Thursday, January 17, 2008

Fair Tax or Flat Tax? How Will Americans Benefit Most?

There is an old saying: Two things are certain, Death and Taxes.

Scientists are working hard every day to work on the Death predicament... but what are we doing about taxes?

Currently in the US, every dollar that we make is taxed on the order of +60% over four levels of government and by many means of taxation. We have Federal Income tax, Social Security and Medicare tax, State income tax, state sales tax, property tax, stamp tax, gas tax, gift tax, real estate tax, car tab tax, recreational vehicle tax, estate tax, luxury tax, capital gains tax, etc, etc, etc... I think the point is well made in that list...

So the general question that I would like to discuss is: With all these taxes on our achievements and wellness, not only how do we succeed, but why do we try?

It is very well known, and even discussed by Karl Marx, that the best way to stimulate economic growth is by reducing the taxation of the people. Imagine that... even the brainchild of the Communist Manifesto went forward understanding that communism stifled economic prosperity. But it seems that his followers today fail to grasp the fundamentals of economics, and have instead focused on his dreams of a Utopian communist society (aka Pipe Dream!)

Our infinitely complicated tax code in the United States is currently set up to stifle non-government controlled economic growth. There are penalties on savings, penalties on success, penalties on achieving breakthroughs in business that may bump you into a "higher tax bracket". So the harder you work, the harder you are taxed... Therefore, it is better to achieve the minimum and settle for modest results.

Let's look at an example. Imagine that you make $100 in a month in your business. The government says that if you make $100 in your business, you will be taxed $15. Your after tax earnings are $85. Now, suppose you had a boost in business, and the next month you made $101. The tax code is set up in a way that you are now in a new tax bracket, being taxed at a higher rate, and you will be taxed $20 for the month. So your second month after tax income, though you had more business, was $81. This is how our tax system currently works...

So where is the incentive to work harder?

It is in a new tax code system.

Currently, our tax code is 16,845 pages long... it is a mess of varying taxes, tax exemptions, blah blah blah... So how do we fix it?

Two solutions have been suggested: Fair Tax and Flat tax. Which one is better?

The Fair Tax is a plan that would eliminate income tax, and move the entirety of the Federal Tax to a consumption based tax rate of around 23%. What this means is that of the $101 made in the month, you get $101 in your pocket (or bank). Then the tax is applied when you go to purchase, say, a ream of paper for $5. The price after tax would be $6.15. Supposing that the ream of paper is the only purchase you needed to make in that month, your $101 will have been taxed only the one time, leaving you with an after tax amount of $99.85. Food is exempt from the consumption tax... so it is voluntary tax based on the level of your consumption. Assuming consumption rates stay the same, the net income to the government will be revenue neutral. However, there will be a boom to the economy because there is more money on the front side of the consumer process, so consumption rates would likely increase (though one would hope that SAVINGS rates increased!). There are a few down sides to the Fair Tax. The first glaring one is that to protect the citizens from a consumption tax AND an income tax, there will need to be a constitutional amendment. Repeal the 16th and rewrite to ensure that the Congress does not impose an income tax. The second is the uncertainty in tax revenue. You can predict trends in income, but if those trends do not pan out, the revenue will be short (which is fine by me... the US government does not need a 3 Trillion dollar budget!)

The Flat Tax is a flat, one rate, income tax. No matter what tax bracket you are in, you pay one tax one time. CATO institute suggests that maximum economic growth occurs with a total tax rate around 18%. That means if you make $100 you pay $18. If you make $101, you pay $18.18 and so on. There are no tax brackets, no penalties for success... just a one sentence IRS tax code that says: If you live and work in the US, You pay 18% income tax.

Of course neither tax fix deals with state and local taxes... so the flat tax rate would have to consider state and local tax rates to achieve the maximum economic growth. The logic behind the 18% is that all of the taxes listed above must add up to 18%.

Is one better than the other? I think they are equally effective in limiting government control on personal success and economic progress.

Is one easier to implement than the other? Yes. The flat tax would be the first step in halting the out of control government, and making a proactive change in our economy and society. The fair tax is a radical idea that would take much time and money to implement... though once implemented, it could be a great way to leverage power from the government back to the people (imagine consumption strikes to limit income to the government!).

