An Oped in the Wall Street Journal on the "fair tax" proposal. As usual, I have to wait 30 days to post the full version
The bill eliminates the personal and corporate income tax, estate and gift tax, payroll (Social Security and Medicare) tax and the Internal Revenue Service. It replaces them with a single national sales tax. Business investment is exempt, so it is effectively a consumption tax.
I've been writing about consumption taxes for a while. Some previous posts on these points, VAT (WSJ), A progressive VAT, Consumption tax, Tax reform, Taxes, Alternative Minimum Tax, also Wealth and Taxes Convexification and complication Tax graph Economists and Taxes Corporate tax burden Tax Reform Tax reform again (WSJ) Corporate tax reading list Corporate tax (zero) Trump taxes 2 Those address a lot of the what ifs and whatabouts.
But it's not progressive! (Meaning, better off people pay the same rate, not the same amount, not "politically progressive").
Already the "fair tax" proposal adds
Each household would get a check each month, so that purchases up to the poverty line are effectively not taxed.
Yes, effectively universal basic income from Republicans! One could do more. And as in the above forest of links there are plenty of ways to make a consumption tax as progressive as you'd like.
But the most important point, with added emphasis:
the progressivity of a whole tax and transfer system matters, not of a particular tax in isolation. If a flat consumption tax finances greater benefits to people of lesser means, the overall system could be more progressive than what we have now. A consumption tax would still finance food stamps, housing, Medicaid, and so forth. And it would be particularly efficient at raising revenue, meaning there would potentially be more to distribute—a point that has led some conservatives to object to a consumption tax.
Even the supposedly far right radical Republican plan bends here to political expediency in my view. Why should this particular tax add progressively, rather than just finance transfers?
Won't the rate be too high? If the government spends 40% of GDP, and consumption is 85% of GDP, then the consumption tax rate has to be 47%. Wow!
But taxes overall must finance what the government spends. Collecting it in one tax rather than lots of smaller taxes doesn’t change the overall rate. It’s better for voters to see how much the government takes.
(Currently taxes don't cover spending because we borrow a lot, but that can't last forever).
What about "starve the beast." Consumption taxes or a VAT are so efficient, government will grow. Keep an inefficient system so that government is forced to cut spending. While great economists advocated that view, it does not seem to be working!
BTW, I don't have a big view on consumption tax, sales tax, VAT. From where we are now, all three are about the same. There are differences, that will matter in the end. The fair tax bill actually has a lot of the thought out detail one expects.
The main point: Get out of the day by day politics. It's great news that a clean good fundamental reform idea is making it to actual legislation.
This is a big moment. For a long time, consumption taxes have been debated in academic articles, books, think-tank reports, administration white papers and so forth. When the U.S. eventually decides to reform the tax code, consumption taxes will be the obvious answer. It is great news that real elected politicians like Rep. Carter get it, and are willing to stick their necks out to try to get it passed.
No, it’s not likely to pass this year, or next. All great reforms take time. The 8-hour workday and Social Security started as wild-eyed dreams of the socialist party. Civil rights took bill after bill being voted down. The income tax took a long time. But if we never talk about the promised land and only squabble over the next fork in the road, surely we will never get there.
"The bill eliminates the personal and corporate income tax, estate and gift tax, payroll (Social Security and Medicare) tax and the Internal Revenue Service. It replaces them with a single national sales tax."
ReplyDeleteNo it certainly does not nor can it. The ability for the government to levy an income tax is governed by the 16th amendment to the Constitution.
It is IMPOSSIBLE for an act of Congress in and of itself to amend the Constitution.
There is a difference between "the ability" to levy an income tax (which is what the 16th Amendment gives) and the actual levying of an income tax. Cochrane is talking about the latter. And he is right.
Delete"There is a difference between the ability to levy an income tax (which is what the 16th Amendment gives) and the actual levying of an income tax."
DeleteThat difference being control of Congress changes from one party to the other that can happen as often as every two years.
That is why we have strict requirements for making changes to the Constitution - to PREVENT really important political / economic decisions from being subject to political whims.
If the "Fair Tax Act" was such a large improvement over the income tax, it would include replacement of the income tax (repeal of the 16th amendment) and be subject to the requirements for Constitution Amendment consideration.
https://en.wikipedia.org/wiki/Twenty-seventh_Amendment_to_the_United_States_Constitution
The misconceptions on this site are mind boggling. Instead of projecting opinions , please go to fairtax.org/FAQ to get the answers, It is so simple. Number one, every one ALREADY is paying a tax on EVERYTHING they buy be fore they get their money. That's currently called Federal Payroll taxes. FairTax eliminates ALL FEDERAL payroll taxes! Fact! Every item/product, created in the US of A is taxed and taxed and taxed again with the income tax on EVERY person who is involved in the manufacture, the transportation the stocking of shelves and the selling of that product. FairTax eliminates AL that double and any Double taxation. It is a Consumption tax because nothing is taxed if it has already been Taxed in the US. If you buy out side the us and do not resell it is not taxed. If you buy from the second hand store it is not taxed. If you save money the interest is NOT taxed. ONLY NEW GOODS AND SERVICES are taxed! What could be simpler? You get your entire pay check. No accounting, No need to keep track of what you earn. Employee personnel in business' will be one person. Compliance costs are decreased as much as 90% No forms to fill out. April 15 is just a spring day! FairTax; When you understand it, you will demand it.
