Monday, January 7, 2008

Progressive Fiscal Stimulus and the Fair Tax

Brenda has argued in comments here that any fiscal stimulus should target the poor. Lawrence Summers appears to agree:

fiscal stimulus only works if it is spent so it must be targeted . Targeting should favour those with low incomes and those whose incomes have recently fallen for whom spending is most urgent.


And now Pat Regnier wants us to believe that Mike Huckabee and other Fair Tax fanatics are progressives.



Critics, including conservative commentator Bruce Bartlett, have argued that people generally think of sales taxes in terms of mark-ups - that's how state sales taxes are expressed - and that FairTaxers are just trying to come up with the lowest possible number to make their idea easier to sell. A 30% tax on food and medicine would be hard on the poor, wouldn't it? If that's all there was to the plan, yes. On its own, a national sales tax would be extremely regressive - that is, it would tax everyone who spent everything they earned (and that's a lot of us) at 23% of their income, while those who made enough money to set some aside would, in effect, pay a lower overall rate. But the sales tax plan would partly offset this effect by sending every household in America, from the family of a poor single mother to Warren Buffett, a check to cover the taxes on their spending up to the poverty level. Factor in that cash from the government, and each family's net tax burden goes down, so that the Fair Tax looks more progressive.


Bruce Bartlett and others have argued that the 30% tax would fall short of covering even current government spending even if these checks were never sent out. And yet Mr. Regnier fails to miss the massive fiscal stimulus (or was that irresponsibility) of the Fair Tax replacement plus more transfer payments. As progressive as the Fair tax crowd wish to dress this pig up, this is not a serious policy proposal.

Hat tip to Mark Thoma for his coverage of the latest from Lawrence Summers.


18 comments:

wellbasically said...

If they save it, then the bank lends it out and somebody else spends it.

Anonymous said...

Economist Dale Jorgensen, Harvard University, was commissioned to find out what portion of current prices were represented by costs for complying with the federal income tax code (i.e., embedded tax costs). He concluded that 22% (average) of every retail dollar, spent by consumers, constituted a price-embedded tax. Thus, in addition to individual income tax and FICA withholding, individuals are unwittingly paying these unseen, embedded business tax costs with every purchase of a new product, or service.

Under FairTax, prices would fall, due to removal of embedded business tax-related costs. Concurrently, wages may rise due to a mix of factors, including reversion of withheld pay (or some portion thereof) to employees, advancement opportunities due to business expansion resulting from retained earnings, and/or increased demand for labor accompanying increased competition (from that expansion). Where profits (or wages) appear lucrative, competition will move into the market space, driving out excesses (immediately present after FairTax is enacted), arriving at new "market-adjusted" prices.

For FairTax to constitute 23% of new transaction cost (i.e., "market-adjusted" price plus FairTax), a mark-up of 29.9% (tax exclusive rate) on the new "market-adjusted" price is necessary. (Before balking, consider what we're paying now if income tax rates are converted to tax-exclusive sales tax rates on net income instead of percentage of gross income. The following figures can be compared to the 29.9% FairTax mark-up: Fifteen pct bracket = 17.6%, twenty-five pct bracket = 33.3%, twenty-eight pct bracket = 38.9% (! really), and thirty-five pct bracket = 53.8% (! that's how bad it is).

In order to make FairTax a progressive consumption tax (such as that recently called for by Warren Buffett), all citizen-families are simply sent a monthly consumption [tax] allowance, called a "prebate." This prebate is intended to reimburse taxes on necessities for every citizen family without need for record-keeping or reporting. Moreover, the direct payment bypasses the creation of a tax code specifying exempted products and services around which a lobbyist industry could grow. The amount is variable, based on family size, and is equal to the FairTax rate on poverty-level spending, as defined by the Dept. of Commerce. At present, a family of one would receive ~$200/month, a family of four, ~$500/month. Thus, the "effective" FairTax rate paid by citizens, will *never* equal the full 23%. Of course, U.S. visitors (legal, and illegal) will pay the full FairTax when they purchase anything new, at retail (used are not taxed again). Under FairTax, working families will have their whole paychecks (minus any state or local income tax withholding) plus their monthly family prebate.

Additionally, citizens will no longer have to spend the average 50 hours per year preparing their federal tax returns. Having more monthly income may result in using credit less, and saving more. Larger savings will make it easier to purchase a home, at a lower interest rate and monthly payment. (Thus, mortgage deductions are no longer applicable when income is not the basis for taxation).

