PolySciFi Blog

I still need to write up
something longish on social security, but there's a dissertation in the way.

In the mean time, consider this article by George Will on John Linder's consumption tax plan. The basic idea is to 1) eliminate the income tax, 2) eliminate the separate collection of social security and medicare taxes, and 3) fold it all into a single sales tax.

To maintain progressivity in the tax code, every household would get a check each month equal to the amount of taxes that would be taken on the purchase of basic goods (e.g., food & clothes) necessary to live at the poverty line.

The text of the bill under discussion is here.

Linder claims this approach will have the following effects:

• Dramatically reduce the costs of goods and services by 20 to 30 percent.
• Allows you to keep 100 percent of your paycheck, pension, and Social Security payments.
• Gross Domestic Product will increase by almost 10.5 percent in the first year after enactment.
• Compliance costs would decrease by 90 percent.
• Real investment would initially increase by 76 percent relative to the investment that would be made under present law. While this increase would gradually decline, it remains 15 percent higher than under the existing tax structure.
• Exports would increase by 26 percent initially and would remain more than 13 percent above the level under the current tax system.
• Real wages will increase.
• Increases incentives to work by as much as 20 percent in many households, leading to higher economic growth and efficiency.
• Interest rates will fall 25 to 35 percent.

I add the following effects:

• Up to a 15.3% tax cut for the poor who currently pay social security and medicare, but not income taxes.
• The elimination of a lot of money from politics. (No loopholes = no lobbying)
• A significant reduction in the cost of government (a much smaller IRS would be needed, though I see the need to police black market transactions).
• More predicatable revenue flows (consumption is pretty constant across all classes, income varies wildly with the economic cycle for the rich who bear most of the income tax burden)
• Improved competitiveness of US businesses in the global market (with no corporate tax, margins get wider and administrative overhead goes down)
• The temporary displacement of a few million workers (tax professionals, lobbyists) whose services would be absorbed into more productive activities over a few years (other than the actual remittance of taxes, tax professionals add little value to an economy)
• A temporary bump in the nominal price of goods followed by an extended decline in the real price of goods (more than likely the full tax would be initially passed along, but this wouldn't represent any actual increase in the chunk taken out of your income as your take home pay would go up significantly. The decline in real prices comes from price competition eating away the margins saved in the simplified tax code compliance).
• Market distortions will be lessened (no favoritism from the tax code)
• Internet sales will be taxed (otherwise we create a monster distortion in the market would be created)
• Lots of corporations will headquarter in the US (0% corporate tax rate)
• The EU will be pissed. However, they'll also eventually adopt this sort of plan. However, corporations are less likely to want to move again as they'll be no financial reason to do so.
• Savings will increase dramatically (which tends to add capital to the market) but IRAs 401Ks and all other tax sheltered investments will be eliminated (but then again, every investment will be tax sheltered)
• I, and millions of others, will dance a jig in happiness each April 15 as I eat a cake with John Linder's visage on it.

My inner libertarian also likes the idea because I get greater flexibility with my money (I could save or I could spend the extra take home money) (ok, my outer libertarian would like the idea for the same reason).

Now there's three decent questions about the plan that I know of. 1) Will a 23% sales tax really cover all that? 2) How will this affect charitable giving? 3) What about the housing market and the interest rate deduction?

My short answers to those concerns are the following:

1) Maybe 23% is too low. Maybe it's too high. I'm open to debate as to what the exact number should be. However, due the increased efficiencies that will gained and the stimulative effect that this should have on the economy, I fully expect that the percentage should be significantly less than the 45% (30 + 15.3) or so that comes out of my income now.

On 2 and 3, the worry is that without the tax deduction for home interest and giving, the demand for charitable giving and housing will go down.

However, that deduction is still effectively there. Interest payments and gifts do not represent a sale. So as you make your monthly home payment or your gift to charity, those transactions are not taxed (though the initial value of the house would presumably be taxed). So the fraction of your income going to these two activities are excluded from taxation. This is exactly the same effect as if you were deducting these items from your income when computing your income tax.

However, you would be getting this deduction without having to fill out a 1040.

The same deduction reasoning applies to IRAs, cept that now there's no cap on the deduction nor a government penalty for early withdrawal!

And the same deduction reasoning applies to medical care, cept now there's initial hurdle to clear before you start taking the deduction!

Anyways, leave a comment as to what you think of the idea of a national consumption tax replacing the taxes that are taken out of your paycheck.

Update

Here's a FAQ on the fair tax.

Spakkadi has thoughts on the fair tax as well.

Update2

In the comments, Matt asks a good question - he's just paying 15% in taxes now, wouldn't this be a tax hike on people like him?

Well there's three parts to the answer.

First, 15% is your income tax rate. The consumption tax replaces the collection of all payroll taxes - income, social security, and medicare. 15% + 7.65% (social security + medicare) = 22.65%. So it'll be like you got an immediate raise of 22.65% on which you would be paying a consumption tax of 23%. But wait, there's more! (Social security and medicare are still there, the means of revenue collection are changed to be a part of that 23% consumption tax)

Second, you'll also get a check each month (as would everyone) offseting the taxes you're paying for necessities. While I don't know what the exact number would be, according to the the Fair Tax FAQ for spending of $28,808 (I think that's equivalent to the same income), that works out to an effective tax rate of 17.3%.

Third, that 7.65% that employers are saving on social security and medicare would eventually work their way into a combination of lower real prices and higher salaries due to market forces. This would happen almost immediately at Walmart (prices more likely than salaries), slower elsewhere. Likewise the same effect will happen on corporate taxes which go away. This effect is further heightened by the savings that each company will have in tax code compliance (sales taxes are much simpler than the mess of loopholes that is corporate tax code).

So even ignoring the combination of effects in my third point, you'll have an immediate tax savings of 22.65-17.3=5.35%. If you include the third point, then you save at least another 7.65 points for a total of 13.00%. So your federal tax bill would be cut by 13.00/22.65 = 57%!.

(Note some numbers were adjusted above cause I f'd up my arithmetic. This caused a reduction in the bottom line savings from 59% to 57%.)

Update 3
Above, Matt lists some more objections. My response to his response to my response to his response (aren't blogs great for debate?) are in the comments to that same post.