Taxes: Fair or Foul?

The second in a series on the principles of taxation.

Somewhere in the Analects of Confucius, the Master says that the first step in solving a problem is to call things by their right name. When things are mislabeled, it is very difficult to think about them correctly. On the other hand, if you do not wish people to think correctly about an issue, the first step is to mislabel things. If you deliberately wish to confuse people, you can start in no better place than to give things the wrong name. A name describes what a thing is, and if you wish to conceal from people what that thing is, then call it something it is not.

However, mislabeling things does give a clue to the fact that someone is trying to mislead you. If someone is afraid to call something by its right name, then they are afraid that people will find that thing fearful. Which brings us to the 30% National Sales Tax. I use this name because it describes what the thing is. But if you have not heard of it before, it is because the supporters of this idea do not call it by this name. They are afraid that any name which accurately describes it would certainly cause people to fear it. And I am afraid that they are right. The name they have chosen is one that gives an opinion about the tax, rather than describe what it is. One is certainly entitled to one's opinions; one is not entitled (this side of Karl Rove and George Bush) to misuse the language. And the opinion they have rendered on their own plan, the mislabel they have chosen for it, is the “Fair” Tax. I am not concerned, for the moment, with whether this opinion, rendered as a “name,” is accurate. My concern for the present moment is why they chose this particular bit of propaganda for their moniker.

The reason is simple: they have perceived, quite correctly, that fairness is a basic principle of a just tax system. Now, I do not know what standards the backers of this tax use to render the judgment of fairness on their plan. I have searched their web site (www.FairTax.org) in vain for a definition of “fairness.” So I will have to supply my own. And I believe that we can define fairness as justice.

But what is justice? Obviously, there are many different notions of what constitutes justice, but I believe that they all have one thing in common, namely the idea that what one gets should be proportional to what one gives, that one's rewards should be commensurate with one's contributions. There is not much dispute, I believe, about this principle. However, the devil is in the details. No one will quarrel with the proposition that if you spend a dollar, you should get a dollar's worth of goods; if you pay for a pound of ground beef, you should get a pound, and it wouldn't be just if the butcher had his thumb on the scales. This is justice in exchange, or what Aristotle called commutative or corrective justice. This kind of justice deals with exchanges between individuals or between firms acting like individuals.

But there is another kind of justice called distributive justice, which deals which how collective entities (a family, a company, or a state) distribute their corporate products to the individuals that make up that collective entity and contribute to it. And it is a fairly well established principle that rewards from the corporate entity (the state, in this case) should be distributed in proportion to the contributions each individual makes. Now, there are many different kinds of contributions to the common good (which is, or should be, the “product” of the state). There are soldiers to protect us, nurses and doctors to heal us, mothers to give us life and serve as our first teacher, entrepreneurs to create new wealth, and so forth. It is difficult to judge the relative merits of each of these contributions, but we know that life would be more precarious, or even impossible, without the contribution of each of these people. Hence we know that it is in our best interests to see that each person is properly rewarded for their contribution to our comfort and well-being.

There is another kind of contribution to the common good that we all make, one way or the other, and that is the contribution of money to pay for the whole thing. This brings us (at last) to the question of taxes. Who should pay, and how much? I think the answers are: “Everyone,” and “In proportion to the benefits they receive.” Now, we don't have to worry too much about the first point, since many taxes will be passed on, one way or another, in the prices we pay for things. Hence, everyone will pay, even if taxes are not directly collected from everyone. It is the second point that is the interesting one, since we receive different levels of rewards from society and from government. For example, the police are there to protect us in our persons and our property. Now, we all have the same “property” in ourselves and receive the same benefit (in theory) from police protection. But we have differing amounts of property in “things.” Some have very little, but others have a great pile of things, and derive greater benefit from the protection of those things. Clearly, they receive a greater benefit and should pay a larger proportion of the costs of police protection.

