Free Republic
Browse · Search
News/Activism
Topics · Post Article

Skip to comments.

Tax and Social Security Reform: Thinking Outside the Box
NCPA ^ | Thursday, September 29, 2005 | Hans Fehr, John C. Goodman, Sabine Jokisch, Laurence J. Kotlikoff

Posted on 09/29/2005 11:50:45 AM PDT by ancient_geezer

NATIONAL CENTER FOR POLICY ANALYSIS
Tax and Social Security Reform: Thinking Outside the Box
NCPA Study
No. 275
Thursday, September 29, 2005

by Hans Fehr, John C. Goodman, Sabine Jokisch, Laurence J. Kotlikoff

  1. Executive Summary
  2. Introduction: Five Radical Reforms
  3. The U.S. Tax System: The Case for Reform
  4. Elderly Entitlements: The Case for Reform
  5. Modeling the Effects of Tax Reform
  6. An Eleven Percent Flat-Rate Income Tax
  7. A Flat Rate Consumption Tax
  8. Combining Tax Reform and Social Security Reform
  9. Conclusion
  10. Notes
  11. Appendix
  12. About the Authors
Executive Summary

This study examines the effects of fundamental tax reform as well as combining tax reform with fundamental Social Security reform.

Tax reform consists of replacing personal and corporate federal income taxation with: (1) an 11 percent flat-rate income tax, or (2) a 14 percent flat-rate tax on personal consumption, or (3) a 14 percent value-added tax (VAT), or (4) a 16 percent federal retail sales tax with the same effective tax rate as the tax on personal consumption and the VAT. The first reform taxes all income at one low rate. The next three reforms tax all consumption at one low rate.

Under each tax reform, the new tax is rebated to the lowest one-third of income earners. While we don&rsquot model the form of these rebates, they could be provided as vouchers for the purchase of health insurance, contributions to personal retirement accounts, or contributions to Individual Development Accounts (IDAs). We also remove the cap on the Social Security payroll tax, but keep the benefit structure in place so that the tax rate on all wage income is the same.

A complaint about previous tax reform proposals is that they undermine the somewhat progressive features of the current fiscal system. The reforms considered here enhance progressivity. The bottom one-third of the income distribution of each age group gains the most under each reform proposal.

All four tax reforms entail very low tax rates for three reasons: (1) the additional payroll tax revenue from eliminating the payroll tax ceiling is used as general revenue, (2) the income and consumption tax bases are comprehensive, and (3) the reforms do not exempt large fractions of the population from taxation, as occurs, for example, under former Congressman Dick Armey&rsquos flat tax proposal. Under the Armey flat tax, half the population would escape the tax and the other half would have a significant amount of untaxed income.

An Eleven Percent Flat-Rate Income Tax. Under this proposal all income is taxed only once, at its source, when it is realized, at one low rate. Everyone would pay the tax, regardless of income, and there would be no deductions, exclusions or exemptions. This would mean no more deductions for home mortgage interest, charitable contributions, and state and local taxes. It would also mean that employee benefits, including health insurance and pension contributions, would no longer be excluded from taxable income. Moreover, there would no longer be tax-free municipal bonds. Nor would individuals would be able to make tax-free deposits and realize tax-free growth in their IRA and 401(k) accounts. In return, people would get to keep 89 cents of each additional dollar of income they earn.

A Fourteen Percent Flat-Rate Tax on Personal Consumption. The theory behind a consumption tax is that people should be taxed based on what they take out of the economy, not on what they put in. The reason: when they save and invest, those dollars add to the capital stock and raise workers&rsquo productivity and family incomes. The act of saving, in other words, creates benefits for other people.

This proposal is identical to the previous proposal with one exception: we do not tax income that is saved. Households would be able to deduct their saving, regardless of the form of that saving, but would have to pay tax on all of their dissaving, regardless of its form. Since all income is eventually consumed, all income under this proposal would eventually be taxed.

