Do we Even Understand Tax Policy?

Do people really understand the taxes we pay?

The more I read and hear people talking about tax policy, to more I am convinced that most people a) do not really know what they pay in taxes, save in a very vague sense,* b) they really don’t understand/know how federal income taxes work, and c) address discussions of tax policy in a manner that looks more like theology than policy analysis.

Now, speaking for myself, I know what I pay in property taxes.  I know what I pay in sales taxes (both as a percentage, but there is that handy line on every receipt).  I even have a pretty good idea what kind of excise taxes I pay on a gallon of gasoline off the top of my head.**  However, when it comes to knowing exactly what I will pay in terms of the bulk of taxes that I pay (i.e., income and payroll taxes), things are a bit fuzzy.

Now, this is not to say that I can’t find out, or that I have no idea.  It is just that it takes some effort to get this information.  Moreover, I don’t think most people really have a concrete notion of what taxes they are paying.

To wit: yes, there are a lot of number on one’s pay stub.  And there is a rather depressing difference between the gross income and net income numbers.  Yet, in all honesty, which of those numbers do people pay attention to?  Clearly it is the amount that they can actually deposit in their checking accounts.  Indeed, I would wager that most people do not know the difference between payroll and withholding taxes and likewise likely could not tell you which one costs them more per check.  Indeed, the general confusion on the payroll v. income tax issue is part what keeps the “half of people don’t pay taxes” meme alive.   In terms of deductions to a given check, I suspect that most folks don’t even pay that much attention in terms of how much is taken out for non-governmental reasons (e.g., for health insurance, contributions to retirement, etc.).

Beyond the question of paycheck awareness, I would further argue that most people’s perception of whether they pay taxes or not (or whether they pay too much) is the result of whether or not they get a refund every year—never mind that getting a refund simply means you loaned the feds a few dollars, interest free, for a few months.  In other words, most people likely think that their taxes are “too high” if they have to write a check every April 15th, and are less inclined to be upset if they get a refund—never mind that the issue of actually how much of their incomes go to taxes has nothing to do with the payment/refund situation, but rather is a function of their monthly withholding.

And even if we pay attention fairly closely, we don’t know what our effective tax rate is until we do our taxes (and either do the calculations ourselves, or more likely, TurboTax does it for us).  Indeed, our conversations tend to focus heavily on marginal rates, but such a focus muddies the waters, as the real issue, ultimately, is the effective rate (if, what we want to do, is understand what people are actually paying, including ourselves).  This speaks, by the way, to the complexity of the tax code—the myriad of deductions, credits and the like that go into the ridiculously complex nature of calculating our annual tax liabilities.

In short>  by debating marginal rates, we don’t really capture what is actually happening in terms of what is actually being paid.

For example, note the following from CBS’ Moneywatch columnist Carla Fried:

According to the IRS, the average effective tax rate for the top 400 was 18.1 percent in 2008. While that tax rate is indeed 33 percent higher than the national average of 13.6 percent, it is also lower than the 19.6 percent average effective tax rate paid by folks with 2008 adjusted gross income between $200,000-$500,000, and the 24.1 percent average rate for filers with AGIs of $500,000-$1,000,000.

There is something odd about a tax system that produces the above outcome.

Setting aside the question of super-wealthy individuals, I would recommend the following posts:

Now, the scenarios in the above (which, I expect, are not that far off from those of many readers) are not intended to make an argument (at least from my perspective) on the rightness or wrongness of the current levels of taxation, but they do underscore, I would argue, that the rhetoric about taxes and the reality of the way they work are not in sync with one another.  Certainly what this underscores is that we use the tax code as much (if not more) as a means of rewarding certain behaviors as opposed to using it to raise revenue to pay for government.

What’s my basic point?  We have ongoing, passionate debates about taxes, but I don’t think we, as a public, understand the tax system as a whole and we really do not have a solid grasp on what we are individuals actually pay.  I think this contributes to a rather imperfect debate, to be sure.  I am not arguing that better understanding would lead to a particular outcome in terms of the policy debate (i.e., in favor of more, less, or the same levels of taxation), but I am increasingly convinced that we are talking about a system that doesn’t actually exist.

Fundamentally, the problem here is that we really have no idea what a given change in tax policy would actually cost us.  We just know that we don’t want to pay more taxes, even if we are a bit unclear on what we (and other people) actually pay.  This is not a helpful baseline for debate.

At a minimum, the fact that we need armies of tax preparers every year (either the human kind or the software kind) tends to suggest that we, as a public, do not understand the taxes we are paying.  Perhaps Congress ought to be focusing on fixing that problem (nd no, I shan’t be holding my breath in that regard).

—-

*And yes, any given reader may well know all of these details intimately.  My assertions, however, has to do with the general level of knowledge on these matters.

**My guess was 35.5 cents per gallon.  The magic of the Googletubes tells me, in fact, I pay 36.4 cpg (18.4 for the feds and 18 for Alabama)—although counties can levy up to an addition 5 cpg and cities can add .5 to 4 cpg (source).  Indeed, upon consulting with the state’s web site (see here), it looks like a I normally pay a total of 41.4 cpg.

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Steven L. Taylor
About Steven L. Taylor
Steven L. Taylor is a Professor of Political Science and a College of Arts and Sciences Dean. His main areas of expertise include parties, elections, and the institutional design of democracies. His most recent book is the co-authored A Different Democracy: American Government in a 31-Country Perspective. He earned his Ph.D. from the University of Texas and his BA from the University of California, Irvine. He has been blogging since 2003 (originally at the now defunct Poliblog). Follow Steven on Twitter

Comments

  1. I spent a semester of Law School studying Income Tax and I’m not even sure I understand it sometimes. Not to mention the fact that a good portion of what I learned in 1993 isn’t even applicable anymore.

  2. […] me@OTB:  Do we Even Understand Tax Policy? addthis_url = 'http%3A%2F%2Fwww.poliblogger.com%2F%3Fp%3D19678'; addthis_title = […]

  3. john personna says:

    There is something odd about a tax system that produces the above outcome.

