Monday, January 14, 2008

The Huckabee Tax Plan...

I was explaining to a friend of mine that Mike Huckabee's tax plan is going to start haunting me in my dreams...I can't seem to stop thinking about it, since it's one of those things that makes so much sense for the first 5 seconds but upon further reflection is the worst idea ever.

Primer: Huckabee's tax plan is to abolish all existing taxes, both individual and corporate, and replace them with a flat consumption tax. Households would be reimbursed for tax paid on purchases up to the poverty line in order to avoid having the tax be too regressive.

So why would it make sense? The main appealing feature is that it would (theoretically) be easier to implement, since income taxes are a big pain in the ass for a lot of people. (Also, other countries have shown significant increases in compliance as the result of a simplified tax code, which would be a good thing.) It could be done automatically at point of sale, which seems great. BUT...upon closer reading, there are monthly tax rebates available based on cumulative purchasing. This means that some 200 million checks would have to go out each month and cumulative purchases would have to be reported just like income is reported now, which puts us back to where we started in terms of administrative hassle. (Besides, don't we already approximate the point-of-sale idea for income taxes with the whole concept of witholding? Just thought I'd ask.) Unlike Huckabee implies, the system can't just reimburse each household for purchases up to the poverty line automatically, since some households may be very low spenders and thus not entitled to the full rebate. Furthermore, reimbursing retroactively creates a problem for those with liquidity constraints, whereas the current income-tax witholding system at least partially accounts for this.

So why else is it a bad idea? Let me count the ways...I will even ignore the common ones that everyone is already complaining about and focus on the more subtle issues:

Issue 1: According to Mike Huckabee's web site, the FairTax (don't you love that name?) is "a simple tax based on wealth." Ummm...wrong. Wait, let me think....no, still wrong. The only way that the FairTax, which is a consumption tax, is actually a tax based on wealth is if individuals' wealth levels and purchasing habits are always proportional. It's pretty easy to argue that this is not the case- I'm sure we all know a few $30,000 millionaires as well as the wealthy janitors and such who got that way by not buying anything and investing well.

Issue 2: Not unrelated to the issue above, a flat consumption tax is a huge boon for the super wealthy (and thus more of a burden on everone else), since they can't even begin to spend all of the money that they have- there are only so many Gulfstream G5's that Larry Page and Sergey Brin can buy, for example. (I think, in fact, that they have even chosen to share a used Boeing 767 rather than a new G5, and used goods aren't even subject to Huckabee's consumption tax!) One solution would be to place a higher tax rate on super-luxury items, but this is a) not addressed by Huckabee, and b) likely to upset/punish the producers of such items, who generally happen to employ many average or low-income individuals.

Issue 3: Huckabee's web site makes the following assertion: "Expert analyses have shown that the FairTax lowers the lifetime tax burden of all of us: single or married; working or retired; rich, poor or middle class." The page also says, in the sentence immediately before the above quote even, that the tax plan is revenue neutral. Um...if everyone is paying less over their lifetimes, this is mathematically impossible, no?

Issue 4: The rationale behind abolishing an income tax is that is seems inefficient to tax people for being productive and working more. I would argue that it might be a bit demoralizing, but not inefficient. After all, on a basic level, why do people work? They work so that they can buy things in order to improve their quality of life. A consumption tax reduces this purchasing power in largely the same way that an income tax does- who cares if you get to keep all of your $10 an hour if an after work beer now costs $12? (Obviously I am exaggerating, but you see the point.) This issue deserves a closer look as well as some economic background:

