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From The President's Advisory Panel on Federal Tax Reform

Box 9.2. Comparing the Treasury Department’s Revenue-Neutral Rate Estimate with Estimates Made by Retail Sales Tax Proponents

In their submission to the Panel, proponents of the FairTax claimed that a 30 percent tax exclusive sales tax rate would be sufficient not only to replace the federal income tax, but also to replace all payroll taxes and estate and gift taxes and fund a universal cash grant. In contrast, the Treasury Department concluded that using the retail sales tax to replace only the income tax and provide a cash grant would require at least a 34 percent tax-exclusive rate.

Some may wonder why the tax rate estimated by FairTax advocates for replacing almost all federal taxes (representing 93 percent of projected federal receipts for fiscal year 2006, or $2.0 trillion) is so much lower than the retail sales tax rate estimated by the Treasury Department for replacing the income tax alone (representing 54 percent of projected federal receipts for fiscal year 2006, or $1.2 trillion).

First, it appears that FairTax proponents include federal government spending in the tax base when computing revenues, and assume that the price consumers pay would rise by the full amount of the tax when calculating the amount of revenue the government would obtain from a retail sales tax. However, they neglect to take this assumption into account in computing the amount of revenue required to maintain the government’s current level of spending. For example, if a retail sales tax imposed a 30 percent tax on a good required for national defense (for example, transport vehicles) either (1) the government would be required to pay that tax, thereby increasing the cost of maintaining current levels of national defense under the retail sales tax, or (2) if the government was exempt from retail sales tax, the estimate for the amount of revenue raised by the retail sales tax could not include tax on the government’s purchases. Failure to properly account for this effect is the most significant factor contributing to the FairTax proponents’ relatively low revenue-neutral tax rate.

Second, FairTax proponents’ rate estimates also appear to assume that there would be absolutely no tax evasion in a retail sales tax. The Panel found the assumption that all taxpayers would be fully compliant with a full replacement retail sales tax to be unreasonable. The Panel instead made assumptions about evasion that it believes to be conservative and analyzed the tax rate using these evasion assumptions.

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the Panel concluded that a number of features of the retail sales tax would make it difficult to administer and enforce at the high tax rate necessary to be revenue-neutral. A federal retail sales tax assessed at a rate of at least 34 percent, added on to state retail sales taxes, would provide a substantial inducement for evasion at the retail level. Retailers and shoppers could use a number of techniques to evade a retail sales tax. For example, unregistered cash sales to a consumer would allow a transaction to escape taxation. Retailers facing a high retail sales tax might also misapply exemption criteria, whether intentionally or unintentionally, and fail to tax goods that should be taxed. Or, the retailer might collect the tax from customers, but keep the money rather than remit it to the government. At high tax rates, the gain to retailers from evasion is high.

Empirical evidence suggests third-party reporting substantially improves tax compliance, particularly when tax rates are high. For the portion of income from which taxes are not withheld and there is no third-party reporting, income tax evasion rates are estimated to be around 50 percent. There is no third-party reporting in a retail sales tax. Retailers would add their retail sales tax to the pre-tax price for their goods and would remit that amount to the government, but shoppers would not separately report what they bought, and at what price, to the government. The government would rely on retailers alone to report their own taxable and exempt sales.

To obtain exemption from tax, retail purchasers might try to fabricate exemption certificates or otherwise masquerade as tax-free buyers of retail products. For example, individuals might create “paper” businesses solely to obtain business exemption certificates and avoid taxes on purchases for personal use. A related problem involves individuals with legitimate businesses using their business exemptions for personal purchases or for goods or services to give to employees in lieu of cash compensation. Using their business purchase exemption would provide a discount equal to the retail sales tax rate.

With a retail sales tax, retailers would have the responsibility to determine whether the ultimate use of a good or service would be for a business purpose, and therefore would be deserving of the business purchase exemption. Retailers are often ill-equipped to carry out this role. State experience suggests that abuse of exemptions is common, in part because distinguishing between business and individual consumer purchases of so-called “dual use” goods and services – goods and services that are commonly purchased by both businesses and final consumers, such as a plane ticket – can be difficult and costly.

Considering who wrote the report - the defenders of Big Government and the welfare state - I'd hardly consider them an objective source to assess the merits and drawbacks of the Fair Tax. Where did this term "revenue neutral" come from? I would think that we all agree a true fair tax system should leave the government with LESS revenue than it does today. The income tax feeds the beast. So what do I want - as being on the record as getting rid of the income tax? I want to starve the beast, slim it, get rid of the bloated monstrosity we call government today. So this notion we need to pay 30% to the government should be the wrong baseline - unless you and the other opponents of the Fair Tax like Mr. Barlett think government is worth taking that much from our wallets. The difference between us is I think government already consumes too much of our income. If we really want to shrink government drastically, a Fair Tax will have to throw the so-called "revenue neutral" criteria out of the window. Honestly, we should not replace our current revenue sources - all manner of taxes with ONE tax just to fund the the Big Government status quo. As revolutionaries, we want to bring back small government to America. A government that consumes 15% of our national income would be far different from a government that now commands 43% of it - and there is tax evasion under the income tax. Any responsible conservative should get us in the former direction - a far more sound basis for the kind of government we truly need and deserve in America today.