    Sure, but it’s also worse than that, because AGI does not include tax exempt income (muni bonds, the ancient refuge of the rich)

  4. john personna says:

    Though, the alternative minimum tax is older than I remember (enacted in 1969). Its impact fades somewhere between well off and rich.

  5. Tsar Nicholas says:

    Well, given the state of left-wing, public sector “eduction” it’s doubtful the general public understands the difference between shit and Shinola, much less relative tax burdens, how taxes actually are paid, etc., etc.

  6. Drew says:

    Excellent post, this is an important topic.

    However, I think the swipe at tax views as theology is misguided. Not for an important subsection of taxpayers- see below. I believe you are absolutely correct that most W-2 people – just as they buy a house geared to the monthly payment – gear to the net paycheck. “I make $70K” eventually translates to an intutive “and so my take home is X.” They equate the two.

    I think the point you miss, especially wrt marginal rates is that employers have a very keen sense of what they pay. And I know this as a business owner, and as someone who deals with business owners basically 24/7. We make quarterly estimates, in conjunction with accountants’ detailed calculations. We pay our employees’ matching payroll taxes. As high income individuals our taxes asymptotically approach the marginal rate and so on. And because these people are the employers, and sensitive to their personal effective tax rates and the cost to employ, this has a very important impact on work, employing and investment.

    Yes, you are correct, a W-2 office worker may not be that attuned, and marginal rates may not affect their behavior, but so what, they aren’t employing.

    Two last points:

    If I might, please, skip two canards. First, citing low effective rates for people with high investment income is just a false portrayal. The investment capital had to be earned at some point, and was taxed once. That it subsequently is put at risk and earns investment income only means it is double taxed. I don’t see how taxing capital formation can be a good thing, and the notion that the rich don’t pay high taxes just wrong. Second, citing the “meme” of “half don’t pay taxes” is just a debating tactic. I don’t know any serious person who doen’t understand that any worker pays payroll taxes, every purchaser pays sales taxes and every renter and home owner pays real estate taxes. But this very website (I believe it was James) posted awhile back a study that included all tax incidence. The story is still largely the same: high income earners really pay much of the freight. To just throw out the notion of non-income taxes is not a pursuasive case or change reality.

  7. john personna says:

    Drew knows that we all can choose our level of risk, and our tax exposure. If we had enough, we could just buy a treasury bill ladder and not worry. Double taxation? No. The tax would be on the new risk-free income, not the original capital..

  8. Andy says:

    I looked at this very issue over on my own blog and I largely agree with this post. I did my own calculations and determined that my effective income tax rate was 3.5% and my total federal tax rate was 11.5%.

    Drew,

    You’re right that high income earners pay much of the freight, but that doesn’t change the fact that they are paying historically low effective rates. Everyone’s paying historically low effective rates – that’s one problem. The frequent appeal-to-consequences arguments that people like you make on the dangers of raising wealthy effective tax rates are reasonable in a world with no deficits or debt, but we don’t live in that world.

  9. JKB says:

    Well, yes, people mostly clueless about taxes. Part of that is the magic of withholding. It is the same as installment buying, people will pay more when they pay a little bit over time. It was what made the income tax palatable and fed the bureaucratic beast. Just ask the small business person who has to file quarterly and you’ll find someone who is painfully aware of the tax bite. It is revealing in how many people think their tax refund is a benefit from the government instead of a return of overpayment.

    There are two reasons they have stiff penalties for not withholding enough over the year. First, the government uses the monthly income to keep going and second, writing that check is a very edifying experience. if you couple that with the fact most people wouldn’t save to have the cash available thus experiencing the government as debt collector and the politicians would instinctively feel the lynch mob’s noose ever time they spoke of taxes.

    But then that is how the scam was organized so lamenting it now is somewhat disingenuous. Same with “payroll taxes” which were sold as Federal Insurance Contributions (the FIC in FICA). I was only when the ponzi scheme was revealed that “payroll taxes” started being bandied about.

    Just for giggles, do you know what your liquor or tobacco taxes are? I doubt it, although sometimes itemized on the sales receipt, most of the time they are in the price with only sales tax added. I see Alabama controls all the liquor sales so your liquor tax is built into the price directly as profits from the liquor sales.

  10. JKB says:

    We should add that many people have been relieved of the awareness of their property taxes by escrow, paying a monthly contribution and never actually seeing the bill or having to write the check.

    The greatest trick the tax and spenders every played was removing the taxpayers’ awareness of taxes via withholding, escrow and transaction-taxing.

  11. hey norm says:

    my effective federal tax rate is 11.25%

    drew…
    first – “…high income earners really pay much of the freight….” sure…they also hold most of the “freight”. in fact they hold a lot more, proportionally, of the “freight” than they pay.
    second – to pretend that the “half of all people don’t pay taxes” meme doesn’t exist is just disingenuous. you see it from tea baggers on this website, you here it from republican leadership, and you see it constantly on the fox propoganda channel. it is false, and yet it forms a good part of the discussion.
    third – you want to conflate investment capital and investment income and call it double-taxation. jesus-god…talk about canards. i’ll take that one with a nice blackcurrant and wine reduction. thanks.

  12. Dave Schuler says:

    most people a) do not really know what they pay in taxes, save in a very vague sense,

    The plan is working!

    I recall a study that was done that IIRC included tax lawyers, accountants, and IRS agents. They were all presented with the same tax problem. Nearly everybody gave a different (wrong) answer.

    I strongly suspect that not only is federal income tax law so complex that nobody understands it, it changes with enough frequency that nobody can understand it. I’ve mentioned it before: major overhauls in the tax code have happened roughly every 20 years. We’re due.

