The FairTax is revenue neutral at $0.23 out of every retail dollar spent.The FairTax is imposed on a base indisputably twice as large as the base of taxable income
today. The truth is that the FairTax rate is the lowest rate possible for any tax plan that does not
tax returns on capital more than once or tax the necessities of life, and is far less than the
marginal rates on labor or capital required by the current system.
The FairTax rate of $0.23 out of every retail dollar spent on new goods or services works.
The Beacon Hill Institute at Suffolk University and Laurence Kotlikoff, Professor of Economics
and noted public finance expert at Boston University, recently teamed up to provide a sound
methodology for estimating the FairTax base and computing the FairTax rate.1 Their report:
• Demonstrates that the 23 percent rate (as compared to current rate terminology for the
taxes the FairTax replaces) specified by the Fair Tax Act (HR 25) is eminently feasible.
• Suggests what led Gale2 and the President’s Advisory Panel on Federal Tax Reform3 to
reach the opposite – and incorrect – conclusion.
Beacon Hill Institute and Dr. Kotlikoff estimate the FairTax base for 2007 to be $11.244
trillion. Implementing the FairTax rate of 23 percent on this base would generate federal tax
revenues equal to $2.586 trillion – $358 billion more than the $2.228 trillion in tax revenues
generated by the taxes it repeals. According to the Congressional Budget Office, 2007 spending
(assuming current levels) is projected to be $3.285 trillion. Revenues from the FairTax at a 23
percent tax rate ($2.586 trillion) plus other federal revenues not repealed by the FairTax are
estimated to yield $3.209 trillion – an amount $76 billion less than the CBO projection. The $76
billion figure is remarkably small when set against the more than 30 percent increase in the real
value of discretionary spending since 2004.4 At 23 percent, non-Social Security spending in
2007 would be $2.102 trillion compared to $2.113 trillion in 2006, a difference of only $12
billion or less than one percent.
The report goes on to prove that implementation of the FairTax, including the
requirement that state and local governments pay the tax on their purchases, entails no reduction
in state and local real spending, provided that these governments adjust their tax structure to
maintain the same state/local tax burden on taxpayers under the current system.
The FairTax lowers the lifetime tax burden for most Americans.
In other research, Dr. Kotlikoff finds that the FairTax lowers marginal tax rates on work and
saving, cuts remaining average lifetime tax rates,5 and enhances overall progressivity. This
occurs because the reduction in these rates is proportionately much greater at the low end of the
earnings distribution than at the high end. Consider a middle-aged couple with two children
earning $20,000 per year compared to that same couple earning $500,000 per year. In switching
to the FairTax, the low-income couple’s FairTax rate is only 1.5 percent versus 11.0 percent
under the current system. The high-income couple’s FairTax rate is 20.5 percent versus 35.6
percent under the current system. The low-income couple gets an 86 percent cut in their average
remaining lifetime tax rate, whereas the high-income couple gets a 42 percent cut.
Kotlikoff’s analysis compares the total effective marginal6 and remaining lifetime
average7 tax rates under the current system with those under the FairTax for 42 typical
income/age/marital status categories: Two marital status groups (single individuals or married
couples), three age groups (ages 30, 45, and 60) whose spouses are the same age, and seven
income groups. Both the single-headed households and the married households have two
children to whom they gave birth at ages 27 and 29. Their earnings between now and retirement
are assumed to remain fixed in real terms and each household is assumed to have a home, a
mortgage, and non-mortgage housing expenses.
Average remaining lifetime tax rates measure what percentage of remaining lifetime
resources the taxpayer pays to the government, netting all future federal tax payments against
Social Security benefits received and the FairTax prebate. These rates provide a more realistic
estimate of the true effective tax burden than comparisons of taxes versus income for a single
year (as done by the tax panel). These findings indicate that the FairTax entails either a
significant or a substantial reduction in the remaining lifetime tax rates of all of our stylized
households. For example, the stylized single age 45 household with $35,000 in annual income
pays, on average, 20.7 percent of its remaining lifetime resources to the government under our
current tax system, but only 5.4 percent under the FairTax. The same aged married couple (see
table below) in which both spouses earn $35,000 faces a 21.3 percent current average tax rate,
but only an 11.6 percent average tax rate under the FairTax.
The FairTax benefits retirees who depend mostly on Social Security.For older, low-income households, the FairTax generates a major reduction in remaining lifetime
taxes. Again, the reason is that the elderly not only continue, under the FairTax, to receive the
same real Social Security benefits, they also receive the FairTax prebate. The average Social
Security benefits for a retired couple living solely on Social Security are $18,776. The FairTax
prebate for this couple is $4,697 which is $381 more than the FairTaxes the couple would have
to pay if they spent the entire $18,776 on taxable consumption.
Let’s look at a single 60-year-old earning $15,000 a year. His or her average remaining
lifetime tax rate falls from 9.8 percent to -28.0 percent! Middle-income and upper-income
seniors also experience lower average lifetime tax rates under the FairTax compared to the
current tax system. High-income seniors experience average remaining lifetime tax rates under
the FairTax of 18.2 percent for singles and 19.3 percent for couples. However, these rates are
significantly lower than what they would experience under the current system: 40.8 percent for
singles and 41.5 percent for couples.
In general, the FairTax offers several other benefits to seniors. The FairTax repeals the
taxation of Social Security benefits and adjusts Social Security indexing to preserve the
purchasing power of seniors. The FairTax ends all record keeping and income tax filings of any
kind for seniors, totally insulating them from the high costs and abusive tactics of tax preparers.
