RSS Feed MenuSome days ago, I wrote an article itemizing the strengths and weaknesses of a Mike Huckabee candidacy. I praised the former governor’s intelligence and civility – but worried about his attraction to the bunkum idea of a Fair Tax. Gov Huckabee replied with a full-throated defense of the plan’s merits. Huckabee finished second in the delegate count in the 2008 nomination contest. He has to be considered a front-tier candidate for 2012. The merits (and demerits) of a Fair Tax thus remain unfortunately very relevant.
So we return to the debate with a series of four posts on the Fair Tax plan by a leading student of the tax system, Hirschel Adler. In my opinion, he leaves the concept a smoking ruin. Click here to read the entire series.
-David Frum
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The FairTax’s most unique proposal is a ‘prebate.’ Under the prebate proposal, every family unit in the United States would receive a monthly payment from the federal government “covering taxes on all basic household necessities”. It would only be paid to lawful residents.
There are three major problems with the prebate as proposed: (1) The calculation proposed in the statute does not work. (2) Making sure there would be no fraud would cost a fortune and given the federal interest in border security, we might find the federal government has no interest in preventing fraud, and (3) most taxpayers could not imagine anything worse than the federal government issuing 100 million checks a month, more than one trillion checks a year.
The prebate does not cover the FairTax on one hundred percent of all basic household necessities. The prebate provides for a 23% payment based upon the expected purchases at the poverty level. As the FairTax is calculated on a “tax inclusive basis”, to cover the FairTax at the poverty level, the simple math requires a payment of 30% for the prebate. This is a big ‘oops’ in that a single person would receive a prebate of $2392.00 on poverty level purchases that would include FairTaxes of $3106.00. Whether either the prebate or having the federal government pay 100% of everyone’s FairTax until there have been purchases equal to the poverty level are made is a good idea or not, the promise that the prebate covers 100% of these taxes is a huge pillar in FairTax sales pitch. That promise is not fulfilled. (This could be remedied by redefining the calculation of the poverty level amount or providing that the prebate is 30% of the poverty level purchases.)
Insuring that the monthly prebate payment only goes to legal citizens and not to illegal residents, scammers and dead people would take an army of administrators. Insuring that the federal government “does its job” with respect to enforcement is a fairly new but important consideration for any new law.
While there are other serious technical issues with respect to the prebate, the last question I have with the prebate is “Who wants the federal government keeping track of where every legal American is every month? Who wants the federal government creating another huge entitlement program? Who wants the federal government issuing an additional billion checks or deposits a year?
More to come…
buddyglass // Sep 3, 2010 at 11:32 am
@easton: “if you people want to implement it, try it at a state level and prove us wrong”
IMO a state-level pilot might not mean much with regard to whether the federal version would work. Couple reasons:
1. A higher percentage of most states’ populations live within striking distance of the state border, compared to the United States as a whole. (With obvious exceptions).
2. Crossing state borders is much easier than crossing national borders.
3. One and two above means a state-level FairTax would be much more prone to border shopping.
4. On the flip side, the sales tax rate for a state would be much lower than the federal rate. If a state implemented a FairTax and it “worked”, that wouldn’t necessarily reassure me that it would “work” at the federal level, since the federal sales tax rate would be so much higher.
All that said, certain states do derive a substantial amount of their income from sales tax. Of the taxes that the state of Texas collects, 55% are from sales tax. (Sales tax receipts represent only 25% of total state revenue, though, since substantial revenue comes from the fed and from licensing & fees.)
Dutchman3 // Sep 3, 2010 at 12:53 pm
Buddyglass,
“The prebate is intended to maintain the status quo in which someone at the low end of the income spectrum is relieved of his obligation to pay federal tax since, you know, he’s basically poor and can’t afford it.”
And, if the Fairtax simply relieved the poor from paying income taxes, similar to the 47% that don’t pay today, I might not have set my hair on fire. But, the Fairtax also relieves 30 million working families from paying their FICA insurance premiums, something that isn’t true today. My objection is to the clear fact that the Fairtax sets up a huge group of working families that pay absolutely nothing each year to the cost of the federal government, yet still qualify for full retirement and health care benefits. That is not what our country is all about, imho! At the same time, retirees that have paid their premiums for 45 years or so, and are now receiving those benefits, would be forced to resume paying for their benefits with their sales tax dollars. Very unfair!!!
