The Fair Tax Is About Economic Growth

By Louis R. Woodhill

Mike Huckabee’s recent surge in the polls has focused attention on the FairTax, which would replace personal income taxes, payroll taxes, capital gains taxes, corporate income taxes, and the death tax with a national retail sales tax.

There are many benefits to the FairTax, but the most important one is economic growth. By replacing taxes that burden capital investment with a tax that falls 100% on consumption, the FairTax would produce dramatically higher levels of investment, productivity, wages, and GDP growth. You would hear a “great sucking sound” as investment was pulled into the U.S. economy, not only from the rest of the world, but via the savings of our own people.

Right now, the Social Security Trustees forecast the real long-term growth rate of the U.S. economy at about 2.0% per year. This is a reasonable projection of what current policies would yield. However, I believe that adoption of the FairTax would increase growth to at least 3.5%.

How significant is the difference between 2.0% and 3.5% real growth? Let’s look at the numbers over a 75-year period, the way the Social Security Trustees do.

Our economy would be almost three times larger in 2082 if we average 3.5% growth than it would be if growth averaged 2.0%. The “present value” of our GDP over the 75-year period would be more than 70% larger. The implications of this difference are staggering

For one thing, the financial problems of Social Security and Medicare, which seem overwhelming today, would simply disappear. For 2007, the combined costs of these programs will total about 7.5% of GDP. Under the Social Security Trustees’ GDP growth assumptions, these costs are projected to balloon to over 17.5% of GDP in 2082. However, if our GDP grows an average of 3.5% per year, the same projected real-dollar costs would total only about 6.0% of GDP—less than today.

Here’s another way to look at the potential impact of the FairTax. If you add our national debt to the projected (75-year) “unfunded obligations” of Social Security and Medicare, the Federal government is in a $48 trillion financial hole. However, assuming Federal revenues at their historic average of 18.5% of GDP, a real GDP growth rate of 3.5% would increase the present value of Federal revenues from about $138 trillion to about $236 trillion. This additional $98 trillion is enough to pay off all of our “debts” and pay for a tax cut equal to 3.9% of GDP.

Because higher economic growth has such a dramatic effect on the present value of Federal revenues, it is neither necessary nor desirable to implement the FairTax at its “static-revenue-neutral” tax rate of 23% (“inclusive” rate). A tax cut equal to 3.9% of GDP would bring the FairTax rate down to just over 18%. In fact, it would take a FairTax rate of only 13.4% to produce the same present value of Federal revenues with average real GDP growth of 3.5% as the 23% rate would yield if GDP growth averages 2.0%.

So, why would the FairTax produce a dramatic increase in GDP growth?

There is a reason why our economic system is called “capitalism”. It is capital investment—private capital investment—that makes our economy grow. This is clear from an examination of the “Produced Assets” numbers published by the Bureau of Economic Analysis (BEA). The ratio of real GDP to real “Produced Assets” (i.e., total invested capital) has been constant at 0.331 for the past 54 years. More capital investment yields higher GDP.

By eliminating all taxes on savings and investment, the FairTax would dramatically increase the profitability of business investment in the United States. It would make the U.S. the preferred location for manufacturing for export. It would make globalization work for, rather than against, American workers.

The FairTax would allow companies to reinvest all of their profits in growth. Raising capital is difficult and time-consuming for small companies, so many of them must limit their growth to what they can finance out of cash flow. The FairTax would not only permit these companies to reinvest the money they are now paying in taxes, it would also allow them to reinvest all of the money they are now spending on tax lawyers and accountants.

The impact of lower taxes on businesses can be dramatic. By cutting their corporate income tax rate from 40% to 12.5%, Ireland increased its average annual real economic growth rate from around 3% to more than 7%. The FairTax would reduce the U.S. corporate income tax rate from 35% to zero. It would also eliminate the “compliance costs” of this tax, which are estimated to be as burdensome as the tax itself.

There are those who claim that the FairTax is “regressive”—that it would benefit “the rich” at the expense of “the poor”. Yes, the FairTax would eliminate all taxes on capital. And yes, it is “the rich” who own most of the nation’s capital. However, there is a huge distinction between who owns the capital and what the capital actually is. It is also vital to understand who benefits from the capital that “the rich” own.

A young man starting out as an auto mechanic needs a very expensive set of tools. Tools are capital. If the young man borrows the money he needs to buy his tools, the tools (capital) will be owned by “the rich”. However, what the tools actually are is the capital that makes it possible for the young man to earn a decent living.

The economy as a whole gets a 33.1% annual return on invested capital. Most investment is made by, and owned by, “the rich”. However, “the rich” receive only 16% of the total return. Most of the benefit, 57%, goes to workers. Government (all levels) gets the remaining 27%. While the FairTax will make “the rich” richer, the vast majority of the economic benefits will go toward making the rest of America richer.

The U.S. economy averaged 3.72% per year real growth for the 75 years ending in 2006. There is no reason why we can’t average 3.5% for the next 75 years. We just need enough capital investment. The FairTax would give us that investment.

Louis R. Woodhill, an engineer and software entrepreneur, is on the Leadership Council of the Club for Growth. He can be reached at

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