on all of his purchases, whether they are of manmade goods or things provided by nature?
By Laurence Kotlikoff | February 24, 2008
SUPPOSE A presidential candidate proposed taxing wealth and using the proceeds to reduce taxes on workers and provide a rebate large enough to cover taxes paid by poor workers. Such a candidate would be hailed by the left and reviled by the right.
What presidential candidate would propose such a thing? Who has most of the wealth? How much of it do they spend each year? The triennial Survey of Consumer Finance provides some information on this. The top 1% of the wealth holders -- that is, the 1% of us who have the most net worth, held (in 2004) 33.8% of the Net Worth (Table W50-2, line 1, column 12), up from 30% in 1989 -- had about 13.6% of the income (Table 50-1, line 29). [Keep in mind that the top 1% of the income spectrum is not the same as the top 1% of the wealth spectrum.] Who makes the large political contributions? The people with interests to protect.
I'll come back to the "rebate" issue later.
Dr. K. continues:
Thus, it's remarkable that so many Democrats, with the exception of presidential candidate Mike Gravel, oppose the FairTax and so many Republicans, particularly presidential candidate Mike Huckabee, support it. In fact, the FairTax, which replaces all federal taxes with a federal retail sales tax and provides a rebate, represents a way to tax wealth, reduce taxes on wages, and disproportionately redistribute money to the poor.
There must be a good reason! It might have something to do with the distributional effects of the FairTax. A study -- described below -- not beloved of FairTax proponents -- shows that the top 1% of the income spectrum would reap awesome -- 6-figure! -- annual benefits.
Dr. K. continues:
A sales tax effectively taxes wealth?
It does. When we buy goods and services in a sales tax world, part of the payment goes to sales taxes. So we end up with fewer real goods and services.
Ah, but what about the wealth that Mr. M. doesn't need to spend each year because he can only buy so many things? It sits and grows, and burns a hole in his pocket, and enables him to buy up such things as land -- urban land, where even a small underused lot with an obsolete building can produce enough income to keep a family comfortable in retirement, while they wait for the land to appreciate till they can't stand it any longer and MUST sell; farm land, so that those who want to farm must rent from the absentee owner, or find inferior land to use (the landed gentry, who collect rent, without laboring. Nearly as effective as sharecropping and slave ownership, but it sounds so entrepreneurial, so capitalist!!); and oil rights, and other scarce resources. In other words, to privatize all that value which rightly shouldn't be subject to privatization at all!
Dr. K continues:
Take Mr. Megabucks, who is sitting on $65 million and wants to buy a jet like Oprah Winfrey's - a 10-passenger, $50 million Global Express XRS. Under the FairTax, the jet costs him an extra $15 million because of the 30 percent sales tax. Mr. Megabucks gets the jet, but the extra $15 million, which he had budgeted for Beluga caviar, Dom Pérignon, and other flight snacks, goes to Uncle Sam.
Now $15 million is 23 percent of $65 million - so the FairTax cost Mr. Megabucks 23 percent of his wealth. Precisely the same outcome would arise were Uncle Sam to directly tax Mr. Megabuck's $65 million in wealth at a 23 percent rate, leaving him with $50 million to buy the jet at the original price.
The FairTax cost Mr. Megabucks 23% of his wealth? No, just of the portion he chose to spend. Big difference!! And Uncle Sam shouldn't have to depend for our revenue on whether Mr. Megabucks feels like spending this year or not. And when he must pay a penalty of even just 23%, he will buy jets less frequently. Is that the goal? Is it also the goal that people will buy less food? Fewer diapers? Less clothing? Fewer houses? Less furniture?
Dr. K. continues:
What if Mr. Megabucks sits and counts his money? With a direct wealth tax Mr. Megabucks pays $15 million immediately and is left with $50 million in purchasing power. Under the FairTax, Mr. Megabuck is in the same boat. Retail prices rise by 30 percent and Mr. Megabucks finds that his $65 million can only buy $50 million in real goods and services; Mr. Megabucks has the same number of dollars, but 23 percent less purchasing power.
His $65 million sits and grows -- perhaps by leaps and bounds in a hedge fund, which likely would be exempt from the FairTax, don't you think? --
Dr. K. continues:
This equivalence is no coincidence; taxing consumption is mathematically identical to taxing the resources used to buy consumption - current wealth holdings plus wages as they are earned. The beauty of the FairTax is that taxing wealth at a 23 percent rate generates enough revenue to reduce workers' marginal tax brackets to 23 percent. This is dramatically lower than the 30 percent to 45 percent marginal tax bracket confronting most workers under our combined income and payroll taxes.