“1. If your only income is SS then you are most likely poor enough for the prebate to almost entirely cancel your tax burden.
2. If SS isn’t your only income, then most likely some of your other income is taxable. FairTax nukes that tax. The only time you’d be “double taxed” is if you were drawing significant income from an account that would have previously been tax-exempt (e.g. Roth IRA). These people are screwed a little bit, but not hugely. Conversely, anyone drawing money from a 401k or standard IRA experiences a windfall.”
For #1, I don’t know what you mean by “almost entirely cancel”, but here are a few numbers to consider. If the average SS check is $1,000, then a retired family of two would be living on $24,000 per year plus their $5,000 prebate, or a total of $29,000. Assuming they spend it all on taxable purchases, their sales tax would amount to $6670, minus the $5,000 prebate for a net federal tax of $1670. They pay nothing today, and would pay $1670 under the Fairtax. Is that a good deal for them?
For #2, it turns out that a retired couple can draw up to $30,000 in two SS checks, plus $18,000 in investment drawdown and pay absolutely no federal tax on that $48,000. Under the Fairtax, they would have $53,000 to live on including the prebate, and if they spent it all on taxable goods and services, they would pay $12,900 in sales taxes, offset somewhat by their $5,000 prebate for a net tax payment of $7,900. Nothing today, $7,900 under the Fairtax. Please convince me that retirees should support the Fairtax.
wiseoldowl // Sep 3, 2010 at 9:05 pm
Dutchman, I have to agree, FICA premiums should continue to be funded by a percentage of gross income. Since the premium is based on a percentage of gross income, the payroll report will be very simple to complete. Besides, under the FairTax as written, businesses will still be required to report their employees’ gross income to determine future benefits. By doing this the FairTax rate could be reduced to 15% to 18%.
In one other post, I mentioned that the only thing I would change on the FairTax is to eliminate taxes on government spending. Now I have two changes. I can’t think of any others, but you are welcome to try and convince me.
Dutchman3 // Sep 3, 2010 at 9:16 pm
wiseold owl,
“Based on 2009’s GDP, the FairTax at the rate of 23% would have generated more federal revenue than was actually collected, and that includes the current $290-billion lost due to tax evasion and the prebates of $690-billion. Consumer spending for 2009 was $14.119-Trillion not including used goods. Actual receipts were $2.105-Trillion. To figure the amount of revenue the FairTax would have generated you take 23% of $14.119-Trillion which is $3.247-Trillion less $290-billion for tax evasion and another $690-Billion for the prebate and you end up with $2.267-billion. This is $162-Billion more than our current system generated.”
Facinating, and quite inaccurate, my friend. GDP in 2009 was about $14+ trillion. Using the BHI/Kotlikoff assumption in their 2006 rate study, 81% of GDP would be taxed by the Fairtax. I see no logic to change that assumption.
81% of $14 trillion is $11340 billion, and when taxed at 23%, tax revenue comes to $2608 billion. I don’t know where you got $290 billion for evasion, and believe you have it mixed up with the Tax Foundation estimate of $290 billion for compliance costs? I’ll use a very optimistic estimate of 10% evasion, so that leaves $2347 billion, and after subtracting $600 billion to pay for the prebate, net revenue would be $1747 billion. That is $358 billion less than was collected by the 2009 income/payroll taxes. Oh well, what’s a half trillion+ swing among friends?
What am I missing?
wiseoldowl // Sep 3, 2010 at 9:24 pm
Dutchman, I agree, FICA premiums should continue to be funded by a percentage of gross income. Since the premium is based on a percentage of gross income, the payroll report will be very simple to complete. Besides, under the FairTax as written, businesses will still be required to report their employees’ gross income to determine future benefits. By doing this the FairTax rate could be reduced to 15% to 18%. As the FairTax is written, those earning poverty level or less will not be contributing one dime towards their future S.S. benefits. I still believe in the prebate but I don’t like the fact that it would give a free ride to millions of Americans. Keeping FICA premiums as a percentage of gross income eliminate their free ride.
