2001; however, this study excluded the largest 1,350 corporations and all businesses with less
than $5 million in assets.15 Slemrod later reviewed his previous studies and estimated that
retailers spent a total of $40 billion, at a rate of $20 per hour, complying with the federal income
tax in 2004.16
PricewaterhouseCoopers conducted the first national estimate of retailer compliance with local
and state retail sales tax over the period of August 2004 through March 2005.17 This study found
that in 2003 the average annual state and local retail sales tax compliance costs were $3.09 per
$100 of sales tax revenue collected. As a percentage of taxable sales, costs for smaller
businesses were found to be more than six times greater than those for the large retailers.
Robert J. Cline and Thomas S. Nuebig asked how compliance costs for multi-state retailers are
affected by the different complexities of the sales tax.18 In their analysis, they use the 1998
Washington Department of Revenue study as the base for estimates of the compliance costs for
companies with different sizes and serving different states.19
Hodge, Moody, and Warcholik note that compliance costs vary by type of taxpayer, income
level, and state.20 They estimate that individuals, businesses, and nonprofits spent an estimated 6
billion hours, at a cost of $265.1 billion, in 2005 complying with the federal income tax code – a
figure that they expect to rise dramatically over the next decade.
In 1996, the Tax Foundation estimated the total compliance costs of the current federal tax
system, the flat tax, the USA Tax system (a business cash flow tax), and the national retail sales
tax.21 They found that the current federal system cost $225 billion in 1996, while all three
alternatives would reduce costs dramatically. They estimate that the flat tax would cost $9.2
billion, the USA Tax $36 billion, and the national retail sales tax just $8.2 billion.
Building on the work of these studies and using estimates of our own, we calculate the cost of
administration, collection, and filing for governments, businesses, and individuals for the
FairTax and for the current system. We next proceed to estimate FairTax revenue collections.
III. FairTax Revenue Collections
In this section, we estimate the tax revenue that would have been collected under the FairTax.
To do this, we calculate the FairTax base in 2005 and the spending-neutral tax rate, following the
15 Slemrod and Venkatesh (2002).
16 Slemrod (2004).
17 PricewaterhouseCoopers. “Retail Sales Tax Compliance Costs: A National Estimate,” Volume One: Main Report
9, April 2006. Prepared for Joint Cost of Collection Study. Available at
http://www.pwc.com/Extweb/pwcpublications.nsf/docid/E1F22DB30D07DBA785257164006DDE9E/$file/jccspart-
1-vol-.pdf.
18 Cline and Nuebig (1999).
19 Washington State Department of Revenue. “Retailers’ Cost of Collecting and Remitting Sales Tax,” December
1998. Available at
http://dor.wa.gov/docs/reports/Retailers_Cost_Study/retailstudy.doc.
20 Hodge, Moody, and Warcholik (2005).
21 Hall (1996).
Tax Administration and Collection Costs: The FairTax vs. the Existing Federal Tax System 9
methodology set forth in Bachman, et al.22 We then present the corresponding estimates of the
gross and net FairTax revenue that would have been collected in 2005. The reason for selecting
2005 is that it is the most recent year for which there are data on the operating costs of state
government revenue collection agencies, data on budget appropriations, or other data necessary
for our calculations.
At first glance, the FairTax is a revenue-neutral proposal and may be seen as a proposal to
replace the amount of revenue that the federal government would have under current law dollarfor-
dollar. However, because the imposition of a sales tax is likely to affect prices, simply
replacing the dollar value of the current tax revenue may not allow the federal government to
maintain the real value of the services it currently provides. The tax-inclusive FairTax rate for
2007 is set to be 23 percent in H.R. 25, but many authors have argued that this rate would not
raise enough revenue to keep the federal government’s purchasing power constant. Besides
keeping current spending constant in real terms, the estimated rate must also ensure raising
enough additional revenue to finance the FairTax rebate of taxes on poverty level spending
(prebate) and the administrative credit paid to businesses and governments collecting the tax.
Table 2: FairTax Base and Rate Estimates
A. Revenue $ billions
1. Revenue to be replaced 1,943.14
2. IRS savings (9.74)
3. Net revenue to be replaced [1. + 2.] 1,933.40
B. Base
4. Private consumption 8,274.10
5. Federal government consumption 834.10
6. State and local government consumption 969.74
7. Gross tax base [4. + 5. + 6.] 10,077.93
C. Base adjustments
8. Non-taxed transfers adjustment 249.51
9. Prebate base adjustment (2,011.30)
10. Administrative credit base adjustment (48.02)
11. Adjusted tax base [7. + 8. + 9. + 10.] 8,268.12
12. Tax-inclusive rate [3. ÷ 11.] 23.38%
13. Tax-exclusive rate [3. ÷ (11. - 3.)] 30.52%
Billions of $ except percentage figures. Numbers may not add up because of rounding.
Source: Authors’ estimations using CBO and IRS data for 2005.
