Saturday, March 01, 2008

Progressivity of the FairTax

The FairTax is a proposed federal sales tax on goods and services. Advocates for the FairTax estimate that a tax rate of 23% would be high enough to replace all current federal taxes, including social security, etc., while dissidents say it would have to be much higher. To make the tax progressive, the federal government would issue monthly payments for each person equal to the sales tax rate multiplied by the federal poverty level income. This essentially removes all tax burden for people who spend at or below the poverty level.

Why switch to FairTax? The most obvious benefit of the FairTax is the simplification of the tax code. There is only one tax rate, and only businesses have to file taxes. This reduction in tax-time stress and record-keeping costs would represent a modestly substantial improvement in our lives.

The main other known effect of switching to FairTax would be a change in the progressiveness structure of the tax code. If the estimate of 23% FairTax tax rate is correct, the moderately wealthy would pay slightly less tax and the extremely wealthy would pay slightly more. In his NY Times article, Why Democrats should love the FairTax, Laurence Kotlikoff waxes profound:
Our [current] tax system is regressive because none of the corpus - the principal - of the wealth of the rich, including our more than 400 billionaires, is subjected to taxation. Instead they pay taxes only on the income earned on their wealth.But this income comes primarily as capital gains, which are taxed at only 15 percent. Furthermore, capital gains taxes are levied only when wealth holders realize their gains - when they sell their appreciated assets.
Who knew! Kotlikoff continues:
But the superrich don't need to sell their gains. If they need cash they can borrow using their appreciated assets as collateral.
Can IIIIIIII do this too? Suppose I have $50 million in stocks. How can I turn those stock into spending money without paying that stupid 15% capital gains tax? Kotlikoff has the answer: just take out a loan from the bank for a million dollars. I don't have to pay taxes on a loan! And the bank will be happy to give the loan since I already have $50 million in stocks as collateral. What have I been waiting for? So I take out the loan. At the end of the year I have to pay it back. But that's OK because I can take out another loan to pay it back. Actually, my new loan has to be 6% bigger to cover interest, but 6% is still much less than a 15% tax. Moreover, the million dollars of stocks that I chose not to sell has risen in value by at least 8%, thanks to the excellent advice from my well-paid financial advisers.

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