Some Thoughts on Tax Reform

As predictable as the sun rising in the East, this April 15th brought a pronouncement from the President that he and his administration will be working to simplify the administration of the income tax. Heard that one before from other Presidents, and I’m still waiting.

One “reform” being championed is the so-called Fair Tax, promoted as being a way to replace the income tax and payroll taxes with no revenue loss to the government. Facially simple, it provides a national sales tax, currently pegged at a 23% rate, to be assessed against purchases of new goods (and services, I believe). Each taxpayer would pay this tax, and each household would receive a “prebate” in the form of a check from the government in an amount calculated to provide the household with a monetary equivalent to what exempting certain basic necessities from the tax would save. This amount takes into consideration the size of the household, and the federal poverty level for such household.

Immediately, the following comes to mind. What constitutes a “household”? Should two adult individuals living under the same roof be a household, or should this combination be counted as two households? Determining the answer to this question and monitoring compliance therewith will, IMHO, not reduce the costs of administration of the tax system as is promoted by the proponents of the Fair Tax.

Then, what are basic necessities? Do prescription pharmaceuticals qualify? If so, how does the proposed prebate take into account the need for the purchase of drugs by a “household” where one or more of the members thereof suffers from a chronic illness, where the Fair Tax being paid on the needed prescriptions exceeds the amount of the prebate?

What about internet sales? Will the current exemption from sales taxes be abolished? If so, how will these be monitored for compliance? Seem like additional administrative costs will be needed.

My favorite is the exemption of the sales of used goods from imposition of the tax, on the basis of the goods already being taxed. Does this not guarantee that there will be a booming market for used “stuff”, to the detriment of sales of new? Is this not contrary to the idea that replacing the current tax system with the Fair Tax will encourage the creation of more manufacturing jobs in the U.S.?

Then, what about the components that go into finished products? Current sales tax laws generally allow an exemption for those components that are not sold to the ultimate end users of the products of which the components are a part. The pure Fair Tax would impose a tax on each such component, as I understand it; and to be “fair”, that should be the result. Otherwise, if these kind of exemptions are enacted, the application and collection of the tax will become as complex as the current system, as exemptions are monitored, distinctions made, compliance assured.

Finally, for purposes of this post, we are assured that as the “rich” purchase big ticket items, the burden will be borne more by them. Hogwash; if they are truly “rich”, they will purchase what they want from other countries with lower effective tax rates. This could be avoided, to some extent, by adoption of a Fair Tax Compensating Use Tax to be sure that the 23% is paid; but again, does this not increase the costs of administration, etc., to levels similar to or higher than the current costs of administering the present system?

There is a certain basic sense of simplicity with the idea of the Fair Tax, and its appeal is based on this. Like all proposals for reform, however, it raises more questions than it answers. And, as with all proposals for reform, it creates additional employment opportunities for accountants and lawyers. To pretend otherwise ignores reality.


Filed under Economics, taxes, The Economy

7 responses to “Some Thoughts on Tax Reform

  1. I’ll go on to address the idea of a Flat Tax on income; a flat percentage on income, everyone pays the same, done.

    First, what is income?

  2. Zippy

    Exactly, 6, though even if we came up with a broader definition of “income,” money is power in the economy, rather than any type of accurate correlation of the worth of one’s efforts to the society as a whole. That’s why we see CEOs making decamillions a year while even the highest paid professionals (white or blue collar) make a tiny fraction of that, and those most hardworking scut workers get, well, scut.

    Which is why, for the sake of democracy and the health of the republic, some kind of progressive taxation is a inescapable necessity. Plutocracy always emerges when democracy is applied to the tools of power rather than actual humans, one by one.

    And as I recall, the so-called Fair Tax would ended up increasing taxes by huge amount for most people and, as all sales taxes, is naturally regressive, disproportionately hitting bread-and-butter expenses and, thus, naturally, “soaking” the poor.

  3. Yes, Zippy, sales taxes are by their very nature regressive. The proponents of the Fair Tax inform us that this is taken care of by the “prebates”.

    Rather than prebates, why not exempt basic necessities from the application of the tax? Prescription drugs, basic unprepared foodstuffs, that sort of thing. Clothing is an issue here; to exempt it means that a Dior gown is the same as a package of Fruit of the Loom briefs. Simplicity dictates the same treatment for all items within a category.