A Fourteen Percent Value-Added Tax (VAT). A second way to tax consumption is with a value-added tax (VAT). This approach taxes business sales minus the costs of a) intermediate inputs and b) net investment in plant and equipment. Since the value of sales at each stage of production incorporates the costs of intermediate inputs used, what is really being taxed is the additional value that has been added. Across all businesses, taxing value added minus net investment is the same as taxing national income minus net investment. But net investment equals net saving (since what is saved is invested), and income not saved is consumed. Hence, the VAT represents an indirect way to tax consumption.

An advantage of the tax is its ease of administration. Instead of 129 million individual tax returns, the tax would require only 20 million business establishments to file returns. A disadvantage is that the tax tends to be hidden and therefore not transparent. Consumers are usually unaware of how the tax affects the prices of items they buy. Workers are usually unaware of how the tax affects their take-home pay.

The VAT considered here would not be restricted to what most people regard as &ldquobusiness&rdquo enterprises. The tax would also apply to schools, hospitals, churches, nonprofit charities and even state and local governments. Under the current system, the federal government collects employee income tax revenue from all of these entities. If we were to abolish the income tax on wages, we must collect an equivalent amount in the form of a VAT. The mechanics are doable, even though they will strike many people as novel.

Some foreign countries exempt certain economic sectors from the VAT. But every exemption means a higher tax rate.

A Sixteen Percent Retail Sales Tax. The most direct and transparent way to tax consumption is with a retail sales tax. Unlike the VAT, this tax would be visible to consumers when they purchase goods and services. Even fewer entities would need to file returns than under a VAT. Think of the stages of production for a loaf of bread. A VAT would be collected from the farmer, the miller, the baker, the wholesaler and so forth. A sales tax concentrates the entire collection at the point of final sale. The advantage is lower cost of administration. A possible disadvantage is increased incentives for evasion and avoidance on the part of retailers and their customers.

Like the VAT, a retail sales tax would have to be collected from the nonprofit sector and state and local governments. Although this is doable, most state governments exempt these sectors from their own sales taxes. Any exemptions, however, require a higher tax rate. The 16 percent retail sales tax rate effectively equals the 14 percent rate of the previous two consumption tax proposals. The difference between the two rates reflects the way in which they are expressed.

Incorporating Social Security Reform. Social Security reform has two provisions: (1) phasing out the old system by paying workers in retirement only those benefits they have accrued as of the time of reform, and (2) instituting mandatory personal retirement accounts. Tax reform can be combined with Social Security reform. For example, if one were to raise the flat consumption tax rate to 17 percent, one could devote three percentage points to personal retirement accounts, matched by one percent contributions from both employees and their employers. These five percent accounts will grow over time and completely replace the current pay-as-you-go system in about four decades.

Simulating the Impact of Reform. The current tax system imposes huge and unnecessarily burdensome compliance costs on taxpayers. It also distorts incentives, leading to a misallocation of resources and encouraging the growth of an underground economy. We do not attempt to estimate the gains from reducing those distortions in this study. Instead, the model used here is well-geared to assessing the macroeconomic consequences of tax reform, including estimates of the required tax rates, the impact on saving and investment decisions, real wages, real interest rates, and the welfare consequences for broad classes of taxpayers grouped by income and age.

Economic Consequences of Tax Reform. Our simulations show that moving to a consumption tax, whether implemented as a personal consumption tax, a value-added tax, or a retail sales tax, would cause a substantial increase in the nation&rsquos capital stock. This, in turn, would raise wages and real output compared to the current system. Specifically,

  • National income would be 6 percent higher than otherwise by 2030, and 9 percent higher by 2050.
  • Real wages would be 4 percent higher by 2030 and 6 percent higher by 2050.

As noted, low-income families proportionally gain the most from these reforms and there are especially large payoffs for future generations:

  • For those born in 2000, the lifetime gains are almost 14 percent for the bottom third of the income distribution, 4 percent for those in the middle and 2.4 percent for those at the top.
  • For those to be born in 2030, the lifetime gains are 18 percent, 6 percent and 3 percent, respectively.

