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Larry Kotlikoff defends the Fair Tax
Here is the link, via Greg Mankiw. If we are comparing the Fair Tax to the traditional VAT, compliance is issue number one and I'm not convinced by Kotlikoff's defense:
This [compliance] is a reasonable concern, and one I share. In examining the real revenue-neutral FairTax rate, my co-authors and I ignored compliance issues, not because they are unimportant, but rather because we had no firm basis for estimating their impact...
...it’s clear that the incentive to cheat will be significant. But it’s also clear that the incentive to evade income taxes is greater than would be the incentive to evade the FairTax. Moreover, much of the evasion under the FairTax would come in the same form and done by the same actors as evasion under the income tax; for example, a waitress who fails to collect FairTax on tips is also, presumably, not paying income taxes on those tips under the current system....
The reasons I’m not overly worried about evasions number five. First, the vast majority of retail sales occur in major retail outlets, like WalMart. Second, we’ll have vastly fewer taxpaying entities (14 million rather than more than 100 million) on which to focus our enforcement efforts. Third, we’ll have hundreds of thousands of otherwise unemployed IRS agents, accountants, and tax attorneys to enlist to enforce a single tax. Fourth, we can always compel firms to report, via 1099-type forms, their sales to other firms. This will provide the same records that arise under a VAT. Fifth, the government can stipulate that all retail sellers provide buyers with a written receipt, regardless of whether the transaction is or is not in cash, specifying that the FairTax has been paid. Thus if sellers don’t mail in the taxes, there will be a paper trail of the evasion. Sellers who try to bribe buyers to forgo receipts and split the FairTax among themselves run the risk of having the buyer turn them in.
I would say this: push for a Fair Tax and if you're lucky you'll get something like a VAT, if only for reasons of enforcement. Plus you'll also get the same income tax we have now, which isn't going away anytime soon. New Zealand, of course, did something like this. "Fair Tax = Tax Increase"; it's a pretty good and simple slogan.
On most of Kotkiloff's other points, he's simply "fighting for a draw," as they say. Think through federalism with no federal income tax as a base for state and local taxes. The transition issues are a monster. If encouraging savings is the main goal, why not just eliminate the taxation of capital income under the current scheme?
Posted by Tyler Cowen on January 17, 2008 at 05:59 AM in Economics | Permalink
Comments
I refuse to call it the fair tax because that is a silly PR name. It has damn little to do with fairness and most of the arguments for it are based on efficiency issues. It is a national sales tax. There is nothing particularly fair about that, it is both more and less fair than the income tax. By the way I think those that instituted the income tax really missed an opportunity by naming the tax based on what it is on instead of calling it something arbitrarily appealing like "The Perfect Tax."
Posted by: Michael Foody at Jan 17, 2008 7:40:14 AM
Isn't that the guy I heard on NPR yesterday defending his health plan? I thought his arguments there were kinda facile too (like brushing aside the privacy concerns of the government having a huge database of everyone's health information with "well, they already have Medicare databases and the world hasn't ended yet!").
Posted by: Andromeda at Jan 17, 2008 7:47:35 AM
Boy, talk about moving the goal posts! One of the main selling points of the national sales tax is that we get rid of the IRS and the costs of collecting the tax. Now the proponents of the sales tax say that we still will need the same people doing the same thing....
In terms of evasion and enforcement, I think that the buying on a vacation thing is the hardest thing. Just think, if you go on a vacation, remember to bring receipts for all the expensive things in your possession to prove that you didn't buy them on the trip.
And of course for the rich; they can legally buy many sorts of pre owned things that are not taxed at all;
privately owned Antiques
Estates
Classic cars
Paintings owned by indviduals (but not galleries)
Posted by: RobbL at Jan 17, 2008 8:05:15 AM
I think larry is deliberately ignoring the urge to avoid/evade sales taxes. His own state has an annual 'sales tax holiday' one weekend per year, and shares a border with a no sales tax state. The presence of huge shopping malls directly on the border belies his statements. And this is in a state with a 5% sales tax.
Posted by: rogerrabbit at Jan 17, 2008 8:12:48 AM
I just used the fairtax calculator found on their website. It says that the fairtax will decrease my purchasing power by $200. I guess thats fair, considering I'm a college student. I just won't buy textbooks every other semester. It would be just like highschool where I did not get textbooks in half of my classes because the school could not afford them.
I know that there are a certain number of students in all of my classes that do not purchase the required textbook due to the expense. If the fairtax was enacted, this percentage would significantly increase.