Delete"When you understand it, you will demand it."
DeleteFine, include the full repeal of the 16th amendment, eliminate ALL exceptions, and put it to a vote as an approved amendment to the Constitution.
1. The reason I am adamant about eliminating all exceptions is this. We pay taxes in part to fund our legal system which establishes and protects property rights.
DeleteTo say that certain types of goods when sold / resold should be exempt from taxation to me says that the property rights of the new owner should not exist.
If the new owner isn't willing to pay taxes on the transfer of a property (no matter what type of property it is - new, used, or otherwise), why should that new owner receive any legal protection of his rights to that property?
If a used car is stolen, should the owner of that used car reasonably expect our legal system (police, courts) to remedy that situation? If so, should not the owner of that used car help pay for that legal system?
2. The Fair Tax act fails to address seasonal variations in consumer expenditures coinciding with the holiday season (higher spending in November / December, lower spending in January / February). That is a big reason that we have an income tax. It provides a more stable revenue source for the federal government across the year.
So, if the Fair Tax is going to get any traction (IMHO), it needs to eliminate any and all exceptions, it needs to address seasonal variations in consumer / business expenditures, and it needs to clear the high hurdle of replacing the Constitutional ability of Congress to levy an income tax.
"The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration."
DeleteIt is clear that the Congress has the power to collect taxes on income, but I can't find the part where the Congress has the obligation to do so?
You are correct - a variety of funding choices are given to Congress:
DeleteUS Constitution, Article 1, Section 8
https://en.wikipedia.org/wiki/Enumerated_powers_(United_States)
1. Levy taxes
2. Coin money
3. Borrow against the full faith and credit of the US
It is clear that Congress when faced with deficits (expenditures exceed income) can refuse to cut spending, refuse to levy additional taxes, refuse to coin money, and refuse to borrow.
Under that scenario, it falls upon the Treasury to come up with needed funds under Article II, Section 3 - The "Take care clause".
This:
https://musingsandrumblings.blogspot.com/2019/09/the-case-for-equity-sold-by-u.html
One reason that we have an income tax over a consumption tax is because of seasonal variations in consumer expenditures coinciding with the holiday season (Thanksgiving / Christmas). People / companies spend more in the later months of the year and spend less in the early months of the year.
ReplyDeleteAn income tax provides a more stable revenue source for government funding for that very reason.
Have the new tax start in November. The government finances everything anyway, it would make no difference in how government spends.
DeleteThose financing charges (interest payments) are spread across the entire year. So you run into the possibility of insufficient revenue to pay financing charges on a seasonal basis (can't pay the bondholders in March, but can pay them in December).
DeleteThe change of income tax revenues also occurs when the economic conditions change. As an example, California relies heavily on capital gains There are years of surplus and deficit. A VAT would also vary based on consumption it is regressive as the rate is the same, but it does not cover all types of consumption such ad buying a used car is not subject to a VAT.
DeleteYes, it is very difficult to save from one month to the other, right? :D
Delete"Yes, it is very difficult to save from one month to the other, right? :D"
DeleteFor a spend heavy government? Absolutely. Ever known a government whose first thought is to pay back debt with surpluses (even monthly ones)?
We already have parts of the tax code in the form of a tax-free retirement accounts, like 401k/IRA/Roth IRA, that bear some limited similarity with a consumption tax system. If you put money in the Roth IRA on a post-tax basis, then it can grow tax-free until retirement and you pay no tax on withdrawals. That means no tax on capital gains or dividends or interest.
ReplyDeleteThere are some limitations to these, however. For instance, Roth IRA's have income limits. But, backdoor Roth IRAs makes those limits de facto irrelevant. If we want to make the Roth IRA more popular, we can remove the income limits. We can also increase the amount that can be contributed. The higher these limits are, the more the tax system becomes like a consumption tax system. The other major source of limitations surrounds withdrawals (either mandatory or related to age limits). I don't think these are the worst thing in the world (though we should also facilitate conversion of retirement funds to HSA and education savings account and back without any tax penalty, they would probably need to have equivalent Roth versions for it to work itself out well), but I would admit that they wouldn't exist in a true consumption tax system.
One other issue with Roth IRAs is that there can be some abuse, particularly from what I understand when it comes to private investments and funky valuations. There were some articles about Peter Thiel's huge Roth IRA a few years ago.
You'll never get there, even if you talk about it ad infinitum.
ReplyDeleteThe global minimum corporate income tax of 15% will be collected by foreign governments from American corporations that do not pay at least 15% tax on their income. The "Fair Tax Act of 2023" eliminates the income tax in the U.S., replacing it with a 30% value-added consumption tax on the consumer. Corporations' and business firms' operations and income are exempt from the "Fair Tax" levy. Ergo, American corporations and business firms selling to foreign entities will be forced to pays 15% of the imputed income assigned to their worldwide operations to foreign governments.
Real estate transactions will attract the 30% consumption tax under the proposed Act unless the transaction is for investment. Citizens and legal residents buying new construction real estate for personal, non-investment, use will pay 30% of the pre-tax transaction cost to the Federal government under the "Fair Tax Act". This will privilege sales of existing housing and suppress construction of new housing.
