What do you mean fair. I imagine some people would think any progressive tax is unfair, as it makes rich folks pay more per dollar earned then poor folks. Others might think that any nonprogressive tax is unfair, as it does nothing to address the hughly unequal distribution of wealth in our country.
Is there any set deffinition that economists and politicians use when the talk about a fair tax system.
Generally tax policy people and economists discuss “equity.” The general public would probably call it fairness. Within equity, the discussion turns to “vertical equity” and “horizontal equity.”
In vertical equity, the person with more income pays more tax than the person with less income. Someone that makes $100,000 should pay more than someone that made $50,000.
In horizontal equity, two people with the same income pay the same tax. For example, it would not matter if your income came from a job, a business or selling your house.
In a perfect system, these concepts of equity would apply very broadly. For example, if two people died at 80 years old and had earned the same amount of income over their lifetimes, they would have paid the same amount of tax over their lives (probably adjusted for interest). This would be equitable but impractical.
Thanks 19. A follow up question:
Do you mean a person of higher income pays more in absolute terms, or more per dollar earned?
I believe the theory would only require the higher income person to pay more in absolute terms but would not object to paying a higher marginal rate.
As you can imagine, I would find it highly unfair if I earned less than you but paid more tax in absolute dollar terms. I might also find it unfair (but probably less so) if we paid the same rate.
I don’t know how to predict how other people will behave. (This last election is proof of that.) But I do know how I would behave if a consumption tax was put in place:
I would buy nothing.
I will never own a flat-panel HDTV. I will grow as much of my own food as possible. I will definitely raise chickens and probably goats. I will log trees from my property to build a house so I will not have to pay a 30% markup on already-pricey lumber. I will eat out at a restaurant maybe once a year. I will not buy a new car until mine can no longer pass inspection.
Maybe everyone will see their sudden increase in take-home pay and be ecstatic and spend like crazy, even at 25+% prices. But I think more people will spend even less, buy fewer things, and grind our economy to a nice halt. I also think black- and gray-marketing and barter will become extremely common.
But that’s just me. I’m aware that I don’t understand how 59 million of my fellow countrymen think.
Follow-up to this: How many times do we think the government will be forced to raise the consumption tax in order to compensate for the revenue lost to decreased sales? (i.e., they say 25% sales tax now, but if prices climb 25%, some people will likely buy less than they do today … and the governement will take in less revenue than it had projected, so it will have to raise the rate to 27% … which will result in even more people slowing down their spending … so they will have to raise the rate to 30% …)
Whatever we do,(combination of flat income tax and NST, or present system), we have to have a system whereby people LOSE BIG TIME if they do not file a return. For example, the prostitute who makes $100 K/year in the “underground economy”.Under NST, she pays taxes on her rent, food, gas, condoms, etc. If she wishes to recover, she must declare income and pay taxes (this assumes that she would have something coming back). We also have to have a system whereby nobody gets anything from the government (student loans, subsidized mortgaes, etc.) without declaring income and filing a return. You can be part of the underground economy, but if you don’t file a return, you get nothing. Thuis has two benefits:
-(1) “Free Riders” in the underground economy wind up paying-they cannot escape the NST
-(2) those who pay nothing get no benefits. No tax returns, no SS, no welfare, no food stamps.
no tax returns … no social security … no welfare … no food stamps … isn’t that the neocon wish list?
You need to go to the fair tax website (www.fairtax.org), and see the actual contentions and statistical conclusions of the framers of the fair tax legislation, before you reject the whole thing out of hand. It is true that no one–even the most astitute economic analysts–knows for sure what a retail sales tax will result in. But, with as screwed-up and complicated and costly a system as the current one is, don’t you think we should at least give serious consideration to a serious and well thought out proposal to replace it?
The tax avoidance/preparation industry is much larger than most folks imagine. The fair tax proposers estimate that the total cost of complying with the filing of income tax returns to the private sector is in excess of $250 billion annually*. Because of this, you can be sure that those who make their living off the income tax system will vehemently oppose the fair tax.
The above figure doesn’t include the incredible amount of emotional capital wasted in complying with income tax filing.
I wasn’t ignoring your cite before, you linked to the wrong website in the first page “fairtax.com” vs “fairtax.org”. A quick run through their website though, in the “research paper” section reveals that their a little scimpy on the details of their calculations, my post that you quoted was admittedly very “back of the envelope”, but I’d argue that it was still more of a research paper then what they’ve given here. If they have the actual numbers posted somewhere deeper in the website, can you link to the URL? Regardless, I’ll give the site a more through reading when I have more time.
Everyone realizes that our tax code is needlessly byzantine and complex, and that this leads to abuses, waste and headaches. But I don’t see that this is a result of having a progressive income tax, which isn’t inherintly complicated. The cause of the complexity is from a century of Congress passing exceptions, extra rules, etc. Switching to a completely new form of taxation will be dangerous, expensive, exhausting, and will not address the actual problem, as congress can pass exceptions into a NST as happily as they can into the income tax, and people will find loopholes as quickly and as easilly as they do now. If the will exists to reform the tax code, it certainly exists to close tax loopholes and simplify the existing system to get rid of abuses.