But is FairTax actually fairer? To provide substantive answers, Prof.'s Kotlikoff and Rapson (10/06) have 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."

The current income-based tax system is also more expensive to run, because of the manner in which the tax code is gamed by politicians and lobbyists. Politicians realize great power, and attract constituencies for support, by granting tax favors (i.e., credits, deductions, exemptions) through lobbyists. Fully, fifty-three percent of Washington lobbyists are there because of the tax code! The tax code is continually changing, making it more complex - more difficult to understand. And, the salaries and costs of tax lawyers and lobbyists end up in higher prices of the products and services we buy. Additionally, the time and money required to keep records, file returns, report for audits, retain accounting and legal help, pay IRS penalties and interest, is time and money lost for other productive, or recreational, activities. Depriving us of the use of withheld wages increases our expenses through zero-interest withholding, inflation, return preparation time, and interest paid on credit cards and loans that otherwise may not have been necessary. Summed up, the cost of tax compliance, nationally, has been estimated to range anywhere from $265 billion to twice that amount, depending on the extent to which tax-avoidance consultation is sought and utilized. These expenses constitute a substantial hidden tax which is incomprehensible to the average working American. And the FairTax gets rid of all of it for most Americans, and most of it for business owners.

We, as FairTax advocates, believe that government should serve We, the People, with a fair tax system that will not enable politicians to pit poor against rich (creating barriers to achieve wealth, adding tax penalty to the sacrifices made for personal success). Nor do we want politicians to continue using business as a tool to hide taxes from consumers, often villifying business, which discourages entrepreneuship, personal achievement, economic growth. Liberty and happiness depends on restoring the fruits of labor to those who produce them. We believe that the tax function should align with economic growth, not against it, that government should be paid for in the same manner as working Americans - when, and because, something is sold!

As things stand at present, the system primarily benefits politicans who cater to special interests through lobbyists who game the tax code. The politician seeks to capture them as constituent voting blocks, dependent on continued syphoning of taxpayer dollars to their members' benefit. This is increasingly repugnant to the average working American who often finds it difficult to meet the needs of his, or her, own family in an environment where federal and state business income taxes substantially contribute to trade inequities resulting in the loss of American jobs! Thus, the Sovereign are continually degraded by features of Congress's income tax policy. The most rapidly-growing needs-based "special interest" group has become the Citizens! You see? Congress has nearly all the power; and We, the People, have become We, the Serfs, robbed and enslaved. Getting the federal government's hands out of our family paychecks is the single most important reason to replace the income tax with a consumption tax, the FairTax.

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."

(May reproduce in whole or part. - Ian)

reason said...

I guess political spam will become a fact of life for a while (sigh).

Shane Taylor said...

Bruce Bartlett explained the bait-and-switch of Fair Tax distribution claims:

One problem with analyzing the distributional consequences of the FairTax is that its supporters sometimes argue that after-tax incomes will rise by enough to pay the higher prices for goods and services once the 23 percent is added to the prices people pay today. At other times, they argue that prices will fall once income taxes currently embedded in prices are removed, implying a free lunch in which everyone is better off and no one is worse off. Actually, it’s a double free lunch because not only do you get to keep all the taxes currently withheld and pay no more for goods and services now, but you get the rebate as well.

Free lunch and a pony no one has to pay for. Assuming wages are not sticky. *cough*

The tax is sold as neutral for current revenue, but a rebate means it is not spending neutral. Current revenue includes a personal exemption, the Fair Tax does not. Hence the rebate.

Bartlett goes on to explain the inducement for states to shirk, the baiting Americans to cheat, and just how credulous an outlier such a tax would be. The Fair Tax is a rancid onion. When you remove one rotten layer another bogus conceit is revealed.

Jack said...

I love the rancid onion analogy. Very poetic. It's new to me. And it describes the smoke screen of rhetoric sorrounding the (Not so) Fair Tax. Why Huckabee's opponents don't start beating on his head about it is only understood when one realizes just how regressive any form of a genral value added tax is for the general public. Note that none of the supporting arguments ever discusses the fact that those whose earning are in the multiple hundred thousand and up range will pay no tax on a very large portion of that income. Such high income recipients are likely to spend les of their total incomes each year as they accumulate goods i n the early years of their earning.