Old age pensioners who saved for their retirement out of after-tax income prior to 2023 will see their savings unexpectedly taxed at a confiscatory rate of 30%. For many elderly who require assisted living services, the taxed cost of those services will become prohibitive and some not insignificant share of those old-age pensioners will find their saving depleted much more rapidly under the "Fair Tax Act of 2023" than they anticipated prior to the introduction of the Act. A goodly number will be forced onto the state welfare rolls that would be forced there under the U.S. Code.
Economists promote the consumption tax because it is held to be less distortionary than an income tax on labor. For small tax rates on commodities this may well be true, as Frank P. Ramsey asserted, but a consumption tax imposed on commodities and services at the rate of 30% of the pre-tax price of those commodities and services can not be considered to be a small tax rate and the "Fair Tax Act" consumption tax cannot be deemed to be less distortionary than the income tax it replaces absent demonstrative proof, a priori.
"The Fair Tax Act of 2023 eliminates the income tax in the U.S., replacing it with a 30% value-added consumption tax on the consumer. "
DeleteNot even that.
https://www.congress.gov/bill/118th-congress/house-bill/25
The Act does not in and of itself repeal the 16th Amendment to the Constitution (nor can it).
Instead it becomes just an additional tax on top of the income tax already assessed by Congress.
"They have paid a lifetime of taxes to provide these sources of funding that likely would have been taxed much less in retirement, and yet now they're supposed to pay the same tax as everyone else"
DeleteI am assuming from your comment that you are a retiree. If this is the case you "own" the rest of us a huge amount of unpaid taxes: it is call "national debt" and it is around 31 tr.
So stop complaining, you have been living (are living) out of a sea of liabilities to be assumed by the youngers folks.
Anon., the Fair Tax Act does not purport to repeal the 16th Amendment. What the Act does say is that if the 16th Amendment is not repealed by such and such date then the Fair Tax Act expires and is thereafter of no force or effect.
DeleteThe Act states that the consumption tax replaces following federal levies: the income tax, the social security tax on labor earnings, and the Medicare and Medicaid taxes on labor earnings. By replacing those tax levies the Fair Tax Act avoids double taxation.
The authors of the legislation have thought the double taxation aspect through. What hasn't been addressed in the legislation is the uncompensated negative externalities that the Act imposes on different demographic cohorts, such as senior citizens that must fund their own Healthcare services that Medicare and Medicaid or private insurance don't cover (see 'hollymerry60' above).
"I am assuming from your comment that you are a retiree. If this is the case you "own" the rest of us a huge amount of unpaid taxes: it is call "national debt" and it is around 31 tr." -- El emperador desnudo--'the naked emperor'.
DeleteOne of the advantages of having lived a long life is a classical education that the younger generations seem to be bereft of. The United States of America has been endowed with a republican form of government. It also has a written constitution. When the citizenry pay the taxes lawfully levied on them, their obligation for further services are not extinguished but they are not individually required to provide more of their property than that which is their lawful tax burden. A further benefit under the constitution is the inalienable right of free expression. The naked emperor seeks to still that protected speech by observing, incorrectly, that today's retirees owe ("own" is clearly a 'typo') younger generations the full face value of the federal debt which he puts at $31 trillion ("it is around 31 tr.") One can quibble about the exact sum, for it changes daily, but there is no doubt about the premise underlying his assertion--the premise is false.
I very much doubt that one could find today, or even yesteryear, a qualified economist who would honestly ascribe to the premise expoused by El emperador desnudo.
The individuals that I had in mind as exemplars of the impact that the FTA would have on the elderly will celebrate their 80th wedding anniversary this coming October, if they should live that long. The husband served in the allied forces that landed in Normandy on June 6th, 1944, and fought his way with his corps across northern France, the Lowlands, and Northern Germany till V-E Day and continued serving there until demobalization in 1946. He raised a family of five, and was named inventor in two U.S. patents granted to his employer. His wife was a homemaker in the traditional mold. Never wealthy, the couple saved, planned well, and looked forward to a quiet retirement. The ex-soldier is 103 years of age: his wife, 99 years of age. The details are unimportant, but suffice it to say that a consumption tax such as that proposed under the Fair Tax Act would turn their lives upside down by heavily taxing their residual savings at a time when they most need those savings to pay for the private nursing care they need to support themselves in their old age. Instead, they will be forced onto the public welfare rolls ("the dole")--a state of affairs that they have assiduously avoided their entire lives. This is one further distinguishing characteristic of that older generation that grew up in the Great Depression--the stigma of being on 'the dole'. This situation is not unique; it is a mere example of the uncompensated externalities that enactment of the FTA will impose on one demographic segment of the citizenry who cannot hope to recover from its effects by changing their behavior.
El emperador desnudo is entitled to his opinion under our laws. But that is as far as it goes.
I agree that a consumption tax makes a lot of sense. Most people who wince at the mention of a consumption tax think that it would favor the rich because the rich spend or "consume" a lower percentage of their income than lower income people do. But factoring in a refund or rebate check in the same amount to everyone, a consumption tax would be more progressive than the present income tax structure is. Plus, we wouldn't require nearly as large of an IRS anymore and billions of dollars would be saved each year; tax preparation fees do nothing for the GDP. Great article!