I'm not opposed to untaxing wages -- not at all! But this is not the way to do it. And we shouldn't be taxing wealth only when it gets spent, and we shouldn't be taxing all kinds of wealth, either. Some kinds should not be subject to taxation at all, and some kinds -- the kinds produced by nature, scarce resources like urban land, waterfront land, naturally fertile agricultural land -- should be taxed in a way that guarantees that they'll get put to their highest and best use, not sat on for future gain.
Dr. K continues:
The FairTax sales tax rate isn't graduated; everyone's resources get taxed at the same 23 percent effective rate. What makes the FairTax progressive is its rebate. The rebate is a trivial share of the resources of the rich, but 23 percent of the resources of the poor. Since our current tax system is regressive, adopting the FairTax would achieve progressivity.
Well, some of us have lots of resources. Inherited resources, for example, and windfall resources that we didn't earn. Ah -- here it is. The rebate! May I tell you about the rebate? The rebate is based on the Federal Poverty Line. That is the level of income below which we consider a family to be impoverished, and above which we consider their income to be sufficient to meet their needs, wherever in America they might live. In 2008, the Federal Poverty Guideline for a single person is $10,400; for a family of 4, $21,200. The "Rebate" Dr. K refers to would sent to each single person a monthly check for $199 (1/12 of $2,392); each family of 4, $406 (1/12 of $4,876) to cover their taxes on the first $10,400 or $21,200 of their annual spending. All well and good. But there are few places in America where a single adult can actually get by on $10,400, or a family of 4 get by on $21,200 -- just to meet their most simply defined needs. Take a look at this page to see the cost of living in some of America's least expensive counties. Now you'll have to delve into the de tail a bit, because that cost of living includes the taxes they currently pay, but it appears to me that the "FairTax" would burden them even more than our current system does. (Subtract columns 8, 9 and 10 from column 7, to get their net taxes after credits, and then divide that result into column 11, to see what percentage of their income they're currently paying in taxes, as renters.) If $406 comes in each month in a "rebate" (sometime even called a "prebate") how does that compare to column 7? (and actually, this is not quite apples to apples, because column 7 includes local and state sales taxes which are not going to simply go away if we enacted the FairTax.) In general, column 7, even subtracting out the credits in the next 3 columns, is going to be a lot more than the $406 "rebate".
But is 23% really the figure? William Gale makes the case that the real number is closer to 60% and could go higher, depending on assumptions regarding whether state and local governments pay the FairTax, how much tax evasion there is, and whether we are talking about replacing only personal income and corporate income taxes, or those plus payroll and estate taxes.
Which brings me to the distributional aspects of the FairTax. [Check out the table on page 5 for a colorful summary.] A National Sales Tax is WONDERFUL for people in the top 1%, in every state. Their federal taxes will drop like a rock -- by anywhere from $80,000 (WV) to $442,000 (CT). They have everything to gain from this. And the next 4% makes out okay, too. And if they are the only audience that matters, the FairTax is a true winner. I am reminded of David Cay Johnston's description of a taxi-ride with a retired senator after his earlier book, Perfectly Legal, was written:
After finishing the book, I got off a plane and shared a taxi with a former state senator who is personally very comfortable. He told me that I was being overly kind to politicians in my analysis. He said, "Every year that I was in office I knew who my 10 biggest donors were. I knew that I had to show them that I was working for what they wanted or they would just take their money and go to the other guy. And, you know, I don't think I ever once looked in the mirror and said, 'What am I doing for the average person in my district?'"
And in the lowest quintile, where incomes are not sufficient to meet people's most modestly defined needs, taxes will rise by from $2,700 (AL) to $4,800 (RI).
And let's consider the practicality of this:
One could reasonably argue that the whole idea of a 50-60 percent national sales tax is so implausible that it should be dismissed out of hand. Would the public ever tolerate a tax that adds $10,000 or more to the cost of a new car? Or $50,000 to the price of a new home? Or$5,000 or more to average annual medical costs? [source: http://www.itepnet.org/sale0904.pdf]
Would GMAC finance the extra $10,000? Would Ditech finance the $50,000? I rather doubt that they would have in 2005, and am quite sure they would not in 2008! And do most car buyers have the extra $10,000 cash? Do most home buyers have an extra $50,000 sitting around for paying a tax on a new home? What do you think this would do to the demand for new homes? What do you think it would do for the owners of existing homes?
