Tuesday, January 29, 2008

Is the Fair Tax really fair?

In the January 29, 2008 MSN article "Is the Fair Tax really fair?," Jeff Schnepper says "Some tax-system critics, including GOP candidate Mike Huckabee, want to get rid of income taxes and payroll taxes and replace them with a national sales tax. Here are the plan's pros and cons."
Let's be fair. Our current tax code is a disgrace. It often makes no sense. It's tough on taxpayers trying to fill out their returns. It penalizes some people who should not be penalized.

Some people hate it so much that they want to get rid of it.

That's what Republican presidential candidate Mike Huckabee wants to do. The former Arkansas governor wants to junk personal and corporate income taxes and federal payroll taxes and replace them with a national sales tax called the Fair Tax.

I should note that the idea isn't actually Huckabee's. It comes from Atlanta radio talk-show host Neal Boortz, U.S. Rep. John Linder, R-Ga., and the Americans for Fair Taxation. The group is chaired by Leo Linbeck, who runs a big Houston construction company and is prominent in Republican circles in Texas.

How the Fair Tax would work

We now have an income tax -- a tax on what the courts have called an accession to wealth, clearly realized, over which you have dominion. Generate the income, and you're taxed immediately. It really doesn't matter what you do with the income. Unless it's exempt by statute, such as employer-provided health insurance premiums, or under the Constitution, like municipal-bond interest, it's part of your taxable base.

Our income tax system is also progressive. At certain break points, you pay a higher marginal rate on additional income. The more money you make, the greater the percentage you pay on additional income. For 2008, a married couple pays 10% on the first $16,050 in taxable income. But the couple pays 35% on all taxable income in excess of $357,700.

The Fair Tax is a whole different game. Instead of taxing income, this tax would hit consumption. Its proponents want to substitute what's often described as a flat 23% national sales tax on nearly all goods and services. But that 23% figure is a mirage. You'd actually pay 30% at the cash register, according to the proponents' Web site.

Think of it as a tax on your buying power. Fair Tax proponents say income taxes now make up about 23% of the cost of goods sold. Take away that tax and the cost of a $100 good, they say, would drop to $77. The Fair Tax would collect that $23 discount as a straight sales tax, which works out to 30% added to the price of goods and services. State and city taxes could be added on top of that.

The Fair Tax would include a complicated rebate system to shield the poor. According to Huckabee, "All of us would get a monthly rebate that will reimburse us for taxes on purchases up to the poverty line." By "us," he means you, me, Bill Gates and Oprah Winfrey.

What the Fair Tax might do for the economy

Would the Fair Tax make for a better economy? The Huckabee team says yes, and here are the arguments:

* Retail prices could fall. Fair Tax supporters say 20% of all prices today represent the hidden income and payroll taxes embedded in the price of everything we buy.

* Eliminating corporate income taxes and capital-gains taxes would make the United States a more desirable place to do business. Cut transaction costs, and you encourage more people to get into the game.

* There would be reduced losses of tax revenue from the underground economy.

*Illegal immigrants, many of whom do not report income or pay taxes, would be forced to pay their share of the Fair Tax. So would the 40 million foreign tourists who visit the U.S. each year.

*Social Security and Medicare taxes could be eliminated. These regressive taxes are probably the largest tax burdens on lower-income taxpayers. The Social Security Administration will get 6.2% of all wages and salaries up to $102,000 in 2008. Medicare gets an additional 1.45% from all wages and salaries.

*The Fair Tax would minimize the congressional tinkering and behavioral manipulation that permeates our current tax code. Special benefit provisions and lobbyist-generated deductions and exclusions would be gone.

*Substituting the Fair Tax could mean that the Internal Revenue Service could be disbanded. (That might sell the deal.)

Savers and investors would win big

The biggest winners under the Huckabee plan would be most savers and investors. A consumption tax gives savers something like an unlimited-deductible individual retirement account. There would be no tax hit until the dollars were actually spent. While the money was saved or invested, it would grow fully tax-free.

Financial companies would get an enormous windfall. Most of their expenses are payroll-related, and, relatively speaking, they spend little on goods and services. Much of their profit is generated by investments. That wouldn't be taxed until spent.

Investors should also gain by the increased value of shares in companies that they bought or owned. That's because of the elimination of both corporate income and payroll taxes.

And the wealthy, who now pay 35% on their marginal income, would rejoice at a big tax break down to 30% of their consumption expenditures. In other words, a round of golf at Pebble Beach would cost them, but merely collecting dividends would not.