ReplyDeleteI think I'm in agreement with you but I have some questions.
ReplyDelete1) If I sell my house and buy another, do I have to pay the consumption tax on the purchase price of the new home? Only on the increased value of the new home? Am I not buying it with equity from my former home that has been accumulated based on a prior investment of already taxed funds? If the consumption tax applies to the whole of the new purchase, over time would not accumulated wealth be taxed away to nothing in dribbles?
2) Could your idea possibly take the form of a transaction tax where some small percentage is taken every time money changes hands for any reason - and all transactions are conducted through a third party exchange service that extracts and remits the transaction tax? No more currency required, no more tax returns to be filed, and there would be no tax liability for wealth that is not spent, e.g. inherited assets. Under such a system, how is the incremental total extraction of net worth referred to above avoided?
3). As you suggest, everyone should be entitled to a basic survival standard of living - food, medical care, shelter, education (possibly at Stanford?). Tax should only be collected in such a way that everyone is left with means to afford basic requirements for survival. Those requirements should be the same for everyone regardless of position in society. This is not a socialist view, rather we have to decide what kind of society we want to live in - one where as a culture we want everyone to have their survival needs met, or one in which we compete for the good life so some win and some lose. I think most people would be willing to sacrifice a little so that they don't have to stand by and watch others wanting.
I think about this frequently. Just my two cents worth.
Ideally, a consumption tax would be levied on consumption of housing services, either actual rent for renters or imputed rent for homeowners. The purchase of an asset is not consumption, and should not be taxed as such.
DeleteWhat this bill actually does, I don't know.
You can find the bill here.
Deletehttps://www.congress.gov/bill/118th-congress/house-bill/25
"The rate of the sales tax will be 23% in 2025, with adjustments to the rate in subsequent years. There are exemptions from the tax for used and intangible property; for property or services purchased for business, export, or investment purposes; and for state government functions."
The ink isn't even dry on it and there are a number of exemptions. Wanna bet that list would grow over time?
Why exempt used goods? Is a used car not a consumption good just like a new car?
Why exempt state purchased goods? So consumption by individuals is bad but consumption by state governments is good?
Why exempt goods purchased by business and investment purposes? So to dodge the tax all that I need to do is incorporate myself and / or purchase antique furnishings - I bought an antique chair both as an investment and as a needed product to operate Joe Blow, Incorporated.
The "Fair Tax Act" is a sales and use tax. Goods purchased in Canada imported into the U.S. will be taxed at the 23% rate of the marked-up price (or, at the 30% value-added tax rate if the price is pre-tax) for the user's personal "use" unless the goods are employed in producing goods and services that will be sold to final users, i.e., consumers in the U.S., or exported to foreign markets. However, this one area where the details matter. The Fair Tax Act consumption tax is to be collected by the state governments, but the state governments, other than the government of California don't maintain border controls that would capture imported consumer products entering the state. This will be a favorite loop-hole until the federal government closes it.
Delete"Goods purchased in Canada imported into the U.S. will be taxed at the 23% rate of the marked-up price (or, at the 30% value-added tax rate if the price is pre-tax) for the user's personal "use" unless the goods are employed in producing goods and services that will be sold to final users, i.e., consumers in the U.S., or exported to foreign markets."
DeleteWith at home / remote working being established as a viable solution to the Covid outbreak and whatever else may come down the pipe (and yes I did work from home during that time), everything in my house (desk, computer, bathroom, etc.) is as you say a good used in producing other goods. So why shouldn't I just incorporate myself (Joe Blow, Inc.) and claim all expenditures as business expenses necessary for me to work?
Where do you draw the line?
Anon., see https://www.congress.gov/bill/118th-congress/house-bill/25 for a detailed description for determining what is and what is not considered to be a taxable consumption good or service.
Delete“(2) INVESTMENT PURPOSE.—No tax shall be imposed under section 101 on any taxable property or service purchased for an investment purpose and held exclusively for an investment purpose."
DeleteFunny, how is the government going to decide how I used a property over time (black helicopters in the sky?).
I bought an antique chair, claimed it was for investment purposes, and on occasion sat on that chair. Did I hold it EXCLUSIVELY for investment purposes or did I make functional use of it?
How does the consumption tax deal with people going to Mexico and Canada for consumption? Wouldn’t this massively increase travel, retirement, second homes, boats, etc in Mexico and Canada? Especially with the rise of remote work…
ReplyDeleteI like the national sales tax, plus taxes on property, plus taxes or tariffs on imports.
ReplyDeleteTaxes on personal or corporate income have become an international shell game.
Read Michael Pettis on why the concept of "free trade" is
misleading in the modern context.
I think any "simple" tax with a high rate will be found to have inherent problems if studied closely. A better solution might be a combination of several simple low rate taxes, possibly starting at a high threshold for income, earned and unearned. That way inevitable inequities can be balanced, and under the table transactions would at least be partially taxed.
ReplyDeleteIt may be worth noting that 47% is not as outrageously high tax rate as it sounds. 1/1.47=0.68, so 47% consumption tax is equivalent to 32% income tax.
