| Abstract: |
As specified in Congressional bill H.R. 25/S. 25, the FairTax is a proposal to
replace the federal personal income tax, corporate income tax, payroll (FICA)
tax, capital gains, alternative minimum, self-employment, and estate and gifts
taxes with a single-rate federal retail sales tax. The FairTax also provides a
prebate to each household based on its demographic composition. The prebate is
set to ensure that households pay no taxes net on spending up to the poverty
level. Bill Gale (2005) and the President's Advisory Panel on Federal Tax
Reform (2005) suggest that the effective (tax inclusive) tax rate needed to
implement H.R. 25 is far higher than the proposed 23% rate. This study, which
builds on Gale's (2005) analysis, shows that a 23% rate is eminently feasible
and suggests why Gale and the Tax Panel reached the opposite conclusion. This
paper begins by projecting the FairTax's 2007 tax base net of its rebate. Next
it calculates the tax rate needed to maintain the real levels of federal and
state spending under the FairTax. It then determines if an effective rate of
23% would be sufficient to fund 2007 estimated spending or if not, the amount
by which non-Social Security federal expenditures would need to be reduced.
Finally, it shows that the FairTax imposes no additional real fiscal burdens
on state and local government, notwithstanding the requirement that such
governments pay the FairTax when they purchase goods and services.
Implementing the FairTax rate of 23% would produce $2,586 billion in federal
tax revenues which is $358 billion more than the $2,228 billion in tax
revenues generated by the taxes it repeals. Adjusting the base for the prebate
and the administrative credit paid to businesses and states for collecting the
tax results in a net tax base of $9,355 billion. In 2007, spending at current
levels is projected to be $3,285 billion. Revenues from the FairTax at a 23%
tax rate, plus other federal revenues, are estimated to yield $3,209 billion
which is $76 billion less than current CBO spending projections for 2007. The
$76 billion amounts to only 2.73% of non-Social Security spending ($2,177 --
$2,101). This is a remarkably small adjustment when set against the more than
30% rise in the real value of these expenditures since 2000. Ensuring real
revenue neutrality at the federal level, given the net base of $9,355 billion,
implies a rate of 23.82% on a tax-inclusive basis and 31.27% on a
tax-exclusive basis. These and other calculations presented here ignore a)
general equilibrium feedback (supply-side and demand-side) effects that could
significantly raise the FairTax base (see, for example, Kotlikoff and Jokisch,
2005), b) the possibility that tax evasion would exceed the considerable
amount automatically incorporated here via the use of NIPA data, which
undercount consumption expenditures due to evasion under the current tax
system, and c) the roughly $1 trillion real capital gain the federal
government would secure on its outstanding nominal debt, were consumer prices
to rise by the full amount of the FairTax. The FairTax redistributes real
purchasing power from state and local governments to their state and local
income-tax taxpayers. It does so by reducing factor prices relative to
consumer prices and, thereby, reducing the real value (measured at consumer
prices) of state and local income tax payments, which are assessed on factor
incomes (namely, factor supplies times factor prices). Gale (2005) and the Tax
Panel (2005) recognized this loss in real state and local government revenues
in claiming that these governments need to be compensated for having to pay
the FairTax. But what they apparently missed is that this loss to these
governments is exactly offset by a gain to their taxpayers. Were state and
local governments to maintain their real income tax collections -- the
assumption made here -- by increasing their tax rates appropriately, their
taxpayers' real tax burdens would remain unchanged and there would be no need
for the federal government to compensate state and local governments for
having to pay the FairTax on their purchases. The second is that H.R. 25 does
not preclude state and local governments from levying their sales taxes on the
FairTax-inclusive price of consumer goods and services. This produces
significantly more revenue compared to levying their sales taxes on producer
prices. Moreover, Gale (2005) and the Tax Panel (2005) arrived at a higher tax
rate because they did not estimate the Fairtax rate, but instead estimated a
sales tax of their own design which had a substantially narrower base. |