Now, even with a flat-tax, the rich will pay a greater amount, but should they also pay a greater proportion of their income? This brings us to the great debate about taxes: Should they be regressive (the poor pay a larger proportion of their incomes), flat (everybody pays the same percentage), or progressive (the rich pay a larger proportion of their income)? Each of these answers embodies a different ideal of justice. Here we cannot reduce things to a rule (as we could in the case of simplicity) but must make a judgment about what constitutes justice.

A regressive tax embodies the ideal of the ruling class as the leaders of society who should receive the bulk of the rewards. At its most extreme, regressive taxes express the ideals of a slave society, since you can regard the slave as someone who is taxed at a 100% rate, minus some “prebate” equal to the level of subsistence the that the master is willing to give to the slave. One would think that regressive taxes are excluded from a democratic society, but in fact many of our tax structures are regressive. Sales taxes are one example. Another is the differential rates of taxation for income from capital and labor. Labor is taxed at a higher rate than capital gains, which is regressive because the rich tend to make a higher percentage of their income from their capital rather than their labor.

A flat tax embodies abstract ideals of economic and political equality; each person is deemed to be rewarded by the economic system in a manner proportional to his or her efforts. As such, the flat-tax has some appeal from the standpoint of the ideals of equality. However, the evidence that people are rewarded in exact proportion to their contributions and productivity is weak at best, and flat contradicted at worst. Look at the following chart (click on the chart to get a clearer view).


What it shows us is that median wages (adjusted for inflation) have been flat since 1973. Yet in that same time-frame, productivity for all classes of workers has increased dramatically. What has happened is that one relatively small group has appropriated to itself all the gains arising from increased productivity; the connection between contributions and rewards has been broken. Now, while there may be good arguments for a flat tax in the case of taxes on wealth (land taxes, for example), these arguments are weak when applied to incomes, at least in the concrete situation in which we find our society. This is not only a violation of basic justice, but has deleterious practical consequences as well (see The Investor's Dilemma and The Investor's Dilemma II).

This would seem to leave progressive as the only system that would meet the standards of fairness and justice, at least, in our current situation. Those who receive a disproportionate share of the rewards should contribute a disproportionate share to the upkeep of the commonweal.

Both the 30% National Sales Tax and the Flat-Tax proposals make a nod in the direction of progressive taxation, the former by establishing a universal welfare program that prebates the sales taxes up to the poverty level, and the latter by a standard deduction equal to the poverty level. In the case of the Flat tax, the degree of progression is trivial. Further, since the tax only replaces the income tax and leaves the FICA taxes in place, it ends up being regressive. A worker will pay the 17% flat tax, plus the 7.65% payroll taxes. A self-employed person (like myself) will get a flat tax of 32.65%, which is close to the marginal rate for the richest Americans, and I am by no means rich. Further, since the FICA taxes stop at about $90,000, the resulting structure is regressive.

In the case of the National Sales Tax, "progression" is an outright lie. The “progression” comes only if you assume that the rich convert all of their income to consumption, which is patently untrue. At the extreme, a man like Warren Buffet has difficulty converting even 1% of his income into consumption; therefore his tax rate will equal 23% of 1%, or 0.0023% of his income. This is a rate more compatible with a class-based or even a slave society than with a democratic nation.

Obviously, there can be different judgments about justice; it is not something that can be calculated, but must resolve itself back to some basic, but “unprovable” notions about the kind of society we want. But I do believe that any discussion will have to take into account the factors that I have mentioned here, namely the proportion between the benefits one receives and the contributions one makes.

14 comments:

Andrew T.,  Wednesday, December 19, 2007 at 6:55:00 PM CST  

Taxation is government theft.

B. Y. Clark Thursday, December 20, 2007 at 7:39:00 AM CST  

I am surprised Ian hasn't commented yet.

This is a nice post. My only attempt at this topic on my blog made a weaker attempt to make some of these arguments, but I just don't have the time or a strong desire to flush all of it out.

I think it would be great to do a piece based on Sen, Nozik, or Berlin's work to take apart the "fairness" idea of this tax plan... but alas I've got too much to do. So have at it... there might even be a book in it for you.

Ian Thursday, December 20, 2007 at 3:31:00 PM CST  

What is [tax, i.e.] justice? you ask, Mr. Medaille (with the little thingy above the e - hmmm, not American). Your answer? Your oh, so comforting "distributive justice."