Bachman and his coauthors accounted for these facts when estimating the base and rate that
would be needed for 2007.23 However, because we had selected 2005 as our reference year for
22 Bachman, et al. (2006).
23 Ibid.
Tax Administration and Collection Costs: The FairTax vs. the Existing Federal Tax System 10
this study, we needed to calculate the base and the rate that would have been needed in 2005 to
then estimate the revenue that the FairTax would have raised that year. For this, we apply the
methodology used by Bachman, et al. to 2005.24
Table 2 presents our estimates of the FairTax base and the rates for 2005. We start on line 1 with
the net revenue collected by the taxes that would be replaced by the FairTax in 2005, which the
IRS reports to be $1,943.14 billion.25 Since the IRS will neither be responsible for administering
the taxes that are being replaced nor for most of the FairTax administrative operations, this will
reduce the revenue needed to finance the IRS.26 We estimate these “savings” to be $9.74 billion
and reflect them on line 2.27 Therefore, the net revenue to be replaced in 2005, as shown on line
3, is $1,933.40 billion. As mentioned before, there are other items that would adjust the revenue
needed under the FairTax. Such items are: Non-taxed federal government transfers, the prebate,
and the administrative credit to be given to sellers and state and local governments. However,
the spending needed in these categories depends on the rate in place. Since we are calculating
the rate at this point, we have to make the corresponding adjustments to the base, not the revenue
itself, in order to accommodate for these changes in spending.
We now consider the FairTax base. In very basic terms, this base is composed of all private and
government final consumption of goods and services, except for spending on education. In
section B of Table 2, we present the estimation of the FairTax base for 2005.28 Private
consumption is estimated at $8,274.10 billion, federal government consumption at $834.10
billion, and state and local government consumption at $969.74 billion. The gross base
calculated by adding these three numbers is estimated to be $10,077.93 billion, as shown on line
7.
We now present the estimates of the adjustments made to the base to accommodate for changes
in the revenue that are related to the FairTax rate. The first adjustment is to account for the fact
that the change of tax system reduces the nominal amount of federal government transfers
needed. Since there is lower spending in real dollars in this category, this is equivalent to
increasing the base. Consequently, on line 8 we present an estimate of an increase to the base of
$249.51 billion to accommodate for the lower revenue needed for federal transfers. The FairTax
must also raise sufficient revenue to fund the FairTax prebate and the administrative credit. The
prebate is a rebate of taxes (albeit in advance, giving rise to the term “prebate”) to qualified
households that effectively exempts all households’ purchases up to the poverty level. The
administrative credit is the amount that the sellers and the state and local governments will keep
from the revenue they collect. Since these are both increases in the revenue to be collected, we
accommodate for them when calculating the tax rate by decreasing the base. On line 9 we show
24 The explanation of the methodology used to estimate the gross base, the adjusted base, and the rates is beyond the
scope of this study so we refer the reader to the work of Bachman, et al. (2006).
25 IRS Data Book, FY 2005, Publication 55b.
26 Note that these savings only require an adjustment of the revenue, and not an adjustment of the base of the
FairTax. Less spending by the federal government implies lower taxes paid by taxpayers, which implies a higher
disposable income. Marginal propensity to consume is very close to 1 for the United States, which implies that this
drop in federal consumption will be picked up by private consumption. Finally, since the tax base for the FairTax is
all consumption (except education), this means that the base does not need to be adjusted.
27 We explain how we estimated the IRS savings in Section VII.
28 The estimates for this section of the table were obtained using the same CBO estimates as in Bachman, et al.
(2006) but for 2005. We refer the reader to Table 2 on page 667 of that paper for the specific sources.
Tax Administration and Collection Costs: The FairTax vs. the Existing Federal Tax System 11
an estimate of ($2,011.30) billion for the adjustment needed in the base because of the prebate,
and on line 10 we present an estimate of ($48.02) billion for the adjustment needed because of
the administrative credit. By adding lines 7 through 10, we obtain the estimate of the adjusted
FairTax base, which is $8,268.12 billion as presented on line 11.
By dividing the estimate on line 3 by the estimate on line 11, we calculate the estimated taxinclusive
FairTax rate for 2005 of 23.38 percent (line 12), which implies a tax-exclusive FairTax
rate for 2005 to be 30.52 percent (line 13). With the tax-inclusive FairTax rate estimate, we now
calculate the tax revenue that would have been collected by the FairTax in 2005. We should note
at this point that since the federal government will reimburse households with the prebate, we
can consider the amount of revenue collected inclusive of the prebate as the FairTax gross tax
revenue, and the amount of revenue collected minus the prebate as the net FairTax revenue.
Table 3: FairTax Revenue Estimates
A. From FairTax revenue $ billions
1. Gross FairTax revenue 2,356.60
2. Prebate (470.32)
Net FairTax revenue [1. + 2.] 1,886.28
B. From revenue to be replaced
4. Net revenue to be replaced 1,933.40
5. Transfers revenue adjustment (58.34)
6. Administrative credit revenue 11.23
Net FairTax Revenue [4. + 5. + 6.] 1,886.28
Billions of $. Numbers may not add up because of rounding.
