State FairTax Concept Riddled With Problems

This week’s Courier Herald column. It’s is the latest in a series looking at efforts to cut and/or eliminate Georgia’s income tax. You can read earlier installments beginning here.

With Labor Day safely in the rearview mirror it’s time for everyone to get back to work. For us here, it’s time to resume looking at Georgia’s tax structure. Today we get to the heart of the matter and look at why some want to eliminate the state income tax. They believe we can implement the FairTax at the state level only.

In some GOP circles, the FairTax has become the holy grail of tax reform. It is a silver bullet that is proposed as a costless transition where other people will pay more, current taxpayers will pay less, and the country would achieve an economic renaissance that would approach nirvana.

There are some valid concepts in the FairTax, namely one of shifting the embedded FICA taxes on US labor to taxes that can be rebated on exports and imposed on imports. Other parts and assumed calculations are more troublesome. Regardless, let’s stipulate for the purposes of this column that the FairTax does what supporters claim. The point here is to explain why a policy that may work at the national level would fail miserably if attempted singularly at the state level.

Let’s start with Economics 101 – a class many forget the premise of when lecturing others on things that don’t actually work. The simple models used in basic economics have some broad assumptions that don’t exist in the real world. One of these is that the models contain no “leakages”. This means that all money, goods, and labor exist only within the model, forcing the reactions and ultimate outcome.

States don’t set broad macroeconomic policy for a variety of reasons, but chief among them is that it is easy for changes at a state level to have the benefit “leak” to another state. To put it in non-economic terms, imagine a Georgian that just experienced a windfall and spends it.

Some of that money will remain here (utilities and some groceries) but the bulk of that money will quickly cross state lines with the purchase of most automobiles, interest on their mortgage that has been securitized around the world, and consumer goods mostly made overseas. The result is that much of the benefit originally generated in Georgia is quickly shared by other states.

Contrast that with a move that Georgia makes that puts Georgia in an economically disadvantageous position. The burden of that tax or policy falls quicker in Georgia. The rise of the internet makes it quite easy to purchase across state lines. An increase in the sales tax is quite easily avoided on major purchases – much easier that folks can avoid income taxes by changing their state of residence while actually working in Georgia.

Then there’s the service economy, which is now the dominant jobs creator in the U.S. and Georgia. The FairTax extends sales taxes to services. Folks say with a straight face that this is to avoid “picking winners and losers”. Every type of tax code picks winners and losers. A transition to the FairTax inherently picks manufacturers as winners over service occupations as losers.

How is that? A service – everything from hairdressers and handymen to doctors and lawyers – is essentially labor. And income tax is a tax on labor. A sales tax on services is the same as an income tax on labor. The incidence of economic burden from these taxes are the same.

The top sales tax in Georgia is currently 8.9%. The top income tax rate is 6%. Not only would service industries and individuals in this area not see tax relief, but they would pay more under a FairTax than they currently pay – and that’s before adding an expected increase in the sales tax rates.

While it is difficult for individuals to move based on tax burden, it’s much easier for employers. Imagine the large legal and accounting firms based in Atlanta suddenly faced with adding 8.9% or more to each of their bills. Their customers would seek professional services in other states, and the jobs would eventually flow to them.

I’ve had the above conversation in much more detail with FairTax advocates and they are undaunted by all the economic gobbledygook. When asked about the costs, their comeback is always the same: It will be outweighed by the resulting economic growth.

Where does this growth come from? They claim it’s from the tax cuts. But they also claim that the bill doesn’t require spending cuts because it is “revenue neutral”. For every person that benefits, another pays more. Those that benefit have more to spend, but those who pay more have less. The status quo remains. There is no economic windfall from tax cuts, because by their own words, the bill isn’t a cut.