The so-called “FairTax” movement has generated very little coverage so far in either the mainstream media or the progressive wonkosphere. Yet as a political force, its potency is growing — as Chase has pointed out, FairTax supporters were probably the reason Mike Huckabee did so well in the Ames straw poll, overcoming the resistance of the Club for Growth (the Federal Election Commission may investigate the relationship between the FairTaxers and the Huckabee campaign in Ames); Fred Thompson, meanwhile, is on the defensive over claims that he flip-flopped on the issue (it seems that, in a very Fred Thompson-esque moment of sloppiness, he offhandedly signaled his support for the idea, only to backtrack later).

Besides Huckabee, John McCain, Ron Paul, Duncan Hunter, and Tom Tancredo have endorsed the plan; Rudy Giuliani and Mitt Romney have declined to do so, but, along with Thompson, they have been careful not to dismiss the idea altogether. The FairTax Book is a cult favorite at Amazon; one of its authors is prominent talk radio host Neal Boortz, who has been an enthusiastic advocate for the idea. And the FairTaxers have spawned a legion of letter-writers; we can no doubt expect at least a couple of them to make their way to the comments on this post, to correct my own mistakes — real or perceived.

Your humble blogger is not an economist, nor was I well acquainted with the ins and outs of the FairTax proposal before I started researching this post; as such I don’t pretend to be an expert, but I can pass on some of what others are saying about the idea, in hopes that progressives will pay a little more attention to what looks like a rather dangerous plan.

The FairTaxers propose, essentially, to abolish the IRS and do away with all personal and corporate income taxes, and payroll taxes — leaving only an across-the-board 23% sales tax to replace them. Here’s a first point of concern: under the FairTax, you will be paying taxes on food. You’ll pay taxes on medicine. If you rent an apartment, you’ll pay taxes on your rent. This isn’t your father’s sales tax.

And it’s fairly clear that that 23% figure is misleading. While its supporters claim that the proposal is revenue-neutral — meaning that the federal government would not lose tax revenue — economists have suggested that the math doesn’t add up:

The FairTax bill pegs [the rate] at 23 percent in order to fund the government at current levels without raising the deficit. (If you think of the FairTax like a state or local sales tax, you’d say that this is a markup of 30 percent on prices at the store….) But economist William Gale of the Brookings Institution says that this number is way, way too low. “They’re telling kind of a big lie about tax reform,” he says.

Gale calculates that a 23 percent rate would blow a $7 trillion hole in the budget over 10 years, and that a more realistic rate is 31 percent, and higher still if you allow for evasion. And if lobbyists convince lawmakers to exempt things like health care or other necessities — a real possibility, given the culture of Washington — the gap looks even bigger.

So everything you buy will cost at least a third more than it does now? FairTax supporters argue that the markup would be offset by a decline in prices. Why? Because the taxes we pay under the current system are already “embedded” into the price chain. Eliminate those taxes — which they figure to be around 30% — and prices will go down by just the amount of the new sales tax. But there’s a very big problem with this assumption, as Money Magazine’s Pat Regnier explains:

Part of the problem is the way Boortz and Linder are using the idea of embedded taxes. In an eight-year-old study paid for by AFFT, Harvard economist Dale Jorgenson noted that because the taxes paid by everyone in the chain of production are embedded in the cost of goods, prices could decline an average of 20 percent if all those taxes were scrapped. The FairTax Book devotes an entire chapter to this idea. What The FairTax Book fails to mention is that prices can only fall this sharply if companies cut wages. I asked Jorgenson about this, and he agreed. Say your salary is $100,000 a year today, but you take home $80,000 after taxes.

Your company is still paying that extra $20,000. In a FairTax world, it will save that money, and be able to lower its prices accordingly, only if it can reduce your salary to $80,000. In other words, your take-home pay is the same as before. Sure, you’d get to “keep 100 percent of your paycheck,” as Boortz and Linder repeatedly write, but it would be a smaller paycheck. That’s kind of a big thing to leave out.

As with other flat tax proposals, there seems to be a strange sort of free-lunch mentality among FairTax advocates. Jay Bookman of the Atlanta Journal-Constitution wondered about this:

Under the proposed Fair Tax, low-income Americans won’t pay taxes; corporations won’t pay any taxes either. Yet its advocates guarantee that the Fair Tax will generate the same amount of revenue as today’s system. Basic arithmetic requires that somebody’s taxes increase. Who will that somebody be?

