lines in the sand

Libertarian Fair Tax Opposition is Misdirected

Nick Flint is a libertarian who used to support the Fair Tax but now opposes it. He explains why:

But we should oppose the FairTax because:

1) It's not going to prevent Federal spending from getting out of control.  Indeed it incentivizes the federal bureaucrats and politicians to continue inflating the budget deficits and demanding 'more more more' from tax payers....

He is making the same mistake here that most of us have made - thinking that taxes and spending are related.  It may have been so at one time, but since Lord Keynes gave politicians permission to spend money they didn't have, that relationship hasn't meant much.

We have tried controlling spending by cutting taxes, but deficits just got bigger (even when the cuts resulted in more revenue).  Many want to prevent that with a balanced budget requirement in the Constitution and, though Washington can't bring itself to propose one, a number of states have tried it.  The experience here in Florida on that score is not encouraging.

Our spending is limited to revenues so it seems obvious that cutting taxes will cut spending.  Following that reasoning, Gov. Crist sold voters on mandated tax rollback, with the result that many jurisdictions are turning to fees for things like emergency medical services and fire departments.  And of course since Kelo, all a government need do to raise income is condemn the family homestead and turn it over to developers.

Tax reform does not equal spending reform.  The present "conservative" administration cut taxes then created the largest entitlement program since Johnson.

I agree that the Fair Tax won't get spending under control, but no other tax reform is likely to, either.  That will take spending reform.  And although that isn't the purpose of this proposal, it does have one element that could create some pressure in that direction: by exposing the tax burden that is largely hidden by the current scheme.

If we can do that much and restore the freedoms I mentioned before, we should go for it.

What Libertarians Should Like About The Fair Tax

Many libertarians oppose the FairTax, feeling it doesn't go far enough toward the goal of eliminating taxes altogether.  That would be fine if it were mainly a tax plan, but it goes to great lengths to avoid affecting tax revenues any more than necessary.

So why change the tax system if it doesn't change the taxes?  Because it enhances liberty.

It does this in several ways:

It virtually eliminates the collection of personal and business information that the government presently engages in for taxation purposes
It makes taxes visible
It reduces the opportunities for government to manipulate personal and business behavior
It eliminates most of the peripheral costs of compliance
It gives taxpayers more control over how much tax they pay

The government collects a staggering amount of information to levy taxes. For personal income taxes it wants to know how much money you make, of course, what your marital status is, how you invest your money, who you donate money to, and scads of other information that should be none of the government's business.  And if you have a business, it's even worse: how much you paid each employee, what kind of equipment you have and when you bought it, how far do your employees drive for business.  You may even have to keep two sets of books, one for financial purposes and one for tax calculations.

The FairTax requires none of this.

The tax would be visible on each sales receipt. Currently about 22% of each sale of new merchandise or services goes to cover various Federal taxes that have been incurred to produce that item.  Under the FairTax, none of these taxes would be hidden in the production process but would be calculated, displayed, and collected at the point of sale.  The taxpayer is then armed with more complete knowledge of what his government is costing him.

Manipulating the citizenry is what most of the present tax code is about. It is full of incentives for some behaviors and penalties for others.  While there is some danger of that in any taxation method, starting fresh with a simple, transparent approach would make it easier to guard against.

Complying with the present tax code is virtually impossible. Filing a tax return is so daunting that helping individuals do it is a multibillion dollar industry, and businesses spend even more.  With the FairTax, the only question is whether the transaction is taxable. If it is, then include the tax.  It is no more complicated than the sales tax that most states already impose.

Since sales of used items are't taxed, it's possible for a person to pay virtually no tax if he restricts purchases to them, especially the large ones like houses and cars.  (I'll have to admit that buying some things used, like food or toilet paper, may not be attractive.)

I happen to agree with those who think the only fair tax is no tax, but demanding an all or nothing approach assures that the only movement will be towards more.  It's unfortunate that promoters chose the name FairTax, since such a subjective term makes an easy target.

While this scheme does nothing directly to change taxing or spending, it does much to promote individual freedom and liberty.  And by making the tax burden more visible, it can help create support for decreasing rather than increasing spending.

The Answers

  Earlier this week Jerry Bowyer had seven questions for the Fair Tax crowd.  Unfortunately it was the weekend before I could answer them for him.

Why do you think that a sales tax is less prone to corruption and complexity than an income tax?

Okay, he actually had eight questions because this is two.  Complexity and corruption each need their own answers.

Complexity is relative.  A sales tax can become complex as demonstrated by the recent need for Florida to establish a commission to review its sales taxes and simplify exemptions.  But states in the U.S.  Have had sales taxes since 1930 and I don't know of any that require a two page form, numerous tables, pages of supporting schedules, and the assistance of accountants and lawyers to calculate and pay. 

With a sales tax, there will be corruption, but I've seen no convincing evidence that there will be more than we have now.  At the state level sales taxes are often ignored or manipulated, but that is generally on resale transactions, which are not taxable under the fair tax plan.  Sales taxes on new items should be relatively easy to track and enforce.

Are sales taxes, where they are currently in operation, simple and free from special interest lobbying?

No, they're not.  But with a tax based on the amount of the transaction rather than estimates involving depletion allowances, depreciation methods, mileage allowances and other arcana, there will be fewer opportunities for low visibility favors.

A Value Added Tax (VAT) is guaranteed to be complicated, since it is applied at each level of production and may even have different rules in each case.  The fair tax  avoids this type of complexity by taxing a product once at the point it leaves production

The current income tax has taken a long time to become what it is.  Perhaps 90 years hence the sales tax will need replacing, but it is unlikely that even then it will have become the hydra that we have today.

