A Comparison of the FairTax Base and Rate with Other National Tax Reform Proposals David G. Tuerck, Ph.D. Jonathan Haughton, Ph.D. Paul Bachman, MSIE Alfonso Sanchez-Penalver, MSF February 2007 The Beacon Hill Institute at Suffolk University 8 Ashburton Place, Boston, MA 02108 Web: www.beaconhill.org; phone: 617-573-8750; fax: 617-994-4279; e-mail: [email protected]. December 2006 Table of Contents Executive Summary .........................................................................................................................1 I. Introduction................................................................................................................................. 4 II. The FairTax ............................................................................................................................... 9 A. Introduction............................................................................................................................ 9 B. The FairTax Base ................................................................................................................. 10 1. Personal Consumption Expenditures ................................................................................ 11 2. Government Consumption Spending ................................................................................ 13 3. Estimating the FairTax Base ............................................................................................. 15 C. The FairTax Rate ................................................................................................................. 16 1. Replacing Tax Revenue .................................................................................................... 16 2. The Prebate ....................................................................................................................... 16 D. Tax-inclusive versus Tax-exclusive Rates........................................................................... 18 E. Determining the FairTax Rate.............................................................................................. 18 F. Federal Spending with a 23 Percent Rate............................................................................. 28 G. Vertical Equity and Horizontal Equity................................................................................. 35 H. Distributional Effects........................................................................................................... 36 III. The Current Federal Tax System............................................................................................ 38 A. Introduction.......................................................................................................................... 38 B. The Current Tax Base .......................................................................................................... 39 C. The Current Tax Rates ......................................................................................................... 41 D. Distributional Effects........................................................................................................... 41 IV. The Hall-Rabushka Flat Tax ................................................................................................. 43 A. Introduction ......................................................................................................................... 43 B. The Flat Tax Base ................................................................................................................ 43 C. The Flat Tax Rates ............................................................................................................... 45 D. Distributional Effects........................................................................................................... 46 V. The Business Transfer Tax .................................................................................................... 48 A. Introduction ......................................................................................................................... 48 B. The BTT Base ..................................................................................................................... 49 C. The BTT Rates .................................................................................................................... 50 D. Distributional Effects........................................................................................................... 50 VI. Comparing the Tax Bases ...................................................................................................... 52 A. Comparing the Rates and Bases of the Four Tax Systems ................................................ 52 B. Comparing the Theoretical Base of FairTax, Flat Tax, and BTT ....................................... 55 VII. Conclusion ............................................................................................................................ 57 Appendix A: The Mathematics of State and Local Finance under the FairTax ........................... 59 Appendix B: Methodology........................................................................................................... 61 References .....................................................................................................................................66 Table of Tables Table 1. A Comparison of the 2007 Tax Rates and Bases............................................................................................2 Table 2. GDP and Consumption, United States, 2001-2005 ($ billions)....................................................................11 Table 3. Computation of FairTax Base, 2007 ($ billions) ..........................................................................................14 Table 4. Revenue from Income, Payroll, and Estate/Gift Taxes, 2003-2007 ($ billions) ..........................................16 Table 5. Computing the FairTax Base Reduction Due to the Prebate for 2007..........................................................18 Table 6. Computation of the 2007 FairTax Rate ($ billions)......................................................................................27 Table 7. Federal Revenue and Expenditure Under the FairTax with a 23 Percent Rate ($ billions) ..........................30 Table 8. Non-Social Security Spending, 2003-2007 ($ billions)................................................................................31 Table 9. Average Tax-Inclusive Rates by Income Groups for the FairTax (Replacing Current Income, Payroll, and Estate and Gift Taxes) ..........................................................................................................................................37 Table 10. Average Tax-Inclusive Rates by Expenditure Groups for the FairTax (Replacing Current Income, Payroll, and Estate and Gift Taxes) ...................................................................................................................................37 Table 11. Major Sources of Revenue as a Percent of Total Revenues .......................................................................38 Table 12. Computation of the Tax Base for the Current Federal System ($ billions) ................................................40 Table 13. Computation of 2007 Tax Rates for the Current Tax System ($ billions)..................................................41 Table 14. Average Tax-Inclusive Rates by Income Groups for the Current Tax System (Including Income, Payroll, and Estate and Gifts Taxes)..................................................................................................................................42 Table 15. Average Tax Rates by Expenditure Groups for the Current Tax System (Including Income, Payroll, and Estate and Gifts Taxes).........................................................................................................................................42 Table 16. Flat Tax Base ($ billions) ...........................................................................................................................45 Table 17. Proposed Revenue-Neutral Flat Tax Rate ($ billions)................................................................................46 Table 18. Average Tax Rates by Income Groups for the Flat Tax (Replacing Current Income, Payroll, and Estate and Gift Taxes).....................................................................................................................................................47 Table 19. Average Tax-Inclusive Rates by Expenditure Groups for the Flat Tax (Replacing Current Income, Payroll, and Estate and Gift Taxes)......................................................................................................................48 Table 20. Business Transfer Tax Base Calculations ($ billions) ................................................................................49 Table 21. Computation of Revenue-Neutral BTT Tax Rate ($ billions) ....................................................................50 Table 22. Average Tax-Inclusive Rates by Income Groups for the BTT (Replacing Current Income, Payroll, and Estate and Gift Taxes) ..........................................................................................................................................51 Table 23. Average Tax-Inclusive Rates by Expenditure Groups for the BTT (Replacing Current Income, Payroll, and Estate and Gift Taxes)