The Tax that Will Not Die
I should have known, but I just found out that another FairTax bill was introduced in Congress last month. John Linder (R-GA) introduced H.R. 25, "The FairTax Act of 2007," on the first day of the 110th Congress. There are 55 cosponsors. The numerous problems with this "permission-to-live" tax, as Murray Rothbard described consumption taxes, I have already explained here, here, and here.
Rothbard sums things up nicely: "There can be no such thing as 'fairness in taxation.' Taxation is nothing but organized theft, and the concept of a 'fair tax' is therefore every bit as absurd as that of 'fair theft.'"
Comments (61)
Not to mention this is merely a new tax, and won't be proportioned.
Published: February 25, 2007 9:23 AM
Make all taxes voluntary.That would be fair.
Published: February 25, 2007 2:22 PM
My fear is it will eventually be passed without repealing the 16th Amendment.
Published: February 25, 2007 3:21 PM
A voluntary tax is a contradiction in terms: There would be no way to distinguish it from the terms "gift," or "donation," or from user fees. Given this, we may as well use those terms.
Of course a "tax" would really only be voluntary if there were no unjust restriction on a person's ability to give the money to somebody else for the same service. A voluntary tax, therefore, implies competition in the provision of all government services, and so anarchism. Not that there is any problem in that!
Published: February 25, 2007 4:12 PM
Hey, Read HR 95- It is a retail level consumption tax. Rebates to everyone monthly to cover the lower income groups- them that has and spend will pay the most. I know this dosen't fit well with the strictly Libertian/Austrian philosophy but it is a start, to level the playing field until smaller limited government gets instituted, if ever. The amount of money wasted on the current IRS methods is estimated at about 30% of current price levels.
Semper Fidelis,
JimT
Published: February 25, 2007 6:44 PM
I'm all for a perfect world immediately. No half-measures that would move in the right direction!
Published: February 25, 2007 7:49 PM
The problem with every single iteration of this is that the "Fair Tax" is always sold, forst and foremost, as being "revenue neutral", which is another way to say that it is about 90 times higher than it ought to be. The spending side is SO much more important than the taxing side as to render this debate all but irrelevant. Current federal liabilities and spending will bankrupt us all, period. Cut about 99% of current spending, repeal the 16th amendment (along with all amendments after the 13th), then we can talk about a consumption tax, AFTER we get rid of fiat money inflation.
Published: February 25, 2007 8:11 PM
Not only there is no such thing as a "fair tax"... there is also no such thing as a "consumption tax" - since consumption cannot ever be taxed (prices are formed by supply and demand conditions, and sellers cannot "shift costs" forward, otherwise no business would ever go bankrupt regardless of its cost recklessness).
Only when the proponents of HR 25 realize they actually support a 23$ revenue tax that sellers would pay regardless of their income (profit) - we can start the discussion:
- about the effect of "FairTax" on businesses that already incurred input costs and face market prices that don't allow them a 23% profit margin (and what would "transition period" actually do for them in terms of their existing supply and demand conditions)...
- Whether such tax would really abolish the IRS, since it relies on taxpayers (sellers) to monitor themselves for a nominal fee. At the same time, both sellers and buyers have a huge incentive to cheat on this tax, while government is clueless about the amounts of goods and services sellers really have (since inputs are not taxed). All this would lead to more intrusive and malign government's inspection and we should not cheer to the abolishment of the IRS if it gets replaced by some post-Soviet style "financial police."
- We can talk about demand side as well - what would "prebates" and abolishment of tax (that most of Americans don't even pay) do to increase total spending by more than 30$, which would be necessary for businesses that currently break even. In other words, in order to avoid initial catastrophe, everyone's paycheck must go up by the amount significantly higher than 30% (to account for people's increase in saving, because time preference tends to decrease as wealth goes up).
...BUT FIRST, the proponents of HR 25 should stop with the use of fraudulent or incorrect terms.
Published: February 25, 2007 9:17 PM
Correction, "$" sign should be replaced by "%" in following:
[HR 25 (FairTax) is nothing but a 23% total revenue tax (that's why it is not a 30% consumption tax, but really a 23% sales/revenue tax)... and 30% or higher increase in spending -from the day one- is needed to absorb it)].
Published: February 25, 2007 9:23 PM
I acquiesce to the FairTax because it eliminates most of the taxation on productive activity. I can earn income and/or sell PRODUCER goods without paying a penny to the federal government.
Under the FairTax, I can also save and invest as much as I want without paying any taxes to the federal government. At the macro level, this will greatly help facilitate more liquid equities markets, i.e. there would be no reason for somebody to sell their stock for tax purposes, or hold a stock longer than they wanted to for tax purposes.
SASHA: Due to the enormous benefits the FairTax provides to producers, especially the producers of high-end producer goods, the price of consumer goods would be much lower; this is in addition to the $600 Billion in regulatory savings captured by producers (corporations no longer need an army of tax lawyers). As a result of a larger supply at a lower cost, Say's Law will ensure that demand grows accordingly.
and Sasha, you must also remember that used goods are not taxed; this includes property and automobiles, a sizable chunk of change. Thirty-five percent of owners with mortgages, 15 percent of owners without mortgages, and 46 percent of renters in United States spent 30 percent or more of household income on housing. As for new constructions, the sales tax will only be applied to the structure (or improved) portion of the property.
Rent would be taxed as well, and mortgage payments would be partially taxed. On mortgages, loan recipients would pay a 23% tax on interest payments, minus the Fed funds rate; for example, if the $200,000 loan recipient is paying 50% principle (mid-term), the loan rate is 6%, and the Fed Rate is 3%, then the 23% tax would only be paid on 1/4th of the total payment. In this case, it would work out to a $90 tax on a $1200 payment. This process also encourages the timely payoff of loans, as all interest payments will incur a 29.8% (tax-exclusive) surcharge on payments to the bank (not the Fed).
This taxation of interest payments will also counteract the Federal Reserve's manipulation of the economy. Since taxes are paid on the difference spread between the loan rate and the Fed funds rate, if the Fed lowers rates, loan recipients will pay a little bit more. If the Fed raises rates, loan recipients will pay less in taxes. This will help prevent asset bubbles and will smooth out the boom-bust cycle (somewhat). Furthermore, it creates demand for tighter monetary policy: current loan recipients.
