Um . . . no

By Megan McArdle

I'm no fan of the Fair Tax. But this from Kevin Drum is just wrong:

The issue isn't so much Social Security benefits, which are currently tax-free for nearly all retirees but would end up being subject to a sales tax. The "prebate" feature of the FairTax proposal would, in theory, take care of most of that. Rather, it's retirement savings, which would end up getting taxed twice. Say you earn $1000 at age 64, pay taxes on it, and then stick the remaining $800 in the bank. The next year you turn 65. Under current law, that retirement money is yours free and clear because you've already paid taxes on it. But if a sales tax is in place, that $800 isn't worth $800. It's only worth about $600. Surprise! All that money you've saved for retirement is suddenly worth a whole lot less than you thought it was. Better not plan on taking any of those Caribbean cruises you've been dreaming about.



This is transitionally true--once. (And could be fixed in a variety of ways, such as boosting Social Security checks). But on average, it is not.

Assume for simplicity's sake that we are choosing between a fair tax of 20% and an income tax of 20%.

Income tax Worker gets paid $2,000, loses $400 to tax, consumes $800, saves $800. 10 years later, retires and spends the other $800.

Sales tax Worker gets paid $2,000, pays no income tax. Buys $1000 worth of goods, 20% of the value of which is tax. Saves $1,000. 10 years later, buys $1000 worth of goods, 20% of the value of which is tax.

The senior pays the same amount of taxes, no matter what. It gets more complicated when you add time preference for money, interest, investment and growth. There is no reason, however, to claim that the Fair Tax results in double taxation. Broadly speaking, the reason a fair tax hits seniors harder is that they don't save; they run down savings. And the Fair Tax is structured to benefit those who save.

Politically, this is probably a killer. But economically, it might well actually be good, encouraging seniors to delay the date at which they retire and start drawing down savings.

This article available online at:

http://www.theatlantic.com/business/archive/2008/01/um-no/2563/