  • From an efficiency perspective, the best markets to tax are those where the parties involved are the least elastic in terms of changing behavior as a function of price (or wage). (This minimizes what is called deadweight loss, which is basically the amount of economic well-being that evaporates into thin air as a result of a tax or other market distortion.)
  • Taken in the tax context, how much do you really think that people change their work habits as a function of their take-home wage? I would argue that, because we are socially conditioned to the idea of the 40-hour work week if nothing else, the answer is likely to be "not much". To think about it another way, do you think that Bill Gates would have worked harder if his marginal tax rate were lower? The drive for innovation and success often has to do with much more than just monetary reward. (Either that or people aren't good at distinguishing LOTS AND LOTS of money from just LOTS of money.)
  • On the other hand, how much do you think that people change consumption behavior as a function of price? I point you to the overwhelming growth and success of Wal-Mart as an answer to that question. (Okay, fine, technically this argument requires that they would buy more stuff at Wal-Mart than they would otherwise, but I think that that is a small leap to make.) Furthermore, psychology would suggest that the behavior change would be greater with consumption than with income because the coupling of decision-making and payment is stronger with consumption than with labor.
  • Therefore, based on the above points, the income tax is likely to be more economically efficient. (I will concede that the consumption tax will encourage beneficial saving that perhaps individuals were too impatient to engage in otherwise, but that benefit doesn't outweigh the downside of the consumption tax and is way too paternalistic for my tastes.)
  • In terms of economic outcome, it doesn't matter whether you tax consumers or producers, and the tax burden is generally shared by consumers (in the form of higher after-tax prices) and producers (in the form of lower pre-tax prices). This is completely overlooked in Huckabee's argument, and it means both that a) workers wouldn't see the full dollar benefit of income-tax abolition, since wages would go down in equilbrium, and b) producers don't get a free ride, since the prices for the goods that they sell (at least to American consumers) will go down in equilibrium.
  • Consumption and production are economically two sides of the same coin- where is the incentive to innovate and produce when people aren't willing and/or able to buy your products? This is a factor that cannot be ignored when considering a consumption tax.


Issue 5: While it might lower landfill costs, encouraging trade in used goods (by not subjecting them to the tax) is not necessarily good for the economy, since there is not really any economic value added in pure resale. (The government statistics people must agree with me here since used goods sold are not included in the calculation of gross domestic product.) You would have to make a tenuous argument that knowledge of a good resale market would encourage people to purchase more new stuff, since they know that they can sell it later if they want to, in order to make a good case here.

Issue 6: Huckabee asserts that abolishing the corporate tax will make American products more competitive globally because it will lower prices on exports. I buy this, I really do. However, let's come back to this revenue neutral issue, i.e. the fact that tax dollars have got to come from somewhere. So if the corporate tax is at least partially baked into the price of goods produced by U.S. corporations, then other countries are helping to pay that tax when they buy our exports. Huckabee's plan implies that the consumption tax would not apply to exports (otherwise the price of exports would actually go up, not down, negating the increased competitiveness point), which means that the whole dollar amount of what used to be the corporate tax is now the reponsibility of the U.S. population. Also, the corporate tax is felt by shareholders of U.S. companies, some of which are not U.S. citizens. This amount would also shift solely to the U.S. population. Thus, there is a cost of this increased competitiveness in the form of higher taxes for American households. (If you want to think more about this concept, ponder why high-tourism states generally have high sales taxes but low property and income taxes.)

Issue 7: I actually started thinking about the tax issue in the context of Kahneman and Tversky's model of loss aversion. The general idea of loss aversion (which has been shown to exist empirically) is that losses are felt more strongly than equivalent gains. Calibration of this model suggests that losses are felt roughly twice as uch as gains. Why is this relevant here? Loss aversion predicts that a loss is felt less stongly when coupled with a gain than when coupled with another loss. In this context, the loss in question is the money that an individual is paying in taxes. With an income tax, the tax loss is coupled with a gain in the form of wages. With a consumption tax, the tax loss is coupled with a loss of money in the form of payment. Granted, there is a gain from getting the item purchased that could mitigate this effect, but the monetary loss is still present. This would also imply that the income tax would be more efficient in that it would result in less "pain" due to actually paying the tax.