The FairTax repeals the income tax imposed on investment income and pension benefits or IRA
withdrawals. No form of savings or investment is taxed. The beneficiaries and owners of
pension funds, IRAs, and 401(k) plans (with assets of over $11 trillion in 2003) will not have to
pay taxes on these plans upon withdrawal, despite taking an income tax deduction for the
contributions to most of these plans. (For a complete discussion of these benefits, please see
“The FairTax Benefits Seniors,” available at
http://www.fairtax.org/PDF/The_FairTax_benefits_seniors_11-7-06.pdf).
The FairTax preserves the overall progressivity of the federal tax burden.The FairTax not only lowers remaining average lifetime net tax rates, it also maintains and,
indeed, enhances overall progressivity in the tax system. Consider middle-aged married
households. The FairTax average lifetime tax rate is very low – only 1.5 percent – for the couple
with $20,000 in annual earnings, and much higher – 20.5 percent – for the couple with $500,000
in annual earnings. The reduction in the tax rate is proportionately much greater at the lower end
of the earnings distribution than at the high end. In switching to the FairTax, the $20,000-
earning couple experiences an 86 percent cut in their average tax rate, whereas the $500,000-
earning couple experiences a 42 percent cut.
The FairTax: A very progressive long-run outcomeTo get another meaningful picture of how persons in various income groups fare under the
FairTax in the aggregate, Dr. Kotlikoff models the dynamic macroeconomic and microeconomic
effects of replacing the income tax system with the FairTax.9
His model considers three income classes within each generation. It compares what the
economy is like under the FairTax versus what it would be like if the current system were to
remain in place. This approach gives a realistic view of the impact of America’s aging
population, coupled with high and growing health and pension benefits that necessitate much
higher payroll taxes, with potentially damaging effects on the U.S. economy. The FairTax offers
a solution to this dismal economic future.
The shift to the FairTax raises marginal labor productivity and real wages over the course
of the century by 18.9 percent and long-run output by 10.6 percent. Moreover, the FairTax
reduces by half the long-run increase in the effective rate of wage taxation needed to pay the
Social Security and health care benefits of an aging population. These macroeconomic gains
have important microeconomic welfare implications. In the long run:
• Low-income households experience a 26.7 percent welfare gain under the FairTax
• Middle-income households experience a 10.9 percent welfare gain
• High-income households experience a 4.7 percent welfare gain
This is a very progressive long-run outcome.
Progressivity also marks the entire transition. Low-income households, which are
initially alive at the time of the reform, whether they are young, middle age, or old, all
experience welfare gains ranging from 8.3 to over 20 percent. Who pays for these gains? The
answer is hardly anyone. The initial rich elderly and rich middle aged, as well as some middle
age/middle-income households are somewhat affected, but their welfare losses are quite small
compared to the welfare gains experienced by the current poor and future generations.
In switching from taxing income to taxing consumption and adding high progressivity via
a rebate, the FairTax introduces many progressive elements into our fiscal system, removes one
very regressive element (the payroll tax), and provides much better incentives to work and save.
Switching to the FairTax raises long-run capital intensity, thus raising long-run real wages by 19
percent compared to the base-case alternative. The reform also generates major welfare gains for
the poorest members of society, including those now retired and those yet to be born.
In short, according to Dr. Kotlkoff’s analysis, the FairTax offers a real opportunity to
improve the U.S. economy’s performance and the well-being of the vast majority of Americans,
regardless of income and when they were born.
The FairTax dramatically improves the U.S. economy.New economic research shows that the economy fares much better under the FairTax. The
economy as measured by GDP is 2.4 percent higher in the first year and 11.3 percent higher by
the tenth year than it would otherwise be. Consumption increases by 2.4 percent more in the
first year than it would be if the current system were to remain in place. The increase in
consumption is fueled by the 1.7 percent increase in disposable (after tax) personal income that
accompanies the rise in incomes from capital and labor once the FairTax is enacted. By the tenth
year consumption increases by 11.7 percent over what it would be if the current tax system
remained in place, and disposable income will be up by 11.8 percent.
Following the implementation of the FairTax plan, the higher take-home wage provides
an immediate incentive for people to work more. During the first year, this will lead to total
employment growth of 3.5 percent in excess of the baseline scenario, which continues to grow
through year ten such that total employment is 9.0 percent above what it would have been under
the baseline scenario.
The impact on total labor income is even more pronounced, increasing due to both an
increase in after-tax wages and an increase in the number of people working. Total labor income
will rise 27.4 percent in the first year. By year ten, labor income will be over 41 percent higher
than what it would have been under the baseline scenario
The FairTax improves the international competitiveness of American producers.Today, we have a tax system that remarkably subsidizes foreign-content vehicles, assisting
Korea, Japan, Germany, and others in competing against the American worker. How do we do
so? The U.S. government’s failure to remove the tax on exports (as do the other 29 OECD
nations) creates a large and artificial relative price advantage (estimated to be over 18 percent)
for foreign goods, in both the U.S. market and abroad.11 A recent MIT report states that the U.S.
failure to recognize and confront this problem costs us more than $100 billion in exports
annually.12 In effect, the U.S. tax system is distorting the international marketplace and is
literally moving good jobs out of this country at a devastating and unsustainable pace. The
FairTax remedies this by taxing foreign-produced goods as U.S.-produced goods are taxed and
by exempting exports fully from taxation, thereby restoring a level playing field for U.S. and
foreign-produced goods.