Distribution of the FairTax burden

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Effective tax rate comparison graph

The FairTax (H.R.25/S.25) is a proposal for changing American tax laws to replace all federal personal income taxes, payroll taxes, corporate taxes, capital gains taxes, self-employment taxes, gift taxes and inheritance taxes with a national retail sales tax and monthly tax rebate to households of citizens and legal resident aliens. The FairTax's impact on the distribution of the tax burden is a point of significant dispute. The plan's supporters argue that it would broaden the tax base, be progressive and start taxing wealth, while opponents argue that a national sales tax would be inherently regressive and would decrease tax burdens paid by high-income individuals.^[1]

[edit] Tax burden impact

President's Advisory Panel for Federal Tax Reform's analysis of a hybrid National Sales Tax - impact by income percentile

President's Advisory Panel for Federal Tax Reform's analysis of a hybrid National Sales Tax - impact by income level

In a Congressional committee hearing, Congressman Linder stated that "the President's Advisory Panel for Federal Tax Reform, with the help of the Treasury Department, concluded that the FairTax is the only reform proposal that completely untaxes the poor."^[2] However, that bipartisan panel's final report to the President rejected a National Sales Tax.^[3] The panel's evaluated plan differed from the FairTax legislation in several areas. However, they reported that with the rebate, the overall tax burden on middle-income Americans would increase while the tax burden on the very rich would drop. According to the report, the percent of federal taxes paid by those earning from $15-$50,000 would rise from 3.6 to 6.7 percent, while the burden on those earning more than $200,000 would fall from 53.5 to 45.9 percent.^[3] The report states, "Families with the top 10 percent of cash incomes would benefit substantially from the retail sales tax. Their tax burden would fall by 5.3 percentage points – from 70.8 percent to 65.5 percent. Middle-income Americans, however, would bear more of the federal tax burden. A typical married couple at the bottom 25th percentile of the income distribution earns $39,300 per year and would pay $5,625 dollars in federal taxes in 2006. Under the retail sales tax with a Prebate, the same family would pay $7,997 in net federal taxes after the Prebate of $6,694, resulting in a tax increase of $2,372, or 42 percent."'^[3] These calculations only compare the income tax to a sales tax, as the Panel was not allowed to consider reforming payroll taxes.^[4] The Tax Panel also did not consider the embedded tax cost (tax incidence) associated with corporate income taxes that affect the personal tax burden under current law (see Supporting theories of effect). Comparatively, the retail sales tax burden presented has the corporate tax cost included.^[3]

FairTax supporters argue that the tax burden would shift to those who do not pay taxes under the current system and those with wealth.^[5] The FairTax would dramatically broaden the tax base to include all 300 million Americans and an estimated 30 million to 40 million foreign tourists and visitors. This would more than double the federal government's tax base.^[6] A study on marginal and average tax rates found that the FairTax would reduce most households’ average lifetime tax rates and, often, by a lot.^[7] Economists at Boston University found that the FairTax rewards low-income households with 26.7 percent more purchasing power, middle-income households with 10.9 percent more purchasing power, and high-income households with 4.7 percent more purchasing power.^[8] Dr. Carl Milsted, senior editor of the Free Liberal, suggested that the FairTax would be a significant tax break for high net-worth individuals, so it should be combined with a wealth tax. He claims that such a system would allow a lower tax rate on consumption, while maintaining current levels of taxation on high net-worth individuals.^[9] Economist Laurence Kotlikoff of Boston University states that the FairTax would be a tax on wealth unlike the current system that taxes income.^[5]

Economist William G. Gale at the Brookings Institution writes: "Under the AFT proposal, taxes would rise for households in the bottom 90% of the income distribution, while households in the top 1% would receive an average tax cut of over $75,000." Gale continues, "If households are classified by consumption level, a somewhat different pattern emerges. Households in the bottom two-thirds of the distribution would pay less than currently, households in the top third would pay more."^[10] While Gale's analysis differed from the FairTax legislation, he is referring to absolute tax dollars—ranked by income, households at the lower end of the distribution will tend to pay more in absolute taxes, while households at the higher end will tend to pay less in absolute taxes. Ranked by spending or consumption, households that currently spend less on consumption would pay less total taxes, while households that currently spend more would pay more. A low-income family may spend $25,000 on goods and services consuming 100% of their income. A higher income family making $100,000 may spend $80,000 on goods and services and save $20,000. The higher income family is consuming only 80% of their income on taxable goods and services. When presented with an estimated effective tax rate, the low-income family above would pay a tax rate of 0% on the 100% of consumption and the higher income family would pay a tax rate of 15% on the 80% of consumption.

These conclusions are contradictory according to Gale. The FairTax proposal is regressive on income and progressive on sales. Classical economic analysis indicates that the marginal propensity to consume (MPC) decreases as income increases. Households at the lower end of the income scale spend almost all their income, while households at the higher end are more likely to devote a portion of income to saving. However, MPC and income elasticity of demand tend to increase as wealth increases. These facts explain the apparent contradiction in the data; households at the extreme high end of consumption often finance their purchases out of savings, not income.^[10] This savings would be taxed when it becomes a purchase. Income earned and saved would not be taxed immediately under the proposal. In other words, savings would be spent at some point in the future and taxed according to that consumption. FairTax advocates state that this would improve taxing of wealth. Laurence Kotlikoff stated that the FairTax could make the tax system much more progressive and generationally equitable.^[5] "Their view that taxing sales is regressive is just plain wrong. Taxing consumption is effectively the same as taxing wages plus taxing wealth." Kotlikoff continues, "But what about saving one's wages and wealth and spending these funds plus accumulated interest in the future? Doesn't this avoid the consumption tax? No. You end up paying consumption taxes not just on the original sums, but also on the accumulated interest."^[5] The payroll tax system is regressive on income with no standard deduction or personal exemptions taxing only the first $94,200 from gross wages, and none earned from capital investments or interest. The Center on Budget and Policy Priorities states that three-fourths of taxpayers pay more in payroll taxes than they do in income taxes.^[11] Under the FairTax, it would be eliminated.

[edit] Current system vs. the FairTax

[edit] Average remaining federal lifetime tax rates

[edit] Marginal effective federal tax rates on saving

[edit] Marginal effective federal tax rates on working

[edit] See also

• FairTax
• Predicted effects of the FairTax

[edit] Notes

[edit] References

• Boortz, Neal, Linder, John (2006). The Fair Tax Book, Paperback, Regan Books. ISBN 0060875496.
• Ose, Al (2002). America's Best Kept Secret Fairtax: Give Yourself a 25% Raise, Paperback, Authorhouse. ISBN 1403391890.
• McCaffery, Edward, J. (2002). Fair Not Flat : How to Make the Tax System Better and Simpler, Hardcover, University Of Chicago Press. ISBN 0226555607.
• De Vlieghere, Martin; Vreymans, Paul (2006-09-11). Path to Sustainable Growth. Lessons From 20 Years Growth Differentials In Europe (4.9Mb pdf). WorkForAll. Retrieved on 2006-10-14.

[edit] External links

Wikiquote has a collection of quotations related to:

Taxation

• FairTax.org - Americans For Fair Taxation

Legislation

• H.R.25: FairTax Act of 2005 - text of bill H.R.25
• S.25: FairTax Act of 2005 - text of bill S.25