Hugh and Hank Adler on the Fair Tax Fantasy
HH: You know, on April 15th, hundreds of thousands of Americans demonstrated, and they were concerned over how much money is being spent. They were concerned at rising tax rates. They are concerned at the direction of the country. I’m going to cover a lot of that in today’s show, but this hour, I want to make sure that we put out in front of people what not to do, that we do not want that energy dissipated or misdirected, that it not flow into a river which goes right into an empty hole from which all that energy will never return. I don’t want you to sign up for the fair tax. Joining me in studio today is my co-author. I have put out a brand new book with my co-author, Hank Adler, who is a professor of accounting at Chapman University’s business school. We’re both at Chapman. I’m at the law school, he’s at the business school. And a few months back, Hank and I sat down and looked at the fair tax, which is out there in book form by my colleague Neal Boortz and Congressman John Linder, and about which I get e-mails every single day. And we went through it line by line, piece by piece, and we wrote our own book called The Fair Tax Fantasy: An Honest Look At A Very, Very Bad Idea. The Fair Tax Fantasy is now available. You can order it at www.hughhewitt.com. I’ve posted it up there at the top of the website. And in studio with me is Hank Adler, because Hank Adler, we just do not want this to get off. We don’t want them to suck up the energy of the tax reform movement. Hank, hello, good to have you in studio.
HA: It’s good to see you, Hugh. Thanks for having me here today.
HH: I want you, I’m going to do the questions, you’re going to do the answers, because that makes it easiest. Can you sum up for people what the fair tax proposal is?
HA: Sure, Hugh. The fair tax proposes to eliminate the income tax, the payroll taxes and the estates taxes, and put in place a 30% tax on all retail purchases. The people that wrote the fair tax talk about it being 23%. It’s really 30, and I’m sure we’ll come back to that. But it taxes everything except R & D, education and purchases for investment. So with every retail purchase every American makes, it’ll be subject to a 30% fair tax. It proposes, some of the interesting parts of it is the fair tax people propose to provide every American with what they refer to as a prebate. And it’s intended to pay those retail taxes up to the poverty line. As we’ve discussed, they’ve missed the calculation a bit, but the theory is that the people below the poverty line will not have to pay any of their taxes.
HH: Now that prebate is just a nightmare. We get into that in the book.
HA: Yeah, an unmitigated nightmare. It’s administered by registering literally every American, and having the government mail to them a check, or make a deposit, every month, twelve months a year, $20 billion dollars plus a month, which is they’d have to mail something like $114 million checks a month, twelve months a year, or $1.3 billion dollars in checks. It is a really, and we’ll talk about, I hope we’ll talk about that at length, a real nightmare. And you know, they assume they can get all that accomplished. And I don’t think there’s a prayer they get it accomplished. We have a very simple idea that when looked at closely at all is just, at least I think, a real nightmare for the American people.
HH: Hank and I went round and round on what to name this book, and Hank finally came up with the Fair Tax Fantasy, because that’s what it is, Hank. It’s a fantasy. I mean, people wish for the IRS to go away. And you’re no, you were a partner at Deloitte. You were a tax accountant. You teach tax now to students. You were not a fan of the Internal Revenue Code as it presently is written.
HA: Oh, I think the Internal Revenue Code’s a nightmare, Hugh. It’s way too complex. If you were going to design a mistake, it probably would be the Internal Revenue Code, because what you want is you want a tax system that is really, really simple for about 90% of the people. But you also want a system that for the remaining 10% that are doing complicated transactions is going to grasp all the money, all the taxes that would be fair for each taxpayer.
HH: And as I posted at the website where the Fair Tax Fantasy’s available, www.hughhewitt.com, we are not opposed to tax reform. In fact, we’re big proponents of tax reform. Did we put tax reform into the book, our own particular proposals, though, Hank?
HA: No, we specifically left it out of the book, and we left it out of the book because we wanted to have a book that discussed the fair tax. And what we both agreed to was that if we started to put proposals into the book, the way we would be attacked on our ideas is that our proposals would be attacked. And it’s my plan to put something in a technical journal probably in the next six months to a year on a plan that I think makes some sense.
