Taxing Sales under the FairTax – What Rate Works?

Boston University ^ | September 2006 | Laurence J. Kotlikoff et al

[pigdog]

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.

[ChildOfThe60s]

So we'll keep the fair tax and reimpose the income tax as well.

Right on!
Remember the Reagan tax cuts? We got lower rates in exchange for losing deductions. Later the rates go back up and the deductions are still gone. Unless we can cripple the government's ability to grow, these efforts are largely academic.

[xcamel]

I used to have pity on such poor souls, knowing that another beating was just around the corner for them. Sadly, many innocents also took beatings because of people like piggy, never knowing when to just shut up, and fueling a rage in those of "less control". You know, genuine Schadenfreund when they walk out in front of a speeding bus...if for nothing more than the realization that "silence is golden"

[xcamel]

Without spending limits, there is no real tax reform. HR25 is just another 2-card-monty.

[pigdog]

Done!

[samm1148]

That is an excellent idea. I write that with no sarcasm intended. I think there are many good alternative tax strategies. I like some of the elements of Fair Tax. I just don't believe its advocates understand the underlying problem: Out of control government spending.

Like gun control the problem has nothing to do with weapons. It has everything to do with criminal behavior.

[pigdog]

The FairTax bill itself cannot also be a repeal bill, but the bill's language does call for repeal of the 16th and it is very much the intent of the AFFT organization to see it repealed. There is at least one repeal bill before the house right not.

While the repeal process goes on (a typical 7 year period) the FairTax bill does eliminate the income (and some other) taxes, the appropriate parts of the tax code, the IRS (along with its funding), and requires the destruction of the income tax records. All of these things together help give some protection (along with a tax system that is simple and promotes economic growth) against having an income tax imposed while the repeal goes forward.

If there are enough votes to pass the FairTax - and I think there are - there will be enough votes along with the things mentioned above to keep the income tax bugbear away. Every single FairTax supporter I know strongly supports the repeal of the 16th and it's important to note that right now there is nothing to prevent Congress from imposing both. With the FairTax as law there is a good bit of protection as the repeal process takes time.

[Always Right]

quite possibly I have more personal and other attacks directed at me than any other single poster on these threads - and yet the Mods do nothing to inhibit such attacks

Somebody call the wambulance! When will you ever learn the difference between attacking an article/author/politician and attacking another poster. It is really not all that complicated. Although you are in full spin mode in your self-pity and aren't about to admit your error. It's very easy, all you have to do is say 'my bad' and go on. In your thousands of posts you have never once admitted an error. You always choose the path of lying and spinning to defend your errors. I really don't understand your mentality.

[pigdog]

"Out of control government spending. "

There's no question that it IS out of control but I can tell you with absolute certainty that FairTax supporters wery much understand (and agree). Trying to control spending, however, without first getting some sort of a grasp on the taxing mechanism itself will accomplish little and the proof of that pudding is that is has not done so in almost 100 years now.

The FairTax bill is a revenue bill, though, and not a spending bill - the requirements are quite different - but once it becomes law the taxpayers will have a mechanism to truly know what "their government" costs them on each loaf of bread, bunch of bananas, or badass BMW ... it'll be shown right on the receipt for that purchase. And it will be the marginal rate that is shown while the actual effective FairTax rate will be much less as one can find out by using the anonymous FairTax calculator.

It will also provide txpayers with some measure of control over tax revenue and - at the very least - an excellent mechanism to be aware of and pressure congressmen for lower rates ... which we all want.

[pigdog]

"Congress will be FORCED to engage in entitlement reform because the system is nearing insolvency. The FairTax will not change that. "

Actually the FairTax will change things quite a bit WRT entitlements. Funded as it is from the overall tax revenue rather than just wage income will provide a wider base to allow more time to hopefully revamp the system. An with the visibility of the tax rate apparent to every purchaser on his receipt it will certainly not be long before Congress will be pressured to act to straighten out the mess.

For my money both should be eliminated - but I'm only one vote. I intend to make my wishes known to my cowardly congressmen though (and repeatedly).

">... the FairTax is MORE PROGRESSIVE than the combined Federal tax regime of today ... "

Actually I think the FairTax is more properly described as a proportional rather that a progressive or regressive tax system.

"Under the current system, even the bottom income quintile pays a combined tax rate of about 6%. Under the FairTax it would be NEGATIVE."

In fact the latest CBO complete tax year figures show that the bottom quintile have a combined household effective income tax rate of 2,5% ($14,800 income and $355.20 in tax). These folks would still pay the FairTx at the marginal 23% rate but their effective rate would frequently be negative (depending on their consumption habits).

the FairTax makes the rate highly visible to all on every purchase and will most likely cause those - especially those who now pay no tax - to be QUITE observant of tax rates. With that in mind, there will be no "climbing through the roof" nor will excise taxes do the job.

with enough votes to pass HR25 there will certainly get to be a more informed taxpayer as to rates of tax - and you can bet that a congressman advocating raising tax rates on all 300 million of us will get lots of press - bad press - and a lot of constituent calls and complaints ... and most likely soon lose his job.

