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Tuesday, December 18, 2007
posted by Kyle Hampton | 2:45 PM | permalink
I want to disclaim at the beginning that I am no tax policy expert. Yet, I think that the concepts argued for and against the “fair tax” as proposed by Mike Huckabee are simple enough that most people should be able to understand them.

Mike Huckabee describes on his campaign web site his version of the Fair Tax:
When the FairTax becomes law, it will be like waving a magic wand releasing us from pain and unfairness.

The FairTax will replace the Internal Revenue Code with a consumption tax, like the taxes on retail sales forty-five states and the District of Columbia have now. All of us will get a monthly rebate that will reimburse us for taxes on purchases up to the poverty line, so that we're not taxed on necessities. That means people below the poverty line won't be taxed at all. We'll be taxed on what we decide to buy, not what we happen to earn. We won't be taxed on what we choose to save or the interest those savings earn. The tax will apply only to new goods, so we can reduce our taxes further by buying a used car or computer.

Our current progressive tax system penalizes us for working harder and becoming more successful. As we climb the ladder, the government lurks on each rung, hungry for a bigger bite out of our earnings. The FairTax is also progressive, but it doesn't punish the American dream of success, or the old-fashioned virtues of hard work and thrift, it rewards and encourages them. The FairTax isn't intended to raise any more or less money for the federal government to spend - it is revenue neutral.
There are a lot of different points to be made. Easily dismissed is the claim that the Fair Tax will release us from pain and unfairness. Such a silly claim gets at the unseriousness of the Huckabee campaign in general. More substantively, only six countries have ever adopted retail sales taxes at rates of 10% or more; none do now. 58 Fla. L. Rev. 1043, 1048; Joel Slemrod, Presentation to the President's Advisory Panel on Federal Tax Reform: The Costs of Tax Complexity (Mar. 3, 2005), available at http://www.taxreformpanel.gov/meetings/ docs/slemrod 03032005.ppt.

Huckabee next says that all will get a monthly rebate for purchases up to the poverty line. This argues against one of the main points that he promotes in arguing for the Fair Tax: administrative ease. Huckabee has argued for abolishing the IRS, but it seems that he would have to replace it with some other agency by which to mail out every American’s monthly rebate check. The type of money being passed through the mail would also invite all sorts of criminal behavior (remember how well the debit cards went after Katrina?).

Huckebee also says that the Fair Tax will create positive incentives for saving. That is probably true. Through a combination of zero tax on savings and the dramatic increase of goods after the Fair Tax is enacted, people are likely to refrain from spending. The Fair Tax creates the incentive to withhold income from being put back into the economy. How this will affect the economy only an economist could predict, but the incentives seem to lead to a slowing of the economy as people withhold their dollars from the marketplace. However, eventually, even savings will be taxed as they are spent. The savings argument is misleading because it really only marks a delay in taxation, not an abolition of the tax on savings.

Huckabee argues that both taxes are progressive. However, the Fair Tax is difficult to make progressive. Since the tax applies to all at the point of sale, regardless of economic status, it would generally appear to be either a flat or regressive tax. The single rate of taxation on purchases hits low-income people harder than high-income people because the purchases are a larger proportion of the low-income person’s wealth. Higher income people are able to save a larger portion of their earnings. Thus, even with the rebates he proposes, for anyone above the poverty line, the tax is regressive. To make it progressive, Congress would have to add in additional complexity Graduated tax rates, differential rates, or higher rates all would lead to increasingly complex taxpayer behavior and legislative and administrative responses. 88 Calif. L. Rev. 2095, 2141.

In sum, and these certainly aren’t all the points to be made about the Fair Tax system, the Fair Tax likely does little to improve the current tax system and likely does harm. It does little to improve the complexity or administrative burden. It only shifts the time of taxation from when it was produced to when it was consumed. Finally, it likely dulls economic growth by creating a disincentive to spend.

Beyond its inherent political impracticability, the Fair Tax should be rejected. The better alternative, and the more realistic one, is the one Mitt Romney has proposed: lower marginal rates, end the death tax, end taxes on savings, and lower corporate taxes. These things combined will do more for the economy and the nation than the enactment of the Fair Tax.

