Archive for February, 2008

FairTax Questions Answered

Wednesday, February 27th, 2008

Commenter Dan1 had some good questions/ critiques regarding my earlier post about The FairTax plan. I started to write out a long, involved response in comments, and decided it was worthy of a post of its own. Quoting Dan, with my responses interspersed:

If the cost of the good comes down to 78 cents and the Fair Tax generates .22 or 23 cents in revenues, then great.

Quick distinction — this price drop should happen behind the scenes. That is, an item that used to cost a dollar will still have a dollar price tag on it. The difference is with the seller, who will pocket 77 cents and send the 23 to the state — rather than the current plan where he pockets the dollar but later pays income tax on it. Specifically, this is called an “inclusive tax” as opposed to an “exclusive tax” such as most state sales taxes. Why make it an inclusive tax? Because the existing income tax it’s replacing is inclusive, and frankly because of the perception of price.

This is important in a moment….

The point is if you start taxing purchases, then you cause everyday people to defer purchases, which signals a decrease in tax revenue.

People also say that lowering income taxes will reduce revenues, but every time we do it, revenues paradoxically go up.

You are correct in the effect, but not the result. People may very well defer purchases. What the tax would do is strongly encourage savings, as you only pay taxes when you spend money. Most economists agree that a high savings rate is good for an economy. Why?

Because people aren’t using that extra cash to stuff their mattresses; they’re investing it. (Or perhaps they’re merely putting it into the bank, and the bank is investing it.) High levels of investment in companies makes an economy grow. A lot. More investment means more jobs, means more competition for labor, means higher wages, means higher… spending.

It also means more kewl American products for people in other countries to drool over and buy.

Purchases that can be made outside of the new tax zone (i.e. the entire US) will be made outside the US. And since most of those nations don?t have large sales taxes, the consumer benefits, the other nation benefits, and the US loses out on tax dollars. That means less federal funding.

Why would Americans buy more outside the U.S. if prices haven’t changed here? Here’s where my earlier point of the tax being “behind the scenes” comes into play. Something that used to cost a dollar will still cost a dollar (or maybe $1.01). Even if that perception is not there, I can spend a dollar there, or 78-cents-plus-23-cents here. Hmmmm…

In fact, there will be an opposite effect. If the cost of making a product actually drops 22% as predicted, exports will BOOM, because they’ll be 22% cheaper. People in other countries will be able to buy the same American products much more cheaply.

At the same time, Americans will buy more American goods, and fewer foreign goods, because both with have the FairTax added, but the American goods will be much cheaper. That is, the American product will be 78 cents plus the tax. The same product (but foreign manufacture) will be a dollar plus the tax.

Why the difference? Because we’ve removed all the cost that embedded taxes adds to the cost of a product. (multiple levels of income tax, payroll tax, etc. etc.). The foreign country (until they too decide they like the FairTax) will have all that extra cost in their prices.

That actually is a very important point. The FairTax will be massive… for the first country that implements it!. If it works as expected, other countries will quickly pick up on it. We Americans are used to being trendsetters though, having been the first in modern times to try that crazy “all men are equal” idea that many people at the time thought would never work.

To recapture the lost revenue new taxes or tweaks would occur or the Fair Tax percentage would have to rise until it was generating the same level of revenue.

Lowering income tax rates raises revenue because it make total income go way up, and the smaller percentage of the higher income equals a higher tax revenue. This is not theory, it’s historical fact. It has worked every time we’ve done it.

So… if lowering income tax rates raises total income, what will happen when we lower it to zero? For a number of reasons, including those outlined above, total income should go up. Way up. The overall economy will grow. As it grows, spending will ultimately grow as well.

If sales tax is higher in the US it will affect the cost of travel and vacations. Tourism will suffer. If hotel rooms and a plane tickets are taxed at 22%, then foreigners as well as US citizens will take their vacation dollars outside the US and all of the tax revenue is lost forever, but a tweak to the tax code can increase the tax on international travel to recoup some of the lost revenue.

Again, the end prices will change very little. Tourism will not suffer, because prices won’t change. In fact, tourists will increase the tax rolls because part of what they spend here will go to taxes.

Ditto “underground” economies such as drug dealers. I might make big bucks selling cocaine, but when I turn around and buy that flashy car I’m going to be paying taxes on it.

LOL. Inventories being exempt means that the government loses out on even more revenue. GDP is between 13 and 14 trillion and the annual US budget is about 2.5 trillion dollars. How much of that 13 trillion could be said to be stored in inventories? Whatever it is 22% of it is a hell of a lot of money and a considerable portion of the budget.

Yes, but most of the taxes on that inventory has already been paid. How do you “lose” revenue you’ve already taken in?

There would certainly be some flux in the short term if this became law. But hell, the government spends far more than it takes in anyway, so they should be able to weather a short term fall in revenue — especially if it results in a significantly strong economy down the road. Even so, hold on one more minute. I’ll get back to this.

There is a new book out on the FairTax, called FairTax: The Truth: Answering The Critics. It just came out, and I’ve been marking notable passages as I read it. Here are a couple that I thought were very telling…

From page 30:

When Bill Archer (R-Tex) was chairman of the House Ways and Means Committee, he routinely quoted an informal survey of five hundred international companies located in Europe and Japan. These companies were asked, “What would you do in your long-term planning if the United States eliminated all taxes on capital and labor and taxed only personal consumption?” Eighty percent–that’s four hundred out of five hundred–said they would build their next plant in America. The remaining 20 percent–the other hundred companies–said they would relocate their business to America altogether.

Four hundred new plants and a hundred new companies (and thousands of new jobs). Just for starters.

That was the foreigners; let’s look at Americans. Page 41:

[W]e have more than $12 trillion sitting in offshore accounts…. Don’t misunderstand. Most of the money sitting offshore has been earned in a perfectly legal manner. …[Companies] just haven’t yet decided to repatriate these funds. Why? Taxes….

In a FairTax conversation with former Federal Reserve chairman Alan Greenspan, the chairman was asked if he thought this offshore money would in fact come back into American markets in a FairTax world. Well, he said, a small portion might remain offshore for other good business reasons–but the remainder would certainly come home.

How long would it take for that to happen? he was asked. Years? Decades?

“Months,” the chairman responded.

Months. Remember that bit about exempting existing inventory and how the government would take a big hit? Now what do you think pouring twelve trillion dollars worth of investment might do to government revenues? What would it do to job creation and wages?

To be honest with you Dan-o, the more I read about the FairTax, the more I like it. The relative ease by which I’ve been able to answer fairly challenging questions is surprising to me. It’s a strong plan, and it’s been very well thought out. Read the book. (The new book is better than the original because it was written with many of the common criticisms and challenges in mind — the first book explains it, the second book does that and responds to many of the “buts”….)

Beyond all that, I think the biggest reason for passing it is this: it would represent the largest transfer of power from American government to We The People since the country was founded. The federal government has been growing virtually unchecked for over 200 years. It’s time for the people to reclaim their full measure of freedom from those who think they know best what’s good for us.

1: Not to be confused with Farmer Bob.