"Show me just what Mohammed brought that was new, and there you will find things only evil and inhuman, such as his command to spread by the sword the faith he preached." - Manuel II Palelologus

It should be noted that FairTax.org and Dr. Laurence Kotlikoff have rebutted the conclusions of the President’s Tax Panel. Specifically,

“Panel statement #3: The FairTax proponents’ calculations used faulty assumptions and a higher sales tax rate would be needed to be revenue neutral.

“FairTax response: The Treasury estimates for a national retail sales tax reported by the panel were not an estimate of the FairTax legislation. The panel concocted a base of their own, one apparently designed to produce the highest possible rate. Rather than follow the FairTax legislation, they apparently used a typical state sales tax base that is far, far narrower (many exemptions) than the single-rate/no exemptions FairTax.”

FairTax.org continues...

“In addition, the Treasury refused to compare rate quotes on an apples-to-apples basis. Rather than quote the rates for replacement systems in a direct comparison to the income/payroll tax rates they replace, they used ‘econospeak’ sleight of hand to compare apples to oranges. Since the ill-fated beginning of the income tax, it has been quoted by government (and taxpayers) in what economists call a ‘tax-inclusive’ manner. ‘My tax rate was 23 percent’ means if you earned $100, the government kept $23. If you talk about that rate as if it were a sales tax, which is added on to a purchase (tax exclusive), the income tax rate is 30 percent. No matter what, the government gets $23.

“... the Treasury **refuses to make public** [emphasis mine] its scoring methodology – estimating the tax base and revenues – for these plans. Providing such methodology is standard operating procedure in the academic world, yet the Treasury has ignored requests for this information from both FairTax.org and academia.

“...The Beacon Hill Institute at Suffolk University and Laurence Kotlikoff, Professor of Economics at Boston University, have teamed up to provide a sound methodology for estimating the FairTax base and computing the FairTax rate.4 Their paper demonstrates that the 23 percent rate specified by the Fair Tax Act (HR 25) is eminently feasible and suggests what led Gale5 and the President’s Advisory Panel on Federal Tax Reform6 to reach the opposite – and incorrect – conclusion. (Paper available at http://www.fairtax.org/PDF/TaxingSalesUnderFairTax.pdf .)”

Study both: http://snipurl.com/taxpanelrebutted + http://snipurl.com/ftgalerebuttal

With regard to effective percentages that different income groups would pay, as shown charted in the article, Prof.’s Kotlikoff and Rapson (10/06) have said,

“...the FairTax imposes much lower average taxes on working-age households than does the current system. The FairTax broadens the tax base from what is now primarily a system of labor income taxation to a system that taxes, albeit indirectly, both labor income and existing wealth. By including existing wealth in the effective tax base, much of which is owned by rich and middle-class elderly households, the FairTax is able to tax labor income at a lower effective rate and, thereby, lower the average lifetime tax rates facing working-age Americans.

“Consider, as an example, a single household age 30 earning $50,000. The household’s average tax rate under the current system is 21.1 percent. It’s 13.5 percent under the FairTax. Since the FairTax would preserve the purchasing power of Social Security benefits and also provide a tax rebate, older low-income workers who will live primarily or exclusively on Social Security would be better off. As an example, the average remaining lifetime tax rate for an age 60 married couple with $20,000 of earnings falls from its current value of 7.2 percent to -11.0 percent under the FairTax. As another example, compare the current 24.0 percent remaining lifetime average tax rate of a married age 45 couple with $100,000 in earnings to the 14.7 percent rate that arises under the FairTax.”

Study: http://snipurl.com/kotcomparetaxrates

And, finally,

“...once one moves to generations postdating the baby boomers there are positive welfare gains for all income groups in each cohort. Under a 23 percent FairTax policy, the poorest members of the generation born in 1990 enjoy a 13.5 percent welfare gain. Their middle-class and rich contemporaries experience 5 and 2 percent welfare gains, respectively. The welfare gains are largest for future generations. Take the cohort born in 2030. The poorest members of this cohort enjoy a huge 26 percent improvement in their well-being. For middle class members of this birth group, there’s a 12 percent welfare gain. And for the richest members of the group, the gain is 5 percent.”

Study: http://snipurl.com/kotftmacromicro