ataxingmatter

Fair Tax? Huckabee's win in Iowa requires more discussion of his tax proposals

Mike Huckabee won the Iowa Republican caucuses last night, as certainly most everyone knows by now.  Many may not realize, however, that Huckabee has taken a position in favor of the so-called "fair tax" (a national sales tax, which is claimed to be feasible at a 30% tax-exclusive rate) and also claims that adopting a national sales tax will permit abolishing the IRS.  His website proclaims the possibility of an IRS "going-out-of-business sale."

For background information, you can see various earlier "consumption tax" posts about the issues here, and in particular my most recent post on the "Fair Tax" at this link.

The problems with the tax reform Huckabee supports are legion.  The rate is unrealistic (even when expressed appropriately as a tax-exclusive 30% rate rather than as a 23% tax-inclusive rate).  It would have to be much higher to account for the many items that won't be taxed (imputed rents, government expenditures), the rebates for a poverty-level consumption, the "reimbursements" to states to act as the federal tax collectors, and the loss from non-compliance by taxpayers and by withholding agents. 

The idea of abolishing a federal tax agency is unrealistic.  States cannot be forced to be the federal tax collectors, and their taxes are quite different from the proposed tax, so something will have to give.  Most likely result--a new federal IRS-like agency that works on sales tax issues, audits, collection and enforcement to replace the current federal IRS. 

States also are likely to increase their use of income taxes.  So we might (might but likely not) get rid of the income tax in order to have a consumption tax (more likely we'd add a consumption tax component to federal taxation).  But states would likely (probably) increase their reliance on income taxation.  The result would be increased audit and enforcement issues at the state level, replacing possibly somewhat laxer audit and enforcement issues at the federal level.  Not much of a gain for individual taxpayers.

Sales taxes are regressive.  Income taxes can be (and ours is) progressive.  The majority of Americans have long supported progressive taxation and have recognized that it is unfair to expect lower-income families to bear a  proportionate share of the tax burden.  The "fair tax" supposedly deals with this through rebating a poverty level amount to every single household (even Bill Gates would get one).  But that's both arbitrary and complex.  Children don't count for as much as adults.  Single parents get the shaft compared to married couples. The amount won't cover real needs for poor and almost poor families since the poverty threshold is a 1960s number that doesn't really cover today's needs. 

And the transition problems are enormous.  People who've saved under one system would be taxed when they spend it under the new system, unless some kind of very complicated tracking system were initiated. Either fairness or simplicity would be thrown out the window, no matter what.

Of course, Huckabee doesn't get the description of the "fair tax" right, even given what the "fair tax" purports to be.  He says, for example, that it is a tax on wealth.  Not so.  It is a tax on expenditures (consumption).  (He says that later too.)

So did Iowans just not understand what Huckabee was talking about?  Or did he just come across as folksy and down to earth, so they voted for that?  Or did his use of his "Christian conservatism" win the day for him (see his website about his belief that faith belongs in politics)?  I suspect it was some combination of all three.  And each one of those possibilities is very disturbing.  The first means that Americans continue to be too darned ignorant about policy issues that really matter.  The second means that Americans learned nothing from the disaster of the Bush presidency, when a "good ol' boy" from Texas was elected with almost non-existent credentials for leading a superpower mainly because he projected a "just one of the folks" image (which was put on for the cameras--he's a rich kid, after all).  The third is very worrisome--religion has taken an unprecedented role in public affairs under Bush, and Americans don't seem to heed the lessons that our founders paid particular attention to--that governments should stay out of religion and religion should stay out of government.

I'm crossing my fingers that this was a fluke and that Americans will know better than to buy this kind of tax hokem as the symbol of the regime change we need.

Note (added 1/7/08):  See Tom Redburn, Huckabee's Tax Plan Appeals, But Is It Fair?, NY Times, Jan. 6, 2008.

Hoover Institution's Henderson wants to use the AMT "crisis" to convert the regular tax to a flat tax

Supply-side economists think they've figured it all out.  They (apparently) really think that people make decisions about accepting promotions and moving to rural areas based on whether the federal income tax is flat or progressive.  I've always doubted the economists'  conclusions based on the wealth-maximizing version of the motives behind human behavior, and I especially doubt them when it comes to tax policy, because tax never stands alone and is so intertwined with everything else--what kinds of goods and services the state provides, what we view as our obligation to help those with less, whether we think government is a better regulator of the public good than private, profit-making interests, and so on.

