(D) It is possible that the FairTax would make most people better off, but much of that gain would be a direct result of making the tax code less fair.
This sentence incorrectly assumes that economic growth will be distributed unfairly. The FairTax is called “fair” because it disproportionately benefits the poor and middle class and the economic studies support this statement.
The FairTax entirely untaxes the poor and reduces the tax burden on the near poor substantially. The FairTax taxes all consumption above the poverty line equally at 23 percent. The FairTax is progressive, and by two out of three commonly used measures of progressivity is more progressive than the current system. Finally, and most importantly, under the FairTax the vast majority of American families will be much better off because the economy will boom, U.S. economic competitiveness will be enhanced, compliance costs will fall, and incomes will grow.
By measures that capture real-world economic effects, the gains disproportionately go to low- and middle-income groups. Americans For Fair Taxation regards such an outcome as fair, just, and equitable. We believe that the American people do as well.
A Gini coefficient is a standard measure of inequality.
[7] The higher the number, the more progressive the tax. Conversely, when looking at an income distribution, the lower the number, the more evenly distributed it is.
As can be seen from the chart above, the FairTax has a higher Gini coefficient than any other tax except the estate and gift tax, and is therefore more progressive than all taxes except the estate and gift tax as measured by its impact on expenditure per capita.
Footnote: [7] For an explanation of the Gini Coefficient, see http://en.wikipedia.org/wiki/Gini_coefficient.
The FairTax makes spending after tax more equal and income after tax somewhat less equal.
[9]
Laurence Kotlikoff of Boston University, using a methodology considering lifetime effects, found that virtually every income and age cohort would be better off under the FairTax but that those in the lower-income groups are disproportionately better off. For example, take a middle-aged couple with two children earning $20,000 per year compared to that same couple earning $70,000 per year or $500,000 per year. The low-income couple gets an 86 percent cut in their average remaining lifetime tax rate; the middle-income couple gets a cut of 46 percent, whereas the high-income couple gets a 42 percent cut.
[10]
His study uses a dynamic life cycle general equilibrium model to simulate the impact of the FairTax on the U.S. economy. The inclusion of demographics, including a realistic initial age structure of the population, realistic mortality rates, and realistic fertility rates means that the model is able to show how the economy fares over time in the absence of tax reform compared to how the economy fares with the FairTax enacted. Switching to the FairTax precipitates a very major increase in the U.S. capital stock and real wages over the course of the century, prevents what would otherwise be a doubling of the highly regressive payroll tax, and effects very major welfare gains, particularly for the poorest current and future members of society. Implementing the FairTax at 23 percent gives the poorest members of the generation born in 1990 a 13.5 percent welfare gain. Their middle-class and rich contemporaries experience a 5 and 2 percent welfare gain, respectively.
[11]
Only studies that adopt a one year or very short horizon and look at income class show the FairTax to be less progressive than the current system. These studies use data showing that poor people in the aggregate spend many times their income year in and year out which is, of course, impossible. What is really going on is that many who are counted as poor are business owners who lost money, students living off of their parents, or those with illicit or unreported sources of income. The studies are inherently flawed.
To be accurate, FactCheck.org should include the Kotlikoff studies on distribution that specifically examine the FairTax.
Footnotes:
[8] Tuerck, et al., op. cit.
[9] Ibid.
[10] See Table 5 in Kotlikoff and Rapson, 2006.
[11] Jokisch and Kotlikoff, 2007.
Other points made by FactCheck.org
[C]onsumers would pay taxes on a great many things that may not intuitively seem like consumption. The list would include:
(E) Interest on credit cards, mortgages and car loans
This sentence is misleading. The FairTax does tax the loan service charges or fees charged by the lending institution to the borrower. If the lending institution does not separately state these charges, but rather rolls them into the interest rate for the loan, then a portion of the interest is really hidden services charges. The FairTax taxes only that small portion of interest. For example, on a typical home mortgage only about one-half of one percent of interest is subject to tax. This represents the value of the financial intermediation services provided (such as loan origination fees, loan servicing fees, etc.) that are disguised as “interest” today. Thus, on a $200,000 mortgage the FairTax liability (calculated by the bank) would be $230 per year or only $19 per month.
