How To Measure The Effects of the FAIRtax on ​Different I​ncome Brackets​

Beauty is not the only thing that is in the eyes of the beholder.  FAIRtax critics and supporters of the status quo insist on looking at a consumption tax through income tax glasses, and not rose-colored ones I might add.

Whether a tax system is, indeed, “fair” is a complicated economic and philosophical question that  has many facets and tends to be oversimplified by focusing on the distribution of taxes in relation to income.  If the relative tax burden goes down as income goes up, then the tax is said to be regressive.  If the reverse applies, taxes go up as income increases, then the tax is said to be progressive. 

While looking through their “income tax glasses,” critics of the FAIRtax and the defenders of the status quo love to label the FAIRtax as regressive and think somehow that ends the discussion.  Regressive means “not fair,” and if the FAIRtax is regressive, then the FAIRtax is “not fair.”

Economists have long recognized that a single year snapshot of income is not a reliable measure of a person’s economic resources and that when used to measure the overall tax burden for an individual or family, it provides misleading results.  A single mother in a low-skilled job who barely makes ends meet from paycheck to paycheck and the medical student doing an internship could have the same annual income, but their future lifetime income streams are dramatically different. 

According to Laurence Kotlikoff, noted economist and New York Times-
bestselling author, a consumption tax is neither progressive or regressive.  When properly measured against lifetime resources, it is proportional.  A single uniform tax rate requires everyone to pay the same rate on their spending over their lifetime.  The beauty of the FAIRtax prebate is that it transforms a proportional tax into a progressive tax.  Although everyone pays the same tax rate at the cash register, the prebate totally untaxes the poor.  It accomplishes this by means of a monthly cash payment to each household equal to the taxes owed on spending up to the poverty level. 

To demonstrate the progessvity of the FAIRtax, Dr. Kotlikoff conducted an analysis of several household types that differ with respect to earnings and spending patterns, including single and married households, and young, middle aged and senior adults.  For each household type he calculated the net average remaining lifetime tax rate under the current income tax system and under the FAIRtax.  In both cases, Social Security benefits received were subtracted from taxes paid.  And, in the case of the FAIRtax, the prebate was also subtracted from taxes paid.  The net taxes paid over the lifetime are then divided by the lifetime earnings, to get an average tax rate over the household remaining life.

The true measure of the burden of a tax is the change in people’s economic situations as a result of the tax.  Are they better off?  Not measured by the change in their economic circumstances in just one year, but rather have their after-tax incomes increased over their lifetimes? 

The table below shows his findings.  If you look at the rates for young adults, you will see two columns, one showing the lifetime tax rate under the current system and the other showing the lifetime rate under the FAIRtax.  You will see that for every level of income (from 10,000 to $250,000), the FAIRtax lifetime rate is less than the rate under the current system.  The same pattern holds true for all income and household age groups, whether single or married.

This finding holds true for under the current system for young adults.



But if all groups benefit, can this be fair?  Yes.  The graph below shows the percentage tax reduction in average lifetime tax rates for a married couple with two children for various income groups.  You can see that the higher percentage reductions are greater for the lower income households.  The two-adult, two-child household with annual income of $20,000 would pay on average 2.4% of its remaining lifetime income to the federal government under the FAIRtax compared to 7.1% under the current income/payroll tax system – a 67% decrease.  The same family with an annual income of $50,000 would pay 11.3% of lifetime income in taxes under the FAIRtax compared to 17.6% under the current system – a 36% decrease.  And finally, the same household earning $500,000 would see taxes as a percent of lifetime income decrease from 35.9% under the income/payroll tax system to 21.1% under the FAIRtax – a decrease of 41%.
 


Many economists have argued that assessing the “fairness” of a method of taxation is not simply a matter of how the tax burden is distributed across income groups. 

Lawrence Lindsey, former director of the National Economic Council, recently cautioned the Senate Committee on Finance that “An overemphasis on redistribution at the expense of economic growth and economic dynamism and entrepreneurship is severely misplaced if what one really cares about is the well-being of the typical citizen of the country both today and in the future.  . . . In the long run, policies that
promote economic growth are almost invariably the ones that help the typical individual the most.”

A switch to a consumption tax, like the FAIRtax, promotes savings and investment, increases productivity and wages and creates jobs.  According to Stephen Entin, Tax Foundation economist, moving to a consumption tax base could raise incomes across the board by ten to fifteen percent, about $5,000 to $10,000 for middle income families. 

In the words of Stephen Entin:  The tax system should not be used as an instrument of wealth and income redistribution or social engineering. Equality of opportunity should be a guiding force in our tax system, not equality of outcomes.”  The FAIRtax does, indeed, measure up.

Karen Walby, Ph.D.
Director of Research

1 Why the Fairfax Will Work, Tax Notes, Feb. 4, 2008.
2 Kotlikoff and Rapson, ‘‘Comparing Average and Marginal Tax Rates Under the FAIRtax and the Current System of Federal Taxation,’’NBER Working Paper No. 12533, revised October 2006.
3 Fairness in Taxation, March 3, 2015.
4 Kotlikoff and Rapson, ‘‘Comparing Average and Marginal Tax Rates Under the FAIRtax and the Current System of Federal Taxation,’’NBER Working Paper No. 12533, revised October 2006.
5 Testimony to the Senate Committee on Finance, Hearing on Tax Reform for Individual Taxpayers.