TAX REFORM?
by Peter Bearse
When might our yearning for simplicity lead us astray? – When dealing with the economy. We see this happening now with schemes for tax reform. We recognize that current tax arrangements have become mind-numbingly complex and rather unfair. So we seek a simple tax. Enter Steve Forbes with a “Flat Tax.” Never mind that it fails to address the root of our economy’s failings. Never mind that it’s just another income tax with which Congress can play its social engineering via tax incentives’ games. It’s flat; and since, according to Tom Friedman, the economic world is also “flat,” flat must be good.
And so we have the all three Republican candidates for Congress in the 1st C.D. competing on flatness -- on how quickly and strongly they recommended the Flat Tax. Unfortunately, they’re informed by ideology, not economic understanding. Why would a Flat Tax be good for the economy? What basic economic problem would it help to solve? What good would it do besides providing less business for accountants, lawyers and H.R. Block?
The major source of our economic problems is that we have been living far beyond our means. Savings have been very low and sometimes negative (dis-saving). Consumption has been unsustainably high. We have financed higher spending by drawing down equity in our major asset, our homes. Our trade deficit has been consistently negative, with imports far higher than exports. Our federal deficit has ballooned. Private debt has risen like the flames of a house afire. China and oil exporting countries have supported our excess spending by buying our country’s debt – to the extent that their “Sovereign Investment Funds” are buying our industry. How does a Flat tax address these problems? It doesn’t. It is simply a simple-minded, politically inoffensive expedient.
What would help us get a grip on our economic future? – a Consumption Tax [CT], otherwise (though somewhat misleadingly) called a “national sales tax.” As you can tell from the name, it taxes spending on consumption, not income, savings or investment. Thus, by its very nature, it provides disincentives to excess consumption and positive incentives for higher savings, investment and earnings.It is not nearly as simple as a Flat Tax. Members of Congress can still try to play games with it to favor some interests over others. Yet, it’s better than the current income tax and the proposed Flat Tax in its ability to help us strengthen and rebuild our economy.
Another advantage is that the CT would force our government to live within its means. This is because calculations show that a “reasonable” CT rate (say, 7-12%) would not generate enough revenue to finance the U.S. government at its current, excessive rate of expenditure. So what!, says this economist. It’s about time that Washington has to live within its means. To the extent that this is deemed to be a serious issue, we can consider another so-called tax which is not a tax but a fee on undesirable pollutants – a “Carbon Tax”. This would, in turn, be better than the highly touted “cap and trade” arrangements to reduce carbon emissions and fight global warming. But this calls for more discussion.
PETER BEARSE, Ph.D.
International Consulting Economist
March 16, 2008
NH INSIDER
in Politics, Economy, Income Tax, Fair Tax Coalition, Consumption Tax, Flat Tax, Tax Reform, Budget Deficit
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Reader Comments (10)
Fixed by NHInsider Staff !!!
The FairTax plan took 10 years of research & analysis, cost $23 million, has over 600,000 grassroots supporters, is endorsed by 80 professional and university economists an is co-sponsored by 72 Congressmen!
I recommend reading the paper by The Beacon Hill Institute at Suffolk University and Laurence Kotlikoff, Professor of Economics at Boston University (available at http://www.fairtax.org/PDF/TaxingSalesUnderFairTax.pdf.). It presents a sound methodology for estimating the FairTax base and computing the FairTax rate. Their paper demonstrates that the 23 percent rate specified by the Fair Tax Act (HR 25) is eminently feasible.
Hard economic research by respected scholars on the price of consumer goods reveals that from 20% to 25% (depending on the product) of all prices today represent hidden income taxes and payroll taxes. Once these taxes are repealed and replaced with the FairTax, it is likely that market pressure would force retail prices to fall and the cost of consumer goods will be about the same as before, thus not putting retirees at a disadvantage. The proper tax rate has been carefully worked out; 23 cents of every dollar spent does the job of: (1) raising the same amount of federal funds as are raised by the current system, (2) paying the universal rebate, and (3) paying the collection fees to retailers and state governments. Also consider that only 30% of the people pay Income Tax, whereas 100% will pay with the FairTax. This includes the 50 Million visitors to America as well as illegal aliens. Unlike some other proposals, this rate has been independently confirmed by several different, nonpartisan institutions across the country. Detailed calculations are available from FairTax.org.
Since the FairTax eliminates income taxes and payroll taxes (Social Security and Medicare), which are costly to collect and end up as "embedded" in the price of everything we buy, the FairTax would eliminate the distorting effect that income and payroll taxes have on the economy. Eliminating embedded taxes will also do something else -- it will remove significant price disadvantages suffered by American producers competing with tax-free imports. Eliminating corporate income taxes and capital gains taxes, which the FairTax would do, would likely make the American economy the most desirable place in the world to do business. Therefore, when people see their paychecks are much bigger, because they will not pay Income Tax, Social Security Tax or Medicare Tax coupled with the monthly prebate check, there will not be widespread cheating or tax evasion. By the way, it only takes one to cheat the Income tax system; it takes two to cheat the FairTax system (the retailer and the buyer).
Your statement that a tax of 7-12% would be sufficient to fund the government would seem to be refuted in Mr. Vanderboegh response. He says the tax rate amount needed is 2x or 3x your proposed tax. I guess it is your view that we can cut up to 70% of the federal government's spending. That would be remarkable, and it would be interesting to see what you would cut to achieve this. Can you tell us:
a - what was the US gross national consumption for a recent year
b - what a 12% tax on this would bring in
c - what the current federal revenues are
d - what programs get cut so that b = c?