Dr. K. continues:
Our tax system is regressive because none of the corpus - the principal - of the wealth of the rich, including our more than 400 billionaires, is subjected to taxation. Instead they pay taxes only on the income earned on their wealth. But this income comes primarily as capital gains, which are taxed at only 15 percent. Furthermore, capital gains taxes are levied only when wealth holders realize their gains - when they sell their appreciated assets.
Correct. Fix that! But don't tax all kinds of wealth indiscriminately. Tax those kinds that represent ownership of something from the natural creation -- e.g., land, broadcast spectrum, water rights -- or scarce things made valuable by the very presence of the community -- landing rights at LaGuardia, geosynchronous orbit "lots," etc.
Dr. K. continues:
But the superrich don't need to sell their gains. If they need cash they can borrow using their appreciated assets as collateral. When they die, they can hand their heirs their appreciated assets with a step-up in basis, which wipes out prior capital gains. With the right estate planning, they can also avoid most estate and gift taxes. Unlike most of us, what the superwealthy and just plain wealthy pay in taxes is a matter of choice - their choice. When Warren Buffet says his tax rate is much lower than his secretary's, he's got it right.
Real capital doesn't appreciate. In fact, left unused, it depreciates quickly, and even well taken care of, it depreciates. What appreciates is what is scarce and finite and not subject to being created by individuals. Tax that.
Dr. K. continues:
So why do so many Democrats think the FairTax is regressive? Because they consider taxes relative to annual income rather than resources, and the former is a terrible proxy for the later. Bill Gates's income this year may be zero given what's happening to stocks. If so, a man with over $47 billion in resources will be classified, based on income, as no better off than the homeless. And since Gates's consumption is based on his resources, not his current income, the ratio of this "poor" person's FairTax payments to his income would be sky high. Measuring taxes relative to income will thus suggest regressivity with respect to consumption taxation where none exists.
Well, we might have found a point of agreement. I don't want to tax Bill Gates on his success, except to the extent that he has made his money through monopoly power.
Dr. K. concludes:
Our economy needs a simple, transparent, and progressive tax system. The FairTax is the answer. Democrats should give it another look and a fair chance.
The FairTax is not the answer. But Land Value Taxation is. Republicans, Democrats, Greens, Independents and others should all give it a careful look and an indepth study. Not only would it be a superior form of taxation, it would also put us on the road to solving serious problems of sprawl, low wages, poverty, job creation, wealth concentration, long commutes, excessive fuel usage, air pollution, greenhouse gas output and its results -- problems in which none of our current "solutions" are making even a small dent.
That sure beats a tax designed primarily to shift the burden of taxes off our most prosperous society members and onto to those who already struggle.
I would not want my son or daughter to learn their economics at the feet of such a teacher, or a candidate who purports to intend to serve the common good to be advised by such a person. We are ill-served.
Laurence J. Kotlikoff, a professor of economics at Boston University, is an economic adviser to Mike Gravel and a consultant to FairTax.org.
There is no indication that consumer spending on goods and services, around $9 trillion annually, is ever likely to do anything other than stay roughly the same or grow year over year (with the exception of occasional recession-induced corrections, which are relatively minor - in fact, historically consumer spending levels swing less than income levels do).
You might argue that if retail prices go up as a result of enacting the FairTax, then people would spend less on luxury items or non-essential goods and services. But that would require (1) dismissing that wage earners would have a heck of a lot more spending power without income tax with-holdings, and (2) ignoring the well-studied concept of embedded taxes, which make up roughly 22% of the cost of all retail items we purchase today. The market equilibrium forces would almost immediately drive all prices downward the moment these embedded tax costs are taken out of the supply chain.
Furthermore, I will never believe that people in America, when freed of income tax burdens, would suddenly be inclined to just sit on their money and not spend it. Where do you get that from?? Do you live in the same consumer culture I live in?
The benefits of replacing our arcane income tax with the FairTax go way beyond what I can type here. If you think continuing with income taxes is the way to go, you should talk to my employer. As I type this they're evaluating which offshore locales to relocate the portion of the business (software) that caters to non-US customers. This is so we can compete on a more even playing field with our competition abroad. In a global marketplace, companies that aren't saddled with the income taxes we endure as US workers have quite an upper hand!