Source: Authors’ estimations using CBO and IRS data for 2005.
Table 3 presents our FairTax revenue estimates. We calculate the net FairTax revenue from two
perspectives as a check to see that our estimations balance. First, we calculate the gross FairTax
revenue by multiplying the estimate of the gross tax base on line 7 of Table 2 by the taxinclusive
rate of 23.38 percent, which yields the estimate of $2,356.60 billion presented on line 1
of Table 3. We next calculate the amount of the prebate by multiplying the estimate on line 9 of
Table 2 by the same 23.38 percent rate. This yields the negative estimate of $470.32 billion
presented on line 2 of Table 3. We then add these two estimates to get the net FairTax revenue
of $1,886.28 billion.
The second perspective we use is to adjust the estimate that we show on line 3 of Table 2 with
the revenue estimates of the transfer reduction and the administrative credit. The thinking
behind this perspective is that the revenue the FairTax must be collecting, without counting the
prebate, must equal the net revenue that was being collected before, adjusted by the changes in
spending to keep federal government spending constant. Therefore, in part B of Table 3, on line
4 we present again the value of the net revenue to be replaced: $1,933.40 billion. Since the
federal government’s transfer requirements decrease, we must reduce this revenue by the amount
no longer needed for those transfers. The negative amount of $58.34 billion, presented on line 5,
Tax Administration and Collection Costs: The FairTax vs. the Existing Federal Tax System 12
is calculated by multiplying the estimate on line 8 of Table 2 by 23.38 percent.29 Similarly, since
the administrative credit is an increase in the needed revenue, we multiply the estimate on line 10
of Table 2 by 23.38 percent and obtain an estimate of $11.23 billion.30 Adding lines 4 through 6
of Table 3, we obtain the net FairTax revenue of $1,886.28 billion.
These estimates assume that there is no monetary accommodation and, consequently, that prices
do not increase. If prices were to increase, the base values would be adjusted accordingly, and
the tax-inclusive rate would yield the necessary revenue. The advantage of the assumption of no
monetary accommodation is that we can compare the revenues and costs between the two
taxation systems directly. We observe, therefore, that the net revenue under the FairTax in 2005
is lower than the net revenue replaced, in real terms. The prebate is a tool for redistribution of
income, meaning that it simply causes the FairTax to collect and return additional revenue.
Therefore, at this point, we observe that, overall, taxpayers would have to pay less in taxes to
maintain the current services provided by the federal government under the FairTax than it does
under current law, which implies that the FairTax would increase the taxpayers’ purchasing
power.
IV. FairTax Revenue Collection Process
The process of collecting the FairTax from the consumer and putting the revenue in the hands of
the federal government, as specified by H.R. 25, involves three sectors: Sellers, which include
both retail stores and service providers, state governments, and the federal government itself.
The sellers collect the tax on their sales to individuals, state and local governments, and the
federal government. They then deduct the administrative credit (0.25 percent) from their
collections and forward that money to the state sales tax authority. The state then remits the tax
collections from the retailers plus the tax on their purchases of labor (compensation paid to
government employees) minus the administrative credit to the U.S. Treasury. Finally, the federal
government receives the monies from the states and remits the FairTax on its labor purchases. It
should be noted that, for this paper, federal governmental enterprises are considered to belong to
the sellers’ sector and not the federal government sector. This is because government enterprises
collect the FairTax on the services they sell to the consumer, as do businesses in the private
sector.
In order to compare the administrative costs under both tax systems, we must identify the net
(additional) costs/savings that the FairTax would bring in each of the three layers of FairTax
revenue collection, which would allow for more precise pinpointing of specific issues. This
presents a difficulty, however, since the savings that the FairTax would bring to the private
sector (individuals, businesses, and nonprofit organizations) cannot be easily distributed among
these three layers. The simple solution, which we apply in this study, is to consider the savings
to the private sector separately and bring all the estimates together, later, to calculate the total
costs/savings resulting from the implementation of the FairTax. We start by estimating the net
costs to sellers of collecting the FairTax from their sales and sending the money to the state
governments. We then consider the costs to the state governments of administering the FairTax
29 The negative rate shows that an increase in the base is equivalent to a reduction in the revenue.
30 The negative rate shows that a decrease in the base is equivalent to an increase in the revenue.
Tax Administration and Collection Costs: The FairTax vs. the Existing Federal Tax System 13
as well as collecting the tax revenues from the sellers, the taxes on the labor purchases of local
governments and their own labor purchases, and finally remitting the money to the U.S.
Treasury. We then estimate the net savings that the federal government would enjoy, while
accounting for the costs of collecting the FairTax on its labor purchases as well as processing the
prebate payments. Before bringing it all together to estimate the total costs/savings, we estimate
the savings in the private sector. We point out that when estimating the costs of collecting the
FairTax revenues and remitting them to the appropriate authority, we do so under the assumption
that the FairTax, like the existing federal tax system, would have been in place for a long time,
for the reasons given in the introduction. Thus, we are not considering the start-up costs of
implementing and then running the FairTax.
V.
