In an interview published in the May 1956 issue of U.S. News & World Report, T. Coleman Andrews, the former director of the Internal Revenue Service for the Eisenhower Administration, was asked why he felt the income tax was unfair. His answer was both surprising and pure Lockean/Jeffersonian in tone:
“I don’t think it’s fair because of the manner in which it is applied. I don’t think it’s fair because I object to invasions of the people’s right of property by the Government. I also think the discriminatory manner in which the rates are graduated is unfair” [emphasis added].
In his answer to the follow up question, “Do you believe in the principle of the capacity to pay?”, he pointedly rejected this Marxist tenet which is the basis for an income tax system:
“No, I don’t. I don’t believe he” [i.e., a man who earns more] “ought to be penalized by being required to pay nearly 50 times more on only 10 times more income,…I don’t believe we ought to take it away from people just because they’ve earned it. I don’t think we ought to use tax legislation to enforce social ends” [emphasis added].
Mind you, these comments did not come from a “tax protester” but from one who was responsible for the enforcement of the regulations pertaining to and the collection of income taxes! Yet, the irony behind those promoting the income tax is precisely that it is the only way in which taxation can be made fair. The question to be posed to such individuals remains ─ “Fair for whom?” Certainly not to those who are taxed more heavily in an inverse proportion to their endeavors! As I have pointed out in the previous seven essays, the income tax is nothing more than a means for the fascists in Congress to tighten their grip of power upon the populace and to advance their economic-stagnating, impoverishing agenda of wealth re-distribution ─ a distribution in which the result is the complete elimination of all wealth and a reduction of the entire country to an existence characterized by mediocrity and demoralization. Such is, as I have quoted in this series, the opinions of such esteemed greats in the field of economics as F.A. Hayek and Milton Friedman.
So what is the answer? I am in agreement on one point with those who advocate for the income tax, i.e., that a government’s system of taxation should be fair. So I give you as an answer to what is a fair method of taxation ─ The Fair Tax. No, I am not being coy with that answer ─ that is the name of the proposed change to our tax system as found in the House Bill H.R. 25 and its Senate version S.296. The Fair Tax has been referred to as a national sales tax or just a plain consumption tax as Adam Smith referred to it in his classic work, The Wealth of Nations.
There are many who attack this kind of tax, yet when they do they misrepresent how it is laid out in the two bills in Congress (I will deal with these attacks in the following essay). In criticizing this method, claiming that a “sales tax” would be oppressive to those in the lower income levels, opponents who support the status quo of an income tax overlook the fact that all income taxes are equivalent to sales taxes as they are ultimately paid by the consumer ─ the only difference is the consumer is not aware of them or just how much of the tax is imbedded within their purchases. Adam Smith lays out the case for this in his section on taxes and wages in The Wealth of Nations. He points out that income taxes increase the cost to those who produce goods or render services and that the only way they can recover those costs is to pass that cost on to the consumer:
“A direct tax upon the wages of labour, therefore, though the labourer might perhaps pay it out of his hand, could not properly be said to be even advanced by him; at least if the demand for labour and the average price of provisions remained the same after the tax as before it. In all such cases, not only the tax, but something more than the tax, would in reality be advanced by the person who immediately employed him. The final payment would in different cases fall upon different persons. The rise which such a tax might occasion in the wages of manufacturing labour would be advanced by the master manufacturer, who would both be entitled and obliged to charge it, with a profit, upon the price of his goods. The final payment of this rise of wages, therefore, together with the additional profit of the master manufacturer, would fall upon the consumer….In all cases a direct tax upon the wages of labour must, in the long-run, occasion both a greater reduction in the rent of land, and a greater rise in the price of manufactured goods, than would have followed from the proper assessment of a sum equal to the produce of the tax, partly upon the rent of land, and partly upon consumable commodities….The declension of industry, the decrease of employment for the poor, the diminution of the annual produce of the land and labour of the country, have generally been the effects of such taxes….together with the profit of those who advance it, must always be finally paid by the landlords and consumers.”