The fairtax would significantly decrease the sales of technology, considering people my age buy expensive things like laptops, ipods, cell phones, digital cameras, etc. Also, this will result in more copywrite infringement when the teachers have to hand out photocopies of the textbook and students really stop buying CDs and DVDs.
Posted by: brainwarped at Jan 17, 2008 10:06:00 AM
Well, I'm a moderate fan of the Fair Tax proposal. I recognize that it does have some potential problems, but I believe that it would be better than the current system.
I noted in your comments, though, that you made the common mistake that there would be an income tax in addition to the sales tax.
The key provision of the proposal is that it replaces the income tax, and repeals the 16th amendment.
If you're discussing a national sales tax proposal, and it doesn't include that, you're not discussing the fair tax plan. Most fair tax advocates would be against it without repealing the 16th amendment.
I don't think that the fair tax will ever be implemented because of this, but I still like the idea.
Posted by: Louis at Jan 17, 2008 10:45:49 AM
While we are throwing out ideas, let's end all deductions against income taxes and end corporate income taxes. Those two changes alone would fix many problems with incentives in the income tax system. If we are getting dreamy, let's go for property taxes: As I write here, they are even easier to enforce, progressive and do not distort behavior.
Posted by: David Zetland at Jan 17, 2008 11:14:16 AM
"First, the vast majority of retail sales occur in major retail outlets, like WalMart. Second, we’ll have vastly fewer taxpaying entities (14 million rather than more than 100 million) on which to focus our enforcement efforts."
This is why one of the more common arguments against such a high national sales tax rate is that it would effectively eliminate small businesses, as the "major retail outlets" will be the only ones capable of absorbing the compliance costs.
"Third, we’ll have hundreds of thousands of otherwise unemployed IRS agents, accountants, and tax attorneys to enlist to enforce a single tax."
And this is the source of the next most common argument: renaming the IRS and giving those people access to the records of everything we buy and sell on a daily basis is nothing even remotely close to abolishing the IRS and does nothing to alleviate the concerns of those that claim the IRS is an invasion of privacy. I've never quite understood how people concerned about the government knowing how much you earn and what you invest in would feel they have more privacy if instead the government only knew everything you spent money on.
"Fourth, we can always compel firms to report, via 1099-type forms, their sales to other firms. This will provide the same records that arise under a VAT. Fifth, the government can stipulate that all retail sellers provide buyers with a written receipt, regardless of whether the transaction is or is not in cash, specifying that the FairTax has been paid."
According to the proponents of a national sales tax, the high tax rate will be absorbed when the costs of production drop by roughly 20%. I wonder if they've factored all these paperwork and compliance costs into that 20% drop in prices.
Posted by: mith at Jan 17, 2008 11:28:23 AM
Every defense of the "fair tax" by a reasonably intelligent and informed observer ends up being a defense of some form of expenditure tax--VAT or other--that then goes on to say, "This is sort of like that." It's like recommending a tiger as a pet by noting that cats are good pets and tigers resemble cats in some ways. I have never seen an attempt to defend the superiority of the "fair tax" over a VAT. "We can't be bothered to think about evasion" doesn't cut it.
Posted by: Alan Gunn at Jan 17, 2008 12:11:22 PM
I agree (well, have long agreed, thought not because of reading him) with David_Zetland. If all taxes
were property taxes, you wouldn't have to account a zillion transactions each year, and it would be
fully transparent. Yes, people would then devote significant resources to "proving" that their property
is worth a lot less, but if anyone can get on the internet and see that giveaway, we have a case of
irresistable force meets more immovable object.
Posted by: Person at Jan 17, 2008 12:18:01 PM
Why would a buyer turn in a non-compliant seller? The very idea is ludicrous. If I'm buying from a seller who doesn't collect the tax, *I BENEFIT TOO*.
I, for one, would shift as much of my consumption as possible into secondary and grey markets to avoid the tax. Why does he think enforcing tax laws against people who sell stuff, which literally anyone can do, will be easier than enforcing it against payroll firms? There's only so much I can cheat on my taxes when the state already has already got hold of the money through withholding and I have to file legal documents to get it back. The taco stand on the corner doesn't have to do anything special at all to cheat, just a wink and a nudge.
Posted by: Noah Yetter at Jan 17, 2008 12:39:32 PM
The NST seems unecessarily radical, given what it is trying to accomplish.
As Tyler said, you could just retain the income tax but exempt investment income.