The only other change I would make is to not tax government spending. This just does not make sense.
By the way Dutchman, you are the one who convinced my on both of these changes, even though I don’t believe I would consider any other changes, you can try to convince me.
Dutchman3 // Sep 3, 2010 at 10:09 pm
woo-woo,
The wiseoldowl is getting wiser it seems? You are probably the first Fairtax proponent I have come across that would even talk about changes to HR25. Most simply say that HR25 should be passed as is, a totally naive position. I spent ten years on Capitol Hill and never saw a major piece of legislstion pass without amendments. Turns out no one gets everything they want. The legislative process depends on compromise!
While you are in the mood for change, how about we keep the gift/estate taxes? Under current rules, those taxes affect only the very wealthy, and by including those taxes on the list to be replaced by the Fairtax, it appears to be one huge gift to the wealthy. Don’t misunderstand-I am not guilty of wealth envy, but I don’t approve of dynasties. You want to be wealthy–earn it, don’t just win the birth lottery!!
Turns out that if we made those three changes–FICA, government taxation, and retaining gift and estate taxes, we could create a revenue neutral national consumption tax rate of 10%, otherwise known as the “tithing rate”.
Best regards,
Hank
wiseoldowl // Sep 4, 2010 at 1:27 am
Dutchman
I disagree with you on keeping the gift and estate tax. To me, these are the most unfair taxes of all. I am not wealthy by a long shot, but if I was, and I created my wealth, I should have the right to choose who it should go to and it sure wouldn’t be the government. Under the FairTax, they will eventually receive their share anyway. If it goes to my heirs, it will either be spent or it will be invested. In either case it will stimulate the economy. If they spend it, the tax will be paid as it is spent; if they invest it, jobs will be created. Actually if my estate was worth $12-million, I would probably will most of it to St. Jude Children’s hospital. I wouldn’t want to give half of it to the government first. It will be much more wisely spent by St. Jude hospital.
Dutchman3 // Sep 4, 2010 at 4:07 am
wiseoldowl,
OK, can’t win ‘em all. How about bagging the “cold turkey”, overnight transition scheme, and phasing in a consumption tax over five years? No other country in the world has ever successfully funded their central government with a sales tax, and there are too many unk-unk’s about the Fairtax. We have had the income tax for almost 100 years. Taking five years to switch over and make corrections where necessary seems reasonable to me. How about you?
wiseoldowl // Sep 4, 2010 at 9:00 pm
Dutchman,
And what steps would you propose for this 5-year transition?
Dutchman3 // Sep 4, 2010 at 10:23 pm
Woo,
It’s really quite simple. In year one, lay on a 5% sales tax, and when it’s time to pay income taxes, add a line on the 1040 which reduces your net tax burden by 20%. In year two, the sales tax is 10%, and income tax burden is reduced by 40%. In year 3, the sales tax is 15% and income taxes are reduced by 60%. By year 5, the sales tax of 23% or whatever is needed is in place and there are no more income taxes. All unexpected problems have been resolved. Even Congress couldn’t screw that plan up. (Or could they?) At the same time, the prebate could be introduced incrementally. With a five year transition, I would also suggest that the inventory tax credit be eliminated, saving some $350 billion in unnecessary costs.
wiseoldowl // Sep 5, 2010 at 6:42 am
Sonuds good, but there are two problems I can see. First, there would be a significant increase in administrative costs during this period both for businesses collecting the tax and government policing. Business compliance cost would increase due to the addition of the sales tax without the elimination of the other taxes. For this same reason, it would also increase the cost of operating the IRS. They will also have an additional tax to monitor. Second, if we don’t eliminate all the current taxes from the beginning, they may never be eliminated. The second problem is the one that concerns me most.
wiseoldowl // Sep 5, 2010 at 7:51 am
I also agree that the inventory tax credit should be eliminated. This will be an administrative nightmare. Retail prices may increase somewhat in the beginning but will slowly drop as inventories are replaced.
