Making the rounds this morning in the econoblogosphere, Bruce Bartlett dissects presidential candidate Mike Huckabee's preferred method of taxing everybody in the U.S. in Why the Fair Tax Won't Work (HT: Greg Mankiw, Mike Moffatt). The key points, as we see them:

1. "On the day the FairTax is imposed, a worker's disposable income would rise, but he would have to pay more for everything he buys."
• If that worker is now paying less than 23% of his income in federal taxes, he will be immediately worse off.
• If that worker is now paying more than 23% of his income in federal taxes, he will be immediately better off.
2. A rebate will be offered to offset some of this disadvantage for lower income workers, although everyone will receive it.
• "In effect, it would constitute a national welfare program with a flat payment for every American regardless of need."
• As proposed, children are "just another form of consumption to be taxed," especially for single parents. "A single parent with three children would geet only about the same rebate as a childless couple."
• The rebate mechanism is where an extraordinary amount of political manipulation will occur on a regular basis, similar to the kind of jockeying that goes on today in state governments in deciding where a state sales tax will be imposed.
3. Imposing the FairTax will penalize certain groups more than others based on their situation in life.
• Young people and couples who need to borrow to establish themselves (buying their first cars, homes, child-rearing) will have to pay sutstantially more to do so.
• People with established income savings will in effect be double-taxed for their thrift. Having already paid income taxes that reduced the amount they could save, the FairTax will tax them a second time for their saved income when they spend it, such as in retirement.
4. The FairTax hinges on seeing prices fall by 22% on the day the FairTax takes effect, which is the estimated amount by which the price of the taxed good has been increased by the effect of "embedded" income taxes paid by people in the production chain for the product that is built into the price as we see it today.
• For economic stability, wages would also have to decline by 22%.
• Historical evidence reveals that wages are fairly rigid in practice, and therefore unlikely to drop as believed by FairTax advocates. That means the component of prices represented by wages are unlikely to drop as well.
• The net economic effect of this wage and price "stickiness" will be to significantly reduce the money supply in the U.S. That has huge consequences, especially if you consider that the Great Depression largely resulted from the Federal Reserve's slashing of the money supply by roughly 33% in the years from 1929 to 1933.
• The Federal Reserve's likely response would be to increase the money supply, using monetary inflation to move prices up to the level needed to balance against "rigid" wages. So no lower prices.
5. The FairTax rate is not really 23%. It's actually 30%.
• Here's how that works: Let's say that with the FairTax applied to a $1.00 item, you will be paying $1.30 for that item out of your pocket. The FairTax folks say that since that additional 30 cents is 23% of the total $1.30 that you're paying, 23% is the amount of your tax.

  Here's where that's wrong. The fair tax is nothing more or less than a national sales tax. Like every other sales tax, it's a percentage of the price of the item against which it's levied. The additional 30 cents you pay is 30% of the $1.00 price of the item, so you're really paying a tax of 30%.

6. The FairTax will be applied to items purchased by the government.
• That only makes government more expensive. The FairTax paid by one government agency would be recovered by another, adding redundant administrative costs for what would otherwise be a net tax revenue wash.
7. The FairTax will drive brand new, and in some cases, really perverse ways of avoiding paying the tax.
• Consider housing. "Not only would rent be taxed by the FairTax, but so would new home purchases. However, previously purchased homes would be free of tax in perpetuity, no matter how many times they changed hands. Given the large stock of existing homes, it could be many years before a new home is built in America if the FairTax takes effect."
8. A superior option would be a Value Added Tax, which avoids nearly all of the problems inherent in the FairTax.

While tax policy is definitely Bruce's forté, we would be remiss if we didn't acknowledge that he has a new book coming out on January 8: Wrong on Race: The Democratic Party’s Buried Past - Bruce's blog post expanding upon his December 24, 2007 Wall Street Journal op-ed offers a preview of his venture into the history of the U.S. Democratic Party's views on race from the earliest days of the nation through the run-up to 2008's presidential election.

Labels: taxes

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