Thanks in advance for your hard work.
The comments reveal that the choice of Flat Tax (FT) or Consumption Tax (CT) is likely to hinge on what is politically acceptable rather than the results of economic analysis. I was aware of the analysis done already, to which Emm refers, that shows that "the tax rate amount needed is 2x or 3x your proposed tax rate." Thank you for this reminder, Mike, but please note that my statement of what seems to be a "politically acceptable" rate is not my "proposed rate." The latter would be higher and, by reference to the "Carbon Tax" and need for "more discussion" at the end, I'm anticipating the need to cover part of the CT revenue shortfall.
Please also note that many of the benefits of the FT that Vanderboergh nicely cites would also arise from the CT since the CT would also replace the income tax. Making the "American economy the most desirable place to do business" and lowering prices would raise revenues from the CT for any given tax rate. "Widespread (tax) cheating or tax evasion" would also be reduced.
As for the rate question, a CT rate of higher than 12% may be as "eminently feasible" as the "23% rate specified by the Fair Tax Act..."
Arithmetic on the CT as thorough as that reported by Vanderboergh may have already been done but I have not had time, myself, to do the research or calculations required in the midst of a growing campaign for Congress. Sorry, Mike. Your questions are pertinent and need to be addressed. Thank you for them.
As for one of them,"what programs get cut," studies of government waste over the years have provided a great number of cutting opportunities.
Our discussion indicates that the choice of taxes to replace the income tax need to be viewed in the context of many features of the larger economy and government policy, not in isolation. FT analysts have done a good job [Thank you for the helpful references, Harold!] but still do not address the consumption v. investment issue(s) that I call the "major source of our economic problems." The FT would not "eliminate the distorting effect" of our economic arrangements in providing incentives for excess consumption and dis-incentives for low savings and investment.
The bottom line is this: I am sure remaining questions can and will be answered as we move forward but, if they can't and/or the CT is found to be politically infeasible, then I would vote for the FT as the second best alternative.
If all purchases were taxed, the rate could be a lot less than 23%. But all purchases are not taxed. If you buy municipal bonds, you are not taxed, if you buy stock in General Electric you are not taxed. If you buy a vacation home you are not taxed. But buy a toaster oven and you are taxed.
The supporters of this "FairTax" would flee like rats from a sinking ship if it were really to be fair and tax ALL expenditures. What they want is a tax on the little stuff, but not the big stuff that they will spend the bulk of their income and assets on.
I think any politician who promises to balance a budget by cuttung waste ought to be made to suffer the political equivalent of hanging, drawing, and quartering. There is no department in the government called "waste" that you can simply delete. Obiously we can cut expenditures by getting rid of stupid earmarks, but after we cut spending by $20-40 billion, we are still a long way from a 70% reduction your tax rate would imply.
My recollection is that the total amoiunt of discretionary spending is around 35% of the federal budget, and most of this is military, so unless one thinks the remaining 17% is entirely waste, or you plan to take away Medicare, medicaid, and social security, or you intend to disband the armed forces, or default on treasury debt, you have to set a realistic tax rate. The real federal budget will be more than $3.5 trillion next year. Our GDP is $15 trillion, so the budget is 23-25% of the economy. Consumption is roughly 70% of the economy, as I recall, so to pay for the government with a consumption tax will require a tax rate of 33-35%.
At a theoretical level, consumption taxes are attractive, particularly if you start from the philosophical position that one of this county's bigget problems over the past 40 years is we have become too much of a consuming country. I also think a carbon tax makes sense. Together, with a high enough tax rate, these could raise the necessary money to fund government without a salary tax, reduce consumption in general and energy use in particular, and drive investment. I am concerned about the equity of these taxes- they are very regressive, and I wonfer how this gets dealt with. Since most of the supporters tend to be high income types, my suspicion is they don't worry about regressivity. In fact, they approve of it.
I agree with your statement that dependence upon budget cutting won't suffice, but I also believe that you underestimate the extent to which serious pruning of the budgetary trees can make a difference. As usual, the truth is somewhere in between.
I also share your concern about regressivity, especially since economic inequality is a time bomb of an issue that lies at the root of political inequality, which is contrary to our Constitution. Yet, as you know through the law and administration of sales taxes, regressivity can be offset by exempting consumption for subsistence. "Subsistence" doesn't include yachts for the rich.
A "carbon tax" would be an effluent fee per ton of carbon emissions from major polluters like power plants. It,too, need not be regressive. To the extent that it is passed along to consumers of energy, it provides an incentive to reduce energy waste or the purchase of products from carbon emitters.
This note is too brief to do a lot of justice to your comments but I hope it is somewhat responsive nonetheless.
I headed up a sub-committee this summer on bringing a sales tax to NH (don't worry, we voted it down!) and a key thing I learned was that the more you exclude from the base, or things being taxed, the higher you must set the tax to bring in a given amount of revenue. Leaving out subsistence I guess would mean excluding food, clothing, fuel, water, housing. Maybe drugs and a couple other things. That means the tax on the remaining sonsumption would have to be that much higher. It's nice to say we are going to tax the heck out of the rich folks' yachts, but this does not bring in any significant amount of money.
If you are serious about a consumption tax, I think some sort of analysis of how much needs to be raised, and what the tax rate would need to be and on what the tax would apply, is called for.
As for how much "waste" can be cut from the government without fundamentally changing the government mission, I would be interested in what you have to say. I doubt its more than $40 billion, but even if it is 5x that, or $200 billion, that is only 6% of the federal budget.
Tax pollution/consumption, not income/productivity. You indeed have TheCorrectAnswer.com on this and many other issues!