  13. mpw280 says:

    Since norm loves to use the gay slur can we call him an Obama ballwasher? mpw

  14. mpw280 says:

    Dave, if everyone gave a wrong answer is there a right answer? I seem to remember that the IRS people got it the most wrong as well. When GE makes 4.5 bil and pays no income tax there is obviously a problem, but then again GE has the best tax people in the US, even better than the IRS obviously. mpw

  15. @mpw:

    Actually, I would prefer that you didn’t.

    Indeed, this is a good time to remind everyone to try and refrain from the use of language that is primarily intended to inflame one’s political opponents.

    Forward the discourse, please, as opposed to simply going the playground (or worse) route.

    Thanks.

  16. My guess is, if you ever ran a business you know a lot more about the variety and levels of taxation than you do now.

  17. Dr. Schuler, the situation you describe is, of course, true and should be anathema to anyone who fundamentally believes in the rule of law. When the law is utterly ambiguous to even the professionals and may be selectively enforced according to whatever criteria someone with power decides, may I suggest that the word tyranny isn’t exactly out of order.

  18. James Joyner says:

    @JP: “Though, the alternative minimum tax is older than I remember (enacted in 1969). Its impact fades somewhere between well off and rich.”

    Clearly, I’m just this side of “well off” as the AMT hits us like a sledgehammer every year. We basically lose all our deductions, including the write-off for dependent children and for child care, because of it. I don’t have any heartburn with my overall rate of taxation–which is higher than I’d like but somebody’s gotta pay–but I hate the randomness of it all. And, as Steven notes, it means that I really have no idea how much we’ll owe in income taxes for a given year until months into the next year.

  19. @Charles:

    My guess is, if you ever ran a business you know a lot more about the variety and levels of taxation than you do now.

    This is, no doubt, the case.

    However, that really isn’t the point.

  20. Drew says:

    jp –

    You may be surprised, but you are actually close, in my opinion, to the only argument that could even be close to being viable. I still think you are wrong – its double taxation. The money could be put into a mattress and never get taxed twice. You are wrong by definition.

    But the issue turns on the effects and neccessities of various forms of taxation. eg Property taxes are taxes on previously earned income – but we do it to get a service: schools, sewers. Its really a user tax.

    But you selected a narrow investment vehicle in your example – the academically so called “risk free” investment. Given the inflationary environment, do you really consider it risk free?? Given that inflation is government induced, do you really not consider it a tax??

    And given the need to avoid capital depreciation, is there not the need to put the capital at (traditional) risk? And why, again, is taxing risk capital a good thing?

  21. Patrick T. McGuire says:

    Perhaps Congress ought to be focusing on fixing that problem …

    The solution to all this, and more, is the Fair Tax.

  22. Dr. Taylor, ok. I think it is a little obfuscating to use “we” so much. It is clear from the examples provided and plenty of personal anecdotal evidence that the experts don’t — and more importantly, can’t — determine the effects of any changes to taxation, so what chance do “we” have? Is it necessary that “we” understand it? Hell, we can’t even get the members of Congress to read legislation before passing it, much less understand it.

  23. Dave Ely says:

    Hey Drew

    I spent money saved from taxed income to start my business. Does that mean that the income I make from my business shouldn’t be taxed? Or should I be taxed because in addition to risking my capital, I also work to make sure there is a return?

  24. The greatest trick the tax and spenders every played was removing the taxpayers’ awareness of taxes via withholding, escrow and transaction-taxing.

    Escrowing property taxes isn’t about increasing government spending. It’s about secured lenders (quite sensibly) wanting to make sure the secured asset doesn’t get seized because the mortgagee didn’t bother to pay their taxes. If the mortgage processor is paying them, they know they’ve been paid.

  25. Also in re: escrow accounts and property taxes, it is a pretty transparent process. It is hardly as obscure as figuring out one’s effect tax rate.

    My mortgage holder pays my taxes, but I get a statement every year from the county, plus I get an escrow account statement that details what I have paid in and what has been paid out.

  26. lunaticllama says:

    there’s no problem. economic elites have lobbied successfully to ensure that they pay low taxes. thus, capital is taxed at a lower rate than labor. this is no secret, and why anyone would wonder why this happened is refusing to look in the mirror. there’s nothing mysterious about it, and our media tax debate is continually obsessed with ensuring that things remain as they are.

  27. Drew says:

    Andy –

    “Everyone’s paying historically low effective rates – that’s one problem.” I assume this is in reference to a current fallacy making the rounds. In fact Doug M posted here an essay on it, citing some prof, and I had a go-round with Johnny P on it, to no productive result. I think JP’s ego won’t allow him to admit he got completely snookered. Let me try with you.

    This prof cited taxes to GDP as his measure and declared that we were paying at historically low levels – like 1950 or such. Let me just tell you that taxes as a percentage of personal income have doubled in the same time frame cited by the prof. An inquiring mind probably would want to reconcile this. We shall return to this.

    GDP is a spending concept. So we must ask what drives spending. And that’s where the problem arises. Spending is generated not only by earnings or personal income, but borrowing. So that it what the nation has done, its created GDP by borrowing and hanging a liability up on the balance sheet. To measure taxes to GDP ignores this. To someone like me, in finance, I got a belly laugh at the prof’s assertion. Perhaps it more difficult for others. Let’s personalize it.

    You are an Average Joe making an income, and using it to pay taxes, rent an apartment, buy food, clothes etc. You have a personal, or “family GDP.” If you save 4%, then the balance of your income finances the spending I just cited. Now. Suppose you get a wild hair and buy a $500K home, and a $50K car. You time finance it – you borrow. Now your “personal GDP” skyrockets, and your income to GDP plummets, as does your tax (a subset of income).

    Let me ask you a question, are you now suddenly undertaxed, after all, your tax to GDP ratio is low?? Could you go to your boss and say “my income to GDP ratio is at an all time low, I need a raise?” I’m thinking not.

    Anyone who understands accounting – there is both an income statement and balance sheet, or corporate finance, would look at this profs argument and just scoff, as I did.