The FairTax is still a tax, and all taxes are a form of theft, but its far better than what we've got. If my choice is between being mugged and assaulted, or being pickpocketed, I prefer being pickpocketed.
Published: February 26, 2007 8:15 AM
You know, Laurence_Vance, you make a good point. Tax system B is worse than tax system A because "taxes are bad". A very strong, very compelling argument. I'll bring that up next time anyone recommends simplifying the tax code. Thanks.
Published: February 26, 2007 9:13 AM
This new non-fair tax is similar to the GST system introduced in Australia and New Zealand. The compiance costs are bourne by those who are GST registered. Thousands more tax inspectors and administrators are hired by the govt. You get to pay for that too. Anyone in business providing goods or services must answer intrusive questions and supply important data about their activties on a regular basis. Every such person or organisation has to calculate the tax, store the cash for a time and pay it to the tax dept. The time burden is not trivial. I am aware of those who gave up their business activities and either retired or becmae employees for someone else or went on a benefit. The major overlooked threat is the amount of information on business and individuals this type of tax system gives the tax man. He sees everything. The nature of the information that MUST be provided each month gives a most revealing picture of your activities and dealings.
In effect this system is analogous to the transponders that the UK govt is intending to introduce for people to have in their cars. Every trip is to be monitored and charged. Everything can be analysed. In this case the same applies.
BTW the GST was not "revenue neutral" as the pollies said it would be. Tax take went up big time. Other taxes which were supposed to be reomoved remained in force. All of them got increased over time. So much for that promise.
Instead of asking for a new tax seek to banish that which you have already got.
Sione
Published: February 26, 2007 11:37 AM
We will never see a net reduction of taxes without a new revolution.
Published: February 26, 2007 1:26 PM
NICK BRADLEY SAID:
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"I can earn income and/or sell PRODUCER goods without paying a penny to the federal government."
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Sure. But the demand for intermediate (producer) goods directly depends on demand from final goods producers (and that depends on consumer's demand). So if you introduce 23% revenue tax, without an increase in spending of 30% (for which you need increase in wages and salaries a lot higher than that to account for saving preferences) - so even inputs producers would suffer severely.
NICK:
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"Under the FairTax, I can also save and invest as much as I want without paying any taxes to the federal government."
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Investors in consumer's good would suffer 23% revenue tax as I explained. Since the purpose of any saving is future consumption, once 23% revenue tax starts destroying smaller businesses and their jobs, the expectations about future prices and increase in time preference would occur.
NICK SAID:
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"Due to the enormous benefits the FairTax provides to producers, especially the producers of high-end producer goods, the price of consumer goods would be much lower;"
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Prices of inputs are also created by supply and demand - not by cost shifting. In other words, at the day of FairTax, the inputs producers will initially cheer. They are not crazy to reduce their prices from current market levels, because their profit goes up. Unfortunately for them, 23% revenue tax will slam many businesses without financial power to absorb it, which would negatively affect the demand for inputs. As a consequence, there would be a downward pressure on prices of inputs and profits... meaning that there will be no profit-attraction of new producers in inputs production.
NICK SAID:
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"and Sasha, you must also remember that used goods are not taxed; this includes property and automobiles, a sizable chunk of change."
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O yes, I remember. So what? Before a good can become used - it has to be new once. And according to "FairTax" its seller will get his revenue taxed by 23%, even if he currently does not make any income. Fair, indeed.
NICK SAID:
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"Rent would be taxed as well, and mortgage payments would be partially taxed."
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HOORAY. Let's tax those bastards. But guess what - rent cannot be taxed, since landlords cannot shift costs forward form the day one... The total price of rent will be whatever market decides - and landlords and sellers will have to absorb 23% revenue tax. That’s not stimulating at all to them.
NICK SAID:
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", if the Fed lowers rates, loan recipients will pay a little bit more. If the Fed raises rates, loan recipients will pay less in taxes. This will help prevent asset bubbles and will smooth out the boom-bust cycle"
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Nope. Loan recipients always pay whatever is their market price, while lenders will have to absorb any tax.
NICK SAID:
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"this is in addition to the $600 Billion in regulatory savings captured by producers (corporations no longer need an army of tax lawyers)."
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Unfortunately, financial police that would replace IRS in case of the "FairTax" would probably cost lot more, because its task would be much more difficult.
As I explained, businesses pay 23% tax - not individuals. If customers are willing and able to pay, let's say $4,558 for a good or service, seller gets to keep only $3,510, after tax is paid to government. Seller now has an incentive to make a deal with a consumer to only charge him, let's say, $4,000 - but not to report this transaction to government. In that case, both sides are benefiting from tax evasion. And since the Fair Tax Act would make purchases of inputs tax free, government would be clueless about the total output of goods and services that can be sold in a black market. In order to control every single seller, government would have to organize something larger than IRS, in order to spy on every single seller in the USA.
Published: February 26, 2007 3:27 PM
"As I explained, businesses pay 23% tax - not individuals."
Businesses do not pay taxes: individuals pay all taxes, either customers get the tax passed directly to them, the employees get compensation less than would have w/o the tax, or the shareholders eat the tax or a combination of the three. You should know better Sasha.
Published: February 27, 2007 12:22 AM
Will,
I don't know if you should know better. i don't expect a lot from sales tax advocates.
Individual buyers would not pay FairTax. If it was possible to pass this tax forward to consumers regardless of market prices - then no business would ever go bankrupt. You can try to argue that somehow demand would go up and that increased cost would not lead to reduction in profits... But that is still not "passing costs forward' - but simply accepting market prices.
Also, you should know that employees are also paid according to market prices and not based on cost of their employers (only when employers get driven out of business and demand goes down, there would be a drop in demand and worker's earnings). But you can't say that employers pay that tax.
Finally, Fair Tax is confiscated at the time of the purchase, so individual shareholders do not even get to touch that portion of their sales… it never gets to retained earnings. That's what I meant when I said that business pay that tax... Of course that individuals, like owners and their employees, would suffer from this brutal 23% revenue tax ("businesses" are not sentient beings) - but it is important to realize that FairTax is just a revenue tax, confiscated from sellers, regardless of their income/profit (or a lack of it).
