Summary of Recent Research by Laurence J. Kotlikoff on the FairTax Plan
LAURENCE J. KOTLIKOFF, PH.D.
Professor of Economics at Boston University, fellow of the American Academy of Arts and Sciences, and former senior economist, President's Council of Economic Advisers. Kotlikoff has published extensively in the field of public finance and tax reform, including papers on the FairTax, which are targeted to laypeople as well as professional audiences.
WHY DEMOCRATS SHOULD LOVE THE FAIRTAX
The Boston Globe, February 24, 2008
Suppose a presidential candidate proposed taxing wealth and using the proceeds to reduce taxes on workers and provide a rebate large enough to cover taxes paid by poor workers. Such a candidate would be hailed by the left and reviled by the right.
THE CASE FOR THE "FAIRTAX"
The Wall Street Journal, March 7, 2005
The FairTax would reduce the excess burden of our tax system by roughly two-thirds! A very conservative estimate of this annual saving is 2% of GDP or about $250 billion for the coming year. Add in the $250 billion in wasteful tax compliance, and we're talking about significant savings. This article, written for non-economists, was originally published in the Wall Street Journal.
COMPARING AVERAGE AND MARGINAL TAX RATES UNDER THE FAIRTAX AND THE CURRENT SYSTEM OF FEDERAL TAXATION
This paper compares, for a set of 42 household types, the total effective marginal and average tax rates on working, savings, and average remaining lifetime tax rates under the current system and the FairTax.
- The FairTax significantly reduces marginal tax rates on work, on savings, and substantially lowers the overall tax burdens on current and future workers.
- All 42 household types (classified by income, marital status, age) have lower average lifetime tax rates under the FairTax.
- Average remaining lifetime tax rates measure what percentage of remaining lifetime resources the taxpayer will pay to the government.
- The rate calculation takes into account all future federal tax payments net of Social Security benefits and the FairTax prebate.
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 at low earnings is proportionately much greater at the lower end of the earnings distribution than at the high end. In switching to the FairTax, the couple earning $20,000 experiences an 86-percent cut in its average lifetime tax rate, whereas the couple earning $500,000 experiences a 42-percent cut.
(1) $0.23-out-of-every-retail-dollar-spent rate (23 percent, tax inclusive/30 percent, tax exclusive)
To read the complete paper, go here.
THE FAIRTAX AND MIDDLE AMERICANS -- A CASE STUDY
January 20, 2008
Meet Frank and Mary Middle, an illustrative forty-year-old Kansas couple with two children. Frank and Mary both earn $25,000 per year, putting their household's annual income right at the middle value for all American households. They jointly own $50,000 in regular assets, and each has a $50,000 IRA to which they will each contribute $2,000 per year through retirement at age 65. Frank and Mary intend to help their children attend college by paying $10,000 (measured in today's dollars) per year in tuition for each child. Finally, the couple has a $200,000 house with a twenty-year $150,000 mortgage.
How do Frank and Mary fare under the current tax system and the FairTax? The Middle's net taxes are dramatically lower at all ages under the FairTax. And thanks to the lifetime tax cuts, the Middles are able to enjoy increases in their annual living standards ranging from 27.9 percent to 33.5 percent!
TAXING SALES UNDER THE FAIRTAX: WHAT RATE WORKS? TAX NOTES, NOVEMBER 13, 2006
(with Paul Bachman, Jonathan Haughton, Alfonso Sanchez-Penalver and David Tuerck)
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.
This study uses a dynamic life cycle general equilibrium model to simulate the impact of the FairTax on the U.S. economy. The inclusion of demographics, including a realistic initial age structure of the population, realistic mortality rates, and realistic fertility rates means that the model is able to show how the economy fares over time in the absence of tax reform compared to how the economy fare with the FairTax enacted. Switching to the FairTax precipitates a very major increase in the U.S. capital stock and real wages over the course of the century, prevents what would otherwise be a doubling of the highly regressive payroll tax, and effects very major welfare gains, particularly for the poorest current and future members of society. Implementing the FairTax at a 23-percent (1) gives the poorest members of the generation born in 1990 a 13.5 percent welfare gain. Their middle-class and rich contemporaries experience a 5 and 2 percent welfare gain, respectively. This study suggests that the FairTax offers a real opportunity to improve the U.S. economy's performance and the well-being of the vast majority of Americans. The winners from this reform, primarily those who are the least well off, experience very major gains, and the losers (the most well-off) experience only minor losses.
IS THE U.S. BANKRUPT?
Dr. Kotlikoff concludes that countries can go broke, that the U.S. is going broke, that remaining open to foreign investment can help stave off bankruptcy, but that radical reform of U.S. fiscal institutions is essential to secure the nation's economic future. His paper offers three policies to eliminate the nation's enormous fiscal gap and avert bankruptcy: first among these is the FairTax.
Tax reform is essential to solve the impending fiscal problems of the U.S. which will reach a crisis when the baby boom generation retires. There are several candidates for wholesale tax simplification and reform, including a value added tax (VAT), a flat tax, and a federal retail sales tax. The most straightforward reform is the federal retail sales tax (FairTax), which taxes purchases of final consumption goods and services at a single rate. In principle the VAT and flat taxes would also tax only consumption; but in practice, they will likely be implemented with very generous transition rules which would leave us taxing not consumption, but rather wages. Such a "reform" would be highly inequitable, both on intra- and intergenerational grounds. Consequently, Kotlikoff favors the federal retail sales tax as a means to tax all consumption.
Most of Bartlett's article misstates research on the FairTax, criticizes unnamed proponents of the FairTax, lambastes unattributed views of the FairTax, and engages in political punditry. This paper takes a close look at Bartlett's “analysis,” exposing his repeated use of straw men for what it is -- rhetoric disguised as economics.
DOES IT PAY TO WORK AND SAVE?
For more information, contact Karen Walby, Ph.D., Director of Research & Chief Economist, FairTax.org at firstname.lastname@example.org.