Bookman plugged a variety of different income figures into the “FairTax calculator” at the organization’s website. Among other things, he found that the George and Laura Bush family would save ten times as much money under FairTax as would the middle-class Bookman himself. What he didn’t find was anybody who would pay more. But surely someone has to pay more?

Perhaps the FairTax answer is that no one need pay more, since a flat sales tax-based system would generate more economic growth (an argument very similar to that made by adherents to the bastardized supply-side theory that “cutting taxes increases revenue”). I’m in no position to analyze this theory myself, though other observers have suggested that the opposite could just as well be true, which makes sense: if you’re imposing a steep tax on consumption, isn’t it natural to expect that consumption will go down? And if consumption goes down, doesn’t that mean the economy isn’t growing?

Critics who doubt the claim that FairTax would be “revenue neutral” come from both sides of the political spectrum. Besides those who worry that the plan would stunt America’s economic growth, there are fiscal conservatives who oppose FairTax because they believe that, since the tax would not generate sufficient revenues to cover government expenses, the government would end up being obliged to reintroduce income taxes — so that in the end, the sales tax would only add to the complexity of the US tax code. Cato Institute scholar Daniel Mitchell, for instance, has said he would only support a FairTax plan after an amendment to the Constitution to permanently abolish income taxes. Liberal critics, on the other hand, argue — convincingly, I think — that FairTax’s built-in revenue problems, along with the controversy that would be created over raising sales taxes, make it the perfect vehicle for “starve-the-beast” enthusiasts who, like Grover Norquist, want to shrink government to the size where they can “drown it in a bathtub.”

Ultimately, you don’t need to be an economist to understand the biggest problem with the FairTax proposal: it is a profoundly regressive tax. Supporters argue that the regressivity would be mitigated by the “prebate” included in the plan, whereby the government would send each taxpayer a monthly check calculated to offset the amount of sales taxes paid on income up to the federal poverty line. This would indeed reduce the burden of the tax on the very poor (though it should be noted that the poverty line, widely considered to be far too low, is not a very useful way to measure poverty and need in America). And this would do nothing to counter the main effect of the FairTax, which would amount to a massive transfer of wealth from the middle class to the rich. Like any flat tax, the FairTax would shift the burden of taxation onto the middle class. TPM Cafe’s Chris Fonzone provides a useful series of links explaining the regressivity of sales taxes in particular. The basic principle is clear: with a regressive tax, the less you earn, the more taxes you pay.

FairTax advocates have another answer for this: they argue that wealthy people, with their luxurious tastes, spend more money than the rest of us — thus their tax burden will remain comparatively high. Fonzone observes that this argument misses the point entirely:

In and of itself, the fact that the wealthy spend more does not prevent a tax from being regressive; THE ISSUE IS NOT THE AMOUNT SOMEONE SPENDS, IT IS THE PERCENTAGE OF THEIR INCOME THEY SPEND. And as demonstrated above, the share of the wealthy’s income that is taxed will go down and the share of total taxes that the wealthy pay will – by definition – go down. That’s the very definition of a regressive tax shift.

Ultimately, this is why the FairTax will fail: it violates common sense and American values. Regnier cites Republican Congressman John Linder, co-author of The FairTax Book, who calls opponents of regressive taxation “communists.” I believe that it is wrong for the middle class to be forced to bear a greater tax burden than the wealthy. If that makes me a communist, so be it. I suspect it makes the great majority of Americans communists. Progressive taxation is a basic principle of American life: we share the tax burden equally, which means we are all taxed according to the portion of our income we can afford to pay. It isn’t right for the wealthy to get a break on the backs of the middle class, no matter how you spin it.

There are other problems with the so-called “FairTax.” The claim that it would mean the abolition of the IRS has been met with skepticism, as critics note that a sales tax would still require administration and enforcement. There are also questions about the transition costs that would be involved in making the change. But in the end, it’s the plan’s regressivity that makes it most suspect.

FairTax advocates are correct to say that the federal tax code, as it stands, is unfair and needlessly complex. But their proposal isn’t the only answer. There are detailed proposals for truly fair, progressive tax reform — the kinds of things Democrats should be supporting, as they’re opposing the efforts of the FairTax folks.

Posted by Paul Curtis
Thursday, August 16, 2007 at 11:17 am

8 Responses to “About That Whole “FairTax” Thing”

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