Published: February 27, 2007 1:04 AM
Correction. It shoud say: "But you can't say that employees pay that tax."
Published: February 27, 2007 1:05 AM
So to be more precise, I repeat:
Sellers pay sales tax (regardless of our views of the legal entities that get taxed) - not buyers, who would suffer from reduction in supply, only after sellers get slammed with their sales tax.
Published: February 27, 2007 1:16 AM
I find these conversations here to be silly. The "Fair Tax" would be far preferable to the current system. We should not oppose it just because we would prefer to do away with most taxes altogether.
Published: March 1, 2007 8:38 AM
"The "Fair Tax" would be far preferable to the current system."
I think I would find this claim more persuasive if the FT repealed the 16th amendment. Are we really to believe that this tax will end the income tax once and for all without abolishing the 16th?
Published: March 1, 2007 8:57 AM
Proponents of the "Fair" Tax always give me an uneasy feeling because they seem to be working so hard to sell their idea to libertarians that they don't see their own contradictions. Consider the two following two arguments I've seen in favor of the Fair Tax:
1. The Fair Tax will make paying your taxes easier. People won't have to go through the onerous process of preparing taxes. This will make taxpayers happier and will shrink the size of the IRS.
2. The Fair Tax will make taxes more visible to the consumer, since every purchase will drive home the cost of government spending. Therefore, libertarians should support it since it will expose the terrible cost of government to everyone.
So which is it? Will the Fair Tax work like income withholding and make happier, more compliant taxpayers (without actually reducing the tax burden), or will it motivate us all to demand that government cut spending to spare us from this terrible burden?
You could make a case that both are true, but I think it would be futile. People cannot be both agitated by the Fair Tax and happy about it.
At best, the Fair Tax will shift the burdens around and possibly give back a few hours or days to the average taxpayer who doesn't have to spend it on doing taxes. At worst, it will be implemented right on top of an unchanged existing income tax, greatly increasing the tax burden. In between is some scheme that partially lowers the income tax or soon raises the new sales tax.
Only the most gullible fool would trust the government to put us at the extreme that favors the taxpayer. Anywhere in the middle is going to be a net loss of liberty.
Published: March 1, 2007 11:29 AM
Dan,
Unfortunately, even if we abolish the 16th amendment, there is no guarantee that our current Supreme Court will uphold the old interpretation of unconstitutionality of income tax.
If we abolish the 16th Amendment, we're stuck with the Constitutional authority to tax however it wants, as long as direct taxes are apportioned (proportional to state's population).
This raises a question: is income tax a direct tax? In Federalist #21, Hamilton wrote that indirect tax is any duty, which amount a citizen can control with the attention to his own resources. According to Hamilton's flawed logic, you can just "pass forward" any tax, and consumers can choose the amount of taxes they pay.
But how is that different to income tax. Unlike capitation (poll) tax, you can avoid income tax by altering your activities. If you choose to work and earn less - your amount of total taxes will be smaller. Just like you can avoid "FairTax" by avoiding market transactions with other individuals (producing only for personal consumption), you can also avoid income tax by doing the same.
So if you argue that the "FairTax" is constitutional - the tax on earnings is equally constitutional, even after 16th amendment is abolished.
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HOWEVER,
Both "FairTax" proposal and our current "income tax" are unconstitutional in their present forms, since they represent non-apportioned taxes on property (they cannot be extracted from an activity before it results in something you own). And no, 16th Amendment does not provide for taxation of wages and salaries, since there is no taxable "income" when you exchange your body's service for money (that is an even exchange of goods and services between two sides, in which both parties enjoy perceived benefit, while monetary gain is equal to the value of good/service you sacrificed in that transaction).
As I explained on this thread, regardless of the alleged benefits to our aggregate demand and supply, the "FairTax" would be paid by sellers in form of 23% revenue tax, since you cannot "pass forward" any cost beyond your market price. Both sales and income taxes are not much different from taxes on land and buildings, which Hamilton used as examples of direct tax... essentially, if you own less property, you will pay less taxes.
In other words, there is no such thing as indirect tax. And as long as government exists, it will tax us in various direct forms. The only constitutional requirement is to make this tax apportioned among states according to their census. If citizens want to further reduce their tax burden, they might want to hold the government accountable to the 5th amendment: government cannot take a penny from you if it isn’t used to provide you a "just compensation"... And of course, they should rebel against big government if they feel they are overtaxed, at least with ballots.
Published: March 1, 2007 12:16 PM
Sasha wrote:
"Unfortunately, even if we abolish the 16th amendment, there is no guarantee that our current Supreme Court will uphold the old interpretation of unconstitutionality of income tax."
I hadn't thought of that, but you are right. What took an amendment a century ago would probably not need as much weight in order to be considered "constitutional." (They could simply file it under the general welfare clause, along with universal health care).
Published: March 1, 2007 12:31 PM
Careful Dan, because there is a danger to confuse the legality of government's spending with the legality of taxation methods... Those are two separate issues.
Published: March 1, 2007 1:04 PM
Supporters of the Fairtax - The main spending action of the spending Congress is to spend with a near unbroken spending record of 200 years of spending and the greatest (spending) focus for the current crazy spending Congress is ** to raise spending ** and the spending Congress will take the chance to spend while they play games for more spending.
In my view, the Fairtax is like stumbling on the thief which has been stealing half your property and you place the rest of your property at his care!
The enforcement of this will be worse than what we have (all collection is at one point, so avoidance becomes far more leveraged and essential and a huge black market will develop); Are you ready for RFID?
Basically the entire proposal is both (1) misguided fantasy (2) deceptive.
If taxes are 5% rather than 50% netting about $500B nationwide, or even 10% (goodbye state, local, federal, medicare, social security, whatever else, only essential courts, national defense, etc) the ** real ** goal is achieved.
There's an geniune way out of this mess: cut ________. Can you fill in the blank?