Economic Consequences of Tax Reform Plus Social Security Reform. In some ways, Social Security reform is even more important than tax reform because it avoids dramatic increases over time in payroll taxes that would otherwise be needed to pay benefits to the elderly. Overall:

  • Taxes as a percent of national income will rise from 36 percent today to 46 percent by 2030 and 50 percent by the end of the century in the absence of any reform.
  • With the package of reforms proposed here, however, taxes will peak at 42 percent of national income in 2030 and recede to 33 percent by the end of the century.

Lower taxes mean more disposal income, which, in turn, leads to more personal saving and more capital accumulation. Moreover, the expansion of capital leads to higher real wages:

  • Without reform, real wages at mid-century will be 10 percent lower than otherwise because of elderly entitlements.
  • With the set of reforms proposed here, real wages will be 4 percent higher than otherwise by mid-century and 10 percent higher by the end of the century.
  • Without reform, average take-home pay for workers will be 26 percent lower by 2050 and 31 percent lower by the end of the century because of elderly entitlements.
  • With the set of reforms considered here, take-home pay will be almost 4 percent higher than otherwise by 2050 and almost 15 percent higher by the end of the century.

Moreover, combining consumption tax and Social Security reform creates very large and very progressive benefits for future generations:

  • For individuals born in 1980 and newly entering the labor market today, families in the bottom third of the income distribution can expect a 13 percent increase in their lifetime standard of living, compared to less than 1 percent for those in the middle and less than 2 percent for those at the top.
  • For those to be born in 2030, the gains (relative to what otherwise would have happened) are 54 percent for the bottom third, 27 percent for those in the middle and 11 percent for those at the top.

Conclusion. To remain competitive in the modern international economy and to avert the crushing burden of unfunded elderly entitlements, we need both tax reform and Social Security reform. Some have supposed that these are two completely separate endeavors. In fact, the two reforms may be easier to adopt and implement if they are combined.

Next »

12770 Coit Rd., Suite 800 - Dallas, TX 75243-1739 Phone 972/386-6272 - Fax 972/386-0924

601 Pennsylvania Ave. NW, Suite 900, South Building - Washington, DC 20004 Phone 202/220-3082 - Fax 202/220-3096

Copyright © 2004 National Center for Policy Analysis All rights reserved - Privacy Policy



TOPICS: Business/Economy; Government
KEYWORDS: socialsecurity; taxes; taxreform
Navigation: use the links below to view more comments.
first 1-2021-37 next last
A very interesting new study covering a broad range of possible options, for Social Security and tax reform and their effects as regards the economy and individual household.
1 posted on 09/29/2005 11:50:46 AM PDT by ancient_geezer
[ Post Reply | Private Reply | View Replies]

To: Taxman; pigdog; Principled; EternalVigilance; rwrcpa1; phil_will1; kevkrom; n-tres-ted; Zon; ...
A Taxreform bump for you all.

If you would like to be added to this ping list let me know.

John Linder in the House(HR25) & Saxby Chambliss Senate(S25) offer a comprehensive bill to kill all income and SS/Medicare payroll taxes outright and replace them with with a national retail sales tax administered by the states.

H.R.25,S.25
A bill to promote freedom, fairness, and economic opportunity by repealing the income tax and other taxes, abolishing the Internal Revenue Service, and enacting a national retail sales tax to be administered primarily by the States.

Refer for additional information:


2 posted on 09/29/2005 11:53:20 AM PDT by ancient_geezer (Don't reform it, Replace it!!)
[ Post Reply | Private Reply | To 1 | View Replies]

To: Taxman; pigdog; Principled; EternalVigilance; rwrcpa1; phil_will1; kevkrom; n-tres-ted; Zon; ...
A Taxreform bump for you all.

If you would like to be added to this ping list let me know.

John Linder in the House(HR25) & Saxby Chambliss Senate(S25) offer a comprehensive bill to kill all income and SS/Medicare payroll taxes outright and replace them with with a national retail sales tax administered by the states.

H.R.25,S.25
A bill to promote freedom, fairness, and economic opportunity by repealing the income tax and other taxes, abolishing the Internal Revenue Service, and enacting a national retail sales tax to be administered primarily by the States.

Refer for additional information:


3 posted on 09/29/2005 11:54:00 AM PDT by ancient_geezer (Don't reform it, Replace it!!)
[ Post Reply | Private Reply | To 1 | View Replies]

To: ancient_geezer

mark.


