fairtax white paper ebook

FairTax® is a registered trademark for Americans For Fair Taxation®

FairTax White Paper eBook

The FairTax® Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (H.R. 25 / S. 122) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system. FairTax Earning Power – Real Not Diluted Earnings Under the FairTax proposal not only do more Americans have jobs, but they also take home 100% of their paycheck, pensions, or Social Security checks. Employees keep 100% of their paycheck. Pensioners keep 100% of their pension.

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THE FAIRTAX PREBATE The Prebate is designed to ensure that no American pays federal taxes on spending up to the poverty level. All valid Social Security cardholders who are legal U.S. residents receive a monthly Prebate payment equivalent to the FairTax paid on essential goods and services, as measured by the Dept. of Health and Human Services poverty level expenditures. This is a well-accepted, long-used poverty level calculation that includes food, clothing, shelter, transportation, medical care, and so on. The amount of the Prebate payment is computed by multiplying the poverty level expenditures by the FairTax rate according to the following schedule. For a two adult, two child household the annual prebate amount is $7,135 and $595 per month. 2013 FairTax Prebate Schedule1

One-adult household Two-adult household Family Size Annual

Consumption Allowance

Family Size

Annual Consumpt

ion Allowance

Family Size Annual Consumption

Allowance1

Annual Prebate Amount

Monthly Prebate Amount

1 person $11,490 $2,643 $220 couple $22,980 $5,285 $440 and 1 child $15,510 $3,567 $297 and 1 child $27,000 $6,210 $518 and 2 children $19,530 $4,492 $374 and 2 children $31,020 $7,135 $595 and 3 children $23,550 $5,417 $451 and 3 children $35,040 $8,059 $672 and 4 children $27,570 $6,341 $528 and 4 children $39,060 $8,984 $749 and 5 children $31,590 $7,266 $605 and 5 children $43,080 $9,908 $826 and 6 children $35,610 $8,190 $683 and 6 children $47,100 $10,833 $903 and 7 children $39,630 $9,115 $760 and 7 children $51,120 $11,758 $980

1 For Families/households with more than 8 persons, add $4,020 to the annual consumption allowance for each additional person. The annual consumption allowance is based on the DHHS 2013 HHS Poverty Guidelines as published in the Federal Register, January 24, 2013. The annual prebate equals 23% of the annual consumption allowance.

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EFFECTIVE TAX RATE Effective Tax Rates vs. Stated Tax Rates. Is the 23% FairTax revenue neutral rate higher or lower when compared to income and social Security taxes people pay today? Most people are paying that much or more today – much of it just hidden from view. The income tax bracket most people fall into is 15 percent, and all wage earners pay 7.65 percent in payroll taxes. That’s 23% right there’re, without taking into account the 7.65% employer matching! On top of that, you have to add in the business taxes and associated compliance costs passed on to consumers in higher prices. Because the 23% FairTax rate of $0.23 on every dollar spent is not imposed on necessities, a household spending $31,020 pays an effective rate of 0.0%, not 23%. That same household will have a federal tax burden of 6.0 percent of his or her income under current law.

-23.0%

0.0%

7.7%11.5%

17.2%20.1% 21.6% 22.3% 22.6%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

$15,510 $31,020 $46,530 $62,040 $124,080 $248,160 $496,320 $992,640 $1,985,280

Note: The Tax rate is calculated by subtracting the annual prebate from the FairTaxes on spending and dividing that result by annual spending.

FairTax Rate as a Percent of Spending: 2013Two Adult/Two Child Household

Annual Spending

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ADMINISTRATION

The FairTax is administered primarily by existing state sales tax authorities. It requires no itemization, receipts, IRS forms, tax audits, tax brackets, deductions, capital gain concerns nor individual or corporate tax compliance costs. There are no hidden taxes on goods purchased and no loopholes, exemptions or exclusions; corporate taxes are abolished and used goods are not taxed. Retailers are paid 0.25% to collect the FairTax at the original point of purchase and the same amount goes to state sales tax authorities a collection fee.

STATE TAX SYSTEMS

No state is required to repeal its income tax or piggyback its sales tax on the federal sales tax. All states have the opportunity to collect the FairTax on behalf of the federal government. Thus, states will find it beneficial to conform their sales tax to the federal tax. Most states will probably choose to conform, making the compliance costs of retail businesses in that state much lower. The state is paid a 0.25 percent collection fee by the federal government to collect the tax. For states that already collect a sales tax, this fee proves generous. A state can choose not to collect the federal sales tax, and either outsource the collection to another state, or opt to have the federal government collect it directly. If a state chooses to conform to the federal tax base, it will raise the same amount of state sales tax with a much lower rate – in many cases more than 50 percent lower – since the FairTax base is broader than its current sales tax base. States may also consider the reduction or elimination of property taxes by keeping their sales tax rate at or near where it is currently. Finally, conforming states that are part of the FairTax system will find collection of state sales tax on internet and mail-order retail sales greatly simplified.

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SCHOLARLY RESEARCH

The FairTax has been called the most thoroughly researched tax reform plain in recent history.

• If the FairTax had been in effect in 2009 and 2010, it would have generated $171 billion more in revenues in 2009 and $267 billion more in 2010 than the current federal income tax system. The FairTax rate of 23 percent on a total taxable consumption base of $11,809 trillion will generate $2.188 trillion [1]

• The FairTax has the broadest base and the lowest rate of any single-rate tax reform plan. [2] • Real wages are 10.3 percent, 9.5 percent, and 9.2 percent higher in years 1, 10, and 25, respectively

than would otherwise be the case. [3] • Disposable personal income is higher than if the current tax system remains in place: 1.7 percent in year

1, 8.7 percent in year 5, and 11.8 percent in year 10. [4] • The economy as measured by GDP is 2.4 percent higher in the first year and 11.3 percent higher by the

10th year than it would otherwise be. [4] • Consumption increases by 2.4 percent more in the first year, which grows to 11.7 percent more by the

tenth year than it would be if the current system were to remain in place. [4] • The increase in consumption is fueled by the 1.7 percent increase in disposable (after-tax) personal

income that accompanies the rise in incomes from capital and labor once the FairTax is enacted. [4] • By the 10th year, consumption increases by 11.7 percent over what it would be if the current tax system

remained in place, and disposable income is up by 11.8 percent. [4] • Over time, the FairTax benefits all income groups. Of 42 household types (classified by income, marital

status, age), all have lower average remaining lifetime tax rates under the FairTax than they would experience under the current tax system. [5]

• Implementing the FairTax at a 23 percent rate gives the poorest members of the generation born in 1990 a 13.5 percent improvement in economic well being; their middle class and rich contemporaries experience a 5 percent and 2 percent improvement, respectively. [6]

• Based on standard measures of tax burden, the FairTax is more progressive than the individual income tax, payroll tax, and the corporate income tax. [7]

• Charitable giving increases by $2.1 billion (about 1 percent) in the first year over what it would be if the current system remained in place, by 2.4 percent in year 10, and by 5 percent in year 20. [8]

• On average, states could cut their sales tax rates by more than half, or 3.2 percentage points from 5.4 to 2.2 percent, if they conformed their state sales tax bases to the FairTax base. [9]

• The FairTax provides the equivalent of a supercharged mortgage interest deduction, reducing the true cost of buying a home by 19 percent. [10]

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REFERENCES

[1] Bachman, Paul, Jonathan Haughton, Laurence J. Kotlikoff, Alfonso Sanchez-Penalver, and David G. Tuerck, “Taxing Sales under the FairTax: What Rate Works?” published in Tax Notes, November 13, 2006. Revised estimates, Sept. 2011. Click here to read the full paper.

[2] Tuerck, David G., Jonathan Haughton, Paul Bachman, and Alfonso Sanchez-Penalver, “A Comparison of the FairTax Base and Rate with Other National Tax Reform Proposals,” The Beacon Hill Institute at Suffolk University, February 2007. Revised estimates September 2011. Click here to read the full paper.

[3] Tuerck, David G., Jonathan Haughton, Keshab Bhattarai, Phuong Viet Ngo, and Alfonso Sanchez-Penalver, “The Economic Effects of the FairTax: Results from the Beacon Hill Institute CGE Model,” The Beacon Hill Institute at Suffolk University, February 2007. Click here to read the full paper.

[4] Arduin, Laffer & Moore Econometrics, “A Macroeconomic Analysis of the FairTax Proposal,” July 2006. Click here to read the full paper.

[5] Kotlikoff, Laurence J. and David Rapson, “Comparing Average and Marginal Tax Rates under the FairTax and the Current System of Federal Taxation,” NBER Working Paper No. 12533, revised October 2006. Click here to read the full paper.

[6] Jokisch, Sabine and Laurence J. Kotlikoff, “Simulating the Dynamic Macroeconomic and Microeconomic Effects of the FairTax,” National Tax Journal, June 2007. Click here to read the full paper.

[7] Tuerck, David G., Jonathan Haughton, Paul Bachman, Alfonso Sanchez-Penalver, and Phuong Viet Ngo, “A Distributional Analysis of Adopting the FairTax: A Comparison of the Current Tax System and the FairTax Plan,” The Beacon Hill Institute at Suffolk University, February 2007. Click here to read the full paper.

[8] Tuerck, David G., Jonathan Haughton, Alfonso Sanchez-Penalver, Sara Dinwoodie, and Paul Bachman, “The FairTax and Charitable Giving,” The Beacon Hill Institute at Suffolk University, February 2007. Click here to read the full paper.

[9] Tuerck, David G., Paul Bachman, and Sylvia Jacob, “Fiscal Federalism: The National FairTax and the States,” The Beacon Hill Institute at Suffolk University, June 2007. Click here to read the full paper.

[10] Walby, Karen, and Dan Mastromarco, “Promoting home ownership: How the FairTax’s benefits for homeowners exceed the mortgage interest deduction,” Americans For Fair Taxation White Paper, February 2007. Click here to read the full paper.

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The FairTax prebate explained

Under the FairTax, all Americans consume what they see as their necessities of life free of tax. While permitting no exemptions, the FairTax (HR25 / S122) provides a monthly, universal prebate to ensure that each family unit can consume tax-free up to the poverty level, with the overall effect of making the FairTax progressive in application. This is not an entitlement, but a rebate (in advance) of taxes paid – thus the term prebate. Everyone pays taxes at the cash register. Although everyone pays the same tax rate at the cash register, the chart below shows that the effect of the prebate is to increase the actual tax rate (annual taxes paid as a percentage of annual spending) as the level of spending increases, a progressive tax rate structure. For example, a person spending at the poverty level ($31,020 for a family of four) has a 0% effective tax rate because the annual prebate of $7,135 refunds all of the taxes they paid in their annual spending of $31,020. Whereas someone spending at twice the poverty level has an effective tax rate of 11.5%, and so on. Annual spending would have to be in excess of $14 million per year to reach the statutory rate of 23%.

-23.0%

0.0%

7.7%11.5%

17.2%20.1% 21.6% 22.3% 22.6%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

$15,510 $31,020 $46,530 $62,040 $124,080 $248,160 $496,320 $992,640 $1,985,280


FairTax Rate as a Percent of Spending: 2013Two Adult/Two Child Household

Annual Spending

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Calculation of the prebate: The monthly prebate check is calculated by multiplying the annual consumption allowance as measured by the Department of Health and Human Services poverty guidelines times the FairTax rate and dividing by twelve. Poverty level spending represents what it costs families of varying household size and composition to buy their necessities. The table below shows the monthly prebate amount for households of varying composition.

2013 FairTax Prebate Schedule

One-adult household Two-adult household Family Size Annual

Consumption Allowance

Annual Prebate

Monthly Prebate

Family Size Annual Consumption

Allowance

Annual Prebate

Monthly Prebate

1 person $11,490 $2,643 $220 couple $22,980 $5,285 $440 and 1 child $15,510 $3,567 $297 and 1 child $27,000 $6,210 $518 and 2 children $19,530 $4,492 $374 and 2 children $31,020 $7,135 $595 and 3 children $23,550 $5,417 $451 and 3 children $35,040 $8,059 $672 and 4 children $27,570 $6,341 $528 and 4 children $39,060 $8,984 $749 and 5 children $31,590 $7,266 $605 and 5 children $43,080 $9,908 $826 and 6 children $35,610 $8,190 $683 and 6 children $47,100 $10,833 $903 and 7 children $39,630 $9,115 $760 and 7 children $51,120 $11,758 $980 For Families/households with more than 8 persons, add $4,020 to the annual consumption allowance for each additional person. The annual consumption allowance is based on the DHHS 2013 HHS Poverty Guidelines as published in the Federal Register, January 24, 2013. The annual prebate equals 23% of the annual consumption allowance.

Qualification: All qualified families are entitled to receive the monthly prebate. A “qualified family” consists of all family members sharing a common residence. Family members include an individual and his or her spouse, children and grandchildren, parents and grandparents. Children/students living away from home are considered family members if they are registered as a student for at least 5 months out of the year and receive at least 50 percent of their support from the family unit. Children of divorced parents are considered to be family members of the custodial parent. Incarcerated individuals are not eligible to be a member of a qualified family. In order for a person to be counted as a member of the family for purposes of determining the size of the qualified family, a person must have a valid social security number and be a lawful resident of the United States. Unlike the Earned Income Tax Credit, the application/registration form that families who choose to receive the prebate must file is simple and straightforward. Those choosing not to register will not receive a prebate. The registration form requires only the following information:

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1. the name of each family member who shares the residence; 2. the social security number of each family member; 3. the name of the family member to whom the monthly prebate check should be paid; 4. a sworn statement that all listed family members are lawful residents, that all family members

sharing the common residence are listed, and that no family members are incarcerated; 5. the address of the shared residence; and 6. the signature of all family members 21 years of age and older.

Administration: The Social Security Administration (SSA) will send out the monthly prebate on or before the first day of every month. Prebate payments can only be made to persons 18 years or older. If a family wishes to designate more than one person to receive the prebate, then the prebate payment will be divided evenly among those persons designated. Example: two single people sharing the same residence would be able to each get a prebate check. Registration renewal: After the initial registration, any qualified family that fails to renew its registration each year, within 30 days of the family determination date, will cease receiving the prebate 90 days following the failure to register. However, the family can file to get up to six months of missed prebate checks later (with no interest on missed payments). A possible method of assigning registration renewal dates would be on the birth date of the person filing the application. Thirty (30) or more days before the annual registration date, the sales tax authority is required to mail a proposed registration to each qualified family that simply needs to be signed and mailed back in if the family’s circumstances have not changed. Administrative Cost: In accordance with instructions from each qualified family, SSA will provide the prebate in the form of a paper check via U.S. Mail, an electronic funds transfer to a bank account, or a “smartcard” that can be used much like a bank debit card. (This method is already in use to provide other benefits from the federal government.) The National Taxpayers Union estimated that the cost of mailing monthly prebate checks via the U.S. Post Office would be approximately $260 million.1 To the extent the SSA uses electronic funds transfer/direct deposit and “smart card” technology; this amount would be reduced substantially. According to the SSA, Office of the Chief Actuary, over 92% of social security benefit payments were paid with direct deposit in 2011. Fraud Prevention: When the state sales tax authorities process the prebate applications they will validate all names and social security numbers against the SSA database. States already do this in relation to the administration of other state/federal cooperative programs such as unemployment compensation benefits and child support enforcement. They will also check for duplicate social security numbers being claimed by different households to prevent more than one household listing the same person as a household member. Any duplicate social security numbers will have to be resolved before the prebate payment is made. It is unlawful to willingly and knowingly file a false prebate claim. HR25 provides for both civil and criminal penalties. The civil penalty is equal to the greater of $500 or 50 percent of the claimed annual prebate amount not actually due plus repayment of any falsely due prebate amounts. A criminal penalty of imprisonment for up to one year may also be imposed. 1 Update of National Taxpayers Union estimate to account for first class postage increase and an increase in the number of households.

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Fiscal Impact: The estimated number of households for 2011 is 114.8 million. Assuming 100 percent participation by all eligible households, the maximum cost of the prebate would be $543 billion. For comparative purposes, this amount is less than one-half of the amount of tax expenditures (standard deductions, personal exemptions, Earned Income Tax Credit, mortgage interest and charitable contribution deductions, and various other tax preferences) doled out under the current federal income tax system that are repealed when the FairTax is enacted. For 2012, the total of all of these tax breaks is estimated to be $1.25 trillion.2 What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR 25 / S 122) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system.

What is Americans for Fair Taxation® (FairTax.org)?

FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX. Authored by Karen Walby, Ph.D., Chief Economist, Americans For Fair Taxation, 2007. Updated April, 2013. (AFFT Documents\Papers on a specific subject\explanation of prebate)

2 Donald B. Marron, How Large are Tax Expenditures?, Tax Policy Center as published in Tax Notes, March 28, 2011.

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Feature Current Income Tax FairTax Flat Tax

Legislation 113th Congress: 120 bills to amend the Internal Revenue Code have been filed. There were 4,428 changes to code in last decade.

113th Congress: H.R. 25 has 63 co-sponsors and the Senate companion bill, S. 122 has 7 (as of 4-7-13).

113th Congress: S 173. No cosponsors and no House companion bill (as of 4-7-13).

Type of tax Individual and corporate income taxes, payroll, self-employment, capital gains, estate, gift, and alternative minimum taxes (AMT).

Single-rate national sales tax on final retail consumption with no exemption. Business inputs are not taxed. Education tuition is not taxed.

A hybrid subtraction method VAT, which taxes capital value- added at the business stage and labor value added by a tax on wages, in addition to current payroll taxes.

Taxes replaced Not applicable. All income and payroll taxes including capital gains taxes, self-employment taxes, estate and gift taxes, and the AMT.

The current personal and corporate income taxes, capital gains taxes, and the AMT. Current payroll taxes are not replaced.

Base and rate Taxes the same income multiple times. Marginal income tax rates range from 10 to 39.6% for persons and 15 to 39% for corporations. Payroll taxes at 15.3 percent. Estimated net tax base is $8.000 T and revenue neutral rate is 24.7%.; (2010 est.)

Taxes income once when spent. Revenue neutral rate is 23%. Has the broadest base and lowest rate possible of any tax plan that does not tax the poor or double tax income. Estimated net tax base is $9,511 T (2010 est.).

Statutory rate is 17% of taxable income plus payroll taxes remain in effect. Estimated net tax base is $8,614 T. Revenue neutral rate is 22.92%; however, payroll taxes increase marginal rates by 15.3% on labor. (2010 est.)

Progressivity and upward mobility

Steeply accelerating marginal rate structure taxes those who have to save or earn more in a given period to accumulate wealth. Earned Income Tax Credit households face the highest marginal rates. Payroll taxes impose regressive rates on labor.

The prebate untaxes spending up to the poverty level, literally untaxing the poor. Since taxation is based on consumption, the FairTax allows taxpayers maximum choice as to the level and timing of taxation. The FairTax rewards hard work, savings, and wealth accumulation.

A standard deduction results in a progressive effective income tax rate; however, the retention of current payroll taxes maintains the regressive tax on labor.

16th Amendment The 16th Amendment is required to impose the income tax system.

FairTax plan promotes repeal and is the only proposal that can repeal the 16th Amendment.

Requires 16th Amendment. Does not protect against coexistence of VAT and income taxes.

IRS $12.1 B budget w/ 100,000+ employees

Abolished. Administered by states and small sales tax bureau in Treasury Dept.

Retained with reduced role.

Effect on the economy

Taxes savings, labor, investment, and productivity multiple times, creating a disincentive to work, save, or invest thereby reducing real wages.

Untaxes wages, savings, and investment; lowers interest rates by about 25%; increases capital stock, productivity, and real wages.

Eliminates the tax bias against savings and investment, lowers interest rates. Increases productivity but taxes labor income at a higher rate than capital.

Border adjustability Ensures U.S. exports are taxed twice – once by the U.S. tax system and then by the importing jurisdiction with ad valorem taxes. Favors imports over domestic products by failing to tax imports after VAT rebates (a 17% price advantage).