HH: But where we are right now is we want to demolish the attractiveness of the fair tax, because as we’ll discuss in this hour, it’s very attractive to a lot of elected officials who want the easy charge of a mobilized base who think they’re going to get something for nothing, who think that the fair tax will work. And we’ve got to persuade Republicans, and especially the tax reform movement that was so visible on April 15th, and all the tea parties, not to get sucked into this. Now just generally speaking, though, Hank, what about federal income taxes? Do you agree with me they’re too high?
HA: I think they’re much too high, and I think we’ve proven over the last what would be 25 years, every time we’ve lowered the tax rates, the government has collected greater revenues. So why anyone would want to raise the rates we currently have would be counterproductive.
HH: Now let’s also talk about our self-interest. If the fair tax were somehow adopted, I would benefit quite a lot, because…in fact, almost every American who makes six figures or more will benefit quite a lot from the fair tax. How would you do under the fair tax?
HA: Well, I played with the numbers last night thinking I’d come on here today. I would be just a huge winner. It reduces my taxes by about 60%, Hugh.
HH: And I think I’m probably about the same as you. My guess is I’m pretty much the same as you. And so it’s not because we don’t like the idea of paying less taxes. It’s because it’s a nightmare for the country, and a nightmare for the Republican Party, and a nightmare for conservatives. Back to the fair tax, you indicate in it, and I do, too, that the tax rate being proposed, the sales tax rate being proposed, is 30%. Yet you know, by the time we open the phones here, they’re all going to stand and scream it’s 23%. It’s not. It’s 30%. And you know, you explained it. You came up with this in the book. If you want to get a dollar for this pen, you make this pen, no matter what it cost you, you want to sell it, you want to get a dollar back at the end of the day. Under the fair tax, what’s it going to sell for?
HH: $1.30. And that’s a 30% sales tax.
HA: Anybody who…there are 45 states that have sales taxes. In all 45 states where we have a dollar to the seller, and 30 cents to the government, considers it a 30% tax.
HH: But the fair tax proponents say that $1.30, that thirty cents, is only 23% of a $1.30, so our fair tax proposal’s only 23%. And we spent a lot of time talking about this as we put together the Fair Tax Fantasy. Give your theory as to why they do that.
HA: Well, let me give you the number, first. The way they get to the 23% is they multiply the $1.30 by 23%, and that will yield a thirty cent tax. My best guess is, I don’t know these folks, but my best guess is they did a lot of focus groups, and the focus groups started to tilt when you got above a 25% tax. And somebody with a great mind said well, geez, if we do it this way, and we do it that way, nobody will ever figure it out, it’ll be 23%. The piece that I find most, I guess humorous is the right term with that is if I was going to sell that pen for a dollar, the way I would compute the tax, instead of using the 23% rate that they use is I would say okay, it’s a dollar times 30%. That’s my tax, 30 cents. How do I check it? It’s 23% of a $1.30. I mean, it’s really, really nuts.
HH: It’s really, really nuts. It is a 30% tax. And anyone who tells you no doesn’t want to deal with the facts on that. Now this morning, I was talking with Michael Medved, my friend, about the new book The Far Tax Fantasy. And Michael’s invited us to talk to him on the air about it. I’m looking forward to that. And he’s attracted to some parts of it. He said what’s the biggest objection to it? I told him that mine was the effective rate to accomplish what they want to accomplish would have to be so much higher than 30%. There are a lot of studies out there. You did all the academic legwork on this. But by the time that the states shifted over, and most of them will have to shift for reasons we cover in the book, by the time they actually recaptured all the money we need, they say it’s tax neutral. I think we’re above 50%, Hank. Is that what your estimate was in the end?