ReplyDeleteAnon., it would be if your average income tax rate was 20%, or less, before enactment of a national retail sales tax ("NST") at a rate of 47% on the tax-exclusive price of all goods and services, including essentials, that the household purchases. If the gasoline for your private automobile is $4/gallon before application of the NST, you will pay $5.88/gal. on a tax-inclusive price basis. Your income tax average rate of 20% plus your FICA tax rate (8.55%) on gross employment earnings (assumed to be 80% of gross income) gives an effective tax-inclusive rate of 26.84% which is equal to a tax-exclusive NST rate of 36.6867%. The majority of U.S. households have average income tax rates well below 20%. This example household must earn $5.47 for every $4.00 gallon of gasoline it currently consumes before enactment of your 47% NST rate, but $5.88 after your 47% NST rate becomes effective. Note that the tax-exclusive NST under the Fair Tax Act is 29.87%, not 47% as your comment seems to imply.
DeleteIn practical terms, the 50 states will collect the NST, deduct their administrative fee and send the net tax revenue to the U.S. Treasury. The price tag hanging on the goods you purchase will state the tax-exclusive price of the article. The NST will be applied at the retailer's check-out cash register, along with the State's sales tax, because that is how the States collect their sales tax revenue. 'Sticker shock' comes at the retailer's check-out counter. If the State's sales tax is 10.1%, the gross sales tax will be 40.1% of the article's tax-exclusive price.
Welcome to the Brave New World of consumption taxes.
"In practical terms, the 50 states will collect the NST, deduct their administrative fee and send the net tax revenue to the U.S. Treasury."
DeleteOr 25 states will collect the NST and 25 states won't.
https://www.congress.gov/bill/118th-congress/house-bill/25
The act prescribes penalties to the individual for failure to pay taxes under section 504. Penalties that apply to state wide failures are non-existant.
Shouldn't you be sticking to what Canada will and will not do?
I am in favor of a fair tax and everybody paying. Anybody I know that has their own business or restaurant cheats like crazy and I’m sick of it.
ReplyDeleteGreat point! Pretty much everyone cheats, except of those who cannot, like regular employees, whose taxes are deducted from their paychecks. This is why tax rates have to be progressive and adjusted accordingly to make up for the cheating.
DeleteYou would just end up with a national sales tax and all the other taxes, too, after a period of about 10 years. Even repealing the 16th Amendment wouldn't stop this since a future Congress would just pass another income tax at some point that would be ruled constitutional by a future Supreme Court despite the 16th Amendment's repeal. The Constitution is no longer really a barrier to anything, and hasn't been for a long time now.
ReplyDeleteIn terms of 'economic efficiency', a lump sum tax levy is thought to be the least distortionary form of taxation. The second best form of taxation, relative to creating economic distortions, is a consumption tax. Frank P. Ramsey examined the optimal form of a commodity tax to raise a predetermined level of revenue for a national government. He noted that in order to determine the global optimum tax levy, the tax rate, in money per unit of commodity, should be a small fraction of the pre-tax price of the commodity. If this condition does not hold then there is no unique optimum tax rate--i.e., there are multiple local optimum tax rates. He further demonstrated that, in the case where the only input to production was labor, the optimal tax rate was a single rate levied on all commodities (in lieu of a tax levied on labor).
ReplyDeleteBy specifying a uniform rate of tax (as a percentage of the gross price, e.g., 23%, or as an ad valorum tax on the pre-tax price, e.g., 30%) the Fair Tax Act is not attempting to minimize the economic distortion of the proposed consumption tax. The Act provides that the tax rate on consumption can be adjusted in the second and subsequent years if the tax is not generating sufficient revenue for the government. This is a tacit acknowledgement that the consumption tax will reduce economic output as demand adjusts downward and production decreases to reflect the lower level of demand.
It is probable that the introduction of the consumption tax will induce a negative shock to the U. S. economy in the year it first comes into effect. When the Goods and Services Tax (GST) was brought in by the government of Canada, that country's GDP registered a drop of 7%. The GST rate was 7% of the pre-tax price of goods or services invoiced. The GST rate was later lowered to 5% of the pre-tax price.
"When the Goods and Services Tax (GST) was brought in by the government of Canada, that country's GDP registered a drop of 7%."
DeleteWhen the GST was brought in by the government of Canada, were other taxes eliminated / reduced or was it just another tax lopped on top of all the rest?
The GST was introduced and first implemented by the Progressive Conservative Party of Canada, then in power under Mr. Brian Mulroney, prime Minister and leader of the party.
DeleteThe GST replaced the previous federal Canadian excise tax on manufactures produced in Canada. That excise tax was levied on the producers of goods manufactured in Canada, and as such the tax levy was incorporated ("buried" was the term used at the time) in the ex-works price of Canadian manufactured products. When retailers sold those products, the mark-up factor magnified the impact of the excise tax on the price paid by consumers on manufactures for domestic use in Canada and exported Canadian manufactured product prices paid by consumers in foreign markets. That was one rationale advanced to justify the introduction of the GST. A further rationale advanced by the Mulroney-led government was this: Revenue from the GST would be applied to reduce the indebtedness of the federal government. This was a political ploy by the Progressive Government to counter the image of a so-called conservative government raising taxes at a time when deficit spending had led to a ballooning federal debt-to-GDP ratio.
