One of the key economic issues that should be considered, when establishing tax policy, is “Tax Volatility.” This is a measure of how much tax revenue can be expected to rise and fall, with changes in economic conditions. Tax Volatility is defined as the standard deviation of the annual percent change in revenues over a period of years (usually 10 or more years).
In short, a tax that produces the same level of revenue for the government from year to year, despite changing economic conditions, would be said to have no volatility. By contrast, a tax that produces far less revenue during times of poor economic conditions, than in times of prosperity, is considered to be very volatile.
All taxes tend to fall into one of only a handful of categories. They are as follows:
- Income Tax
- Personal Income Tax
- Corporate Income Tax
- Sales Tax
- Property Tax
- Sin Tax
- Severance Tax
- Value Added Tax (VAT)
Of those taxes, virtually all economists of any stature agree that the Severance Tax, which is a tax on natural resource extraction, is by far the most volatile, While Property Taxes are by far the least volatile.
But these are just differences in volatility and this is not meant to suggest that we should do away with Severance Taxes nor should we rely more heavily on Property Taxes. But they are things that need to be considered, when establishing tax policy. I only mention them first, because it would be difficult to find any economist who would disagree with the above statement.
The second most volatile tax is generally agreed to be the Corporate Income Tax, followed by the Personal Income Tax. This statement is also widely accepted by most economists. There are some detractors, who would disagree. But they are few and all are associated with either the Washington, DC political establishment or a lobbying organization. I invite you to peruse articles from non-partisan economic analysis organizations like The Tax Foundation or The Pew Charitable Trust. You will find that Corporate Income Taxes are widely considered to be extremely volatile, followed by Personal Income Taxes.
Sin Taxes are not widely used as a major source of revenue, so it’s difficult to calculate their volatility. But if Nevada is any measure, Sin Taxes probably rank rather high up the volatility scale. The problem with Sin Taxes is that their volatility is not easy to predict. For example, with the exception of those few people who are truly gambling addicted, a person who has less disposable income will be less likely to gamble. But someone who has lost his job may be more likely to drink and smoke. However, since sin taxes are not a major revenue source, either in the states or at the national level, we can pretty much eliminate them from this conversation. I just wanted to mention them, so nobody would think I forgot them.
Sales Taxes are somewhat more volatile than Property Taxes, but much less volatile than any form of income tax (corporate or personal).
A VAT is touted as a consumption tax, but it is most assuredly not a “sales tax”. Since it’s collected at every point that value is added, along the way from raw materials to finished product, it has many things in common with both a sales tax and a corporate income tax. In fact, these similarities can be so confusing that, during his 2016 presidential campaign, Ted Cruz even claimed that his VAT was a flat income tax, despite every major business and economics publication pointing out that it was a VAT. But, this blending of features means that, based upon its exact features, its volatility comes in somewhere between a corporate income tax and a sales tax.
Let’s take a look at each of these forms of tax and think about why they exhibit different levels of volatility. We also need to look at who pays each tax and what that tax means to the taxpayer.
Although we are looking at federal tax policy, looking at the history of taxation across the various states that have tried different approaches to taxation, will give us a window into what tax policy works best, for revenue stability.
Property Tax (paid by the individual):
Keep in mind that Property Taxes are collected only at the state level. We address them here, simply as a matter of comparison.
The Property Tax is by far the most stable form of tax. This is because taxing authorities tend not to lower property values, during times of recession. So, if the property value remains the same, the property tax will remain the same. This would appear, at first glance, to be an ideal tax for dealing with tax volatility, except for one very important issue.
A tax on property effectively means that the taxpayer doesn’t really OWN his property. That annual property tax is effectively a lease from the government. Think about it… If the taxpayer doesn’t pay that annual “lease,” the government will take back that property. That’s right. As long as property is taxed, it means that the government is granting you the right to use their property, for as long as you make that lease payment.
So, although a Property Tax is by far the most stable revenue producing tax, it should not really be considered a “tax,” but rather a “lease payment.” Therefore, besides being only a state tax, this factor should remove Property Taxes from consideration as a source of government revenue, at any level of government.
Severance Tax (paid by the individual):
Keep in mind that Severance Taxes are collected only at the state level. We address them here, simply as a matter of comparison.
