Sunday, July 08, 2007
COMMENTARYNothing's fair about the Fair Tax
From the RoundTable blog
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Michael J. Cassidy
Cassidy is executive director of The Commonwealth Institute for Fiscal Analysis in Richmond.
In "Take another look at the Fair Tax" (June 26 Commentary), Donald Koop criticizes Rep. Bob Goodlatte for concluding "without attribution" that the Fair Tax sales tax rate would need to be much higher than Fair Tax proponents' proposed 23 percent. Yet, the Brookings Institution, the congressional Joint Committee on Taxation and the Institute on Taxation and Economic Policy have all estimated that the Fair Tax proposal would need to be implemented at a much higher rate -- somewhere between 45 and 60 percent -- in order to replace all federal tax revenue on a revenue-neutral basis.
Why? Because the math behind Fair Tax's 23 percent figure is based on some questionable assumptions. The Institute on Taxation and Economic Policy demonstrates step-by-step why the math in the Fair Tax plan does not add up.
First, it is confusing to claim the sales tax rate is 23 percent. For a $100 purchase, Fair Tax proponents tell us that the tax would be $30, which most people would characterize as a 30 percent rate. It turns out that the 23 percent figure comes from dividing the sales tax by the cost of purchases plus the tax. So, yes, the $30 tax divided by the $130 price plus tax does equal 23 percent, but no ordinary person would think of computing a sales tax in that manner.
In addition, almost a third of the projected sales-tax revenues from the Fair Tax plan are supposed to come from taxes that the government will pay to itself. When the government buys goods or services, it would somehow pay itself a tax. Without these phantom governmental tax payments, the sales tax rate would have to jump to 42 percent to stay revenue neutral.
Finally, a quarter of the remaining sales taxes from the Fair Tax plan are supposed to be paid on items such as church services, free care at veterans hospitals and a variety of hard-to-tax financial services such as free checking accounts. If we disregard the supposed taxes on these items, the sales tax rate would have to climb to 50 percent or more to stay revenue neutral.
The bigger problem with the Fair Tax plan is that it is regressive and would be a windfall for the rich, but increase taxes on the poor and elderly. Currently, federal income and estate taxes are generally progressive. That is, taxpayers with high incomes pay a larger share of their incomes in taxes than do middle- and low-income taxpayers. A national sales tax would be the opposite.
To be sure, the Fair Tax plan includes a monthly payment to all taxpaying units, regardless of income, based on an adjusted poverty threshold for each unit's family size in an attempt to address the inherent regressive nature of a national sales tax.
But even when you include these "prebates" in the analysis, it would take a much higher share of the earnings of low- and middle-income families than from the wealthy.
That's because most Americans must spend most or all of their incomes to make ends meet, while the rich can afford to spend a much lower share of their incomes.
Moreover, older Americans tend to spend a greater share of their incomes than younger Americans, which means that a national sales tax would be particularly burdensome on the elderly.
As a result, replacing most federal taxes with a national sales tax would mean very large tax increases on most Americans and very large tax cuts for the wealthy. Specifically, the Institute on Taxation and Economic Policy analysis revealed that:
n In virtually every state in the union, the bottom 80 percent of taxpayers would face much higher taxes under a sales tax. Nationwide, these tax increases would average about $3,200 a year.
n On average, the 80 percent of Americans in the middle- and lower-income ranges would pay 51 percent more in sales taxes than they now pay in the federal taxes.
n In contrast, the best-off 1 percent of all taxpayers nationwide would get average tax reductions of about $225,000 each per year.
There is also the question of what would happen to Virginia state sales tax policies if there were a national sales tax. Considering about 20 percent of all state and local revenue comes from taxes levied on sales within the state, a national sales tax would severely hinder Virginia's ability to maintain this critical $6 billion source of revenue that provides needed services in education, health care and public safety.