    I don’t know if the prof was an English major, heh, or maybe a children’s book author, but if he’s a finance guy he should know better and we can only assume he’s an idiot, or a crook. Not good.

    Let’s get real people. Taxes are not at an all time low.

  28. Drew says:

    “Hey Drew

    I spent money saved from taxed income to start my business. Does that mean that the income I make from my business shouldn’t be taxed? Or should I be taxed because in addition to risking my capital, I also work to make sure there is a return?”

    Hey Dave Ely –

    The capital account in the equity section of your balance sheet should not be taxed. Your salary income should be taxed at OI rates, and corporate tax rates should be eliminated completely.

    Get back to me when you have something original, interesting and not so damned light to say.

  29. john personna says:

    Re. Risk, bonds and inflation. Investment advisers woul have us look at historic returns.

    Yes it would suck to try to establish a ladder today, but it might be nice owning a ladder established years ago.

  30. Hey Norm says:

    @mpw280…
    I repeat…I did not ask these folks to wear tea bags dangling from their hats. If you feel it is a gay slur that is a bias you bring to the party and I have no control over your biases. This us a complex world and words have many meanings. for instance drew’s canard about doubl-taxation…canard in French is duck. you silly goose.

  31. john personna says:

    (I do find the double taxation argument, on this, unconvincing. But enough folks seem to be on it 🙂

  32. Andy says:

    Drew,

    I’m am not using GDP as a basis for calculating the tax burden, but effective tax rates. Also, I’m only considering federal taxes because, obviously, state and local taxes vary widely.

    By that measure – effective federal tax rates – the tax burden for all income brackets is historically low. These numbers only go to 2005, but the Obama cuts reduced taxes for many people even further.

    Now, those are aggregate numbers and there is some year-to-year variability, especially with the top earners. I’m sure there are discrete groups of people who, because of circumstances, are paying higher effective rates than they used to. That kind of underscores the entire point of Steven’s post – effective tax rates are highly circumstantial in some cases, especially when state and local taxes are added to the mix.

    I don’t think, however, it’s possible to look at the CBO data on historic effective federal rates and conclude that they are anything but low today.

    The fact of the matter is that I think everyone is going to have to kick in some more to help get us out of this mess we’re in.

  33. Andy says:

    and by “low today” I mean “low relative to what they used to be.”

  34. Steve Verdon says:

    Norm,

    Please stop using the term tea bagger.

    Thanks.

  35. Drew says:

    Andy –

    Sorry, that’s just arithmetically incorrect.

  36. Drew says:

    Steve V –

    Unsolicited advice. Attempting to debate with Hey Norm, mantis, ponce, anjin etc will be about as productive and intellectually rewarding as debating a turnip. Notice I basically don’t engage with these guys.

    JP, Reynolds (and your colleagues Taylor, Mataconis, Knapp etc) often aren’t my cup of tea, but I read, respect and consider what they have to say. That said, I sure wish Reynolds would cease and desist on the racist thing. Boring, and publicly embarrasing for him. Whatever…

  37. Andy says:

    Drew,

    What is incorrect? Effective tax rates have gone down. If you have some data to show demonstrating something different, then show it.

  38. john personna says:

    My opinion was that when “tea bagger” was painted by a perverse fringe meaning, mainstream conservatives should have said “you’re sick, get out of here.”

    It was a strategic error, stemming from an odd kind of insecurity. I mean, I still buy tea bags (thought I think loose leaf superior). I haven’t been scared away.

    Now, I don’t say “tea bagger” … but that’s just because I just feel sorry for tea partiers who let that one run away from them. It’s incredibly weak of them to feel injured by it. But again, I can be kind.

    John, the Loose Leafer

  39. Steve Verdon says:

    I strongly suspect that not only is federal income tax law so complex that nobody understands it, it changes with enough frequency that nobody can understand it. I’ve mentioned it before: major overhauls in the tax code have happened roughly every 20 years. We’re due.

    I think this is a good summary of the problem with trying to understand taxes. Marginal rates are important when it comes to actions that can increase one’s income. All economic decisions are made at the margins you look at the marginal cost vs. the marginal benefit and decide to go ahead or not, at least ideally.

    Increasing the marginal tax rate increases the marginal cost meaning you’ll have less economic activity than if the marginal rate was not increased. In theory.

    Another point, the top marginal rates are at a level where the elasticity of taxable income suggest these rates are far from the top of the Laffer curve. Thus, further tax cuts will not result in additional revenues.

    Research by leading tax policy experts Emmanuel Saez and Joel Slemrod have this as one of their conclusions,

    Nevertheless, the essential insight underlying the ETI [elasticity of taxable income] remains valid: that income tax rates cause taxpayers to respond on a wide range of margins and, under some conditions, all of these responses reflect inefficiency, because they would not have been undertaken absent the tax rates. This is especially true of high-income, financially savvy taxpayers who in most countries have access to sophisticated tax avoidance techniques. There is clear evidence of responses that would fall in the first two tiers of the Slemrod (1995) hierarchy–timing, shifting, avoidance–based on U.S. evidence since 1980, but only at the top end of the income distribution.–link

    In other words, changes in the tax rates do change people’s behavior and this results inefficiencies that will both lower economic output (taxpayer welfare) and tax revenues.

    None of this is to say we shouldn’t increase taxes. We are in a precarious fiscal situation. Problem is I’m worried that if we do increase taxes the spending cuts will not materialize. We really do need both.

  40. Steve Verdon says:

    Drew,

    I have editing rights to every comment here. If Norm really wants to get into a pissing contest he will lose.

  41. john personna says:

    So do you drink, Steve?

    Reeeeallllly a bad precedent to make a rated-G beverage product off-limits at OTB.

    You know, just because some sickos have an alternate meaning.

  42. john personna says:

    (lols, maybe you should demand they be taken off the shelf at your local super.)

