Monday, March 13, 2006

Fair Tax Revisited

By Jim Simpson

With the possible loss of Congress in this year’s midterm elections looming large in the Republican psyche, and the Democrat political/media machine cranking up the pressure to an unprecedented fever pitch, some conservative pundits, who should know better, are starting to do what Republican politicians all to frequently do when the pressure is on: they are losing it.

Of course we have the obvious example of William F. Buckley surrendering the game to the relentless, uniformly negative news from Iraq emanating from the relentless, uniformly antiwar, anti-bush media.

But the others sound deceptively reasonable at first. They correctly point out that people are fed up with this Republican Congress’s empty rhetoric, their bald hypocrisy in spending like Democrats, their almost universal cowardice in the face of partisan Democrat attacks, and their inexcusable timidity in pushing the conservative agenda.

The pundits correctly point out that in order to regain the initiative, Republicans need to go on the offense. There are many popular issues that would resound favorably for Republican candidates in November: making tax cuts permanent, taking real action to stem illegal immigration and vigorously articulating our successes in Iraq and Afghanistan – something they have inexplicably never done. But I don’t hear a Republican clarion call over any of these.

Ignoring these issues, the commentators lunge for more imaginative stuff, as if these dotards would willingly go for something even more risky. For example, one noted pundit who I usually admire, suggests that Republicans roll out the "Fair Tax".

The Fair Tax folks propose to replace the current income tax system with a national sales tax, called a "consumption" tax by economists. In theory it's a good idea. You can basically do two things with money; either spend it on consumer goods (i.e. consume it) or save it. Right now we have no problem with the consume part. As a nation we have been over-consuming for years.

Most economists agree that boosting the U.S. savings rate is critical. Saving is essential because it promotes investment, and investment is the engine of long-term economic growth, i.e. prosperity. Over the past fifty years it has been low, and since the early 1980s, on a nonstop downward trend. It went negative last year (this means people are spending more than they make – and borrowing the difference).

Because it taxes only consumption, people can avoid the tax by putting money into savings. And despite the often heard complaint that "we don't make enough to save", reducing or eliminating a tax liability that consumes up to 40% of income by saving instead of spending it is one heck of an incentive. Hence, all else being equal, the consumption tax would spur savings and therefore fuel long-term economic growth. So in theory, this is a sound idea. But theory and reality often clash. In this case, the theory doesn’t take politics into account. And in Washington, politics is everything.

The U.S. Congress will repeal the income tax, to recall a memorable quip by Nikita Khrushchev, "when shrimps learn to whistle." Congress derives a substantial share of its power through the vast array of controls over our economy imposed by the Internal Revenue code. One Fair Tax proponent admitted that even Republican members of Congress are "afraid of the loss of power that would come from a repeal of the current tax code..." A consumption-based tax system would be a direct challenge to Congressional power.

No. If there is one thing I know it is the U.S. Congress. They would fight any effort to repeal the income tax. Therefore, if a national sales tax is proposed, it will pass. What? Did I say, "pass"? That's right. I am certain a version of the tax would pass. But remember, that's only half of the deal. Congress won't do the other half. They won't repeal the income tax.

Congress will, after countless sessions, debates and caucuses, decide to support a "modified" consumption tax. The proposal's supporters will introduce a modest national sales tax offset with a few small reductions in the income tax and sell it as a way to "initiate reform" of the tax system. After all we don't want to jump into things, now do we? They will propose that we "phase in" the consumption tax, and the income tax reductions will support the fiction that they intend to "phase out" the income tax.

The idea's Congressional proponents, with typically heroic denial, will enthusiastically support this as a "major first step" on the road to a consumption-based taxation system. Because of "concern" over the deficit, raised by some “fiscally conservative” Democrats, the proposal will be revenue neutral, meaning that after all is said and done we won't even get a tax cut out of it. Instead we will suddenly be faced with the sticker shock of a new tax raising the price of every single thing we buy, every day. That will be in addition to filing our April Fool's tax returns. And we’ll have Republicans to thank for it!

What paltry income tax cuts there are will be offset by the political damage when, after supporting the bill’s passage, Democrats accuse Republicans of instituting a regressive system of taxation. After all, sales taxes tax everybody, rich and poor, at the same rate. And the poor spend a greater percentage of their income on consumption goods, so they would actually pay a greater share of their income in taxes. Democrats call that “regressive.” (The Fair Tax proposal makes an exception for those under the poverty line, but don’t look to the Dems to point that out.) So now the class warfare rhetoric will be have double whammy: “regressive” sales taxes coupled with tax cuts for the “rich!”

What a brilliant way for Republicans to win reelection!

But that's just the beginning. Congress has an almost mythic ability to turn to its advantage even the most innovative challenges to its power, and this one isn't even that innovative. After the modified “Fair Tax” bill passes, a strange thing will begin to happen. The proponents will somehow lose steam and be unable to garner support for further changes. It may not all be deliberate. Maybe some of the idea’s Congressional supporters fail to get re-elected. Maybe one dies. No matter. Genuine, committed supporters of any proposal which consciously strips Washington of power as this does, will always be a very small group, with little real clout. The rest of the clan will be unenthusiastic about further changes.

The whole proposal reminds me of the term limits idea. In the early 1990s, new Republican candidates all over the country made noble promises to limit their tenure to only a few terms. Most revealed their hypocrisy early on by repudiating their pledge. They dishonored the whole party. Meanwhile the genuinely principled among them stuck to their pledge and retired after only a few years, thereby robbing us of the best people before they even got enough experience to be of any real benefit! Dems were conspicuously AWOL on this issue, no doubt in hiding so people wouldn’t see how hard they were laughing.

As with the term limits idea, the myopic stupidity of this one will too late become clear: Congress will simply use the national sales tax as yet another source of new revenues, which was what it intended to do when it agreed to pass the proposal in the first place. Income tax rates will again start creeping up and then the national sales tax rate will also begin its upward march. This is what happened with the FICA tax (Social Security). Initially that tax was 2%. Today it is 15.3%!

If a Democrat Congress takes over, then just imagine what will happen. Not only will income and consumption taxes begin to creep up but, since the national sales tax is now law, why not do as the Europeans and impose it at every level of production? That's called the "Value Added" tax, or VAT for short. Creating new sources for tax revenues as would occur with the national sales tax and the VAT, actually makes it easier to raise taxes, because the increase can be distributed over a greater variety of taxes. Instead of one large increase, you have a lot of little ones. And small increases in any one kind of tax are less likely to be noticed or objected to.

Congress curries votes by promising to reduce, increase or redirect tax revenues to benefit particular targeted groups. It is patently insane to dangle yet another source of tax revenues in front of this demonstrably greedy and self-serving group while at the same time expecting them to relinquish one of their most effective tools of power. No, the consumption tax is a horrible idea. Not because it is not theoretically sound. It is theoretically sound. But in practice it will only serve to give the Washington permanent establishment a way to raise yet more taxes and further entrench their power.

Let’s not make a bad situation worse. I would settle for simply making the already-in-place Bush tax cuts permanent. Abolishing the death tax, for example, would be huge. But all of the cuts were beneficial. The only error was making them temporary. Now Congress should do what Bush pledged early on: make those hard won cuts permanent. It may not keep Republicans in the majority, but at least we would get something of value out of this disappointing, feckless bunch.

We have the facts on our side, we have the ideas on our side, we have the principles on our side. Why can’t the people we hire sell them? To those nervous Congressional Republicans we worked so hard to elect to a majority, I say “put up or shut up.”