Friday, January 4, 2008

The Only Certainty. (Updated)

The new year is upon us and the holidays are over. Most people are looking beyond the remaining winter months to the coming spring, with its glorious explosion of color, life, and 1040s.

Now that I've brought your wistful reverie to a screeching halt, let's talk taxes. This is the time of year when most Americans start turning out their file cabinets and old shoe boxes (don't smirk, you know you have 'em), compiling the precious bits of evidence they'll need to protect their hard earned dollars from the grasp of Uncle Sam, or rather, with which to persuade him to return some of our hard earned income that he's been squandering for us the last twelve months.

Fittingly, The Christian Science Monitor has an article today about the Presidential Candidates' tax policies. It's a fair rundown of the differences and similarities of each camp's ideas, and pretty predictable: the Democrats, to a man (and woman) want to raise taxes, the Republicans (generally) want to lower them.

Then there's Huckabee and (gasp!) Paul. They favor something called the Fair Tax, and that is my major point of contention with this article.

The Fair Tax, simply put, goes back to the Constitutional requirement that all taxes should be equally applied. It entails eliminating the current tax code, income, business, FICA, etc, and doing away with the IRS. In order to raise revenue for the government, a 23% inclusive tax is set on all new goods and services, including food. This tax should not affect prices, since the Fair Tax theory assumes that with corporate income and other taxes abolished, the taxes that are embedded in products' prices (which all consumers pay) will no longer factor into the price of consumer goods. To ease the sting of paying taxes on necessities like food, the Fair Tax plan allows for a "prebate," mentioned in the article. Basically it is an advance reimbursement from the government to each household to cover the taxes they would pay on bare necessities, according to income level. All of this is spelled out in the 2005 book, The Fair Tax, by Neal Boortz.

Since reading the book I've become pretty interested in the Fair Tax, especially in light of the tax troubles we've been having here in Indiana. I feel that government must have some income to fulfil its duties to citizens and build infrastructure, but I have come to feel more and more displeased with our current tax system. As it is, our tax code punishes the middle-class heavily, and is often used as a means of income redistribution (see 'Earned Income Credit'). It seems to me that the only fair means of taxing people in this day and age is a tax on consumption. The Fair Tax fits that bill rather nicely.

The problem is that the media doesn't like it, or at least, mis-characterizes it as a sales tax. A sales tax is a surcharge added onto a product at the point-of-sale. The Fair Tax is inclusive, meaning the price on the tag is what you pay; it's also not a VAT, which is added incrementally at each step in the production and distribution process. This list of complaints in the article is pretty standard:

But other economists point out that some of those deductions, such as the
one for interest paid on home mortgages, are enormously popular. Sales taxes are
regressive – that is, they affect the poor, who must spend a higher percentage
of their income to live, more than the rich.

And there is debate over whether a 23 percent national sales tax,
as called for by Huckabee, would raise enough money to replace the taxes lost.
Some economists say the rate would have to approach 50 percent, particularly as
Huckabee's plan also calls for a "prebate" cash subsidy for poor taxpayers.

Let's address them a little. Firstly, the deductions are popular because they allow people to recover more of the taxes they've paid out of their paycheck the previous year. Under the Fair Tax plan, there is no income tax, so people already have the money, to spend or save as they wish.

Secondly, that sales taxes are regressive, and impact the poor unfairly: the poor may have to spend a higher percentage of their income to live, but the rich also buy more, and more expensive products. There's also this: with a tax on consumption, there's a simple way to avoid it. Don't buy anything. Let's have some personal responsibility, people. If you're poor, do you really need 18" rims on your car or the latest cell phone? In addition, the Fair Tax is only applied to new goods and services. Eschew the new car for a used one, on which the taxes have already been paid.

Lastly (and my favorite), revenue replacement: this is typically used by government as a dodge. We're hearing it now in Indiana. "We can't abolish property taxes because replacing the revenue would mean raising other taxes to prohibitive levels." What about addressing the real problem and cutting spending? That's why taxes are so high in the first place. Besides, eliminating the IRS means there's less revenue needed anyway.

I'm no shill for the Fair Tax, even though everything I've said is pretty much right out of the book. I think it places a little too much faith in manufacturer lowering prices when they no longer need to transfer their corporate tax costs onto consumers. I don't quite understand how it will be phased in, so that we're not paying the inclusive tax on top of the embedded taxes. I also am not sure how it will coexist with current state tax codes. Here's the rest of the story. I do know, however, that our current system is badly broken, and adding new exemptions and credits just makes the problem worse. Raising taxes on businesses just drives them offshore, taking jobs with them. Taxing property is an affront to the principle of ownership, and income taxes amount to government theft.

Nothing may be certain but death and taxes, but one needn't lead to the other.

Update (1/5/08): Ramesh Ponnuru poses an interesting question at the Corner:

"The notion is that getting rid of income taxes will cause prices to drop
to offset the impact of the new sales tax. My question in response: If this
theory of how the economy works is valid, then shouldn't wages drop 23 percent,

A very valid question. My feeling is that yes they would, however, that yes should be qualified by the statement that wages have been fairly stagnant for a while now. I know of people who have not gotten a raise in three years, and my own company's annual raises are nowhere near what is needed to keep up with cost of living. So, they probably wouldn't drop, per se, but the stagnation of wages would probably get worse.

Also, I should add another concern I have about the Fair Tax, and that is the so-called 'prebate,' designed to offset taxes a family would pay on necessities. The idea is that in order to keep the tax fair, you cannot allow exemptions for things like food. If one product was exempt, other manufacturers would demand exemptions, leading to a mess similar to what we have now. I'm not sure I agree. State sales taxes (in Indiana at least) exempt food, and I can't think of any other manufacturers clamoring to get their products exempt. Plus, I'm mistrustful of receiving money from the government for any reason, particularly on a regular basis.