If one earns money as a benefit of participating in our poliltical economy why should there be an objection to paying income tax in order to support the continuation of that society?

Brenda Rosser said...

Regarding Lawrence Summers and his proposal for a $75 billion tax cut for the poor.

First, I think that hedge fund folks, along with those who oversaw the development of this financial crisis, should taken with a grain of salt. Summers fits both criteria.

Second, $75 billion isn't going to go very far. Especially in the context of a pathetic multiplier effect. Dollars flowing to big monopoly corporations paying low wages and low taxes. Dollars that are most likey going to someplace other than where the dollars are spent in any case.

Or, OTOH, many of the dollars from the tax cut may be simply diverted to paying off debt. [This would suit hedge fund guys the most because they so heavily involved in the sale of credit insurance -by way of credit default swaps- and therefor praying hard for less debt defaults.]

I've read: "30 to 40 trillion dollars (or more) value of credit default swaps (CDS) outstanding"

Ken Houghton said...

The comment from Ian is spam, and should be deleted. (See the discussion of the same comment at Eat Our Brains.)

For one thing, it almost kept me from g/e/t/t/i/n/g/ t/o/ reading Brenda's comment.

Anonymous said...

Ken,

Always good to have an exchange of ideas, even if these ideas are shared elsewhere (yes, I researched and wrote them, posting where pertinent). Don't know that censorship does anything but aid tyranny. You might want to rethink your knee-jerk comment and decide to engage the ideas expressed.

More on Bartlett's prejudiced thought here, and again, here - not to mention the thrashing he received in response to his "Scientological beginnings of FairTax" at The New Republic.

Shane Taylor said...

Ian, where does the money for the monthly rebate come from? What taxes do you want raised? What spending do you want gutted?

Kevin Carson said...

The FT is just another example of the Republican obsession with taking taxes off of returns on property, and shifting them onto returns on labor? To hear them talk, labor is just another "factor of production," no different morally from land or capital. So why is a consumption tax that falls disproportionately on wage income pretty much OK, while a tax on investment income is flaming red ruin on wheels?

With the rebate, I concede the working poor might break even or possibly a little better, and the destitute might actually come out ahead. But the majority of the working class and the upper middle class will come out far worse. The main beneficiaries will be the upper brackets, who will make out like bandits.

Come to think of it, the rebate functions pretty much like our current welfare system. Because of the income distortions under capitalist privilege, there is underconsumption by the working majority and overaccumulation by the propertied minority. The state steps in to mitigate the destabilizing tendencies. It returns a small fraction, out of the total amount stolen from the working majority, and give just enough to the most destitute to prevent an absolute collapse of purchasing power or politically destabilizing levels of hunger and homelessness. The state's enforcement of privilege results in a majority of the population receiving less than its labor product, while the welfare state help's only the underclass and lumpenproles. From the standpoint of the propertied classes, it's a pretty good deal: they give back a tiny fraction of what they stole, as a kind of political insurance.

The Democrats aren't much better. While the Republicans favor "across the board" tax cuts that go almost entirely to the rich, the Democrats (Crolyites to the core) favor targeted tax credits for social engineering purposes.

The best thing would be a populist tax cut, based on taking people off the income tax rolls from the bottom up. Any president who eliminates all direct corporate welfare spending, and uses the savings to raise the personal income tax deduction to $30,000, will guarantee himself a second term. What we need is a non-capitalist free market agenda of cutting taxes and spending: cutting taxes from the bottom up, and welfare from the top down.

Anonymous said...

The FairTax rate of 23 percent on a total taxable consumption base of $11.244 trillion will generate $2.586 trillion dollars – $358 billion more than the taxes it replaces. [BHKPT]

The FairTax has the broadest base and the lowest rate of any single-rate tax reform plan. [THBP]

Real wages are 10.3 percent, 9.5 percent, and 9.2 percent higher in years 1, 10, and 25, respectively than would otherwise be the case. [THBNP]

The economy as measured by GDP is 2.4 percent higher in the first year and 11.3 percent higher by the 10th year than it would otherwise be. [ALM]

Consumption benefits [ALM]:

• Disposable personal income is higher than if the current tax system remains in place: 1.7 percent in year 1, 8.7 percent in year 5, and 11.8 percent in year 10.