Published: March 3, 2007 7:31 AM
Sasha - I might be mistaken but the argument 'businesses can't pass on costs' in this case is flawed - Consumers would have the additional money (by non-payment of taxes) that businesses would collect in taxes.
Published: March 3, 2007 7:33 AM
JIMB,
You didn’t show that my argument is flawed. Even if from the first day people's spending goes up by necessary 30% to offset 23% revenue tax (and it would not, because there is nothing to increase demand by that exact amount on the first day of tax implementation) - you cannot say that sellers "pass forward" any cost. They simply accept their market price - which would in some cases be above people's average variable cost, while in some cases it would be below it (and that's why businesses go bankrupt).
So it's not all about semantics. Saying that consumption can be taxed is incorrect from economic and logic perspective and this conclusion is very important when it comes to legal issues. Even if we abolish 16th amendment, the "FairTax" and "income tax" are equally direct duties and equally unconstitutional.
Published: March 3, 2007 8:21 AM
One can argue that selective taxes on sales of only certain luxury items and imports (something that Founders saw in their lifetime) would be avoidable, in accordance with the constitutional intent, and different from other general direct taxes such as "FairTax" and "income tax." Of course, something like that would be insufficient to finance Leviathan that we now have for government.
Published: March 3, 2007 9:45 AM
Sasha - People would have increased income to spend and sellers would immediately put up prices to cover their costs.
Sellers in general DO pass on a great many costs (in the economic sense - no matter the accounting figures) if those costs also affect 'aggregate' income or restrict competitors sufficiently. That's why you find, in inflation, many sellers passing on costs quite quickly and effectively in markets where 'demand' might at first seem insufficient (but which is affected by a failure of other suppliers) and also where there is a large and growing demand (high incomes from inflation).
Published: March 3, 2007 9:52 AM
JIMB,
People would not spend exactly 30% more from the first day of tax implementation, or even after it. Even if you increase people's earnings by 40% (which would not happen) - there would also be increase in saving, and demand would perhaps not increase by 30%.
Sellers in general DO NOT pass any costs. They accept market prices - which act as agent of natural selection: eliminating those firms that cannot recover their average variable cost. If firms were able to pass any cost forward, regardless of market prices, than no business would ever go bankrupt. It's rather simple point to understand.
Your reference to inflation is irrelevant to our discussion. With inflation, more currency results in higher demand - and sellers accept higher market prices automatically.
Published: March 3, 2007 10:25 AM
As I said in one earlier discussion:
"Many economists seem to think that only force of supply matters... so if the cost goes up, you just jack up your price expecting a drop in supply and wait for demand to react... But that does not happen in the real world. Here, in reality, we have to check demand before we do anything. And demand always changes, it's unpredictable, and not measurable (when we become able to measure people's taste and preferences, I'll let you know). In other words, my costs can go up or down, but I will not mess with my prices until my demand (expressed in shortages or surplus) tell me to do so. Why? Because only the will of my customers matters and if I don't follow it and if I, instead, only focus on my desired profit, I'll be in deep trouble.
Oh, another thing... as Rothbard said, when my costs go down, I don't drop my prices immediately. Everyone cheers when that happens and no one is thinking about dropping their prices to "help out" their customers... But unfortunately, some of us get greedy and start producing more at larger profit... and profitability attracts new competition. So eventually supply goes up, prices go down, and natural selection weeds out those who are not close enough to that MR=MC point. But again, we are not dropping our prices first facing lower costs..." Likewise, sellers are not able to increase their prices to any point they want to, when their costs go up.
So your argument must be that everyone's spending will go up by an exact 30% from the first day of "FairTax" hypothetical implementation. But even if that happens (and it would not) - you can only say that sellers would accept new market prices - and that government would tax their revenue, regardless of income. In other words, we would have a direct, non-apportioned, unconstitutional tax.
Published: March 3, 2007 10:39 AM
To prevent potential misunderstanding:
An increase in people's unforced savings (which would not happen if "FairTax" was implemented) would be wonderful, especially for wealthy people that can raise good amount of credit - and it would indirectly stimulate future aggregate supply (increase in pool of potential investment funds for new production). The problem is that first month's "life-support prebate" of the "FairTax" plan would not be sufficient to offset a devastating effect of 23% revenue tax on current stocks of final goods. Even subsequent income-tax-free checks would not be enough to offset 23% revenue tax for every final good's seller (especially for those businesses that currently focus on customers that presently pay little or no income tax, but unlike Wal-Mart do not have huge assets that can save them).
Published: March 3, 2007 12:54 PM
Sasha - But of course sellers "pass costs" if they could not there would be no sellers. You are saying something different than this; and I believe you are saying something different than did Rothbard. Sellers cannot (if they have already priced correctly) pass a ** change ** in costs forward under ** unchanging demand **.
In my view, you do not have the 'ceteris paribus' condition necessary to make that argument (but even if you did it would be in serious question: prices are discovered and the shift of power between buyers and sellers changes. At any time a business may be able to charge more).
I am presuming in our FairTax fiction - most sellers would increase their prices by the change in costs at the same time buyers would find they have additional money at their disposal. The 'cost plus' actions of sellers (see Reisman on this) is a common business practice that is effective for most cases, and I assume that is what would be done in this fictional situation.
As far as businesses 'observing demand closely' and not passing costs or reductions forward until a change in volume occurs, that is not a factual generalization - it depends on the industry and the good in question. For example: a monopolistic company will tend to underprice their products relative to increase the barrier to entry so that they maintain the largest feasible market share and keep their costs per sale low (100 copies of Windows would never sell at the price it would be profitably offered).
Firms with a large market share are concerned primarily with "number of users" even if they potentially decrease their ROE. Increases in costs then are likely absorbed by the 'monopolist' firms.
I can make the opposite argument: if a monopolist senses that they could be losing their monopoly, them may instead increase their prices rapidly (just under the average switching costs) to give them a warchest for a different product. They are passing the costs on with the assumption that the market will be filled with future competitors.
In my view, strategy is a lot more nuanced than is appreciated, although the Austrians at least are interested in it.
Published: March 3, 2007 2:46 PM
Sasha - A gigantic devaluation of existing savings would occur (they are post tax and suddenly are converted to pre-tax).
