Would the FairTax Raise or Lower Marginal and Average Tax Rates

National Bureau of Economic Research ^ | December 2005 | Laurence J. Kotlikoff

[ancient_geezer]

Would the FairTax Raise or Lower Marginal and Average Tax Rates

Laurence J. Kotlikoff, David Rapson NBER Working Paper No. 11831 Issued in December 2005 NBER Program(s):   PE ---- Abstract ----- This paper compares marginal and average tax rates on working and saving under our current federal tax system with those that would arise under a federal retail sales tax, specifically the FairTax. The FairTax would replace the personal income, corporate income, payroll, and estate and gift taxes with a 23 percent effective retail sales tax plus a progressive rebate. The 23 percent rate generates more revenue than the taxes it replaces, but the rebate’s cost necessitates scaling back non-Social Security expenditures to their 2000 share of GDP. The FairTax’s effective marginal tax on labor supply is 23 percent. Its effective marginal tax on saving is zero. In contrast, for the stylized working households considered here, current effective marginal labor taxes are higher or much higher than 23 percent. Take our stylized 45 year-old, married couple earning $35,000 per year with two children. Given their federal tax bracket, the claw-back of the Earned Income Tax Credit, and the FICA tax, their marginal tax is 47.6 percent. The FairTax imposes a zero marginal tax on saving meaning that reducing this year’s consumption by a dollar permits one to increase the present value of future consumption by a dollar. In contrast, the existing federal tax system imposes very high marginal taxes on future consumption. For our stylized working households foregoing a dollar’s consumption this year to uniformly raise consumption in all future years raises the present value of future consumption by only 45.8 to 77.4 cents, i.e., the effective marginal tax rates on uniformly raising future consumption via saving facing our households ranges from 22.6 percent to 54.2 percent. The FairTax also reduces most of our stylized households’ remaining average lifetime tax rates ? and, often, by a lot. Consider our stylized 30 year-old, single household earning $50,000. The household’s average remaining lifetime tax rate under the current system is 21.1 percent. It’s 16.2 percent under the FairTax.

[PubliusMM]

Apart from the prior discussion regarding economic equivalence; and, recognizing that tax reform must (at some point) be joined by governmental spending reform, there are a number of very attractive elements to the Fair Tax plan as outlined in HB25 and SB25.
First, federal revenue will be determined by spending on NEW goods and services. The underlying notion is that the sale of a new item with an inclusive tax (regardless of rate) then represents that total value to the economy.
Second, a large portion of those folks currently evading federal income taxes in a variety of ways get to, finally, pay at least a portion of their assigned share, assuming they buy goods and services. This group includes drug dealers, extortionists, con men of many stripes, and so on.
Third, the Fair Tax supports the benevolent greed of commercial enterprises. The plan, as proposed, will require all commercial entities to report closing book value inventory numbers on the date of conversion. This dollar amount is 'grandfathered' into the new system, and once sales pass that number, all further sales are subject to the Fair Tax. Further, it should be relatively quick to see net costs for new goods and services approximate current net costs, because the income tax implications of the current commercial economic model are removed.
Fourth, by taxing goods and services, removing the current withholding process, and applying only to new goods, I (and all of you) have greater control over not only income, but the timing of tax payments.
There are a couple of downsides...most notably, there may be requirement for Constitutional amendment to truly abolish the government's ability to tax income. And, second, there is not enough 'stomach' in Washington, right now, to make this all happen.
While I greatly admire and mostly support President Bush, as quickly as he caved on Social Security privatization, I can't expect that he'll take on this fight.
And, of course, the current lobby industry in Washington would be decimated by a plan such as this one (or the Flat Tax) as they would not be as able to push for favorable treatment of their paying constituents.

All in all, after looking at Forbes' Flat Tax Plan and Lindner's Fair Tax Plan, I believe the best bet for current and future generations is the Fair Tax, but either must be coupled with sane spending reform (line item veto, balanced budget amendment, review of current 'entitlement' programs in terms of their constitutionality, etc.).

