"When the FairTax becomes law," Mike Huckabee promises, "it will be like waving a magic wand releasing us from pain and unfairness." That's quite a tax policy. I've always found sales taxes to be more like a magic wand imbuing me with lots of pennies, even though the sweater clearly said $25.95.
And let's be clear. That is what the "FairTax" is. A sales tax. A big one. The magical tax fairy is going to float down from her wondrous revenue castle and, with a click of her enchanted rates calculator, eliminate all federal income and payroll taxes. But she will leave in its place a hefty sales tax affecting everything you purchase (save educational spending). For every dollar you spend, you will pay an extra 30-or-so cents in "FairTaxes." It's like the worst magic trick ever.
I say "30-or-so cents" because no one is exactly sure what the required rates will be. This gets a little tricky, so bear with me. The FairTax folks swear on a stack of bibles it will be 23 percent. But that calculation appears, impressively, to be both wrong and misleading. When most of us hear 23 percent taxation, we imagine paying a dollar and then being asked for 23 additional pennies, for a total of $1.23. Not the FairTaxers. They run their calculations as "tax inclusive," which means they include the total tax in our hypothetical dollar. So they imagine the item costs 77 cents, then the shopkeep adds in their 23 cents of taxation, and then you divide that total dollar -- which includes the added tax -- by the tax rate, to get your 23 percent. But that's not how we're used to thinking of these things. If the total cost of your item is 77 cents, then adding 23 cents is a tax rate of 30 percent. So under the FairTax scenario, a dollar of goods would have you handing over 30 cents of taxes.
That's the misleading part. The wrong part is that the FairTax proponents assume full compliance with the FairTax -- no evasion, no black market in untaxed goods. To assume no shopkeep will ever sell a pack of cigarettes without adding and reporting the tax really does require a magic wand. It's one thing to tout this plan as releasing us from "pain and unfairness." But ending tax evasion? Why, that's downright un-American!
Additionally, the FairTaxers neglected to factor in that everything the federal government buy will now have a 30 percent sales tax on it, meaning spending will go up. On the flip side, they did factor in the increased revenue the government would derive from its own purchases, so it's not as if they were unfamiliar with that aspect of their plan. The President's Advisory Panel on Federal Tax Reform, however, took compliance and federal purchasing into account, and calculated that you'd need a 34 percent sales tax rate to achieve revenue neutrality. William Gale, Director of the Economic Studies Institute at Brookings, did the math and came up with 39.3 percent. However you slice it, it's a hefty sum, and FairTax proponents are trying to underplay it.
Nor is the FairTax progressive in any but the loosest sense of the term. It would, to be sure, lower the tax burden on those making less than $24,000 a year. It would also lower the tax burden on those making more than $100,000 a year. Guess what happens to those in-between? The magical tax fairy waves her wand and increases their tax burden. That, apparently, is what FairTaxers believe to be unfair about the current system -- it rests too lightly on the middle class. Indeed, in their own chart meant to sell the plan, they subdivide the country into income brackets, the highest of which is "$75,223 and up." That bracket, then, includes a schoolteacher making $80,000, and it includes billionaires like Warren Buffett, and those making tens of millions a year, like the Yankee’s Alex Rodriguez. As they say, there are lies, damn lies, and then there are FairTax statistics. We live in a country where the top one percent of the country earned more than a fifth of all income in 2005. In that country, rich does not begin at $75,223. Indeed, in 2004, about 60 percent of Americans made between $25,000 and $100,000. I don’t know what you call raising taxes on the great middle, but progressive ain’t it.
Moreover, the FairTax doesn't graduate its rates progressively (save for a complicated a minor "prebate" scheme that's not really worth going into), it taxes proportionately. It levies the same rate across the income distribution, assuming that because 34 percent of millions is more than 34 percent of thousands, it's progressive. But 34 percent of $50,000 a year leaves you with $32,500. 34 percent of $5 million leaves you with $3,300,000. The burden is not the same, even if the tax rate is.
The FairTax, in that way, is not very fair at all. Indeed, not only is it not fair, it's not honest, not well-targeted, not well constructed, and not well distributed. But at it's core is a worthwhile idea: Taxing consumption, rather than savings. It's true that we spend too much and save too little, and we'd be better off bringing that a bit closer to balance. Saving and investing ensures appreciation of money, meaning that, in the long-term, we can spend and invest quite a bit more. There's no reason not to set the tax system to encourage this. And there are actually progressive, fair ways to do so. Next week, I'll talk about some of them.