Notice the points advanced by Smith in these statements regarding the income tax:
- Income taxes cause a decrease in productivity and an increase in unemployment among the poorer classes in society.
- Income taxes are buried within the price of goods and services individuals purchase.
- As a result, income taxes cause a rise in the cost of these goods and services.
- The consumer thus ultimately pays the income tax as they become part of the price of his/her purchases.
So the income tax is just as much a consumption tax as The Fair Tax, but with more insidious consequences. Thus it is that Smith gives this concluding assessment of income taxes ─ “Absurd and destructive as such taxes are, however, they take place in many countries” [emphasis added].
Although I stated that the amount of increased costs caused by the income tax are buried within the prices of all goods and services and are not as evident as a sales tax that we see printed out on our sales receipts whenever we make a purchase, thanks to millions of dollars spent on studies conducted by economic scholars at such learned institutions as Harvard, Stanford, and others, we do know what this cost is. For every $100 we spend on all goods and services we pay an average of $23 to the central government to cover the imbedded income taxes and their associated compliance costs that businesses must bear. This means then that those goods and services actually cost us only $77, but the government adds their share onto it to make up the $100 price. So not only are you having snatched from your labor an arbitrary amount in the form of income tax withholding, you are also paying for it again in the purchases you make to the tune of 23%!
So just how is the Fair Tax structured and what makes it “fair”? Let me begin by pointing out what would happen to our current tax system if the two previously referenced bills in Congress were passed and signed into law. If passed, the Fair Tax would eliminate the following taxes:
- The individual income tax
- The alternative minimum tax (AMT)
- Corporate and business income taxes
- Capital gains taxes
- Social Security taxes
- Medicare taxes (and other related payroll taxes)
- The self-employment tax
- Estate taxes
- Gift taxes
In place of all of these taxes the Fair Tax would stand as a single tax, applied to all new purchases of goods and services at a standard flat rate for everyone. As you can see, unlike the VAT (Value Added Tax) being considered by President Obama’s “Debt Reduction Commission”, the Fair Tax is a replacement tax, whereas the VAT is an additional, imbedded and hidden tax in addition to the income tax. This is a critical distinction to keep in mind as opponents try to paint it as a tax that will be on top of the prices we already pay. Such a depiction is not only patently false, but if set forth knowingly, a duplicitous lie. The result of the Fair Tax on the prices we pay for goods and services would amount to about the same as what we currently pay.
Let’s use the example of a purchase of a pair of shoes which costs $100. Out of that $100, $23 is the amount that the government takes as its “cut” in imbedded income taxes and their associated business costs. This means that the actual price you are paying for the shoes is only $77 and the remaining amount is income tax costs, or what economists term an “inclusive tax rate”. To put it another way, in order for you to have $100 to spend under a tax rate of 23%, you would have to have earned $130 ($130 * 23% tax rate = $30 in taxes; $130 earned – $30 taxes = $100 to spend on shoes). If you really want to see just how much in income taxes you are paying for that $100 pair of shoes, you should add the amount of taxes you paid out of your earnings to net out the price for the $100 shoes plus the imbedded income taxes within the cost of those shoes and you will see where you are actually paying the government $53 in income taxes for those shoes (granted, only $30 of that amount are your personal income taxes and the rest are the taxes of those who produced and sell the shoes, but income taxes are income taxes)!
With the elimination under the Fair Tax of all income-related taxes, those same shoes will still cost $77 (remember that $23 of imbedded income tax cost is no longer present in the shoes). At the checkout register you will be charged 30% in sales taxes, which comes to $23.10. When you look at your sales receipt you will see that you are right back where you were before in purchasing the shoes ($100.10) but with one huge difference ─ you no longer have to earn $130 just to net the necessary $100 to purchase the shoes! With no income tax you keep every penny you earn, pay within pennies the same amount for products and services you currently pay, and the government receives the same dollar amount in revenue! However, this is only the beginning of the boost to our economy.