It goes something like this,

"Those who accumulate the most wealth derive the most benefit from the country or state, the tax system should be progressive. Those who earn the most should pay a higher percentage of their income in taxes than do those who earn the least."

Says who? How much higher should my tax percentage be? Who decides how much more is enough?

This is plain Socialism, ("From those according to their abundance, to those according to their needs") and is antithetical to a free-enterprise, freeholder, capitalist system.

Now, it may be that I inherited my wealth (Writer's note: I have not). However, someone, somewhere worked and sacrificed to accumulate it. So what? Lucky me. It is no business of yours. But, let the politician stake a claim to my income, and get them together to discuss paying for their government programs, and the envy card is played - pitting those of lesser means, who stand to gain, against me. Under the existing system where "fairness" is a cover for coercion, the more I work, the less-entitled I am to the fruits of my labor. The more wealth I sacrifice to accumulate, or for which I assume investment risk, the greater the share of my past labor is assigned to government servitude.

Our tax system (as a funding mechanism for interest payable to the Federal Reserve, originally, a founding collection of bankers and super-rich individuals who caused the depression, increased their own wealth, and have steadily devalued our currency) has been the disaster of our country and led to an income tax code, continually in change, 60,000 pages and counting; countless bartered tax favors between lobbyists and politicians; tax shelters for the wealthy, not available to those with lesser means; tax lawyers; dependent constituencies - just to get started!

Our tax system has become institutionalized tyranny that undermines personal initiative and cultivates dependency.

The FairTax ends this destructive, socialistic view by taxing everyone at the same rate on purchases above the poverty level. FairTax progressivity does not enable politicians, under pressure by some 35,000 lobbyists for special tax status, to determine how much of my wealth is stripped from me (increasing the number of minutes in every working hour that I spend as a tax slave). (Writer's note: I have no such accumulated wealth.)

Under FairTax, I decide how much tax I pay whenever I decide to spend my hard-earned wealth to enjoy it. (If I purchase the boat in the Bahamas, I had better not port it in the U.S.A, or I'll be stuck for a tax on it (or anything else I bring back that is purchased offshore). If I buy a car in Windsor, I'd better leave it there because the FairTax will be assessed on it if I bring it back to Detroit.) Because I spend more, I will pay more, but it will be me deciding, and I will not mind so much, because I'll have confidence that the FairTax ends the politicians' presumption upon my wealth..

The foregoing aside, "Is the FairTax actually fairer to current income groups? To provide substantive answers, Prof.'s Kotlikoff and Rapson (10/06) have concluded,

"...the FairTax imposes much lower average taxes on working-age households than does the current system. The FairTax broadens the tax base from what is now primarily a system of labor income taxation to a system that taxes, albeit indirectly, both labor income and existing wealth. By including existing wealth in the effective tax base, much of which is owned by rich and middle-class elderly households, the FairTax is able to tax labor income at a lower effective rate and, thereby, lower the average lifetime tax rates facing working-age Americans.

"Consider, as an example, a single household age 30 earning $50,000. The household’s average tax rate under the current system is 21.1 percent. It’s 13.5 percent under the FairTax. Since the FairTax would preserve the purchasing power of Social Security benefits and also provide a tax rebate, older low-income workers who will live primarily or exclusively on Social Security would be better off. As an example, the average remaining lifetime tax rate for an age 60 married couple with $20,000 of earnings falls from its current value of 7.2 percent to -11.0 percent under the FairTax. As another example, compare the current 24.0 percent remaining lifetime average tax rate of a married age 45 couple with $100,000 in earnings to the 14.7 percent rate that arises under the FairTax."

Further, per Jokischa and Kotlikoff (2005) ...

"...once one moves to generations postdating the baby boomers there are positive welfare gains for all income groups in each cohort. Under a 23 percent FairTax policy, the poorest members of the generation born in 1990 enjoy a 13.5 percent welfare gain. Their middle-class and rich contemporaries experience 5 and 2 percent welfare gains, respectively. The welfare gains are largest for future generations. Take the cohort born in 2030. The poorest members of this cohort enjoy a huge 26 percent improvement in their well-being. For middle class members of this birth group, there's a 12 percent welfare gain. And for the richest members of the group, the gain is 5 percent."