States that rely heavily on Severance Taxes tend to see wild swings in tax revenue. This is because of the tremendous volatility of the base of this tax. It’s not so much related to the economy, in general, but rather to the price of oil. When oil prices are high, those revenues soar. But when oil prices drop, no new wells are drilled and the flow from existing wells may be reduced to the minimum required to keep them open. So government entities that rely on Severance Taxes see dramatic swings in their tax revenue from those sources of revenue.
According to data from the Pew Charitable Trust (see table), the highest tax volatility over the last ten years occurred in Alaska, North Dakota, and Wyoming.
|Severance Tax Volatility||47.0%||32.9%||39.5%||31.6%|
|Severance Tax % of Revenue||62.3%||45.7%||7.5%||35.6%|
As you can see from the above table, all three of those states rely very heavily on Severance Taxes. But Texas, which is the largest oil producer in the USA, had an overall tax volatility of a mere 6.1%. That’s because, although the Texas Severance Tax Volatility was in the middle of the range of all four states, Severance Taxes made up only 7.5% of the overall Texas tax revenue.
Although the corporations that remove the resource from the ground are the ones who directly remit those state Severance Taxes, the corporations are only a conduit. It is the final consumer, who ultimately pays all Severance Taxes that are passed on by the corporations, in the form of higher prices for gasoline, oil, and plastics, among other things.
Certainly, there may a place for Severance Taxes, at the state level. However, even at the state level they should not be relied upon as a major source of revenue. But, they are certainly not something that fits our discussion on federal taxes, except as a comparison, to demonstrate the problem of tax volatility.
Income Tax – Corporate (paid by the individual):
The Corporate Income Tax is second only to the Severance Tax, in volatility. The reason for this is so simple that it can be described in one sentence. During times of recession, not only do businesses earn less profit, on which to be taxed, but many are able to write-off large losses, which also substantially lowers their tax payments.
If any branch of government is relying on Corporate Income Taxes for a large part of their revenue, then they can expect significant volatility in their revenue collections.
And, yes, Corporate Income Taxes are paid 100% by individuals. Businesses treat all taxes as just another cost of doing business. Of course, every cost of doing business has a profit margin applied to it and that amount is passed on to the consumer in the final retail price of the product. So not only does the consumer have to pay those Corporate Income Taxes, but the consumer also pays a profit margin on top of those taxes.
Income Tax – Personal (paid by the individual)
The thing that makes Personal Income Tax volatile, is that in a recession, a taxpayer who loses his job, pays ZERO Personal Income Tax. It’s not a gradual drop. The taxpayer’s salary goes from XXX dollars to ZERO dollars. That means that his tax liability drops instantly to ZERO. This applies to every person who loses a job in a recession, including those who have savings to live on, be it a modest amount or a million dollars. Many of those people won’t change their life-styles. If a person’s tax liability is based on his INCOME, then when his INCOME goes to ZERO, so does his INCOME tax liability. It should be noted that seldom do unemployment benefits rise to a taxable level, under a Personal Income Tax.
Others, who see their hours reduced, will pay less tax, than before. But many will still be earning enough to pay some amount of income tax. If that were the case for every worker, then a Personal Income Tax would not be nearly as volatile as it is.
It’s the fact that people who completely lose their income in a recession, suddenly pay ZERO income tax, that causes such dramatic Personal Income Tax Volatility.
Value Added Tax (paid by the individual)
Although a VAT is touted as a consumption tax, its effect is to tax all the businesses along the line, for the value they add, which interestingly, is roughly analogous to income, and then pass that tax on to the next value adder down the line, till the whole thing is collected at the cash register. In other words, it’s being collected at the cash register, like a sales tax, but the consumer is actually paying the income tax that each company in the line of production owes. The tax authorities just change the description from “income tax” to “value added tax”, to make it sound more palatable and tax the product at a slightly different level. In the end, the individual pays all of the tax, at the cash register, like a sales tax, but with much different effect.
However, since a VAT is collected all along the line, if any or all intermediate companies have losses that can lower the value they add, it means that the VAT suffers from some of the same problems as a corporate income tax. Of course, a lot of this is dependent upon the VAT calculation method, of which there are three basic types – Addition Method, Invoice Method, and Subtraction Method. Some methods are more susceptible to Tax Volatility than others. On the positive side, a VAT does benefit from the feature that it is collected at the cash register, like a sales tax. The end result is that, based on the particular type of VAT, the volatility will be somewhere in the range of worse than a sales tax, but better than a corporate income tax.