The businesses most hurt would be those selling to people that are not paying taxes: they would be forced underground.
The people not paying taxes (the unemployed) would be hammered.
There are many arguments against the 'FairTax' ... in fact it is so bad that it's hard to know where to begin.
Published: March 3, 2007 2:52 PM
JIMB,
I already covered "your" objections to "FairTax". I already said that: "income-tax-free checks would not be enough to offset 23% revenue tax for every final good's seller (especially for those businesses that currently focus on customers that presently pay little or no income tax, but unlike Wal-Mart do not have huge assets that can save them)."
I mentioned savings (future consumption) in our last discussion about "FairTax"...
So I will turn to your previous posting:
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Your statements are incorrect. Of course that sellers DO EXIST without "passing costs forward". That's due to the fact that market prices (determined by supply and demand, as everyone knows) are greater than average variable cost (or equal to it) for surviving firms.
Regardless of your increase in demand - you still cannot say you "passed forward" anything. You just accept market price and you may get selected for success by market's selection - if those market prices allow you to recover your variable cost. That's first lesion in economics... and no - I did not misunderstand Rothbard, nor violate ceteris paribus.
When it somes to the first day of the "FairTax" - it's a matter of simple arithmetic: 23% revenue tax must be offset by at least 30% increase in spending for everyone, which would create market prices that are sufficiently high not to create any loss due to the "FairTax". There is nothing in "FairTax" proposal that would increase everyone's spending on the first day by at least 30%.
Your monopoly theory is also completely wrong, even from a mainstream perspective. Read Rothbard's brilliant description of monopoly pricing.
Market price is never "set" - not even by a monopolist. Why? Because price is set by both demand and supply. A monopolist can try to get to the point where marginal revenue equals marginal cost (even though he can really only guess about that point)- but that will not determine price! Instead, a monopolist will have to take this produced quantity to marketplace and let it intersects with "demand curve," which is only in G-d's hands!
Same goes for theoretical "pure competition". Marginal revenue curve that needs to be forecasted when you incur costs - actually equals to a horizontal demand curve (because firms are price takers, no matter what quantity you produce). A suggestion that a firm can control or predict the market price would actually suggest that all existing firms have some kind of unified control over people's destinies and preferences.
If price was "set" below market demand for a produced supply, a monopolist would face shortages and market outrage. Some of his competitors would simply buy his artificially cheep goods and resell them at real market price.
Published: March 3, 2007 3:53 PM
No one should be allowed to pass introduction to microeconomics class, without understanding this:
- Market prices are not "set" by any seller (not even a monopolist), since prices are formed by market demand at a given supply.
- Since market prices are not "set" by sellers, they are unable to "pass forward" anything - they can only hope that market prices will offset their average variable cost (and in many cases the don't and businesses have to close down).
- Producers are only able to only set their production output, and they try to produce quantity which they thing will be optimal based on PROJECTED (forecasted) demand - but the final market price is out of their hands.
- Even if a monopolist is producing quantity that he thinks will produce market price that is so low to create a "barrier" for competition - he will probably make a mistake and demand (hence, market price) maybe lower or higher than he predicts (leaving him with surplus or shortages at his desired price).
Published: March 3, 2007 4:25 PM
I think I would find this claim more persuasive if the FT repealed the 16th amendment. Are we really to believe that this tax will end the income tax once and for all without abolishing the 16th?
What would be gained by abolishing the 16th? The Supreme Court has said that the 16th amendment created no new taxing power - the income tax was legal before the 16th, and would still be legal if it was repealed.
Published: March 3, 2007 5:52 PM
Peter,
You are correct in saying that tax on wages and salaries is not based on 16th amendment - but the Supreme Court had also said that income tax is unconstitutional, since it represents non-apportioned direct tax on people's property. Since "FairTax" aims to tax people's revenue (it would be taken from the sellers' earnings based on market prices) - this tax is equally unconstitutional.
People who propose "FairTax" (and those who pretend to oppose it, while trying to promote incorrect view that consumption can be taxed) have major problems with their arguments, even if they refuse to accept the law of demand and supply:
- everyone's demand will not increase by at least 30% after this tax is implemented, in order to even allow conditions in which this particular cost can be recovered in form of higher market prices.
- their tax is any more voluntary or indirect than "income tax" and HR 25 would only get us to another taxing option of federal government.
- their claim that black market sellers (like drug-dealers) is flawed, since only legal sellers pay sales taxes... Any consumer, including a drug dealer, pays total prices based on supply and demand.
- The fact who really pays sales tax is illustrated by my earlier example: "If customers are willing and able to pay, let's say $4,558 for a good or service, seller gets to keep only $3,510, after tax is paid to government. Seller now has an incentive to make a deal with a consumer to only charge him, let's say, $4,000 - but not to report this transaction to government. In that case, both sides are benefiting from tax evasion. And since the Fair Tax Act would make purchases of inputs tax free, government would be clueless about the total output of goods and services that can be sold in a black market. In order to control every single seller, government would have to organize something larger than IRS, in order to spy on every single seller in the USA."
-------
PS
[A little note for ECO 3000-4000 level, since I mentioned point where marginal revenue equals marginal costs (in order to prevent replies that would take us completely away from our topic):
Firms are generally not profit maximizes as Rothbard correctly noticed). Since firms can only set their output (and not the market price), they would never target a production quantity based on MR=MC projection. Every projection comes with some standard error, and prediction of MR=MC point would include the distribution of outcomes in which MC is greater than MR - and no one will produce anything unless he expects its price to exceed its cost; and the difference between MC and MR becomes steeper as the quantity goes above MR=MC.]
Published: March 3, 2007 6:49 PM
Sasha - "Passing costs forward" is nothing less than saying "consumer demand is rising and sufficient" - it is never claimed (as seems to be implied by your argument) that a company can force consumers to absorb their costs at will. That is a straw man.
The attempt to pass costs forward is the action of every entrepreneur. Costs, of course, represent consumer demand for alternative uses of the goods used in production. In this case, it is equivalent to saying "demand for the entrepreneurial good exceeds the sum of the demands for the alternative uses of the goods used in production of the entrepreneurial good".