The current income-based tax system is also more expensive to run, because of the manner in which the tax code is gamed by politicians and lobbyists. Politicians realize great power, and attract constituencies for support, by granting tax favors (i.e., credits, deductions, exemptions) through lobbyists. Fully, fifty-three percent of Washington lobbyists are there because of the tax code! The tax code is continually changing, making it more complex - more difficult to understand. And, the salaries and costs of tax lawyers and lobbyists end up in higher prices of the products and services we buy. Additionally, the time and money required to keep records, file returns, report for audits, retain accounting and legal help, pay IRS penalties and interest, is time and money lost for other productive, or recreational, activities. Depriving us of the use of withheld wages increases our expenses through zero-interest withholding, inflation, return preparation time, and interest paid on credit cards and loans that otherwise may not have been necessary. Summed up, the cost of tax compliance, nationally, has been estimated to range anywhere from $265 billion to twice that amount, depending on the extent to which tax-avoidance consultation is sought and utilized. These expenses constitute a substantial hidden tax which is incomprehensible to the average working American. And the FairTax gets rid of all of it for most Americans, and most of it for business owners.

We, as FairTax advocates, believe that government should serve We, the People, with a fair tax system that will not enable politicians to pit poor against rich (creating barriers to achieve wealth, adding tax penalty to the sacrifices made for personal success). Nor do we want politicians to continue using business as a tool to hide taxes from consumers, often villifying business, which discourages entrepreneuship, personal achievement, economic growth. Liberty and happiness depends on restoring the fruits of labor to those who produce them. We believe that the tax function should align with economic growth, not against it, that government should be paid for in the same manner as working Americans - when, and because, something is sold!

As things stand at present, the system primarily benefits politicans who cater to special interests through lobbyists who game the tax code. The politician seeks to capture them as constituent voting blocks, dependent on continued syphoning of taxpayer dollars to their members' benefit. This is increasingly repugnant to the average working American who often finds it difficult to meet the needs of his, or her, own family in an environment where federal and state business income taxes substantially contribute to trade inequities resulting in the loss of American jobs! Thus, the Sovereign are continually degraded by features of Congress's income tax policy. The most rapidly-growing needs-based "special interest" group has become the Citizens! You see? Congress has nearly all the power; and We, the People, have become We, the Serfs, robbed and enslaved. Getting the federal government's hands out of our family paychecks is the single most important reason to replace the income tax with a consumption tax, the FairTax.

Many of us have joined FairTax.org in order to build a national movement to free ourselves, our family pocketbooks, and our businesses from confiscation of income, and punishment of productivity. And this we say to our federal representatives,

"Either scrap the code and enact the FairTax, or we intend on replacing you with someone who will."

B. Y. Clark Thursday, December 20, 2007 at 3:38:00 PM CST  

There is a nice op-ed piece in the Atlanta paper today... take a look:
http://www.ajc.com/opinion/content/opinion/bookman/stories/2007/12/19/bookmaned_1220.html

B. Y. Clark Thursday, December 20, 2007 at 3:41:00 PM CST  

To quote Ian "Our tax system has been the disaster of our country"...
really? So maintaining our status as the economic powerhouse of the world throughout the post-WWI era has proven to be a disaster??? Really? Perhaps our tax code is not the most rational or straight forward, and could another system be better, YES. But the 30% national sales tax is not the answer...because your premise that our tax system is a DISASTER is faulty.

John Médaille Thursday, December 20, 2007 at 4:03:00 PM CST  

In regard to the need for progressive taxes, Ian asks, says who?

Says, Adam Smith, that's who:
It is not very unreasonable that the the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion. (Wealth of Nations, Book V, Chapter II, Article I)

You're not going to accuse Smith of being a socialist are you?

Now that I've answered your question, get you ever get around to answering any of the questions that you have been asked so often but have ducked so far?