• Consumption increases by 2.4 percent more in the first year, which grows to 11.7 percent more by the tenth year than it would be if the current system were to remain in place.

• The increase in consumption is fueled by the 1.7 percent increase in disposable (after-tax) personal income that accompanies the rise in incomes from capital and labor once the FairTax is enacted.

• By the 10th year, consumption increases by 11.7 percent over what it would be if the current tax system remained in place, and disposable income is up by 11.8 percent.

Over time, the FairTax benefits all income groups. Of 42 household types (classified by income, marital status, age), all have lower average remaining lifetime tax rates under the FairTax than they would experience under the current tax system. [KR]

Implementing the FairTax at a 23 percent rate gives the poorest members of the generation born in 1990 a 13.5 percent improvement in economic well-being; their middle class and rich contemporaries experience a 5 percent and 2 percent improvement, respectively. [JK]

Based on standard measures of tax burden, the FairTax is more progressive than the individual income tax, payroll tax, and the corporate income tax. [THBPN]

Charitable giving increases by $2.1 billion (about 1 percent) in the first year over what it would be if the current system remained in place, by 2.4 percent in year 10, and by 5 percent in year 20. [THPDB]

On average, states could cut their sales tax rates by more than half, or 3.2 percentage points from 5.4 to 2.2 percent, if they conformed their state sales tax bases to the FairTax base. [TBJ]

The FairTax provides the equivalent of a supercharged mortgage interest deduction, reducing the true cost of buying a home by 19 percent. [WM]


References:

[ALM] Arduin, Laffer & Moore Econometrics, “A Macroeconomic Analysis of the FairTax Proposal,” July 2006.

[BHKPT] Bachman, Paul, Jonathan Haughton, Laurence J. Kotlikoff, Alfonso Sanchez-Penalver, and David G. Tuerck, “Taxing Sales under the FairTax: What Rate Works?” published in Tax Notes, November 13, 2006.

[JK] Jokisch, Sabine and Laurence J. Kotlikoff, “Simulating the Dynamic Macroeconomic and Microeconomic Effects of the FairTax,” National Tax Journal, June 2007.

[KR] Kotlikoff, Laurence J. and David Rapson, “Comparing Average and Marginal Tax Rates under the FairTax and the Current System of Federal Taxation,” NBER Working Paper No. 12533, revised October 2006.

[THBNP] Tuerck, David G., Jonathan Haughton, Keshab Bhattarai, Phuong Viet Ngo, and Alfonso Sanchez-Penalver, “The Economic Effects of the FairTax: Results from the Beacon Hill Institute CGE Model,” The Beacon Hill Institute at Suffolk University, February 2007.

[THBP] Tuerck, David G., Jonathan Haughton, Paul Bachman, and Alfonso Sanchez-Penalver, “A Comparison of the FairTax Base and Rate with Other National Tax Reform Proposals,” The Beacon Hill Institute at Suffolk University, February 2007.

[THBPN] Tuerck, David G., Jonathan Haughton, Paul Bachman, Alfonso Sanchez-Penalver, and Phuong Viet Ngo, “A Distributional Analysis of Adopting the FairTax: A Comparison of the Current Tax System and the FairTax Plan,” The Beacon Hill Institute at Suffolk University, February 2007.

[THPDB] Tuerck, David G., Jonathan Haughton, Alfonso Sanchez-Penalver, Sara Dinwoodie, and Paul Bachman, “The FairTax and Charitable Giving,” The Beacon Hill Institute at Suffolk University, February 2007.

[TBJ] Tuerck, David G., Paul Bachman, and Sylvia Jacob, “Fiscal Federalism: The National FairTax and the States,” The Beacon Hill Institute at Suffolk University, June 2007.

[WM] Walby, Karen, and Dan Mastromarco, “Promoting home ownership: How the FairTax’s benefits for homeowners exceed the mortgage interest deduction,” Americans For Fair Taxation White Paper, August 2006.

juan said...

uh, ian, a monthly 'prebate' for working poor on day by day, week to week budgets will not cut it unless the 'big idea' is a means to further stress and take more from those with the least, and please please don't tell me that charitable contributions take care of that.

why, exactly, is this so-called 'fair tax' needed; what is it imagined to overcome or mitigate?

juan said...