[Man50D]

Not true. You will stiller have to have a government agency to enforce collection and remittance.

What's not true? The fact no tax system is designed to reduce spending or The Fair Tax will abolish the IRS and its multi billion dollar price tag? The former is true as any tax system's only purpose is to collect money from the people. You would realize the latter is true if you visit the Americans For Fair Taxation website and read Fair Tax FAQ #10 you will realize the the agency required to enforce collection and remittance will be the existing U.S. Treasury. Consequently billions will be saved.

[Always Right]

And we all know if it is said on the fairtax website FAQ's that it must be taken as gospel. How dare someone suggest that it might be more complicated than adding one line to a state tax form. No state has anywhere near the same tax base as what the fairtax does. No state taxes all services. And states will not be all that happy to assist the feds when they discover the feds are going to tax all state government expenditures too.

[Prost1]

I read the posts on the prior thread and one thing stood out.

The language of the LAW.

If the Language of the LAW is not changed, then there is no guarantee of the 23% or any %, it will be up to some pseudo-economic bureaucrat.

Am I wrong?

[Dimples]

Hmmm... where to start ... so many incongruities ...

The Payroll tax would be eliminated ...

These taxes are merely replaced not eliminated. Payroll, Corporate Profit and Personal Income taxes are REPLACED by the FairTax ... and it collects the same amount of tax money (supposedly.) Some will gain, some will lose. The economy will suffer, goods will cost more, the money supply is likely to be inflated ... savings will be devalued, evasion will rise, the rate will increase, most will have LESS of idea of how much tax they pay ... that's "my point."

Windfall Profits Tax? ...

Where did that come from? Profit tax = Corporate Profit Tax (but some here blow a gasket when I say "Corporate Profit Tax" claiming that corporations aren't the only business entities that pay tax. True enough; but all the rest pay Personal Income Tax, not profit tax. Anyway, I mean the Corporate Income (Profit) tax.

Entitlement reform is not gonna happen.

You are entitled to your opinion, but I, for one do not intend to stand idly by to be raped and pillaged by an ongoing financial disaster. Entitlement reform, to me, is FAR more important than whether I pay may tax at the register or out of my paycheck.

I don't mind the progressiveness of the FairTax precisely b/c I control it.

Actually you can't. You think you can control your tax bite ... and maybe, on a limited basis you can ... but you can do that now as well. The Progressivity of a tax system is related to the effective rate structure. If the rate varies in direct proportion to the taxed amount, then the structure is progressive ... no matter what YOU, as an individual spend. You are the one ranting about how no one pays taxes except the rich ... well that's a statement about the progressivity of the system. You are advocating for one the worsens the problem you claim is so severe.

...Lobbyists...

If you think the FairTax changes the desire to lobby, the opportunity to lobby, the willingness of politicians to be lobbied, the ability of Congress to alter the tax code, the ability to exempt certain new categories of spending, tier the rate, tier the prebate, eliminate the prebate, ... and on and on then you truly have no understanding of politics and government. While the FairTax might provide a system "reset" the system is fundamentally unchanged by it.

Claim what you will about the economic ramification of the FairTax, or its distributional aspects, but suggesting it will fundamentally alter the nature of people, politicians, lobbyists, and government is pure fantasy.

[Dimples]

Think about what you said:

How much did you spend over the course of a year? Simple -- take your income from all sources and subtract your net savings, multiply that by the NRST (tax-inclusive) rate, and there's your total taxes paid.

OK, that sounds a lot like filling out a 1040, with schedules A, B, & C: ... take your income from all sources ...OK, you've got your last paystub, or your W2 (some form of which will likely still exist for SS/MC wage reporting.) Then you've got your investment income, you know the Schedule B stuff, then you've got your capital gains (Schedule C), then you've got your rental income, then you've got your gambling income, then you've got your "other" income. I've probably forgotten a few, but today, I get statements ... probably still will under the FairTax.

That "simple" statement of "take your income from all sources" is no less complex under the FairTax than it us under the Income Tax.

Next:

... subtract your net savings ...

Hmmmm ... net savings ... do I get a statement for that? Let's see take the starting balances of all my accounts and add them together, then take the ending balances of all my accounts and add them together, then subtract the ending total from the beginning total ... simple. OK. I never had to do THAT before. But you're right, it's not that hard. ... by the way, if I used some "savings" to purchase an equity or asset, and the asset has increased in value, does that increase my net savings? or should I ignore that? ... I'm sure the average investor will know what to do.

...multiply that by the NRST...

OK. THAT'S easy.

For effective taxation, subtract twelve times the monthly FCA "prebate" from the total taxes you paid out.

OK, that's easy too. The answer is $5,243.34. Is that good? Last year I got a refund.

The only way this gets anywhere even close to complicated is if a significant portion of your purchases are for used/previously-taxed goods, which would not be subject to the NRST -- the total amount spent here would need to be subtracted from the "income minus savings" total before calculating taxes.