Honestly I fear that the gov’t will talk about these grand schemes for “pulling the income tax out by the roots”, we’ll argue about it for a few years, eventually abandon it as impractical and then not actually get to the business of reform.
Man, all these horror scenarios about a vat… I guess the people talking about all these ‘problems’ haven’t noticed that most of the world has a VAT already. Why not simply look to see what their experience has been?
In Canada we have a 7% GST. I have been on both sides of that issue, as an employee and consumer, and as an employer. Most of the problems listed in this forum do not exist, but some do.
Administering the tax is not hard at all. As a business owner, I would simply keep track of all the tax I paid out for expenses, and the tax I collected. Subract expenses from collections, and send the rest to the government. I found it easier to keep track of than income tax.
The tax does not apply to everything. For instance, food in a grocery story does not have a GST. However, chips in a 7-11 do. House sales do. Car sales do. When the tax first came out, there was a lot of jockeying around with exemptions before everyone was happy, but since then it seems to be a non-issue.
The underground economy is a problem. Especially in the services industry. Often, when you hire a private contractor to work on your home, you’ll get two prices - a ‘cash price’, and a price if the transaction has to go on the books. If you have a 25% VAT, you’ll see a LOT of tax avoidance in industries where accounting is shoddy, like construction. But then, they avoid income taxes now by doing the same thing. But what a VAT would stop would be the massive tax avoidance that goes on everywhere else.
Poor people get a GST credit. You have to file a tax return to get it, but once your income goes below a certain level, you start getting an increasingly larger GST credit. Theoretically, you could use this system to eliminate the GST entirely for the very poor.
My biggest worry about the VAT is that once the government gets its hands on a wholly new source of revenue, you’ll eventually wind up with BOTH a VAT and the current income taxes. That’s been the experience in most countries that have one. In Canada, the GST was supposed to be temporary. Now we run budget surpluses, but we still have a GST. On the other hand, existence of the GST has allowed our income tax rates to drop to stay competitive with the U.S., while the government maintains a higher level of spending.
Another problem with implementing a VAT in the U.S. is that it would be a shock to the economy, because the economy is already distorted by tax loopholes and incentives. Remove them all at once, and you’ll create problems. For example, in the U.S. mortgage interest on a private residence is tax deductible. Remove the tax, and you remove some incentive to own houses instead of renting. This will, in the short term, cause a glut of housing and probably a price drop in housing. That will hurt people who have equity in their houses. Canada, by the way, does not allow interest deductions. There are many other corrections that would happen in the economy if the income tax vanished tomorrow.
Therefore, the way to implement a VAT would be on a gradual basis. A fair tax law might start with a 5% VAT and a corresponding decrease in income tax. Then after five years, the VAT goes to 10%, and income tax decreases more. Perhaps ultimately, rather than having just a VAT you might wind up with a system in which there is a 15% flat tax and a 7% VAT. That would match Canada’s GST, which would be a good thing for both economies. The VAT would be low enough that it would limit the amount of avoidance that goes on. A truly flat tax with no loopholes would make the tax system more efficient and remove the distortions created by a complex tax code.
Almost all of the posts in this thread have been about a National Sales Tax, I agree a VAT tax might not be a bad idea. Of the systems listed by the OP, I think it has the most promise, though I haven’t looked into it too much.
GST == General Sales Tax??
Anyhoo, we have state sales taxes here, some of which go as high as 7% I belive, they’re not a problem. If we wanted a national sales tax of a few precent, that might not be a problem either. But whats being advocated here is replacing the national income tax with a NST. This will have to be many times larger then the current state sales tax inorder to make up the income tax, and as such will supress supress consumption, cause a large amount of loopholes (people passing things off as business expenses, buying things from fleamarkets, unreported sales, buying overseas etc etc etc), increase the national budget (the gov’t has to pay its own tax, as do people on SS) and without a large and complex sysytem of reimbursements and welfare, create a regressive tax. Also, as you point out, the transition will be difficult. It will also be expensive.
Most damning, I think, is that for all this, its not clear a NST will solve the original problem of an overly complex and loophole ridden tax code. These problems didn’t arise from what we taxed, but in our gov’t willingness to pass new tax laws every couple of months.
What’s the difference between a National Sales Tax and a VAT? A VAT IS a national sales tax. The GST (goods and services tax) is exactly that.
