In Slate, Steve Landsburg praises “Huckabee’s Innovative Tax Plan,” aka the FairTax (neither mentioned by name nor linked, and of course not Huckabee’s own brainchild at all). Landsburg’s specialty is coming to outrageous conclusions–things you know in your heart can’t be true–based on irrefutable economic logic. The fun part of reading his columns is trying to find where the problems are (kind of like a compass-and-straightedge construction “proof” I remember from the Journal of Irreproducible Results that all angles are equal to a right angle). And who knows, maybe he’ll turn out to be right! Not this time, though.
In the long run, most people, or at least most families, do spend what they earn. (Why earn it if you’re not going to spend it?) True, some of us die with money in the bank, but usually our children or grandchildren step in to spend the remainder for us. So, as far as your dynasty is concerned, a 20 percent income tax and a 20 percent sales tax are equally painful.
Well, first of all, the richer you are the less likely you are to spend everything you earn, especially if you don’t factor in your descendants squandering your estate. A major problem with the FairTax is that it’s even more regressive than its flat rate makes it seem, for just this reason. And balancing present versus future values is, at least, tricky (I’ll mention one major problem below).
Landsburg then compares sales taxes to unlimited IRAs, and cites research to show that unlimited IRAs (with no withdrawal penalties) are Good.
Bottom line: Unlimited IRAs, coupled with somewhat higher tax rates, have advantages and disadvantages, but the advantages are bigger. And whatever can be said about unlimited IRAs coupled with somewhat higher tax rates can equally be said of a national sales tax.
Well, maybe, sorta, to first order. The popular exposition he cites, however, mentions a critical detail Landsburg omits:
First, even though the higher savings rate may boost the economy, so that in the long run other tax revenues would increase, in the short run there would be an unambiguous tax-revenue shortfall. Second, complete tax exemption of IRAs raises political-fairness issues, because some incomes would no longer be subject to taxes.
Taxing IRA money when it is withdrawn, as is done under current law (back-loaded IRAs), addresses the fairness issue. We could solve the revenue timing problem by taxing the money before it is invested rather than upon withdrawal (front-loaded IRAs). Though it may seem counter-intuitive, front-loaded and back-loaded IRAs are equivalent on a net present-value basis.
That is, waiting to tax your money until your grandchildren spend it is going to be a problem for the government’s revenue. The front-loaded IRAs that can address the problem are not equivalent to sales taxes.
Back to Landsburg:
Another alleged difference between sales and income taxes is that income taxes can be graduated, while sales taxes can’t. Maybe, maybe not. There might be a way to design a graduated sales tax. Your credit-card providers have a pretty good idea how much you spend each year, and the government could in principle use that information to set your tax rate. Yes, there are a lot of details to be worked out, and yes, it’s highly intrusive—but I’m not convinced it’s any more intrusive than what we’ve got now.
Is Landsburg really suggesting that the government enter into some unholy alliance with credit card companies? Maybe not, but for now I’m pretty skeptical that a graduated sales tax can be made to work. And it’s emphatically not what Huckabee and the FairTax folks have in mind.
But the good news is that the details don’t matter, because there’s an easier way to design a graduated sales tax. Namely, keep the graduated income tax and add a provision for unlimited IRAs. Presto, you’ve got the equivalent of a graduated sales tax.
That’s not necessarily desirable. You could well argue that a flat tax rate is a feature, not a bug. But that’s a topic for a different column. The point of this column is that the whole flat-versus-graduated issue is quite tangential to the sales-versus-income-tax issue. And the underlying issue becomes a lot clearer once you realize that a sales tax is a modified income tax.
And here we have the real problem with Landsburg’s column. He is not talking about the FairTax at all, or about anything that (as far as I know) any prominent political figure has proposed. The FairTax backers most assuredly do not see the flat-versus-graduated issue as tangential to the sales-versus-income-tax issue. And rightly so, I think; one of the few virtues of the FairTax is its simplicity. Landsburg’s unlimited IRAs might or might not be a great idea, but they have less to do with this year’s presidential politics than he says.