Dutchman3 // Sep 5, 2010 at 2:14 pm
Speaking of administrative night mares, do you understand the headaches that will be associated with Sec 801-806, the implicit tax on interest bearing investment and debt instruments? Each month, the financial institutions would have to recalculate the implicit tax based on ther latest Treasury short, medium and long term Treasury rates. And, the implicit taxes are in addition to normal service charges.
I’m not sure everyone understands what implicit taxes are all about, so here are two examples.
(1) Assume a $10,000 Visa/MC debt on which the debtor is making minimum monthly payments. If the interest rate paid on the debt balance is 18%, and the current short term basic interest rate is 3%, than the implicit tax would be calculated as follows:
15% (differential) x $10,000 x 30% (exclusive) divided by 12 (months) = $37.50/month
This would add a significant amount to the overall debt service monthly costs. Granted, the 18% interest charge generally only applies to higher risk users or users with late or missed payment records. But there should be little doubt that the costs of consumer debt will increase.
(2) Assume a long term bond of $100,000 paying 3% annually. If the long term Treasury interest rate were to rise to 5%, the implicit tax would be calculated as follows.
2% (differential) x $100K x .30 exclusive% divided by 12 (months) = $50 tax/month . This in effect reduces the gain from the bond investment by 20%. Of course, as the Treasury rate rises over time, investors could move their money to instruments paying a higher rate. But care needs to be given to possible penalties for early withdrawal of funds. There might be a tendency by investors to invest in shorter term variable rate instruments tied to the basic interest rate rather than long term fixed rate investment instruments in order to avoid the potential tax or penalties.
It isn’t clear just what possible economic policy change is behind the language in Sec. 801. What is fairly clear is that the risk of acquiring fixed rate investment and debt instruments may be higher relative to variable rate instruments. In effect, it would seem that the Treasury Secretary would be in a better position to significantly affect the financial free market in the United States under the terms of HR25. The announcement of the monthly basic interest rates would be a closely watched event for both investors and borrowers.
In view of all of the above, perhaps Sec. 801 should be deleted? That would mean a reduction in the taxable base of $290 billion, and a revenue loss of $67 billion which could be made up by increasing the rate by .8 percent.
How does this one strike you?
wnettles // Sep 6, 2010 at 12:53 pm
The way that most of us “working class citizens” who pay a boatload of taxes on our income each year figure it is that a tax on consumption of new goods and services beats a tax on our income, hands down. Tax gets too much to bear, we change our government. We did it before, you remember, when the King of England forced a tax on tea and sugar and many other food items necessary for survival. If our elected political entities cannot fathom the basic principles of capitalism and free enterprise, then, we will replace them. Whether this comes about at the ballot box or with a little more vigor, we will see. But, mind you, we will replace those that cannot or will not fairly represent us.
The FairTax Act is the single most researched piece of tax reform legislation currently before the Congress of the United States. I say let’s give it a go, and, if it does not work, what have we lost? A tyrannical tax structure? No great loss. But, a whole lot of gain for the “working class”.
The abolition of the income tax and the replacement of it with a fair and just revenue collection system such as the FairTax Act will rocket this nation out of our current economic recession and might just prevent a depression, like we had in 1933. We repealed alcohol prohibition, we can repeal the income tax. Both were regressive in nature and depressed our economy. Both grew the size of government. Both need to be banished from our realm. The FairTax would be a revenue neutral replacement for the unfair and unjust taxation of our income. Let’s do this now before our economy completely collapses under the weight of government.
sammyd29577 // Sep 7, 2010 at 11:25 am
Dutchman3
In your post from Sep 3, 2010 at 12:53 pm, you seem to be forgetting that the 23% figure comes out of the embedded taxes that exist today and ARE paid by the end consumer.
The Fair Tax would simply be more visible than the embedded taxes.
What is wrong with letting the consumer see the taxes instead of hiding them all along the steps production???
fairytaletax1 // Sep 30, 2010 at 12:34 am
This is a funny video about the author of the fair tax Rob Woodall http://www.youtube.com/watch?v=JZUgmeg7hGg