Does it apply to non-profits?

HR 25 Section 706-(a) NOT-FOR-PROFIT ORGANIZATIONS- Dues, contributions, and similar payments to qualified not-for-profit organizations shall not be considered gross payments for taxable property or services for purposes of this subtitle.

More people can take deductions for charitable donations, including to churches, than under the income tax since you don't have to consider itemized deductions.  In fact it is not even necessary to track them because they are realized each Sunday morning when the cash hits the collection plate.

Actually, I have a problem with this one.  It is the beginning of the kinds of special exemptions found in many state sales taxes.  It puts the government in the position of deciding who is qualified to get special treatment which in turn gives it control over them.  That is why I believe, for example, that we have gotten the tax treatment of churches exactly backwards in the past.  We've even had recent cases of the IRS investigating churches over political speech from the pulpit.  But I realize this puts me closer to the fringe than most fairtaxers.

Are used goods, non-taxable?

If so, this means less goods production, more yard sales, eBay stuff, etc. Won’t this hurt traditional retailers and goods producers?

Supply and demand should largely compensate for this.  As demand for untaxed used goods rises so will their prices until they reach an equilibrium with new products.  And some goods, such as food and services, don't have much of a used market.

Why wouldn’t this encourage evasion through rehabilitation? After all what exactly constitutes New vs. Used? If I repair a car, it’s used, but what if I upgrade it? New engine, but old chassis, is that new or used?

At the consumer level, I don't understand the problem here.  When you buy a new engine to put in the old chassis you pay the sales tax on it.  Whoever buys it from you is buying a used vehicle.  I'll admit that for a business this could be problematic.  If a professional refurbisher buys a used chassis, rehabs it, and sells it, I can see that the chassis could be considered raw materials and his ultimate sale might be taxable.

This is hardly evasion, though.  One of the biggest pluses to the fair tax is that it does away with the income tax's penalties on wealth creation and savings.  Preserving the utility of goods results in savings just as surely as stuffing money into an IRA.

What about the transition period?

Before the sales tax takes effect, won’t there be a buying binge? Afterwards, won’t there be a buying drought?

I'm not sure, but it sounds like Bowyer is assuming that on implementation day, prices will rise 30%.  Many Fairtaxers claim that since the it replaces the hidden taxes already in prices, they will stay the same.

I don't believe either claim.  I would expect prices to rise some but considerably less than the 30% of a fair tax.  At the same time workers would see their take home pay increase by at least 8% as Social Security, Medicare and income tax withholding disappear.  Even with higher prices the net result would resemble the fairtaxers prediction.

A common question is, "How can you be sure prices will come down?" Maybe Bowyer is, in fact, describing the mechanism.  A buying binge would create upward pressure on prices and we could see the beginnings of his 30% increase even before implementation.  The "drought" would then bring prices down to the new level.

As an IT professional, I have often seen difficulties in transitions, but rarely to an extent that would justify not going forward.

Isn’t it true that the rate is not really 23% but 30% at least, because it’s tax-inclusive?

The underlying idea of the Fair Tax is that it seeks to replace hidden taxes with a single visible one.

Before the Fair Tax 23¢ of every dollar spent finds its way to the Federal treasury.  With the fair tax 23¢ of every dollar goes to the Federal treasury.  Whether you want to call that a 30% tax on a 77¢ price or a 23% tax on a $1.00 price is semantics.

How do we determine the interest portion of mortgage payment?

This is laid out in section 801 of HR 25.  Essentially, the portion of any interest rate above that on the Federal debt (not the funds rate set by the Federal Reserve) is taxable.  That will minimize the ability to game the system by pricing houses low and mortgages high.  A market effect that would also inhibit such arrangements is that they would have to include severe prepayment penalties.

The Fair Tax has it's share of difficulties: it isn't even fair.  But even with its problems it is vastly superior to the income tax that exists today.  Making the change would not be easy, but imagine what it would be like if people with names like King or Washington had let that be reason enough not to try for something better.

Lies, Damned Lies and Semantics

Last weekend, Bruce Bartlett got the Fair Tax Fanatics' collective goat with this column.  Without question, the most damaging argument that Bartlett and others bring to the table is that what supporters call a 23% embedded tax is really a 30% sales tax.  Who would pay $1.3 million for a million dollar house?

So what is this “Fair Tax” thing?

First, it isn't fair. Taxes are legalized confiscation and inherently unfair. But backers had to call it something catchy to sell it, so I'll cut them some slack on that.

Every price has taxes built into it. There are payroll taxes, income taxes and excise taxes, not just on the business that sells an item at retail, but also on the ones that provide materials to make that item and that transport those materials and finished goods. Of each dollar consumers spend, whether for a bottle of water or a million dollar house, about 23 cents goes for some some kind of Federal tax and then most states add a sales tax on top of that.

The Fair Tax proposal eliminates all those buried taxes and replaces them with a single very visible levy on the retail sale. Since it replaces 23% of current costs, it is calculated as 23% of the total sale price: Washington gets 23 cents and the seller gets 77 cents. Bartlett chooses an alternate calculation, calling 77 cents the price and adding 30% to that ( 77 x 30% = 23). Both approaches have the same result so this is a battle of semantics, not substance.  Unfortunately for the promoters, the 30% markup is more intuitive for most people, especially when critics neglect to mention that at the same time that happens, the dollar they are applying it to drops to 77 cents.

I'm not a fanatic about the Fair Tax, but I do favor it over the current system and any of the other alternatives being discussed.  Over the next few days, I'll explain why.