Okay, I will get off my soapbox now. Go Hillary.

Sidenote: Steve Landsburg has an interesting Slate article on the Huckabee plan. Why is it that economists are so much more convincing than politicians? I do have to note, however, that the time element of consumption coming after (sometimes well after) income means that the tax rate has to be higher in order to be revenue neutral than if the time element was not an issue. Who would have ever thought that there would be a benefit to people spending money that they don't have yet?

In case you are curious: Apparently Bruce Bartlett agrees with me on a general level.

5 comments:

Dutchman3 said...

Jodi,

You need to take a moment off from your dissertation and read the Fairtax book. Your first point misses the whole prebate concept. The monthly prebate check (in advance) has nothing to do with spending, or taxes for that matter. It's simply a cash grant entitlement based on family size and the poverty level as established by the federal government for that particular year. The Fairtaxers would prefer everyone think about it as a tax refund, not an entitlement, but they are wrong. It's just not the same as an income tax refund caused by over withholding from your paycheck. And the one thing our federal budget doesn't need at this time is another massive entitlement program. There is an economic train wreck coming, probably in my life time---and I'm old!

As for used goods, the term "used" means that the Fairtax has been previously paid. And it's likely that the 30% sales tax which is embedded in the price of new goods will become part of the resale price, at least a portion of the tax. No one should expect to save any money by buying used other than the usual used product discount that exists today.

One big issue you might consider is the Fairtax plan to tax governments at all levels. Basically, the Fairtax is only revenue neutral because 21% of the cost to fund the federal government is hidden in higher state and local taxes, and the dubious plan for the federal government to tax itself. (If that's such a good idea, maybe we ought to lay a 100% tax on federal government purchases and thereby lower all individual taxes. What utter nonsense.) Governments can't tax themselves into prosperity.

Why don't you cross over the Charles and visit the Beacon Hill Institute which has done most of the Fairtax studies. Perhaps they can explain just how state and local governments won't be impacted? And just how the federal government taxing itself isn't a scam?

Good luck!

Jodi said...

Thank you dutchman for your insight...personally, I think I would rather stick a fork in my eye than read the FairTax book, but I don't doubt that your explanation of the system is correct. The Huckabee for President web site states:

"All of us will get a monthly rebate that will reimburse us for taxes on purchases up to the poverty line, so that we're not taxed on necessities. That means people below the poverty line won't be taxed at all."

From what you are saying, the word "reimburse" here is misleading, as is the statement that people below the poverty line won't be taxed at all, since it's possible for them to spend so little that they could have a negative effective tax rate if your description of the rebates is correct. A pre-defined check going out each month makes the system a bit simpler but doesn't solve the problem of issuing some 2.4 billion checks per year!

From what you are saying, there are enough relevant details that aren't being publicized that I would be suspicious of the plan even if I wasn't before...

Dutchman3 said...

Jodi,

Your suspicions are well warrented. Over the last three years, I have gone from being a flaming Fairtax supporter to a firm opponent. My overarching concern is that the Fairtax plan tried to do too much too fast. As a result, the Fairtax is going nowhere, imho.

As an example, consider this. By including payroll taxes in the mix of taxes to be replaced by the Fairtax, and then proposing the prebate, I estimate that 30 million workers may pay no net federal tax, yet will still be eligible for full retirement and health care benefits. Compare that number to the less than 1 million workers under current tax law that can reduce their income tax liability to near zero using deductions, exemptions, and credits, and then completely offset the 7.65% payroll tax amount through the use of the refundable EITC and Additional Child Care credits. Is that the kind of America we really want? FDR envisioned a contributory program, not a free lunch!

At the same time, all senior retirees, who faithfully paid in to the Trust Funds for 40 to 50 years, would be forced to resume paying into the trust funds with their sales tax dollars. Is that really fair?

My list of concerns about the Fairtax scheme is quite long and growing. The devil really is in the details!

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