  43. Hey Norm says:

    Drew…
    You claim of double-taxation is just flat out wrong…period. I’m sure engaging me on your error would be frustrating. I see why you would avoid it.
    Steve V…
    As for any imagined “pissing match”…well I’m sure you are flattered.

  44. Hey Norm says:

    drew…your also wrong about effective tax rates not being at a near all-time low. Again, if I were you I wouldn’t engage on that either.

  45. tom p says:

    Do we Even Understand Tax Policy?

    have not read the post, have not read ANY of the comments, yet somehow, someway… I feel very safe in answering “No.” The world is very easily divided into those who don’t understand, and those who only think they understand.

  46. Pete says:

    Once in this thread the Fair Tax was mentioned. It would be very interesting to have a debate on the Fair Tax here at OTB.

  47. john personna says:

    Pete, doesn’t the Fair tax rely a bit on this confusion? People don’t understand what they’ve got, but are promised a “fair” alternative, which is pretty ill-defined.

    I personally don’t want to go through the Fair Tax debate, because anything offered by idealists now would be watered and corrupted long before it make it to mainstream discussion. And certainly by time it got passed it would be as riddled by concessions.

    No, I’d rather work on reducing the concessions and loopholes in the current tax code.

  48. Patrick T. McGuire says:

    …doesn’t the Fair tax rely a bit on this confusion?

    Only if you choose to be confused. The Fair Tax is actually quite simple if you spend a few minutes to learn about it.

  49. Pete says:

    JP, McGuire is correct. The name was adopted because the concept is the “fairest” method of taxation to be proposed. You shouldn’t default to the Idealistic label because it is the most researched tax “reform or replacement” idea to date. Simply put, it taxes consumption rather than income. Isn’t the biggest problem of the income tax the ability to determine WHAT is income? Why else do we have the IRS code with 70,000 pages and millions of words? So, keep an open mind when considering an alternative to the monstrous income tax code.

  50. Hey Norm says:

    I don’t know anything about fair tax but maybe someone can help me understand how a tax on what you consume…when lower and middle income folks consume with all or most of their income and upper income folks consume with a fairly small portion of their income…is fair?

  51. Pete says:

    Norm, the Fair Tax was written to provide reimbursement to every registered household, rich and poor, for the Fair Tax on necessities. Simply put, people living at or below the poverty level would pay NO tax, because the Fair Tax on necessities, would be rebated. Also, since the Fair Tax would not be implemented without a repeal of the 16th amendment, all federal income taxes would be abolished and FICA taxes would no longer be withheld. So all W-2 earners would receive their gross pay.

    How many people avoid paying income taxes today? Rich people with avoidance schemes, underground economy, people and corporations who earn money overseas and leave it there to avoid the highest corporate tax rate among developed countries, criminals, illegal immigrants, etc? But everybody consumes; the Fair Tax only taxes new goods and all services. Used goods are not taxed. Rich people who pay 15% in income taxes due to loopholes, etc. would pay the Fair Tax rate on new goods and all services (23%) Poor people today may not pay any income tax, but they pay FICA. They wouldn’t pay FICA under the Fair Tax.

    The concept is so outrageously simple and fair that any open minded person should find the idea very appealing. People who denigrate it are largely those who would relinquish the power to game the IRS code for their own selfish benefit. Since you seem interested by your response, I urge you to go to: http://www.fairtax.org and click on About the Fair Tax link, then the reearch papers link and enlighten yourself.

  52. Hey Norm says:

    Who determines what are necessities? Just playing devils advocate…that doesn’t seem so simple.

  53. Pete says:

    The department of Health and Human Services decides the poverty level for different size households. That level includes whatever they decide the basic necessities cost: food, housing, medication, etc.

    To elaborate further on your earlier question, I have copied and pasted from the Fair Tax site a more expanded explanation of why the Fair Tax is considered progressive:

    The FairTax actually eliminates and reimburses all federal taxes for those below the poverty line. This is accomplished through the universal prebate and by eliminating the highly regressive FICA payroll tax. Today, low and moderate income Americans pay far more in FICA taxes than income taxes. Those spending at twice the poverty level pay a FairTax of only 11.5 percent — a rate much lower than the income and payroll tax burden they bear today. Meanwhile, the wealthy pay the 23 percent retail sales tax on their retail purchases.

    Under the federal income tax, slow economic growth and recessions have a disproportionately adverse impact on lower-income families. Breadwinners in these families are more likely to lose their jobs, are less likely to have the resources to weather bad economic times, and are more in need of the initial employment opportunities that a dynamic, growing economy provides. Retaining the present tax system makes economic progress needlessly slow and frustrates attempts at upward mobility through hard work and savings, thus harming low-income taxpayers the most.

    In contrast, the FairTax dramatically improves economic growth and wage rates for all, but especially for lower-income families and individuals. In addition to receiving the monthly FairTax prebate, these taxpayers are freed from regressive payroll taxes, the federal income tax, and the compliance burdens associated with each. They pay no more business taxes hidden in the price of goods and services, and used goods are tax free.

    How can the FairTax generate lower net tax rates for everyone and still pay for the same real government expenditures? The answer is two-fold. Firstly, the tax base is dramatically widened by including consumer spending from the underground economy (estimated at $1.5 trillion annually), and by including illegal immigrants, those who escape their fair share today through loopholes and gimmicks. In addition, 40 million foreign tourists a year will become American taxpayers as consumers here. Secondly, not everyone’s average net tax burden falls. For households whose major economic resource is accumulated wealth, the FairTax will deliver a net tax hike compared to the current system.

    Consider, for example, your typical billionaire, of which America now has more than 400. These fortunate few are invested primarily in equities on which they pay taxes at a 15 percent rate, whether their income comes in the form of capital gains or dividends. In addition to having the income from their wealth taxed at a low rate, the principal of their wealth is completely untaxed either directly or indirectly. Assuming they and their heirs spend only the income earned on the wealth each year, the tax rate today is 15 percent. In contrast, under the FairTax, the effective tax rate is 23 percent. Hence, the very wealthy will pay more taxes when the FairTax is enacted. In a nutshell, those who spend more will pay more but low, moderate and middle income taxpayers will benefit from the greatest gains in reduced tax liabilities.