I think presenting Rothbard's argument here doesn't match what we are talking about at all. Rothbard was talking about forcing companies to pay additional costs and whether the effect of that fell on the company or the consumer. It hits ROE (as you point out), and only later affects consumers (some companies fail) because costs cannot be shifted forward in the face of correct pricing (MC=MR).
But we are not talking about the same demand. We are talking about a rise in demand that is 'equal' to the rise in expenses - an entirely different situation.
We agree it will not be uniform and many companies will be savaged and saving destroyed, etc. (I hadn't realized that you'd made those points already...).
I note that Home builders passed their costs very well in the years prior to the recent correction (rising expenses and revenues); many other firms have not and have failed because expenses have risen faster than revenues.
Firms also do not just 'accept market prices' because they target their competitors. If for instance, it is sensed that a competitor is financially weak, a strong firm will sometimes cut pricing (or offer free incentives) to drive the weaker firm out, provided there is a sufficient barrier to entry to make the final landscape worthwhile (note that Microsoft gave Internet Explorer and many other goodies away for free to protect it's market - taking down Netscape).
The market also shifts from a buyer's market to a seller's market. That is the way things do work (i.e. factually supported). Financial assets, for instance, are frequently bought because they RISE (demand many times decreases when the price falls - hence the inversion of the supply / demand characteristics and the oscillation between a buyers market and a sellers market). Any market of goods whose prices are rising and whose goods are not quickly spoiled can become an 'asset' market, changing the dynamic significantly.
Published: March 3, 2007 10:46 PM
No one is "passing cost forward." That is completely out of touch with any economic reality. Likewise, a firm is never setting prices, even when it wants to punish a weak competitor - it is only setting output, predicting (or in case of firms with great market power: trying to influence favorably) prices that will be formed by demand (economics 101). Once again, prices are formed in a process that DOES NOT CARE about producers wishes or costs. It's a cruel world out there, in which market prices eliminate those companies whose average variable cost is not low enough. There is no "passing forward" in any sense, no matter how hard someone wants something like that.
You miss Rothbard's theory completely: he said that firms do not pass any cost forwards - not just "additional" and "non-tax" costs, as you seem to imply. If you want: I'll quote Rothbard's exact statement.
And what increase in demand you talk about? Again - even if you insanely claim that any increase in costs due to "FairTax" will be offset by a simultaneous increase in demand - that increase MUST be greater or equal to 30% (to make up for 23% revenue tax). HOW IN THE WORLD WOULD EVERYONE'S SPENDING INCREASE BY 30% PERCENT, when so many American's don't even pay so much in income taxes (plus with any increase in income you don't have an equal increase in spending)?
Regards.
---
PS
[And one more thing I forgot; As Karl Menger's theory of value explained (based on Aristotle's observations), the future prices of final goods are not affected by prices of inputs, but its the other way around (since demand for inputs only comes from final goods' producers, based on demand for their goods). So even if we abolish income tax for inputs, producers of inputs would not generally benefit if, on the other hand, final goods' producers get hammered by a 23% revenue/sales tax. You basically reduce their cost, but at the same time reduce their earnings, since final goods sellers' (demand for inputs) would generally not see an increase in their customers' spending by a necessary 30% to offset the effects of "FairTax," and many would be forced out of business...]
Published: March 3, 2007 11:12 PM
People who are unfamiliar with Rothbard may legitimately ask: who is misquoting him here, when it comes to “passing costs forward” myth. I must quote the Man. He said:
“Consider: all prices are determined by the interaction of supply, the stock of goods available to be sold, and by the demand schedule for that good. If the government levies a general 20 percent tax on all retail sales, it is true that retailers will now incur an additional 20 percent cost on all sales. But how can they raise prices to cover these costs? Prices, at all times, tend to be set at the maximum net revenue point for each seller. If the sellers can simply pass the 20 percent increase in costs onto the consumers, why did they have to wait until a sales tax to raise prices? Prices are already at highest net income levels for each firm. Any increase in cost, therefore, will have to be absorbed by the firm; it cannot be passed forward to the consumers. ”
I think this settles at least the debate about what Rothbard really claimed and I don’t expect any further debate on this. According to reality and basic economics, even real estate sellers did not pass any cost forward – it was the rising market prices that selected many for success (prices fell far above their average variable cost). But guess what: many of them now suffer reduction in market prices and they often fall below their AVC, eliminating them from markets. There was no “passing costs” at any moment… just forces of market selection that in competitive markets are out of hands of a single firm.
Published: March 3, 2007 11:28 PM
The quote came from:
http://www.mises.org/story/1768
Once you understand how prices are formed, you will realize that there is no consideration of cost in marketplace - at all. Cost affected supply side of price formation, but any additional cost burden like sales tax will have to be absorbed sellers. Increase in demand may only help you to survive the market price once it's formed.
But even if I stop responding to baseless insisting that something is "passed forward" during sales in some philosophical sense (although demand that creates price at a given supply does not care for any costs of sellers - but only their willingness and ability to buy) - there is still no response regarding arguments that I listed against "FairTax" and refutation of its advocates' claims (it is still unconstitutional, harmful, revenue-confiscating-regardless-of-profits, black-market promoting scheme).
Published: March 3, 2007 11:45 PM
Sasha- By your first argument, no consumer can set prices either. Prices do not care about a consumer's situation. Obviously there's some disconnect with reality here ...
I think you interchange the definitions of the word "set": it can mean 1 - to control the price, 2 - to decide on what price at which it makes sense to transact. #1 has not ever been argued. #2 has.
This isn't an argument about FairTax -- we agree that it is nonsense -- it's a discussion about whether costs ** can ever or are ever ** passed on. I think they can and are. There is factual and logical arguments to support that view.
And in fact the last paragraph should demonstrate that Austrian pricing theory and the theory of demand (and thus many of the derivative arguments) are on not always on firm ground.
Published: March 4, 2007 12:15 AM
Sasha - "The last paragraph" referring to a switch in goods as "expenses" more of which are demanded at lower prices to goods as "assets" more of which are demanded at higher prices.