Can you answer, for example, just why you think the Arabs and Hugo Chavez are going to lower the price of oil because we have a consumption tax?

Can you answer how you will account for the fraud that will obviously be massive in such a scheme?

Can you tell us why you only quote from "bought and paid for" studies, rather than independent sources, all of which are negative?

All you ever do is post the same Huckabee propaganda without answering any of the hundreds of questions posed to you. You cannot deal with the negative consequences of this hare-brained scheme, and hence you avoid them.

But the biggest sign of your intellectual bankruptcy is the opening sentence of your post in which you question my status as an "American" because I spell my name correctly. One can only wonder what you think being an American means, and why the spelling of a name would compromise that?

Ian Thursday, December 20, 2007 at 7:51:00 PM CST  

John, I'd pronounce your name as "ma-day’-lee," but I'm probably pronouncing it like just another "intellectually-bankrupt" American who ain't got no cultcha, eh John?

Mr. Smith's words "should contribute" implies a voluntary action, not a government-run confiscatory scheme. Now, if I'm wrong on this, let me know.

You should know that under FairTax I fully expect that charitable contributions will rise because families will have more disposable monthly income to work with.

John Médaille Thursday, December 20, 2007 at 9:28:00 PM CST  

Ian says, Mr. Smith's words "should contribute" implies a voluntary action, not a government-run confiscatory scheme. Now, if I'm wrong on this, let me know.

Per your request, you are wrong, and I am letting you know. The context is taxes that have to be paid. You really should read before you comment. I gave you the reference; it shouldn't be that difficult.

Ian says, You should know that under FairTax I fully expect that charitable contributions will rise because families will have more disposable monthly income to work with.

No, they will have less and Jorgenson has admitted this. When the "fair-taxers" say that people will keep 100% of their pay, they mean 100% of their current take-home pay. In other words, the exact amount of cash they already get. BUT, they will have to then pay the 30% tax. This cannot equal more; it must equal less. The "studies" get the 22% number only by including the 7.65% payroll tax that the employee pays, which will go to the employer under this plan.

Further, you have yet to explain how this will drive down oil prices, or prices in any other market that is structured in the same way. Prices will not decline as you claim. Some might, in limited markets of a certain shape. But not generally. So, prices may fall a little, taxes will rise a lot.

And yes, continuing attacks on my name do indeed make you look like a boob. Is that the effect you are after? You have succeeded beyond the dreams of avarice.

Ian Thursday, December 20, 2007 at 10:13:00 PM CST  

You're in disagreement with Kotlikoff et al's research conclusions, as I've posted them above, which show that FairTax will be less regressive than the current system. Fine. Have at it.

If Adam Smith is advocating a government grab, it leads us where we are today. Whenever you have a politician gonna decide how much of your personal industry is going to be servitude, you've got tyranny - unless the system treats all fairly. The last 90+ years have borne this out based on where we now find ourselves. My position on this is no different. FairTax is the answer to fair and equitable tax treatment and strengthening a land of opportunity of, by and for We, the People.

I was waiting for you to tell me: How do you pronounce your name, pray tell?

Andrew T.,  Friday, December 21, 2007 at 12:49:00 AM CST  

Ian,

The best course is abolishing the income tax and replacing it with NOTHING. Taxation is inherently unfair.

And only one candidate in the running proposes to do this.

B. Y. Clark Friday, December 21, 2007 at 8:33:00 AM CST  

The founder of the libertarian philosophy Robert Nozik says that inheritance are not to be considered a just transfer of wealth, since you did not earn it.

Many of the "FairTaxers" like to fancy themselves libertarians, yet would be appalled at having to give up any inheritance, because it is not a libertarian policy, nor are they true libertarians... they just want someone else to pay for the government.

John Médaille Friday, December 21, 2007 at 1:56:00 PM CST  

Ian, you seem to be caught on the horns of a dilemma: you excoriate progressive taxation as "socialism," and then praise the "fair" tax as progressive. So is the fair tax socialism? Or is it just not progressive?