So, reading between the lines, we can see that GST was not fully offset by repeal of the former excise tax imposed on Canadian manufactures. We can infer that the GST was also intended to restore fiscal balance at the federal level in Canada. (cf., The Fiscal Theory of The Price Level, J. H. Cochrane, Princeton Univ. Press, 2023.) What the actual situation was at that time remains uncertain as no full accounting has ever been given by a government of Canada.
The political history of the GST is an interesting example of initial revulsion followed later by complete acceptance. The GST has not prevented subsequent federal governments from raising the income tax rates on middle income and upper income families, nor did it deflect an attempt by the current Liberal Party of Canada (J. Trudeau, prime minister) from raising the income tax rate on owners of small- and medium-size private domestic corporations that hold excess cash balances inside their corporations. That attempt failed in the face of overwhelming popular opposition to the proposed tax levy. Tax revolts in North America are not an impulse specific to the U.S. taxpayer.
The way to figure this out scientifically is to compare the various tax systems around the world and see how rates and types of taxes correspond to quality of life in the geography.
ReplyDeleteIf you are correct, states with low income-tax rates should fare no worse than those with high income tax rates. Also, you are predicting that states with high consumption tax rates do better than those with low consumption tax rates.
I predict it actually has much more to do with the % of revenues coming from property or land taxes, because those taxes are easy to enforce and correspond with quality of life in a geography.
Run the data and all this should be clear, one way or the other.
Why don't you tell us what the tax would be for a family of four with an annual income of $ 75,000? How does it compare with the current tax.
ReplyDeleteAnon., given your basic information for comparison between the two tax regimes, the following representative household was developed and used in the comparison of the after tax impact. The family budget is first developed under the current income tax legislation and regulations.* Next, the family budget under the Fair Tax act is developed based on the consumption spending determined under the current income tax regime grossed up by 30% to account for the Fair Tax Act consumption tax. This approach assumes consumer-products production is static, i.e., consumer demand is inelastic ( price elasticity of demand ~ 0). A basic assumption underpinning this example is that whatever the tax scheme the government imposes on its citizens, the citizenry strive to maintain the lifestyle and real consumption spending that they have been accustomed to under the previous tax regime. It is seen in this comparison that this representative household is not forced to adjust their real consumption spending following the replacement of the income tax system by the Fair Tax Act consumption tax. This will not be the case for all income brackets and age brackets. It will require a more in-depth look at the full implications of converting to the proposed consumption tax than can be undertaken in a blog post, to determine whether social welfare is improved or diminished under the Fair Tax Act.
Delete(A) Data.
Family of four: husband (40 yrs), wife (35 yrs), two children (< 17 yrs). Income, $75000. Mortgage interest, $18,485. Mortgage principle payment, $10,429. Medical exp., $500. Property taxes and utilities, $20000. Childcare services, $5000. IRA, self, $5000. IRA, spousal, $1000. Income tax withheld: $0. Income tax installments paid: $0.
(B) Current income tax system.
Federal taxes paid: $148 (refund)
Disposable income: $46,233.
Discretionary income: $20,733.
Free cash flow after IRA contributions/retirement savings: $14,733.
Consumption spending:
Medical: $500
Child care expenses: $5,000.
Other consumption spending: $14,733.
(C) Fair Tax Act system.
Federal subsidies received: $6,382. (23% of federal poverty level for a family of four in the year 2022.)
Disposable income: $52,467.
Discretionary income: $25,317.
Free cash flow after IRA contributions/retirement savings: $19,317.
Consumption spending:
Medical: $650. (1.30 × $500.)
Child care expenses: $6,500. (1.30 × $5,000.)
Other consumption spending: $19,153. (1.30 × $14,733.)
Residual: $163.00, to additional savings or additional consumption.
* The tax/refund calculator used in creating this example is available at
https://turbotax.intuit.com/tax-tools/calculators/taxcaster/
The Congressional Budget Office ("CBO") during December 2022 examined a proposal to raise revenue by imposing a consumption tax of 5% on sale/purchase transactions in the U.S. Details are found at https://www.cbo.gov/budget-options/58637 . CBO chose to model the Invoice-Credit value-added tax ("VAT") method commonly used in OECD member countries. CBO assumed that certain goods and services would be either exempt or "zero-rated". It examined two alternatives: a narrow list of exempt and zero-rated goods and service and a broader base of exempt and zero-rated goods and services. The rationale is given in the summary remarks. In the 2nd year the incremental increase in revenue is estimated at $330 billion and $200 billion for the narrow range of exempt and zero-rated goods and services and for the broader range of exempt and zero-rated goods and services, respectively. The VAT rate used in the estimates is 5% of the invoice amount. The Canadian GST rate is 5% and is based on the broader category of exempt and zero-rated goods and services using the Invoice-Credit method of collection. As Canada's GDP is about one-tenth of the U.S. GDP, Canada would be expected to have revenue of $20 billion (USD) or $27 billion (CAD).
DeleteThe 10-year cumulative revenue effect is $3,050 billion for the narrow range of exempt and zero-rated goods and services, and $1,950 for the broader range of exempt and zero-rated goods and services.