Published: March 4, 2007 12:17 AM
Sasha - You'd have to demonstrate, in the case of Real Estate sellers, that none of them raised prices in the face of their rising expenses and found that the market would absorb the price increases.
In my view, perhaps wrong, I think you are on really shaky ground - the direct Rothbard quote clears up the debate quite nicely: I've nothing more to add other than thanks for the opportunity for discussion.
Regards.
Published: March 4, 2007 12:31 AM
JIMB,
You are trying to create argument out of nothing. First, you tried with logically flawed statement such as: if businesses could not pass costs forward, there would be no sellers. I explained why this is absurd, since prices are formed in a process that has no regards for people's costs - and that's so many firms are eliminated due to market prices. The fact that some businesses are selected for success has nothing to do with their "passing" of anything: they just accept favorable market price, even if they are monopolists and their supply equals market supply.
You try repeatedly to convince someone that firms "set" the market prices, while everyone knows that force of demand meeting market supply creates these prices, regardless of someone's wishes. That even goes for a monopoly, which can only set the quantity based on forecasted demand and hope that market price will be close to the price they hoped for.
You also tried with misinterpretations of Rothbard. He never implied that tax costs would be magically "passed forward", when in fact everyone is charging the most he can for given demand and supply conditions. Now you try to misinterpret my statements (should I be flattered):
Of course that no customer can "set" the price, and I never claimed such a thing. And when I say "set" - I think of dictionary definition of that word. if you prefer, we can say: "determine." But the fact that neither buyers, nor sellers can "determine" market prices only proves my point.
Buyers and sellers cannot "pass forward" any of their desires, costs, whatever. They will have to accept market price. In case of monopoly (single seller), seller sets the market supply, while in cases of monopsony (single buyer) the buyer sets the market demand. But even in those scenarios - you cannot talk about "price setting" by either side, hence no passing forward of anything goes into price formation mechanism.
----
As far as real estate sellers go, I demonstrated basic economics quite clearly: a cost of real estate sellers IS NOT a part of price formation, because buyers care only about their own willingness and ability to buy once they face some given supply. Production cost is only one of several determinants of supply - and once that supply is produced, it is not considered any more in the market outcome. Even if you skipped basic economics, the fact that many of real estate sellers are going out of business should tell you that their costs do not determine market prices.
I have no idea how you got the idea that Rothbard's quote proves that I am on a "shaky ground." I can only attribute that statement to your defense mechanisms. Please read Rothbard's statement one more time (I'll even put it in bold again):
"any increase in cost, therefore, will have to be absorbed by the firm; it cannot be passed forward to the consumers. "
Anyway, you're welcome.
Published: March 4, 2007 1:05 AM
Sasha - If consumer demand is sovereign - consumers ** must ** ultimately pay all costs as consumers are the ultimate source of replacement funding for business. Forcing losses onto business then are ultimately losses to consumption and consumers.
In a world of shifting demand and inflations and disinflations and deflations, businesses find they are ** not ** pricing at MC=MR, some to their detriment, others to their benefit. Ability to "Passing costs on" (or "pricing power") is an excellent summary of that situation.
I think it a grave error to "stop at round one" of changes. If a cost is imposed on business without rising (real) consumer demand (i.e. "costs cannot be passed on"), the marginal business fails, demand for products for that business fails, supply also shrinks, and consumers end up paying higher costs. If it ever could be argued that MC=MR, it would be true ** only ** at the first event. The final incidence of the cost falls on the weakest entity in the chain of production (the producers of the product with the most substitutions).
In my view, the prior posts cover the remainder of the ground you mention.
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Published: March 4, 2007 12:29 PM
JIMB,
Your last comment was not very coherent and it is still economically unsound. Much of your "disinflations and deflations..., MC=MR" talk I didn't even understand. By the way, I covered more than "round one" of sales-tax effect couple of times before on this blog, but since you wanted to talk about "shifting costs forward" I focused on that, without any "grave errors."
Consumers don't have to pay all costs of producers (that’s why so many of them get eliminated in a process of market selection, which benefits consumers). Furthermore, surviving firms do not have to get their total costs covered by market prices. They stay in business if their variable cost gets covered.
Once again, cost is only one of the determinants of supply. It does not determine prices and people who think that all businesses can just "pass forward" sales tax are economically illiterate.
When prices are formed - firm is not passing anything to anyone - it exactly opposite (prices are passed onto firms PRE-EXISTING costs; some survive it and some don't). Demand determines prices for existing supply - and if prices cover AVC, they can keep doing business.
Published: March 4, 2007 12:49 PM
Sasha - Bottom line we disagree only whether businesses ever find a market that allows them to recapture higher expenditures. They can and they do.
Every successful business is one that managed to "pass their historic costs forward". Who IS compensating the business for their costs after all?
Since 'negative goods' have no meaning it might be easier to see this way: "passing the cost forward" means the value sacrificed by the business to produce the good is exceeded by the value acquired by the sale to a customer. That's all. That's it. It's clear from the context.
But what is even better, is that it accurately explains a lot of pricing actions in the market: get a minimum cost, add a profit margin, see if the market will bear that price ...
So in my view, what was being said was very clear and not directly at odds with the views of Rothbard's or yours (although I disagree on the applicability of Rothbard's analysis in the FairTax case because no business would be pricing at MC=MR just after it was imposed).
In the longer run, no businesses exists long without passing their fixed and variable costs to the consumer. If the market will not bear it, variable costs will rise (replacement of production capital - fixed costs - is necessary) until the business either finds that they can "pass higher costs forward" or they fail.
That is the source of the "absurd" claim that "if businesses could not pass costs forward, there would be no sellers." There wouldn't be: there would be a loss on ** every ** transaction. Passing cost is nothing less than finding the market able to bear costs, and hopefully able to bear costs plus margin.
In practice, businesses do attempt (if they feel it is warranted) to "pass changes in costs forward as well". The factual evidence, say of homebuilders, is that some DID pass their rising costs forward to the consumer. They didn't have to (they could have taken less profit). How did that happen in a world "where it cannot?"
Firms behave in this manner as a matter of factual record. It is economically sound because past costs (especially over some time) are one of the most reliable records of the current structure of consumer demand, even though consumer demand (and costs) do change.
