Wednesday, December 19, 2007

The “Fair Fax” Just Ain’t Fair


Reading Jon Wakefield’s op-ed in Monday’s TD, “Tax Code Change Would Benefit All” (
http://www.inrich.com/cva/ric/opinion/oped.apx.-content-articles-RTD-2007-12-17-0062.html) might lead you to believe that he had discovered Nirvana. Mr. Wakefield has apparently become a true believer in the so-called “Fair Tax” proposal. In his article he spits back the arguments made by Americans For Fair Taxation on their website (http://www.fairtax.org ). And it sure is a compelling argument. The Fair Tax proposal would repeal all federal income-based taxes and replace them with a 23% federal sales tax on all purchases made in the United States. It would eliminate everybody’s nemesis, the Internal Revenue Service, and would convert April 15 into just another beautiful spring day. No more loopholes, no more tax cheating, no more expensive tax lawyers or CPAs, no more H&R Block commercials all winter, no more anxiety-producing tax forms, no more keeping of receipts. It would truly be a taxpayer’s heaven. But, would it be fair?

A tax system should have only one purpose—raising revenue for the government to carry out the functions that the representatives of the citizens have assigned to it. In addition, under the theory that those who accumulate the most wealth derive the most benefit from the country or state, the tax system should be progressive. Those who earn the most should pay a higher percentage of their income in taxes than do those who earn the least. Finally, a tax system must not only be fair, it must also be perceived as fair by the citizens.

Under these standards, our current tax system ranks low. First, rather than being only a mechanism for raising revenue, our current system is used continuously by the government as a mechanism for controlling the behavior of individuals and corporations in our society. When the government wishes to encourage certain activities it offers tax incentives to those who abide by those wishes. Likewise, when the government wishes to discourage certain behaviors it places tax costs on those behaviors. This management of our society by use of the tax code is probably as old as the code itself and has been used by both Republican and Democratic governments. It explains why the Internal Revenue Code is thousands of pages rather than only a few pages long.

Second, our tax system is unfair and is perceived by most citizens as unfair. It is set up as a yearly game between the citizens and the IRS. The objective of the IRS in this game is to maximize the amount of taxes each citizen pays. The objective of each citizen is to minimize the amount of taxes he, she or it pays. The rules of the game are tens of thousands of pages long, and those who can afford expensive CPAs or tax lawyers who have mastered those rules are going to play the game much better than those who can’t. A tax system in which the amount you pay depends on how clever you and your tax preparer are is not a fair system. And it cannot be perceived as fair. Many taxpayers get the feeling that somehow they are paying more than their fair share of taxes. They fear that their neighbor has discovered a hidden deduction that they don’t know about. Or they fear the dreaded audit in which the IRS will discover that they have claimed more in deductions than the law allows.

The unfairness of the system extends into its progressiveness. Although our tax system is, on its face, progressive, the presence of so many loopholes and deductions and credits and shelters reduces the tax burden on those with higher incomes. The result is that in many cases individuals with high incomes may be paying a lesser percentage of that income in taxes than do individuals with lower incomes.

Look, I would love to see our present system replaced with a fair tax system. I would love to see the IRS disappear. I would love to eliminate the anxiety I suffer every year in playing the 1040 game. However, I see no purpose in replacing one unfair system with another unfair one.

By their very nature sales taxes are not progressive. In a state with a 5% sales tax, everybody who makes a purchase in the state pays the same 5% tax regardless of their income. Further, since lower income families spend a far higher percentage of their incomes on subsistence items such as housing, clothing, food or fuel, the 5% percent tax they pay on each purchase is more onerous. The Fair Tax proponents are, of course, aware of this inequity. They have tried to deal with it by creating a mechanism called the “prebate”.

Under the Fair Tax prebate, the Social Security Administration (you read me right) would mail a check to every household in the United States each month. The purpose of this prebate would be to compensate each household, in advance, for the amount of sales tax it pays on subsistence. The Fair Taxers have established an “annual consumption allowance” for each household that varies with the number of persons residing in that household. For example, for 2007 had the Fair Tax been in effect, the consumption allowance for a single adult household with three children would have been $20,650. For a two adult household with one child the allowance would have been $23,900. The sales tax that would apply on the amount of this allowance is calculated and constitutes the annual prebate. One twelfth of this amount would be sent to the household each month--$396 for the first household above, $458 for the second household. (If this sounds complicated, blame the Fair Taxers, not me).

The Fair Tax proponents prepared a chart that demonstrates that with the addition of the prebate feature the federal sales tax would actually be progressive. There are two problems with the chart. The first is the assumption that a household’s annual income and its annual spending will be the same. The second is the calculation of the tax rate as a percentage of the amount the household spends rather than as a percentage of the household’s income. If we look at a hypothetical real world (how’s that for an oxymoron), however, things are not as fair as they seem.

Let’s look at some examples:

The Smiths have an annual income of $50,000. They would like to put away part of their income in a savings account. However, with the cost of living in their city being so high, they are unable to save and end up spending all their income. The 23% federal sales tax they pay on their $50,000 consumption amounts to $11,500. Based on the size of the Smith household, they receive a prebate of $5,497. Therefore, the actual federal tax they will have paid is $6,003. As a percentage of their income, they are paying a tax of about 12%.

