Making the FairTax More Fair

On Oct 13, 2010, at 6:29 PM, David R. Block wrote:

12) Repeal the Income Tax amendment and implement the Fair Tax as put forth by John Linder and Neal Boortz.>> I’m not going to copy from The Fair Tax Book, or the book Fair Tax: The Truth in copious amounts. They wrote the books, and I don’t have any problems with it that I have been able to find.

I’m a big fan of Fair Tax:

But I still have a couple concerns about it, which Billy hints at:

> Regressive taxes, how wonderful. Tax the poor to lighten the burden on the rich.
> Why didn’t I think of that ?

Actually, that’s not quite true. It would actually *reduce* the tax on the poor, especially as it would reduce hidden taxation costs in prices. It would also help the working poor by eliminating Social Security payroll taxes.

The problem is that it increase taxes on the lower middle class, who spend most of their income but currently pay virtually no income tax. The rich who invest/save large chunks of their income would generally pay less than they do now. For example, FairTax Calculator says my family would pay only $30K in taxes, versus close to 100K now:

That money has to come from somewhere. This redistribution would almost certainly lead to economic growth and job creation, but it would still be regressive (except for the very poor).

I do think there is a way to fix the FairTax, though:

1. Make a national Sales Tax replace the Payroll Tax

The payroll tax is what hits lower income Americans and complicates hiring. If we replaced all payroll taxes with a FairTax-like national sales tax of, say 10%, it should achieve most of the economic benefit without becoming overly regressive. At a guess, it should at least reduce taxes for those making less than $75K per year, which seems sufficiently progressive, and gets us into the range of those who pay more on income taxes than payroll taxes.

This still leaves the problem of how to account for Social Security when we only capture spending rather than income, but for now let’s assume that’s a solvable problem.

2. Create a financial tax to replace the income tax.

Most income tax only affects the rich already. If we are going to tax the rich — which we have to do, since they have most of the money — we should do it in a way that encourages appropriate behavior.

What do we want the rich to do? Generate value to the economy, by either working or investing. Including taking risks that the poor and middle class do not. This implies we should penalize the rich for being selfish or safe.

The FairTax would tax all spending from the rich, which is a good first step. Still, a 10% FairTax wouldn’t bring in enough revenue. The remainder would have to come from taxing either a) wealth or b) financial transactions.

2a) Wealth Tax

If we don’t want to penalize investments, a “wealth tax” means taxing either property or savings (defined as FDIC insured).

We could model this on FairTax, in that we set a baseline exemption based on the federal poverty level:

To convert income to wealth, use the treasury rate. For example, if the poverty level is $10,000, and the treasury rate is 5%, then the “wealth exemption” is $10K/.05 = $200,000. To obtain a “fair” tax rate, I propose again indexing to 10% of the treasury rate, e.g. 0.5% for a treasury rate of 5%.

For example:

  • a $1 million home would have $800K taxable, which at 0.5% comes out to $4,000 per year.
  • an individual with the maximum $250K in FDIC-insured deposits across two banks ($500K) would have $300K taxable. They would pay $1,500 a year on a national wealth tax, which effectively reduces their interest from ~1.25% ($6,250 per year) to 0.95% ($4,750).

Annoying, but hardly devastating, and a good stick for prodding the rich to take riskier or longer-term investments to earn better yields.

I have no idea whether a national property tax would be legal, but making it legal would be a fair exchange for repealing the 16th amendment. 🙂…

2b) Financial Instrument Tax

I was intrigued by Billy’s proposal a few years ago for a tax on financial transactions.

The simplest and most effective (and FairTax-like) would probably be some kind of Transfer Tax, paid by the seller (to encourage holding investments longer):

Apparently we had one as late as 1966 for stocks:

The United States had a tax on sales or transfers of stock from 1914 to 1966. This was instituted in The Revenue Act of 1914 (Act of Oct. 22, 1914 (ch. 331, 38 Stat. 745)), in the amount of 0.2% (20basis points, bps). This was doubled to 0.4% (40 bps) in 1932, in the context of the Great Depression, then eliminated in 1966.

It’s been reconsidered recently, but never went anywhere:

Unfortunately, at the tax rate we are proposing (0.5%), it would (inferring from that article) only raise around $500B, vs. the $1250B from corporate and individual income taxes we need to replace.

We could increase that by covering more than just stocks, but I suspect there isn’t much other wealth out there to tax.

I am also worried about pushing that rate higher, as capital is even more flighty than people. Taxing transactions at too high a rate risks killing the financial industry; we only want to maim it, so it can’t run as fast. 🙂

Perhaps if we had a low (0.5%) rate for direct asset transactions (e.g., stocks) but doubled it for indirect (e.g., derivatives) it would do better, and also dampen speculation. Of course, it could have the perverse effect of making derivatives seek *higher* returns to compensate, though even 1% on a 13% Junk Bond doesn’t seem like it would dramatically alter behavior.

And it still may not be enough, but it should at least get us into the ballpark. Maybe the magical stimulative effects of eliminating payroll and income taxes would do the rest. Plus, simply adding friction to high-end financial instruments seems like a good thing.

Again, the Right hates it, but if tied to an elimination of the income tax, that might turn them around. And maybe capital flight is not a horrible thing, as long as it didn’t completely kill the revenue stream. Frankly, I’d rather have rich people living and working here and storing their money abroad than vice versa.

An interesting feature of tying wealth taxes to treasury rates is that they would be counter-cyclical — low when the economy is week, but high when it is strong. That’s good from the perspective of stimulating/dampening the economy, but hard on financial management, as government revenue dries up when you need it most, aggravating deficit spending. The only solution I could think of offhand is — in a world with a hypothetical balanced budget — ensuring some portion of this revenue is dedicated to a rainy-day fund. e.g., anytime treasury rates exceed 10%, the surplus revenue automatically goes into a counter-cycle fund that can’t be tapped. But rainy days funds are notorious for being leaky.

Still, this seems like a viable model that addresses the concerns of a pure FairTax and a mere financial transaction tax, at least at first blush.

What do the rest of you think?


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Obama probably did the best he could do, and that’s the point. The best our current two parties can produce today — in the wake of the worst existential crisis in our economy and environment in a century — is suboptimal, even when one party had a huge majority. Suboptimal is O.K. for ordinary times, but these are not ordinary times. We need to stop waiting for Superman and start building a superconsensus to do the superhard stuff we must do now. Pretty good is not even close to good enough today.

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Matt Miller nails the issue right on the head. A brilliant analysis.

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… the deeper vacuum comes not from liberal or conservative ideology per se, but from the interest groups and campaign funders that help each side seek power.

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