An empirical investigation of the FairTax as an alternative to the federal personal income, corporate income, estate and gift, and payroll taxes

Dissatisfaction with the current federal tax system is fostering serious interest in a national retail sales tax. Specifically, the FairTax Plan intends to replace most of the federal taxes with a national retail sales tax and is gaining momentum in Congress because of its purported progressive features. The FairTax is promoted as being progressive but there is considerable opposition to this claim. Using the most recent 2005 Consumer Expenditure Survey (CES) data and estimating lifetime income from a Panel Study of Income Dynamics (PSID) panel tracked over 1968-2005, the distribution impacts of the FairTax Plan are examined, as well as the current federal tax system it intends to replace, under both annual income and lifetime income approaches. Global measures of progressivity suggest that the current federal tax system is progressive while the FairTax is regressive. While the FairTax Plan is much less regressive under lifetime income approach, it is still not comparable to the current federal tax system from the aspect of progressivity. Additionally, the current federal tax system produces, in comparison to the FairTax Plan, a larger reduction in the inequitable before-tax income distribution. However, both tax systems are found to induce some degree of horizontal inequity, which negate the redistributive effects of the tax systems. The results of the present study are robust in regard to who currently pays the employer payroll taxes (i.e., the employers or the employees), revenue-neutral sales tax rate assumptions, and different discount rates, age ranges, and PSID sample selection criteria used for lifetime income estimation