Unfair Criticism of the Fair Tax
Regular readers know that I think the flat tax is the more astute tax reform option, but I admire the Fair Tax because it has the same pro‐growth features as a flat tax (low tax rate, no double‐taxation of saving and investment, no special loopholes, etc). As such, I feel compelled to offer a partial defense against Bruce Bartlett’s anti‐Fair Tax column in the Wall Street Journal. Bruce notes some of the political obstacles to a national sales tax, and I largely agree with those observations, but Bruce also says that Fair Tax advocates are wrong to advertise the “tax‐inclusive” rate. It is true that ordinary Americans think of “tax‐exclusive” rates when looking at state sales taxes, but the Fair Tax people are seeking to compare their proposal to the current income tax, which is calculated on a “tax‐inclusive” basis. So while it’s true that sales tax advocates should not let people assume that the Fair Tax is calculated the same way as a state sales tax, this does not mean the “tax‐inclusive” rate is not an appropriate measure when looking to overhaul the tax code. Bruce also cites the revenue estimates of the Joint Committee on Taxation as if they were carved on stone tablets, but the JCT has a long track record of inaccurate predictions because of their assumption that tax policy has no affect on economic growth. Using the JCT as an authority is akin to letting the other side serve as both player and umpire:
In reality, the FairTax rate is not 23%. Messrs. Linder and Chambliss get this figure by calculating the tax as if it were already incorporated into the price of goods and services. (This is known as the tax‐inclusive rate.) Calculating it the conventional way that every other sales tax is calculated, with the tax on top of the price, yields a rate of 30%. (This is called the tax‐exclusive rate.) The distinction is confusing, but think of it this way. If a product costs $1 at retail, the FairTax adds 30%, for a total of $1.30. Since the 30‐cent tax is 23% of $1.30, FairTax supporters say the rate is 23% rather than 30%. …professional revenue estimators have always concluded that a national retail sales tax would have to be much, much higher than 23%. A 2000 estimate by Congress’s Joint Committee on Taxation found the tax‐inclusive rate would have to be 36% and the tax‐exclusive rate would be 57%. In 2005, the U.S. Treasury Department calculated that a tax‐exclusive rate of 34% would be needed just to replace the income tax, leaving the payroll tax in place. But if evasion were high then the rate might have to rise to 49%. If the FairTax were only able to cover the limited sales tax base of a typical state, then a rate of 64% would be required (89% with high evasion).