We'll add this to the long list of questions you refuse to answer, like how this scheme will lower the cost of oil. You seem to be more obsessed with finding "un-American" names that with answering questions about your 30% National Sales Tax.

John Kindley Friday, December 21, 2007 at 5:36:00 PM CST  

If you don't mind, I'll take the lazy way of commenting by copying something I posted on my blog a while back on the matter of taxation, titled "Anarchism without anarchy." I take my start from the great 19th century lawyer and legal theorist Lysander Spooner's argument in his treatise "No Treason" that the only real law is natural law and that the Constitution is without authority (because "consent of the governed" is a fiction), as well as the corresponding libertarian understanding that "taxation is theft." It seems to me that any discussion of the justice of taxation should likewise take its start from and address these ideas:

. . . [R]ecognizing that our government has no inherent right to exist and that the "majority" has no natural right to rule over the minority does not necessarily as a practical matter entail quixotically advocating the immediate abolishment of the government. If the government prevents or punishes a genuine crime (e.g. murder or robbery, but not smoking pot, prostitution, gambling, or other mere vices), there is no injustice, even though the government has no real authority of its own, because it's not doing anything anyone else wouldn't have the right to do in the state of nature. And I think we can probably all agree that it's in fact preferable to have such justice carried out by a generally recognized "due process" than by vigilantes or private armies.

Does it have the right to take property from some in order that others don't starve? Maybe, on the theory, recognized by Thomas Aquinas among others, that stealing food from the bounty of others when there is no other way to prevent the starvation of one's self or one's family is not really theft at all. The government has no right to do what a private citizen has no right to do, but in this instance could be said to be doing what a starving poor person would have a right to do, on their behalf. But assuming this hypothetical poor person had a choice (as the government acting on his behalf presumably does), would he be morally justified in stealing from somebody who was himself struggling to make ends meet, when he could just as easily steal from someone with enough money in the bank to pay his own grocery bills many lifetimes over?

The most fundamental way to prevent poor people from starving in the first place would be to restore to them what they have a right to in the first place and what government has taken from them: a free and equal share of the earth and the earth's natural resources, or its equivalent in the form of a "Citizen's Dividend," funded by a "Single Tax" on the unimproved value of land and other natural resources. (A Google search will turn up several good explanations of these concepts.)

In these concepts is also found the only means by which this enterprise known as the government, which has non-consensually arrogated to itself the business of dispensing justice and protecting us, may legitimately pay itself for the "services" it bestows upon us. Since the unimproved value of land (even of that land which has improvements attached to it) belongs to every member of the society equally, the government is justified in collecting on behalf of society the "rent" associated with this value, in the same way that the government (like any private citizen in the state of nature) would be justified in recovering and returning to its rightful owner stolen property. (Inheritance taxes on property "owned" by a dead person and therefore by nobody could be justified on similar grounds.) Since this rent could not be collected and distributed in the absence of a government-type organization, the organization would be justified in skimming off the top its costs in collecting and distributing the rent, which presumably would include the necessary muscle to collect the rent and to maintain itself in existence against enemies foreign and domestic. Since that money would be coming out of each of our "Citizen's Dividends" to enable the collection of such Dividends, what we'd really be paying for is the protection of our property (and personal) rights -- and that's how a police, a military, and a "welfare" system (more precisely, a substitute for the welfare system grounded in justice rather than charity or policy) could be founded on a technically non-consensual but nevertheless just basis.

Jeremy Sunday, December 23, 2007 at 9:03:00 AM CST  

Excellent essay, Mr. Médaille! As I argued in a past blog post called Let the Free Market Eat the Rich, the rich are far more dependent on the stabilizing, moderating, managerial, and police functions of government than we are. The whole function of a tax regime, in my ever so humble opinion, is to socialize onto the people at large the costs of maintaining unnatural aggregations of wealth. I honestly don't think you even have to make the distributist's classic moral point on this issue (though you certainly *can*), because absent the intrusion of government, these obscene accumulations naturally dissipate if there is not some outside input into maintaining them. That's where hoodwinking the people into supporting your hoarding comes in real handy.

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