4 posted on 09/29/2005 11:57:17 AM PDT by stevestras
[ Post Reply | Private Reply | To 3 | View Replies]

To: ancient_geezer

The 16% retail sales tax cited here is far less than what I've seen in the past (I want to say it was 26% or 24%). Why is this so much lower than previous proposals?


5 posted on 09/29/2005 11:58:43 AM PDT by SittinYonder (Flea, feather, bird, egg, nest, twig, branch, limb, tree, and the bog down in the valley - o.)
[ Post Reply | Private Reply | To 3 | View Replies]

To: SittinYonder

The particular form (16%) here is to replace income taxes only, leaving the SS/Medicare payroll taxes as is, and has a little higher rebate making the proposed rate for income tax alone 16% instead of 15%.

According to the article, replacing SS/Medicare taxes and implementing personal savings accounts as well, an additional 3% would be necessary bringing the total 19%.

The other factor is that the study is current and reflects the Bush administration tax cuts, which current proposals do not.

19% sure looks alot better than 23% for a revenue neutral rate of a fairtax like implementation.


6 posted on 09/29/2005 12:07:59 PM PDT by ancient_geezer (Don't reform it, Replace it!!)
[ Post Reply | Private Reply | To 5 | View Replies]

To: ancient_geezer

Thanks!


7 posted on 09/29/2005 12:13:13 PM PDT by SittinYonder (Flea, feather, bird, egg, nest, twig, branch, limb, tree, and the bog down in the valley - o.)
[ Post Reply | Private Reply | To 6 | View Replies]

To: SittinYonder; Taxman; pigdog; Principled; EternalVigilance; rwrcpa1; phil_will1; kevkrom; ...
Table of contents with links that work:

NATIONAL CENTER FOR POLICY ANALYSIS

Tax and Social Security Reform: Thinking Outside the Box
http://www.ncpa.org/pub/st/st275/
NCPA Study
No. 275
Thursday, September 29, 2005

by Hans Fehr, John C. Goodman, Sabine Jokisch, Laurence J. Kotlikoff

  1. Executive Summary
  2. Introduction: Five Radical Reforms
  3. The U.S. Tax System: The Case for Reform
  4. Elderly Entitlements: The Case for Reform
  5. Modeling the Effects of Tax Reform
  6. An Eleven Percent Flat-Rate Income Tax
  7. A Flat Rate Consumption Tax
  8. Combining Tax Reform and Social Security Reform
  9. Conclusion
  10. Notes
  11. Appendix
  12. About the Authors

8 posted on 09/29/2005 12:16:38 PM PDT by ancient_geezer (Don't reform it, Replace it!!)
[ Post Reply | Private Reply | To 5 | View Replies]

To: ancient_geezer
According to the article, replacing SS/Medicare taxes and implementing personal savings accounts as well, an additional 3% would be necessary bringing the total 19%.

How can a 3% increase in sales tax replace the SS/Medicare tax of 15.3% on most wages. That doesn't make any sense.

9 posted on 09/29/2005 12:27:12 PM PDT by KarlInOhio (We need a strict constructionist - not someone who plays shadow puppet theater with the Constitution)
[ Post Reply | Private Reply | To 6 | View Replies]

To: ancient_geezer

bumped and bookmarked.


10 posted on 09/29/2005 12:30:13 PM PDT by groanup (shred for Ian)
[ Post Reply | Private Reply | To 8 | View Replies]

To: ancient_geezer

Seems to me you have stated many times that you thought the appropriate level for the fair tax was closer to 19%. Very prescient of you. Compliments.


11 posted on 09/29/2005 12:44:16 PM PDT by groanup (shred for Ian)
[ Post Reply | Private Reply | To 8 | View Replies]

To: KarlInOhio

How can a 3% increase in sales tax replace the SS/Medicare tax of 15.3% on most wages. That doesn't make any sense.

Retail consumption is a much broader tax base than FICA wages capped at $90k.