Naturally border adjustable. U.S. exports are not taxed since consumed abroad, but imports are taxed on an equal basis as U.S. produced goods. World Trade Organization (WTO) compliant.

Favors imported goods and effectively punishes exports. Could potentially be made border adjustable; however, uncertain if border-adjustable VAT would pass WTO muster.

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Feature Current Income Tax FairTax Flat Tax

Other international competitiveness concerns

Imposes the highest marginal corporate tax rate in the world, impelling companies to locate overseas and market back to the U.S.

Makes the U.S. the only advanced country in the world with a zero rate of taxation on income, creating the world’s largest tax haven for direct investment.

Territorial system - income generated overseas is not taxed by the U.S. This will further encourage the migration of industry and jobs overseas.

How the FairTax Compares, January, 2013

Feature Current income tax FairTax Plan Flat tax

Complexity and compliance costs

72,536 pages of tax code, regulations, and IRS rulings. More than 6B man-hours wasted filing an est. 249M forms by 2010. Total annual compliance costs exceed $431B.

Individuals exempt from filing tax returns. Businesses making retail sales will file sales tax returns for a total of about 15 to 20M tax filers. Compliance costs reduced 90%.

Tax withholding and payroll tax deductions from paychecks continue. Individuals and businesses must still track income and file income tax forms. Compliance costs reduced by 50%.

Taxpayer rights Tax code requires massive disclosure, recordkeeping, individual audits, and collection activities where constitutional protections yield.

As the Founding Fathers intended, the FairTax does not directly tax individuals and privacy rights are preserved.

A flat tax still requires individual reporting, individual audits, and collection activities.

Compliance rates and effect on tax gap

System increasingly disregarded, contributing to unfairness. Through evasion and innocent error, tax gap now totals more than $450B.

Reduced tax rates, fewer numbers of collection points, visibility, and simplicity ensure the FairTax is enforced at lower cost with higher compliance rates. States have used sales taxes for over 60 years.

Improved compliance from simplification and rate reduction; however, same number of collection points as current law and international enforcement is complicated through territoriality.

Effect on non-filers and illegal immigrants

An estimated 18% of “taxpayers” have simply dropped out of the system and no longer file returns. The income tax fails to capture the cash payments and other undocumented transactions with illegal immigrants.

Non-filers and illegal immigrants are taxed when they purchase goods and services for consumption. Illegals who do not have a valid SSN will not receive the prebate. Hence, the FairTax fosters coordination of tax and immigration policy.

Unlikely the tax gap attributable to non-filers will change. Nonpayment of payroll taxes by illegal immigrants will likely remain problematic.

Payment of taxes Taxes due when income is earned or an item of income is sold or exchanged. Income & payroll taxes deducted from individual paychecks.

Taxpayers pay tax when they elect to consume beyond the poverty level. Retailers are provided a credit of one one-quarter of one percent to offset compliance costs.

Taxpayers are taxed on income when earned.

Social Security and Medicare funding

Labor foots the bill with a highly regressive 15.3% payroll tax on wages up to $106,800 and 2.9% Medicare tax imposed thereafter.

A portion of the tax is dedicated to funding Social Security based on total wages and the current payroll tax rates. Social Security benefits are adjusted to preserve purchasing power.

The flat tax leaves the payroll taxes under the current system in place to fund Social Security and Medicare

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Visibility and effect on future tax burden

47% of filers pays zero income tax and are completely unvested in the tax system. Among the hidden costs they do not see are the $431B in compliance costs, $307B in corporate taxes, and the drag on economic growth from the deadweight loss it engenders. Estimated to be 2-5% of GDP.

The FairTax ensures a built-in downward pressure on the size of the government by vesting everyone equally in the tax system, by exposing the full costs of the federal government, and by requiring the government to raise taxes for everyone rather than to shuffle taxes from one industry or income class to the next.

The flat tax buries capital value- added taxes in the business sector. The flat tax’s touted two-thirds supermajority to raise rates offers only illusory protection, as a simple majority can override that supermajority requirement.

Sustainability and feasibility

Lawmakers, policy makers, economists, and taxpayers agree that the current system is a monstrosity held in place by an intricate web of special interest groups and must be replaced. Changes are adopted every year.

Once enacted, taxes must be raised on every consumer in the U.S. to change the base. States have used sales taxes for over 60 years; they are in effect in 45 states. The tax can be collected in conjunction with state sales taxes.

A flat tax just won’t stay flat. Nearly flat in 1913, it eventually devolved into the mess we see today. The flat tax bill itself cannot even be introduced in pure form.

Karen Walby, Ph.D., Director of Research, Americans For Fair Taxation, March 5, 2013..

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The FairTax: The Key to Restoring America’s International Competitiveness3 By

Dan R. Mastromarco, LLM, Taxation

The United States tax regime influences business from the cradle to the grave: whether or not to start a business, what business to start, how to organize it, where to locate it (here or abroad), how to fund and run the business, when and how to expand it, when to hire, when to terminate it and how to unwind it. Over the course of the last 25 years, I have seen how tax policy affects business from many angles: as a practitioner, an advocate, a federal prosecutor, an adjunct professor, an author of treatises and a book on the policy process, and as a Congressional counsel. And from these differing perspectives, I cannot help but see the discouragement of many economists whose voices of reason are ignored; not so much because they are discordant, but because they are drowned out by the deafening din of lobbyists. Our tax system has in a nutshell devolved into an unholy trinity of lobbyists, industry seeking relative advantage and Members who seek campaign contributions, all of whom would sacrifice at the altar of a public auction our national prosperity for relative advantage. The good news is that Tax reform is coming. It is a tide that if resisted by this Congress will be passed by their replacement. But the bad news is that the direction of tax reform remains to this day uncertain. What will reform look like? What are the criteria by which reform will be adjudged? Will reform be accomplished in name only, to leave to another generation the ultimate fix when the economy has worsened? Understanding how we have gone astray is as easy as hearing the central chorus of economists. They will tell you that the critical maladies of our current system are three-fold:

• its complexity, prolixity and crushing compliance costs; • its high marginal rates which trample productive income, stifle growth, job creation and wages; • an anachronistic international tax system that is self-flagellating.

This paper addresses our anachronistic international tax system. And many will tell you, that the solution to this crisis is a consumption tax that makes the taxes we pay visible, ensures all Americans are stakeholders, is neutral as to savings and investment, lowers marginal rates, reduces compliance costs and removes the anti-competitive nature of our non-border adjustable extraterritorial tax system. The best of these is the FairTax, which stands in such stark contrast to the causus male of our current system that it illuminates the path this Nation must take to regain the trajectory of our prosperity. A High Corporate Tax Rate Makes the U.S. Noncompetitive in the Global Economy.-- When the media, pundits and politicians use the term “tax rate,” they often neglect to explain what they mean. When economists refer to the national statutory rate they always mean the government’s tax rate imposed by law and assessed on income/profits, and they typically mean the top statutory marginal rate. This is very different from the effective tax rate, which is the total tax paid as a percentage of total income earned, and which accounts for all brackets, deductions, credits, depreciation, and preferences in the tax code and is a function of what the entity actually pays in taxes. 3This whitepaper is taken from the testimony of Dan R. Mastromarco before the Congress of the United States, Joint Economic Committee, Nov. 17, 2011.

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In the U.S., corporations that earn profits of more than $18.3 million are taxed at an outstanding top statutory marginal rate of 35 percent.4 The statutory combined rate adds to this state and local tax rates (on average 4.2 percent), yielding a 39.2 percent statutory combined rate. Owners of S corporations, partnerships and sole-proprietorships based on the current budget proposal pay a national statutory rate of 39.6 percent (not including payroll taxes) on income over $383,350. But that same taxpayer pays 10 percent on income up to $8,600, and 15 percent on income up to $34,900, etc. Depending on deductions, a taxpayer might pay a relatively modest average tax on total earnings, yet nonetheless face a 39.6 percent marginal tax on any activities that could push income higher—such as extra effort, education, entrepreneurship, or investment. The chart below shows where the U.S. ranks among developed countries when considering corporate rates.

2010 Corporate Tax Rates, U.S. vs. OECD Countries

U.S. OECD Average U.S. Rank National Statutory Rate 35.0% 23.4% 34th out of 34 Statutory Combined Rate 39.2% 25.1% 33rd out of 34 Effective Rate 29.0% 20.5% 33rd out of 34 In short, the U.S. has the dubious distinction of sporting a national statutory rate of 35 percent and a statutory combined rate of 39.2 percent, compared with average OECD rates of 23.4 percent and 25.1 percent, respectively. For tax policy considerations, marginal decisions (such as extra effort or investment) depend mainly on marginal incentives (extra income, after taxes). For this reason, it is the marginal rate that has the greatest negative effect on the economy.

Mercatus Center Senior Research Fellow Veronique de Rugy has done excellent work in charting corporate income tax rates. According to her findings, the U.S. has the highest national

statutory corporate tax rate in the OECD. In 2011, national statutory corporate tax rates among

the thirty-four members of the OECD will range from 8.5 percent in Switzerland to 35 percent in the U.S. When sub-national taxes are added, the U.S. has the second-highest statutory combined corporate tax rate – 39.2 percent – after Japan’s rate of 39.5 percent. Marginal tax rates became the central theme of a revolution in economic policy that swept the globe during the last two decades of the twentieth century, with more than fifty nations significantly reducing their highest marginal tax rates.

4 According to the 2008 SOI, there were 1.8 million C Corporations for that year, 4.05M S Corporations, 3.14M Partnerships (LLCs, LLPs, LP’s, et. cet.) and 22M sole-proprietorships.

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According to World Bank rankings, the U.S.' relative ranking on the "total tax cost" imposed on businesses has gone from bad to worse, falling from 118th in 2010 to 124th in 2011. The total tax cost expressed as a percent of before-tax profits is 46.8%.5 The U.S. effective corporate tax rate on new investment was 34.6 percent in 2010, which was the highest rate in the OECD and the fifth-highest rate among 83 countries. The average OECD rate was 18.6 percent, and the average rate for 83 countries was 17.7 percent.6 How did we arrive at this point? We arrived here because it appears that Congress would rather trade influence in doling out special interests tax breaks that reduce the tax base and raise marginal rates than hear the chorus of economists. In 1990, the Organization for Economic Co-operation and Development (OECD) average statutory combined corporate tax rate was 41.1 percent, higher than the U.S.’ rate of 38.7 percent. But while other nations have been racing over the past few decades to slash corporate tax rates to welcome multinational corporations, the U.S. has stagnated. Lowering marginal tax rates is part of a revolution in economic policy that swept the globe during the last two decades of the twentieth century. More than fifty nations significantly reduced their highest marginal tax rates on individual income. The U.S. sat on the sidelines.

5 The World Bank, Paying Taxes in 2011: The Global Picture, Table 4. 6 Chen, D. and Mintz, J. "New Estimates of Effective Corporate Tax Rates on Business Investment." Tax and Budget Bulletin, No. 64, February 2011.

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The U.S. International System is Anachronistic. The U.S. international tax system is today an embarrassing anachronism. When it was shiny and new in 1918 – the year President Woodrow Wilson donned his top hat to become the first president to leave North America -- we led the way in enacting a system where income taxes duly paid to a foreign country could be credited against U.S. income taxes. Ten years after that, in 1928, the League of Nations introduced draft model income tax treaties, based on this formulation. Time has passed us by. As our tax code remains anchored in the past, developed at a time when the U.S. was more insular in trade and a dominant capital exporter, before the age of consumption taxes, the world economy and our role within it has transformed. Throughout the 1920s, the U.S. was running budget surpluses. Today, of course, the U.S. is a net debtor nation running huge budget deficits, and trade deficits with nearly every major partner in nearly every traded good. In the 1920s, we were a net creditor nation. While in 1961, the U.S. exported just under $21 billion ($159 billion real terms today) and imported approximately $14.5 billion in merchandise ($110 billion today), we exported $1.4 trillion of goods and services and imported $1.8 trillion from January to August of this year alone.7 During the 1920s, federal revenues averaged about 4 percent of GDP. In recent history, from 1971 to 2010, revenues have averaged 18 percent of GDP. Technological improvements in communications and transportation, and the opening of formerly closed markets have created permanent interdependencies among nations that will exponentially increase this volume of trade and with it the need to get our international tax regime right with the times. Our failure to evolve with the international economy has been succeeded only by our failure to keep pace with evolutions in its tax laws. Today, the U.S. is:

• in the minority in trying to tax its multinational corporations on their foreign earnings. • virtually alone in imposing some of the highest tax rates in the world

7 http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf

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• and virtually alone in failing to adopt a border-adjustable destination based consumption tax.

High Rates Diminish Foreign Investment and Discourage Repatriation.— How do these anachronisms perversely influence corporate decision-making and impede competitiveness? At the core of our international tax system, as most tax policy gurus know, is the principal of extraterritoriality. What this principal means in the context of outbound transactions is that the U.S. system will tax its individual residents and citizens, and corporations on their worldwide income under the rates specified in IRC section 1 and 11 (the individual and corporate rates), regardless of where that income is derived. U.S. taxpayers engaged in activities abroad generally compute taxable income in the same manner as U.S. taxpayer producing solely with the U.S. Because the norm of international juridical taxation, with the U.S. generally follows, cedes the primary taxing authority to the country or territorial connection (i.e., where the income is earned) and the residual taxing authority to the county of residence, the U.S. seeks to avoid double taxation by crediting any income taxes paid to the foreign country, against the income tax otherwise due in the U.S.8 One of the largest exceptions to deferral is, of course, Subpart F, which was introduced in the Kennedy Administration in exchange for lowering rates, and is intended to discourage U.S. corporations from redirecting income outside the U.S. in order to avoid immediate U.S. taxation. While the extraterritorial credit system is at least in theory straightforward -- by crediting the foreign taxes paid on the foreign income up to the rate of tax imposed on that income we seek to avoid taxing the same income twice -- it is ridiculously complex in application. That is because before one can determine what credit can apply, the U.S. resident, citizen or corporation must first determine where the income and deductions are sourced under an elaborate set of rules, modified further by treaty and the intercompany transfer pricing rules. One must determine whether and to what extent the foreign taxes are even creditable. One must then compute the direct and indirect credit (on dividends) by distributing the income within more than nine separate “baskets” for which the foreign tax credit is individually limited – enough baskets to turn any sane individual into a “basket” case. And neither least nor last, before determining the credit to which one is entitled, one must determine if deferral from a subsidiary must yield to any one of the separate rules under Subpart F pertaining to Controlled Foreign Corporations. Because the U.S. is virtually alone in trying to tax its multinational corporations on their foreign earnings, it incentivizes companies to avoid those taxes indefinitely by keeping profits overseas. That in turn encourages companies to use accounting maneuvers to shift profits to low-tax countries and to invest profits offshore. However badly U.S. multinational corporations who earn money overseas want to bring that money back home to the U.S., our international tax system discourages, and some would say “penalizes” repatriation of foreign earnings by imposing a 35 percent residual U.S. tax at the time of repatriation. As a result, several high-profile U.S. multinational corporations are sitting on large piles of cash earned from foreign operations. Yet these same corporations are actually borrowing money rather than repatriating their offshore cash.

How much money is trapped offshore? U.S. multinational companies MNCs currently hold an estimated $1.4 trillion in foreign earnings overseas. About $581 billion in after-tax dividends will be 8 A U.S. parent of a foreign subsidiary is generally not taxed on the earnings of the subsidiary until distributed at which time the credit is imputed. (IRC section 951-960.

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distributed to U.S. shareholders, according to one recent study.9 And that same study stated that spending could increase gross domestic product by $178 billion to $336 billion and will add 1.3 million to 2.5 million jobs if we were to offer a temporary reprieve from the repatriation tax, as well as boost U.S. tax revenues. About half of OECD nations do not have this problem because they have “territorial” tax systems.

Our extraterritorial income tax system affects U.S. entities and corporations in more ways than by frustrating their effort to repatriate earnings like their competitors based in lower taxed jurisdictions can do. That is, in a manner of speaking, just a symptom. The greater infirmity is that rate of the tax we impose makes the U.S. one of the least favorable locations to base international operations.

Again an understanding of the U.S. international tax system is critical. Broadly stated, nonresident alien individuals, unincorporated entities even corporations are taxed like U.S. taxpayers on most U.S. Business income. An individual is taxed when it is engaged in a trade or business on income effectively connected to that trade or business (IRC section 871(b). A foreign corporation is likely taxed under IRS section 11 on its taxable income effectively connected with the conduct of a U.S. trade or business (IRC section 882). But nonresident individuals are also subject to U.S. taxation on some types of recurring investment income. And a corporation who is conducting a trade or business may be also subject to the Branch Profits Tax.10

Paradoxically, despite having the highest national statutory rate, the U.S. raises less revenue from its corporate tax than do the other members of the OECD on average. In fact, federal corporate income taxes raise little revenue compared with other federal taxes; roughly comprising 11.6% of total federal tax revenues. At $191 billion, they were equal to 1.3 percent of the nation’s gross domestic product.

The combination of high rates, worldwide taxation and a competitive global marketplace makes our corporate tax system extremely punishing. But it is the marginal tax rate -- the rate on the last dollar of income earned (which is very different from the average tax rate, which is the total tax paid as a percentage of total income earned) – that matters the most. The rate at which we tax decisions at the margin matters in at least two regards: (1) it discourages foreign corporations from locating their corporate offices or subsidiaries in the U.S. and in locating plants, facilities here for production purposes (i.e., it influences the location where capital is deployed), and (2) it encourages outsourcing of plants, facilities and production facilities of domestic multinationals to jurisdictions where the taxes imposed are less.11

9 “The Benefits for the U.S. Economy of a Temporary Tax Reduction on the Repatriation of Foreign Subsidiary Earnings,” by Laura D’Andrea Tyson, Ph.D.; Kenneth Serwin, Ph.D.; Eric Drabkin, Ph.D. (October 13, 2011).

10 The branch profits tax is an extra income tax imposed by the U.S. on foreign corporations that earn profit from their U.S. investments or U.S. business operations.

11Salvador Barrios (European Commission), Harry Huizinga* (Tilburg University and CEPR) Luc Laeven (International Monetary Fund and CEPR) and Gaëtan Nicodème (European Commission, CEB, CESifo and ECARES), International Taxation and Multinational Firm Location Decisions (April 2009). See also Claudio A. Agostini, "The Impact of State Corporate Taxes on FDI Location," Public Finance Review 2007; 35; 335.

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Border Adjustable Taxes Act as Unanswered Trade Subsidies.-- Add to this the fact most of our trading partners effectively rebate their taxes at the border and provide for themselves a powerful export trade subsidy and benefit for consumption of domestic goods that is unanswered by the U.S. It is a widely understood proposition that the U.S. should not target a particular trade deficit level, subsidize its exporters or impose tariffs on imports. The reason, established clearly in economic theory, is that doing so interferes with mutually beneficial transnational economic exchanges, to the disadvantage, in the aggregate, of both countries’ economies. However, the U.S. government should not, as a matter of policy, accord a huge advantage to foreign companies competing in the U.S. market or impose a huge disadvantage on American producers and workers selling their goods and services in the U.S. and foreign markets. That has been the effect, however, of border adjustable VATs. Consider this. The U.S. tax system imposes heavy income and payroll taxes on U.S. workers and businesses producing goods in the U.S. whether those goods are sold in the U.S. market or abroad. Recall U.S. corporate taxes are the about nine percentage points higher than the OECD average.12 The U.S., however, imposes no corresponding tax burden on foreign goods sold in the U.S. market. Moreover, foreign VATs -- a major component of the revenue raised in most developed countries -- are rebated if foreign goods are exported to the U.S. market. This creates a large and artificial relative price advantage for foreign goods, in both the U.S. market and abroad. The table below illustrates this point. American producers pay two sets of taxes when selling into foreign markets. Conversely, in U.S. markets, foreign goods bear no U.S. tax and the foreign value added tax is forgiven. Thus, a most manifest unfairness in the U.S. tax system is that it places U.S. producers – including businesses and workers in manufacturing, agriculture, mining, and forestry – at a large competitive disadvantage relative to their foreign competitors here and abroad. Our failure to counteract these border-adjusted taxes explicitly encourages consumption of foreign, goods. And it converts many of our nation’s retailers into tax free trade zones for foreign produced goods.

