Wednesday, March 5, 2014

Why everyone should like the Fair Tax.

It's no secret that our current Federal tax system is detrimental to economic growth. The system punishes savings and investment as well as income earned from work. But what are the true costs of our current tax system? A 2005 study by the Government Accountability Office reported that the compliance and efficiency costs associated with the federal tax system are large. When analyzing the compliance costs of the tax system, the study noted: 
"combining the lowest available estimates for the personal and corporate income tax yields a total of $107 billion (roughly 1 percent of GDP) per year" [1]
According to the Cato Institute, these costs may be as large as $200 billion per year. [2] And according to a study by economist Art Laffer (famous for the Laffer curve) et al. "U.S. taxpayers pay $431.1 billion annually, or 30 percent of total income taxes collected, just to comply with and administer the U.S. income tax system" [14]
 Additionally, the GAO study reports that the efficiency costs of the federal tax system are even larger:
"The two most comprehensive studies we found suggest that these costs are large—on the order of magnitude of 2 to 5 percent of GDP each year (as of the mid-1990s)." [1]
Keep in mind the GAO notes: "the actual efficiency costs of the current tax system may not fall within this range because of uncertainty surrounding taxpayers’ behavioral responses, changes in the tax code and the economy since the mid-1990s, and the fact that the two studies did not cover the full scope of efficiency costs" [2]
The waste and inefficiency of the current federal tax system is so obvious, that many individuals and organization have proposed alternative, more efficient, tax systems. Enter the Fair Tax, a 23% national sales tax on all new goods and services.The Fair Tax would repeal and replace the income tax, corporate tax, payroll taxes, capital gains tax, estate tax, etc while generating the same amount of revenue as under the current tax system. 

The current tax code punishes work, saving, and investment. Under the Fair tax, work, saving, and investment would be encouraged while consumption would be discouraged. Productive work and investment in new capital is the driving force behind economic growth and under the Fair Tax plan, it should be expected that these things will increase relative to the current tax system. Luckily, econometric studies have attempted to predict how the economy would change in response to the implementation of the Fair Tax. Most, if not all studies, find that the economy will perform better under a Fair Tax than under the current tax system. For example, Arduin, Laffer, and Moore Econometrics finds that growth in real GDP, employment, domestic investment, disposable income, and even consumption will increase fairly dramatically over the current system. [3]

One might be surprised that consumption would rise in response to a tax on consumption. However, real incomes are expected to rise under the Fair Tax plan and people tend to spend more when they perceive themselves to be richer. According to the study, "We estimate that following the implementation of the FairTax, consumption will grow in excess of the baseline growth path by 2.4 percent in the first year alone. The increase in consumption arises even though total savings (and investment) in the U.S. economy increases due to the growth in wealth and international capital flows"[3]
Similarly, an econometric study of the effects of the Fair Tax on the economy by the Beacon Hill Institute show that real GDP, investment, employment, and consumption will grow faster under the Fair Tax than the current system. In fact their study concludes with the following statement:

"There are few, if any, policy opportunities in the U.S. that offer such large gains to so many people. Moreover, households in all income groups would, on average, experience increased welfare under the FairTax" [4] 

Despite the economic efficiency of the Fair Tax, many people are against it because they think that it is regressive and will lead to the poor paying a larger share of their income in taxes than the wealthy. However, this is not the case. According to the Fair Tax website:

"While permitting no exemptions, the FairTax provides a monthly universal prebate to ensure that each family unit can consume tax free at or beyond the poverty level, with the overall effect of making the FairTax progressive in application...While everyone pays the same tax rate at the cash register, the prebate results in effective tax rates (annual taxes paid divided by annual spending) that increase as the level of spending increases a progressive tax rate structure. For example, a person spending at the poverty level has a 0% effective tax rate, whereas someone spending at twice the poverty level has an effective tax rate of 11.5%, and so on." [5] 

Other things likable aspects of the Fair Tax:

-The Fair Tax would likely encourage legal immigration as opposed to illegal immigration since only US citizens would be eligible for the prebate meant to reduce the tax burden on low income individuals and families. Illegal immigrants would effectively be paying the full 23% Fair Tax on news goods and services. 

-Former Senator Mike Gravel states the significant reduction of paperwork for IRS compliance and tax forms is estimated to save about 300,000 trees each year. [6] 

-Proponents believe environmental benefits would result from the FairTax through environmental economics and the re-use and re-sale of used goods (used goods aren't taxed). 

Econometric Studies and the Fair Tax:

-The Beacon Hill Institute estimated that within five years real GDP would increase 10.7% over the current system, domestic investment by 86.3%, capital stock by 9.3%, employment by 9.9%, real wages by 10.2%, and consumption by 1.8%. [7]

- Economists Laurence Kotlikoff and Sabine Jokisch reported the incentive to work and save would increase; by 2030, the economy's capital stock would increase by 43.7% over the current system, output by 9.4%, and real wages by 11.5% [8]

- Economist John Golob estimates a consumption tax, like the FairTax, would bring long-term interest rates down by 25–35% (as more money is saved, the cost of money (interest rate) declines, promoting investment which is actually supported by savings). [9]

-An analysis in 2008 by the Baker Institute For Public Policy indicated that the plan would generate significant overall macroeconomic improvement in both the short and long-term [10]

-The Beacon Hill Institute concluded that the FairTax would save $346.51 billion in administrative costs and would be a much more efficient taxation system [11]

-Princeton University Econometrics surveyed 500 European and Asian companies regarding the effect on their business decisions if the United States enacted the FairTax. 400 of those companies stated they would build their next plant in the United States, and 100 companies said they would move their corporate headquarters to the United States [12]

-A study by Kotlikoff and Sabine Jokisch concluded that the long term effects of the FairTax would reward low-income households with 26.3% more purchasing power, middle-income households with 12.4% more purchasing power, and high-income households with 5% more purchasing power [13]

Overall, the Fair Tax is a great idea worth pursuing. 




1 comment:

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