In all fairness?

There has been much discussion in the Republican camp about implementing a “fair tax” policy in the United States. As a result, I took a look at the website – www.fairtax.org – and searched for information with regard to whether the policy is a good idea. The idea of a single sales tax – 23% -- on everything, and the elimination of income taxes, seems, on the surface, to be the fairest and most equitable way to collect taxes from individuals. On second glance, though, the idea of a single sales tax is progressive (not in the tax sense, but in the political sense), but not necessarily in a good way.

To start, the proposal would only affect the federal taxes. This means that you would not have to pay federal income taxes, either as an individual or as a business. That sounds great, right? Keep in mind, though, that it does not eliminate state income taxes, state sales taxes, state luxury taxes, local property taxes, local income taxes, etc. The measure is only intended to meet the needs of the federal government, so the average taxpayer still has to contend with whatever the state decides to do to him. For the moment, though, let’s set aside these concerns, and focus on the taxes at the federal level only.

When it comes to economics, conservative pundits often turn to the “Father of Economics”, Adam Smith. After all, he was the rule-maker for this crazy-little-thing called capitalist economics. Here’s what Smith had to say about taxes: “[t]he subject of every State ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the State.” Smith’s position is clear: people ought to contribute to a country based on their abilities, which is indicated from the revenue they get while being protected by the State. On the other hand, Smith’s writing is inimical to the idea of taxing wages: “a direct tax upon the wages of [labor] must, in the long run, occasion both a greater reduction in the rent of land, and a greater rise in the price of manufactured goods, than would have followed from a proper assessment of a sum equal to the produce of the tax, [levied] partly upon the rent of land, and partly upon consumable [commodities]." Thus, you have two positions: (1) people ought to be taxed on the money they make (revenue); but (2) people ought not be taxed on the money that they earn (wages). What’s the difference?

To find consistency within Smith’s arguments, one must simply look at the two words: revenue and wages. From the perspective of a firm, revenue is the money that comes in, and wages are one of the costs of business. For household, earnings are the money that comes in, and expenditures represent the costs leaving the household. If you put these concepts into a cyclical diagram, you get the wealth cycle. According to Smith, what should be taxed is the expenditures/revenue part of the wealth cycle, but not the wages/warnings part. Thus, a tax on consumption is consistent with what Smith has stated. The “fair tax” policy meets this ideology, because it is a tax on consumption. So far, so good.


However, that is not the end of the analysis. Check out this website: http://www.progress.org/banneker/adam.html. Notably, read the following:

“Bearing all these things in mind, there are two types of taxation which obtain Smith's recommendations: a tax on luxury consumables and a tax on ground-rents (the annual value of holding a piece of land).

“On the subject of luxury consumables, he is adamant about the [definition] of 'luxury' and of 'necessary.' By his definition, a 'necessary' may vary from place to place and from time to time. At the time of his writing, linen shirts, leather shoes and a minimum of food and shelter were definitely to be regarded as essential to a [minimum] decent standard of living. Taxes on salt, soap, etc., he harshly criticized as inequitably taking from the poorest elements of society. Taxes on luxuries, which were to include tobacco, he considered excellent in that no one is obliged to contribute to the tax: "Taxes upon luxuries have no tendency to raise the price of any other commodities except that of the commodities taxed ... Taxes upon luxuries are finally paid by the consumers of the commodities taxed, without any retribution."

“More deserving of [praise] is the tax on ground-rents: "Both ground- rents and the ordinary rent of land are a species of revenue which the owner, in many cases, enjoys without any care or attention of his own. The annual produce of the land and [labor] of the society, the real wealth and revenue of the great body of the people, might be the same after such a tax as before. Ground-rents, and the ordinary rent of land are, therefore, perhaps the species of revenue which can best bear to have a peculiar tax imposed upon them."”

So, Smith adds a few quirks to the basic concept of consumption-based taxation. First, taxation of necessities is a bad idea because it “inequitably” taxes the least-fortunate. Second, taxation of luxuries is a good idea because the obligation to pay a luxury tax may be easily avoided by not consuming the luxury. Finally, Smith posits that “revenue which the owner, in many cases, enjoys without any care or attention of his own” should be subjected to taxes; this is revenue from capital gains or investments. Consequently, a basic tax on consumption is not Smith’s answer – rather, it is careful taxation on certain consumables and forms of revenue that should be applied.

Fair tax advocates have the right idea – tax consumption instead of income. However, fair tax advocates have politely dodged issues such as tax incidence and regressive application of taxes based on proportional expenditures. Fair tax advocates, through their policy, would tax necessities as much as they would tax luxuries. The fair tax policy also does not include a taxation upon rents – income not earned directly through labor – which is something that Smith suggested would be an ideal tax.

Thus, I present the following “fair tax” policy, modeled upon the suggestions by Smith:

· A sales tax on luxuries, up to 30% based on value.
· A sales tax on the sale of homes, up to 40% of the amount above the tax-appraised value.
· No sales tax on necessities, such as food, clothing, rent, or fuel.
· A sales tax on rent income, up to 25% based on amount received.
· A tax upon revenue from investments, mutual funds, and other non-labor revenue, up to 35% of gain.
· No income or FICA taxes based on earnings.

But a blanket sales tax? No, thank you. That’s one thing about Canada I didn’t really enjoy.