You could also get the same impact on progressivity by consolidating the FICA and personal income taxes into one income tax, exempting up to the poverty level, and then taxing hte rest at one rate. That rate would probably have to be 30%-35%, and you could make employers pay some share of it, just as employers pay a share of the FICA tax under current law. The NST tries to shift the incidence of the employer half of the payroll tax onto employees, which I don't like. If prices were perfectly flexible, of course, it wouldn't matter. But, in reality, I'm not sure all firms would immediately raise everybody's wages by 8%. In reality, the adjustment in wages would probably be a real fiasco.
None of these major tax reform proposals will ever be passed anyway. Its just a way for marginal candidates to get noticed, which is unfortunate. A flat, or even graduated, consumption based tax with no deductions would be a wonderful thing if we could get it.
Posted by: steve at Jan 17, 2008 1:38:16 PM
"I, for one, would shift as much of my consumption as possible into secondary and grey markets to avoid the tax."
You mean like an appreciable percent of the population does for its income?
Posted by: meter at Jan 17, 2008 2:16:01 PM
Why is it that people think tax evasion will be worse under a national sales tax then on an income tax? Do we really know how many people are cheating on their taxes now?
Tyler, you seem to have a dim view of the FairTax proposal. Is that because you think the current system is pretty good or do you have an alternative idea that you have been waiting to blog about?
Posted by: Sam at Jan 17, 2008 3:23:29 PM
Tyler thinks that support for the replacement of the income tax with a NST would ultimately translate into a retention of the income tax plus a VAT. The change from NST to VAT is politically rather innocuous -- most European consumers aren't even aware of the difference -- so that probably would happen. But any attempt to retain the income tax would be politically doomed. Most of the support for an NST comes from the promise to eliminate income taxes. These proposals typically involve the repeal of the 16th amendment. Yes, the politicans would prefer to have both taxes, but that is politically DOA.
On the other hand, the elimination of taxes on income from capital gains is indeed a less drastic reform, but politically it has zero support. It would strike many voters (including me) as extremely unfair, since it would allow rich inheritors to live entirely tax free off investment income.
In summary, the fair tax may be more radical than Tyler's proposal, but it has loads more political appeal. Memo to politicians: don't hire Tyler as a campaign stragegist.
Posted by: David Wright at Jan 17, 2008 5:40:03 PM
Have any of you that are critical of the plan ever read the actual bill (HR 25) that would implement the FairTax, or do you base your criticisms on what you imagine a national sales tax to be like?
http://www.fairtax.org/PDF/HR25_2007.pdf
Posted by: MAD at Jan 17, 2008 5:45:47 PM
Whenever I go to New York or LA or other big cities I notice a lot of the small stores don't accept credit cards but do have an ATM machine right outside the store. After making my purchase in cash I generally do not get a receipt. Sales tax in these states is around 9% I'm guessing, and these guys already seem to be gaming the system. This does not bode well for a national sales tax.
A couple states have no income tax and only use a sales tax. Nevada is one. I hear in the news the legislature is trying to do away with this and implement an income tax too. Government revenues fluctuate too wildly with only a sales tax is one of the reasons.
If states that have always only used a sales tax are now trying to implement an income tax, that is not a ringing endorsement for a national sales tax to replace income tax.
All states would also have to get rid of their income taxes and switch to sales taxes or implement their own IRS. Thus the sales tax rate would be significantly higher then quoted for the federal rate.
What really will be the overall sales tax rate in New York City if there is no income tax and only sales and property taxes? It seems like it would really be huge. Anyone know?
Maybe it may be hard to sneak a new 50 inch plasma TV over the border from Canada, I bet I can get a whole load of new clothes in. I certainly can't be expected to keep the receipts for clothes I purchased in the US and brought for my vacation in Canada. Although I do have a nice printer if I needed a receipt for a new laptop or diamond tiara.
Border states will lose a lot of sales revenue, and shopping trips to Europe will be subsidised by the money we save on our new wardrobe. I guess this won't help people who aren't that rich, but if I live in NYC and take business trips to London...
I kind of rambled but I did have 3 points.
1) There already seems to be a lot of non-compliance with sales taxes from small businesses using cash.
2) There are some states that only use sales tax and they face serious problems, and we would force all states into this model.
3) Those able to afford it will simply shift a significant portion of their consumption (clothes, jewelry, medicine...) to foreign countries.