Advantage for Foreign Producers

Sold in U.S. market Sold in foreign markets U.S. production Pays U.S. income and

payroll taxes. Pays U.S. income and payroll tax & foreign VATs.

Foreign production Pays no U.S. income or payroll tax and no foreign VAT.

Pays foreign value-added tax.

The U.S. has adopted this self-destructive policy, in part, because of our entirely laudable commitment to free enterprise and our rejection of mercantilism. At least since WWII, American business and political leaders have viewed free trade as the basis for international peace and prosperity. As the dominant economic and military power, the U.S. led the movement to dismantle trade barriers, both by setting the example and by supporting a New World Order of international trade regulation (GATT and WTO), economic cooperation (OECD), and customs unions (such as the European Union and NAFTA). According to the OECD, its members have reduced their average tariff rates from 40 percent at the end

12 Edwards, Chris, “The U.S. Corporate Tax and the Global Economy,” Cato Institute, September 2003.

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of World War II to 4 percent today. The average import duty on goods in the U.S. is currently 1.7 percent. Today, the 29 of 30 OECD countries have enacted border-adjustable tax regimes. America stands nearly alone as the sole developed economy, which refuses to adopt a border-adjustable tax system. The European Union 15 has an average standard VAT of 19 percent, and the average OECD standard VAT is 18.5 percent. During the 1990s, Mexico and Canada increased composite rates to 15 percent from 10 percent and 7 percent, respectively, and China adopted a 17-percent VAT in 1994. As foreign governments have increased the VAT, they have also reduced effective corporate income taxes. Meanwhile, high U.S. corporate tax rates today coupled with our custom of taxing the foreign income of corporations based in the states causes the flight of corporations' headquarters to countries that exempt taxation of overseas income. In effect, the U.S. tax system is distorting the international marketplace and literally driving plants and good jobs out of this country at a devastating and unsustainable pace. There are, after all, only so many assets we can sell to foreigners before the entire financial system enters into a severe crisis. Some economists mistakenly argue that if America adopted a border-adjusted tax system, any relative price change would be eliminated by an offsetting appreciation in the dollar. If the FairTax were implemented, for example, they hypothesize that the price change would be offset by a 23 percent immediate appreciation in the dollar. The appreciation in this case, they contend, would be caused by a reduction in U.S. demand for foreign currency to acquire (the now more expensive) foreign goods and an increase in foreign demand for U.S. currency to acquire (the now less expensive) U.S. goods. However, the arguments are dubious. The problem with that logic is that the demand for U.S. dollars is not limited to the traded-goods market. Nearly $90 trillion in U.S. assets owned by households and non-financial businesses are denominated in dollars. Financial institutions trade trillions of dollars in securities and currency each day based on expectations and guesses. Furthermore, the non-traded goods and services sector is also denominated in dollars and exceeds the traded-goods sector in size.13 A study by Professor Jim Hausman of the Massachusetts Institute of Technology is helpful to understanding this problem.14 13 If, however, these economists are right and there is no increase in the competitiveness of U.S. goods because of a 23-percent increase in the price of the dollar (more or less precisely) relative to foreign currency, then that means the FairTax will have succeeded in increasing the wealth of the American people by something on the order of $20 trillion (23 percent of $90 trillion) relative to the rest of the world, an instantaneous increase nearly equal to the value of all the goods and services produced in the U.S. over two years. That would be reason enough to enact the FairTax. Unfortunately for American asset owners, it is impossible for the traded-goods sector to dominate the currency movements, since the dollar-asset markets are perhaps 100 times as large as the annual traded-goods market (net basis). See B. 100 and B. 102, Flow of Funds Accounts, U.S. of America, Fourth Quarter 2004, Federal Reserve System, for statistical information on asset markets. 14Professor Hausman found:

1. That the existing disparity in treatment of corporate income taxes and VATs for purposes of border adjustment leads to extremely large economic distortions.

2. That U.S. exporters typically bear both domestic income taxes and foreign VATs in selling abroad. 3. That foreign exporters in countries relying largely on VATs typically receive a full rebate of such taxes upon export

to the U.S., and are not subject to U.S. corporate income taxes. 4. That this situation creates a very significant tax and cost disadvantage for U.S. producers in international trade with

significant impact on investment decisions – leading to the location of major manufacturing and other production facilities in countries that benefit from current rules on the border adjustment of taxes.

5. That elimination of the current disparity in WTO rules (by eliminating border adjustment for either direct or indirect taxes) would increase U.S. exports by 14 to 15 percent, or approximately $100 billion based upon 2004 import levels.

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Border-adjustable taxes are, quite simply, the most powerful weapons foreign producers have against U.S. producers and workers. Our failure to adopt a destination-based consumption tax sends a clear message to American producers: Please, move your plants and facilities overseas, hire foreign workers, and then market your products back to the American consumers who are punished for saving and rewarded for overspending. It sends a clear signal to retailers: stock foreign inventory. It sends a clear signal to consumers: buy foreign products. The problem is that American industry and consumers are taking the Congress’ tax policy advice. Market forces do work. And the burgeoning trade deficit is one of the consequences of our failure to confront this reality. The decimation of our domestic producer base results in job losses for America’s middle class, lost opportunities for the young, suffering for the poor and a widening wealth gap.

The Solution: Three Ways the FairTax Helps Businesses As we lament the maladies of the current system, Congress has clear options. The best example of a tax regime that would permanently save compliance costs is the FairTax. The FairTax has been introduced in the House by Representative Rob Woodall as H.R. 25 and in the Senate as S. 122 by Senator Saxby Chambliss. The House bill now has 66 cosponsors, more than any other tax replacement plan in a century. The Senate bill has 8 cosponsors. Some are on this Committee. The FairTax is an integrated tax replacement system that repeals all current taxes imposed by the Internal Revenue Code on income and wages, including personal, gift, estate, capital gains, alternative minimum, Social Security, Medicare, self-employment, and corporate taxes. In place of these taxes, the FairTax imposes a single-rate tax on the final retail sale of new goods and services used or consumed in the U.S. at the revenue-neutral rate of about 23 cents from every dollar spent.15 The FairTax plan also amends the U.S. Constitution so that the income tax chapter of American taxation is closed forever. To ensure the FairTax does not cascade, business-to-business transactions are not taxed under the FairTax. Intermediate goods and services are properly treated as inputs into goods and services sold at retail. Unlike the current system that taxes income multiple times and on an inconsistent basis, the FairTax taxes income only once, upon consumption.

15 This is a tax-inclusive rate, the same means by which the income, payroll and capital gains taxes it replaces are measured.

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The FairTax Would Give the U.S. the Most Internally Sound and Competitive Tax System Effect on Direct Investment, Locational Decisions, and Repatriation.— Consider what would happen to the current international tax problems posed above if the FairTax were adopted beginning with the consequences of the U.S. being the world’s largest national market with a zero marginal rate of tax on productive activity, investment and capital returns. Such a change would have profound relevance for both foreign direct investment and domestic locational choices. The U.S. would become the most attractive jurisdiction in the world from which to export, attracting both foreign direct investment and domestic investment to base operations here. This, of course, satisfies the fundamental policy goal of those who are considering a territorial taxing regime for the U.S., as many countries have adopted: that goal is to ensure that a choice between headquartering a company in the U.S. or overseas would not be influenced through the application of high U.S. marginal tax rates to global income with no connection to the U.S. save the fact that the location of the headquarters of the company. The FairTax provides the equivalent of a territorial taxing regime because it does not tax foreign sourced income at all, and therefore cedes taxing jurisdiction to the country of income source. But it improves upon this choice dramatically. The FairTax would not also encourage investment overseas as the territorial tax movement, by its own rationale, admits would occur. In fact, a zero rate of U.S. tax would give foreign jurisdictions two choices: Reduce their tax rate on savings and investment (which will stimulate global economic reform and growth) or lose investment to America. Companies now American in name only would repatriate investment and jobs back to our shores. Adoption of the FairTax would also end the problem posed by deferral – which imposes a penalty for repatriating income earned overseas. Companies here now in name only would repatriate investment and jobs back to our shores without penalty, since the earnings of subsidiaries would not be taxed to the parent at all and the taxes paid to foreign nations would not be limited by the complex foreign tax credit rules. And since the U.S. would not tax foreign returns to capital (as it would not tax U.S. returns) the U.S. market for investment in stocks, in business, in real estate and otherwise would effectively become the world’s largest tax haven for investment capital.

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Answering the Problem Posed by Border-Adjustable Tax Subsidies.-- There are two ways tax-writers could confront the reality of global border-adjustable taxes: (1) encourage our trade representatives and trading partners to allow income taxes to be border-adjusted, or (2) adopt our own destination-based consumption tax. The first will never happen. To get some sense of the Herculean task involved with the former tack, consider convincing the WTO’s Member countries to eliminate the admittedly artificial distinction now drawn by the WTO between direct taxes (income taxes) and indirect taxes (consumption taxes) on which their trade subsidies depend. These are the same nations willing to sue in international courts to get the U.S. to abandon its relatively minor export incentive worth about $4 billion annually (the Foreign Sales Corporations) so as to preserve for themselves this unilateral advantage. Even if such diplomacy were to miraculously prevail, eliminating the indirect/direct distinction would only countervail a sliver of the trade subsidy, and then only for exporters. If the direct/indirect distinction were fully eliminated, an export subsidy would only allow exporters to defer or exempt a portion of their income tax, when payroll taxes constitute about 36 percent of the gross collections by type of tax. And lest we forget, since America has record trade deficits, this does nothing to level the playing field on imports which continue to compete against domestic producers unfairly on our own soil. The best alternative is to enact what the rest of the world has enacted – a destination-principle tax system (also known as a border-adjusted tax system) – that incorporates our entire tax burden. We need to move to a tax system that taxes all goods consumed in the U.S. alike, whether the goods are produced in the U.S. or abroad. We need to eliminate those aspects of the U.S. tax system that artificially place U.S. production at a competitive disadvantage compared to foreign production. How would the FairTax accomplish this full-scale border adjustability? As an indirect tax, fully WTO-compliant, the FairTax would: • repeal all upstream federal taxes now embedded in the product price of U.S. goods and eliminates

any business-to-business taxes, including payroll taxes, • completely exempt foreign consumption from taxation. Only goods and services for final retail sale

in the U.S. are taxed, and • impose the FairTax on foreign goods entering our shores for final consumption.

Recall the table above which showed the unfair application of foreign and U.S. taxes on exports and imports restively. In essence, under current law, foreign and U.S. taxes are doubly imposed on goods produced in the U.S., while imports that compete against U.S. produced goods are exempted from taxation. Now consider how under the FairTax, the table would look entirely neutral as to whether foreign or U.S. goods were consumed here or abroad.

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The U.S. Tax System under the FairTax

Sold in U.S. market Sold in foreign markets U.S. production Pays the FairTax. Pays foreign value-added tax Foreign production

Is exempted from the source country VAT, but pays the FairTax

Pays foreign value-added tax

Conclusion Only the FairTax plan can claim that under its regime, foreign manufactured goods and U.S. manufactured goods will pay the same tax when the goods are sold at retail. Only the FairTax can make the claim that U.S. businesses selling goods or services in foreign markets will be fully relieved of federal tax (including payroll taxes). What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR25/S13) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system.

What is Americans for Fair Taxation® (FairTax.org)? FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX.

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Why retailers should support the FairTax Retailers are more profitable under the FairTax.

• Like other firms, retailers enjoy a zero corporate tax rate and their shareholders are not taxed on dividends or capital gains on their investments.

• Administering the FairTax is less costly than what retailers must be today. It provides a net

reduction in paperwork and overhead by the elimination of federal income tax withholding and payroll tax deductions for employees, corporate taxes and associated corporate tax planning, record keeping, compliance, and litigation; though such burdens for their ongoing collection of sales taxes may increase slightly. Only four states do not currently require sales tax collection.16

• Administering the FairTax is less costly than what retailers must do today. The record keeping and reporting requirements for retail businesses are simpler for a sales tax, compared to the current federal income/payroll tax system.

• The FairTax provides that retailers receive ¼ of one percent of gross collections as compensation for administrative expenses, including point-of-purchase software upgrades (Total payments to retailers are estimated to be in excess of $5 billion based on 2007 consumption).17

• Business compliance costs estimated to be $161.7 billion18 are lowered by a 95 percent.19

16 New Hampshire, Oregon, Delaware and New Mexico. Alaska has 89 municipalities that impose a sales tax; whereas, Delaware and New Mexico impose gross receipts taxes on businesses which resemble sales taxes since the tax is generally passed on to consumers. 17 Bachman, Paul, Jonathan Haughton, Laurence J. Kotlikoff, Alfonso Sanchez-Penalver, and David G. Tuerck, “Taxing Sales under the FairTax: What Rate Works?” published in Tax Notes, November 13, 2006. http://www.beaconhill.org/FairTax2006/TaxingSalesundertheFairTaxWhatRateWorks061005.pdf 18Laffer , Winegarden, and Childs, “The Economic Burden Caused by Tax Code Complexity, April, 2011.

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The economy grows, more people have jobs, incomes increase more rapidly.

• Those taxpayers receiving a payroll check benefit from higher disposable income from the first day under the FairTax, due to the repeal of the payroll tax in its entirety. Studies estimate the increase in wages to be at least ten percent.

• All known economic projections predict a much healthier economy.20 People are willing and able to purchase more goods and services in a healthy economy. Typical estimates are that the economy is 7 to 14 percent larger within 10 years and consumption grows substantially. Some studies show the potential gains to be much higher.21 Real wages increase. Retailers make more money in a prosperous, growing economy.

• Research predicts consumption increases by 2.4 percent more in the first year than it would if the current system were to remain in place. By the 10th year, consumption increases by 11.7 percent over what it would be if the current tax system remained in place, and disposable income is 11.8 percent higher.22

§ This increase in consumption is fueled by a 1.7 percent increase in disposable (after-tax) personal income once the FairTax is enacted which grows to an 11.8 percent increase by the tenth year.

• Consumer interest rates fall dramatically, between 25 to 30 percent thereby increasing consumer’s ability to finance consumption.23 Since consumer interest is not deductible under present law; the effect of lower interest rates strongly and positively impacts credit card or consumer loan-financed purchases.

• The FairTax plan provides a prepaid monthly rebate of taxes (prebate) to every registered household to cover the consumption tax charged on their spending up to the federal poverty level ($31,020 for a family of four). Likewise, Social Security benefits are adjusted to preserve their purchasing power.

• Corporate income and employer payroll taxes are embedded in the price of everything we buy. Once these taxes are repealed, marketplace competition and the lower cost of doing business should drive down pre sales-tax prices..

19 Hall, Arthur P., “Compliance Costs of Alternative Tax Systems II,” The Tax Foundation, Special Brief, House Ways & Means Committee Testimony, March 20, 1996. He estimated that under a national retail sales tax compliance costs would decline by 95 percent. 20 For a brief summary of findings, see Research Summary, the Impact of the FairTax on the Economy. http://www.fairtax.org/PDF/SummaryOfTheFairTaxOnTheEconomy.pdf 21 Arduin, Laffer, and Moore Econometrics LLC, A Macroeconomic Analysis of the FairTax Proposal, July, 2006 at http://www.fairtax.org/PDF/MacroeconomicAnalysisofFairTax . To the extent that higher productivity growth is linked to higher capital accumulation (a likely scenario), the growth effects will be even greater. For instance, if the larger accumulation of capital induces a one-quarter percent increase in productivity growth, total economic output in year ten would be 19.4 percent greater than the baseline scenario as opposed to 11.3 percent. In addition, the GAO has cited estimates that efficiency costs associated with our current tax system are 2 percent to 5 percent of GDP. To the extent the FairTax reduces these efficiency costs, a likely supposition, economic growth can be further enhanced by up to 16.3 percent above the baseline scenario. Combining these two impacts, the FairTax increases economic growth by up to 24.4 percent greater than the baseline scenario by year ten. 22 Arduin, Laffer & Moore Econometrics, ibid. 23 Golob, John E., “How Would Tax Reform Affect Financial Markets?” Economic Review, Federal Reserve Bank of Kansas City, Fourth Quarter, 1995. He estimates a 25 to 35 percent drop (p. 27). See also Hall, Robert E. and Alvin Rabushka, The Flat Tax, Second Edition, Stanford, California: Hoover Institution Press, 1995.

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Uniform tax treatment of all retailers. § The FairTax base is final consumption, i.e. retail sales to the end users of all new goods and

services. It levels the playing field between service-providing businesses and goods-producing businesses, and treats all retailers the same regardless of their mode of distribution – in-store, catalog, or online.

§ All sales to end user consumers residing in the United States, by Main Street retailers and online vendors, are taxable; thereby eliminating the economic distortion caused by differential treatment under current law.

• Direct mail and e-commerce sales from out-of-state sources are, in practice, rendered tax-free because state use taxes are poorly enforced. Under the FairTax, all retailers must collect the tax on all sales to persons residing within the United States.24

• States that choose to conform to the FairTax federal tax base have the added advantage of information sharing and clear interstate revenue allocation rules. The ability for the states to collect these heretofore uncollected taxes is a major incentive for states to conform their sales tax to the FairTax base. Retailers suffering from tax-free direct mail competition or internet sales by out-of-state retailers see a major competitive disadvantage eliminated.

Complying with the federal tax system becomes much simpler.

• Instead of having to comply with the complexities of the income tax and payroll tax, there is one national retail sales tax on all goods and services. The retailer simply calculates its total gross payments (retail sales plus federal sales taxes) on a monthly basis.

• No more uniform inventory capitalization requirements.

24 Although state sales and use taxes are owed on all online transactions, states are prohibited from requiring remote sellers to collect and remit those levies. A 1992 U.S. Supreme Court decision (Quill Corporation v. North Dakota, 112 S.CT. 1904) said states can only require sellers that have a physical presence or nexus in the same state as the consumer to collect so-called use taxes. When a seller does not have nexus, consumers are required to calculate and remit the taxes owed to their home states at the end of the year; however, most people are unaware of this and states lack an effective enforcement mechanism. Online and catalog sellers, thereby, have a significant price advantage over Main Street (tax-paying, community-based) businesses and other traditional retailers that must collect a sales tax on all transactions.

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• No more complex rules governing employee benefits and retirement plans.

• No more tax depreciation schedules.

• No more tax rules governing mergers and acquisitions.

• No more international tax provisions.

• Over time, most states will conform their sales taxes to the FairTax, reducing the costs of complying with multiple rules in each state and its political subdivisions.

• The retailer’s accounting, tax, and personnel (human resources) departments shrink dramatically.

The bottom line: BottomThe FairTax is a win for wage earners. For business. For retail. The FairTax is a win-win for both businesses and wage earners. People will choose to work more, earn more and spend more because marginal tax rates are so much lower. The economic pie will be bigger so even though people will save a higher proportion of their income, the amount of income that is spent will increase. Second, we do not live in a closed economy. Because the FairTax eliminates taxes on capital, foreign capital will flow into the United States to finance increased investment, creating businesses and jobs. What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR 25 / S 122) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system. What is Americans for Fair Taxation® (FairTax.org)? FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX.

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The impact of the FairTax on American manufacturing, agriculture, trade, and

international competitiveness The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll taxes with an integrated approach including a progressive national retail sales tax, a rebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar revenue neutrality, and through companion legislation, the repeal of the 16th Amendment. The FairTax plan reduces the cost of American manufacturing and agriculture considerably. Under the FairTax, American manufactured or grown goods and services no longer enter the marketplace burdened with hidden corporate taxes, the cost of compliance with such taxes, and Social Security employee matching. This amounts to an average cost reduction from 12 percent to in some cases more than 25 percent. Said another way, American goods become 12 to 25 percent more competitive.

