Wednesday, November 23, 2011

The Fair Tax

The majority of Americans support a balanced budget amendment. They expect congress to live within its means. At the same time Senator Lugar and Representative Stutzman, two out of many elected representatives both support the fair tax measure, specifically the national sales tax of 23%. This tax would combine the Social Security Old Age Survivors Insurance tax of 10.6%, Social Security Disability tax of 1.8%, Medicare Tax of 2.9% on wages with the death tax, and Federal Income tax which has tax brackets of 10%, 15%, 28%, 33% or 35%. In essence it would do away with the Internal Revenue Service.

It does not surprise me that the Fair Tax of 23% would conflict with the majority of Americans who support a balanced budget. Two of the largest programs already have balance budget statutes. Both Social Security and Medicare cannot borrow money nor can Federal General Revenues be used to support these two programs. These programs can only consume their respected dedicated payroll taxes and the funds in their respected trust funds. United States Code Title 42, Chapter7, Subchapter VII, Sec. 911 (a). This statute was passed in 1984 after the Big Fix of 1983 which raised the social security based, tax, retirement age and began subjecting social security benefits to federal taxation. This statutes primary goal was to restrain both Social Security and Medicare from consuming all federal revenues.

The fair tax would remove the balanced budget statute from these two programs. We have seen how congress is inadequate to cut just $120 Billion a year from $1.5 Trillion deficits. Combining these dedicated payroll taxes with Federal General Revenues will cause even more budget constipation. We should be focusing on the General Budget separately, not combined with two programs with very difficult ideologies. When attempting to solve a problem, you separate the problem into its basic parts, not combine many different problems. This only leads to pointing fingers.

However, the national sales tax has other problems. Workers who have saved money to make a purchase of a home, car, etc in the future have paid payroll taxes and these funds have been subjected to federal income taxes already. The national sales tax would now tax them once again. For 50% of workers, they have already paid 7.65% payroll tax and had no federal income tax liability. This would be like paying 31% tax on each dollar earned. For those other 50% of the people this savings was most likely taxed at a minimum of 10%. This other 50% of the work force would be then have 41% of each dollar they saved subjected to 41% federal tax.

However, there are those who would fair just slightly better. Those who set aside pretax money in 401K’s or IRA’s would not have paid tax on this income and with the Federal Income Tax eliminated would escape subject to the current tax when withdrawn. Granted, 23% would be far greater than the current federal income tax structure, but less than after tax savings.

Municipal bonds are generally free from all state and federal income taxes. One reason for government to do this is to lower their cost of borrowing. With a national sales tax, there is no incentive to invest in municipal bonds that pay a lower rate if in the end a taxpayer ends up paying 23% tax on it.

We then have to ask the question, what about Veterans Disability payments for service connected injuries? Those who are injured in the line of service and receive disability payments currently pay no federal or social security taxes on these payments. With the fair tax, these funds would now be taxed when spent at 23%. We also have insurance payments that are currently untaxed as well as pain and suffering payments from law suits where negligence of another party caused injury now being taxes at 23%. It is very possible while trying to simplify the tax structure of the US; we create a nightmare of other problems, Unintended Consequences.

Yard/garage sales would see a boom as a way to escape 23% sales tax. I would predict automobiles would see the average age on the road increase by 20%. Currently the there are 14 million cars sold in the US. These owners keep cars about 4 years and then are sold as used. I could envision that these new car buyers would now keep their cars 5 or even six years, reducing sales to fewer than 11 million cars, possibly even more. Used cars would see a boom as well as auto maintenance suppliers and services.

Americans are resourceful and this sales tax would lead to more conservation of resources by utilizing produced goods for a longer period of time. This would reduce manufacturing jobs and innovation as the market adjusts to less demand.

Then there is the question about Social Security. Social Security is paid to those who have wages subjected to the Social Security base. If you have no wages, you are not eligible for social security unless you qualify as a spouse or dependent. The elimination of the payroll tax and the enacting of a sales tax would have all people supporting social security, even those who paid and are now beneficiaries. Would everyone now be covered since they now support the program through sales taxes? How would benefits be calculated. Currently there is no link between taxes paid and benefits received. Combining these revenue sources into one may result in either faster means testing of Social Security and reducing it to a welfare program, outright repeal of the program and combining it with the current welfare programs or the near total consumption of all revenue and cuts to all other programs.

As an engineer, I would prefer keeping the programs and dedicated taxes separated. Review the programs effectiveness based on its needs alone. If the program is not self supporting by its revenue source, then the decision to raise taxes or cuts benefits does to become more of a political nightmare that we have now.

Myth 6
High deficits in the future make it difficult to pay social security benefits
Social Security by law cannot borrow money. It has statutory authority to spend only those funds received from the dedicated social security tax on wages, tax on benefits and funds in the trust fund. Federal Law prohibits transferring general revenues to any trust fund. [4]

By law the trust fund cannot be drawn down to zero. The trustees must submit a report promptly to congress detailing benefit cuts or tax increases when in any given year the trust fund is projected to fall below 20% of that given years expenses. Social Security's ability to pay future promised benefits is dependent solely on the ability to raise social security taxes. [5]

4] United States Code Title 42, Chapter7, Subchapter VII, Sec. 911 (a),
http://www4.law.cornell.edu/uscode/42/911.html

[5] United States Code Title 42, Chapter7, Subchapter VII, Sec. 910 (a),
http://www4.law.cornell.edu/uscode/42/910.html

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