In my view, the terminology obscures the underlying principles, which are factually and logically accurate. They do not deviate from Rothbard's view, they compliment it with a more accurate market-behavior terminology.
Published: March 4, 2007 3:35 PM
Sasha - Consumers ** must ** ultimately pay all costs if consumers are sovereign: everyone is a consumer - including businesses - so a business failure is also a reduction in (the investor's) consumption. Thus (in the end) 'consumers pay all costs'. That is a necessary implication to the Austrian theory.
A particular consumer might refuse to pay a price to a particular business sufficient to absorb costs, but that loss will be born by the investors in the business, who will not gain the ability to increase their consumption as they originally wished.
That is why consumption can only rise in a (relatively) free capital market; the choices made in investment affect the ability of economic actors as a whole to consume.
(There is a serious deficiency in the theory here - are there "real" profits if people go mad and consume everything so that they perish? There's something to be said for objective values ...)
Published: March 4, 2007 3:51 PM
JIMB,
You are misinterpreting Rothbard again. According to the Man, no one aims to price at MC=MR, and I explained why would aiming at that point be illogical... Plus you're absolutely wrong: Austrian theory does not imply that consumers pay every single cost of businesses, since many of them go bankrupt. But anyway...,
You ask: "who IS compensating the business for their costs after all?"
In many cases, the answer is: NO ONE, and they go bankrupt, or many surviving firms don't recover their total cost, but they still stay in business (since they can pay for their variable cost).
Our disagreement comes from the fact that you are trying to deny market reality, as well as basic economics:
Sellers can only set their output (supply) - while prices get formed when that supply interacts with consumers demand. It is prices (revenue) that gets passed onto sellers costs - not vice versa.
Again, I didn't understand most of what you tried to say, but if you still try to (incorrectly) imply that sellers unilaterally set the prices - it can't be good.
Published: March 4, 2007 9:27 PM
Sasha - In my view, these posts just aren't being read. The main criticism is 'costs are not passed forward' for ANY firm is demonstrably false. The phrase 'passing costs forward' means adding new costs to the price or pricing cost plus margin and finding the market will bear the (new) price.
It means nothing else. It doesn't mean 'cost determines price'. It doesn't mean 'costs are goods that can be traded'. It doesn't mean 'historical costs are paid by transactions'. It doesn't mean 'consumers have to pay the price increase'. It means that the the discovered market price covers the firm's historical (raised) costs.
And consumers do pay the additional costs of many firms - it happens all the time. It is a factual reality. In other words, MC != MR. You cannot assume away the market price discovery process by asserting apriori MC = MR which is not necessarily true (especially in light of inflations and disinflations and deflations) and then continue to 'prove' that what just happened (cost increases passed on in higher prices) couldn't have!
It's circular anyway. MC = MR already necessarily implies 'costs can't be passed on' so one can't start with that and call it a proof.
Published: March 4, 2007 11:48 PM
JIMB,
In order to prove that ANY firm is "passing" anything forward in pricing process, you have to prove that a firm is setting the market price. That's the only way you can prove that they "pass" anything during the price formation. Unfortunately for you, NO FIRM SETS THE PRICE, since they are formed by demand that meets some already produced supply.
Like said before, the price (revenue) gets passed back to a seller's cost, not vice versa. That’s why market prices are eliminating those sellers when price is not greater than average variable cost.
PS
Your MC=MR talk is incoherent and irrelevant. Either you prove impossible - that any firm is setting market prices (as you initially claimed) - or simply stop with nonsense about "passing" anything forward when it comes to prices, which are out of sellers' hands.
Published: March 5, 2007 10:30 AM
Sasha - Which happens every time the firm raises prices to cover costs and the market accepts the higher prices for goods or services (it is discovered that $5 increase in price causes less than $5 loss in revenue).
re: In order to prove that ANY firm is "passing" anything forward in pricing process, you have to prove that a firm is setting the market price.
Published: March 5, 2007 6:13 PM
JIMB,
Often time, there is an increase in cost (supply eventually drops, not immediately!) - but demand is also decreasing. As a result, you don't have to have an increase in price.
Firm is not "raising" anything - it is market that raises prices. If a firm tries to charge beyond that market price, it will get stuck with surplus.
Once again, it is demand at a given supply that sets the price. Sellers cost is only one of the determinants of supply - not price.
Published: March 5, 2007 8:38 PM
JIMB said: "(it is discovered that $5 increase in price causes less than $5 loss in revenue)."
===
What do you mean by this? Trying to joke?
Published: March 5, 2007 8:46 PM
Sasha - Look at it this way: the firm is now (because of market changes) underpricing it's product. They are "setting" the price under the new market level (and they are, in this case, determining the price) and MC > MR.
The FairTax proposal, excluding it's other problems, is exactly this situation. Higher cost meets higher demand. Two things are changing at once ...
No, it's not a joke if we are talking MC, MR analysis: $5 increase in price causes less than $5 decrease in revenue for the marginal unit so there is a net gain across all the 'prior' units sold.
Published: March 6, 2007 8:13 AM
JIMB,
NO, I will not look at it that way. Firm is not pricing anything. Market is forming prices - which may or may-not cover a firm's cost. In other words: firm is not passing anything forward - it is the market price that is passed to its cost.
Your MC, MR is a total joke, but it's even irrelevant to our topic.
Published: March 6, 2007 7:17 PM
Allow me to use Hoppe's interpretation of Rothbard http://www.mises.org/etexts/hhhonmnr.asp :
"Production, as explained Rothbard, precedes the sale of final products, and production costs must be incurred before consumers can demonstrate their preference for one’s products. Cost curves on the one hand and the demand and revenue curves on the other do not exist simultaneously! The only curves that exist simultaneously with cost curves are entrepreneurially estimated FUTURE demand and revenue curves.
However, in deciding on the quantity of goods to be produced, every producer will always set his output so as to maximize his expected money earnings, ceteris paribus."
In other words - firms are setting the output (supply) not prices. Therefore, firms cannot pass anything forward in pricing process, since that's out of their hand once they display their supply.
Published: March 6, 2007 7:22 PM
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