HA: I think it runs somewhere between 40, 45, and 53%. It’s a huge number, but it’s…when the states, it would be almost impossible for the states to maintain their systems. So what would happen is over time, maybe over a relatively short period of time, the states would be forced to adopt this methodology so you’d have piling on. You’d have the states paying, you know, states adding their fair tax, you’d have the fair tax as its proposed. The academics that I’ve read, the federal study done for the presidential commission indicated a much higher rate, I think you end up with something pretty close to 50%.
HH: Let’s talk about what’s taxed and not taxed under the fair tax proposal. In the Fair Tax Fantasy, we have a fairly extensive list of the exceptions. They say it’s everything but education and R & D, but I want to make sure people understand it also applies, for example, to food.
HA: Yes, it’s going to…their…virtually every sales tax, and I can’t say I know it’s all, essential things are left off the rolls. And generally, groceries is the one we look to first, services in a lot of states. I think in California, they’re thinking about taxing services, currently. But everything, virtually everything that’s not for investment and education. Some of the more interesting things that are on that list are we would start to pay a fair tax on trash collection. We would start to pay a fair tax on the hiring of a police officer in a state.
HH: Every state and local government expenditure, except those for education, get hit with a fair tax?
HA: Yes, and I know that’s difficult to believe, Hugh, and we’ve had these long conversations about the Constitutionality of being able to impose a tax on state purchases. But if where we lived decided to hire a police officer, they’d have to pay a 30% tax.
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HH: Hank, the biggest selling point by people who are in favor of the fair tax is that it lets people keep 100% of their salaries, and that taxes essentially become voluntary upon passage of the fair tax. What do you make of that argument?
HA: Well, it has a corollary, too. In the original books on the fair tax, Hugh, it was that you could keep 100% of your salary, and also prices would go down. But the reality has set in, and yes you would be able to keep 100% of your salaries, but most of the technical data has shown that prices will go up by 30% to offset it. So there’s really no, there’s no magic in that pill.
HH: And you also lose the deductions on which at least some people listening right now rely. It will be devastating for charities. The charitable deduction will be gone completely, not just diminished as under President Obama’s “tax reform”. And of course, the mortgage interest deduction goes away. What happens to housing under the fair tax, Hank Adler?
HA: Well, let me give you the two pieces of housing, Hugh. The first piece is that because the fair tax provides for no tax, for no fair tax as an investor, we’re going to have an, we would have an unequal market between the investor and the homeowner who purchases a new home to live in it. Quick numbers, if we talk about a $300,000 dollar house, under the fair tax, and this is using the 30% rate, not worrying about what the state rate would be, not worrying about the fact we think the 30% rate is low, the buyer to live in a home is going to pay $390,000 for that new home. The $300,000 that goes to the builder, and a 30% tax, $90,000 dollars to the government. At the same time, if an investor comes along and buys that house, he’s going to pay a $300,000 dollar amount and no tax. So you’re going to have a market that is instantly going to move forward and push the renter, the renter in place and give the investor a huge advantage.
HH: Now existing homes would not be taxed if they were sold, only new houses, correct?
HA: That’s correct, but that’s the engine of our economy.
HH: Yup, new home building is a massively important sector, and I just wanted to make sure that we are accurate. One of the things we’ve tried to do, Hank, in this book is to accurately portray the arguments of the fair tax proponents. We think they’re so bad that we don’t have to do anything. We don’t have to shift around the detail, we don’t have to be deceptive, we wouldn’t be anyway. But it’s such a big target, basically we can pick our circle and hit it.
HA: Yeah, I mean the housing thing is just a nightmare. If you have children of the age who are out buying their first house, and you think about them paying a 30% premium over somebody who’s wealthy and out buying rental housing, it’s just a frightening thing. The other half, I think, that you asked me is what happens to existing housing. When you lose your deduction, and many, many, many Americans have very substantial mortgages and interest payments every month, when you lose that deduction, you’re not going to lose the requirement to make that interest payment. You’re still going to have to make your mortgage payment every month. And the impact of having prices go up by 30%, link to losing that deduction on a home, it’s just huge numbers.
HH: Let’s also talk about what happens to imports. It’s one of those key things that I brought up with Michael Medved today when we were talking about this, because it matters a great deal. We’ll start a trade war to end all trade wars with this.