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16 Comments:


Can you imagine the chaos visited on the economy if thie were implemented, either immediately, or gradually. Talk about a mess.



I used to be a supporter of the fair tax, but no more. The US economy will TANK with the fair tax. What will happen when everything we buy is increased by 30%?



To say no countries have a sales tax above 10% ignores the fact that the EU charges a 17% - 19% Value added Tax (VAT), which is essentially like a retail sales tax (Plus they have high income taxe!). So I would disagree with that statement, although if you examine the tax structure of Europe, you would clearly not want to adopt what they have.

Just thought I would point that out.



Thanks Kyle,
That certainly isn't a complete list but it isn't hard to see why only a candidate like Huck would adopt such an obviously flawed plan even when faults and shortcomings are so easy to find.
I would like to add that most of us remember from micro-economics 101, what sales taxes do. It keeps people who would otherwise enter the market out, both buyers and sellers. Gains from trade are unrealized. Plus it creates a huge incentive for black markets. These are not ways to stimulate the market, and keep America competitive with a growing Asian economy. I wish I had a whiteboard and 10 short minutes to show him. I guess that divinity school didn't offer advanced classes like that. My personal favorite way to streamline the tax code is a flat tax, but I'll save that for another day.
I hope he doesn't try the awe shucks I'm just a good ol' boy approach when he is pressed about this. Staying in a Holiday Inn Express isn't enough too fool the country.



This tax plan will create all kinds of political fights. What will the poverty level be? Who will determine it? Will there be annual adjustments to it like a cost of living increase? Are the monthly tax rebates to go to families or individuals? Do minors get a rebate on the taxes that they must pay? This will also cause a big dip in all sectors of the economy as people realize that they can save a huge amount by purchasing used items. This will have major ramifications for the auto and building industries. It will just be a matter of months after this tax in enacted before politicians try to get reductions or exemptions for industries that are having problems. This will be a nightmare.



I just thought that I would add this comment from David Frum at the National Post.
"The currently front-running candidate in Iowa, former Arkansas governor Mike Huckabee, has built his campaign on a plan to abolish the Internal Revenue Service and replace the federal income tax with a national sales tax ... Economists and tax experts virtually unanimously agree that the plan is beyond unworkable -- that it is downright absurd."
http://www.nationalpost.com/opinion/story.html?id=169952

Amen!

Another worthy question is “how does the fair tax account for retirement accounts”. It seems like all the tax benefits vanish. Suddenly your 401k and IRA's are the same as any other savings account? That would really upset a huge percentage of the population, who historically are very good voters.



Are you aware we are more than double taxed on our dollar as our system stands right now? Do any of you run a business? If the government comes to you right now and tells you about a new corporate tax you now have to pay, where do you come up with the money to pay it? You get it from your customers. The consumer, who is paying for your service and your taxes from his after taxes dollar. That is double taxation!!!
Pass through all the taxes from a products consection, marketing and distribution and on average 22% of EVERYTHING we buy is taxes. And we pay that with our after taxes dollar. Can't you see that?

Why does the government have a need to know how much a citizen earns? These forms are intrusions into our lives. I want the government to leave me alone. I'll pay taxes, but let me have the final say on where my money goes.

By Anonymous kiboheagen, at December 18, 2007 at 5:49 PM  


Mike -

The stuff that I've read makes an explicit distinction between the VAT and a national retail sales tax. That's why I didn't include them in this. Otherwise I would agree. Check the citations for more information.



I am extremely skeptical of the promises made by the proponents of a national sales tax. A flat tax would be a much better and fairer system, but to get there without completely disrupting the economy, we would probably have to do it in steps. Step 1) Lower the rates and make them more equal. Then Step 2) Lower spending. Then Step 3) Repeat steps 1 & 2 over and over again. I figure that a President could achieve a flat tax somewhere near the end of his first term or beginning of his second term. Heck, Vladamir Putin did it in Russia and it's helped their economy.