Secondly the SS reforms proposed includes a Personal Savings Accounts financed and owned by the individual with matching government and businesses contributions to it. Payments into that PSA are not treated as part of the tax rate as the PSA accrues to the direct ownership and benefit of the individual.

Refer to the article's chapter describing the SS side of the proposed reform:

Combining Tax Reform and Social Security Reform


12 posted on 09/29/2005 12:46:01 PM PDT by ancient_geezer (Don't reform it, Replace it!!)
[ Post Reply | Private Reply | To 9 | View Replies]

To: KarlInOhio
The proposed SS reform under this study looks like this:

Combining Tax Reform and Social Security Reform
http://www.ncpa.org/pub/st/st275/st275g.html

"This proposal consists of four elements: (1) replace federal personal and corporate income taxes with a 17 percent flat-rate consumption tax, where the rate is measured on a tax-inclusive basis; (2) use 3 percentage points of the new tax to match contributions of 1 percent each by employees and their employers to create 5 percent personal retirement accounts designed to eventually replace the current pay-as-you-go Social Security system; (3) rebate the 17 percent consumption tax conditionally to the bottom one-third of the income distribution to those with health insurance and retirement accounts, pensions or Individual Development Accounts; and (4) apply the Social Security (FICA) payroll tax to all wage income.

Social Security Reform. In structuring a privatization proposal, we examined the plan of Saving and Rettenmaier,39 who propose 5 percent individual retirement accounts funded by 1 percent payroll contributions from employees, matched by a 1 percent contribution from employers and 3 percent from the government. The government’s contribution could consist of a diversion of payroll taxes or payments from general revenue. In either case, the transition is made possible in our proposal by the new consumption tax.

In the Saving/Rettenmaier proposal, the option to establish a personal retirement account (PRA) is voluntary and lower-income workers get larger government matches in order to replicate the progressivity of the current system. As the PRA balances grow over time, government-paid benefits are reduced. Over the course of one’s work life, a 5 percent account should be sufficient to replace currently scheduled Social Security benefits for an average-income worker.

In this analysis we assume that all workers participate in the private system and all retirees remain in the current system. We also assume that all workers contribute the same percent of wages (5 percent) regardless of income. "


13 posted on 09/29/2005 12:53:57 PM PDT by ancient_geezer (Don't reform it, Replace it!!)
[ Post Reply | Private Reply | To 9 | View Replies]

To: groanup

Seems to me you have stated many times that you thought the appropriate level for the fair tax was closer to 19%. Very prescient of you. Compliments.

Not prescient. just applying what is known and published about the Bush tax cuts and their consequent effective tax rate as compared to pre-2000 tax rates when the FairTax legislation was authored. I merely assume the change in NRST rate would be proportionate to the change in the total effective federal tax rate documented by the Tax Foundation folks.

refer Tax Freedom Day 2005 report PDF: Special Report No.134, April 2005

 

Total Effective Tax Rates by Level of Government
Percent Net National Product(NNP)

Year Federal State Total
1996 21.3% 10.4% 31.6%
1997 21.8% 10.3% 32.1%
1998 22.4% 10.4% 32.8%
19990 22.5% 10.4% 32.9%
2000 23.1% 10.4% 33.5%
2001 22.2% 10.5% 32.7%
2002 1 19.6% 10.2% 29.8%
2003 2 18.8% 10.1% 28.9%
2004 3 18.4% 10.2% 28.6%
2005 19.0% 10.1% 29.1%
Notes: Leap day is omitted to make dates comparable over time. Since depreciation is not available to pay taxes, GDP is an overstatement of spendable income for the purpose of measuring tax burdens. Depreciation is netted out of NNP.

"Overall, NNP provides the best statistical representation of the common notion of “spendable” resources. In 2004 NNP was $10,371.6 billion. Like GDP and PI, NNP is a component of the National Income Product Accounts (NIPA). These accounts are computed and compiled annually by the Commerce Depart-ment’s Bureau of Economic Analysis (BEA)."
Tax Foundation Special Report No.134, April 2005

0 First year introduction of HR2525(Fair Tax legislation).

1 Economic Growth and Tax Reform Reconciliation Act of 2001
2 The Job Creation and Worker Assistance Act of 2002
3 Job Growth and Tax Relief Reconciliation Act of 2003

Sources: Office of Management and Budget; Internal Revenue Service; Congressional Research Service; National Bureau of Economic Research; Treasury Department; and Tax Foundation calculations.