What's not to like about the Huckabee plan

The opponents have strong arguments of their own. Here's a rundown:

*How much must pretax prices go down before you're comfortable paying an additional 30% on your home purchase, kid's tuition and doctor appointments? Increasing the cost of buying a home by 30% would not stimulate the housing market. On a house currently selling for $200,000, a 30% tax means you have to borrow $60,000 more just to get in the door. That doesn't make a lot of sense.

*Arguments that the Fair Tax would eliminate the underground economy are less than persuasive. Add a 30% federal hit to a 6% state sales tax, and you have created a golden opportunity for smuggling. Look at what happened to cigarettes when states increased their prices with higher sales taxes. They're now marketed out of the trunks of cars. Those cheating on their income taxes would cheat on their sales taxes. Just substitute the term "black market" for underground economy.

*The idea that the Fair Tax would eliminate complexity in the tax code also fails to recognize reality. Special interests would almost certainly hire lobbyists to propose exemptions for such things as home purchases, medical services and education. I spent some time in Washington, D.C., and I never met a lawmaker who wanted to run for re-election on the platform of hitting housing, medical services and education with a 30% tax.

*The poor would get little from the Fair Tax because they really don't pay income taxes under our current system. For 2008, if you're married with one child under 17, you have no tax on your first $31,400 in income. The Fair Tax can't beat a zero tax liability. Any real savings would come from the elimination of Social Security and Medicare taxes.

*Bush administration economists have projected that the Fair Tax would actually increase taxes for those making more than $30,000 and less than $200,000. That's because a flat 30% rate on their gross consumption would suck more dollars than a graduated rate on taxable income, after deductions, exemptions and the like. Taxpayers in that range would lose the benefit of the 10%, 15%, 25% and 28% rates on their taxable income.

*Transition rules -- the rules that would apply as one shuttered income taxes and started up the Fair Tax -- would cause chaos. Consider your Roth IRA account. You've already paid income taxes on those dollars. You wouldn't be happy when you spent the money and had to pay a tax again.

*Somebody would have to enforce the sales tax law or it would have no teeth. So, in practical effect, the plan would not eliminate the IRS. The plan would just convert its function from income-tax compliance to sales-tax compliance. Some agency would have to step in.

*Would the national sales tax be enough to raise as much revenue as our current system? Yes, if the rate was high enough, no if it wasn't. I'd bet everything I have that the rate wouldn't remain fixed.

The biggest losers: Municipal bond holders

A subgroup of the wealthy -- those who escape income tax under the current system by investing in federal-tax-free municipal bonds -- would be big losers here. Under the Fair Tax, current tax-free dollars would be hit when they were spent. That would decrease the attractiveness of such investments and potentially increase their cost.

Higher interest rates for state and local projects would result in increased costs for schools, bridges and jails that are normally financed with tax-exempt bonds. Or it might mean higher state and local income and real-estate taxes to cover those costs.

Home values -- and people who work in the real-estate industry -- would suffer. So would those who sell high-priced goods. Cars, appliances and high-ticket items like, say, Tiffany jewelry, could immediately become 30% more expensive. Would the corporate income and payroll tax savings be enough to offset this addition cost? It's arguable, and economists disagree. Personally, I have my doubts.

My biggest fear is the inability of Congress, no matter which party is in control, to control spending.

We raise more tax money today than ever before in our history. The problem is that we increase spending faster than we increase tax revenues. We may end up with both an income tax and a national sales tax. Wouldn't that be a kick in your wallet?

Thursday, January 3, 2008

Part I: Introduction to Economics

Part I of this blog is an introduction to economics.  It covers topics useful to the further study of both macroeconomics and microeconomics.

What is Economics?