  54. john personna says:

    Pete, your explanations make me feel harsher on the Fair Tax, not gentler.

    First, can you imagine the lobbying to get on your “necessities list?” Can you imagine the bureaucratic nightmare in maintaining it?

    Second, can you imagine the immediate pull-back in consumption of non-necessities? It would be a bit of a whack to the economy, wouldn’t it? You tax something you get less. You tax consumption you get less (and more savings, which would be good in a longer term sense).

    Third, after these adjustments, calculating a poverty cut-off, excluding necessities, and so on, you need to set a consumption tax rate high enough to cover the budget.

    You need to bring in something like the approx $600B now generated by income tax.

    No one knows how to do that. BS numbers thrown around for Fair Tax are wild ass guesses, that only “work” because no one is looking at them seriously.

  55. Pete says:

    JP, please perform due diligence by studying the bill. Don’t rely on my possible poor choice of words or confusing explanation. What you described is not the case at all.

    There is no lobbying to identify necessities. The necessities thing, as I understand it, is more of a way to describe what goes into the HHS calculation for poverty level income. It is done today; it will be nothing new.

    Yes, this would influence behavior, but the behavior would be more beneficial to the long term financial health of the economy and the long term health of families. Please give it a brief read and some of your concerns may prove empty.

    The research has shown that the tax is revenue neutral (it will bring at least as much as the income taxes do).

    The rate of 23% was chosen before the current financial mess and Congress would have the power to change the rate. Right now, there are embedded taxes in the price of everything we buy, from withholding, FICA, income tax compliance costs, tax avoidance, underground economy, etc. The research has shown these embedded costs to approximate 22%-28%. So these costs would go away under the Fair Tax and be replaced by a 23% Fair Tax.

    I could go on and on, but I have a business to run and will get back to you later today if you want to continue. Please do a little homework before we continue.

    Thanks, Pete

  56. john personna says:

    As I say, I don’t think Fair Tax is on the real horizon, and won’t waste too much time. But …

    The research has shown these embedded costs to approximate 22%-28%. So these costs would go away under the Fair Tax and be replaced by a 23% Fair Tax.

    Good lord. Magic?

    We replace a 22% to 28% tax with a 23% tax and come out ahead? $600B ahead?

  57. Pete says:

    The tax base expands as many people who do not pay into income tax today will be paying into it. Income sheltered overseas because of high corporate tax rates will be come back to be invested. Did you read my earlier copy and paste? Rich people who pay little in income tax or the dividend/cap gain rate will pay 23% and they do buy expensive, new things. There are states which fund the majority of their budgets from sales taxes; not income taxes. The concept is sound, yet the practical application does present some hurdles. If you are satisfied with the income tax and the way it is used to reward friends and punish enemies, as well as punish achievement, then perhaps the Fair Tax is not your cup of tea.

    There are people in this country who want a better future for their grandkids and beyond. They are willing to have an open mind to new ideas. I hope you are one.

    Okay, if you do not want to learn more, that’s fine. But don’t criticize something you don’t understand. And you don’t understand it at this point.

  58. Patrick T. McGuire says:

    You tax something you get less.

    Which applies to business activity as well which means less tax revenue.

    you need to set a consumption tax rate high enough to cover the budget.

    Or, even better, set a budget that doesn’t exceed revenues.

    BS numbers thrown around for Fair Tax are wild ass guesses, that only “work” because no one is looking at them seriously.

    There are no “wild ass guesses”, this has been extensively researched by people who have an open mind. I guess this is why you find it hard to accept?

  59. john personna says:

    Maybe you misspoke on this bit:

    Right now, there are embedded taxes in the price of everything we buy, from withholding, FICA, income tax compliance costs, tax avoidance, underground economy, etc. The research has shown these embedded costs to approximate 22%-28%.

    If those embedded taxes are indeed in the price of everything we buy, then we already have a consumption tax. You’d be increasing it additively by another 23%?

  60. Pete says:

    I don’t follow your logic. The Fair Tax is paid when a person BUYS something. The embedded costs are associated with the income tax so a person pays taxes when they earn something. Please do your research. There can be no intelligent debate if one party is not prepared with knowledge. I’m certain you went to college. Were you prepared to understand and debate with your instructor without reading the text book?

  61. Pete says:

    JP, sorry, I should say that the embedded costs go away as they are a product of the income tax system. A consumption tax is paid when something is purchased. An income tax is paid when income is earned. Nothing has to be purchased. The embedded costs are a part of the price of everything that is priced for sale. Under the FT proposal, they are replaced by the Fair Tax. The idea being that funding the government is done by taxing consumption, which provides a larger base than income. People will consume by using savings and credit if income is lacking. So the source of available capital used in consumption would actually be less susceptible to income shocks.

  62. john personna says:

    I see now. Yes, part of that list is existing tax.

    And on one level I get your frustration with my casual comments. It’s just that it really seems a superficial glance is enough to spot the “freebies” claimed for Fair Tax.

    It would certainly be possible to replace an income tax of X with a consumption tax of Y. I just think the Free Tax movement is driven by fantasy of a low Y. Or, a free lunch in Y.

    It sure would put the whammy on new car sales, wouldn’t it?

  63. Pete says:

    Yes, it would have certain effects like that. Overall, the idea is supposed to improve the method of tax collection. The IRS tax code today wastes hundreds of billions of dollars of resources.

    Not sure what you mean by the Free Tax movement, but there is nothing free about the Fair Tax; except that taxpayers would be freed from filling out tax forms. The Fair Tax would be noted on the receipts generated by the cash register; just like you see today for state sales tax.

  64. Patrick T. McGuire says:

    It sure would put the whammy on new car sales, wouldn’t it?