It should be noted that a VAT, like a poorly conceived sales tax, will significantly hurt the poor, during a recession and at the time of this publication, no such VAT has ever been proposed in any session of Congress. But this article is about Tax Volatility and when considering only Tax Volatility, a VAT ranks rather high, in that a properly conceived VAT can offer a fair degree of stability to tax revenue.
Sales Tax (paid by the individual)
Sales Taxes are the only form of tax, other than a Property Tax, that offers a solid buffer to volatility, as the economy fluctuates. Furthermore, a properly structured sales tax more equitably and automatically re-distributes the tax load, during a recession. Although there are many differently structured sales taxes around the country, all are somewhat to extremely stable. But not all are equal or fair to low income earners, during a recession.
For our purposes, since we are talking about federal taxes and since the only Sales Tax bill in Congress is HR-25 (The FAIRtax Act of 2021), we’ll use this as our model for a sales tax.
The reason why any Sales Tax is so forgiving of economic fluctuations is that even in a recession, people still have to buy groceries, pay electric bills, and put a roof over their heads. Even those who are unemployed have to eat and put a roof over their heads. They might spend less on groceries and discretionary spending. But they will still spend money and, unlike with an income tax, they will still pay a sales tax – thus less Tax Volatility.
This might sound unfair to those who lose their jobs in a recession, since many of those who are out of work can’t afford to pay tax on even basic necessities, during a recession. But this discussion is about Tax Volatility and the point here is that regardless of other issues, just about any sales tax is going to be less volatile than any type of income tax or VAT, for this reason. Even so, since we are talking about the FAIRtax, there is a very positive answer to that concern of tax fairness, during a recession.
Under the FAIRtax, if a person loses his job during a recession and he does not have savings, his spending will quickly drop below the poverty line, which will reduce his NET FAIRtax burden to ZERO. In some cases, a person may have been living a good bit above the poverty line, but ends up living only a little bit above the poverty line. That person will have a significantly reduced FAIRtax liability. On the other hand, those who have plenty of savings to dip into, for living expenses, may change their lifestyle very little, if any at all. So their NET FAIRtax load will remain the same or nearly the same as it was, before the recession. The FAIRtax automatically adjusts to fit the changing spending habits of the taxpayers.
Due to the function of the FAIRtax Family Consumption Allowance (often referred to at the “Prebate”, because it comes to the taxpayer before the tax is paid), NO FAIRtax is paid on spending up to the poverty level. The income tax tries to un-tax poverty level income, through the standard deduction. But due to the payroll tax and embedded corporate income tax, in the prices of retail products, the standard deduction does a very poor job of un-taxing poverty level income. By contrast, the FAIRtax “prebate,” which is a sales tax version of the standard deduction, very accurately un-taxes cost-of-living expenses and only such expenses.
The net effect is that, under The FAIRtax, tax volatility will be significantly reduced, while at the same time insuring that those who are most vulnerable, in a recession, will pay little to no FAIRtax. The FAIRtax that is collected will come from those who still have money to spend and who continue to contribute to government revenue, through their spending, based on the level of that spending. There are no sudden losses that would directly affect revenue. It’s all proportional, based on consumer spending.
It’s a WIN for the government, in that it creates a more stable revenue stream and a WIN for the taxpayers, rich or poor, in that it automatically and proportionately adjusts to the changing spending habits of individual taxpayers.
So contact your congressman and senators and tell them that you want them to support the FAIRtax.
If you are not aware of the FAIRtax or just want to learn more, I strongly encourage you to read these three books that explain the FAIRtax very well. Also, check out https://fairtax.org
- “The FairTax Book“, (2006), by Neal Boortz and John Linder
- “FairTax: The Truth“, (2008), by Neal Boortz and John Linder, with Bob Woodall
- “The Rich Don’t Pay Tax! …Or Do They? — Second Edition – Revised and Expanded“, (original 2012, updated 2021), by John Gaver
John Gaver is an author and compensated public speaker, who writes and speaks on tax policy issues that span party lines. He has appeared as a guest on numerous broadcast radio programs in the USA and abroad, including such programs as CNBC’s “Opening Bell” and “The Tamar Yonah Show” on Israel National Radio. Read John’s most recent book, “The Rich Don’t Pay Tax! …Or Do They? — Second Edition – Revised and Expanded”, available in print and ebook format, on Amazon, Barnes & Noble, the Apple iBookStore, and other booksellers.Share this page
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