Monday, December 31, 2007

FORMER ARKANSAS governor Mike Huckabee has proposed what sounds like a simple, pain-free fix to the convoluted mess that is the current federal tax code. Mr. Huckabee, along with Republican presidential rival Rep. Duncan Hunter (Calif.), has endorsed what proponents call the "FairTax," which they say will allow the government to dispense with the Internal Revenue Service. As Mr. Huckabee describes it, Americans would pay a consumption tax, "like the taxes on retail sales 45 states and the District of Columbia have now," with a "monthly rebate that will reimburse us for taxes on purchases up to the poverty line, so that we're not taxed on necessities." Mr. Huckabee argues that the FairTax would encourage savings, save compliance costs and improve competitiveness -- all while bringing the same amount of money into the U.S. Treasury. If only.

As Mr. Huckabee correctly points out, there can be advantages to taxing consumption rather than income. FairTax proponents assert that a 23 percent tax rate would generate sufficient revenue to replace the income, payroll, corporate and estate taxes. But that claim is based on a misleading computation that in turn is based on a series of improbable assumptions. The actual tax rate would have to be far higher to generate the same revenue that the government collects now.

First, the 23 percent figure is disingenuous. If the current price of a widget is $1, a 30-cent sales tax would be added at the register under the FairTax. Because 30 cents is 23 percent of $1.30, backers of the tax claim that the tax rate is 23 percent. In addition, to make the claim that the tax would bring the same amount of money into the Treasury, FairTax proponents assume that the government is paying tax to itself on its purchases.

The Presidents' Advisory Panel on Tax Reform -- that's President Bush's tax panel -- calculated that the rate would have to be at least 34 percent, not 30 percent, "and likely higher over time if the base erodes, creating incentives for significant tax evasion." Brookings Institution economist William Gale puts the rate at 44 percent -- and his calculation doesn't take into account cheating, for which there would be ample incentive.

Furthermore, the 30 percent rate assumes that the tax would be imposed on a broad range of goods and services that has no precedent -- putting a hefty and politically implausible extra tax bite on purchases of new homes, rent, food, health insurance, medical care and mortgage interest.

Finally, the FairTax would hit the middle class the hardest. Consumers would receive a monthly "prebate" on expenditures up to the federal poverty level, providing a cushion and probably even a modest benefit for those with the lowest incomes. The top earners, those with incomes greater than $200,000, would see significant tax cuts. So who makes up the difference? It's likely that taxpayers with incomes in the middle range -- about $40,000 to $100,000 -- would pay more. And they call that a FairTax?

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