“So, what will voters in my Congressional District pay under the FAIRtax?” is a question you can expect to hear from your Congress Member. The question is reasonable when you think about it. 

The problem is that your Congress Member is effectively asking you to compare the FAIRtax to today's income taxes. It's asking you to fit a round peg into a square hole. The task is difficult, but we have a credible way to complete it. Our methodology comes from a paper by our economist, Karen Walby, Ph.D., “Good for Taxpayers, Good for Businesses, Good for the Economy.” 

Comparing the FAIRtax to today's income tax requires making assumptions. The first step is to choose a cross-section of communities in your Congressional District representing the high, middle, and low ends of income and wealth. You may know which municipalities these are, but if you need help, there are resources on the web.

When I made a presentation to my Congress Member, I examined three municipalities in the Seventh Congressional District of New Jersey, which is one of the wealthiest Congressional Districts in the United States. The cross-section I picked was Summit (a suburban upper-middle-class community), Linden (an urban working-class city), and Mount Olive (somewhere in between).

But when you have the municipalities in your district picked out, you still need to determine the median household income in those municipalities. Google will usually provide you with quick answers. The median, where half the households have higher income and half the households have less, is a better measure than the average because one or two houses in your community can skew the average. For the Seventh Congressional District of New Jersey, I got the following results:
 

Summit, $151,505.

Mount Olive, $101,699.

Linden, $80,200.

The next step is to determine the median household size. You will need this information to calculate both the standard deduction of the Income Tax and the Prebate of the FAIRtax. Google can usually provide a quick answer. For my three communities in Congressional District Seven, the results are:
 

Summit, 2.8, rounded to 3.

Linden, 2.85, rounded to 3.

Mount Olive, 2.63, rounded to 3.
 

With this information, the next step is making a series of assumptions to compare today's Federal Income Tax to the FAIRtax reasonably. Here are the assumptions that I chose:
 

1.  The household demographic is a family of three in each community with two adults and one child. The adults are working-age. All the households file their federal returns as married taxpayers filing jointly.

2.  All of the spending in the lower income households is subject to the FAIRtax. This assumption is conservative since these households undoubtedly use money in a way that’s not subject to the FAIRtax.  These households save and invest, repay loans, purchase used goods, make charitable donations, pay taxes and possibly make tuition payments.  But for the purpose of this comparison, let’s brush these considerations aside and assume these households spend every penny of their income on services and new tangible goods taxable under the FAIRtax. 

3.  The households in the lower-earning municipalities take the standard deduction of $27,700 on their federal income tax returns. These expenditures are all taxable outlays under the FAIRtax and form part of the FAIRtax base. This assumption skews the analysis against the FAIRtax.

4.  Each household’s income, including those in the highest-earning community, consists entirely of wages subject to the Social Security ceiling of $160,200 with no ceiling on Medicare. Thus, the FICA tax covers all their income.

Although business owners might not pay themselves FICA wages, they could pay double that amount in self-employment tax plus FUTA if they work for the business. Or, if they pay themselves as employees, they would pay both employer FICA and FUTA in addition to employee FICA. We disregard employer FICA and FUTA taxes even if they would favor the FAIRtax analysis.

We note that wage-earning households also bear the effects of the employer FICA and FUTA because employers are prepared to incur these costs for the employee but must pay them to the federal government instead. Together, these taxes are 15.3%. However, we conservatively consider only the employee portion, 7.65%, in determining the effective federal income tax rate for the household and the benefit of the FAIRtax.

Households can control their FAIRtax burden through discretionary spending above the poverty level. The Family Consumption Allowance, or Prebate, removes taxes up to the poverty level. We disregard the enhanced control that consumers have under the FAIRtax.

5.  Thus, the FAIRtax calculation for the households in the lower-earning municipalities begins with the Median Household Income minus the Family Consumption Allowance of $34,300. We multiply the difference by 23% to determine the FAIRtax.

6.  The household in the high-earning community itemizes its federal income tax return. We assume the following itemizations:

 

a.  The household in the high-earning community pays $2,500 monthly in mortgage interest, or $30,000 a year, deductible under the federal income tax. (The median home sale price in Summit, New Jersey, according to Redfin.com, is $945,000). Mortgage interest is a non-taxable expenditure under the FAIRtax (except for Financial Intermediation Costs, which we do not consider) and reduces the FAIRtax base.

b.  The average property tax in Summit, New Jersey, is $18,254. However, federal income tax law caps the SALT (state and local tax) deduction at $10,000. This cap is a political issue for New Jersey Congress Members. Property tax is a non-taxable expenditure under the FAIRtax, reducing the FAIRtax base.

c.  The household makes $5,000 annually in charitable donations. These expenses are deductible above the line if the household itemizes on its federal income tax return. But charitable donations are also non-taxable under the FAIRtax and reduce the FAIRtax base.

d.  We assume no provision for medical expenses. The households are employed and have health insurance through their employers.

7.  Thus, the FAIRtax calculation for the household in the high-income community begins with an adjusted FAIRtax tax base minus the Family Consumption Allowance of $34,300 multiplied by 23%.

8.  The income tax calculations come from the TurboTax tax estimator. The TurboTax estimator is available online with no need to buy a subscription.
 

  So, we return to your Congress Member’s question, how would these households manage under the FAIRtax? The good news is that, in all three communities, the households would pay less tax under the FAIRtax. In Linden, New Jersey, the low-income community, the household would pay $12,243 in income and payroll tax. That household would pay $10,557 under the FAIRtax.

In the middle-income community of Mount Olive, New Jersey, the household would pay $16,462 in income and payroll tax. That household would pay $15,502 under the FAIRtax. In Summit, New Jersey, the high-income community, the household would pay $26,255 in income and payroll tax if it itemized. That household would pay $30,457 if it took the standard deduction. That household would pay $15,172 under the FAIRtax.

You need to make several more points to your Congress Member. First, for a family of four at the poverty level of $40,000, Steve Hayes’ recent Chairman’s Report highlighted that the family would pay $3,060 in payroll taxes. That family would pay less than $200 under the FAIRtax.

Second, the FAIRtax provides for adjustment of Social Security benefits for seniors to offset any cost-of-living increases the FAIRtax may cause. Thus, the FAIRtax protects seniors who depend primarily on Social Security payments.

  Third, if the cost of living increases under the FAIRtax, the Family Consumption Allowance, or Prebate, increases, too.

Finally, the elasticity of demand will force the competition to cause pre-tax prices under the FAIRtax to drop. One can argue how far pre-tax prices will fall, but it is clear that, except perhaps for snob items, the one-time price increase will not be 30%. Voters in your Congressional District will be better off.

If your Congress Member asks you how the FAIRtax will affect their voters, I would love to hear how they respond.
 

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