the nontaxation orgy

Sometime in the next two years, we don’t yet know when, the House of Representatives will organize a public orgy. House Speaker Kevin McCarthy, R-Calif., has promised to hold a plenary vote on the Fair Tax Act of 2023 (HR 25).

The pledge was one of multiple concessions McCarthy made to the Freedom Caucus in order to become a speaker. As we will see, the FairTax is nothing more than an exuberant orgy of non-taxation.

Now, you may be tempted by this tax seduction. There is a visceral excitement at the thought of not paying income tax and never having to deal with IRS red tape again. But caution is advised. On close inspection, the FairTax is an apple you don’t want to bite into.

In case you missed it, the main feature of FairTax is that it would eliminate all federal income taxes for both individuals and corporations. They would be replaced by a 23 percent national sales tax, which would apply broadly to goods and services. The FairTax would also dissolve the IRS.

The proposal would also eliminate all federal payroll taxes, which are technically separate from income taxes, although they are imposed on your earned income. That includes the payroll taxes that fund Social Security and Medicare. The proposal would also eliminate withholding taxes, estimated taxes, self-employment taxes, inheritance and gift taxes, and the alternative minimum tax. That’s a mother lode of repealing things.

The Congressional debate on the Fair Tax will center on whether we want our federal government to be funded primarily by revenue mechanisms based on a person’s ability to pay. The salient point of an income tax is that it allows for a progressive rate structure, in which those of us with higher annual incomes pay more than people with lower annual incomes. And by “more” I mean both grossly and proportionally. That is what it means for a tax framework to be based on ability to pay.

By contrast, a consumption tax is conceptually divorced from a person’s ability to pay. These taxes are inherently blind to the economic status or income level of the consumer. The amount of sales tax a billionaire pays when buying a six-pack of Coca-Cola is identical to the sales tax a homeless person pays on the same purchase. You can view that outcome as fair, or you can view it as a perversion of economic justice. Either way, that’s how all sales taxes work.

Here are two other things to keep in mind about the FairTax.

First, it claims to be revenue neutral. That is, it is not intended to either increase or reduce the total volume of tax revenue collected by the federal government each year. This point is highly debatable. Mathematically, there is a rate at which a national sales tax would produce receipts equal to what we collect under current law. No one knows exactly what that rate is, and it could be much higher than the proposed 23 percent figure.

As for revenue, I suspect that FairTax advocates might enjoy if the resulting return was less than all the taxes it would replace.

People in this field have a history of viewing tax cuts as an effective constraint on government spending. You often hear small government advocates comment on the need to “starve the beast.” Realistically, FairTax is a platform to do just that.

Second, FairTax promises price stability. That is, the introduction of a national sales tax would not increase retail prices. The claim seems dubious, but this is what they mean. Hidden within every current retail price is an economic component that corresponds to the built-in costs of each party in the supply chain, from raw material suppliers to manufacturers, wholesalers, and retailers. Some of those built-in costs are attributable to the current income and payroll tax system, both the taxes themselves and the compliance costs that accompany them.

The theory goes that once Congress repeals all income and payroll taxes, the related implicit costs would simply disappear. They would vanish into the ether, by the force of the invisible hand of the market. Conveniently, its removal almost perfectly offsets the effect of the new sales tax. and there you goprice stability.

For some sectors of the economy, the removal of embedded costs is projected to more than offset the introduction of the new tax, so that the prices of those goods and services will actually fall. Picture that: a 23 percent retail sales tax that drives prices down. It’s almost too good to be true. Hint Hint . . . This.

As a self-proclaimed tax policy nerd, I have to admit that I retain a fondness for the idea of ​​an excise tax. The concept has some intellectual merit. Compared with the income tax, consumption taxes are growth-enhancing because they functionally exempt saving, which encourages capital formation.

Despite the well-known growth effects, no country in the world is financed exclusively through a national consumption tax. There’s a good reason for that. Growth potential, while important, is not the only objective.

Most nations combine their progressive income tax with a broad-based consumption tax (ie a VAT). This is a classic pattern. It acknowledges that excise taxes are regressive, but justifies their presence because the resulting tax revenue can support a wide variety of federal spending that would be difficult to support through other revenue sources alone.

The key point is that these consumption taxes supplement entry; they do not replace that.

The dominant trend in international taxation over the last 25 years has been for countries to reduce their corporate tax rates as VAT rates increase. This is usually done for the sake of global competitiveness. In effect, these governments are progressively exchanging the taxation of capital income for the taxation of consumption.

The United States cannot participate in this global trend because we do not have a VAT, or some other national excise tax, to make up for lost revenue. In effect, the FairTax says that we can avoid offsetting by doing away with income tax altogether. That is a high risk proposition. Change a progressive source of income for a regressive one.

Despite my fondness for the excise tax, I can’t jump on the FairTax bandwagon. If enacted, the fiscal implications would be severe, as would the cultural implications. Stripped of all distractions (spurious custodial claims), the FairTax is revealed to have more to do with those lewd cultural shifts than the dry, academic business of tax reform.