This nonpartisan legislation (HR 25 / S122) abolishes all federal personal, gift, estate, capital gains, alternative minimum, Social Security, Medicare, self-employment, and corporate taxes and replaces them all with one simple, visible, federal retail sales tax – collected by existing state sales tax authorities. The FairTax taxes us only on what we choose to spend, not on what we earn. It is a tax on wealth, not wages. It does not raise any more or less revenue; it is designed to be revenue neutral. How do U.S. goods incur federal taxes today, while imported goods do not? Let’s buy a bottle of California wine. Or a Boeing 787. Or some Kansas wheat. Or a Caterpillar D11T dozer. Or some consulting services from PricewaterhouseCoopers. While your invoice will not show it, included in the cost you’ll pay is your share of each provider’s corporate income taxes. And you’ll pay for the tax department, accounting firms, and law firms that figure those taxes and defend the audits or lobby tax-law loopholes. While the taxes themselves can go below zero in a bad year, those compliance costs just keep on toting up. And then there is the matching of each employee’s Social Security contribution.

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In the price you pay are all three costs (taxes/compliance/matching) for the company that provides the glass bottles containing the wine. And the cork provider. And the label printer. And the label ink supplier. And the label glue manufacturer. And the tires on the 737. And the fertilizer for the wheat. And the paint on the dozer. And the Iphones and Ipads carried by your PricewaterhouseCoopers consultants. Whether these products and services are provided here in the U.S. or exported, the purchaser is going to pay all of these costs, along with the actual cost of the product, its marketing, and delivery. Why do American companies move offshore? Antipatriotism or to meet shareholder demand for competitive returns in an ever-less-forgiving world? Further exacerbating this crippling tax burden on American producers is the fact that U.S. corporate taxes are the highest in the industrialized world, with a top corporate rate about nine percentage points higher than the OECD25 average.26 These taxes also rank among the most complex and least stable or predictable, thanks to the incessant work of an army of lobbyists. This drives huge and ever-increasing compliance costs. To the extent that these corporate and payroll taxes and compliance costs imposed on producers and workers have forward incidence (econospeak for “the consumer pays”) and remain embedded in producer prices, relative prices of goods and services go up in the global marketplace. The only alternative left to producers is to make dispassionate decisions about where to produce or invest. That all too often means moving offshore. Now let’s buy some French champagne. Or an Airbus A300. Or some Argentinean wheat. Or a Komatsu D21A-7 dozer. Or some consulting from France’s SOFRECO. While your invoice as a U.S. purchaser will not show it, these providers incurred value-added taxation (VAT) all along the way, which was rebated upon export. Local users pay these hidden taxes; as a U.S. recipient, you do not. When such products arrive here in the U.S., their prices do not include any country-of-origin taxes. There are compliance costs. Sitting side by side, the hidden hand of Uncle Sam raises the price of American goods worldwide, while goods imported into our country bear no such burden from their governments.

It is estimated that border-adjustable tax regimes – virtually the entire world outside of the U.S. – effectively grant their producers an 18-percent price advantage over U.S. produced goods, whether competing here or abroad.27 Since effectively all of our trading partners have such border-adjusting systems, our failure to follow suit results in the equivalent of a self-imposed handicap, stimulating international outsourcing, encouraging plant relocations offshore, and lowering the wages of remaining American workers. A recent report by MIT Professor of Economics Jerry Hausman states that the

25 Organisation for Economic Co-operation and Development (www.oecd.org) 26 Sullivan, Martin A., “On Corporate Tax Reform, Europe Surpasses the U.S.,” Tax Notes, May 29, 2006. If you compute the EU average for each year, you will find that it has declined from 35 percent in 1996 to 26 percent in 2005. 27 Hartman, David A., “The Urgency of Border-Adjusted Federal Taxation,” Tax Notes, September 6, 2004. Conversely, in U.S. markets foreign goods bear no U.S. tax and the foreign VAT is forgiven. Thus, among the most manifest violations of neutrality in the U.S. tax system is that it places U.S. producers – including businesses and workers in manufacturing, agriculture, mining, and forestry – at a large competitive disadvantage relative to their foreign competitors both in U.S. markets and in foreign markets. If Professor James R. Hines, Jr. were to add one more neutrality dynamic to the CEN, CIN, NN, CON, and NON, he might add the notion of Export Import Neutrality, which would integrate not only marginal rates of production but whether or not a consumption tax system treats exports and imports alike in the marketplace. Only a destination-based system can achieve such neutrality.

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U.S.’s failure to recognize and confront this problem costs us more than $100 billion in exports

annually.28

Border-adjustable taxes are consumption taxes that are removed/rebated upon the export of goods from producing nations. Such nations reciprocate when importing, assessing incoming goods with ad valorem29 taxes. Today, 29 of 30 OECD nations have border-adjustable tax regimes; only the U.S does not. By failing to respond, the net effect is the export of both jobs and entire industries. The FairTax levels the playing field. Under the FairTax, imported goods and domestically produced goods incur the same U.S. tax. This stands in stark contrast to the present system, where U.S. companies and workers must pay income tax and payroll taxes, but foreign goods enter the U.S. entirely free of any tax, other than whatever modest customs duties are levied. The FairTax is inherently border adjusted.30 U.S. exports are not taxed since they are not sold at retail in the U.S., but imports are taxed when sold at retail in the U.S. or when brought into the U.S. by a consumer.31 The FairTax is GATT compliant. Under the General Agreement for Tariffs and Trade (GATT), indirect taxes, such as VATs or the FairTax, may be border adjusted, while a direct tax, such as the U.S. income tax, may not. Since the FairTax is indisputably an indirect tax, this border-adjustment feature poses no difficulty in implementation or legal compliance.

28 Hausman, Jerry, “Hausman Study Shows Distortions in International Trading System Hurting U.S. Manufacturers: An Economic Analysis of WTO Rules on Border Adjustability of Taxes,” May 2006. 29 ad valorem - A tax, duty, or fee that varies based on the value of the products, services, or property on which it is levied; a sales tax. 30 Border adjustment is commonly used to describe a feature of most value-added tax (VAT) systems in use today. Such VATs, unlike retail sales taxes, impose a tax at every stage of production, with each new stage reimbursing the prior for taxes it paid. If retailed within a domestic economy, the full tax buck stops with the end user paying the entire tax burden. However, if exported, such taxes are often rebated to achieve a zero tax rate on exports. This is called border adjustment. Because the FairTax does not impose any tax on goods (or services) not sold at retail, including exported goods, there is no need for a border tax adjustment, though the net effect on prices is similarly positive. 31 As with domestically produced goods, imported capital goods and other business purchases are not taxed immediately. But the output of goods produced by capital goods is ultimately taxed when consumption goods are produced and sold at retail.

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Many observers – and unemployed or underemployed American manufacturing workers – take the position that this border adjustment gives foreign firms a large advantage. Since their goods do not include the full burden of their domestic governments in their prices, while U.S. goods and services do, some consider this unfair, or at least uncompetitive. Most business leaders would agree. Professional economists are divided. Some agree. Some argue that foreign exchange rates change in response to border tax adjustment, and little competitive advantage is provided to imports.32 The flight of U.S. jobs would appear to provide all-too-real disagreement with this theoretical viewpoint. Others argue that in the short term, imports (i.e., the traded goods sector) gain an advantage that evaporates over time.33 None argue that failure to reciprocate with a border tax adjustment has an adverse impact on the U.S. manufacturers, farmers, or service providers. Interest rates and currency trading are the significant factors in exchange rates; increased demand for American goods and services is not. There are many things that affect foreign exchange rates. Expectations about interest rates and inflation rates in the two countries are the most important. The magnitude of currency traded by banks, other financial institutions, governments, and private currency traders dwarfs the amount of currency bought and sold because of international trade. The magnitude of currency trading is vast compared to the small amount of excess demand caused by the U.S. trade deficit and changes in that deficit. It is, therefore, far from clear that the changes in exchange rates generated by an increased demand for U.S. goods would cancel out the improvement in the competitiveness of U.S. produced goods caused by the “border-adjustment” feature built into the FairTax. A recent study by Professor Hausman found that:

• Existing disparities in treatment of corporate income taxes and VATs for purposes of border adjustment lead to extremely large economic distortions.

• U.S. exporters suffer both domestic income taxes and foreign VATs when selling abroad. • Foreign exporters in countries relying largely on VATs typically receive a full rebate of such

taxes upon export to the U.S., and are not subject to U.S. corporate taxes when sold here. • This situation creates a very significant tax and cost disadvantage for U.S. producers in

international trade with significant impact on investment decisions – leading to the location of major manufacturing and other production facilities in countries that benefit from current rules on the border adjustment of taxes.

• The adverse economic implications for the U.S. are very large. Ask someone from Michigan. • Elimination of the current disparity in WTO rules (by eliminating border adjustment for either

direct or indirect taxes) would increase U.S. exports by 14 to 15 percent, or approximately $100 billion based upon 2004 import levels.

• Eliminating such economic distortions should be a high priority.

32 See Feldstein, Martin and Paul Krugman, “International Trade Effects of Value Added Taxation,” in Taxation in the Global Economy, Assaf Razin and Joel Slemrod, eds., Cambridge, Massachusetts: National Bureau of Economic Research, 1990, pp. 263-282. 33 Hufbauer, Gary Clyde and Joanna M. Van Rooij, U.S. Taxation of International Income: Blueprint for Reform, Washington, D.C.: Institute for International Economics, 1992; Hufbauer, Gary Clyde and Carol Gabyzon, Fundamental Tax Reform and Border Tax Adjustments, Washington, D.C.: Institute for International Economics, Policy Analyses in International Economics 43, 1996; Raboy, David G., “International Implications of Value Added Taxes,” in Value Added Tax: Orthodoxy and New Thinking, Murray Weidenbaum, David G. Raboy, Ernest S. Christian, Jr., eds., St. Louis, Missouri: Center for Study of American Business/Kluwer, 1989, pp. 131-162.

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In sum, Professor Hausman agrees that exchange rates are not likely to counteract the relative

price advantage of foreign produced goods. To be fair, there are three ways to pay the extortion of our corporate income tax and Social Security systems. Increasing prices is only the first and most obvious way to pay the piper. But sometimes competition limits the raising of prices. This causes providers to seek lower labor costs. Efficiency takes some jobs, and it should. But then jobs move overseas. Finally, with prices as high as possible and labor costs as low as possible, reducing profits to owners/shareholders is the final means to remain competitive. Domestically, higher prices are a huge burden to the least affluent Americans, including retirees on fixed incomes. Lower labor costs hit our least affluent sector hardest as well. But when it comes to export/import tax imbalances perpetrated by current federal tax policy, the job losses have a corrosive effect throughout every sector of our labor market. Then, when it comes to reducing profits to shareholders, the losers are extended to union, public employee, and corporate pension funds as well as the cliché wealthy widows. Clearly, being directly competitive benefits all levels of our society. These are real problems, not esoteric discussions by economists. The FairTax brings more and better jobs to the U.S. Perhaps a more fundamental issue is the overall impact that the FairTax has on the competitiveness of U.S. industry. U.S. businesses are much less likely to locate their plants or corporate headquarters overseas, and foreign companies come to the United States in droves. Americans are employed building these new plants; Americans are employed in the new plants.34 Compliance costs evaporate under the FairTax. American firms no longer face crushing income tax compliance costs, costs that exacerbate years with no profits. Costs that have no exchange value in the international economy, or any economy for that matter. Costs that amount to make-work to the tune of at least $430.1 billion each year, as much as three percent of the American gross domestic product annually. Costs that disproportionately burden small business, the biggest job producer. Under the FairTax, this much sand is removed from the gearbox of the American economy. This much friction evaporates. Under the FairTax, the U.S. becomes a manufacturing haven improving on the Irish model35 and a tax

34 The U.S. capital surplus cannot increase while the current account deficit simultaneously falls. These two quantities must be equal (but of opposite signs). The current account balance is equal to merchandise exports, minus merchandise imports, plus net military transactions, plus net travel and transportation receipts, plus receipts on U.S. assets abroad, minus payments on foreign assets in the U.S., minus foreign aid and other gifts. The difference between merchandise exports and imports is the widely reported merchandise trade deficit (surplus). The capital account balance is the net change in U.S. assets abroad (minus equals outflow), plus the net change in foreign assets into the U.S. (plus equals inflow). Private assets dominate the figures, but government reserve assets and other government assets are included. A capital surplus requires an equal current account deficit. A capital deficit requires a current account surplus. A capital surplus is when foreigners are investing more here than we are investing abroad. Foreign investment may be loans to the U.S. Imports in the merchandise trade accounts may be capital equipment. It is likely that the FairTax causes a capital surplus that consists more of direct investment than lending funds. It is also probable that the FairTax increases the proportion of capital goods as a share of total imports. 35 The Effective Tax Rate for U.S. Companies among the Highest in the World, Tax Foundation, Sept. 13, 2011. http://taxfoundation.org/article/effective-tax-rate-us-companies-among-highest-world

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haven improving on the Cayman Islands model.

The cost of capital is much lower. Banks’ costs are reduced by about 25 percent. And the huge pool of U.S. firms’ profits currently trapped offshore comes home, putting substantial downward pressure on interest rates simply due to the availability of capital. Firms producing here do not pay taxes on their profits, unless an American owner’s profits are used to fund consumption, or a foreign income tax imposes taxes on a foreigner’s income earned here. The United States is the most attractive place to build plants in the world. Our sound political and economic system, educated workforce, unparalleled infrastructure, large domestic market, and − once the FairTax tax is passed − extremely attractive tax system draws capital to, and keeps capital in, the United States. The giant sucking sound is job-producing and productivity-enhancing capital flowing to the United States from throughout the world. The FairTax has broad impact. In conclusion, the income and Social Security tax systems have a broad and universally negative affect on the American society as a whole. The power to tax is the power to destroy. The FairTax has an equally broad impact, though positive. This is a tax through which the individual has the ultimate power to be taxed – or not. To control the amount of taxation with each purchase. And to avoid taxation altogether, should they chose to live very modestly – at or near the federally mandated poverty level. Besides the multitudinous jobs this returns to American workers, it also reestablishes civil liberties with equal, if not greater, quantity. And this freedom, if perhaps esoteric, may be more important than the tangible result of a good job. What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR25/S122) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered

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primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system. What is Americans for Fair Taxation® (FairTax.org)? FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX. Authored by Karen Walby, Ph.D., Chief Economist, Americans For Fair Taxation, 2007. Updated March, 2013. (AFFT Documents\Papers on a specific subject\explanation of prebate)

The FairTax lowers the true cost of a new U.S. produced automobile Background Because the FairTax is a single-stage consumption tax, supporters of a double and treble tax on savings, investment, and exports (our current income tax) would assert that the cost of an automobile would go up by the amount of the FairTax rate. This is not only wrong, it is dead wrong. Automobiles are the second most expensive purchase a family can make beyond a home, yet today we penalize the purchase of U.S. made automobiles. We impose taxes on labor and on capital that literally bury tax costs upstream in the production costs of the vehicle. We subsidize foreign competition by allowing foreign produced automobiles to enter our shores without imposing any U.S. tax, while the foreign governments rebate their taxes (at about 18 cents per dollar on the average) at their border. At the same time, we punish exports with U.S. labor content by imposing heavy taxes which are not, and cannot be, rebated at the border. And to claim that the price of an automobile would rise under the FairTax also fails to understand how the FairTax actually lowers the costs to a consumer of buying a U.S./UAW made automobile by reducing the carrying costs of the debt. The FairTax greatly benefits the industry, and U.S. producers and workers in particular.

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What the FairTax does not do – raise the price of the automobile to the consumer Even if the automakers are not making a profit and therefore do not pay taxes at their entity level, the subcontractors, labor, and the many component parts industries do pay taxes. And they do bear considerable compliance costs. Indeed, the current system alone imposes compliance costs of an estimated $265 billion, which is a dead-weight inefficiency buried in the price of each good and service Americans buy.

And to the extent the prices of goods and services reflect these tax costs, sellers push these costs forward in the product and service prices. In other words, the prices we pay today at the retail level – for instance, the price at a car dealership – reflect the hidden content of taxes and compliance costs imposed upstream. With the FairTax, these costs disappear, and with it, the prices will decline.

Those who support the income tax – and in fact want to continue to impose unnecessary costs on

the economy by complicating it further – make the claim that the FairTax would increase the costs of consumer purchases, such as automobiles. This logic, however, assumes that the price of automobiles would not decline by the repeal of corporate taxes, payroll taxes, and capital gains taxes and administrative costs that automobile manufacturers bear today. They believe the forgiveness of tax at the business level would simply be turned into additional profit when those taxes are repealed, rather than passed along in the lower price of vehicles. However, U.S. automakers know firsthand how competitive is the marketplace. Competition will drive prices downward simply because of the taxes the automobile manufacturers no longer face. What the FairTax does – make automobiles more affordable Interest carrying costs decline. While economists can dicker over how much producer prices – and therefore the costs of the vehicle – will fall, one factor is indisputable: The purchasing costs to U.S. consumers will decline about 10 percent because of the effect on interest. The key question to ask is this: How much would an American wage earner have to earn to buy an automobile under the FairTax versus the income tax? The answer is: A whole lot less than today.

Consider the following math (shown in the table below). Using a down payment of 10 percent (which is a conservative assumption), and assuming that the owner paid 7.65 percent payroll taxes and was in the 28 percent marginal tax rate bracket, let us see how purchasing a new car becomes more affordable under the FairTax.

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Actual cost of purchasing a new car (Wages that must be earned to buy new car)

Components of new car cost Current tax system

FairTax system

(25% Interest rate drop)

NADA average vehicle price* $30,659 $30,659 Down payment of 10% $3,066 $3,066 Auto loan amount $27,593 $27,593 Interest rate** 4.04% 3.03% Interest paid at above rate for 48 months $2,336 $1,741 FairTax on new car purchase — $9,198 Income tax on interest $654 Payroll tax on interest $179 Payroll tax on principal $2,345 Income tax on principal*** $8,585 Total taxes $11,763 $9,198 Total new car cost including taxes $44,758 $41,597

Percent difference -7.06% *NADA DATA 2012, new vehicle average selling price for 2011. **National new auto loan rates for April 4, 2013, www.bankrate.com. Interest rates will drop by 25% under FairTax. ***Assumes purchaser is in the 28% income tax bracket.

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First, look at the current system. Today, a worker must earn $44,578 to be able to pay for the

average new vehicle sold in 2011 (according to NADA) because in order to do so, he first had to give the federal government $11,763 in payroll taxes and income taxes. This leaves $2,336 to pay the interest on the loan and $30,659 for the price of the car. Under the FairTax, our buyer only has to earn $100 to spend $100 – no income taxes or payroll taxes are deducted from his or her wages. The total cost of purchasing the car is $41,597 which includes the price of the car at $30,659 plus total interest of $1,741 and the FairTax of $9,198. This is 7.06% percent less than today, even after the sales tax is added on! The cost savings increase to 12.02% percent if the car buyer is self-employed and pays 15.3 percent payroll taxes (both the employer and employee share) instead of 7.65 percent.

A major cost component of an automobile for a consumer is interest. The FairTax results in interest cost savings on the purchase of a new car in two ways. First, under the FairTax interest rates will decline from their level under an income tax. Interest rates will fall 25 to 35 percent under a consumption tax like the FairTax.36 Rates will drop immediately and quickly toward the current tax-exempt rate. Investors will no longer need to receive a tax premium to achieve a particular after-tax rate of return. The impact of eliminating this “tax wedge” or tax premium on interest can be seen every day in The Wall Street Journal. Tax-exempt municipal bonds tend to yield about 30 percent less than taxable corporate bonds of similar term and risk. 36 For a more detailed discussion of the impact a national sales tax would have on interest rates, see Golob, John E., “How Would Tax Reform Affect Financial Markets?” Economic Review, Federal Reserve Bank of Kansas City, Fourth Quarter, 1995. He estimates a 25 to 35 percent drop (p. 27). See also Feldstein, Martin, “The Effect of a Consumption Tax on the Rate of Interest,” National Bureau of Economic Research, Working Paper No. 5397, December, 1995.