HA: Yes, let’s focus on exports first before we talk about imports. And the export world is really interesting, because, and I think we missed that in our original conversation here, exports would go out untaxed, with the concept that that would be building the American engine. But there is something about having a Dodge truck that costs $20,000 dollars in Michigan cost, you know, plus a 30% tax, not have that tax applied if you bought it in Mexico City. I mean, it just puts Americans at a disadvantage to their own tax system paying more in the United States for an American-made product than you would pay overseas.
HH: We also see it’s going to start a trade war.
HA: I cannot imagine a country that was, currently had U.S. imports, where the cost of those imports went down by the amount of the tax, wouldn’t instantly put additional taxes to get the markets in place. I mean, we wouldn’t allow somebody to bring products into the United States, we have a lot of technical terms for it, but we’re not going to allow somebody to sell something in the United States where it’s going to put our local industry out of business. At least I hope we’re not.
HH: We also have a chapter, and this was kind of fun to write, on what happens to the ordinary person when they have a 30%…I mean, it’s going to be a 30% pop in prices. The fair tax people dispute that. But the academic research, in fact, Governor Huckabee on this show has said oh, Hugh, embedded taxes will go away, and therefore it’s going to be a wash. And that just doesn’t work. Taxes, the experts agree, they’re going to go up.
HA: Yeah, it’s a sum of the parts game. If people are going to get their salaries, they’re going to get 100% of their salaries, then the cost of the manufacturer is not going to go down, so the 30% tax is, it simply becomes an add-on.
HH: Yeah, and so that means prices are going to go up, 25-30-35%, whatever the person…the market’s still going to work. But let’s just say 30%, generally speaking, is where they will rise to. When that happens, what’s going to be the tax avoidance behavior of people who buy anything, Hank Adler? You’ve dealt with legal tax avoidance at Deloitte for years as an accountant to people with assets.
HA: Well, one of the things that happens anytime there’s a tax change, and I’ve dealt with this for thirty years, is behavior changes. If you’re in the market for something that, let’s take just a handsomely rich person who wants to buy a big vacation home. It’s going to cost 30% less in another country. They’re going to buy it there. What generally happens, when you raise taxes beyond what the customers are willing to pay, is that you create an underground market. That’s been true for hundreds of years. I don’t know how it could change under the fair tax. If we have a, if a contractor comes to the door and you don’t have incredible reality chasing you around the house, and he offers you to do it without having this fair tax, and if we use the 50% rate, we’re talking about huge amounts, you’re just going to pay him cash, and that’s going to be the end of the discussion.
HH: Yeah, it’s going to increase the gray economy, not decrease it as the fair tax proponents argue. And there’s a chapter in the Fair Tax Fantasy about customs at the border. As people come back from Europe wearing their Rolexes that they paid 30% less for, not declaring…it’s just a carnival of exemptions and complications.
HA: Oh, and it will be candid camera every day of the week. First off, we have completely different rules for customs, very complicated rules, but the gist of them is if you’re traveling overseas, you can bring back a few hundred dollars worth of stuff free for each trip. The fair tax doesn’t have such rules. The imports, and the tax on imports would be 30% at the border. And the line might go, say, from New York to Ontario, Canada, to figure out how to collect it. It would be impossible within an airport or any kind of shipping port.
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HH: And it takes a Deloitte tax partner to understand some of this stuff. And I think that’s one of their advantages, that we had to destroy a lot of their complexities.
HA: Yeah, Hugh, certainly the initial reaction to let’s just have a 30% tax, how could anybody be anything but positive about that? But it’s like everything else. It’s always in the details. It’s always in the inability to perform on that easy idea.
HH: And the second part is they really bank on the antipathy that is widely and deeply felt towards the IRS. Now I want to take a moment to say I know a lot of fine professionals in the Internal Revenue Service. I have since I worked in the Office of Personnel Management. I know a lot of fine former professionals. You take it away. We’re not fans of the IRS, but we’re not going to beat up on IRS specialists.
