The Not-So-Fair Tax

When Mike Huckabee won the Republican Caucus in Iowa last week, a cheer went up from one particular fringe group: the Americans For Fair Taxation. They proclaimed that "The Fair Tax Wins In Iowa!" I've heard Huckabee mention the "Fair" Tax before, so I decided to investigate.

The "Fair" Tax would eliminate the payroll taxes that most Americans have deducted from their checks. Personal income tax and social security taxes would no longer be withheld. More interestingly, the "Fair" Tax would eliminate taxes such as the estate tax, gift tax, capital gains tax and all commercial real-estate transaction taxes. My assumption going in was that the "Fair" Tax was a scheme to shift the tax burden from the wealthy to the middle class and poor, and it appears that the primary goal is to create a system where wealthy people can accumulate wealth without paying taxes on it, and then pass it along to their heirs without them having to pay taxes on it.

I wanted to do a thorough evaluation of the "Fair" Tax, but there is so much to it that I'd have to dedicate all of my time to deciphering the reports that the Americans For Fair Taxation have paid to have produced. Instead, I chose one claim that struck me as particularly dubious and decided to look into it.

One of the things mentioned over and over in the literature is that the "Fair" Tax is progressive. They claim that they have worked in a way to make it less of a burden on poor people, as opposed to a standard flat tax, which would disproportionately target the lower income brackets. The way they fix it is to send everyone a check once a month, equal to the 1/12th of the "Fair" Tax payments on purchases up to the poverty level. A single person, for example, would get a check for about $196 per month. That way, nobody is paying taxes on life's necessities, or so they claim.

I wondered how it could be that a sales tax that would produce a 30% increase in the cost of all goods and services that people buy (excluding "used" items) could possibly be a larger burden on the wealthy. So I checked out one of the reports that the "Fair" Tax people paid for, titled "A Distributional Analysis of Adopting the FairTax." What I found was not very surprising at all.

"Oh, people can come up with statistics to prove anything, Kent. Forty percent of people know that." -Homer Simpson

From page 4 of the report:

We argue that current expenditure is a better measure of an individual’s well-being than current income. This is because current expenditure is more closely related to lifetime income than is current income and is less subject to temporary shocks. Current expenditure is also a better measure of wealth, since people may live off their savings while undergoing a temporary drop in income. Therefore, we conclude that the FairTax, with the prebate, is more progressive than the current tax law.

There, in a nutshell, is how the "Fair" Tax crowd can claim their plan is progressive. If you spend more money, your "well being" is greater than if you spend less money. (Would anyone other than the rich come up with that?) By their logic, if you take two people who each earn $50,000 per year, the one whose expenditures are $70,000 per year is twice as well off as the one whose expenditures are $35,000 per year. Magical conservathink. Spend yourself into debt to be better off.

On page 19 of the report, in section IV. Distribution on a per Capita Basis, there is an interesting finding:

As noted before, even people in the poorest income per capita deciles have relatively high levels of expenditure per capita. The introduction of the FairTax would not favor these people; they would gain little from the abolition of taxes on income (because their incomes are low), but would pay the FairTax (because their expenditures are substantial), as shown in column (M). This effect is attenuated when the dynamic expenditure-expanding effects of the FairTax are taken into account, but the poorest half of the population (as measured by income per capita) would be worse off due to the FairTax. A similar conclusion emerges from an examination of the pattern of income per capita, shown in columns (Q) through (V) in Table 9. [Emphasis Added.]

So the group's own report states flat out that when you look at the numbers on the basis of income rather than expenditures, the "Fair" Tax actually hurts the poorest half of the population. How is that progressive, again?

And then, to perhaps water down the bitter taste from the report's conclusion, they add:

Note the very low average income of those in the poorest income per capita decile – just $1,243 in 2001 – which is surely a poor measure of the well-being of this group of the population.

Because really, how could you judge someone's well-being by the fact that they live in abject poverty? As long as they're spending lots, then they're A-OK.