Is the FairTax Fair?

Experts face off on the issue
Interviewed by Joshua H. Silavent

Laurence M. Vance holds degrees in both accounting and economics. He is an adjunct scholar of the Ludwig von Mises Institute in Auburn, Ala., for which he has written numerous articles on taxation, including a critical review of The FairTax Book by Neal Boortz and Georgia Congressman John Linder.	Ken Hoagland, a long-time public policy advocate and consultant, is the national communications director for FairTax.org. Mr. Hoagland has helped organize FairTax rallies in the Atlanta area and elsewhere in the nation, and is a frequent contributor on public policy matters ranging from education policy to tax policy. He is based in Houston, Texas.

 

The current United States tax code is undeniably complex, and every year millions of Americans outsource their own tax returns, choosing to pay someone to organize and file their returns rather than spending days, even weeks, sifting through the arcane process themselves. The FairTax system was first proposed in 1995 as a response to the expanding tax code, and is aimed at simplifying the process by establishing a national retail sales tax that would eliminate the need for federal income taxes, and as a result, the bulk of the IRS. The FairTax has since gained a wide following, most notably among Atlanta radio talk show personality Neal Boortz and former Republican presidential candidate Mike Huckabee. However, though general agreement may be found in the need to abridge the current system, the popularity of the FairTax system has also given rise to many critics, who dispute the calculations and benefits professed by its supporters. This month in Atlanta Life, Laurence M. Vance and Ken Hoagland debate three of the most pertinent issues regarding the FairTax. Let us know what you think on our Blog.

Critics of the FairTax have argued that it will cause middle-class Americans to pay a higher share of the tax burden, while the burden associated with those below the poverty level and those in upper-class earnings brackets will decrease. Do you agree with this assessment? Why or why not?

Vance: This assessment is correct. Instead of being in proportion to income, the FairTax is proportional to spending. Since the wealthy spend much less of their total income, their share of the tax burden will be much less than the middle class. Although those below the poverty level who currently pay no income tax would have to begin paying taxes on their purchases under the FairTax, this would be more than offset by a welfare payment given to all Americans (regardless of their income) by the government each month called a “prebate.” Moreover, all taxpayers will have a higher tax burden under the FairTax because the rate is
actually 30 percent and not 23 percent, like is often claimed. Ignoring state sales tax, an item that costs $1 now would cost $1.30 under the FairTax–a 30 percent tax rate. However, FairTax supporters, for obvious reasons, prefer to figure the rate inclusively (the tax is included in the price of the product). They take the $1.30 and say that since 23 percent of that is 30 cents, then the FairTax rate is 23 percent–when, in fact, it is really 30 percent if figured like any other sales tax.

Hoagland: This has been widely misunderstood, largely because of a sleight-of-hand perpetrated on the American public by the President’s Advisory Panel on Tax Reform in 2005. The Panel was comprised of stakeholders in the income tax system, and instead of analyzing the FairTax as defined in pending legislation, they quietly created their own national consumption tax, loaded it with exemptions and exceptions they felt were more “realistic,” ignored the positive distributional effects of eliminating highly regressive FICA payroll taxes, and then declared that such a tax would raise tax burdens on the middle class. Most observers wrongly assumed this “analysis” defined the FairTax. Not so. Analysis by noted economist Laurence Kotlikoff of Boston University finds that the greatest benefit of the FairTax accrues to the poor and near poor, with the second greatest benefit accruing to the middle class. Lifetime tax rates, which examine the actual effect of tax burdens at different periods of a taxpayer’s life, show dramatic reductions in tax burdens for nearly every income segment because the taxpayer base is so dramatically expanded. Eighty independent economists have hailed the FairTax as positive for the nation and a relief for the middle class.

Proponents of the FairTax have suggested that prices on consumer goods will drop by more than 20 percent with the elimination of corporate and social security taxes, offsetting much of the price increase associated with a national retail sales tax. Do you think this assessment is accurate? Why or why not?