Posted by: Robert | September 17, 2008 at 07:00 PM
Robert, I suspect you're right that spending will not rise. Which means that producers and distributors (who are actually equally producers [I originally wrote "distributors"], though we seem to look at them differently) will receive less. We will continue to spend $1, but instead of $0.94 going to producers of various kinds -- manufacturers, growers, processors, distributors, retailer and their employees -- $.75 will go to them. That represents a significant reduction in demand.
Luxury goods might be okay. The wealthiest among us will see a HUGE reduction in their taxes, and will have even more to spend than they do now. The market will shift to producing even more goods to satisfy the top 5% of the population. Is this a good thing? Is trickle down excellent? It doesn't sound right to me, but your mileage may vary.
If people below the 95th percentile or so of the income spectrum find themselves with more disposable income -- which strikes me as extremely counterfactual based on the distributional tables I've seen -- what would happen? Their ability to spend more on housing would drive up the price of housing. But what they'd be buying would not be so much houses, granite counters, refrigerators and bathrooms, but locational values -- and while their purchasing power may enrich the sellers, it doesn't create any demand for manufactured goods ... in other words, jobs. Spending more on land is inert, except to the extent that it enriches mortgage lenders and their shareholders, who haven't done diddly to improve the economy. One might as well drop that monthly mortgage check into a hole in the ozone.
I am as opposed to income taxes as you are. But I don't see any gain for you or for me or for the vast majority of the American people in a tax on consumption.
And if we went the direction I'm recommending, American landlords would be courting your employer with lovely office spaces in which to house their business, and you with appealing places to live in, close to your work. And we all might become reasonably indifferent to whether we owned or rented, because we'd be close to our work and getting what we paid for, with options galore. Seems worthwhile to me, particularly when I factor in the benefits to future generations ... our children and grandchildren -- all of them!
Posted by: LVTfan | September 17, 2008 at 09:39 PM
Glad to hear you're opposed to income taxes as well, but I have to respectfully disagree with your point about Americans, under the FairTax, continuing to spend $1 and leaving $0.75 for the producers rather than $0.94. With income taxes removed, middle class Americans would have ~30% more to spend. So while you could argue that producers would get $0.75 under a FairTax, wage earners would have 30% more in their bank accounts to give them - making it pretty close to a wash to producers.
I've never heard anyone suggest that removing income taxes would cause more businesses to cater disproportionately to the uber wealthy. For one, this special class of people already has plenty of money regardless of our tax policies, what's stopping this "catering to the wealthy" bonanza from happening right now? Furthermore this tiny fraction of society doesn't offer much in the way of economies of scale to the entities selling them expensive widgets. The sweet spot for profitability is in selling high volume at reasonable prices. Selling goods that can command an incredibly high margin are the rare exception - market forces always draw other businesses in to compete when products are selling at an unreasonable premium.
You have quite a focus on property and real estate for deriving revenue. But there's a whole other spectrum of goods and services out there that are vying for consumers' wallets (and thereby providing an opportunity for deriving tax revenues). I also don't buy into the idea that such a significant segment of the population would immediately go looking to buy bigger homes (thereby substantially driving up prices) when they find themselves suddenly getting 30% more take home pay. But most of all, I can't think of any way you could possibly start taxing property owners at the federal level without triggering some kind of nationwide revolt, even after accounting for the removal of income taxes.
Small point here, but as to the environmental angle, wouldn't the FairTax have a provision for that as well? Since only NEW goods are taxed, it would naturally encourage reuse of end-use items for which taxes have already been paid.
That's not to mention the added benefit of deriving tax revenue from tourists and illegal aliens. To me, the true beauty of the FairTax is that it represents such an enormous expansion to the size of the tax base. I don't think anyone could possibly dream up a way to make it any larger. I'd be curious to know what the size of the tax base would be if the revenues were derived entirely from US real estate/property owners, and what the impact would be to the average home owner. It would take a lot of study (similar to the scope of study that has been put into the FairTax).
Sorry for my disorganized rant. Posting this was just a brief escape from a crushing workload tonight.
Posted by: Robert | September 18, 2008 at 12:11 AM
One more point I forgot to mention - the FairTax would not be a replacement for property taxes. It would only be targeting income taxes. Property taxes (or land value taxes or whatever you want to call them) will always be with us.
Also, please address the "prebate" provision of the FairTax, as I feel that provides a brilliant protection to poorer people from shouldering an unfair tax burden. It pretty much counters the anti-FairTax assertion that a consumption tax is simply a mechanism to "shift the burden of taxes off our most prosperous society members and onto to those who already struggle." I wholeheartedly disagree with that.
Posted by: Robert | September 18, 2008 at 12:18 AM