Wednesday, January 2, 2008

Outline of Topics (detailed)

Part I: Introduction to Economics

A. What is Economics?

What determines prices?
Prices have little to do with value
Prices are based on relative scarcity and desirability

Unlimited Needs and Wants

Economic Products

Economic Resources
Blue collar workers
White Collar workers
Special Types of Labor used in Business
International Business Specialists
Green collar workers
Physical Capital
Human Capital
Financial Capital
Natural Resources
Fossil fuels

Macro vs. Micro

Positive vs. Normative Analysis

Limitations of Economics as a Field of Study

B. Economic Perspectives
Opportunity costs
Sunk costs
Incentives always matter
Trade can make everyone better off

C. Simple Economic Models
Circular Flow Diagram
Household and Business Firms
Adding Government
Adding International Trade
Production Possibilities Frontier
Constant Opportunity Costs
Increasing Opportunity Costs
A Change in Resources
A Change in Technology
Illustrating Unemployment
Illustrating the Benefits of Specialization and Trade
D. Supply and Demand Analysis
Prince Controls
Price Floors
Minimum Wage Laws
Price Ceilings
Rent Controls
Changes in Demand
Decrease in Demand
Oprah vs. Texas Cattlemen´s Association
Increase in Demand
Medical Benefits of Wine and Grape Juice
Oprah´s Book Club
Changes in Supply
Decrease in Supply
Orange Juice
Increase in Supply
Bovine Growth Hormone (BGH)
Changes in Supply and Demand
Increase in Supply and Increase in Demand
Increase in Supply and Decrease in Demand
Decrease in Supply and Increase in Demand
Decrease in Supply and Decrease in Demand

E. Personal Investments
Are Credit Card Companies the Crack Dealers of the Financial World?
Unscrupulous practices

Compound Interest: the Importance of Starting to Save Early

Types of Investments
Transactions Money
Bank accounts
Short Term Savings
Certificates of Deposit (CDs)
Money market mutual funds
Long Term Savings
Bond mutual funds
Stock mutual funds
Blue chip
Aggressive growth
Real Estate

Investments in the News:
Dow Jones Industrial Average
S&P 500

Investing Strategies
Payroll Deduction
Dollar Cost Averaging
Mutual Funds: Special Insight or dumb luck?

Part II: Macroeconomic Policy

A. Macroeconomic Policy Goals
a. Economic Growth
i. Importance
1. Historical Perspective
2. Geographical Perspective
ii. Measurement
1. GDP
2. GDP per capita
3. Real GDP
4. Real GDP per capita
5. Limitations of these measurements
a. Standard-of-living vs. Quality-of-life
iii. Alternative Theories of Economic Growth
1. Supply-side economics

b. Low Unemployment
i. Importance
1. Effect on Economic Growth
2. Well-being of the unemployed
3. Well-being of the employed
a. Taxes to support the unemployed
b. Crime and unemployment
ii. Measurement
1. Unemployment rate
2. Labor force participation rate
3. Limitations of this measurement
a. Discouraged workers
b. Underemployment
c. Inaccurate data and deceptive answers

c. Low Inflation
i. Importance
1. Effect of Economic Growth
2. Effect on Economic Efficiency
3. Redistribution of Income
ii. Measurement
1. Price indices
a. Consumer Price Index (CPI)
b. Producer Price Index (PPI)
c. GDP Deflator
2. Limitations of these Measurements

B. Macroeconomic Policy Tools
a. Monetary Policy
i. What is Money?
ii. How Monetary Policy Affects the Economy
1. Expansionary Monetary Policy
2. Contractionary Monetary Policy
iii. The Federal Reserve System
1. Structure of the Fed
a. Twelve Regional Federal Reserve Banks
b. Board of Governors
c. Federal Open Market Committee (FOMC)
2. Functions of the Fed
3. Monetary Policy Tools
a. Required reserve ratio
b. Federal funds rate
c. Open market operations
i. Open market purchases (of government securities)
ii. Open market sales (of government securities)

b. Fiscal Policy
i. Taxation
ii. Government Spending

Part III: Contemporary Economic Issues

A. Political Economy
a. Conservative Republicans
i. Taxation
ii. Government Spending
iii. Gay Marriage
iv. Immigration
v. Abortion
b. Libertarians
c. Liberal Democrats

B. Economics and Religion
a. Christianity
b. Judaism
c. Muslim

Tuesday, January 1, 2008

Outline of Topics (brief)

I: Introduction to Economics

II.  Macroeconomic Policy
     A.  Macroeconomic Policy Goals
          1. Economic Growth
          2. Low Unemployment
          3. Low Inflation
     B.  Macroeconomic Policy Tools  
          1. Monetary Policy
               a. What is Money?
               b. Federal Reserve System
               c. Monetary Policy Tools
                    i. Required Reserve Ratio
                    ii. Federal Funds Rate
                    iii. Open Market Operations
          2. Fiscal Policy
               a. Taxation
               b. Government Spending
               c. Budget Deficits and Public Debt

See also "Outline of Topics (detailed)".