    You will note a lack of exemption for automobiles. While many can argue the ownership of the same is a “basic necessity”, this is an argument with which I disagree. Perhaps making the purchase of a vehicle not exempt will (at least indirectly) result in an examination of issues of urban sprawl, improved public transportation, etc., although I’ve a feeling the return of higher fuel prices (it is inevitable; only the timing is in question) will influence this as well.

  4. The Fair Tax percentage is calculated to be roughly the amount of “hidden taxes”, such as the payroll taxes paid by the manufacturer on its employee’s wages, which is, according to the Fair Tax proponents, 22% of the cost of various goods. I’m not quite sure where they come up with that cost; my calculations, using some of the examples given, arrive at a higher percentage.

    Thus, the reasoning goes, by eliminating these, the basic cost of the goods is reduced, such that the ultimate price to the consumer is roughly equivalent after application of the Fair Tax. Balderdash; the basic price of the goods will not decrease by said percentage, if at all, with the Fair Tax being an “add on”. Reality so dictates; if the basic price is reduced, then the profit would not increase as much as it otherwise could, thereby limiting the ability to increase dividends, etc., and as the Fair Tax is, by its own terms, imposed upon all purchases of new goods, for items where the demand is price inelastic, there will be no motivation to reduce the basic cost thereof.

    Then, if such prices are not reduced, there will need to be larger “prebates”, as there will be yet a higher poverty level, etc., the need to calculate the same requiring additional costs, which then belies the argument that adoption of the Fair Tax will reduce the costs of tax administration.

    I admire the goals of simplicity espoused by those who favor the Fair Tax. I just don’t think it creates such simplicity.

  5. iggydonnelly

    At the Teabag party last night, I noted several people were carrying around the Neal Boortz book on the “Fair Tax”, which was enough to make me wonder if it was a good idea.

  6. Iggy, from a purely intellectual theoretical perspective, a consumption tax such as the “Fair Tax” is, indeed, an idea worthy of consideration. Alas, the devil is in the details, which do not lend themselves easily to a simple solution.

    I’ve condensed much of the above into two points when discussing the “Fair Tax” with its proponents:

    1) It should apply to new consumption of used goods;
    2) There should be an exemption of “basic necessities” from the imposition of the tax rather than reliance upon prebates.

    Those two points need satisfactory answers before I can support anything like the “Fair Tax”.

    I’m not surprised that you saw several folks carrying the Boortz book around. Part of the appeal of the Fair Tax to many is its surface simplicity, when compared to the complexities of the current Internal Revenue Code. I do wonder, though, if these good people really understand what the imposition of such a tax means.

    For example, in its broadest sense, the tax would be applied to the purchase of a residence; there would be no deductions allowed for mortgage interest or real property taxes. Another example: in its broadest sense, the tax should be applied to all purchases of securities, with no “special treatment” of capital gains, for example on disposition of any security. These are two examples of the “social engineering” contained within the current IRC, social engineering which in principle is decried by many who want a change in our income tax system, but which benefit these same folks.

    So, if this was fully explained, I wonder how many persons who currently say they are in support of the Fair Tax would continue such support.

  7. There are similar but different problems with a “flat tax” imposed on income. My question, posed above, still stands: what is “income”?

    I think that most who favor a flat tax do not consider a capital gain income. Such a gain, however, is income under an economic definition of the term. In fact, when one reads section 61 of the IRC, one sees that the current tax law defines income more or less as an economist does. Subsequent sections then go on to define what types of this income are excluded in arriving at the concept of gross income, from which (ultimately) taxable income is arrived, upon which income taxes are paid.

    Thus, under current law, certain employee benefits are excluded from the concept of gross income under the appropriate provisions of the IRC. However, the same are indeed income from an economic definition, and are included in gross income under section 61, subject to the exclusion provided in other sections. Under current law, damages recovered for personal injury are excluded from income; the same, however, are income under section 61, and would be subject to income taxation but for the specific exclusion thereof under a subsequent section.

    Social security benefits received which are greater in amount in the aggregate than the aggregate of FICA withholdings or self-employment taxes paid are income, by any definition; however, under current law, only a portion of the same may be subject to income taxation, under certain circumstances. Compare this with the current treatment of benefits received from a retirement annuity. A part of the benefit is (properly) treated as return of capital; the rest is treated as income earned on the capital contributed to the purchase of the annuity. Why should not Social Security benefits be subject to the same treatment, but for social policy goals inherent within the provisions of the Code?

    I can go on ad nauseum about this topic. In deference to the readers, I’ll quit (at least for now).