Summary Of Recent Research On The FairTax Plan By The BEACON HILL INSTITUTE

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BEACON HILL INSTITUTE
BHI is the research arm of the Department of Economics at Suffolk University in Boston.  It specializes in the development of state-of-the-art economic and statistical models for the analysis of federal, state, and local economic policies and how they affect citizens and businesses.  Dr. David G. Tuerck, director of the research team, serves as the Director of Beacon Hill Institute and as professor and chairman of the Suffolk University Department of Economics.  Formerly, he directed the Economic Analysis Group at Coopers & Lybrand, Washington, D.C. and the Center for Research and Advertising at the American Enterprise Institute. 

MEMO TO BRUCE BARTLETT: JUST DO THE MATH
Tuerck identifies six mistakes made by Bartlett in attempting to identify the distributional consequences of the FairTax. These mistakes, according to Tuerck, arise over Bartlett’s understanding of the price effects of the FairTax, his interpretation of the purpose of the FairTax rebate, and his assessment of the burden of the FairTax on government.

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TAXING SALES UNDER THE FAIRTAX:  WHAT RATE WORKS?  TAX NOTES, NOVEMBER 13, 2006
(with Laurence Kotlikoff, Ph.D.)
This study is a detailed specification of the FairTax base and revenue neutral rate calculation formula.  The revenue-neutral rate is the tax rate needed to maintain the real levels of federal and state spending under the FairTax.  It also shows that the FairTax imposes no additional real fiscal burdens on state and local government, notwithstanding the requirement that such governments pay the FairTax on their purchase of goods and services.

The FairTax base for 2007 is estimated to be $11.244 trillion amounting to 81 percent of GDP.  The FairTax rate of 23-percent levied 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 (all income and payroll taxes, self-employment taxes, alternative minimum tax, estate and gift tax, and capital gains tax).  FairTax revenues of $2.586 trillion, plus other federal revenues not repealed by the FairTax legislation, are estimated to yield $3.209 trillion an amount only $76 billion less than 2007 projected spending of $3.285 trillion. The $76 billion figure is remarkably small when set against the more than 30-percent increase in the real value of discretionary spending since 2000.  At a 23-percent FairTax rate, non-Social Security spending in 2007 is $2.102 trillion compared to $2.113 trillion in 2006, a difference of only $12 billion or less than one percent.

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A COMPARISON OF THE FAIRTAX BASE AND RATE WITH OTHER NATIONAL TAX REFORM PROPOSALS
The FairTax has the broadest tax base and produces the lowest rate to replace the current tax system.

Comparison of bases and rates

The revenue-neutral, tax-inclusive rates are FairTax (23.82%), current law (26.51%), the flat tax (26.76%), and the business transfer tax (24.49%).  For comparative purposes, these rates assume that each of these tax reform plans replaces all federal income & payroll taxes ($2.228 trillion) and provides an equivalent standard deduction/prebate.

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TAX ADMINISTRATION AND COLLECTION COSTS: THE FAIRTAX VS. THE EXISTING FEDERAL TAX SYSTEM

For this study, BHI estimates the net administration, collection, and filing costs of the FairTax by considering each of the revenue collection layers individually retailers and service providers (sellers), state governments, and the federal government.  BHI also accounts for the savings the private sector would enjoy because of no longer having to file the income, estate, gift, and payroll taxes that are replaced by the FairTax.  We do our analysis for 2005, the most recent year for which there are data on states’ collection agencies’ operating costs or budget appropriations.

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THE ECONOMIC EFFECTS OF THE FAIRTAX:  RESULTS FROM THE BEACON HILL INSTITUTE CGE MODEL

A major objective of the FairTax is to promote economic growth resulting in job creation, higher productivity,  and higher wages for working Americans.  The Beacon Hill Institute used their established Computable General Equilibrium (CGE) model to estimate the effects of the FairTax on income, employment, wages, etc. compared to what these indicators would be if the current tax system remains in place.

This study employs a dynamic computable general equilibrium (CGE) model to estimate the impact of the FairTax plan on the economy.  Although complex, CGE models make it possible to analyze large changes in existing taxes or the introduction of new taxes for their effects on a wide array of economic indicators.