At the other end (but not the far end) of the income spectrum are the Jones. The Jones household has an annual income of $1,000,000. Because the Jones are not conspicuous consumers they spend only $200,000 and are able to save or invest $800,000. The 23% federal tax they pay on their consumption amounts to $46,000. Like the Smiths, the Jones receive a prebate of $5,497. The actual federal tax paid by the Jones is therefore $40,503. As a percentage of the household’s annual income, the Jones are paying a tax of a whopping 4%.

Let’s review. Under the so-called Fair Tax, the Smiths with an income of $50,000 would pay a 12% tax. The fortunate Jones, however, with an income of $1,000,000, would pay a tax of only 4%. I don’t know about you, but to me this is not a fair tax.

Despite Mr. Wakefield’s assertion, the Fair Tax plan also has its loopholes. If our Jones household wishes to be less frugal they may choose to buy a $500,000 yacht with the amount of their income they don’t need to live on. If the Jones buy that yacht in Newport News, they will pay a federal sales tax of $115,000. However, if the Jones are smart (and I assume they are), they will buy their yacht from some boat yard in the Bahamas. They will then pay a federal sales tax of zero. And, this loophole does not only apply to the wealthy few. It is also available to those of us who live along the Canadian border. Why buy a $25,000 car in Detroit and pay $5,750 in federal tax on that purchase when you can go across the river to Windsor and buy your car without paying any federal tax.

I can discuss other unfairnesses that I have found in the “Fair Tax,” but this post is already much too long. When the Fair Taxers fix these inequities, I will be happy to support their proposal.

4 comments:

Bert Berlin said...

Mea Culpa.
When I first posted this I made an error. I could say it was a typo or that my calculator screwed up. In any event, in putting in the tax rate for the Jones household, I wrote 2%. That was wrong. I have edited the post to put in the correct 4% figure.
To those of you who might have read the uncorrected version, I apologize

spydrz said...

I'm pretty sure it's not that easy to import a new car from Canada.

Ian said...

"A tax system should have only one purpose—raising revenue for the government to carry out the functions that the representatives of the citizens have assigned to it."

Agreed, and FairTax accomplishes the elimination of social engineering by eliminating utilization of tax "carrots and whips."

"In addition, under the theory that those who accumulate the most wealth derive the most benefit from the country or state, the tax system should be progressive. Those who earn the most should pay a higher percentage of their income in taxes than do those who earn the least."

Says who? How much higher should my tax percentage be? Who decides how much more is enough?

This is plain Socialism, ("From those according to their abundance, to those according to their needs") and is antithetical to a free-enterprise, freeholder, capitalist system.

Now, it may be that I inherited my wealth (Writer's note: I have no inherited wealth). However, someone, somewhere worked and sacrificed to accumulate it. So what? Lucky me. It is no business of yours. But, let the politician stake a claim to my income, and get them together to discuss paying for their government programs, and the envy card is played - pitting those of lesser means, who stand to gain, against me. Under the existing system where "fairness" is a cover for coercion, the more I work, the less-entitled I am to the fruits of my labor. The more wealth I sacrifice to accumulate, or for which I assume investment risk, the greater the share of my past labor is assigned to government servitude.

Our tax system (as a funding mechanism for interest payable to the Federal Reserve, originally, a founding collection of bankers and super-rich individuals who caused the depression, increased their own wealth, and have steadily devalued our currency) has been the disaster of our country and led to an income tax code, continually in change, 60,000 pages and counting; countless bartered tax favors between lobbyists and politicians; tax shelters for the wealthy, not available to those with lesser means; tax lawyers; dependent constituencies - just to get started!

Our tax system has become institutionalized tyranny that undermines personal initiative and cultivates dependency.

The FairTax ends this destructive, socialistic view by taxing everyone at the same rate on purchases above the poverty level. FairTax progressivity does not enable politicians, under pressure by some 35,000 lobbyists for special tax status, to determine how much of my wealth is stripped from me (increasing the number of minutes in every working hour that I spend as a tax slave). (Writer's note: I have no such accumulated wealth.)

Under FairTax, I decide how much tax I pay whenever I decide to spend my hard-earned wealth to enjoy it. (If I purchase the boat in the Bahamas, I had better not port it in the U.S.A, or I'll be stuck for a tax on it (or anything else I bring back that is purchased offshore). If I buy a car in Windsor, I'd better leave it there because the FairTax will be assessed on it if I bring it back to Detroit.) Because I spend more, I will pay more, but it will be me deciding, and I will not mind so much, because I'll have confidence that the FairTax ends the politicians' presumption upon my wealth..

The foregoing aside, "Is the FairTax actually fairer to current income groups? 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."

RVA Foodie said...

Check out www.virginia-organizing.org to find out about a tax reform lobbying effort that would counter regressive taxes (like sales tax, which has a disproportionate impact on the poor) and create a fair tax system for all. That is, if you're not already involved with VOP.