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Second, the taxpayer can use his or her complete earnings to pay for the interest. Using pre-tax

earnings to pay for the interest on a new vehicle is analogous to the home mortgage deduction where home purchasers can deduct interest paid. Deducting interest paid on home purchases is the tax code’s attempt to allow interest to be paid with pre-income tax dollars. Since interest payments are not taxed first under the FairTax, the FairTax extends what is essentially the treatment of home mortgage interest to car buying. But it takes it one step further, granting what would be the equivalent today of a sort of supercharged interest deduction. That is because the mortgage interest deduction does not allow a deduction of such interest against payroll taxes (which three-quarters of Americans pay more of than income taxes). The FairTax allows interest for a new car to be paid before any tax, either payroll or income taxes, further reducing the actual costs of buying a car. Removes the subsidy on foreign vehicles Today, we have a tax system that remarkably subsidizes foreign content vehicles, assisting Japan, Germany, and others in competing against the American worker. How do we do so? By doing nothing to counter the fact that foreign countries rebate their taxes on exported items before they enter our shores and impose an ad valorem tax on U.S. goods.

The U.S. should not grant an advantage to foreign companies competing in the U.S. market or impose a disadvantage on American producers and workers selling their goods and services in the U.S. and foreign markets as we now do as a matter of policy. Foreign VATs, which are a major component of the total revenue raised elsewhere, are rebated when foreign goods are exported to the U.S. market. Conversely, the U.S. tax system imposes no corresponding tax burden on foreign goods sold in the U.S. market. The U.S.’s failure to answer with an ad valorem tax or to remove the tax on exports creates a large and artificial relative price advantage for foreign goods, in both the U.S. market and abroad. The table below illustrates the penalty U.S. producers pay in taxes.

Advantage for foreign producers

Origin Sold in U.S. market Sold in foreign markets

U.S. production Pays U.S. income and payroll taxes

Pays U.S. income and payroll taxes and foreign VAT

Foreign production Pays no U.S. income or payroll tax and no foreign VAT Pays foreign VAT

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Indeed, it has been estimated that border-adjusted regimes effectively grant foreign producers an approximately 18 percent price advantage over U.S. produced goods, whether competing here or abroad.37 Since virtually all our trading partners have such border-adjusted regimes, our failure to follow suit results in the equivalent of a self-imposed handicap, stimulating outsourcing, encouraging plant relocations, and lowering the wages of American workers. A recent report by Jerry Hausman, Massachusetts Institute of Technology Professor of Economics, states that the U.S. failure to recognize and confront this problem costs us more than $100 billion in exports annually.38

Our failure to counteract these border-adjusted taxes explicitly encourages consumption of

foreign, rather than American, automobiles. And it converts many of our nation’s retailers into what are effectively tax-free trade zones for foreign produced cars.

In effect, the U.S. tax system is distorting the international marketplace and literally driving

plants and good jobs out of this country at a devastating and unsustainable pace.

With each passing year, manufacturing has become an ever-decreasing part of the overall economy. Consider that the value of all goods manufactured in the U.S. was roughly 30 percent of the value of all goods and services in the economy in 1953, 25 percent in 1970, 20 percent in 1982, and it fell to 11.5 percent in 2008. The share of the U.S. labor force working in the manufacturing sector fell over the same period from 30 percent to about 9 percent in 2009. Thus, today manufacturing represents less than half of what its share of Gross Domestic Product (GDP) was in the 1950s. Real wages in manufacturing have fallen because the demand for labor has gone overseas. Makes the U.S. the haven for manufacturing Finally, the FairTax will help the autoworkers in one other significant way. The FairTax will make the U.S. the manufacturing capital of the world by being the only industrialized nation with a zero rate of tax on manufacturing and hiring U.S. workers. It will stimulate greater investment, which is the lifeblood of manufacturing; it will exempt all taxes from exported domestically manufactured goods, but tax imports placing them on a level playing field with domestically produced goods; and it will reduce the price of automobiles to the American consumer. A better system would be impossible to design for U.S. autoworkers.

37 Hartman, David A., “The Urgency of Border-Adjusted Federal Taxation,” Tax Notes, September 6, 2004. Conversely, in U.S. markets foreign goods bear no U.S. tax and the foreign VAT is forgiven. Thus, among the most manifest violations of neutrality in the U.S. tax system is that it places U.S. producers – including businesses and workers in manufacturing, agriculture, mining, and forestry – at a large competitive disadvantage relative to their foreign competitors both in U.S. markets and in foreign markets. If Professor James R. Hines, Jr. were to add one more neutrality dynamic to the CEN, CIN, NN, CON, and NON, he might add the notion of Export Import Neutrality, which would integrate not only marginal rates of production but whether or not a consumption tax system treats exports and imports alike in the marketplace. Only a destination-based system can achieve such neutrality. 38 Hausman, Jerry, “Hausman Study Shows Distortions in International Trading System Hurting U.S. Manufacturers: An Economic Analysis of WTO Rules on Border Adjustability of Taxes,” May 2006. .

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What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR 25 / S 122) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system. What is Americans for Fair Taxation® (FairTax.org)? FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX. Authored by Karen Walby, Ph.D., Chief Economist, Americans For Fair Taxation, 2007. Updated April 2013.

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Impact of the FairTax on Small Business

Small businesses create a large effect in the US economy. Nearly six million strong, small businesses (those employing less than 20 people), account for 90 percent of all US employers and employ over 20 million people, about 4.0 per business.39 All this, despite the adverse effects of the current tax system on small businesses. In the words of one small business owner: “Starting a small business means doing the one thing I love . . . and 99 that I hate. . . . A simpler, fairer, and growth-oriented tax code will ease the compliance burden on the small business owner – allowing them to again focus on the one thing they love.”40 Tax regulations create the most difficulty for small businesses. Small businesses spend on average $74 per hour to comply with the federal tax code – the most expensive paperwork burden imposed on small businesses by the federal government. No wonder a recent survey of National Federation of Independent Businesses membership found that 91 percent of businesses responded that they used a professional tax preparer: whereas a decade ago less than two-thirds used professional tax preparers. So it is not surprising that more small businesses identified taxes as the “single most important problem” they face. “Government regulation and red tape” came in second place. Most small businesses pay taxes via the individual income tax. Although many small businesses are not subject to the corporate income tax, the individual income tax affects most businesses in the United States. That is because business earnings are often paid through the individual income tax when “passed through” to business owners. The business income from sole proprietorships, S corporations, etc. is all taxed at the owners’ individual income tax rates. According to NFIB research, over 75 percent of small businesses are organized as S-Corporations, LLCs, LLPs, or Sole Proprietorships, known as pass-through businesses because they pay tax on business income through the individual income tax.41 Lowering corporate income tax rates does nothing to help reduce the tax burden on these businesses. Research suggests that across the board tax cuts, regardless of income level, would increase entrepreneurial start-up and survival.42

39 The Small Business Economy, 2012. US Small Business Administration, Office of Advocacy 40 Roger Harris, President of Padget Business Services, presentation to President’s Advisory Panel on Federal Tax Reform, March 8, 2005. 41 NFIB Small Business Tax Facts, April 18, 2011. 42 Donald Bruce, “Taxes and Entrepreneurial Endurance: Evidence from the Self-Employed,” National Tax Journal, 2002, Vol. 55(1): pp. 5-24.

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The FairTax plan (which replaces federal individual and corporate income taxes (including self employment taxes and the alternative minimum tax), the payroll tax, and the estate and gift tax with a single rate, simple national retail sales tax on the retail sale of all goods and services) dramatically improves the economic environment for small businesses. It reduces compliance costs and tax burdens and improves bottom line profits. Under the FairTax, small business enjoys a zero tax rate. And compliance costs plummet dramatically. Corporations, subchapter S corporations, partnerships, limited liability companies, and sole proprietorships pay no tax on their income. Both the employee and employer share of payroll taxes, the self-employment tax rate, and the estate and gift tax are abolished.

Income tax compliance costs are a much more substantial economic drag on small business than they are for larger businesses. According to the Tax Foundation, small businesses spend $724 to comply with the income tax for every $100 they pay in tax. More than 90 percent of all U.S. corporations have assets of $1 million or less and, therefore, bear tremendous relative compliance burdens. Small corporations bear a compliance cost burden about 27 times greater than the largest U.S. corporations, those with $10 billion or more in assets.43

Compliance costs vary dramatically even among small businesses when measuring business size by the number of employees. Businesses with 5 employees or less pay compliance costs of $7,274 per employee whereas business with 26 to 50 employees pay an average of $768.50 in compliance costs per employee.44

43“Federal Tax Compliance Costs Climb to $225,” Tax Features, Tax Foundation, March 1996, p. 3. 44 DeLuca, Donald, John Guyton, Wu-Lang Lee, John O’Hare, and Scott Stilmar. “Estimates of US Federal Income Tax Compliance Burden for Small Businesses.” Presented at 2007 National Tax Association Meetings. Columbus, Ohio.

$7,274.00

$2,155.00$1,348.50 $1,081.00 $768.50

$296.50$0.00

$1,000.00

$2,000.00

$3,000.00

$4,000.00

$5,000.00

$6,000.00

$7,000.00

$8,000.00

1 to 5 6 to 10 11 to 15 15 to 25 26 to 50 More than 50

Number of Employees

Income Tax Compliance Costs by Size of BusinessCost per Employee

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For the entire group of small business taxpayers, the same study found that compliance costs (at a time value of $45.40 per hour) are at most 1.6 percent of receipts, but are between 2.6 and 2.9 percent of asset value. At a 10 percent pretax yield on assets, this would be equivalent to a 26 to 29 percent additional tax rate on capital income. Thus, although compliance burdens on average do not add much to the price small businesses must charge their customers, they represent a significant additional “tax” on investment income. Moreover, there is significant variation within firms, with the very smallest firms bearing disproportionately higher burdens as a share of gross receipts.

A small business today must use tax accounting rules (which are different than generally accepted accounting principles) to keep track of: Income, inventories, various types of expenses (some deductible, some partially deductible, some not currently deductible and some never deductible), depreciation (which must be recorded in at least two ways for regular and alternative minimum tax purposes), tax basis for assets sold, various pension and deferred compensation rules (including participation, top-heavy and non-discrimination rules), various employee benefits rules, and so on. The small business must also keep track of payroll taxes, including Social Security, Medicare and unemployment taxes as well as file a plethora of information returns on its payments.

Under the FairTax, small business compliance costs drop dramatically because the only question

relevant for sales tax reporting purposes is “How much did you sell to consumers?” Period. Businesses that sell to other businesses would have virtually no compliance costs since intermediate business-to-business sales are not taxed under the FairTax plan. In addition, under the plan, retail businesses receive an administration fee that allows them to keep a portion of the sales tax they collect to compensate them for collection costs. The Tax Foundation estimates that overall compliance costs fall by more than 90 percent.45

Small businesses are found in service, retailing, and other labor-intensive industries. Both complying with and paying the payroll tax and the income tax impose a major burden on these small businesses. Moreover, the service sector and the retailing sector typically have much higher effective income tax rates than other businesses. Kill the estate tax. Each year, many small businesses and farms must be sold out of the family to pay estate and gift taxes when the founding generation dies. After a lifetime of hard work and risk-taking, the state and gift tax deprive the small business owner or family farmer of the right to pass his or her life’s work on from father and mother to son or daughter. The estate tax punishes those that save and work hard to build an enterprise. In contrast, those that deplete their estate by heavy spending in their retirement years pay little or no estate tax.

Under the FairTax plan, the estate and gift tax is repealed. The need for small businesses and farmers to engage in expensive estate planning involving attorneys, complex estate freeze transactions and expensive life insurance plans in anticipation of future estate and gift tax liability disappears.46

Heirs no longer need to sell the business or farm out of the family or borrow heavily, putting the business at risk, to pay the estate tax.

45 Ibid., page 2. 46 William W. Beach, “The Case for Repealing the Estate Tax,” The Heritage Foundation, August 21, 1996, estimates using both the Washington University Macro Model and the U.S. Macro Model of Wharton Econometric Forecasting that repeal of the estate and gift tax would increase Gross Domestic Product by $11 billion per year, create 145,000 new jobs, increase personal income by $8 billion per year and increase federal revenues marginally.

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The FairTax plan increases economic growth. Small businesses thrive in a healthy, growing economy but because of inadequate capitalization and lack of access to sufficient bank credit, they have much more difficulty in a stagnant or shrinking economy. The FairTax causes the economy to grow and become much more dynamic. The substitution of the FairTax for federal taxes on a revenue neutral basis has an immediate and powerful impact on the level of economic activity. GDP would increase by almost 10.5 percent in the first year.”47 Laurence Kotlikoff found that implementation of the proposed tax reform plan “raises the economy’s capital stock by 42 percent, its labor supply by 4 percent, its output by 12 percent, and its real wage rate by 8 percent. It also lowers real interest rates by more than one quarter.”48

The impact of increasing economic growth can be substantial. A 90 percent drop in compliance costs, equal to a $388 billion reduction in tax complexity, would increase GDP growth between 0.8 percent and 0.9 percent. An increase in annual GDP growth by just one percent has the potential, if continued for 10 years, to raise federal revenues and lower interest payments on the debt enough to balance the budget at the end of the 10-year period. For a brief summary of these research studies and others, see Research Summary: The Impact of the FairTax on the Economy, http://www.fairtax.org/PDF/SummaryOfTheFairTaxOnTheEconomy.pdf What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR25/S122) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system. 47David G. Tuerck, et.al., “The Economic Effects of the FairTax: Results from the Beacon Hill Institute CGE Model,” The Beacon Hill Institute at Suffolk University, February 2007. http://www.beaconhill.org/FairTax2007/EconomicEffectsFTBHICGEModel4-30-07.pdf 48 Kotlikoff, Laurence J.and Sabine Jokisch, “Simulating the Dynamic Macroeconomic and Microeconomic Effects of the FairTax,” National Tax Journal, June 2007. http://people.bu.edu/kotlikoff/FairTax%20NTJ%20Final%20Version,%20April%2024,%202007.pdf

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What is Americans for Fair Taxation® (FairTax.org)? FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX. Authored by Karen Walby, Ph.D., Chief Economist, Americans For Fair Taxation, 2005. Updated April, 2013.

The FairTax Benefits Seniors

The FairTax benefits seniors. Let’s count the ways:

1) The FairTax repeals the taxation of Social Security benefits and adjusts Social Security cost of living adjustment to preserve the purchasing power of social security benefits.

2) The FairTax ends gift and estate taxes, along with all of the unfairness to heirs and complex tax

planning for those who earned the money.

3) The FairTax ends all record keeping and income tax filings of any kind for seniors, totally insulating them from the high costs and abusive tactics of tax preparers.

4) The FairTax ensures Social Security’s soundness by funding it with a progressive, broad-based

national retail sales tax, rather than the current regressive, narrow payroll tax.

5) The FairTax prebate lets seniors purchase what they deem as living essentials tax-free up to the poverty-level. Used goods are tax-free as well.

6) The FairTax delivers a tax holiday on IRAs and other tax-deferred plans.

7) The FairTax allows seniors to sell their homes and pay no capital gains taxes.

8) The FairTax lowers average remaining lifetime tax rates.

9) The FairTax generates an economic boom, easing future budget pressure on Social Security and

Medicare.

10) The FairTax ensures your grandchildren have the same opportunity you did.

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Senior citizens are becoming a larger portion of the overall population and the vast majority of them are much better off under the FairTax. In 1970, those over 65 years of age were 9.8 percent of the population. By 2000, seniors were 12.4 percent of the population. In 2012, seniors made up 13.3% of the population, just shy of 42 million.49 The number of seniors 2030 is projected to be twice as large as their counterparts in 2000, growing from 35 million to 72 million and representing nearly 20 percent of the total U.S. population. From 2030 onward, the proportion age 65 and over will be relatively stable, at around 20 percent, even though the absolute number of people age 65 and over is projected to continue to grow.

As would be expected, the average household income of persons over 65 – retirees no longer in the workplace, for the most part – is about 64 percent of the average of all households.50 However, 6.7 million seniors or 16 percent are in the labor force. A smaller proportion of seniors are poor than in the population in general, 9 percent for seniors compared to 15 percent for the population in general.51 Complying with the current tax system is often more burdensome for persons after they retire than when they were working. Retirees turning to their savings and Social Security for income face new tax calculations and complications. Most withdrawals from individual retirement accounts and 401(k) plans are taxable. People over 70½ years old must take required minimum distributions – and usually pay tax as a result – even if they would have preferred not to. Furthermore, any income received over the course of the year, including those 401(k) and IRA distributions, affects whether taxes will be owed on Social Security

TP

49PT U.S. Census Bureau, Population Division, Table 3. Release date, December 2012.

T

50US Census, “Income, Poverty, and Health Insurance Coverage in the United States: 2010”, Sept., 2011, Table A-1. T

51Ibid.

9.811.3

12.5 12.4 13.0

16.3

20.3

0.0

5.0

10.0

15.0

20.0

25.0

1970 1980 1990 2000 2010 2020 2030

Seniors as a percent of total U.S. population

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benefits. In fact, even tax-free income from municipal bonds gets counted in that calculation. All of this affects the amount of money a retiree gets to keep. Many retirees find they need to make quarterly estimated tax payments to the Internal Revenue Service, something they may not have done in their working years.52 And the 16 percent who work will owe Social Security and Medicare taxes as well as income taxes on that income. Up to 85% of Social Security benefits can be taxed depending on how much income a retiree earns. They paid payroll taxes to receive those benefits and must pay taxes on the benefits! The FairTax repeals both income taxes and payroll taxes. 1) The FairTax repeals the taxation of Social Security benefits and adjusts Social Security indexing to protect seniors. The FairTax legislation totally repeals the current income tax on Social Security benefits. The FairTax legislation also adjusts the Social Security benefits indexing formula, commonly known as the cost of living adjustment or COLA, so that benefits increase to the extent, if any, that the federal sales tax results in higher costs to seniors. 2) The FairTax ends gift and estate taxes, along with all of the unfairness to heirs and complex planning for those who earned the money. Under the FairTax, gift and estate taxes are repealed. The need for small businesses and farmers to engage in expensive estate planning involving attorneys, complex estate freeze transactions, and expensive life insurance plans in anticipation of future estate and gift tax liability disappears.53 Heirs no longer need to sell the business or farm out of the family or borrow heavily, putting the business at risk, in order to pay the estate tax. Repeal of the corporate and individual income tax and the estate and gift tax has a substantial positive impact on the stock market.54 Those seniors who own stocks either directly or through mutual funds, individual retirement accounts, 401(k) plans or otherwise, experience significant gains. In 2009, one-third of seniors owned stock and/or mutual funds.55 In addition, unrealized capital gains that would have been subject to the income tax when realized are no longer taxed. 3) The FairTax ends all record keeping and income tax filings of any kind for seniors, totally insulating them from the high costs and abusive tactics of tax preparers. Seniors (and their heirs) no longer need to keep tax records of any kind. Planning needs (and costs) are minimal and simple. There are no income tax filings of any kind. With this change, seniors no longer need assistance with complex forms, nor are subject to the devious and unethical tactics and expense of tax preparers. Nor are seniors the deliberate target of IRS audits – there is nothing to audit!

TP

52PLauricella, Tom, “When Work is Done, Tax Headaches Begin,” The Wall Street Journal, August 27, 2006.

53 Three separate studies found that the compliance costs associated with the estate planning industry exceed the revenue yield of the tax itself. The Estate Tax: Even Worse than Republicans Say, Tax Foundation, Fiscal Fact No. 326, August 29, 2012. 54 See FairTax whitepaper, “Impact of the FairTax on the Stock and Bond Market.” 55

PU.S. Bureau of the Census, 2012 Statistical Abstract of the United States, Table 1211.