Up-Chuck-abee argues that a national sales tax will somehow magically end America's shadow economy. Yeah right! It could easily make things worse though. In order to undercut the prices offered by America's legitimate businesses, a national sales tax could create a huge black market for "national sales tax-free" goods. Those tax cheat underground businesses could even charge more than businesses do today, because all that they've got to do is charge less than legitimate businesses for them to fulfill a need. Yes, the government could fine those businesses or send their owners to jail, but wouldn't that require even more elaborate enforcement and probably an even larger and more intrusive bureaucracy than we currently have with the IRS? What is going to stop people from ordering merchandise abroad in order to skate the rules or what will stop businesses from just going completely underground in order to avoid the taxes? How about smuggling? I’m sure that Mike Up-Chuck-abee with his great records on illegal immigration and fighting crime will make sure that we don’t have everything from kitchen sinks to contraband toys joining illegal drugs in its quest across our huge border with our southern 3rd world neighbor. A national sales tax might just be another scenario of hurting only the businesses who are willing to follow the rules (kind of like one of the main arguments against some gun laws).



Two issues concerning the Fair Tax. BTW, I actually see its potential since several of the issues you bring up are unproven and only a supposition of what might happen. The reason I say this, is because you ignore basic tenents of consumer behavior.

With that said however, my biggest concerns with the fair tax is the liklihood of the federal government to easily introduce it and than begin building on it so that we eventually resemble a western european nation with extremely high sales taxes as well as a high income tax on a Federal level.

The other concern is the ability to create an arbitrage market based on tax avoidance. Used goods are tax exempt in the Fair Tax system, so how difficult is it to take new goods, sell them for ridiculously low prices to a holding company that resells them for fair market value as tax exempt used goods.

Regarding European Sales Tax that statement about 10% is way off. Having lived the last 15 years in Europe the sales tax rates are much higher. In Sweden "moms" which is sales tax on all goods and services is generally at 25% with a few exceptions such as for books.



I actually like the fair tax and wish Romney would support it too. However there are many, many other reasons to support Romney over Huckabee. People are starting to notice Huckabee's flaws as the polls are indicating.



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)



Kyle:

You are also not a tax expert. I suggest you stick to something you know as there is no merit to any of your comments. For instance, not a single prebate will be sent by check in the mail. Prebates will be distributed by either electronic transfers to a bank account or a special charge or debit card.



Dan Mastromarco did a great job of detailing the problems with a "flat" income tax, and how the FairTax would be superior, in rebutting an older Bruce Bartlett objection (which was resurrected for Bartlett's more recent diatribes - adequately rebuked - at WSJ, OpinionJournal, and The new Republic Online). For easier reading, and emphasis, I've paraphrased his 1999 reply to Bartlett following.

(Paraphrased) Reply by Dan R Mastromarco (LL.M., Taxation, Georgetown, principal in the Argus Group, adjunct professor at the University of Maryland, International Management Program, and research consultant to Americans for Fair Taxation - FairTax.org) to:

"A National Sales Tax Doesn’t Add Up" by Bruce Bartlett, December 29, 1999

Many engaged in true tax reform find Bartlett-type attacks exasperating, if not embarrassing. I'd like to convey perspective of both flat taxers and sales taxers who believe that such attacks are counterproductive, but first provide some political history by which to frame said perspectives.

For years Conservatives have posited that a VAT is bad policy (when liberals were discussing it), fearing it would become additional to an income tax (it was called a "money machine"). Circa 1980, conservative intellectuals touted Hall-Rabushka "subtraction method"[ H-R ] VAT which taxed business value added at the business side and labor value added at the labor side. Unlike European VATs (identical in scope), H-R became favorite of Dick Armey and Steve Forbes. It eliminated steeply progressive tax rates and tax on savings. Because of the prior VAT criticisms, H-R was packaged as the "flat tax" and is sold as an income tax to this day, rather than the VAT that its DNA characterizes it as being.

Some conservative commentators have called for the repeal of the 16th Amendment and for the adoption of the flat tax, (despite the fact that it is styled as a direct tax and could not be adopted with such repeal). Mr. Bartlett has called the national sales tax [ie, the FairTax] a VAT (which it isn't), castigated VATs as evil, and has said that sales taxes have become VATs in Europe (which they didn't). In the next breath, he "throws his arms around" the flat tax (which is a VAT). He quotes Bill Gale that the [FairTax] would have to be imposed at 60 percent, but glaringly fails to recognize that if the two bases are the same, he would have to impose that rate for the flat tax to be revenue neutral. In truth, all economists know that the two plans differ NOT in economic effect or base, but in administration.