Consider how much revenue is not collected by the IRS from income generated by the “underground economy”. This is a broad label that applies to everything from income generated from illegal activities (drug dealing, prostitution, etc.) to legitimate work paid for with cash that the recipient never declares, not to mention the “creative” bookkeeping entries that some businesses may employ to circumvent reporting income and paying taxes. Latest estimates on the amount of income generated in this underground economy are conservatively placed at approximately one trillion dollars – that’s $1,000,000,000,000 upon which no income tax is paid! What happens to most of that one trillion dollars? Some of what is earned by illegal immigrants is sent back to their families in their home country. Others might save some of that undeclared income, but a good portion of it is spent on products and services, and those who earn that income through illegal activities will typically spend it on high dollar items. Just for argument’s sake let us suppose that 60% of that one trillion is spent and as a result of the Fair Tax that 23% formerly imbedded income tax is now collected as a sales tax (30%) ─ the government reaps an additional $180 billion dollars which it is currently not collecting!
In 1997 a Congressional Joint Committee on Taxation issued a report compiled by a number of leading economists who had conducted a modeling analysis of our current income tax system with some modifications that were being proposed at the time along with models of changing the system completely to a consumption tax. You can read their entire report at Joint Committee on Taxation. On page 19 of their report it states that
“From the medium to long-run perspective, the consumption tax produced a stronger positive growth effect than the unified income tax….” Then on page 34 it goes on to state that “…tax restructuring in the form of a consumption tax will ultimately produce higher economic growth….”
The benefits that aided in producing these results were spelled out to be the following:
“…reducing the cost of capital through less taxation of capital provides an incentive for additional investment; reducing the marginal tax rate on labor provides an incentive for increased labor effort; increasing the returns to labor through capital deepening can provide an incentive for more labor; and,…reducing distortions in investment decisions by eliminating differential taxation of different types of capital promotes a more efficient allocation of resources.”
In short, moving to the Fair Tax, according to this report, would be the stabilizing boost our economy so desperately needs:
“The broad consensus of all the modeling approaches, that moving from the present-law income tax base to a uniform consumption tax base will result in a long-run increase in GDP, capital investment, and labor effort, provides some assurance that economic analysis can provide useful qualitative information about the long-run macroeconomic effects of major tax policy changes.”
Again, there was another telling consensus regarding the preferability of the Fair Tax over an income tax:
“Most economists support fundamental tax reform because of the expected improvements in economic efficiency. The current income-tax system is highly distortionary, because it taxes income at different rates depending on the sources or uses of the income. Taxes on capital income are fingered as a major culprit, because: (i) capital income is difficult to measure accurately, and hence difficult to tax uniformly across different types of assets, and (ii) even with perfectly-uniform capital taxation, such a tax creates an intertemporal distortion. Established tax preferences such as the mortgage interest deduction also contribute to the distortions among different sources or uses of income. Hence, many economists believe that the most effective way to enhance the efficiency of the tax system would be to move toward a consumption-based tax with a flatter rate structure and broader, more neutral base.
To go all the way, we could move to a proportional, single-rate consumption tax. This switch can be said to have several distinct effects on efficiency. First, the ‘flattening’ of the progressive tax rate structure reduces individual disincentives. Second, the leveling of the playing field is expected to reduce the distortionary effects of taxes. Third, the switch from an income base to a consumption base involves a reduction in the interterporal distortion in exchange for a larger labor-supply distortion, and so may increase or decrease the inefficiency of the tax system. Most economists seem to expect a positive overall effect on efficiency from such a tax change, especially when combined with lower rates.”
In light of this scholarly analysis and conclusion then why have we not moved to the Fair Tax? After all, this study was conducted and published thirteen years ago! The answer is simple ─ politics and power. Due to lobbyist groups and special interests our current members of Congress lack the fortitude to make the changes that would truly move us back to the path of prosperity and security. Furthermore, they like the power that the income tax gives them. By “tinkering” around the “edges” of the tax code they can curry favor with these groups that will in return help to keep them ensconced within their seats of power. Instead, they prefer to throw up objections to the Fair Tax that amount to nothing more than battling the proverbial “straw man”. In the next essay, I will delve further into this solution to our tax and economic woes and answer some of the critics.
-Epaminondas