Simple extrapolation to a VAT rate of 30% is unlikely to be accurate as an estimate of the revenue generated under Fair Tax Act ("FTA") but it could yield an order of magnitude estimate. For the 2nd year of the FTA assuming a narrow range of exempt and zero-rated goods and services and the Invoice-Credit method of collection, the revenue raised is on the order of $2,000 billion. The cumulative 10-year total revenue is on the order of $18,000 billion. These order-of-magnitude estimates for a 30% VAT rate should be compared to current federal income tax and payroll tax revenues.
Henry George would be pushing for land value taxes. Pigou would be pushing for Pigovian taxes. I think both of these should be on the books before we get to consumption taxes
ReplyDelete"It’s better for voters to see how much the government takes. "
ReplyDeleteYes but it's better for politicians that voters don't see how much the government takes or what it spends it on, or God forbid how inefficiently it's spent.
That's why Dem/Progs are using everything from transit to utilities to road to education departments to hand out welfare and pursue the global warming agenda. They don't want taxpayers to know the stupendous bill they are paying for either, and the last thing they want is for these activities to be focused in a single department that can be cut with one swipe of a pen. Not to mention the ego buzz they get from running a massive government. They can always convince themselves that it serves a higher purpose. After all, they're mostly lawyers, and their training is in convincing people of things, not in figuring out the truth.
"It’s better for voters to see how much the government takes. "
ReplyDeleteYes but it's better for politicians that voters don't see how much the government takes or what it spends it on, or God forbid how inefficiently it's spent.
That's why Dem/Progs are using everything from transit to utilities to road to education departments to hand out welfare and pursue the global warming agenda. They don't want taxpayers to know the stupendous bill they are paying for either, and the last thing they want is for these activities to be focused in a single department that can be cut with one swipe of a pen. Not to mention the ego buzz they get from running a massive government. They can always convince themselves that it serves a higher purpose. After all, they're mostly lawyers, and their training is in convincing people of things, not in figuring out the truth.
I will always appreciate you as a brilliant economist but, after having heard on Goodfellows your naive comments on the Ukranian war, all I can say is that you really need to brush up on your understanding of the situation. Starting from a bit of History. You sounded like a foolish neocon.
ReplyDelete"The Pros and Cons of a Consumption Tax", Len Burman and William G. Gale, Thursday, March 3, 2005. Web page ... https://www.brookings.edu/on-the-record/the-pros-and-cons-of-a-consumption-tax/
ReplyDeleteBurman and Gale describe the pros and cons of a consumption tax that replaces the current income tax system. The discussion with moderator Ray Suarez was prompted by the appearance of then chairman of the Federal Reserve Bank before the President's Advisory Panel on Federal Tax Reform established by president George W. Bush to "recommen[d] reforms to the tax code that will make the U.S. tax system simpler, fairer and more growth oriented." Suarez opens with the observation, "[Chairman] Greenspan said the tax code needed to be simplified and suggested one idea worth considering was implementing some kind of consumption tax."
Burman and Gale make the following observations:
1) to replace all of the current system of taxes while raising the same amount of revenue for the Treasury, the consumption tax rate would be on the order of 60%. (The initial consumption tax rate is set at 30% in the Fair Tax Act);
2) "to have a consumption tax at the federal level we need to tax a very broad base of consumption, almost all consumption." (The Fair Tax Act exempts businesses, and investment, from the consumption tax);
3) "if you just say scrap the income tax and replace it with a sales tax or a value added tax, then it would be a huge tax increase on old people, old people who are paying tax on their income as they’re earning it, thinking that when they got to retirement they could spend money and they’d be paying a dollar for everything they bought." (The Fair Tax Act provides an annual grant of 23% of the federal poverty level income--for 2022 a family of four would receive an annual grant of $6,382; for a family of two, or a widow of 1, the grant would be proportionately less);
4) "basically nobody has figured out how to deal with the transition issues without tremendous cost to the Treasury. You can basically say you could have transition rules that would try to protect old people, that would try to protect businesses that have made investments under the old rules that could be harmed under the new system, it would be tremendously expensive." (The Fair Tax Act makes no provision for compensating the cost of transition from the current tax system to the FTA consumption tax system; clearly there will be uncompensated negative externalities imposed on certain demographic segments of the population (seniors and retirees for one), and certainly unearned positive externalities for other demographic segments).
See the the complete interview for further insights and opinions.
"... and there is no new thing under sun." Ecclesiastes I : 9.
The Congressional Research Service has published a revised report on the replacement of the current income tax in part or in whole with a consumption tax. Titled "Consumption Taxes: An Overview Updated January 24, 2023", Congressional Research Service, https://crsreports.congress.gov , Report no. R44342, authored by Donald J. Marples, Specialist in Public Finance, CRS.
ReplyDeleteThe report is a comprehensive review of the characteristics and economic impacts of replacing the current income tax with one of three forms of consumption tax.
A consumption tax would result in a windfall revenue equal to the 23% tax-inclusive sales tax rate in 2025 (30% tax-exclusive rate) multiplied by the amount of national savings (referred to as "old capital") accumulated up to the date that consumption comes into effect. This windfall tax effect will fall largely on retirees and the elderly who have savings set aside to fund the cost of their living and medical health expenses not covered by insurance or Medicare. The beneficiaries of this windfall are all other demographic segments, with the exception of college age youths, as the windfall revenue from the tax on old capital allows the government to reduce the consumption tax rate, according to Mr. Marples.
