Congressman Fattah Responds to Our Critique of His Transaction Tax Plan

July 26, 2011

Last week, Congressman Chaka Fattah responded to my critique of his proposed "Debt Free America Act" on the Huffington Post politics blog. The bill would impose a 1% tax "on all retail and financial transactions, except for personal bank account transactions and those involving financial stocks."

To my key argument that Fattah's proposal would impose an enormous amount of tax "pyramiding," or taxes on taxes, Fattah responds that "the solution [to tax pyramiding] is to identify the potential supply chains that may produce cascading and exempt a specific part of the chain from the transaction tax." While this would certainly solve the problem, it fundamentally changes his proposal from a "transaction tax" into a sales tax. In exempting transactions that contribute to pyramiding, the only transactions for which the tax would apply would be the final consumption of goods and services.

Some numbers might explain this. There are somewhere in the neighborhood of $445 trillion in non-stock market transactions that occur during a year, compared to about $10 trillion worth of final consumption and residential investment. By definition (and verified by history), consumption does not exceed gross domestic product (GDP). If, as Fattah now suggests (correctly), all but $10 trillion of that $445 trillion should be exempted to avoid massive economic distortions, the 1 percent tax would generate merely $100 billion, compared to the $4 trillion he's advertised.

Fattah also proposes to accomplish this in a roundabout and burdensome way. The Treasury Department would be tasked with identifying which of the $445 trillion worth of transactions would be exempt, increasing business uncertainty and setting up an administrative nightmare. This entire scheme would be unnecessary if Fattah just admitted that his proposal is not a transaction tax.

In his conclusion, Fattah states that the 1 percent tax rate "should not change [consumer and corporate] behavior simply because it is being levied on each transaction," and adds that Japan employs a type of transaction tax. The mountain of economic evidence, however, suggests that these types of taxes—gross receipts, turnover, and transaction taxes—lead to large economic distortions and negatively impact economic growth. And while other causes are at work in Japan, its economy has been stagnant for 20 years.

Congressman Fattah describes a result we all want, but the tax he pushes will not get us there. If one takes seriously his revised plan as laid out in his response to me, he is simply proposing a national sales tax on goods and services. Such ideas are not new, and classifying his proposal as a consumption tax might even find some support in Congress. But Fattah then would not be able to claim that he's come up with an idea that would raise $4 trillion while costing nothing to anybody.

It's hard to disagree with Fattah's statement that the U.S. needs "a new system of taxation that is simple, efficient, and fair, which can generate sufficient revenue to satisfy the demands on the federal budget." Unfortunately, his plan will not achieve this.

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