David Henderson at the Hoover Institution is one of those supply siders who believes the arguments (at least, the "moderate claims") --that a flat tax can lead to "more work and more output" while giving "lower-income people a disincentive to advocate [for] more federal government programs, because they will see themselves as paying for those programs" and because "taking roughly the same percentage from everyone's income is more fair."  See David Henderson, Don't Abolish the AMT [instead, change it to a flat tax], Wall St. Journal, May 2, 2007, at A21.  [Aside-- Henderson, like many supply-siders, claims that empirical studies prove supply-sider claims, but doesn't honor his readers by indicating what studies he is resting his views on.]

Henderson advocates letting the AMT downward creep continue, while moving the rates to a low 20% flat tax, so that over time we are (almost?) all moved to a flat tax system instead of the regular, progressive tax system.   He would prefer to lower the exemption amount now, but is satisfied to let it creep downward so that more and more people are paying the "flat tax" rather than the progressive tax.  He doesn't approve the progressive reform of establishing a reasonable income threshold for the AMT that is indexed for inflation. 

The progressive reform is the right one--it lets the AMT continue to do what it does well--ensure that high-income taxpayers are not able to avoid paying their fair share--while at the same time protecting ordinary taxpayers who have already been taxed through the wage-withholding system from having to pay a small additional amount through the AMT because of its broadened base.

One of the big problems with Henderson's favored result--a flat tax where everybody except those under the exemption threshold pays a tax around 20%--is that, in spite of Henderson's claims that a 20% flat tax on almost everybody can be revenue-neutral, such a tax cannot fund the government programs that we all know are necessary, resulting in lower quality of life.  Look at the information that has come out of the recent pet food contamination problem--we have now learned that the FDA has too few inspectors to keep up with the amount of imported foodstuffs, and that factories in China routinely add plastic garbage to food ingredients like wheat and rice gluten to make their exported food even cheaper (and incidentally more toxic and less nutritious).  Does anybody really want to pay less taxes in order to have to take the risks of food contamination that would result from cutting back on FDA enforcement even more?  How about the Center for Disease Control and other similar federal agencies funded with tax dollars?  The fact is, countries with much higher taxes than in the US (which is, in many ways, already a tax haven) have both a higher standard of living and a better quality of life measurement.

Another problem with the flat tax approach is that it is based on a distorted view of what government is all about--most flat taxers (and Henderson appears to be in that majority group, though he couches his arguments in terms of revenue-neutrality) want to downsize government and privatize its functions to the greatest extent possible.  Note Henderson's comment that "lower-income people" will have a "disincentive" to advocate for government programs because they'll be paying for them.   That carries a presupposition that government programs are bad and "disincentivizing" advocacy for government programs is good. What a perverse view of government that is.  We need, instead, to help people understand how important it is to be able to act together through an institution rather than individually on matters that we as individuals cannot possibly address, like poverty, health care, sustainability of quality of life in the face of globalized financial markets, and global warming.

Furthermore, the flat tax will inevitably shift the burden of whatever government we do have onto those least able to pay for it and most in need of governmental help.  This is an inevitable result of eliminating progressivity in the system and placing more and more of the tax burden on ordinary people--by far the vast majority of Americans--who labor to earn their livings rather than earning their incomes from capital.

Note that the AMT does not treat capital gains as an AMT adjustment; they are still taxed at extraordinarily low preferential rates.  Certainly, it is clear that if Henderson had his way, the new, flatter, lower-reaching AMT would become the main tax system and one would assume Henderson wouldn't add capital gains back in to make the preferential rate an AMT preference item.  Although Henderson doesn't address capital gains in this opinion piece, I suspect he would argue that capital gains should not be subject to taxed at all.  In that case, Henderson's "flat tax" world would become one in which tax is exclusively imposed on those who labor for an income.

Henderson claims a 20% flat tax could be revenue-neutral.  But that assumes that it would be politically feasible to get rid of a few additional deductions still not treated as preferences under the current AMT.  The home mortgage interest deduction is the elephant in that room.  I'd support eliminating that (just as I'd support treating the capital gains preference as an AMT add-back), but I doubt if it stands a chance politically.  The political difficulty of eliminating various deductions is one reason a flat tax rate would in actuality have to be much higher--probably around 40% or more-- to be revenue neutral or else the flat tax would result in huge cutbacks to government revenues.