Vance: This assessment is inaccurate. FairTax proponents are correct that the current price of consumer products includes embedded taxes–the tax burdens of businesses that contribute to the overall cost of products–but they are mistaken regarding the amount that prices could fall if they were removed. Personal income taxes, accounting for almost half of federal revenues, are borne by consumers, not embedded in product costs. Federal excise taxes on things like gasoline would still be in place under the FairTax. It is mainly corporate income taxes and the employer share of social insurance taxes that are embedded taxes. There are just not enough embedded taxes to be removed to offset the FairTax. Additionally, it is incorrect to say that because costs will fall by x amount that prices will fall by the same. Not only does this ignore the basic laws of supply and demand, it is based on the fallacy that the costs of inputs in production determine the price of the output they produce. We know that prices will increase by 30 percent with the adoption of the FairTax, but we don’t know how much they will decrease by removing the costs of embedded taxes.

Hoagland: When American producers pay the employer share of FICA taxes plus corporate income taxes (the highest in the world), and the not insubstantial cost of tax preparation ($265 billion last year), these costs don’t come out of profits but rather are offset by either higher retail prices or artificially depressed wages and benefits. The effects of “embedded” tax costs vary between different segments of the economy, but every employer knows that such costs are always borne, in truth, by consumers and workers. These embedded costs put American producers at a price disadvantage with foreign competitors whose governments routinely forgive national taxes on products for export. This reality has helped drive trillions of American dollars offshore and constitutes a real and present threat to the “Made in America” label. Although economists debate the relative effect of these costs on retail prices, wages and benefits, there is little debate that such costs are eliminated with a national consumption tax. Elimination of the corporate income tax, capital gains taxes, and all taxes on earnings and savings will act as a powerful magnet to investment and make the United States the “offshore” tax haven for the world–bringing trillions of dollars back to American shores.

Because the FairTax taxes 100 percent of all new goods and services, consumers would end up paying taxes on many things they currently do not, including home purchases, rent, medical bills, interest on credit cards and mortgages, and additional gasoline and utilities taxes. Furthermore, because state and local governments will also be required to pay the national retail sales tax on most purchases, consumers can expect to pay higher state and local taxes to cover these additional expenditures. Do you think most Americans who support the FairTax understand this? Do you think Americans are willing to accept these changes? Why or why not?

Vance: Few Americans who support the FairTax understand the extent to which it would create new taxes, new taxpayers and new tax collectors. Households that employ domestic workers would have to pay the FairTax on all wages paid. Postage stamps would be subject to the FairTax, as would employee discounts over 20 percent and all Internet transactions. Even barter transactions would be taxed at the fair market value of the goods or services bartered. And not only will state and local governments have to pay sales tax on their purchases, they will also have to pay the FairTax on the salaries they pay government employees. The federal government will do the same–paying the tax to itself. This has the effect of artificially broadening the tax base to maintain the fiction that only a 23 percent rate will be required to maintain current revenues. Most Americans would not be willing to accept the drastic and sweeping changes that would occur under the FairTax. Americans have never taken kindly to the attempts by states to impose taxes on services. And their religious convictions would never permit them to accept turning churches into tax collectors.

Hoagland: Most taxpayers understand that the income tax system is riddled with exceptions favoring the politically powerful. Congressional tax writing committees reward “friends,” contributors and lobbyists, but punish opponents and manipulate citizen behavior. The result is 67,500 pages of nearly incomprehensible complexity that befuddles even the IRS. Only in the context of this dysfunction–a playground for Congress, tax lobbyists and tax policy experts–is the FairTax reasonably judged. Extensive market research reveals that the public welcomes the simplicity of the FairTax and understands that hidden existing taxes simply become visible under the FairTax. Many feel this transparency will create public pressure for Congress to act more responsibly on spending measures. State and local tax adjustments will be offset by higher take-home pay and many retail prices will actually come down as embedded income tax costs are eliminated. Billionaires will pay their fair share, illegal immigrants will pay taxes as consumers and the $1.5 trillion annual underground economy is taxed. Current deductions lose their value when seen in the light of 100 percent take-home pay. Finally, the public welcomes the prospect of robust investment in America under the FairTax because it reverses the current trend and represents a rising sea that floats all boats.