Brad DeLong asks a crucial Fair Tax question:
[I]t’s a mammoth tax cut for the crowd making more than $200,000 a year and a substantial tax increase for those making between $30,000 and $200,000 a year. Does this make economic sense? It is hard to see how: What makes the $200,000-plus crowd especially deserving of a tax cut?
Arnold Kling begins to answer it:
Our current tax system takes its biggest bite out of people who earn much more than they consume. Because the Fair Tax (or any consumption tax) would abstain from tapping this rich vein of unspent earned income, it would taking larger bites out of others to obtain the same revenue.
Consumption taxes reduce tax rates drastically on people who earn more than they consume. To be revenue neutral, they have to increase taxes drastically on people who consume more of what they earn. Whether this is a bug or a feature of consumption taxes is more debatable than Brad lets on.
The economists who support the Fair Tax (or Steve Forbes’s flat tax or any other tax change that would shift the burden from income to consumption) believe that money saved and invested is worth far more to the economy than money consumed. People who make $200,000 a year tend to save a much higher percentage of their income than people who make $30,000. Therefore, giving those high earners a tax cut would mean even more saving and investment, which would mean more economic growth. That’s the thinking. It’s certainly not universally shared among economists, but neither is it some crazy fringe idea.
The politics of such a move, though, are something else entirely. As DeLong writes:
[A] lot more people make between $30,000 and $200,000 a year than make more than $200,000. Politicians prefer, other things being equal, to take positions that are advantageous to more people rather than those that are advantageous to fewer.
Most of the Fair Tax enthusiasts commenting on my Friday post seem to believe that high-income folks currently get out of paying taxes. Surely some do. But high earners as a group still pay enough to fund the bulk of our federal spending. According the CBO’s latest data, the 5.8 million households making $126,300 or more in 2005 (that is, the top 5% of the income distribution) paid 43.8% of all federal taxes and 60.7% of income taxes.
Give those people a tax break, and the money will have to come from those lower on the income scale. That’s simple arithmetic. You could argue that consumption taxes will so stimulate growth that they will leave the real after-tax incomes of the middle class higher even after the tax increase. You could argue that high earners deserve to keep more of their money. You could argue that we should have a smaller federal government and lower taxes for all. But if you’re for a Fair Tax or any other kind of flat-rate tax, you are for shifting some of the tax burden from high earners to the middle class. There’s really no way around that.
Update: BU economist Larry Kotlikoff has a fascinating paper (warning! pdf!) in which he contends that if you look at people’s “lifetime tax rates,” the retail sales tax is more progressive than the current federal tax system. You’ve got to believe in his simulations to buy the argument, but it’s definitely true that taking one-year snapshots of people’s reported income is an incomplete measure of how much their wealth has increased. The basic point is that eventually all wealth is consumed (albeit sometimes by the taxpayer’s children or grandchildren or great-grandchildren), therefore a consumption tax effectively amounts to a wealth tax. I’m still struggling with that eventually.