Eliminating progressive taxation is already underway with the movement--funded almost entirely by hugely wealthy families--to eliminate or downgrade the estate tax.  Even the democrats don't seem to understand that we need to leave the estate tax in place.  An exemption amount of $2 million is plenty--it exempts anybody that we should have any concerns about, and it taxes those who otherwise will escape paying income tax most of their lives (because they don't sell appreciated securities) and then escape tax again at death.  We don't need to use the AMT--which was intended to catch some of these higher-income Americans who weren't paying their fair share--as a way to let even more of them off the hook for their fair share.  That's just plain wrong-headed.  Americans have always considered that people should pay tax according to their ability to pay. 

REVISED 5/4/06

CRS Report on Capital Gains; Republican Push for a Consumption Tax

The Congressional Research Service has put out a small report on capital gains taxation, Capital Gains Tax Rates and Revenues (Apr. 4, 2007), available in BNA Tax Core.  It provides a useful chart with a comparison of ordinary income tax rates and capital gains rates since 1913 and another that looks at capital gain revenues and taxes from 1955 through 2002 (and projected forward). 

Corporate managers and owners (who are the main holders of capital assets in this country) are stepping up the arguments for corporate capital tax rate cuts (see the earlier A Taxing Matter posting on this issue) and individual capital gains tax rate cuts (or purported "fair taxes" that tax only consumption--see Republican bills introduced in the House H.R. 25 and Senate S. 1025).  Regretably, this country already has incredibly low rates on capital gains that give a decided advantage to those whose wealth rests on their ownership of financial assets--the upper crust.  As the report notes, "the current maximum statutory tax rate on long-term capital gains income is lower than it has ever been in the post World War II time frame."  CRS, Capital Gains report (above).

The report considers one of the frequent arguments made by proponents of having income other than capital gains bear all the tax--that having a tax on gains "locks in" capital inefficiently by causing people to hold onto their assets til death (when they get especially preferential treatment) rather than sell the assets and invest in better assets.  It's of course not so clear that assets are really locked-in because of the tax, and it is even questionable whether lock-in is a bad phenomenon, since it would help counter the senseless "day-trading" mentality that currently predominates for many investors.  As the report notes, "[c]ritics are concerned about the distributional effects, possible tax shelter abuses, and the revenue losses associated with reductions in capital gains taxes."  Id.  I'd add an additional overreaching concern--the fact that capital gains accrue mainly to the upper crust, who get the lion's share of tax cuts when rates are reduced on capital gains income, resulting in real threats for democractic institutions.

The report considers an accompanying argument made by capital gains tax-cut proponents--the discredited Laffer notion that cutting taxes raises revenues.

It appears that over the long-run, the revenue generated from an increase in capital gains realizations accompanying a tax cut would not be large enough to offset the static revenue loss from the tax cut itself. A net revenue gain is also less likely under current law than it was in the past, in part because the increase in realizations would be taxed at lower rates than would have been the case in the past.  Id.

Consumption Taxes: Answer to Tax Evasion?

One of the arguments often put forward in support of changing to a consumption tax system is that it would be much simpler and therefore likely to result in fewer compliance problems.  The system most frequently proposed is a value-added tax (VAT) for business, and a wage tax (that could be progressive) for individuals.  Wealthy individuals whose income consisted in large part of capital gains and other investment income would pay little or no direct tax.

How does the claim about compliance hold up?  Bahro Berhan and Glenn Jenkins have written an article that looks at efforts to control VAT evasion.  They suggest that controlling VAT evasion may produce high compliance costs.  The article considers measures used to control VAT evasion in Northern Cyprus and Boligiva and concludes that the measures undertaken in those two countries have imposed significant costs on employers and employees--amounting to about one and one half times the total cost of administering the domestic tax system and 5% of the revenues collected by the VAT system. 

The following is an excerpt from the abstract of the paper (available from the authors).

"Although it is sometimes claimed that Canada's GST [equivalent of a VAT] is self-enforcing--vendors cannot evade tax on sales because purchasers will want to produce evidence that the tax has been paid in order to claim input tax credits--in reality GST fraud is big business.  Solutions to GST evasion generally involve increased audits and therefore increased complaince costs for taxpayers and increased administrative costs for governments, which represent a diversion of resources from more productive activities and an economic loss to the country."  [emphasis added]