Transcript TaxReform Presentation - Alternate 08example

The Fair Tax Problems and
Possibilities
“It is fairer to tax people on what they extract
from the economy, as roughly measured by
their consumption, than to tax them on what
they produce for the economy, as roughly
measured by their income”
-- Thomas Hobbes in Leviathan
Public Finance – ECON 344, Iowa State University
Current System - Personal Income
• Personal Income tax depends on the total yearly income less
possible deductibles.
• Collected on a “pay as you earn” basis.
• Corrections are made at the end of the tax year.
• After corrections are made, taxpayer may owe in taxes or may
qualify for a refund.
Public Finance – ECON 344, Iowa State University
Current System - Business Income
• Corporate tax generally refers to a direct tax on the profits made
by a company.
• Earnings are considered gross revenue less expenses.
• Corporate expenses that relate to capital expenditures are
usually deducted in full.
• These expenses are deducted over the useful life of the asset
purchased.
Public Finance – ECON 344, Iowa State University
Current System - Payroll
• Payroll tax usually refers to two different tax systems.
• First is where employers are required to withhold earnings from
employees check.
• Known as “Pay As You Earn” system.
• Other payroll taxes are paid from employer’s own funds.
• Gets paid into government programs such as social security, disability,
health care, and unemployment.
• Either a fixed charge per employee or a percentage of each
employees pay is what determined this tax.
Public Finance – ECON 344, Iowa State University
Current System - Inheritance
• The inheritance tax, estate tax, and death duty are names given
to various taxes which arise on the death of an individual.
Public Finance – ECON 344, Iowa State University
Current System - Capital Gain
• A capital gains tax is levied on the profit released upon the sale
of a capital asset.
• Capital gain is treated as income and is subject to the marginal
rate of income tax.
• In an inflationary environment, capital gains may be to some
extent illusory: if prices in general have doubled in five years,
then selling an asset for twice the price it was purchased for five
years earlier represents no gain at all.
Public Finance – ECON 344, Iowa State University
Fair Tax - Sales Tax Rate
• Fair Tax legislation would apply a 23% federal retail sales tax.
• Tax would be levied on all U.S. retail sales for personal
consumption.
• Savings, Investments, and Educational tuition would be
considered investments and will not be taxed.
• Personal services such as health care, legal services, auto
repair, haircuts, etc. would be taxed.
Public Finance – ECON 344, Iowa State University
Fair Tax - Effective Tax Rate
• Effective tax rate for a family household would be variable due
to fixed monthly tax rebate.
• The rebates would have the greatest effect at low spending
levels, where they could lower a household’s effective rate to
zero or a negative rate.
• At higher spending levels, the rebate has less effect, and a
household’s effective tax rte would approach 23% of total
spending.
Public Finance – ECON 344, Iowa State University
Analysis of Fair Tax burden
• There is a large concern about keeping taxation progressive
• A straight up sales tax is regressive:
• If everyone paid a high percentage tax on what they purchased, the tax
burden would shift to the poor
• Examples:
• 1. College students.
• Low tax burden now
• High tax burden under straight up sales tax
• 2. The wealthy.
• Higher tax burden now
• Lower under straight up sales tax
Public Finance – ECON 344, Iowa State University
What the president’s panel says
• The President’s Advisory Panel on Tax Reform:
• Created by executive order #13369 by President Bush in 2005 to study
different tax proposals
• Basic goals of American Tax reform:
• 1. Simplify tax code
• 2. Keep tax code “appropriately progressive”
• 3. Long term job growth
• “Replacing the income tax with a retail sales tax, absent a way to ease the
burden of the retail sales tax on lower and middle-income Americans,
would not meet the requirement in the Executive Order that the Panel’s
options be appropriately progressive.”
Public Finance – ECON 344, Iowa State University
Easing the Burden – A prebate
• How to ease the burden on low and middle income Americans?
• Fair tax proposal removes tax burden for income earned under
the poverty level (determined by family size):
• There is an additional problem with smoothed out consumption:
• The checks would be issued once a month
• Examples:
• A college student with an income at the poverty level ($10,400)
• $2,392 a year
• $199 a month
• A family of four with an income at the poverty level ($28,000)
• $6440 a year
• $537 a month
Public Finance – ECON 344, Iowa State University
Prebate and Progressivity
• The prebate makes the Fair Tax more progressive:
• If everyone spent all of their income, the more that people make and
spend, the higher the effective tax rate
Public Finance – ECON 344, Iowa State University
Philosophical Questions:
• American political thought rallies around independence and
freedom
• The prebate would make large amounts of people dependent on
the American government for their monthly checks.
• Does this harm our independence?
• Counter point: A lot of us wait for our Income tax refund every
year, or alter our purchasing behavior due to tax breaks, are we
really all that independent?
Public Finance – ECON 344, Iowa State University
Transition Problems
• Encouraging Savings
• If you were receiving more money from the government than you pay in
taxes just what would you be buying?
• If people are inclined to retain their money rather than spending it, will
that reduce consumption enough to cause a recession?