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4) The FairTax ensures Social Security’s soundness by funding the Social Security program with a progressive, broad-based national retail sales tax, rather than the current regressive, narrow payroll tax. Currently, the Social Security system is funded by a payroll tax from workers, a very regressive tax that will only have to go up as more and more baby boomers retire and fewer and fewer workers fund seniors’ retirement. The increased longevity of Americans only further compounds the problem. The chart below shows that when the program was enacted there were 41.9 workers to support one retiree; now there are only 2.9. The projected Social Security Trust Fund assets increase through 2020, but they begin to decline in 2021, and become exhausted and unable to pay scheduled benefits in full on a timely basis in 2033. The official actuarial analysis projected that immediately increasing both the employee and employer payroll tax rates from 6.2 to 7.5 percent, a rate increase of 21 percent in order to keep the trust fund in balance for 75 years56.

The FairTax funds Social Security with a progressive, national retail sales tax, supported by the spending of every consumer in America, even teenagers, tourists, illegal immigrants, and the army of 18-million people who (illegally) do not file and pay today. FairTax revenues grow with the economy.

56The actuarial study uses a 75 year planning period to determine long term fund solvency. Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance [OASDI] Trust Funds. 2012. “2012 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds.” Washington, DC.

41.9

16.5

5.1 3.7 3.2 3.4 3.4 2.9

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

1945 1950 1960 1970 1980 1990 2000 2010

How Many Workers to Support 1 Retiree?

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5) The FairTax prebate lets seniors purchase what they deem as living essentials tax-free up to the poverty level. Used goods are tax-free as well. Under the FairTax, senior citizens, like others, receive a monthly cash rebate that exempts consumption of necessities (up to the poverty level as determined by the Department of Health and Human Services) from federal taxation.57 Thus, seniors living at or below the poverty level pay no sales tax at all under the FairTax. 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 percent effective tax rate, whereas someone spending at twice the poverty level has an effective tax rate of 11.5 percent, and so on. A couple living solely on Social Security and receiving the average annual benefits for a retiree and spouse of approximately $22,36058 receives a cash rebate of $5,285 per year which is more than the FairTax owed if they spent all their income. As shown in the chart below, they would have a negative FairTax rate of -0.6 percent. They can spend their entire income tax-free while their after-tax purchasing power increases compared to what they have today.

In addition, the FairTax taxes only new goods and services. So seniors can make choices in their spending to reduce the taxes they pay. They can buy used cars, used appliances, used homes, even used clothing.

TP

57For a more detailed discussion of the rebate and fairness issues generally, see FairTax white paper, “The FairTax: Good for

Taxpayers, Good for Businesses, Good for the Economy.” TP

58The average monthly combined Social Security benefits check for retired workers and their spouses is $1,863.30 per month as of December, 2011. Source: Social Security Administration, Master Beneficiary Record, 100 percent data, Table 5.A16.

-23.0%

-0.6%

7.2%11.2%

17.1%20.0%

-30.0%-25.0%-20.0%-15.0%-10.0%

-5.0%0.0%5.0%

10.0%15.0%20.0%25.0%

$11,180 $22,360 $33,540 $44,720 $89,440 $178,880


FairTax Rate as a Percent of Spending: 2013Senior Couple Receivng Average Social Security Benefits

Annual Spending

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6) The FairTax delivers a tax holiday on IRAs and other tax-deferred plans. Forty percent of seniors have IRAs. The income tax imposed on investment income and pension benefits or IRA withdrawals is repealed. No form of savings or investment is taxed. Pension funds, IRAs, and 401(k) plans had assets of $13 trillion in 2010.59 An income tax deduction was taken for contributions to most of these plans. All beneficiaries and owners of these plans expected to pay income tax on them upon withdrawal, but are not required to do so once the income tax is repealed. Roth IRA owners and post-tax retirement savers break even. 7) The FairTax allows seniors to sell their homes and pay no capital gains taxes. The FairTax plan imposes a sales tax on newly constructed homes but exempts existing homes and other used property from any sales tax. Currently, equity payments on homes must be paid from after-income tax earnings (i.e., principal payments are not deductible). The purchase of existing housing is thus subject to the income tax. The value of existing homes will appreciate due to the repeal of the income tax and implementation of the FairTax. An important benefit as seniors have dramatically higher home ownership rates than other age groups (89.7 percent for seniors compared to 68.4 percent on average in 2011).60 Homes are often a family’s largest asset. 8) The FairTax lowers average remaining lifetime tax rates. Average remaining lifetime tax rates measure what percentage of remaining lifetime resources the taxpayer will pay to the government. The calculation of the average remaining lifetime tax rates takes into account all future federal tax payments net of Social Security benefits and the FairTax prebate. According to a recent study of average and marginal tax rates under the FairTax by Laurence Kotlikoff, noted public finance economist and co-author of The Coming Generational Storm: What You Need to Know about America’s Economic Future, “Since the FairTax would preserve the purchasing power of Social Security benefits and also provide a tax rebate, older low-income workers who will live primarily or exclusively on Social Security would be better off.”61 As an example, the average remaining lifetime tax rate for an age 60 married couple with $20,000 of earnings falls from its current value of 10.1 percent to -10.5 percent under the FairTax. The table below presents average remaining lifetime tax rates for seniors62, both those now prevailing (current system) and those that would prevail under the FairTax.

59

PU.S. Bureau of the Census, 2012 Statistical Abstract of the United States, Tables 1217 and 1189. In 2010, private pensions had assets of $8.552 trillion, and government pension funds had assets of $4.343 trillion. In 2005, Individual Retirement Accounts had assets of $3.667 billion. 60 T Table 23. Housing Tenure by Family Type and Age of Householder 55 Years and Over: 2011. 61Kotlikoff, Laurence and David Rapson, “Comparing Average and Marginal Tax Rates under the FairTax and the Current System of Federal Taxation,” October, 2006. 62 Average remaining lifetime tax rates take into account the remaining lifetime Social Security benefits received plus the FairTax prebate divided by remaining lifetime income.

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Average remaining federal lifetime tax rates for seniors: The current system vs. the FairTax

Single Couple

Household income

Tax rate Household income

Tax rate Current system FairTax Current

system FairTax

$10,000 6.5% -27.1% $20,000 7.2% -11.0%

$15,000 9.8% -28.0% $30,000 10.1% -10.5%

$25,000 14.1% -6.2% $50,000 14.2% 1.4%

$35,000 16.7% -5.9% $70,000 17.0% 2.2%

$50,000 21.5% 3.9% $100,000 22.4% 7.9%

$100,000 32.1% 9.2% $200,000 32.2% 12.3%

$250,000 40.8% 18.2% $500,000 41.5% 19.3%

A striking feature of this table is the negative average tax rates under the FairTax of low-income seniors.63 These negative tax rates reflect the fact that, net of Social Security benefits and the FairTax prebate, seniors receive more under the FairTax than they pay in. In contrast, under the current system, low-income seniors would have positive average lifetime tax rates ranging from 6.5 percent to 14.2 percent of their annual income. Another key feature is how much lower average lifetime tax rates under the FairTax are for middle- and upper-income seniors compared to the current tax system. For example, high-income seniors experience significant positive average remaining lifetime tax rates of 18.2 percent for singles and 19.3 percent for couples. However, these rates are significantly lower than what they would experience under the current system – 40.8 percent for singles and 41.5 percent for couples. 9) The FairTax generates an economic boom, which eases future budget pressure on seniors’ entitlements. Replacing the income tax with a consumption tax, such as the FairTax, makes the economy much more dynamic and prosperous. Consequently, federal tax revenues grow, spending is under less upwards pressure, and the deficit declines. Budget pressure on Social Security and Medicare spending, already significant, becomes more pronounced as the post baby boomers enter their retirement years. There are 42 million people in the population age 65 and older today. By 2030, this number is estimated to rise to 72 million, a 71 percent increase. In contrast, by 2025 the number of workers is estimated to rise by only 13 percent. The economic growth caused by the sales tax replacement of the current tax system makes it substantially less likely that federal budget pressures will result in Medicare or Social Security benefits cuts. 63 The results in the table are based on the assumption that all heads of household and spouses are age 60, retire at age 65, and start collecting Social Security benefits at age 66. Earnings between the household’s current (2005) age and retirement are assumed to remain fixed in real terms.

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11) The FairTax ensures your grandchildren have the same opportunity you did.

Seniors are able to take comfort in the fact that their children and grandchildren are no longer laboring under the yoke of the income tax, and are once again able to see their own standard of living improve, one generation to the next. What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR 25 / S 122) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system. What is Americans for Fair Taxation® (FairTax.org)? FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX. Authored by Walby, Ph.D., Chief Economist, Americans For Fair Taxation, 2006. Updated April, 2013.

Why the FairTax is good for young and low-income families There are several reasons why the FairTax (HR 25/S 122), a proposal to replace the current income tax system with a highly progressive, revenue-neutral, federal retail sales tax, will benefit low-income, often young families. And those on fixed incomes for many of the same reasons. The FairTax is the only plan that completely “untaxes” the poor and also dramatically lowers tax rates on young, low-income families living above the poverty level. The FairTax achieves this result by:

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(1) Eliminating all federal payroll withholding taxes, allowing wage earners to take home their entire paychecks – it's the full paycheck plan. Social Security taxes, the most regressive tax of all, are no longer withheld from paychecks.

(2) The FairTax also ends the income tax system, so paycheck-to-paycheck families have no income tax withheld. Neither do they have to keep records, file returns to get their refunds, hire preparers for complex earned income tax credit (EITC) forms, or defend themselves against EITC-targeted IRS audits.

(3) The FairTax allows every family to purchase what they deem as basic living essentials tax free via a system that rebates taxes on all spending up to the poverty level, based on the Department of Health and Human Services poverty guidelines.64

(4) The FairTax ends the sham of corporate taxes – government can levy taxes on business, which will collect and remit them, but never pay them. Business “pays” such taxes by raising prices to consumers, lowering the wages paid to workers, and by lowering dividends paid to shareholders. The FairTax removes these hidden taxes.

(5) Used products are not taxed, allowing these consumers yet another means to reduce their tax burden on spending above the poverty level.

The FairTax is a revenue-neutral proposal, raising no more or less tax than the current system. In addition, used products, used cars, homes, etc., are not taxed under this legislation. Only the FairTax honestly and transparently achieves the goal of completely untaxing America’s low-income strata up to the poverty level.

The FairTax is a discretionary tax.

The FairTax provides individuals with the maximum choice over what to do with their income: They can consume it (and pay taxes) or save it (and pay no taxes). If one chooses to consume for personal benefit beyond the necessities of life, one pays a tax. If one does not, but chooses instead to save and invest for education, a home or a better retirement, one defers consumption and the tax. Unlike current law, the FairTax is not biased towards consumption. It encourages young families to save and invest. If we had enacted a FairTax ten years ago, according to a study by Beacon Hill Institute65, we would each be ten percent better off today. Save faster under the FairTax.

The FairTax puts the amount and timing of paying tax under the taxpayer’s control, it enables young families and homebuyers to save for their purchase faster. Why are individuals able to save faster under the FairTax? First, the FairTax removes the enormous disadvantage to savings and investment under our income tax system. Wage and salary income is included in the income tax base when it is earned originally. If that income is consumed, the benefits of consumption go untaxed. However, if what is left of the wages and salaries is saved (for example, to buy a home), the earnings are taxed as the income

64 See whitepaper, The Prebate Explained, February 2013. http://www.fairtax.org/PDF/PrebateExplained.pdf 65 David G. Tuerck, et.al., “The Economic Effects of the FairTax: Results from the Beacon Hill Institute CGE Model,” The Beacon Hill Institute at Suffolk University, February 2007.

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from that investment is generated. Then, if the income-producing asset, such as a stock or bond, equipment or real property interest is sold for more than it was purchased, the benefit of the capital investment – the capital gain – is taxed a third time. If these investments are inherited, they are taxed yet again. A principal advantage the FairTax has over an income tax, therefore, is that a down payment can be saved without fighting against the cascading taxes on savings. Furthermore, since you keep 100% of your paycheck, you only have to earn $100 to save $100. Under today’s income/payroll tax system, most people have to earn at least $121 to have $100 to save. Education tuition is not taxed.

An equally important feature of the FairTax and its impact on young families is its treatment of education. The FairTax exempts education tuition at the primary, secondary and college level, recognizing that education is an investment in our nation’s intellectual capital and is every bit as important as our investment in physical capital. Education is often a large expense for young families. The FairTax creates jobs, rather than destroying them as our income tax system does. The FairTax additionally benefits lower-income families through increased economic growth. Slow economic growth or recessions have a disproportionately adverse impact on the poor and low-income families. Breadwinners in these families are more likely to lose their jobs, are less likely to have the resources to weather bad economic times, and are more in need of the initial employment opportunities that a dynamic, growing economy provides. The FairTax dramatically improves economic growth and improves wage rates, while retaining the present tax system needlessly delays economic progress. In addition, the FairTax eliminates about 90% of the $430 billion dollars in compliance costs, an annual savings of nearly $3400 for every family in America. These are funds that could be spent on a better education for our children, for a home, or for a better retirement. Ending the sham of corporate taxes

Corporations do not pay taxes – people do. This is not a contest between capitalism and socialism, or good and bad, or Wall Street and Main Street. It just is. The buck does not stop at a corporation, it just passes through. This is the nature of the beast. When a corporation is taxed, any one or all three of the following pass-throughs happen in some measure:

• The corporation will raise the price of its goods or services by the amount of the tax and the cost of compliance, if competition allows. These hidden premiums are hidden in the cost of every good or service bought in or exported by our country. Even those corporations that legally (if artfully) zero their taxes still have compliance costs to pass through. Most importantly, whom do these hidden premiums really hurt? Who can least afford the increased cost? Why – it’s the low-income/fixed-income citizens we set out to protect when we taxed corporations in the first place!

• Often global competition (and WalMart) will not allow pricing to absorb the entire cost of taxes/compliance. What is the next corporate move? Reduce the cost of labor. Who loses their jobs to efficiency or foreign manufacturing? It is our low-income friends again, taking it on the chin and out of their wallets.

• Now, assume prices are as high as they can be and labor costs are as low as they can be, and there are still taxes/compliance costs to pay. What do corporations do? Lower profits to their shareholders. Many economists agree this is the most likely effect of corporate taxation.

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For a mom-and-pop business, that means a lesser lifestyle for Mom and Pop. That means later or no retirement. For Wall Street, that means union pension funds experience lackluster performance when invested in domestic corporations. This may not be a big concern for the low-income, working poor, but that certainly puts a double whammy on the working class. Fewer jobs and threatened pensions. And then there are the undue burdens placed on our fixed-income retirees. Yet again, the very groups we set out to protect with corporate income taxation are those we punish most. In summary, the FairTax is the only complete tax reform plan that honestly, transparently, and comprehensively untaxes (up to the poverty level) those struggling to climb the American ladder of success. See also our white paper for fixed-income and other retirees. What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR 25 / S 122) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system. What is Americans for Fair Taxation® (FairTax.org)? FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX. Updated by Karen Walby, Ph.D., Chief Economist, Americans For Fair Taxation, 2007. February, 2013.

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Research Brief

The FairTax Reduces the Tax Burden for Low and Middle Income Households

When evaluating various tax plans most people want to know how it affects them. That is a difficult question to answer; it depends. It depends on how you measure the tax burden. Ideally, the true measure of the burden of a tax is the change in the individual’s economic situations as a result

of the change in the tax. “The changes should be measured as the effects on everyone’s net-of-tax income after all economic adjustments have run their courses. The burden measure should include not only changes in people’s after-tax incomes in a single year, but the lifetime consequences of the tax change as well.”66 Average remaining lifetime tax rates are a best estimate of these “lifetime consequences.” To calculate the average lifetime tax rate we add up all the federal income and payroll taxes that a person will pay over the rest of their life and subtract from it the benefits they receive to get a net taxes to be paid. In the case of the income tax, Social Security benefits67 are subtracted from taxes paid and in the case of the FairTax, the FairTax prebate68 is likewise subtracted. We then compare the net taxes to be paid to the income that they are expected to earn during the rest of their life.

Household income varies greatly from year to year as the household progresses through the life cycle: single earner, married, children, retirement. Thus average lifetime tax rates provide a more realistic estimate of the true effective tax burden and its effect on an individual’s economic well-being than comparisons of taxes paid versus income earned for a single year.

66 Stephen J. Entin, Tax Incidence, Tax Burden, and Tax Shifting: Who Really Pays the Tax?, The Heritage Foundation, Nov. 5, 2004, p. 1. 67In the case of the FairTax, the Social Security benefits are adjusted upward to maintain the real purchasing power of the benefits as provided for in the FairTax legislation, HR 25 / S 122. 68 The FairTax prebate is a monthly refund of taxes paid to each household set to ensure that households living at or below the poverty level pay no taxes on net. Poverty level spending is determined by household size. For a detailed explanation, see The FairTax Prebate Explained. http://www.fairtax.org/PDF/PrebateExplained2012.pdf

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The chart below displays the results from a research study by Dr. Laurence Kotlikoff which compares net average lifetime tax rates for households from various income categories for both the income tax system and the FairTax. Dr. Kotlikoff created a typical lifetime income stream and expenditure pattern for each household income category using his financial planning simulation model for families in each income category. Then using this representative lifetime income stream, he computes the income and payroll taxes that would be paid by the household over its remaining lifetime. For the income tax system, the net average lifetime tax rate = net income and payroll taxes paid on the lifetime income – Social Security benefits received divided by the household’s lifetime income. For the FairTax, the net average lifetime tax rate = national sales taxes paid on lifetime expenditures – the FairTax prebate - Social Security benefits received divided by lifetime income. The chart below compares the average remaining lifetime tax rates for the current income/payroll tax system to the tax rates that would occur under the FairTax.69 Specifically, it displays the results for a fairly typical two-adult, two child household at various income levels.

69The study estimated remaining lifetime taxes paid, lifetime benefits received, and lifetime income earned for 42 different types of households in various income, marital status, and age groups. Kotlikoff, Laurence J. and David Rapson, “Comparing Average and Marginal Tax Rates under the FairTax and the Current System of Federal Taxation,” NBER Working Paper No. 12533, revised October 2006. http://www.fairtax.org/PDF/Comparing%20AverageandMarginalTaxRates-110206.pdf

7.1%

12.6%

17.6%19.8%

23.2%

29.5%

35.9%

2.4%5.0%

11.3% 12.5%15.2%

17.8%21.1%

0.0%

5.0%

10.0%

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20.0%

25.0%

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$20,000 $30,000 $50,000 $70,000 $100,000 $200,000 $500,000

TaxRate

Annual Household Income

Net Average Lifetime Tax Rates(Couple with Two Children)

Income/Payroll Tax System FairTax

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The net average lifetime tax rate = net payroll/income taxes paid minus social security benefits received divided by annual household income. For the FairTax, net taxes = taxes paid minus the sum of Social Security benefits received and the prebate.

The FairTax lowers net average lifetime tax rates across all income categories. A glance at the chart shows that the FairTax entails either a significant or a substantial reduction in the remaining average lifetime tax rates for each income category. The two-adult, two child household with annual income of $20,000 would pays on average 2.4% of its remaining lifetime income to the federal government under the FairTax compared to 7.1% under the current income/payroll tax system – a 67% decrease. The same family with an annual income of $50,000 would pay 11.3% of lifetime income in taxes under the FairTax compared to 17.6% under the current system – a 36% decrease. And finally, the same household earning $500,000 would see taxes as a percent of lifetime income decrease from 35.9% under the income/payroll tax system to 21.1% under the FairTax – a decrease of 41%.

The FairTax enhances progressivity of the tax system. As can be readily observed the percentage decrease in tax rates for households in the lowest two income categories exceeds the percentage decrease in tax rates for households in the highest two income categories. In fact, the reduction in the tax rate is proportionately much greater with the average lifetime tax rate reduction for the lowest income category ($20,000) being 1.6 times the tax rate reduction for the highest category ($500,000) – thereby improving progressivity of the tax system.