A national sales tax only charges the tax on end-product, retail goods. Stuff bought by individual private, consumers for personal use. Cars, groceries, that sort of thing. The tax is a simple precentage of the cost of the item to the end consumer. If pretax, I buy lumber for a dollar, build chairs out of it and sell the chair to consumers for two doallars, then under a 10% NST I’d charge the person buying the chair an extra 2.20 cents and give that to the gov’t
A VAT is charged on all sales, regardless of who is the purcheser/purchesee. It is a precentage of the value added to the product. So if I run a chair shop, under a 10% VAT, the person selling me the lumber would charge me an extra ten cents, for a total of 1.10$. Ten cents of this would go to the gov’t. I would then charge the end consumer 2.10$, plus a tax of 10% of the value I’ve added to the product (the price I’m selling it for minus the price of the raw material I used to create it). In this case thats 10% of 2.00, or twenty cents, so the final price charged to the consumer is 2.30$, and I send the .20$ off to the gov’t.
I knew I was going to screw that up. The NST example is fine, but the math in the VAT is wrong.
I buy the lumber at a dollar plus 10% tax for a total of 1.10$
I then assemble the chair, adding 1.00$ of value to the product, my value added is then 10% of this, that is .10$. Adding it all up:
lumber + lumber tax + value added + VAT = 2.20$
1.00 + .10 + 1.00 + .10 = 2.20$
In the end the tax paid by the consumer, 10% of the final, is the same and all taxes paid by middlemen are recomped. The advantage to the VAT I think (again, I’m still reading up) is that it allows us to tax a much broader range of economic activity, since all transactions are taxed (minus whatever exceptions the gov’t institutes). This makes for fewer loopholes and lowers the final tax rate, as we are taxing more types of transactions, then we won’t have to them as much to make the same amount of $$.
I would have thought that all sales tax plans would have a way to credit back producers for intermediate products, or else you get all kinds of distortions in pricing, depending on the exact mix of labor, number of steps in construction, etc.
For instance, if I had a product that went through a chain of five intermediates who each added 10% value to something, I’d wind up with this:
First producer buys product for $10. Pays 10% tax.
He adds 10% in value. Sells it to the next guy for $12.10. Next guy pays $1.21 in tax. He adds 10% in value, and sells it to the next guy for $14.50. That guy pays $1.45 in tax. Now we’re already up to $15.95, and the government has collected over 20% in taxes already. On the other hand, a company that buys the material for $10, does all the value-added work in-house, and sells it for $15 pays less than half the tax on the same product. This simply doesn’t make sense. There can’t be a tax system in effect today that does this, can there?
I thought with a VAT, only the end sale to the customer was taxed, and businesses got a business exemption. That’s effectively the same thing as a National Sales Tax, isn’t it? Am I missing a distinction somewere?
In Canada, businesses don’t pay GST. It works like this:
I buy a software product from a wholesaler for $100. I pay 7% GST on it.
I sell software for $150. I charge 7% GST.
I then take the $10.50 in GST I collected from the sale, subtract the $7.00 in GST I paid to the vendor, and send the government $3.50. But I can also deduct the GST I paid for other expenses operating my business. There were plenty of times when my GST return to the government was zero, because the GST I paid out for all my business expenses exceeded the GST I collected from customers.
The other way you could do things would be to give businesses a tax exemption number. Under that system, when the wholesaler sells me the software, I give him my tax exemption number and he doesn’t charge me a sales tax at all. That’s roughly the same thing (assuming the tax rate was adjusted to make it revenue neutral), but it would be more of a pain to administer, I’d think.
The VAT and sales taxes have similar outcomes but the VAT is generally easier to enforce.
With sales tax, the hypothetical chair manufacturer would have to let his suppliers know he is exempt as a business. Of course he may be exempt for the wood going into the chair but not exempt for the hand soap in the washroom. The various codes and regs would be consulted. Something would get screwed up and the audit would be a mess.
With VAT, every supplier would charge the VAT on everything provided. The invoices would state the VAT paid on each purchase. When the business files its VAT return, all that VAT paid to all the other suppliers would then be taken as a credit against the VAT collected from the business’ own customers. The business would remit the difference to the goverment. That difference is the tax on the value added by creating the chairs. There would still be an audit but it should go more smoothly.
They do have a way to credit back producers. The NST does this simply by not taxing anything but the end product, so intermediate products aren’t taxed at all.
The VAT does this by taxing backproducers for only the value they added to the product, not the entire value of the product when it leaves their hands (as you have in your first example). The backproducer then presumably passes this tax to the person who buys the intermediate product from him. The end result is the tax collected by the gov’t and the tax paid by the final buyer are the same as it would be if they had just used a NST of the same rate.
Say a product goes through two back producers and a retailer before it gets in your hands. Each producer and the retailer adds a constant amount J to the value of the product.
The enters the chain at price A.
Without a tax the value of the final produt will be:
A+J+J+J
And the gov’t gets nothing
With a national sales tax, the final value will be
A+J+J+J+Tax
Where the tax is simply 10% of the final value of the product, that is:
(A+J+J+J)*.1
So we get a final cost of
The end consumer ends up paying 10% extra, which the retailer passes to the gov’t.
For the 10% VAT, the price paid by the first back producer is:
A+Tax where the tax is 10% of A, or .1A
the guy that provided A passes the tax on to the gov’t and this first producer adds a value J, and the second producer pays:
A+.1A+J+.1J