Thanks for reading. And, while this is my first post, I've been a lurker around here for many months. I am impressed by the quality of the writing, and the great sense of humor in many of these threads.

[groanup]

Your post is most certainly welcome and, for me, a shot in the arm for the fair tax. There are those who will take issue with your analysis but I find it very informed and thoughtful. Welcome to the debate.

When you get slammed by the anti FT's just remember, they have an agenda which includes making us all slaves to their scheme of tax, bribe, legislate and intimidate.

Welcome,

groanup

[groanup]

Oh, and welcome to Free Republic.

[RobFromGa]

When you get slammed by the anti FT's just remember, they have an agenda which includes making us all slaves to their scheme of tax, bribe, legislate and intimidate.

What a total crock.

[groanup]

Who pissed in your potato salad tonight?

[RobFromGa]

I have no idea what you are talking about.

[Your Nightmare]

Is this the new paper where Kotlikoff admits that the FairTax rate would have to be higher than 23% inclusive?

[Your Nightmare]

The 23 percent rate generates more revenue than the taxes it replaces, but the rebate’s cost necessitates scaling back non-Social Security expenditures to their 2000 share of GDP.

This is a very interesting sentence. Basically, the FairTax generates more revenue but increases expenditures (to pay for the "rebate") more than the increase in revenue.

[lewislynn]

Further, it should be relatively quick to see net costs for new goods and services approximate current net costs, because the income tax implications of the current commercial economic model are removed.

Relatively speaking almost nothing is manufactured here anymore, and more and more "services" are being outsourced offshore...There would be little pretax reduction along with huge 30% after tax increases in prices on day one.

If a domestic manufacturer/business strips away "the income tax implications of the current commercial economic model" s/he would then have to deal with the 30% sales tax implications (price increases) at the other end...simply manufacturing something cheaper only to be heavily taxed at the other end is hardly a solution.

I have a service business. Here's what I know based on the law. From day one I would have to remit "23% of the gross payments" to the government and then I'd have to pay another 23% of what's left when I want to spend it on new stuff.(Silly me, I choose to not alter my lifestyle because you're too lazy to fill out a tax return)...

If I don't increase my prices the amount of the tax I'd come up short of income no matter how many drug dealers pay sales taxes.

[ancient_geezer]

Is this the new paper where Kotlikoff admits that the FairTax rate would have to be higher than 23% inclusive?

Blowing smoke again I see.

You are aware the feds are running a deficit now are you not? But then a revenue neutral tax bill is not required to remove deficits.

"The 23 percent rate generates more revenue than the taxes it replaces, but the rebate’s cost necessitates scaling back non-Social Security expenditures to their 2000 share of GDP."

Of course to pay for the full budget, clearing deficits as well as meet the revenue neutral targets, requires scaling back to the same share of GDP as it was in 2000 when when the 23% was established.

"Revenue Neutral" does nothing to change deficit by definition.

Sorry, but Kotlikoff papers usually target paying deficits as well as meeting the minimal revenue neutral requirments that is all that is required for the legislation.

Nice try at obfuscation though.

By the way, if you don't want to pay the NBER download fee for the paper, I am told that Kotlikoff will be making the full text available to AFT so they can put it up on their website before the end of the year.

[lewislynn]

The 23 percent rate generates more revenue than the taxes it replaces, but the rebate’s cost necessitates scaling back non-Social Security expenditures to their 2000 share of GDP.

Looks like a new economic report specifically about the FairTax legislation has been published.

Yea and "scaling back" means it's not revenue neutral and "rebate’s cost" means fewer people are paying more taxes.

[groanup]

"Relatively speaking almost nothing is manufactured here anymore,"

http://www.nemw.org/mfgfact.htm

[Your Nightmare]

By the way, if you don't want to pay the NBER download fee for the paper, I am told that Kotlikoff will be making the full text available to AFT so they can put it up on their website before the end of the year.

