FairTax Overview
(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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