• If you saved your money rather than spent it, you would be able to do so
without income taxes, making dangerous credit card debt and over
spending much less appealing than our current system
Public Finance – ECON 344, Iowa State University
Transition Problems
• Impications of Transition
• The Fair Tax is going to be regressive by age
• If you already have your home filled with items, you will not be spending
as much as someone who is buying a house and things for their house
• This means that the older generations of Americans will be more inclined
to support this than younger people who use more of their income on
goods and services
• At the same time however, people who have saved and collected money
while suffering the income tax would be double taxed by the Fair Tax\
• Example: if you paid a 30% of your income so in order to save $1000 you
would have to earn $1428. After paying $428 in taxes you would then be
taxed again on what you consume with that $1000.
Public Finance – ECON 344, Iowa State University
Revenue Neutrality
• What is the “right” tax rate?
• Currently there is estimated a 15% evasion rate of federal
income taxes
• The evasion rate is why people question if the proposed 23%
sales tax would be enough, many speculate that the actual tax
may have to be 30-40%
• On the flip side, because people traveling to America would be
spending money here that they would never pay income taxes
on, there would be some positive inflow of foreign money by the
Fair Tax
Public Finance – ECON 344, Iowa State University
Black Market Growth
• Historically black markets emerge wherever there is an incentive
to avoid the laws placed on people
• Prohibition created a huge black market for alcohol
• Drugs and Narcotics are entirely black market items…the
market does exist despite it being against the law and relatively
easy to trace
Public Finance – ECON 344, Iowa State University
Black Market
• If the sales tax in the United States on all purchases of physical
goods and services was 23-40% there would be a huge incentive to
purchase things on the black market
• In Iowa where fireworks are illegal there is a market beyond the
borders of this state at every major highway where fireworks are
legal
• We could expect similar markets to border the United States in
Canada and Mexico,
• We could also expect many people would bring items into America
and illegally sell them
• If you bought 50 laptops that cost $1,000 each and haul them to
Minneapolis, normally they would have $230 in taxes placed on their
purchase, but if you only charged a $100 premium from people, you
would easily be able to cover the costs of the trip with the $5000 you
collect, at the same time people who save $130 on a new laptop
purchase would also be very inclined to seek the black market
Public Finance – ECON 344, Iowa State University
Effects of FairTax on Economy
• Impact of new tax system on the economy
• Variables – Real GDP, Investment, Labor compensation, Consumption,
Employment
• Necessity of an accurate model
• Computable general equilibrium model
• Study by BeaconHill Institute
• Constructed in 2006
Public Finance – ECON 344, Iowa State University
Model Details
• Analysis of variables in economy such as prices, employment,
savings, interest rates, and exchange rates
• Used by CBO and US Treasury
• Details
• Economic relationships among producers, households, government, and
the rest of world
• Equilibrium model (assumes demand equals supply in every market)
• Dynamic model (accounts for secondary effects of tax changes)
Public Finance – ECON 344, Iowa State University
Model Details
• Assumptions
• House holds are assumed to maximize their utility
• Accounts for future policy changes
• Producers are assumed to maximize their profits
• Government taxes, Government spending
Public Finance – ECON 344, Iowa State University
Circular Flow in a CGE model
Source: BeaconHill Institute
Public Finance – ECON 344, Iowa State University
Elasticities
• Behavioral Elasticities of Substitution in Consumption and
Production
• Inter-temporal Elasticity of Substitution
• Intra-temporal Elasticity of Substitution between Consumption
and Leisure
• Intra-temporal Elasticity of Substitution between Consumption
Goods
• Armington Elasticities
Public Finance – ECON 344, Iowa State University
Results
• Effects on economic performance
Table 1. Effects of the FairTax Relative to Current Law (% change)
Source: BeaconHill Institute
Public Finance – ECON 344, Iowa State University
Results
• Effect on GDP
Source: BeaconHill Institute
Public Finance – ECON 344, Iowa State University
Results
• Effect on Investment
Source: BeaconHill Institute
Public Finance – ECON 344, Iowa State University
Results
• Effect on Employment
Source: BeaconHill Institute
Public Finance – ECON 344, Iowa State University
Results
• Effect on comsumption
Source: BeaconHill Institute
Public Finance – ECON 344, Iowa State University
Results
Table 2. Index of Change in Real Output Relative to Benchmark of 100, by Sector
Source: BeaconHill Institute
Public Finance – ECON 344, Iowa State University
Results
• Effects on specific economic indicators
Table 3. Summary Effects of the FairTax on Income Groups Relative to Current Law, 2007-2031
(% change)
Source: BeaconHill Institute
Public Finance – ECON 344, Iowa State University
Results
• Indicator of well-being
• Income
• Consumption
• Leisure
• Utility
Table 4. Lifetime Utility under the FairTax Relative to Current Law (static household mobility)
Source: BeaconHill Institute
Public Finance – ECON 344, Iowa State University
Results
Table 5. Distribution of Household Units by Income Group
Table 6. FairTax Impacts on Instantaneous and Lifetime Utility of Households (relative to
current law, % change)
Source: BeaconHill Institute
Public Finance – ECON 344, Iowa State University
Personal Conclusions
• Prashanth
• Ken
• Mike
• Will
Public Finance – ECON 344, Iowa State University