Net Average Remaining Lifetime Tax Rates

(Two Adult, Two Child Household)

Income Income/Payroll Tax System FairTax

Percent Rate

Decrease $20,000 7.1% 2.4% -67% $30,000 12.6% 5.0% -60% $50,000 17.6% 11.3% -36% $70,000 19.8% 12.5% -37%

$100,000 23.2% 15.2% -34% $200,000 29.5% 17.8% -40% $500,000 35.9% 21.1% -41%

What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR 25/S122) abolishes all federal

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personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system. What is Americans for Fair Taxation® (FairTax.org)? FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX. Written by Karen Walby, Ph.D., Director of Research, Americans For Fair Taxation, www.fairtax.org. February, 2013.

The impact of the FairTax on charitable giving and nonprofit organizations

Many assume that the level of charitable giving in America is driven by the tax code and tax deductions, concluding that if charitable donations were not deductible, then charitable organizations could not exist. Nothing could be further from the truth.

After the 1986 Tax Reform Act, charitable giving increased rather than decreased, despite the lowering of marginal income and transfer tax rates. Charitable giving rose by $6.4 billion, or 7.6 percent, in 1987 after the top tax rate fell from 50 to 28 percent (more than doubling the tax price of giving).70 Likewise, the growth of charitable bequests was most rapid from 1980 to 1987 when estate taxes were coming down.71

70 Stephen Moore’s response in “Republic of Taxes: When Uncle Sam Takes Do Americans Give?” Philanthropy Magazine, Spring, 1997. 71 Based on federal estate tax returns data reported in Reynolds, Alan, “Death, Taxes and Giving: The Conventional Wisdom and Why it is Wrong,” Philanthropy Magazine, Winter, 1997.

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The FairTax increases the incentive to give. The incentive for giving to charitable organizations is not diminished in any respect by the FairTax. It increases. Under the FairTax, wage earners are taking home their entire paychecks – for families of modest means, whose charitable giving is often a very high percentage of their income, this is a substantial increase in available funds. Additionally, these contributions are also made with pre-tax dollars. Under the current system, the charitable deduction only offsets a portion of a taxpayer’s tax liability. For those generally less affluent taxpayers who do not itemize, the price of charitable giving actually goes down under the Fair Tax because they are able to give to their churches or other charitable organizations from pre-tax dollars.

Under the FairTax, the two-out-of-three taxpayers who currently do not itemize deductions are not taxed on charitable contributions, and therefore, for the first time since 1986, the vast majority are actually encouraged to make charitable contributions. It should be noted that percentage ceilings also limit individual contributions today – even if a taxpayer itemizes. For example, all contributions are limited to fifty percent or less of adjusted gross income. This percentage is ten percent for corporations. These ceilings all disappear under the FairTax.

According to Giving USA, charitable contributions totaled $290.89 billion in 2010.72 Of this

amount, 58.5 percent or $170.24 billion was claimed by the 33 percent of individual taxpayers who itemized deductions on their 2010 federal tax returns.73 When the effect of the increase in income from the FairTax is combined with the effect of the change in the price of giving for both itemizers and non-itemizers, recent research by Beacon Hill Institute finds that charitable donations would increase under the FairTax by $2.06 billion. This translates to an 0.89 percent increase in the first year (2007), an increase of 2.40 percent within 10 years of its introduction, and an increase of 4.99 percent after 20 years. These increases are in comparison to a baseline in which the current tax regime continues.74

When do people increase their giving and when do they cut back? It’s the economy! Charitable giving is more a function of the economy than of the tax code. The common phrase, “It’s the economy, stupid!” applies here yet again. Over the past forty years, the level of annual donations almost exactly tracks personal income growth.75,76

72 Giving USA 2011: The Annual Report on Philanthropy for the year 2010. 73 Internal Revenue Service Statistics of Income Data, Table 2.1 Returns with Itemized Deductions: Sources of Income, Adjustments, Itemized Deductions by Type, Exemptions, and Tax Items, by Size of Adjusted Gross Income, Tax Year 2010. 74 Tuerck, David G., Jonathan Haughton, Alfonso Sanchez-Penalver, Sara Dinwoodie, and Paul Bachman, “The FairTax and Charitable Giving, Beacon Hill Institute, February 2007. 75 Moore, op. cit. 76 “The most overwhelming proof that tax incentives have a relatively minor effect on individual charity is the tremendous consistence over time of giving as a percentage of income. Although the tax code has changed frequently and dramatically over the past 23 years, giving as a share of personal income has hovered around 1.83%. This measure reached as high as 1.95% in 1989 and as low as 1.71% in 1985. The narrow range has persisted even though the top marginal tax rate has fluctuated in that period between 28 and 70 percent. It suggests that raising income growth will do more to boost charitable giving than any tax incentive.” Quoted from Barry, John S., “Faith, Growth, and Charity,” Policy Review, March, 1977.

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Source: Data from Giving USA Annual Reports, various years. When the economy is up, along with personal income, Americans give. When the economy falls off a cliff, so does charitable giving. Americans are always generous, but the key to sustaining their giving is a booming economy. Economists have consistently predicted a sustained boom in the American economy once consumption taxes replace income taxation.77 This will drive charitable giving to new heights. When do the wealthy give? When they want to give! While serious wealth is only a narrow sector of charitable giving, when compared to the breadth of modest giving, it does command high visibility in the press. Therefore, it is worthwhile addressing here. The highest net worth benefactors, who grant large donations, are primarily and overwhelmingly influenced by their desire to contribute to a cause.78 Once they make that decision to contribute, they then tailor that contribution to maximize the contribution while minimizing taxes.79 The reciprocal is very rarely the case. Just as the FairTax allows every American to make their business decisions solely on what is good for their customers and employers, rather than being hamstrung by tax consequences, the FairTax unfetters the wealthy from any tax considerations on their charitable giving. What is the effect on religious donations? 77 See Kotlikoff, Laurence J.and Sabine Jokisch, “Simulating the Dynamic Macroeconomic and Microeconomic Effects of the FairTax,” National Tax Journal, June 2007. David G. Tuerck, et.al., “The Economic Effects of the FairTax: Results from the Beacon Hill Institute CGE Model,” The Beacon Hill Institute at Suffolk University, February 2007. Arduin, Laffer & Moore Econometrics, A Macroeconomic Analysis of the FairTax Proposal, June, 2006. 78 The 2000 National Committee on Planned Giving’s updated donor survey results show “unequivocally that the top reason people create a charitable bequest, establish a charitable remainder trust or other planned gift is the desire to support the charitable organization and its mission. Charitable intent as a key motivating factor was much more of a priority than financial or tax considerations.” Quoted from Burrill, Janice H., “The Effects of Estate Tax Repeal on Philanthropy,” Trust & Estates, Oct. 2001, Vol. 140, No. 10. 79 A 1996 Independent Sector poll of people who made charitable donations found that “keeping taxes down” ranked dead last on a list of seven reasons people gave for giving, and was cited as the second least likely factor to influence giving (even behind “being encouraged by an employer”). See Riley, Tom, “The Final Cut,” Philanthropy Magazine, March, 1999.

0.0

0.5

1.0

1.5

2.0

2.5

3.0Giving as a percent of GDP: 1971 to 2011

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While churches rely on charitable donations, they are somewhat impervious to the tax motivation, as charitable contributions are linked more to church attendance than to tax credits or incentives. “Americans who regularly attend church services contribute 2.2% of their income, a much higher average than non-church-goers who average 1.4%. And the churchgoers’ higher level of giving is not confined to [their] own congregations but extends to all types of non-profits . . . Active civic participation, and church attendance in particular, is more important to a healthy non-profit sector than the presence of any tax credit or deduction.”80,81

Non-religious charities such as universities and museums, for example, rely little on donative sources of giving. The large non-profits (whose assets account for more than three-fourths of the total assets of tax exempt charitable organizations) received only 7.8 percent of their income in 1998 from direct public contributions. Revenues from program services and membership, on the other hand, made up 74.5 percent of total revenues.82,83

Additional points Several more points should be mentioned.

• A large source of income for universities, colleges, and other training institutions is tuition payments. Under current law, tuition payments are not deductible, not creditable, and must be paid with after-tax dollars, except for credits available to low income taxpayers. Under the FairTax, all payments for tuition and training are considered investments in human capital and not taxable. Therefore all payments for tuition and training are made from pre-tax earnings.

• Voluntary services provided to non-profits today, under the income tax system, are discouraged because out-of-pocket expenditures are not fully deductible. Under the FairTax, such expenditures are paid from pre-tax earnings.

• Those uncompensated services provided by a charity to that population for which the charity was founded and by which it fulfills its mission do not generate a taxable, retail-delivery event under the FairTax. (This stands in contrast to barter between commercial interests and individuals or between individuals. Such barter does generate a taxable event.)

• Charitable operations, of course, continue to be tax exempt, operating under a sales tax exemption certificate as they do today with most states. The FairTax does not tax purchases made by qualified nonprofits/charitable organizations.

80 Barry, John S., “Faith, Growth, and Charity,” Policy Review, March, 1997. 81 Rose Anne Devlin also found religious giving was not influenced by the fact that charitable donations were tax deductible. See Devlin, Rose Anne, “Charitable Giving and Charitable Gambling: an Empirical Investigation,” National Tax Journal, March, 2000. 82 Large non-profits are those 501(c)(3)s with over $50 million in assets. Percentages are calculated from data in Table 1, “Form 990 Returns of Nonprofit Charitable Section 501(c)(3) Organizations: Selected Balance Sheet and Income Statement Items, by Asset Size,” IRS Statistics of Income Bulletin, Fall, 2001. 83 For tax-exempt charitable organizations, as a whole, contributions from direct public support accounted for 11.12 percent of total revenue for reporting year 1998. Revenues from program services and membership accounted for 68 percent of total revenues. Percentages are calculated from data in Table 1, “Form 990 Returns of Nonprofit Charitable Section 501(c)(3) Organizations: Selected Balance Sheet and Income Statement Items, by Asset Size,” IRS Statistics of Income Bulletin, Fall, 2001.

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• When charities provide products or services to individuals for compensation, essentially a retail transaction, that transaction is taxed. This is comparable to the current system not allowing the deduction of that portion of a gift for which the donor received some return compensation.

What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR25/S13) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system. What is Americans for Fair Taxation® (FairTax.org)? FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX. Karen Walby, Ph.D., Chief Economist, Americans For Fair Taxation, 2007. Updated February, 2013.

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The FairTax: Good for taxpayers, good for businesses, good for the economy84

The national debate over taxation is shifting from the question of whether to alter our current tax system to the question of how to alter it. Today, polls indicate that a large majority of Americans are extremely frustrated with the current federal income tax system. The income tax discourages personal savings and investments by taxing capital gains, dividends, and interest earned. Wage earners struggle under the burden of a very regressive payroll tax. The income tax is complex – so complex that no one, not even the experts, truly understands it. Moreover, for the tax to be enforced, the taxpayer must sacrifice significant privacy. As a result, our citizens are governed by needlessly burdensome tax laws that they cannot understand and that are intrusive, complex, costly, and often invisible.

The tremendous undertaking of replacing the income tax requires the American people to put aside partisan politics to arrive at a consensus on how our government should tax its citizens. Any new system of taxation must fairly and efficiently distribute the burden of funding our government, promote economic growth, present less of a compliance burden, and offer every American better economic opportunity.

Americans for Fair Taxation® (FairTax.org), a non-profit, non-partisan organization, believes

that replacing the current tax system with a single rate, federal sales tax levied on all new goods and services with no exceptions or exclusions, best meets this challenge. Research has shown that the FairTax is a fair and progressive system of taxation that increases economic growth, investment, capital formation, and the creation of jobs and savings.85

84First published as “A Single Rate, Federal Sales Tax is the Best” in Tax Reform, Opposing Viewpoint Series, Greenhaven Press, 2011, pages 157-166. 85Kotlikoff, Laurence J. and Sabine Jokisch, “Simulating the Dynamic Macroeconomic and Microeconomic Effects of the FairTax,” National Tax Journal, June 2007; David G. Tuerck, et.al., “The Economic Effects of the FairTax: Results from the Beacon Hill Institute CGE Model,” The Beacon Hill Institute at Suffolk University, February 2007; Arduin, Laffer & Moore Econometrics, A Macroeconomic Analysis of the FairTax Proposal, June, 2006; David G. Tuerck, Jonathan Haughton, Paul Bachman, and Alfonso Sanchez-Penalver, “A Comparison of the FairTax Base and Rate with Other National Tax Reform Proposals,” The Beacon Hill Institute at Suffolk University, February, 2007; Laurence J. Kotlikoff, and David G. Tuerck, et. al., “Taxing Sales under the FairTax: What Rate Works?, Tax Notes, November 13, 2006. These papers are available at www.fairtax.org/AboutTheFairTax/ResearchPapers.

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The FairTax plan The FairTax plan involves three specific actions:

• Passage of legislation that repeals the income tax, the payroll tax in its entirety, the estate tax, the gift tax, the capital gains tax, the alternative minimum tax, the self-employment tax, and the corporate tax.

• Passage of legislation that installs a single rate, national sales tax on all new goods and services at the point of final purchase for consumption, and that provides for a universal rebate in an amount equal to the sales tax on essential goods and services up to poverty level spending.

• Adoption of a constitutional amendment to repeal the 16th Amendment and to prohibit income taxes. The FairTax will sunset if the 16th Amendment has not been repealed within seven years following enactment, preventing the possibility of having both the income tax and a national sales tax.

The FairTax has been introduced as “The Fair Tax Act of 2013” in the 113th Congress (H.R. 25

in the House of Representatives and S. 122 in the Senate).86 Fairness Throughout the history of our country, our citizens and government have had an objective to increase every American’s chance to achieve economic independence by providing greater opportunities to share in our country’s growth and prosperity. The FairTax helps us achieve this goal. Americans are better off under the FairTax. Although every taxpayer is subject to the same sales tax rate with no exceptions or exclusions, those least able to share in the cost of government will carry no federal tax burden at all.87 Under the current system, the more your income is derived from wages, the more you are affected by payroll taxes. In addition, under the FairTax, no one will pay tax on the cost of essential purchases, and those who demonstrate their greater ability to pay by consuming more, will pay more taxes.88

86 H.R. 25 is sponsored by Congressman Rob Woodall, with 58 co-sponsors in the House as of January 23, 2013. The Senate companion bill, S122, is sponsored by Senator Saxby Chambliss and has 7 co-sponsors. 87 Kotlikoff, Laurence J. and David Rapson, “Comparing Average and Marginal Tax Rates under the FairTax and the Current System of Federal Taxation,” NBER Working Paper No. 12533, revised October 2006; Kahn, Joseph, “Examining a Change to a National Retail Sales Tax Regime: Impact on Households,” Decisions and Ethics Center, Stanford University, November, 1996. 88 The analysis shown in Tables 1 and 2 does not include the 2 percentage points payroll tax reduction for employees which expired on Dec. 31, 2012.

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Table 1: 2011 Income and Payroll Taxes Includes only Employee portion of federal payroll taxes FairTax

Family Gross

Income

Income Tax

Social Security Medicare Total

Tax Effective Tax Ratea

Sales Tax

Effective Tax Rateb

$29,420 -$3,048 $1,824 $427 -$797 -2.7% $0.00 0.0% $58,840 $4,016 $3,648 $853 $8,517 14.5% $6,767 11.5% $88,260 $8,429 $5,472 $1,280 $15,181 17.2% $13,533 15.3%

$117,680 $15,181 $6,622 $1,706 $23,509 20.0% $20,300 17.3%

a Effective R ate = total taxes / family income. The total taxes are computed for a family of four claiming the standard deduction for joint returns ($11,600) and four personal exemptions ($3,700 each). Taxpayers who itemize (1/3 of taxpayers) would have lower effective rates; higher income taxpayers are more likely to itemize. b Assumes that the family spends all income earned, saving nothing and receives monthly FairTax prebate checks totaling $6,767 annually (equal to 23% of poverty level spending ($29,420 for a family of four).

Table 1 shows that a sample family of four with a poverty level income of $29,42089 has an

effective federal tax rate of -2.7 percent of their gross income, when the Earned Income Credit of $3,350 is taken into account. A sample family earning $58,840 pays 14.5 percent of their gross income in federal taxes. Under the FairTax, the family of four earning $29,420 (spending all of their income) pays zero federal taxes (after the prebate90), and the same family of four earning and spending $58,840 pays an effective tax rate of only 11.5 percent on their taxable purchases.

However, this is not the whole picture. While payroll taxes are levied equally between employers and employees, it is the broad consensus among economists, including those at the Congressional Budget Office and the Joint Committee on Taxation, that it is really the employee that bears the burden of the employer portions of Social Security and Medicare payroll taxes, and federal unemployment taxes through lower wages than would otherwise be paid.91 On this basis, the true burden of the current federal income tax system on taxpayers becomes even more dramatic. (See Table 2.)

89 This income level is derived from the poverty level guideline for a family of four, two adults, two children. See Federal Register, Vol. 76, No. 13, January 20, 2011. 90 The prebate is a rebate paid at the beginning of each month, in twelve equal installments. The amount of the prebate is determined by the Department of Health & Human Services’ poverty level guideline multiplied by the FairTax rate. The poverty guidelines are a well established measurement of the poverty level based on expenditures for necessities such as food, clothing, shelter, transportation, medical care, etc. 91 See The Corporate Income Tax and Workers’ Wages: New Evidence from the 50 States, Tax Foundation Special Report No. 169, August 2009; Congressional Budget Office, “Historical Effective Federal Tax Rates, 1979-2006,” April 2009 and Joint Committee on Taxation, “Overview of Present Law and Economic Analysis Relating to Marginal Tax Rates and the President’s Individual Income Tax Rate Proposals,” March 6, 2001.

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Table 2: 2011 Income and Payroll Taxes (Includes Employee and Employer portions of federal payroll taxes) FairTax

Family Gross

Incomea

Income Tax

Federal Unemploymen

t Tax

Social Security

Medicare

Total Taxes

Effective Tax

Rateb

Sales Tax

Effective Tax Ratec

$32,105 -$3,048 $434 $3,648 $854 $1,888 5.9% $617 1.9% $63,775 $4,016 $434 $7,296 $1,706 $13,452 21.1% $7,901 12.4% $95,446 $8,429 $434 $10,944 $2,560 $22,367 23.4% $15,186 15.9%

$126,442 $15,181 $434 $13,243 $3,413 $32,271 25.5% $22,315 17.6%

a Employer payroll taxes (federal unemployment, Social Security and Medicare) have been added to family gross income to measure the true burden of the federal tax system on families.

b The rate assumes that the employee pays both the employee and the employer portions of Social Security and Medicare payroll taxes and federal unemployment taxes through lower wages. The rate = total taxes / family income. The total taxes are computed for a family of four claiming the standard deduction for joint returns ($11,600) and four personal exemptions ($3,700 each). Taxpayers who itemize (1/3 of taxpayers) would have lower effective rates; higher income taxpayers are more likely to itemize. c Assumes that the family spends all income earned, saving nothing and receives monthly FairTax prebate checks totaling $6,767 annually (equal to 23% of poverty level spending ($29,420 for a family of four).

Given that the employer share of payroll taxes in actuality reflects a reduction of the employee’s potential wages, we can determine the “actual” tax burden as shown in Table 2. First, we increase the gross family income amounts from Table 1 by the amount of employer payroll taxes (Federal Unemployment Tax, Social Security and Medicare taxes). Employer payroll taxes of $434 (FUT), $1,824 (SS), and $427 (Med) are added to the employee’s income of $29,420 to obtain a “potential” income of $32,105. The total taxes paid are then compared to the total potential income to determine the actual tax burden which in this case is an effective tax rate of 5.9 percent of their gross income even after deduction of the Earned Income Credit.

The FairTax amount is calculated by multiplying the rate of 23 percent times family income, assuming that all income is spent. This amount is divided by income to yield and effective tax rate. For comparable income levels, the FairTax effective tax rate is substantially less than under the current system. In the case of the family with potential income of $32,105, the effective rate is only 1.9 percent. The tax rate for the $63,775 income level jumps to 12.4 percent but that is still much less than the 21.1 percent rate for the income tax system. The results show that the FairTax is progressive; i.e., the effective tax rate rises as income rises.