    Actually, it should increase new car sales. First, because the end cost of the car would remain the same (a car that costs $30,000 today would cost ~$24,400 after the embedded taxes are removed and then when the consumption tax is added, the purchase price becomes $30,012) and second because people would have more disposable income since they get their paychecks without any withholding.

    More car sales (as well as sales of all other products) means greater production, more jobs, growing economy, etc.

  65. I am amendable to considering the consumption tax idea, although I must confess I am certain that it is a political non-starter and therefore figure the focus should be on income tax reform.

    Having said that, I the following a bit polyannish:

    First, because the end cost of the car would remain the same (a car that costs $30,000 today would cost ~$24,400 after the embedded taxes are removed and then when the consumption tax is added, the purchase price becomes $30,012)

    How do we know, with any accuracy, what the embedded taxes are for a given product, and more especially, can we really count on the retailer to take all of said embeds out of the price of their products? I am not convinced of that fact.

    Indeed, the idea that we would see wholesale price reductions if we changed the tax system strikes me as wishful thinking.

  66. Pete says:

    Steven, embedded taxes are comprised almost wholly of income tax code related items/effects. Embedded costs are withholding, FICA, cost of compliance with tax code (accountants, tax lawyers, tax planning departments in large companies, cost of thousands of IRS agents and associated infrastructure), tax avoidance, sheltering, credits.

    If the income tax code goes away, why wouldn’t these embedded costs go away?

    Yes, this idea is a longshot politically, but that is because the politicians make it so. It is not an idea that needs to be left to politicians. They recoil at the idea of losing their favorite influence casino. Do we not all want a more efficient government? Tax collection under The Fair Tax would be much more efficient. Steven, tax reform left to the politicians is not gonna cut it.

  67. hey norm says:

    i’m sure it would increase car sales in the same way that tax cuts pay for themselves. (please read tha ppropriate amount of sarcasm into that)

  68. Patrick T. McGuire says:

    How do we know, with any accuracy, what the embedded taxes are for a given product, and more especially, can we really count on the retailer to take all of said embeds out of the price of their products? I am not convinced of that fact.

    Indeed, the idea that we would see wholesale price reductions if we changed the tax system strikes me as wishful thinking.

    As for the amount of the embedded taxes, there has been extensive research on this matter going back several years by respected economists. A few books have been written on the subject and the Fair Tax has its own web site with more information on this topic.

    Now, as for the wholesale price reductions, this will happen but only if the government allows the free market to work. After the Fair Tax becomes effective, demand for products will increase due to the increase in disposable income. Manufacturers, retailers, etc. will be eager to capture as much of this new demand as possible and any seller who fails to reduce its price back to a normal profit margin level will lose out to its competitors.

  69. @Pete:

    If the income tax code goes away, why wouldn’t these embedded costs go away?

    Because retailers would want to keep the increased profit that would result from not having to pay those costs.

    Sure, I could see some price reduction in hopes of attracting buyers given the increase in price due to the consumption tax.

    The notion that they would take all the embedded costs out of the price of their goods is incredibly optimistic.

  70. Pete says:

    Indeed, the idea that we would see wholesale price reductions if we changed the tax system strikes me as wishful thinking.

    No we would not see wholesale price reduction. Employees would want their gross pay so their checks would reflect the embedded costs which would initially prevent employers from reducing prices. Yet, the employer matching portion of the FICA withholding would go away, so there is some room to reduce prices.

  71. Pardon–bad choice of words. I meant “wholesale” as in “widespread”

  72. Pete says:

    Steven:

    Because retailers would want to keep the increased profit that would result from not having to pay those costs.

    Yes, until one retailer decides he wants a price advantage, then unless there is collusion, the market will adjust prices downward. Steven, I hope you are a free market advocate.

  73. Pete says:

    Steven:

    Sure, I could see some price reduction in hopes of attracting buyers given the increase in price due to the consumption tax.

    What do you mean an increase? Why do you think there would be an increase?

  74. Pete:

    Yes, until one retailer decides he wants a price advantage, then unless there is collusion, the market will adjust prices downward. Steven, I hope you are a free market advocate.

    Free markets are keen.

    However, that doesn’t mean that all of this will work as neatly as your describe.

  75. What do you mean an increase? Why do you think there would be an increase?

    If something is taxed by 23%, I am pretty sure that means I would be paying 23% more than if it wasn’t taxed. As such, the purchase price would be increased versus what it would have cost sans the tax.

  76. Pete says:

    Of course not. Does the income tax work well? Is it efficient? How much money is wasted trying to track and account for income? Do you have a better idea?

  77. Pete says:

    Steven;

    If something is taxed by 23%, I am pretty sure that means I would be paying 23% more than if it wasn’t taxed. As such, the purchase price would be increased versus what it would have cost sans the tax.

    Steven, Steven, Steven. I’m afraid you have listened only to the detractors. Embedded costs approximate 22.5% of the price at retail. Eliminating them and replacing that cost with a 23% consumption tax is the way this idea works. There should be no pressure to raise prices, except to respond to the increased purchasing power of people who now have more disposable income.

  78. Pete, Pete, Pete,

    You are assuming a perfect (and in my mind magical) substitution of the embedded costs for the fair tax costs. I, however, am assuming that retailers will try to have as much of their cake and eat it too. This strikes me as a reasonable assumption.

  79. john personna says:

    “Free Tax” was a brain wave, but shaped by the way I look at the political motivation.

    For what it’s worth, I’ve always lived way below my means, and some years with totally crazy savings rates. It certainly would have benefited me to be taxed only on what I bought, and not when my options vested. Of course the government would have been short quite a few bucks.

    And in terms of “fair,” yes, large families making much less would have been paying much more than me in those years.

  80. Pete says:

    What is magical about embedded costs caused by the income tax code going away if the income tax goes away?

  81. Patrick T. McGuire says:

    Free markets are keen.

    However, that doesn’t mean that all of this will work as neatly as your describe.