Well, glad to know that LAST part wasn't complicated! OK, now we're into Schedule B (on steroids). Let's see. How much did I pay in State and Local taxes. How about my mortgage payments ... OH , wait, a portion of my interest on my mortgage payment was taxable, so subtract that, and this time my principal was FULLY deductible WOW. Then there were my charitable deductions. OK....

... Now comes the hard part. How much did I spend on non-taxable purchases ... let's see where did I put those receipts ...oh, yeah... I didn't GET many receipts for my not taxable purchases. I got the one for tuition, and the E-Bay stuff ... oh I can probably look at my paypal account and my credit card statements to help figure that out; but then there are the garage sales and swap meets ... oh never mind. Hey you know, I NEVER had to track THIS much detail before just to figure out how much tax I paid!

Other than that exception, however, this whole idea of having to add up each receipt is laughably pointless.

Of course. What was I thinking!

[Dimples]

This is tedious ... and complex. So let's make it simple. Find me an authoritative source that claims that the FairTax will definitively capture transactions from the illegal economy.

[Dimples]

...one trillion dollars of untaxed activity...

Again it's simply a trade off. Every legal dollar that enters the underground was taxed before it was sent underground by a legal income earner executing an illegal transaction. That dollar is not taxed again until it resurfaces out of the underground in a legal purchase. There it flows in a largely tax free transaction to a legal recipient. The dollar is taxed exactly once. Because the tax is levied on income, the illegal activity is biased to avoid legal income transactions of both legal (garden services) and illegal activity (drug deals.) Dollars go underground in order the purchase discount legal products or illegal products.

Under the FairTax every legal dollar that enters the underground is NOT taxed before it was sent underground by a legal income earner executing an illegal transaction. That dollar is not taxed until it resurfaces out of the underground in a legal purchase. There it flows to a legal recipient, who will collect tax on the legal transaction. The dollar is taxed exactly once. Because the tax is levied on purchase transactions, any illegal activity is biased to avoid legal purchase transactions of both legal (garden services) and illegal activity (drug deals.) Dollars go underground in order the purchase discount legal products or illegal products.

There's no difference. Illegal activity is not taxed in either scheme. The dollar is taxed exactly once. There remains a bias to go underground (but the bias shifts from avoiding taxable income to avoiding taxable purchases. No new activity is captured.

[pigdog]

"No, I don't think it's a scam; I think its a bad idea, based on flawed economics; misrepresented to a poorly informed constituency who largely are united by their hatred of the IRS."

You made the above statement WRT the FairTax so I'd like to ask you to present for us the "flaws" in the mathematical derivations as presented in the subject paper of this thread.

"... unless people CHOOSE to spend exactly what they spend today (or more) on TAXABLE items, the FairTax will be short of revenue ..."

Your analysis does not carry the day since not only will consumers actually have more money to spend or save (either of which benefit economic activity), but there will be more taxpayers in the tax base. Despite your continued assertions about the money from the illegal economy being "taxed now by the income tax" that is a huge red herring. As I have shown several times, the illegal funds presently spent in the legal economy provide only a minor amount of tax revenue (if any at all).

The discussion of funds from illegal activities has never been that the FairTax would capture these fund when spent for the illegal things. The statement is and has been that these funds when they are spent under the FairTax for taxable items will generate the full marginal tax rate of 23%.

To see the difference this makes, assume that someone spends $100 for some item under the income tax. The seller might have a profit of, say, $15 on this transaction and pay income tax at a 25% rate. The total tax contribution from the sale would be $100 x 0.15 = $15 which then translates into $15 x 0.25 = $3.75. Under the FairTax this same transaction would generate $100 x 0.23 = $23 - a substantial difference.

The point of these couple of paragraphs is that those presently in the illegal economy will be making a much larger tax contribution under the FairTax thereby offsetting any year to year fluctuations in consumption (which, BTW, is more dependable that income from the standpoint of economic stability).

"... It is well known that the FairTax will DECREASE consumption ... "

REALLY??? Every genuine economic study I've seen on the matter shows quite the opposite. Your statement is especially ironic since the FairTax actually has the effect of taxing wealth over the longer term. This present paper even points that up. Since you believe the opposite, please present a few links to the studies that back up our claim. I've found none, but perhaps I've missed them. If, as you say, it's "well known" then you should be able to do this easily and I look forward to seeing them.

[pigdog]

"Again it's simply a trade off. Every legal dollar that enters the underground was taxed before it was sent underground by a legal income earner executing an illegal transaction. "

As most police Narcotics division cops would be able to tell you, that is simply not the case (and is irrelevant to the actual issue anyway). A good bit of the money so spent is stolen in one way or another. Here are 4 of them - not necessarily representative but indicative and there are many others:

http://www.denverpost.com/news/ci_4380963

http://www.npr.org/templates/story/story.php?storyId=4713714

http://www.whitehousedrugpolicy.gov/publications/factsht/crime/

http://www.nationalreview.com/12feb96/drug.html

So I'm afraid I don't find your argument italicized above as convincing at all.