The idea is economic freedom. The medium for freedom is through a people smart tax code. The rest is up to us.


  1. One comment: I can't speak to how businesses are taxed, but I'm going to assume that it's similar to how individuals are taxed. If you make $100 as an individual, and that puts you in a 15% tax bracket, you pay $15 in tax. If you make $101, and that puts you into a 20% tax bracket, you pay 15% on the part of your income that is within the 15% tax bracket, and 20% on the part of your income that is within the 20% tax bracket (20% of $1 = $0.20). So your total taxes paid at $101 of income would be $15.20. You don't end up with less money in your pocket at $101 of income than you do at $100 of income.

  2. I don't know. You say that only the income in the other tax bracket is taxedx at that rate... I dont know that my paycheck has ever been broken into the $30,000 that is in the poverty tax bracket not being taxed, and then only being taxed on the other money in the higher tax brackets. Of course I am not fluent in economics...

    When are you putting your blog online?

  3. Mr. Huckabee's advocacy of the FairTax is the single most important policy position in this election. Here's why:

    The FairTax rate of 23 percent on a total taxable consumption base of $11.244 trillion will generate $2.586 trillion dollars – $358 billion more than the taxes it replaces. [BHKPT]

    The FairTax has the broadest base and the lowest rate of any single-rate tax reform plan. [THBP]

    Real wages are 10.3 percent, 9.5 percent, and 9.2 percent higher in years 1, 10, and 25, respectively than would otherwise be the case. [THBNP]

    The economy as measured by GDP is 2.4 percent higher in the first year and 11.3 percent higher by the 10th year than it would otherwise be. [ALM]

    Consumption benefits [ALM]:

    • Disposable personal income is higher than if the current tax system remains in place: 1.7 percent in year 1, 8.7 percent in year 5, and 11.8 percent in year 10.

    • Consumption increases by 2.4 percent more in the first year, which grows to 11.7 percent more by the tenth year than it would be if the current system were to remain in place.

    • The increase in consumption is fueled by the 1.7 percent increase in disposable (after-tax) personal income that accompanies the rise in incomes from capital and labor once the FairTax is enacted.

    • By the 10th year, consumption increases by 11.7 percent over what it would be if the current tax system remained in place, and disposable income is up by 11.8 percent.

    Over time, the FairTax benefits all income groups. Of 42 household types (classified by income, marital status, age), all have lower average remaining lifetime tax rates under the FairTax than they would experience under the current tax system. [KR]

    Implementing the FairTax at a 23 percent rate gives the poorest members of the generation born in 1990 a 13.5 percent improvement in economic well-being; their middle class and rich contemporaries experience a 5 percent and 2 percent improvement, respectively. [JK]

    Based on standard measures of tax burden, the FairTax is more progressive than the individual income tax, payroll tax, and the corporate income tax. [THBPN]

    Charitable giving increases by $2.1 billion (about 1 percent) in the first year over what it would be if the current system remained in place, by 2.4 percent in year 10, and by 5 percent in year 20. [THPDB]

    On average, states could cut their sales tax rates by more than half, or 3.2 percentage points from 5.4 to 2.2 percent, if they conformed their state sales tax bases to the FairTax base. [TBJ]

    The FairTax provides the equivalent of a supercharged mortgage interest deduction, reducing the true cost of buying a home by 19 percent. [WM]

    ALERT: Kotlikoff refutes Bruce Bartlett's shabby critiques of the FairTax.


    Now, a "flat" tax rebuttal gives perspective.

    (Paraphrased) Reply by Dan R Mastromarco (LL.M., Taxation, Georgetown, principal in the Argus Group, adjunct professor at the University of Maryland, International Management Program, and research consultant to Americans for Fair Taxation - to:

    "A National Sales Tax Doesn’t Add Up" by Bruce Bartlett, December 29, 1999

    Many engaged in true tax reform find Bartlett-type attacks exasperating, if not embarrassing. I'd like to convey perspective of both flat taxers and sales taxers who believe that such attacks are counterproductive, but first provide some political history by which to frame said perspectives.