    It works that way today. Why else can I today buy a new laptop for $300 when not long ago they were 2-3 times that much? It might take a bit of time, but sellers will be tripping all over themselves in being the first to reduce their prices to capture as much of the new demand as possible.

  82. Really, the whole thing is magic:

    1) My income and payroll taxes go away, leading to a massive increase in my take-home income.

    2) The price I pay for things will be basically the same, because “the embedded taxes” come out and then the price goes up roughly the same amount.

    Ergo: I pay the same for things that I pay now, but have substantially more money to spend and the government has plenty of money.

    This sets off the “if it’s too good to be true” alarms.

    Further, how do you guarantee that the amount of taxes collected via consumption equal the amount of taxes collected via paychecks?

  83. Pete says:

    Steven, I would love to continue this today or any other day, but I must go earn a living. I emailed James about bringing this up as a topic, and maybe between you two, if you are truly interested, you two can give it a brief study and introduce it here.

  84. Patrick T. McGuire says:

    I, however, am assuming that retailers will try to have as much of their cake and eat it too. This strikes me as a reasonable assumption.

    Or, in other words, you are assuming that sellers will be greedy, right? What, as if they aren’t now? Every seller needs to have customers in order to make any money and if they price themselves out of the market, they lose. The converse of this is the greedy seller who undercuts his competitors in order to steal customers from them, expecting an increase in market share to more than make up for the decrease in price. But then, they are all greedy and so effectively keep each other in check.

  85. @Patrick:

    What I am assuming is that the notion that there will be a perfect swap from the aforementioned “embedded costs” for the new Fair Tax costs strikes me as radically simplistic.

  86. Pete says:

    Steven, I wish I had the time to stay here now. So, in the meantime, try: http://www.fairtax.org/site/PageServer?pagename=about_basics_main

  87. Patrick T. McGuire says:

    What I am assuming is that the notion that there will be a perfect swap from the aforementioned “embedded costs” for the new Fair Tax costs strikes me as radically simplistic.

    It may not be perfect but a lot of research has gone into this particular topic by people who are much better informed than me. I suspect in the end, assuming this tax is implemented, that the rate might need to be adjusted somewhat. But with this in mind, there is a good argument that the 23% rate might have to be reduced because the increased economic activity will generate so much tax revenue that the rate would need to be dropped.

    One particular researcher stated that the only drawback that he could find with this tax plan is that there would be too much money in the market as foreign investors would flock to this country in droves to take advantage of the tax haven.

  88. Patrick T. McGuire says:

    @Steven,

    Assuming that the Fair Tax is implemented and it’s everything we are being told, consider if you will the following:

    People who do not now pay taxes, such as foreign tourists, drug dealers, foreign diplomats, etc. would contribute to the tax through their purchases.

    Congress would no longer be able to argue class warfare tax legislation. But using class warfare as an argument, the rich would pay more in taxes because their expenditures are higher than the lower classes and the poor would receive even more money than they do now because of the prebate that is paid to them.

    People would be in control of their tax payments instead of having it forced on them. For example, the tax applies only to new items. So if someone wants to buy a car but doesn’t want to pay any tax, all they need to do is buy a used car.

    Almost everyone would see an immediate increase in their paychecks, raising their standard of living.

    And, finally, the increased demand caused by this plan would result in increased manufacturing and related business activity to meet the demand which in turn would create more jobs which would create more disposable money.

  89. Patrick,’

    I am not arguing that, generically, a consumption tax is harder to avoid than other types of taxes.

    And, as noted, I am not necessarily opposed to the notion.

    However, I take issue with what I would consider a magical transformation in which I get to take more money home each month, but prices remain relatively the same all while the federal government gets the same (if not more!) revenue.

  90. wr says:

    There’s one small problem with the magical car prices theory — an awful lot of autos sold in the US are manufactured outside the country. Their “embedded costs” are not going to fall one penny, since Japanese, German, Korean and other foreign autoworkers will continue under their own systems of taxation. Which means that the prices for foreign cars will jump by almost a quarter. It’s conceivable that US automakers will take the opportunity to lower their own prices so that they don’t change even with this massive new consumption tax — but it’s far more likely they’ll drop their prices much less than that, since their competition will be so much more expensive.

  91. Pete says:
  92. Patrick T. McGuire says:

    It’s conceivable that US automakers will take the opportunity to lower their own prices so that they don’t change even with this massive new consumption tax — but it’s far more likely they’ll drop their prices much less than that, since their competition will be so much more expensive.

    It’s also conceivable that the foreign manufacturers will rush to build their products in the US since they won’t be paying taxes on their profits, which will end up making their products no more expensive than they are today. Already today you have foreign car manufacturers with plants in the US (Toyota, Hyandai, BMW, etc) and they would probably increase their presence in the US for their own good.

  93. wr says:

    Yes, and it’s also possible that magical car fairys will give Range Rovers to every good boy and girl. That’s the trouble with this “fair tax” — it rests on assumptions that ever human being will suddenly stop acting like a human being and start acting like the mythical rational economic person.

  94. Patrick T. McGuire says:

    That’s the trouble with this “fair tax” — it rests on assumptions that ever human being will suddenly stop acting like a human being and start acting like the mythical rational economic person.

    On the contrary, it assumes that all people are greedy and will act in their own self interest. Companies look for every way possible to decrease costs, increase sales, and maximize profits. The Fair Tax affords them a great opportunity to do just that, an opportunity that isn’t available elsewhere. They will be able to buy their resources cheaper, have a larger market with more disposable income and not pay any tax on their income. They won’t be able to resist that combination.

  95. Just one more observation, it appears that proponents of a VAT never seem to factor in the costs of adminstering it to all those affected. It’s as though the pixie dust of good intentions magically removes all the productivity drags of any actual implementation.

  96. john personna says:

    On the contrary, it assumes that all people are greedy and will act in their own self interest.

    Oh, for the days when we hoped for enlightened self-interest.