Economix: A Long Shot Bets on the ‘Fair Tax’

Bruce Bartlett has served as an economic adviser in the White House, Treasury and Congress.

Charlie Neibergall/Associated PressHerman Cain, who announced Saturday that he was seeking the Republican nomination for president, spoke in March at the Conservative Principles Conference in Des Moines.

On Saturday, the pizza magnate Herman Cain announced that he was running for the Republican presidential nomination. While he has to be considered a long shot, he has something going for him that could make him surprisingly viable: his strong support for the so-called Fair Tax.

The Fair Tax is a proposal that has been kicking around for at least 20 years. It would replace all federal taxes, including income and payroll taxes, with a national retail sales tax similar to those levied by the states. Indeed, a prime virtue of the Fair Tax, in the eyes of its supporters, is that it would be collected by the states, thus allowing for abolition of the hated Internal Revenue Service and an end to filing tax returns or keeping financial records.

The rate would be set at 23 percent — but only if you accept the unconventional way in which Fair Tax supporters insist on calculating it. If calculated the way state and local sales taxes are calculated, the Fair Tax rate is actually 30 percent.

Its supporters say 23 percent because a 30 percent sales tax on a $1 purchase would yield an after-tax price of $1.30 and the 30 cent tax is 23 percent of $1.30. I’ve always viewed this as legerdemain designed solely to disguise how high the rate is, but Fair Tax supporters are convinced that their unorthodox way of calculating it is the correct way of doing so.

This is not the only odd feature of the Fair Tax. Another is that governments would have to pay the tax on their purchases, including the federal government, which would pay the tax to itself. Although Fair Tax supporters claim that the purpose of this provision is to prevent people from substituting government consumption for private consumption, the true purpose is to cut government spending by the amount of the tax.

Because the Fair Tax assumes that government spending would be frozen in nominal terms, if the government has to pay 30 percent more for everything it purchases, even though it is paying the tax to itself, real spending must necessarily fall by the amount of the tax.

Another oddity is that Fair Tax supporters insist that once all existing federal taxes are abolished, prices of all consumer goods will instantly fall by about 22 percent. If prices rise 23 percent because of the new sales tax, nominal prices should be about the same as they are now, they say.

At the same time, Fair Tax supporters would also institute a national rebate equal to the tax rate on a poverty level income. Quite apart from the obvious fact that politicians would use this rebate to buy votes – an election-year increase is practically guaranteed – why is the rebate necessary if there is no change in the prices of goods? And because no one is paying income or payroll taxes any more, everyone should have plenty of extra money to spend, right?

It turns out that an unstated assumption of the Fair Tax is that all wages will fall by the amount of income and payroll taxes people now pay. That’s the key reason why producers and retailers will be able, theoretically, to cut their prices.

However, nothing in the Fair Tax compels workers to accept pay cuts and there is no reason to think that they won’t strenuously resist them.

A final oddity of the Fair Tax is that for as long as I have heard of this proposal, its supporters have consistently maintained that a 23 percent rate would exactly equal current federal revenues. Over this period, revenues have been as high as 20.6 percent of gross domestic product, in 2000, and as low as 14.9 percent now.

So either the Fair Tax would have been a huge tax cut 10 years ago or it would be a huge tax increase today.

Despite the transparent silliness of the Fair Tax, in my opinion and those of most serious economists, it has strong support among a small and well-financed group of enthusiasts. In 2007, Mike Huckabee, the former governor of Arkansas, was their guy, and it was absolutely critical to his rapid rise from obscurity to serious contender for the Republican presidential nomination.

Mr. Huckabee is not running this time, but Mr. Cain has made the Fair Tax a cornerstone of his campaign. Most political analysts don’t view him as a serious contender and see the Fair Tax as baggage to be overcome, not a political asset.

While radical and controversial ideas are generally viewed as political albatrosses in general elections because they appeal only to a fringe element within one party, they can be very valuable in primary campaigns. Especially in a divided field with no clear favorite, such as Republicans have today, proposals such as the Fair Tax energize true believers and provide contributions and manpower that can propel an outsider into contention.

Of course, there is nothing to stop other Republican candidates from endorsing the Fair Tax. But the tax’s supporters tend to be very loyal to the candidate who does so first and most passionately. In this election cycle, that person is Herman Cain.

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