14 posted on 09/29/2005 12:59:25 PM PDT by ancient_geezer (Don't reform it, Replace it!!)
[ Post Reply | Private Reply | To 11 | View Replies]

To: ancient_geezer
It looks like the 3% is the payment by the government into a private retirement account, on top of 1% from the employee and 1% by the employer. The SS tax would be applied to all wages (no more $90k cap) [paragraph 1, point 4].

So the net tax for someone in the top rate would go from a marginal rate of 37.9% (35% income + 2.9% medicare) to 29.7% (15.3% SS/medicare + 17% of the amount left after SS).

15 posted on 09/29/2005 1:09:44 PM PDT by KarlInOhio (We need a strict constructionist - not someone who plays shadow puppet theater with the Constitution)
[ Post Reply | Private Reply | To 13 | View Replies]

To: KarlInOhio

So the net tax for someone in the top rate would go from a marginal rate of 37.9% (35% income + 2.9% medicare) to 29.7% (15.3% SS/medicare + 17% of the amount left after SS).

The maximum marginal tax rate, using the FlatTax (tax inclusive rates) savings & investment expempt would be 14% of consumption + 15.3% (29.3%) assuming a capped (90k) wage base for SS/Medicare.

That would somewhat less with no caps on the Social Security wage base. The actual maximum marginal rate with on the total income tax version would be closer to 11% + 8.2% ~ 19.5% using current figures for SS/Medicare tax revenues as a percentage of total wage rather than capped wages.

Under a NRST tax system the maximum marginal rate would comes out something around 19-20%.

The 5 different tax reform systems covered in the study all use rebates to implement progressivity rather than exemptions or deductibility thus marginal rates are with respect to significantly different tax base than the current taxable income base of today's tax system.

I suggest you read the whole report before making guesses as to maximumum marginal rates for the proposals reviewed in the study, as the tax bases are significantly different from the current income/payroll tax system that would be replaced by any one of the five proposals (10 actually with SS refrom being making up 5 varients.)

16 posted on 09/29/2005 1:40:43 PM PDT by ancient_geezer (Don't reform it, Replace it!!)
[ Post Reply | Private Reply | To 15 | View Replies]

To: ancient_geezer
Very interesting indeed! Thanks for the ping!

I haven't had time to look this over in depth yet as I am very busy at present dealing with the results of Hurricane Rita but I STRONGLY suspect that it supports what many of us have been arguing all along!

17 posted on 09/29/2005 2:09:58 PM PDT by Bigun (IRS sucks @getridof it.com)
[ Post Reply | Private Reply | To 1 | View Replies]

To: ancient_geezer

Bookmark


18 posted on 09/29/2005 9:09:39 PM PDT by RATkiller (I'm not communist, socialist, Democrat nor Republican so don't call me names)
[ Post Reply | Private Reply | To 1 | View Replies]

To: ancient_geezer

Excellent info. Thanks for the post and the ping.


19 posted on 09/30/2005 5:43:16 AM PDT by Dementon (You're unique! Just like everyone else!)
[ Post Reply | Private Reply | To 1 | View Replies]

To: ancient_geezer

"In some ways, Social Security reform is even more important than tax reform because it avoids dramatic increases over time in payroll taxes that would otherwise be needed to pay benefits to the elderly."

Bears repeating. This is one of the many things about tax reform that the flat taxers just don't get.


20 posted on 09/30/2005 8:09:08 AM PDT by phil_will1 (My posts are in no way limited or restricted by previously expressed SQL opinions)
[ Post Reply | Private Reply | To 1 | View Replies]


Navigation: use the links below to view more comments.
first 1-2021-37 next last

Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.

Free Republic
Browse · Search
News/Activism
Topics · Post Article

FreeRepublic, LLC, PO BOX 9771, FRESNO, CA 93794
FreeRepublic.com is powered by software copyright 2000-2008 John Robinson