The FairTax Helps Explain Huckabee's Rise
Mike Huckabee’s dramatic rise in the polls has focused attention on the FairTax, for which, among presidential candidates, Huckabee is the leading advocate. The FairTax would replace personal income taxes, payroll taxes, capital gains taxes, corporate income taxes, and the death tax with a national retail sales tax.
As it has moved into the spotlight, the FairTax has drawn criticism ranging from “uninformed” to “deranged”. Let’s take a moment to look at some important points.
First, a “revenue-neutral” FairTax would reduce the taxes paid by tax-law-abiding Americans as a group. This is because the FairTax would collect taxes from people who have incomes (often large incomes), but do not now pay Federal taxes. These include drug dealers and illegal immigrants who work for cash, but also the 40 million foreign tourists who visit the U.S. every year.
Second, the FairTax would cause (pre-FairTax) prices to fall because it would lower the cost of doing business for every company in America.
The Congressional Budget Office (CBO) recently projected (August, 2007) that Corporate Income Taxes will total 2.7% of Gross Domestic Product (GDP) in 2008. Payroll taxes are expected to be 6.3 percent of GDP. Businesses pay half of these, or 3.2%. In addition, the costs to business of complying with the Corporate Income Tax are estimated to be approximately equal to the revenues this tax produces. However, let’s conservatively assume that these costs equal 2.0% of GDP.
Accordingly, the FairTax would reduce business costs by a total of 7.9% of GDP. This would cause (pre-FairTax) prices to the consumer to fall. Prices would not fall by the full amount of the FairTax, but they would fall.
Third, the FairTax would give Americans more money to spend. This would give consumers the wherewithal to pay the higher FairTax-inclusive prices built into what they buy.
The CBO estimates that personal income taxes will total 9.0% of GDP in 2008. Employees pay the other half of payroll taxes, or 3.1% of GDP. The Death Tax collects 0.2% of GDP. In addition to the taxes they pay, individuals incur considerable costs in complying with the Federal tax code. Let’s (conservatively) assume that these amount to 2.0% of GDP.
The FairTax plan provides for a “Prebate” in the form of a monthly check that would be sent to every family in America. The Prebate is equal to the FairTax the family would pay if it earned and spent an income at the official government “Poverty Line” (about $27,000/year for a family of four). The Prebate will ensure that Americans pay no net FairTax on the “necessities” of life. Prebates will equal about 3.2% of GDP, replacing other income-support programs that total 0.4% of GDP.
Because of lower costs, business would be able to reduce their prices by up to 7.9 percent of GDP, while individuals will have additional spending money equal to 17.1% of GDP. Together, these equal 25.0% of GDP. At its proposed tax rate of 23% (inclusive rate), the FairTax would generate Federal Revenues equal to about 18.6% of GDP. Accordingly, this simple “static analysis” shows that the American people would be way ahead with the FairTax.
Most of the benefit would come from eliminating the enormous compliance and administration costs of the existing tax system. However, based upon the CBO projections for 2008, the FairTax at a 23% rate would provide a tax cut that would bring the Federal government’s “tax take” from the historically high level projected for 2008 (19.2% of GDP) down closer to its average for the past 40 years (18.0% of GDP).
Now, so-called “deficit hawks” argue that we should be raising taxes right now, not cutting them. Many of these people suggest that the 2003 Bush tax cuts should be allowed to expire. This would raise the Federal “tax take” by about 2.0% of GDP.
It is impossible to make a rational case for tax increases based upon either the Federal Deficit or the National Debt. The CBO projects a 2008 Federal budget deficit of only 1.1% of GDP and a “Debt Held by the Public” of 35.9% of GDP. Both numbers are low by historical standards, and are low compared with Europe and Japan.
Instead, tax-increase-advocates generally point to the huge “unfunded obligations” of Social Security and Medicare. In their 2006 Annual Report, the Social Security Trustees estimated the “present value to the infinite horizon” (PVIH) of these “unfunded obligations” at $86 trillion.
Given that the corresponding number for future Federal revenues is about $201 trillion (18.0% of the $1117.3 trillion PVIH of future GDP), this is a crushing financial burden. To close this gap via tax increases, Federal taxes would have to be raised by 43% across the board (from 18.0% of GDP to 25.7% of GDP). Moreover, this would (somehow) have to be accomplished with no impact on economic growth. A reduction of only 0.5 percentage points in our long-term average annual real economic growth rate (to 1.4% from the Trustees’ projected 1.9%) would nullify this enormous tax increase and bring the PVIH of Federal revenues back down to $201 trillion.
The FairTax would provide a tremendous boost to economic growth. That is because it would reduce taxes on saving and investment to zero. Economic growth is purely a matter of private capital investment. The more we invest, the faster the economy grows. If Americans did no more than reinvest the taxes that they no longer had to pay on savings and investment and the associated compliance costs, this would be sufficient to raise our real growth rate by 1.4 percentage points.
What difference would it make if America grew at 3.3% per year rather than 1.9%? Well, at a long-term average annual real economic growth rate of 3.3%, the PVIH of future GDP is infinity. This would make the PVIH of future Federal revenues also equal to infinity—at any FairTax tax rate.
Eighteen percent of infinity is more than 18.0% or 20.0% or even 25.7% of $1117.3 trillion. America needs the FairTax.