I've already read the full paper, thanks. The AFT probably doesn't want to post it, though. It exposes the "revenue neutral" lie.

[Your Nightmare]

You are aware the feds are running a deficit now are you not? But then a revenue neutral tax bill is not required to remove deficits.

Kotlikoff isn't talking about paying for the deficit, he's talking about paying for the Family Consumption Allowance.

"Revenue Neutral" does nothing to change deficit by definition.

He says in the abstract that the FairTax is NOT revenue neutral. In fact, it generates MORE revenue than the current system. It's just not enough to pay for the increase in expenditures the FairTax requires.

The paper is full of weaselly language like that in the abstract. I can only guess that the AFT funded the paper.

[ancient_geezer]

The AFT probably doesn't want to post it, though. It exposes the "revenue neutral" lie.

LOL, watch it get posted, as promised. And watch your characterizations go down in flames.

[ancient_geezer]

He says in the abstract that the FairTax is NOT revenue neutral. In fact, it generates MORE revenue than the current system.

Which AFT and others have been saying all along.

 

The 23% rate is based on pre-1999 tax and NIPA/GDP data when the legislation was first introduced, refer to the CATO's description of Calculating the Tax Rate.

A more current calculation based on current tax law (Bush tax cuts in effect 2003) is provided below:

 

http://www.fairtaxvolunteer.org/smart/tax_system.html

 

Table two: national FairTax rate calculation: 2003
Line	Description	FairTax base	Source
	Taxable item	Billions
1	Personal consumption expenditures	$ 7,760.9	NIPA Table 1.1.5, line 2
2	Purchases of new single-family homes	$ 310.6	NIPA Table 5.3.5, line 20
3	Purchases of new mobile homes	$ 7.1	NIPA Table 5.4.5B, line 40
4	Improvements to single-family homes	$ 132.0	NIPA Table 5.4.5B, line 42
5	Less: imputed rent on owner-occupied housing	$ 859.6	NIPA Table 7.4.5, line 3
6	Less: imputed rent on farm housing	$ 11.9	NIPA Table 7.4.5, line 5
7	Additional financial intermediation services	$ 83.1	Financial & risk Intermediation greater than NIPA definition
8	Foreign travel by U.S. residents	$ 39.6	One half of NIPA Table 2.5.5, line 110
9	Less: expenditures abroad by U.S. residents	$ 6.6	NIPA Table 2.5.5, line 111
10	Less: food produced and consumed on farms	$ 0.5	NIPA Table 2.5.5, line 6
11	State and local government consumption	$ 1,058.5	NIPA Table 3.10.5, line 47
12	Gross purchases of new structures	$ 213.4	NIPA Table 3.9.5, line 24
13	Gross purchases of equipment	$ 51.5	NIPA Table 3.9.5, line 25
14	Federal government consumption	$ 658.6	NIPA Table 3.10.5, line 12
15	Gross purchases of new structures	$ 15.5	NIPA Table 3.9.5, line 9
16	Gross purchases of equipment and software	$ 78.1	NIPA Table 3.9.5, line 10
17	Less: state and local government sales taxes	$ 343.9	NIPA Table 3.3, line 7
18	Less: government education expenditures	$ 414.7	Table 255, SAOUS 2003
19	Less: private education expenditures	$ 151.7	NIPA Table 2.5.5, lines 105 & 106
20	Expenditures in U.S. by non-residents	$ 86.7	NIPA Table 2.5.5, lines 112
21	Travel to U.S. by non-residents	$ 33.3	One half, SAOUS 2003 Table 1280
22	National retail sales tax base	$ 8,740.0
Revenues to be replaced
23	Income tax	$ 927.7	Dept. of Treasury; derived from Table B-81 ERP 2004
24	Estate and gift tax	$ 22.4	Dept. of Treasury; derived from Table B-81 ERP 2004
25	Payroll taxes	$ 717.8	Dept. of Treasury; derived from Table B-81 ERP 2004
26	Excise taxes	$ -
27	Total	$ 1,667.9
Revenue-neutral rate calculation
28	Tax exclusive rate (no rebate)	19.1%
29	Tax inclusive rate (no rebate)	15.9%
30	Base reduction equivalent for rebate	$ 1,746.1	Total consumption allowance for 109 million rebate units
31	Net tax base	$ 6,993.8
32	Tax exclusive rate (with rebate)	23.8%
33	Tax inclusive rate (with rebate)	19.3%

 

It's just not enough to pay for the increase in expenditures the FairTax requires.