Brenda, if you're registered with the Financial Times, take a look at:

Give up now? Citi sees "terminal decline" for banksl modern business model

http://ftalphaville.ft.com/blog/2008/01/09/10032/give-up-now-citi-sees-terminal-decline-for-banks-modern-business-models/

Aside from that, hedge funds have been popping; guess that only the largest make the news though.

Anonymous said...

Shane, I meant to preface that last entry with the idea that I'd leave specific tax cuts to others to discuss; that what I'm interested in has to do with the manner in which taxes are extracted.

juan, good question! My answer would be that FairTax does several important things:

• Permits us to pay for government in the process of meeting our personal and family needs, on our schedule of purchases

• Captures past wealth, as well as current earnings; thus, if grandpa doesn't spend it, the inheritors will.

• Ends hiding increased consumer tax load in higher prices, or stressing businesses in tightly competitive markets

• Ends tax embeds in export prices; ends letting imports "off the hook"

• Visitors, illegals pay the full 23% (no prebates); most citizens will pay significantly less than the 23% because of the prebates

• Puts government on the supportive side of entrepreneurial activity, aligning revenues to economic growth using a robust GDP as the base

• Places tax collections closer to the source (states), while reducing points of collection to retail businesses; this additionally sets up innovation where the gargantuan IRS lumbers under gross inefficiences, while the tax gap grows

• Acts to provide a citizen-only, universal "negative income" to alleviate fear and suffering by wage-earning, non-business-only families that the current system engenders both from the private sector, and the government (thus, the ubiquitous "Taxmasters" and "J. K. Harris" commericials)

• Most importantly, restores the foundational idea of We, the People - intended to be "the Sovereign" but, in practice, lost much of that with the passage of the Federal Reserve and Income Tax Acts in 1913 (which is why direct taxation without apportionment was originally prohibited by our wise Founding Fathers).

Brenda Rosser said...

Thanks for the Financial Times link Juan.

Last time I heard hedge funds could (opaquely) delay the day of reckoning by adding more derivatives when the cash flows prove a problem.

I wonder if there is a way to keep track of all derivative trade? Whether anyone has stepped in to regulate the hedge funds yet?

juan said...

combine global electronic markets,
competing national jurisdictions,
potential regulators who are
financially illiterate relative
to those to be regulated
and meaningful regulation of hedge funds is only a slogan.

they are i believe now in process of being regulated by their own success and deteriorating real and financial conditions that cannot be so easily hedged against.

To which I should add that the fund universe is not homogeneous and, at least be label, disaggregates into many types of strategies, e.g. dedicated short bias, emerging market, managed futures, market neutral, etc etc, that along with performance figures can be found at
http://www.hedgeworld.com/
(left side and "Click here for Sub-Indices details")

Bank for International Settlements (BIS), www.bis.org/ , trys to keep track of the derivatives trade which involves more than hedge funds.

Shane Taylor said...

A federal sales tax, which would add 30% to the price of every sale, is only revenue neutral by extracting current federal spending as revenue. Add about half trillion dollars worth of rebates, and the only growth we can expect will be in government debt. Massive tax hikes and/or severe spending cuts are the only viable options with a federal sales tax.

Without a rebate, the federal sales tax is a gift to the richest fifth paid for by the rest of America. Without tax hikes or spending cuts or increasing debt-to-GDP, there is no rebate.

But while a 30% federal sales tax is too low for a rebate, it is too high to survive the extreme inducement to evade. This is especially true considering the frailty and warped incentives built into the federal sales tax from the start.

Bruce Bartlett has taken your federal sales tax to the cleaners, Ian. You are not answering what he actually wrote in Tax Analysts. The Fair Tax is such an administrative abomination that it makes the IRS look like an oasis of efficiency.

Brenda Rosser said...

Juan said: "Bank for International Settlements (BIS), www.bis.org/ , trys to keep track of the derivatives trade which involves more than hedge funds."

Here's the latest:

"According to the Bank for International Settlements (BIS), CDS (Credit Default Swaps) totaling $43 trillion were outstanding at year end 2007, more than half the size of the entire asset base of the global banking system. Total derivatives amount to over $500 trillion, many of them finding their way onto the balance sheets of SIVs, CDOs and other conduits of their ilk comprising the Frankensteinian levered body of shadow banks...

Bill Gross Reality Check
http://jtaplin.wordpress.com/2008/01/11/bill-gross-reality-check/