Arnold Kling  

Kotlikoff on the Fair Tax

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Laurence Kotlikoff writes,

What if Mr. Megabucks sits and counts his money? With a direct wealth tax Mr. Megabucks pays $15 million immediately and is left with $50 million in purchasing power. Under the FairTax, Mr. Megabuck is in the same boat. Retail prices rise by 30 percent and Mr. Megabucks finds that his $65 million can only buy $50 million in real goods and services; Mr. Megabucks has the same number of dollars, but 23 percent less purchasing power.

But the rich miser, under this scenario, pays no taxes under the Fair Tax. He is "in the same boat" because supposedly prices have gone up. It seems to me that Kotlikoff is playing a rhetorical game here.

In fact, the whole op-ed seems to be an exercise in rhetorical games. Kotlikoff makes up stories about wealthy people. Instead, if he were to look at actual figures for income, consumption, and taxation for wealthy people, he would make a more useful argument. But the facts, at least as I gathered them, do not fit Kotlikoff's story.

I will put my point of view in very simple terms. Looking at the data, the U.S. Federal government gathers a considerable amount of revenue from high-income, high-saving citizens. Under the fair tax, as under any consumption tax, that source of revenue would go down. From my perspective as a libertarian, that would be a good thing, for any number of reasons. But Kotlikoff's attempt to persuade liberal Democrats that they should like the fair tax strikes me as dishonest.

Pointer from Greg Mankiw.

UPDATE: Daniel L. Vazzana, an econ professor at Georgetown College in Kentucky, emails:

This appears to be a regressive tax as we move from the middle to the top.

He uses information from a recent op-ed by Cox and Alm on average income and consumption for the top fifth, middle fifth, and bottom fifth of households. The top fifth has $150 K of income and $69 K of consumption. The middle fifth has $45 K and $34 K. The bottom fifth has $10 K and $18 K. The "prebate" of the Fair Tax would help keep the tax rate of the average household in the bottom fifth down to 7.5 percent. But the middle fifth would have a rate of 12.6 percent, compared with 10.8 percent for the top fifth.

A couple of points about Vazzana's calculations. First, note that all of the tax rates are suspiciously low. Remember, this tax is supposed to replace all personal taxes. It is not going to generate the same revenue as our current taxes--a point that William Gale and others have made.

Second, there are arguments to be made on both sides as to whether progressivity of the tax system should be measured relative to consumption or relative to income. Left-leaning economists argue for using income, in which case these calculations hold sway. But a case could be made for using consumption, in which case the Fair Tax would not be regressive.

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COMMENTS (4 to date)
Josh writes:

Arnold, your position makes sense, but I'm left wondering what happens to all that money rich people make if they don't spend it? Eventually that money HAS to get spent, right? Who does that spending? Aren't they high income (or at least high wealth) people?

Maybe the thing you're missing is that, while a lot of tax revenue comes from high income, high saving people, a lot of what would be taxable spending comes from the high income people of yesterday who are now low income (but high worth) and high spending? [I don't have any data, so it's just a question]

Lord writes:

The rich don't have to spend; they already own. Most of what the rich buy are investments and most will never spend it, only the income generated by it. When you become really wealthy, spending is a chore. There just isn't that much a person needs or wants.

Steve Roth writes:

Whether we're talking about taxing consumption or income, we need to work with reliable information.

Cox and Alm themselves point out the fundamental failing of their whole analysis:

"While some of these families are mired in poverty, many (the exact proportion is unclear) are headed by retirees and those temporarily between jobs, and thus their low income total doesn’t accurately reflect their long-term financial status."

Tens of millions of retirees—and the presumably gigantic gap between their collective (non)earnings and spendings—have to be a huge factor. And, uh...students? Who are being supported by well- or at least better-off parents who are nevertheless not part of the "household"?

The sticky issue of "life stages" (my children earn nothing, but the little hoodlums sure seem to consume a lot) is basic to the most freshman-level macro-equity analysis. Why aren't people who know better pointing this out?

Absent this "unclear" information, the whole Cox and Alm thing seems to tell us exactly...nothing.

MarkDC writes:

Fairtax is a farce. It's not a little off, its not a decent idea that needs tweeking -- its a total absolute farce.

And here is why.

The Fairtax math is a house of cards. One huge sourse of revenue that the Fairtax promises will come - guess where -- FROM the government.

The federal government ITSELF will become a major tax payer.

Don't believe it? THen read page 148 of the Farcetax book, I mean Fairtax book. Thats an exact quote "The federal government itself will become a major taxpayer."

In fact, thats the ONLY reason the Fairtax math can distort things enough to claim the tax rate could be 23%. Take away this farce --- don't pretend the government will pay itself 800 billion dollars -- and the tax rate would be more like 60%.

Sixty percent sales tax, of course, is absurd nonsense.

But thats only the START of the absurdity.

This "sales" tax would also be on things like cancer surgery. Yes, if you get cancer surgery and chemo therapy, and have to get two months in a nursing home recovering - you can expect 50,000 in "sales taxes". You might have 100,000 in SALES taxes on your payments to stay alive. Or to keep your child alive.

Well thats fine -- but what if you only make 30,000 dollars -- how will you pay this extra 100,000 in sales tax?

. Kotlikoff doesnt say. By their logic, all prices will do down. Lets pretend that farce is true -- doesnt matter. HOW will someone making 30,000 dollars pay a sales tax of 100,000 thousand on their medical cost to keep themselves or their child alive.

Plus -- this "sales tax" would be on nursing home patients. I mean -- its lunacy. How would an Alzheimer patient pay 40,000 in sales taxes to stay in a nursing home. Do you mean the ALzheimer patient has to move out and live on the street if they can't pay the sales tax?

The insanity doesn't stop there. What about car insurance -- do you know that ALL your insurance premiums will be "fairtaxed". Keep in mind the REAL tax rate would be more like 60% -- not the farce 23% they claim.

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