    For years Conservatives have posited that a VAT is bad policy (when liberals were discussing it), fearing it would become additional to an income tax (it was called a "money machine"). Circa 1980, conservative intellectuals touted Hall-Rabushka "subtraction method"[ H-R ] VAT which taxed business value added at the business side and labor value added at the labor side. Unlike European VATs (identical in scope), H-R became favorite of Dick Armey and Steve Forbes. It eliminated steeply progressive tax rates and tax on savings. Because of the prior VAT criticisms, H-R was packaged as the "flat tax" and is sold as an income tax to this day, rather than the VAT that its DNA characterizes it as being.

    Some conservative commentators have called for the repeal of the 16th Amendment and for the adoption of the flat tax, (despite the fact that it is styled as a direct tax and could not be adopted with such repeal). Mr. Bartlett has called the national sales tax [ie, the FairTax] a VAT (which it isn't), castigated VATs as evil, and has said that sales taxes have become VATs in Europe (which they didn't). In the next breath, he "throws his arms around" the flat tax (which is a VAT). He quotes Bill Gale that the [FairTax] would have to be imposed at 60 percent, but glaringly fails to recognize that if the two bases are the same, he would have to impose that rate for the flat tax to be revenue neutral. In truth, all economists know that the two plans differ NOT in economic effect or base, but in administration.

    An income tax taxes savings and investment multiple times. Both flat tax and FairTax are neutral as to savings and investment, tax income only once, and are both consumption taxes. Both are single rate taxes, have nearly the same base, and would improve the U.S. standard of living. Neither redistributes wealth.

    While some have even suggested that hey are the same plans under different names, the flat tax taxes value added at each stage in the production process, but the FairTax prefers to tax it when it is added up at the end and eliminate the need to make everyone a taxpayer and collector.

    Substantive commonalities between the flat tax and FairTax doesn't mean that there are NO key political and policy distinctions that could be exploited in pitting one against the other. If FairTax supporters wanted to retaliate in response to the Bartlett-type critique, they would have much material with which to honestly do so:

    • The flat tax will make small firms and farmers pay the tax even if they have no profit
    • The flat tax is opposed by many small business groups
    • The flat taxers implicitly support big government by disguising even more of the overall tax burden as the current law
    • The flat tax has been kicking around for nearly 20 years
    • The flat tax makes everyone a taxpayer and collector, while the FairTax exempts 115 million filers [2000 figure] from ever having to deal with the IRS
    • The flat tax is regressive, but the FairTax would enable everyone to keep his full paycheck.
    • The flat tax has not only stalled, it has lost public and Congressional support.
    • The FairTax is instantly understood, while even some proponents of the flat tax don’t understand it
    • There are no transition rules developed for the flat tax and they would be very difficult to craft
    • The flat tax taxes exports and relieves imports from tax
    • The flat tax confuses tax reform with temporary tax reduction and makes both twice as hard
    • The flat tax retains the entire income tax apparatus which erodes as quickly as you can say, “tax bill”

    FairTaxers could advance these truthful points without resorting to bigotry associated with a cultic religious organization. However, for the most part, FairTax supporters have chosen not to attack the flat tax, but rather accentuate the commonalities between the plans - despite the above-noted differences. The reason is that, in the battle for tax reform, the real enemy is our current system.

    Income tax advocates look down upon the articles of Bruce Bartlett with smug chortling, as Bruce is doing their work for them. The IRS and the liberals who want an income tax to ensure (1) taxes can be raised without the American people knowing it, and (2) wealth can be redistributed from the middle class to the poor, do not even need to fight us - we're killing ourselves!

    Perhaps Mr. Bartlett believes that the flat tax will help elect Republicans, effect tax reform, and provide tax cuts; however, the real effect of his criticism is to divide conservatives, to delay serious national consideration of tax reform, and to fertilize the roots of the income tax.

    ( Source - Addit'l at Whitepaper - May republish in whole or part. - Ian)

  4. Great post. I was surprised to see the link included in my AFP email ... nicely done.

    Ian, good to see you're still stalking FairTax posts. ;-) I think your devotion to the FairTax may actually exceed Boortz.