HA: Well, it’s not the personnel. What we should be mad at is the legislature who has created this zillion page, incredibly incompetent, complex Internal Revenue Code. But my experience is no different with the IRS than dealing with the rest of the world. About 90% of the people you deal with every day are terrific, and about 5% are not so terrific, and there are five you’d never like to see again. I’ve only left one meeting shakingly angry with the IRS in my career.
HH: In 30 years of doing so. Now I do want to point out that they promised to abolish the IRS, the fair tax people do. But in fact, you can’t collect a 30% sales tax without a sales tax collection system. And we spent a lot of time in the Fair Tax Fantasy examining their proposal. And let’s go through it in just a couple of minutes here, Hank Adler. How do they propose to get this money to Washington, D.C?
HA: Well, what they’re going to set up is a state organization, it has a fancy name, but they’re going to set up these sales tax administrating authorities, but there are going to be 50 of them, and plus Guam, they haven’t talked any of the places that aren’t easy to get to. But in essence, you’re going to replace the Internal Revenue Service with 50 of these organizations. So you’re going to have 50 organizations that are basically the Internal Revenue Service. And where would you go to hire the people to work there? You’re going to go to experienced tax people. You’re going to hire the people from the Internal Revenue Service.
HH: And they’re going to expand dramatically the duties of the existing Social Security Administration beyond the ability of that agency to continue the effective performance of their already sometimes not-so-easily accomplished duties.
HA: Yes, the way this works, and let’s take a step back on that, the first catching the rabbit part is that every American must be registered with one of these state sales tax administrating authorities before the first prebate dollar can be raised. So that’s 300 million legal Americans registering in 114 million families.
HH: And being classified. They’ve got to be classified.
HA: Classified as every family group. And there’s some as we talk about in the book, there’ll obviously be some opportunities to go around this thing, because there always are. But just the task of registering 300 million, I mean, think about all the controversy that’s already occurring with the Census. But first, we register 300 million people. Everyone has to have a Social Security number from the babe in the woods to the oldest part of the family. That information is then supposed to go to the Social Security Administration to verify every number. How they’re going to do that, I don’t know. Then it goes back to the state, and then the state is charged every month with providing the federal government, the Social Security Administration, with the information to write these 114 million dollar checks, noting that if your daughter moves from out of your house into house B, that somehow has to be reported and tracked. I mean, it’s an unbelievable task. And you and I have talked about great examples where states have tried just to register people who own cars or changed their systems and have failed drastically.
HH: And behind every system change is an enormous software shift. And behind every enormous software shift is an enormous series of glitches, and people taking advantage and working the system. It just simply cannot work. They invent their solutions to everything. If you read the Fair Tax book, and then you read the Truth About The Fair Tax book, both of these co-authored by Neal Boortz and John Linder, and the website for the fair tax people, everything has a solution. They just invent solutions that when you sit and look at them for five minutes, which is all we will require you to do in the Fair Tax Fantasy, they fall apart like tissue under a faucet. They cannot work. That’s why the Fair Tax Fantasy is out there. It’s over at www.hughhewitt.com.
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HH: It has seduced a lot of people. Greg Zimmerman, one of the great Twitter people over at #hhrs on the Twitter feed, just wrote, posted a few minutes ago, damn that Hugh Hewitt, I thought I was all settled on supporting the fair tax. Now I have to do some more thinking. Oh, my brain. Exactly, Hank Adler. We know a lot of people who, as you said, love the idea of the simplicity of getting rid of the IRS, nobody likes the complicated tax code. It is a very seductive but a very bad idea. And I want to turn to the Constitutional problems with it. I mean, what happens to the states under this?
HA: The states are hit with a very odd situation. With the exception of education, the costs of the state would now be, would be taxed under the fair tax. So if a state goes out and they hire a policeman, or a series of policemen, that, his payment, the payment for his services, is going to be subject to that 30% tax, which is a huge number, a huge number that would play into the state budget of obviously every state, city and county in the country.