  • GDP is estimated to be 7.9 percent higher in the first year, 10.9% higher in year 10 and 10.3% higher in year 25 after enactment of the FairTax than what would otherwise be the case if the current system remained in place.
  • Domestic investment is 74.5% higher, 75.9% higher, and 65.2% higher in years 1, 10, and 25, respectively.
  • The capital stock is 9.3% higher in year 5, 14.1% higher in year 10, and 17.3% higher in year 25.
  • Real wages are 10.3%, 9.5%, and 9.2% higher in years 1, 10, and 25, respectively than would otherwise be the case.
  • Consumption drops slightly in the first two years (0.6% and 0.8%), and then be 1.8% higher in year 5, 4.3% higher in year 10, and 6.0% higher in year 25.

The findings for 2007 through 2031 are summarized in Table 1 below.  The table shows the percentage difference in each indicator resulting from implementation of the FairTax for selected years 2007 to 2031.   For example, real GDP would be 7.9 percent higher in 2007 under the FairTax than under the “benchmark” current law and 10.3 percent higher by 2031.

summary of effects of FairTax and current law

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FISCAL FEDERALISM:  THE NATIONAL FAIRTAX AND THE STATES

This study calculates two revenue-neutral state-levied FairTax rates for all 50 states based on the national FairTax proposal.  The first rate calculation assumes an effective date of January 2007 and that states would provide a monthly prebate equal to the state FairTax rate times poverty level spending.  States could lower their existing sales tax rates by at least 1.5 percentage points.  On average states could cut their sales tax rates by more than half or 3.2 percentage points from 5.4 to 2.2 percent if they conformed their state sales tax bases to the FairTax base.  The study also uses the BHI CGE model to estimate the impact of the FairTax on five state economies:  Massachusetts, New Jersey, Illinois, Virginia, and Texas.  It finds that employment, investment, wages and income all experience significant increases under a dual federal and state-level FairTax system.  In two years, these five states would, on average, see employment soar by 14%, investment by 92%, wages increase by 7%, and income jump by 11%.  The economic benefits of the FairTax result from removing the tax wedge currently placed on labor, capital and savings.

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A DISTRIBUTIONAL ANALYSIS OF ADOPTING THE FAIRTAX:  A COMPARISON OF THE CURRENT TAX SYSTEM AND THE FAIRTAX PLAN 

The study analyzes the tax burden in relation to permanent income combining IRS data, consumer expenditure data, and data from the survey of consumer finances.  Compares the distribution of the FairTax, flat tax and business transfer tax.
Expenditure is a better measure of economic well-being, since current expenditure is more closely related to lifetime income than is current income.  Current expenditure is also a better measure of wealth, since people may live off current saving while undergoing a temporary drop in income.  Current expenditure is more closely related to lifetime income than current income and is therefore a better measure of well-being.  Current expenditure is also a better measure of wealth, since people may live off current saving while undergoing a temporary drop in income.  The FairTax benefits those in the lower expenditure categories and it hurts those in the upper categories, making it more progressive than current law.  The result is especially impressive when “dynamic effects” are taken into account, since only households in the highest 10 percent of spending are worse off after the twenty-fifth year of the implementation of the FairTax, whereas all other groups are better off.

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THE FAIRTAX AND CHARITABLE GIVING 

This study addresses how the FairTax affects incomes and the price of giving and how changes in both affect the total amount of giving.  People give more the greater their real before-tax income and the lower the price of giving.
The model predicts that itemizers increase their giving by $9.40 billion from $145.30 to $154.70 billion (by 6%).  Non-itemizers, on the other hand, would increase their giving by $5.62 billion, from $86.80 to $92.42 billion (6.5%).  Overall, when looking at the effect that the increase in income from enactment of the FairTax has by itself on giving, it increases total giving by 6.47 percent from $232.10 to $247.12 billion.
When the price effect is combined with the income effect, the FairTax increases charitable donations by 0.9 percent immediately, by 2.4 percent within ten years, and by 5 percent within 20 years, compared to the baseline situation where the current system remains in place.

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For more information, contact Karen Walby, Ph.D., Director of Research & Chief Economist, FairTax.org at karen.walby@fairtax.org.