A more noteworthy effect of the FairTax on interest, which dwarfs the above, is that the FairTax will bring down interest rates by about 25 percent.
[12] This would reduce the homeowner’s payment from approximately $1,200 per month to $1,014 per month, a monthly savings of $186 per month (based on an average existing mortgage rate of 6.0 percent which decreases to 4.5 percent under the FairTax.)
(F) The result is that many FairTax supporters (about 15 percent of those who wrote to us, for example) do not understand that the 23 percent figure is tax-inclusive.
When 85 percent of the public understands a relatively complex tax issue, then it would seem that FairTax is (1) not being misleading and (2) doing a pretty good job of explaining the issue. We would bet that those same people do not know that the current income, payroll, capital gains, alternative minimum, and estate taxes are also expressed as tax inclusive, which is the whole reason for making the honest comparison in the first place.
(G) In other words, proponents assume that no one will cheat on taxes.
No, but we do assume that the FairTax will do a better job of reducing the amount of cheating that is rampant today. The FairTax would reduce tax evasion by reducing the marginal tax rates and therefore the incentive to cheat and by increasing audit rates and therefore the likelihood of tax evasion being caught. Audit rates would increase because audits would be much simpler and more could be undertaken (assuming that appropriated enforcement resources are held constant). Overall administration and enforcement would be more efficient, given the vastly reduced number of collection points (e.g., there are about 20 or so million taxpayers under the FairTax versus 155 million today).
Footnote: [12] Several economic studies have estimated that switching from an income tax system to a consumption tax system such as the FairTax would result in an interest rate drop of approximately 25 percent. See, e.g., Golob, John E., “How Would Tax Reform Affect Financial Markets?” Economic Review, Federal Reserve Bank of Kansas City, Fourth Quarter, 1995.
Revised explanation of 23 percent rate vs. 30 percent rate
Perhaps a simple example will explain best.
Assume there is a worker named Joe who earns $125 and spends all of his earnings. Let’s further assume that the government requires him to pay $25 in taxes.
If the government put a tax on Joe’s income, he would earn $125 before tax and would have $100 after tax to spend at the General Store. Thus, Joe has to earn $125 to have $100 to spend. Joe would also have to file an income tax return.
If the government put a tax on what Joe spends, he would earn $125 and would have $125 to spend at the store. Of the $125 paid by Joe to the storekeeper, $100 would be for the goods he bought at the store and $25 would be taxes that the storekeeper would send to the government. Joe would not have to file a tax return, as the storekeeper sends the tax in to the government.
Either way, Joe pays $25 in taxes and the government gets $25 in taxes. With a tax on income, Joe pays the $25 directly to the government, and with the tax on spending (sales tax), he pays the $25 in taxes indirectly when he buys something from the General Store. The General Store sends the tax that Joe paid to the government.
We may report the tax rate as $25/$125 = 20 percent, which is the
tax-inclusive rate (meaning that the tax is included in the base). Alternatively, we may think of the tax rate as $25/$100 = 25 percent, which is the
tax-exclusive rate (meaning the tax is excluded from the base).
The 23 percent FairTax rate set out in HR 25/S 1025 is a tax-inclusive rate, as is the current individual income tax, whereas most state-level sales taxes are quoted on a tax-exclusive basis. For ease of comparison, Americans For Fair Taxation gives the tax rate both ways. Both rates pertain, since the FairTax is a tax on spending that is replacing an income tax system, and 23 percent correctly represents the tax burden compared to the current income tax system.
It is both inaccurate and misleading to say, using the above example, that the income tax is 20 percent and the sales tax is 25 percent. This implies that the sales tax burden is higher, when in fact the burden of the two taxes is precisely the same either both taxes are 25 percent or both taxes are 20 percent.
References
Americans For Fair Taxation (AFFT), “Promoting home ownership: How the FairTax’s benefits for homeowners exceed the mortgage interest deduction,” February 2007. Available at
http://www.fairtax.org/PDF/PromotingHomeOwnership.pdf.