An income tax taxes savings and investment multiple times. Both flat tax and FairTax are neutral as to savings and investment, tax income only once, and are both consumption taxes. Both are single rate taxes, have nearly the same base, and would improve the U.S. standard of living. Neither redistributes wealth.

While some have even suggested that hey are the same plans under different names, the flat tax taxes value added at each stage in the production process, but the FairTax prefers to tax it when it is added up at the end and eliminate the need to make everyone a taxpayer and collector.

Substantive commonalities between the flat tax and FairTax doesn't mean that there are NO key political and policy distinctions that could be exploited in pitting one against the other. If FairTax supporters wanted to retaliate in response to the Bartlett-type critique, they would have much material with which to honestly do so:

• The flat tax will make small firms and farmers pay the tax even if they have no profit
• The flat tax is opposed by many small business groups
• The flat taxers implicitly support big government by disguising even more of the overall tax burden as the current law
• The flat tax has been kicking around for nearly 20 years
• The flat tax makes everyone a taxpayer and collector, while the FairTax exempts 115 million filers [2000 figure] from ever having to deal with the IRS
• The flat tax is regressive, but the FairTax would enable everyone to keep his full paycheck.
• The flat tax has not only stalled, it has lost public and Congressional support.
• The FairTax is instantly understood, while even some proponents of the flat tax don’t understand it
• There are no transition rules developed for the flat tax and they would be very difficult to craft
• The flat tax taxes exports and relieves imports from tax
• The flat tax confuses tax reform with temporary tax reduction and makes both twice as hard
• The flat tax retains the entire income tax apparatus which erodes as quickly as you can say, “tax bill”


FairTaxers could advance these truthful points without resorting to bigotry associated with a cultic religious organization. However, for the most part, FairTax supporters have chosen not to attack the flat tax, but rather accentuate the commonalities between the plans - despite the above-noted differences. The reason is that, in the battle for tax reform, the real enemy is our current system.

Income tax advocates look down upon the articles of Bruce Bartlett with smug chortling, as Bruce is doing their work for them. The IRS and the liberals who want an income tax to ensure (1) taxes can be raised without the American people knowing it, and (2) wealth can be redistributed from the middle class to the poor, do not even need to fight us - we're killing ourselves!

Perhaps Mr. Bartlett believes that the flat tax will help elect Republicans, effect tax reform, and provide tax cuts; however, the real effect of his criticism is to divide conservatives, to delay serious national consideration of tax reform, and to fertilize the roots of the income tax.

( Source - Addit'l at FairTax.org Whitepaper - May republish in whole or part. - Ian)



I hate to sound rude, but it seems no one, with the exception if Ian, has =any idea= what they are talking about.

And, I think it was very irresponsible for major candidates, with the exception of Huckabee, to not familiarize themselves with the FairTax. When Romney is attacking Huckabee and the FairTax, he has no idea what he's talking about. Do you still think Romney -- a guy doing a "half-fast" job -- is not going to do a "half-fast" job if elected? The evidence points that way.

And, by the way, there've been a number of presidents without foreign policy experience, who've done a fine job in that area. Thus, I reject your assertions, otherwise.



Mitt's alright, but since he's run a business he, of all people, should know how much the FairTax will help the country. Most importantly the poor and middle class...oh..or maybe that's the problem. The people that the Fairtax seems most threatening to are the "super wealthy", "Politicians" and "Big Business" who can game the current system for tax breaks. I forgot that Mitt get's alot of support from those groups, so maybe he does really know what effects the Fair Tax would have on the economy...hmmmm.
I most love hearing people sound educated when trying to trash the Fair Tax, but clearly, for those who are educated on the plan, they present themselves as absolutely and utterly ignorant.
There are over 75 WELL renowned economists who support the Fair Tax and millions of dollars of research and running numbers to make sure the calculations are as correct as humanly possible. Here check out the list:
http://www.fairtax.org/PDF/Open_Letter.pdf




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