I just thought of another thing. Sales tax would totally screw retirees. They spent all their years building up a retirement fund and paying income taxes. Now they have to pay an equivalent amount of sales tax as they draw down their savings! Although maybe it will make up for young people paying for Social Security they will not receive, and the old people can always move to Mexico or Costa Rica.
-flub
Posted by: flub at Jan 17, 2008 6:22:04 PM
I do not not think the numbers of evaders would increase because there are so many perfectly legal ways to evade it, such as vacations abroad, but I do think the ones that do would be much more successful.
One also has to consider how ambiguous consumption really is. What is consumption and what investment? A new factory, consumption? An antique, an investment? Education, consumption? A classic car, an investment? Healthcare, consumption? Sterling, an investment?
I can imagine everyone opening Chez Moi furnished wholesale and leaving the price tags on everything for 'eventual' sale.
Posted by: Lord at Jan 17, 2008 7:10:44 PM
(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)
Posted by: Ian at Jan 17, 2008 10:08:49 PM
Retention of the income tax would not be politically difficult- no more difficult than it's original implementation. Here is how it would happen:
Income tax eliminated, sales tax implemented- five years pass, proposal made to reimplement income tax on the extremely wealthy only. Passes with many huzzahs and way-to-gos. Fifty years pass and everyone is paying the income tax.
Posted by: Yancey Ward at Jan 18, 2008 1:47:50 PM
If increasing savings is the main goal, why not use the power of the state to create a compulsory savings system? Australia and quite a few other countries have.
Posted by: Ronald Brak at Jan 19, 2008 3:46:09 AM
> If encouraging savings is the main goal, why not just
> eliminate the taxation of capital income under the current scheme?
Leona?? Leona Helmsley? Is that you?
Posted by: That Software Guy at Jan 22, 2008 7:01:02 AM
I personally like the idea of enticing corporations (HQ, operations, white collar, blue collar) away from other countries. The combination of the dollar being "weak" and labor and capitol not taxed under Fair Tax will cause a "race to the bottom" in other countries to retain a tax base - thus destroying their much cherised quasi-socialist systems which may offset any 'savings' from shopping "across the pond" :)
In all seriousness, why employ thousands of brilliant accountants whose job is to protect the very wealthy while cheating the government from X billion dollars of tax revenue?
How do VAT implemented countries project revenue for the next fiscal year btw? Most of them already have an income tax of some sort anyway correct? So either implementation (VAT or NST) is radical in itself...
Posted by: rick at Jan 22, 2008 7:04:58 AM
Personally, since the "Fair" Tax can also be called a National Sales Tax-Inclusive (that's the way supporter's like to posit it, inclusively, to compare with income taxes), I prefer to call it the "NaSTI"... in many facets it is, as been said, at best a draw, and in many facets it is a horribly, horribly, horribly bad loss for the middle classes.
And I am continually amazed that folks keep falling for the disengenuous soundbites and buzzphrases of the "Fair"/"NaSTI" backers, such as
1) "Keep your whole paycheck!"-- Yes, but $0 above now, for prices to stay relatively level after tax--"your whole check" assumed under the numbers of the supporters to be the same same amount as your takehome now, else prices rise.
2) "It taxes the underground!"-- Not really, or at best 1-3%. Supporters are just renaming the alleged "embedded Tax Costs" used to calculate the 23% rate as "sales tax"-- if a "pimp" pays $5 for milk now and $5 under the "Fair"/"NaSTI", it's 6 of one half-dozen of the other, and obviously those in the underground are most likely to partake of the "greymarket," and, finally, a "Fair"/"Nasti" with a prebate would result in a windfall for the members of the underground who have SocSec#s.
3)"Loopholes are gone!"-- Not really. Buying "used" or "overseas" or "greymarket" are ginormous loopholes for the über-wealthy, like buying "used" apartment buildings in Manhattan and paying zero tax, or .. well, et cetera ad nauseum. And the more everyone legally avoids the tax (buying "used," saving more, etc.) the higher the rate must be to remain revenue neutral.
The "Fair"/"NaSTI" will most likely never happen in the USA, but one has to wonder, as many have above-- who says the current system is totally broken anyway... and who stands to have a lower effective rate under a "Fair"/"NaSTI"?
Posted by: Diskatopia at Feb 3, 2008 11:25:32 PM
FYI
Bruce Bartlett's critique of the FairTax is way off base
Here's our response to BB.
http://www.beaconhill.org/FairTax2008/TuerckTaxNotes080204.pdf
Posted by: Frank Conte at Feb 11, 2008 10:14:04 AM