AFFT, “The FairTax and economic growth,” April 2006. Available at
http://www.fairtax.org/PDF/TheFairTaxAndEconomicGrowth.pdf.
AFFT, “The FairTax prebate explained,” February 2007. Available at
http://www.fairtax.org/PDF/FairTaxPrebateExplained2007.pdf.
AFFT, “What the federal tax system is costing you besides your taxes,” April 2007. Available at
http://www.fairtax.org/PDF/WhatTheFederalTaxSystemIsCostingYou.pdf.
An Open Letter to the President, the Congress, and the American people Concerning Reform of the Federal Tax Code. Available at
http://www.fairtax.org/PDF/Open_Letter.pdf.
Arduin, Laffer & Moore Econometrics, “A Macroeconomic Analysis of the FairTax Proposal,” June 2006. Available at
http://www.fairtax.org/PDF/MacroeconomicAnalysisofFairTax.pdf.
Bachman, Paul, Jonathan Haughton, Laurence J. Kotlikoff, Alfonso Sanchez-Penalver, and David G. Tuerck, “Taxing Sales under the FairTax: What Rate Works?” Published in Tax Notes, November 13, 2006. Available at
http://www.beaconhill.org/FairTax2006/TaxingSalesundertheFairTaxWhatRateWorks061005.pdf.
Burman, Leonard E. and Greg Leiserson, “Two-Thirds of Tax Units Pay More Payroll Tax Than Income Tax,” Tax Notes, April 9, 2007. Available at
http://www.taxpolicycenter.org/UploadedPDF/1001065_Tax_Units.pdf.
Chamberlain, Andrew and Gerald Prante, "Who Pays Taxes and Who Receives Government Spending? An Analysis of Federal, State and Local Tax and Spending Distributions, 1991-2004,” Tax Foundation Working Paper No. 1, March 2007. Available at
http://www.taxfoundation.org/files/wp1.pdf.
Jokisch, Sabine and Laurence J. Kotlikoff, “Simulating the Dynamic Macroeconomic and Microeconomic Effects of the FairTax,” National Tax Journal, forthcoming, 2007. Available at
http://people.bu.edu/kotlikoff/FairTax%20NTJ%20Final%20Version,%20April%2024,%202007.pdf.
Kotlikoff, Laurence J. and David Rapson, “Comparing Average and Marginal Tax Rates under the FairTax and the Current System of Federal Taxation,” NBER Working Paper No. 12533, revised October 2006. Available at
http://people.bu.edu/kotlikoff/Comparing%20Average%20and%20Marginal%20Tax%20Rates%2010-17-06.pdf.
President’s Advisory Panel on Federal Tax Reform, “Simple, Fair, and Pro-Growth: Proposals to Fix America’s Tax System,” November 2005. Available at
http://www.taxreformpanel.gov/final-report/.
The FairTax Act of 2007, 110th Congress, introduced by John Linder, January 4, 2007. Available at
http://thomas.loc.gov/cgi-bin/thomas.
Tuerck, David G., Jonathan Haughton, Keshab Bhattarai, Phuong Viet Ngo, and Alfonso Sanchez-Penalver, “The Economic Effects of the FairTax: Results from the Beacon Hill Institute CGE Model,” The Beacon Hill Institute at Suffolk University, February 2007.
Tuerck, David G., Jonathan Haughton, Paul Bachman, Alfonso Sanchez-Penalver, and Phuong Viet Ngo, “A Distributional Analysis of Adopting the FairTax: A Comparison of the Current Tax System and the FairTax Plan,” The Beacon Hill Institute at Suffolk University, February 2007.
Tuerck, David G., Jonathan Haughton, Paul Bachman, and Alfonso Sanchez-Penalver, “A Comparison of the FairTax Base and Rate with Other National Tax Reform Proposals,” The Beacon Hill Institute at Suffolk University, February 2007.
What is the FairTax Plan?
The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR 25/S 1025) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system.
What is Americans For Fair Taxation (FairTax.org)?
FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX.