The report is a useful primer on consumption taxes and income taxes and economic effects of each. A consumption tax is not inherently less distortionary than an income tax, according to this report.
Of the three forms of consumption tax, H.R. 25 ( 118th Congress) would implement a national sales tax ("NST"). This is referred to as a "fair tax" in the literature.
Of course the underlying assumption is that the govt needs to tax or borrow in order to spend which is of course nonsense. And this tax is highly regressive. Rich folks won't pay taxes until their great grand kids spend their inheritances. Swipe left!
ReplyDeleteOf course the underlying assumption is that the govt needs to spend which is of course nonsense.
DeleteBut since government is going to spend (such nonsense), then there are a variety of ways that a government can obtain the funds to spend:
Three are identified in the Constitution
1. Power to tax
2. Power to borrow
3. Power to coin (and presumably print) money
And one not directly identified in the Constitution
4. Power to sell equity
"And this tax is highly regressive."
DeleteA progressive approach would be for the Federal Government (Treasury) to sell public goods to fund it's expenditures.
See https://en.wikipedia.org/wiki/Public_good_(economics)
"In economics, a public good is a good that is both non-excludable and non-rivalrous."
Non-excludable = sold on demand
Non-rivalrous = privatized gains and privatized losses
Why would govt "sell equity". Totally unnecessary. They can borrow from Fed (which s part of govt).
DeleteWhy would govt spend. Totally unnecessary. They wouldn't have to tax or borrow.
DeleteWe can keep this up all day.
Your statement:
"And this tax is highly regressive."
Inflation is also regressive - see today. You have a problem with regressive taxation, but no problem with inflation?
"Why would govt sell equity. Totally unnecessary. They can borrow from Fed (which s part of govt)."
DeleteCongress can choose not to borrow, not to raise taxes, and not to coin / print money - irrespective of the Fed.
Treasury / Executive Branch can choose to sell equity regardless of the wishes of Congress.
"Why would govt sell equity."
DeleteBecause it is a progressive approach to financing government expenditures.
I thought only progressives missed unintended consequences. Would not such a tax at such a high rate drive a cash economy that is outside of the law? Would that not lead to criminal supply chains (i.e. illegal pot in legal pot states) that simply enable and enrich criminals and fraudsters? Aren't rich people still going to lawyer up and evade the tax by leveraging the "few exceptions" to the tax? I remember your academic free trader posts from when Trump was getting into tariffs. It made great sense until Covid and we couldn't manufacture basic medical supplies. Why should we trust academics with this?
ReplyDeletehttps://www.congress.gov/bill/118th-congress/house-bill/25
Delete"The states have the responsibility for administering, collecting, and remitting the sales tax to the Treasury."
Under pain of what? So the state of Rhode Island decides to withhold payment to the federal government.
What recourse does the federal government have under this act?
The act describes in great detail the penalties assessed to individuals who try to skirt the tax under section 504. No such penalties exists when a state as a whole does the same thing.
A cash economy----one of my objections until I thought it through. Your garbage disposal is broken. You call a plumber. The plumber has to buy a new garbage disposal and install it. The plumber has to buy it from somewhere, generating a record. If you pay the plumber in cash and they take it, then you both are in violation of the law and it is traceable. The only way to avoid taxation under consumption tax system is if two people barter with physical assets that they already own. Hence, you call the plumber and he has a used disposal in stock. You trade the disposal (plus labor to install) for a cow that you have in your backyard. (to oversimplify).
Delete"The only way to avoid taxation under consumption tax system is if two people barter with physical assets that they already own."
DeleteNope, both you and the plumber live in the state of Rhode Island. You remit your consumption taxes to the State and the State sends them right back to you rather than forwarding them to the federal government.
See 10th Amendment to the Constitution:
https://constitution.congress.gov/constitution/amendment-10/
"The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people."
State of Rhode Island claims that because no power is given to the United States to collect a consumption tax by the Constitution, they (the State of Rhode Island) are under no obligation to pay it.
I would love to see Professor Cochrane and Professor Laffer have an open discussion about the Fair vs Flat tax to see if one could persuade the other that one system is better. Personally after doing the math, I think the Fair Tax is much better since it's a consumption tax and not an income tax. Income taxes distort more than consumption taxes.
ReplyDeleteI suggest you check the fine print in Fairtax hustle a bit closer. It sounds great.
ReplyDeleteBut until you realize that only a small part of Fairtax is a tax on personal retail sales, and that they have, for example, a 10 billion dollar tax on the state of Texas,
Texas -- and all states all cities all counties must "remit" massive taxes on "all expenditures" in cluding wage expenditures, pension expenditures- operational expenditures.
Texas would owe ten billion - in advance (all such "persons" must remit these taxes "in advance" their "expenditures" are 40 billion")
You would have to be observant enough to note HR 25 definition of a person. It's not just human "persons" -- they include (in their math too!) --
that all government entities are persons. But they never -- ever -- make that clear in their thousands of explainations.