Our current tax system is also unfair because it is highly responsive to political influence on

behalf of special interest groups. Average taxpayers without the means or organization to influence tax policy are at a clear disadvantage. The inextricable relationship between the tax code and lobbyists is evidenced by the fact that more than half of Washington lobbyists are registered on tax matters. Under the FairTax, there are no exceptions and there are no exclusions – there are no loopholes to be exploited by special interests. Under the FairTax, all taxpayers have an equal voice.

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Simplicity A fundamental notion of fairness is that citizens should be able to comprehend the laws that affect them. However, current tax law is beyond the comprehension of most taxpayers, including many of those who devote their entire professional lives to it. In the long-running experiment of the income tax, it is fairly well demonstrated that it is the nature of the income tax as a hidden tax that breeds complexity. The constantly growing complexity of our tax system is part of a trend that began in 1913 and has only accelerated with the nearly perennial enactment of new tax legislation with 4,428 changes to the tax code in just the last decade. The continuous tinkering with the tax code has resulted in tripling the length of the tax code, now a mind-boggling 3.8 million words, and that, on average, has more than one new provision added to it daily.92 The combined federal income tax code, regulations, and IRS rulings have mushroomed from 14,000 pages in 1954 to 73,954 pages by 2013 – an increase of 428 percent.93 To cope with this complexity, nearly 60 percent of taxpayers hire paid preparers and another 30 percent rely on commercial software to prepare their returns. The FairTax is simple: One single rate, with no exceptions and no exclusions, collected at the point of purchase. The simplicity of the FairTax means that tax planning is now within the reach of the ordinary taxpayer, who can choose the amount and timing of federal tax payments by deciding when to make purchases and whether to buy new or used products. Efficiency In addition to the taxes on income that we pay, we also pay the cost of payroll and corporate taxes that are embedded in every product that we purchase. Businesses pass their costs on to consumers in the form of higher prices. But the burden to the consumer doesn’t stop there. We also pay for the cost of complying with the tax code. So complicated has the income tax system become that an analysis of IRS data by the Taxpayer Advocate Service estimated that individual taxpayers and businesses spend 6.1 billion hours each year complying with the filing requirements of the Internal Revenue Code. Massive amounts of our national wealth are consumed merely by measuring, tracking, sheltering, documenting, and filing our annual income. The twin burdens of time and money required for record keeping, tax form preparation, calculating and funding estimated payment schedules, and tracking income and expenses are eliminated by the FairTax. While the economic burden occasioned by compliance has been estimated many ways by many researchers, with a correspondingly large range of values, the most recent credible study shows that U.S. taxpayers waste an astounding $431.1 billion annually on tax compliance. If this figure is near correct, it means that we pay about 30 percent of total income taxes collected, just to … well … pay those taxes.94 Of the $431.1 billion, 88% is the time value costs borne by taxpayers: $161.7 billion by businesses and $216.2 billion by individuals.

92 Taxpayer Advocate Service, 2012 Annual Report to Congress, Executive Summary, Dec. 31, 2012, p. vii. 93 As measured by the number of pages in the CCH Standard Federal Tax Reporter, 2013. 94 Laffer, Winegarden, and Childs, “The Economic Burden Caused by Tax Code Complexity, April, 2011. Paperwork is the most visible compliance cost, but it is clearly not the only cost, and perhaps not the largest cost. Return processing, determining liability, record keeping, and other burdens are an estimated 13 to 22 percent of the total revenue raised by the income tax system.

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The FairTax generates the same amount of revenue as the current tax system, but at a much lower administrative cost. Of the 154 million tax returns filed in fiscal year 2011, over nine out of ten were filed by individuals (143.6 million). Under the FairTax, individuals do not file tax returns. Only businesses that sell goods or services at retail are required to file tax returns, reducing the number of tax filers by at least 80%. These businesses remit the FairTaxes they collect on consumer purchases along with their state sales taxes once per month. They no longer have to administer income tax withholding and payroll tax deduction on wages paid to their employees on behalf of the federal government. According to an estimate by the Tax Foundation, the replacement of the income tax with a national retail sales tax would reduce compliance costs by 95 percent.95 Economic impact Slow economic growth and economic stagnation have an adverse impact on low wage earners. These families are more likely to lose their jobs, are less likely to have the resources to weather bad economic times, and are more in need of the initial employment opportunities that a dynamic, growing economy provides. The income tax retards economic performance by creating a significant bias against saving and investment through double, triple, and even quadruple taxation. Under the FairTax, what you earn is what you take home. Americans are able to save more and invest more. The FairTax dramatically increases investment levels compared to levels that would have been achieved under the current income tax system.96 Increased savings will stimulate investment and productivity and the economy will grow more rapidly, creating demand for workers and improving job opportunities. Because taxes on capital are removed, foreign capital will flow into the United States, creating businesses and jobs. U.S. products competing abroad are free of the hidden costs of taxation while the FairTax is collected on foreign products sold in the United States. Virtually all economic models project a much healthier economy under a broad-based consumption tax such as the FairTax. Summary The ever-increasing taxpayer demand for a simpler, less intrusive system of taxation is building daily. The FairTax delivers these benefits to the American people, and more – more government accountability for taxpayer dollars, the elimination of tax returns for individuals, a tax system which is transparent and less susceptible to being manipulated by special interests, and perhaps most importantly, a tax system that promotes economic growth and job creation. What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll taxes with an integrated approach including a progressive national retail sales tax, a rebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, repeal of the 16th Amendment. This nonpartisan legislation (HR 25/S122) abolishes all federal personal, gift, estate, capital gains, alternative minimum, Social Security, Medicare, self-employment, and corporate taxes and replaces them with one simple, visible, federal retail sales tax – collected by existing state sales tax authorities. The FairTax taxes us only on what we choose to spend, not on what we earn. It does not raise any more or less revenue; it is designed to be revenue neutral. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system.

95 Hall, Arthur P., “Compliance Costs of Alternative Tax Systems,” Tax Foundation, Testimony before the House Ways and Means Committee, June 6, 1995. 96 Kotlikoff, Laurence J. and Sabine Jokisch, “Simulating the Dynamic Macroeconomic and Microeconomic Effects of the FairTax,” National Tax Journal, June 2007; David G. Tuerck, et.al., “The Economic Effects of the FairTax: Results from the Beacon Hill Institute CGE Model,” The Beacon Hill Institute at Suffolk University, February 2007.

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What is Americans for Fair Taxation® (FairTax.org)? FairTax.org is a nonprofit, nonpartisan, grassroots organization dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX. Author: Karen Walby, Ph.D., Chief Economist, Americans For Fair Taxation®, Revised January 2013. (H:\FILES\AFFT Documents\The FairTax-Good for taxpayers, good for businesses, good for the economy)

Research Summary

The Impact of the FairTax on the Economy

Virtually all economists agree that the following will promote economic growth:

• Replacing the income tax with a consumption tax

• Replacing a graduated rate system with a flat marginal tax rate system

• Lower marginal rates and a broader tax base The Fair Tax Act (a progressive national retail sales tax) does all three. Here is a summary of three independent research studies of the FairTax plan analyzing the likely impact on the U.S. economy of replacing the current federal income tax system with a broad-based consumption tax, such as the national retail sales tax plan called for by HR 25 and S 122, the FairTax. Each study utilizes a distinct modeling approach. While the results vary, all three studies show that GDP growth under the FairTax is significantly higher than it would otherwise be if the current federal tax system remained in place.

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(1) THE ECONOMIC EFFECTS OF THE FAIRTAX: RESULTS FROM THE BEACON HILL INSTITUTE CGE

MODEL97 The first study employs a dynamic computable general equilibrium (CGE) model to estimate the impact of the FairTax plan on the economy. Although complex, CGE models make it possible to analyze large changes in existing taxes or the introduction of new taxes for their effects on a wide array of economic indicators. The chart below shows how much higher the growth in certain economic variables would be under the FairTax than if the current federal income tax system were to remain in place, for Years 1, 5, and 10, after the implementation of the FairTax. Real GDP would be 8% higher in the first year than under the income tax system, 11% higher in Year 5 and 11% percent higher in Year 10. Job growth would be 12% higher in Year 1, 10% higher in Year 5 and 8% higher in Year 10. Apply these results to the current level of employment, 133 million, means in just one year, the FairTax would have created 13.3 million more jobs than if the current income tax system remained in place. Investment would be 75% higher in Year 1, 86% higher in Year 5 and 76% higher in Year 10 reflecting the growth due to no taxes on savings and investment income. Wages would be 10% higher in Years 1, 5 and 10.

97 See David G. Tuerck, et.al., “The Economic Effects of the FairTax: Results from the Beacon Hill Institute CGE Model,” The Beacon Hill Institute at Suffolk University, February 2007.

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The findings for 2007 through 2031 are summarized in Table 1 below. The table shows the percentage difference in each indicator resulting from implementation of the FairTax for selected years 2007 to 2031. For example, real GDP would be 7.9 percent higher in 2007 under the FairTax than under the “benchmark” current law and 10.3 percent higher by 2031.

Table 1 Summary of Effects of the FairTax Relative to Current Law:

2007 – 2031 (% change)

Year 2007 2008 2009 2010 2011 2016 2021 2026 2031 Period Indicator 1 2 3 4 5 10 15 20 25

Real GDP 7.9 9.3 9.9 10.3 10.7 10.9 10.7 10.5 10.3 Domestic investment 74.5 88.4 88.0 87.1 86.3 75.9 69.0 65.7 65.2 Capital stock 0.0 2.8 5.3 7.5 9.3 14.1 16.0 16.9 17.3 Employment 11.9 12.0 11.2 10.5 9.9 7.6 6.1 5.3 4.7 Real wages 10.3 10.6 10.4 10.3 10.2 9.5 9.1 9.0 9.2 Consumption -0.6 -0.8 0.2 1.1 1.8 4.3 5.5 5.9 6.0

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(2) A MACROECONOMIC ANALYSIS OF THE FAIRTAX PROPOSAL98

The second study uses a dynamic, supply-side economic model to estimate the impact of the FairTax plan on GDP, savings, employment, capital formation, domestic investment, and interest rates, and disposable personal income. The study includes a comparison of the 10-year economic forecast assuming no change in the current federal tax system compared to the 10-year economic forecast assuming the FairTax is enacted. • The economy as measured by GDP is 2.4% higher in the first year and 11.3% higher by the 10th year than it

would otherwise be.

• Consumption increases by 2.4% more in the first year than it would be if the current system were to remain in place.

• The increase in consumption is fueled by the 1.7% increase in disposable (after-tax) personal income that

accompanies the rise in incomes from capital and labor once the FairTax is enacted.

• By the 10th year, consumption increases by 11.7% over what it would be if the current tax system remained in

place; and disposable income is up by 11.8%.

Following the implementation of the FairTax plan, the higher take-home wage provides an immediate incentive for people to work more. During the first year, this leads to total employment growth of 3.5 percent in excess of the baseline scenario, which continues to grow through year 10 such that total employment is 9.0 percent above what it would have been under the baseline scenario. The impact on total labor income is even more pronounced, increasing due to both an increase in after-tax wages and the increase in the number of people working. Total labor income rises 27.4 percent in the first year. By year 10, labor income is over 41 percent higher than what it would have been under the baseline scenario.

Summary of Results by Year

Cumulative growth over current system Year 1 Year 2 Year 3 Year 4 Year 5 Year 10 Gross Domestic Product 2.4% 5.2% 7.0% 8.2% 9.0% 11.3%

Employment 3.5% 5.7% 7.0% 7.7% 8.2% 9.0% Domestic investment 33.0% 35.4% 36.9% 38.0% 38.8% 41.2%

Income from employment (wages) 27.4% 31.8% 34.5% 36.4% 37.7% 41.2% Consumption 2.4% 4.1% 5.8% 7.1% 8.1% 11.7% Disposable personal income (adj. for changes in the price level) 1.7% 4.5% 6.4% 7.7% 8.7% 11.8%

98 See Arduin, Laffer & Moore Econometrics, A Macroeconomic Analysis of the FairTax Proposal, June, 2006, p.

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(3) SIMULATING THE DYNAMIC MACROECONOMIC AND MICROECONOMIC EFFECTS OF THE FAIRTAX99 In the third study, Drs. Kotlikoff and Jokisch used a life-cycle, general equilibrium model to study the dynamic macroeconomic and microeconomic effects of replacing all federal taxes with the FairTax. The model considered three income classes within each generation, each with its own earnings ability.100 The model generated results with closed and open economies. The results of this study are shown in Tables 4 and 5. The problem with current law: the necessary future tax increase -- What happens if the current system remains in place is shown in the top panel of Table 4 the base case scenario (i.e., no change in the current system). That scenario generates more than a doubling of the payroll tax rate due to the aging of the population as well as a modest but significant long-run capital shortage. Neither America’s aging nor its associated increase in payroll taxes prevents the economy from growing in absolute terms. National income in 2100 is 3.84 times its 2004 value. This reflects growth over time in the supplies of both labor and capital, which expand by factors of 4.19 and 3.17, respectively, over the course of the century. This rising supply of effective labor means rising labor income and, therefore, more wherewithal for workers to save for retirement. The additional saving is, of course, invested, explaining the model’s predicted growth in the stock of capital. However, while the supplies of both labor and capital rise over time, growth in the supply of labor outpaces growth in the supply of capital, thanks, in large part, to the very substantial rise in overall taxation of labor income. Consequently, capital per unit of human capital falls over time, leading to an 8.0-percent decline over the course of the century in the pre-tax wage per unit of human capital. Thus, in the base case, i.e., the current income tax system remaining in place, we see a long-run capital shortage, albeit a moderate one. In combination with the model’s predicted rise in the payroll tax, the decline in the pre-tax wage causes a 21.0-percent decline in long-run after-tax take-home pay. It also results in a major reduction in welfare, which can be avoided via a switch to the FairTax. The FairTax transition path. – Table 4’s second panel reports the results of implementing the FairTax. It shows the transition path arising from eliminating the personal income tax, the personal capital income tax, the corporate income tax, and the payroll tax and replacing them with a consumption tax (a la the FairTax) plus a rebate. Switching to the FairTax improves capital stock, which is dramatically higher in the long run under the FairTax than under the current tax system. Indeed, the capital stock in 2100 is 96.2 percent higher.101 While the expansion of the capital stock proceeds relatively slowly, it is noticeable even by 2010. In that year, the capital stock is 12.8 percent higher. By 2030, the capital stock is 43.7 percent higher than would otherwise have been the case. The increased capital formation also leads to a rise in the real wage per unit of human capital. Rather than declining by 8.0 percent by the end of the century, the real wage now rises by 17.0 percent. This is an 25.0-percent difference in real worker remuneration.

99 See Sabine Jokisch and Laurence J. Kotlikoff, “Macroeconomic and Microeconomic Effects of the FairTax,” National Tax Journal, June, 2007. 100 For a detailed discussion of the model, see above. 101 The index for capital stock in 2100 is 6.22 under the FairTax compared to an index of 3.17 if the current income tax system remained in place. The percent increase of 96.2% equals [ (6.22-3.17) / 3.17 ].

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Again, the pace of the change is slow, but by 2030 real wages under the FairTax are 11.5 percent higher than they would otherwise have been. In transforming the economy’s prospect from one of a capital shortage to one of capital deepening, the FairTax also reduces real interest rates, with the 2100 real interest rate ending up 160 basis points lower than under the current system.

Table 4 Simulation Results for the U.S. (closed economy)

Year Index of National Income

Index of

Capital Stock

Index of

Labor Supply

Index of

Pre-Tax

Wage

Capital Price

Interest Rate

Social Security

Cost Index

Average Wage Tax

Index

Effective FairTax

Rate

FairTax Rebate/

NI

Year to year index values BASE CASE SCENARIO (continuation of the current system)

2004 1.00 1.00 1.00 1.00 1.000 0.075 1.00 1.00 .00 .000 2010 1.12 1.09 1.14 0.99 1.007 0.075 1.08 0.98 .00 .000 2020 1.36 1.27 1.40 0.97 1.008 0.074 1.32 0.94 .00 .000 2030 1.59 1.44 1.67 0.96 0.975 0.078 1.68 1.04 .00 .000 2050 2.10 1.74 2.29 0.92 0.987 0.088 1.79 1.13 .00 .000 2075 2.92 2.37 3.20 0.91 0.992 0.088 1.91 1.07 .00 .000 2100 3.84 3.17 4.19 0.92 0.981 0.087 2.04 1.06 .00 .000

FAIRTAX SCENARIO 2004 1.02 1.00 1.05 0.98 1.261 0.075 0 .00 0.23 0.047 2010 1.17 1.23 1.17 1.01 1.216 0.079 .00 .00 0.24 0.049 2020 1.45 1.65 1.39 1.05 1.158 0.075 .00 .00 0.25 0.053 2030 1.74 2.07 1.63 1.07 1.098 0.075 .00 .00 0.28 0.061 2050 2.38 2.97 2.17 1.10 1.072 0.076 .00 .00 0.28 0.062 2075 3.35 4.45 2.99 1.13 1.048 0.073 .00 .00 0.29 0.065 2100 4.46 6.22 3.88 1.15 1.023 0.071 .00 .00 0.30 0.068

In addition to the above three studies regarding the economic impact of the FairTax, there are a number of studies that examine the effect of consumption taxes in general.

Alan Auerbach of the University of California at Berkeley found that long-run GDP per capita would be 9.7 percent higher under a national sales tax.102

Michael Boskin, former chairman of the Council of Economic Advisers has stated that the long-term gain to GDP from a consumption-based tax reform would be about 10 percent.103

Dale Jorgenson, Ph.D., former chairman of the Economics Department at Harvard University, estimated a near-term 9 to 13 percent increase in the Gross Domestic Product (GDP).104

102 Auerbach, Alan, “Tax Reform, Capital Allocation, Efficiency, and Growth,” in Economic Effects of Fundamental Tax Reform, Henry J. Aaron and William G. Gale, eds., Washington, D.C.: Brookings Institution Press, 1996, p. 58. 103 Boskin, Michael, “A Framework for the Tax Reform Debate,” testimony before the House Ways and Means Committee, June 6, 1995. 104 Jorgenson, Dale W., “The Economic Impact of the National Retail Sales Tax,” November, 1996.

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Gary and Aldona Robbins, Fiscal Associates, show that replacing the current tax system with a flat rate system that taxes capital and labor income equally – such as the FairTax – would increase the GDP by 36.3 percent and increase private output by 48.4 percent over the long run.105 Finally, a 1997 Joint Committee on Taxation report summarized results from nine different economic models, all finding that a change to a single rate consumption tax would increase investment and boost economic growth.106

What is the FairTax Plan? The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR 25) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system. What is Americans For Fair Taxation (FairTax.org)? FairTax.org is a nonprofit, nonpartisan, grassroots organization solely dedicated to replacing the current tax system. The organization has hundreds of thousands of members and volunteers nationwide. Its plan supports sound economic research, education of citizens and community leaders, and grassroots mobilization efforts. For more information visit the Web page: www.FairTax.org or call 1-800-FAIRTAX. Summaries prepared by Karen Walby, Ph.D., Director of Research, Americans For Fair Taxation, www.fairtax.org. September, 2012.

105 Robbins, Gary and Aldona, “Looking Back to Move Forward: What Tax Policy Costs Americans and the Economy,” Institute for Policy Innovation, Policy Report No. 127, September 1, 1994. 106 Joint Committee on Taxation, “Tax Modeling Project and 1997 Tax Symposium Papers,” JCS-21-97, November 20, 1997. Symposium participants: Alan J. Auerbach, Charles L. Ballard, Michael J. Boskin, Roger E. Brinner, Eric Engen, William Gale, Jane G. Gravelle, Dale W. Jorgenson, Laurence J. Kotlikoff, Joel L. Prakken, David Reifschneider, Robert D. Reischauer, Aldona Robbins, Gary Robbins, Diane Lim Rogers, Harvey S. Rosen, Joel Slemrod, Kent Smetters, Jan Walliser, Peter J. Wilcoxen, John G. Wilkins.

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