HH: Yeah, the city of Los Angeles, already deeply, deeply in debt, all of a sudden sees pretty much, because the LAUSD’s off their budget, a 30% increase in their cost of operating, ditto the city of New York, ditto the city that you live in, America. And what are those state and localities going to do? They’re going to raise your taxes. It is a recipe for disaster. What about in terms of, Hank Adler, the student I mentioned, the foreign exchange student, the mythical Saudi Arabian or the Nigerian who’s going to NYU or USC. They get a prebate.
HA: Well, the way the prebate is written is if you have a Social Security number, and if you’re here as a legal resident, you’re going to get a check once a month.
HH: But illegal aliens, of course, do not get it.
HA: No, and you know, no matter where you stand on the illegal alien discussion, they wake up one morning and they’ve got a 30% increase in prices, and they get nothing.
HH: And so they’re living in their crowded conditions, many of them with children, and they wake up and their food bill just went up 30%.
HA: Yeah, and I have no idea, I’m not a political scientist, I have no idea what that means, but it certainly strikes one as very odd.
HH: Now I want to talk a little bit about the politics of this, then we’ll take some calls. What do you think happens if the fair tax becomes the litmus test for the Republican Party like Mike Huckabee wants it to be? He wants everyone to support it. No one but Mike Huckabee has supported the fair tax. They all say something like well, there’s some good ideas there, but I think I know why. But what do you think happens if the tax movement that we saw on April 15th gets captured by the fair tax people?
HA: Oh, I think we can think Republican/Whigs. I mean, there is just not a wide enough body of people out there who would be positively impacted, or at least perceived that they’re positively impacted by the fair tax. And I think when we looked at the numbers, something like 40% of the people who file tax returns today, income tax returns, don’t pay any income tax. It’s hard to imagine why that person would suddenly become a proponent of an idea which would be so difficult to implement, and would likely cost them money.
HH: Yeah, they would obviously get their withholding back if the fair tax was passed, but the Republican Party would be branded as the party of the superrich, not just the rich, because the only people who sit back and look at this, Bill Gates would love this thing, or as you say, you use the three Bobs in the opening chapter which I want to make sure everyone understands it’s the best written chapter and Hank wrote it, the three Bobs. And Bob number one who could be a professional athlete, anyone who’s a multimillionaire is going to love this program.
HA: Yeah, you can’t spend at a rate where if you’re wealthy, you just simply cannot spend at a rate where you would pay the same amount in the fair tax as you would an income tax. It just can’t happen. It’s almost a mathematical impossibility.
HH: Now I do want to anticipate some of arguments back at us, and we’ll be happy to debate Neal Boortz or anybody on this, on any fair media show at any time. You can reach me, firstname.lastname@example.org. You can reach Hank, email@example.com. You can get the book from www.hughhewitt.com. And we will go anywhere at anytime, because we’ve spent a lot of time. Hank, you actually wrote a detailed paper on the fair tax, which is where our conversations got started, for Technical Tax Journal last year.
HA: Yes, I wrote a piece for Tax Notes, I think January of 2008, and we coped it into, actually a preliminary copy went into Townhall.com.
HH: And it does not stand up. The fair tax does not stand up. That’s why we call it a Fair Tax Fantasy. Before I go to the phones, Hank Adler, any final comments on our summary? We’ve barely scratched the surface here of why the fair tax is a fantasy and a dangerous one.
HA: Well, I just think the bottom line is it’s an administrative nightmare, probably unconstitutional in my opinion, I’m not a Constitutional lawyer, and just the wrong direction to go politically, in my opinion.
HH: It is in my opinion, it is unconstitutional, the idea of taxing the states means destroying the states. But I also want to point out it’s politically impossible to accomplish. And every day and every dollar you invest in it is a day wasted and a dollar less to important tax reform. For example, the 16th Amendment, a predicate of this, is that the 16th Amendment be repealed. It isn’t going to happen in our lifetimes, people. You just cannot pass that. We talk about that in the Fair Tax Fantasy.
End of interview.