Interesting the rate come out at 19.3% accounting for expenditure the FairTax requires in rebate.

No, the short fall is the same shortfall that exists under the current tax system, that of the deficits from the consequence of your Congress Critter's spending beyond incoming revenues from the current tax system.

The paper is full of weaselly language like that in the abstract.

In otherwords, Kotlikoff and his study doesn't say at all what you wanted him to say. LOL.

[Your Nightmare]

Interesting the rate come out at 19.3% accounting for expenditure the FairTax requires in rebate.

LOL. Have you read the full paper?

[ancient_geezer]

Just overviw. But enough to know its content.

Unfortunately the download of the final text from NBER has not been released yet, from the last time I checked.

I'm waiting to see who gets th full text up online first, NBER or AFT ;O)

But then I don't seem to have the contacts you apparently have in getting a full copy before it goes online.

[ancient_geezer]

Just noticed that Kotlikoff has released a second paper to NBER as well, I presume you have a copy of that one too.

 

 

http://www.nber.org/papers/W11858

Simulating the Dynamic Macroeconomic and Microeconomic Effects of the FairTax

Laurence J. Kotlikoff, Sabine Jokisch NBER Working Paper No. 11858 Issued in December 2005 NBER Program(s):   PE ---- Abstract ----- America's aging coupled with high and growing old age health and pension benefits augers for much higher payroll taxes, with potentially damaging effects on the U.S. economy. This prognosis is supported by our analysis of a detailed dynamic life-cycle general equilibrium model, which closely captures projected changes in U.S. demographics. The FairTax offers a potential alternative to this dismal economic future. The FairTax proposes to replace the federal payroll tax, personal income tax, corporate income tax, and estate tax (not modeled here) with a progressive consumption tax delivered in the form of a federal retail sales tax plus a rebate. According to our simulation model, these policy changes would almost double the U.S. capital stock by the end of the century and raise long-run real wages by 19 percent compared to the base case alternative. They would also preclude a doubling of the highly regressive payroll tax. Indeed, the poorest members of each cohort experience remarkably large welfare gains from the FairTax. To be specific, today's elderly poor are predicted to experience a 13 to 14 percent welfare gain. In contrast, their middle class counterparts enjoy a 1 to 2 percent gain, and their richest counterparts experience a .5 to 1 percent welfare loss. Poor baby boomers experience 8 percent gains, while middle- and upper-income boomers experience either very small welfare losses or small gains. Once one moves to generations postdating the baby boomers there are positive welfare gains for all income groups in each cohorts. For example, the poorest members of the generation born in 1990 enjoy a 16 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 27 percent improvement in their well being. For middle class members of this birth group, there's an 11 percent welfare gain. And for the richest members of the group, the gain is 5 percent. The remarkable point here is the size of the gains from the reform relative to the losses. Yes, some initial high- and middle-income households are made worse off, but their welfare losses are minor compared with the gains available to future generations, particularly the poorest members of future generations. While our model is highly stylized, it suggests that the FairTax offers a real opportunity to improve the U.S. economy's performance and the wellbeing of the vast majority of Americans. The winners from this reform, primarily those who are least well off, experience very major gains, and the losers experience only minor losses.

[Your Nightmare]

Just overviw. But enough to know its content.

So you don't know that Kotlikoff says that the rate would have to be higher than 23% if there is a prebate. This rate has nothing to do with the deficit.