Tuesday, October 19, 2004

Effective Tax Rate: Current System vs Fairtax System

Since we computed the Effective Tax Rate of the Current System and the Effective Tax Rate of the FairTax, it makes sense to put the two side by side so they can be compared.

Pay particular attention to the green 'Diff' column. It represents how greater an Effective Tax rate would a person would pay under the current system than under the FairTax if a person spent 100% of their income.

Once again you will see an explaination of exactly how a cell value is computed if you click on it.

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At 6:31 AM, Blogger astrophysicat said...

These are all still as you defined "effective tax rate" before, with respect to money spent, and then assuming that all income is spent for the comparison, yes?
This will be a lower bound on the difference (current - fair-tax), where the deviations from this estimate will increase with income (on average).

On the face of it, that looks good, almost absolutely everyone will have less tax under the fair tax. However, if that were really the case, the government's tax revenue will be smaller. So another question might be normalizing these curves to the same total revenue. That requires knowledge of the distribution of incomes to be integrated in and I would suggest you work on that after considering the "saving power" issue because overestimating the tax rate of the wealthy under the fair tax will, after re-normalization, underestimate the tax burden of the poor.

Although I will allow that there is no good reason why we have to sustain the current government tax revenue in the first place.

At 9:14 AM, Blogger quadrupole said...

You are correct, this is all still comparisons assuming spending is 100% of income.

As to revenue neutrality, the FairTax folks claim to have researched revenue neutrality and found the 23% rate to acheive it. One of the big reasons for this being that the personal consumption expenditure (PCE) number for the US is much larger (something like 2-3 times) than the aggregate adjusted gross income (AGI). I've not looked as closely at that as I'd like, but there is definitely a post on the revenue neutrality of the FairTax in my future :)

But first, I need to talk a bit about Buying Power and Saving Power, and probably about the effect of the FairTax on home buyers (I keep hearing folks being apoplectic about loosing the mortgage interest deduction).

At 5:37 PM, Blogger Zachriel said...

quadrapole, I was looking at this graph from your website:

Normally, such a plan is proposed as revenue neutral. That means some people must pay more, and some people pay less.

Your graph clearly indicates that everybody pays less. There is a problem somewhere. Either your own calculations are off, or your tax rate is too low, or something.

At 10:15 PM, Blogger quadrupole said...

Zachriel - Please note, these calculations where made to reflect the highest possible tax rate for everyone under the FairTax, and the lowest possible tax rate for the poor under the current tax system.

The poor have a very well defined set of choices they can make that influence their taxes. They can take or not take the Earned Income Tax credit. They can take or not take the child tax credit, etc. I account for all of those in a way that produces the least tax for the poor under the current system.

As you go up the income ladder the available tax choices explode, and the numbers become less meaningful. This is because in the middle and upper class you can have 5 different households with the same income and household size and they can easily pay five different amounts of tax depending on 401k contributions, IRA contributions, mortgage interest, etc. As you move to higher incomes the available tax avoidance becomes even greater. So yes, I overstate dramatically what the rich pay under the current system.

As to revenue neutrality. An analysis has been done by FairTax advocates showing revenue neutrallity. I have not performed such an analysis myself.

At 2:06 PM, Blogger Dennis said...

I've got a question, I'm not quite into the high intensity research as I see being discussed here, and hopefully my question isn't overly simplistic, but I do believe that this question would have an affect on the effective tax rate/spending of the lower income brackets somehow.
Doesn't the fact that used items have no tax under the Fair Tax have an affect on the effective tax rate on the poor? I'm not sure how you would quantify this, but having been in the lower income bracket at a time in my life I know for a fact that purchasing Used goods is a large part of lower income households expenditures. For a lower income household "Used" items may become an even larger part of household expenditures under the Fair Tax.
There may be a simple answer, or like I said, maybe this is one of those un-quantifiables, since I'm not aware of any research data on a percentage of incomes spent on used products, etc. Just had to ask.

At 2:18 PM, Blogger Dennis said...

I'm wondering if you are taking into account the increased size of the tax base. The research done suggesting that the Fair Tax is revenue neutral takes into account that the number of people paying Taxes will be dramatically increased. Therefore, it's not a given that someone necessarily has to pay more at one end of the scale or the other to make up the difference. You very well could have all income brackets paying less with the expanded base. As a novice at these kinds of calculations, it seems that the researchers for the Fair Tax did a pretty good job making it both a Progressive tax, and keeping the effective rates either lower or very close to current levels.

At 11:03 PM, Blogger quadrupole said...


You asked:

"Doesn't the fact that used items have no tax under the Fair Tax have an affect on the effective tax rate on the poor?"

Probably yes, to some degree, but I don't know of any good data from which to try to estimate the degree.

Additionally my bias in all of my computations has been to try to put an upper bound on the effective tax rate on the poor under the FairTax and a lower bound on the tax rate of the poor under the current system.

My reason for doing so is that I wished to demonstrate, that even under the least favorable set of assumptions, the FairTax is not significantly raising taxes on the poor.

I didn't want someone to be able to come round and dispute my conclusion because they disparaged by estimates of how much the poor spent on used goods (for example). If the FairTax is progressive with the deck stacked against it, it will surely be more so in practice.

Effectively what I've done is spot those who wish to disagree with me their arguments, and *still* the FairTax is progressive.

At 12:23 PM, Blogger Dennis said...

Thank Quadrupole for the answer and all the hard work that you do on this stuff.
I do truly believe that the no tax on used items will have a dramatic affect on the effective tax rate on those in the low and lower middle income brackets. As with many things in economics, this seems to be unquantifiable until someone does some sort of study, but there is no denying it is there. Up until about 3 yrs ago I was in the lower or lower middle income brackets and Used items were a very valuable asset when providing for a family of seven. Like I've said, after the Fair Tax, and with a monthly Pre-bate coming in, many WISE lower income families, with good financial management skills, could easily elevate themselves and their savings and investments through the use of all of the benefits that the Fair Tax will provide. It would be nice to have solid figures to back this theory up, although it seems to be common sense. But in a battle with people who have no concern for common sense, it get's very difficult for some to listen to common reasoning.

At 9:19 AM, Blogger Brian Pearson said...

There is absolutely no tax on used items.


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