The FairTax is not regressive (Part I)

An oft-heard claim about the FairTax is that it is regressive. I do not believe this is the case, human nature being what it is. For most people it is true that the more they make, the more they spend. The structure of the FairTax is such that if this is true, then the FairTax is a progressive tax.

Fair-tax.org: A regressive tax is one where the rate of tax decreases as the ability to pay increases.

Wikiepedia: A regressive tax is a tax imposed in such a manner that the tax rate decreases as the amount subject to taxation increases.

These definitions seem to agree.

The Fair-Tax is not regressive. Overall, the FT is progressive, in that it is designed so that as income increases so does the effective tax rate, asymptotically approaching 23% as income increase, by assuming that annual spending is proportional to annual income (setting aside Bill Gates $1 income against billions of dollars of liquid assets in his net worth).

Yes, that is an assumption, but it is an assumption that is true for the vast majority of people, including high-income people. If that assumption is violated by an individual--a high-income miser--then in that case that individual can create an instance of a "regressive" case where that individual has managed to pay less, as a percentage of income, than normal lower-income taxpayers.

But that no more makes the FT regressive than does someone who legally structures their income and assets such that they avoid paying income taxes makes the current federal income tax regressive. That is, the income tax structure we have assumes that higher incomes (wages, rents, royalties and capital gains) will result in higher income taxes, but it is possible to have high income and pay little in the way of taxes,  for example by investing heavily in AMT-bypassing municipal bonds.

One recent IRS report counted 2,680 filers with incomes of $200,000 or more claiming they owed no taxes at all, up from just 85 in 1977. Those people do not make the current progressive--by presumption and design--Federal income tax regressive. Nor would high-percentage savers (i.e., people exercising avoidance of the Fair-Tax!) make the progressive--by presumption and design--Fair-Tax regressive.

However, we are unlikely to see people making $100,000 or $1M or more *not* spending money in proportion to their income (wealth). Consider this article ("DISENTANGLING THE WEALTH EFFECT:
A COHORT ANALYSIS OF HOUSEHOLD SAVING IN THE 1990s"), which is quite dense, but the charts and graphs at the end indicate that not only is America's savings rate (the difference between what is earned vs what is spent) very low across the board, it is *lowest* at higher income levels. 

In the U.S., household net worth rose substantially in the latter half of the 1990s and the personal saving rate decreased rapidly. Researchers have not reached a consensus about just how these two events are linked, or how to interpret the negative correlation between wealth and the saving rate over a longer time span. The movements in net worth and the saving rate are consistent with a direct view of the wealth effect, in which an increase in wealth directly causes households to increase their consumption and decrease their saving.

Previous macroeconomic research indicates that the aggregate data on consumption, income, and wealth are consistent with a significant and direct effect of wealth on consumption, whereby consumer spending eventually rises on the order of 3 to 5 cents for every extra dollar of wealth that is recognized by households and sustained over a period of time.

We show that the groups of families whose portfolios were boosted the most by the exceptional stock market performance over the latter half of the 1990s are the same groups whose net saving flows fell the sharpest from 1995 through 2000.

In addition, our study verifies that essentially all of the increased spending apparent in the aggregate data can be attributed to an increase in the propensity to consume out of income undertaken by the richest households in the U.S.

So, it seems that for higher-income, wealthier individuals, once they reach a certain level and have their nest egg--that's when they go out and buy yachts and Rolls Royces.

It therefore seems that the underlying assumption for the progressiveness of the FairTax is well-founded.

Also, note that FT would do away with several highly regressive taxes: the current Social Security/Medicare payroll deduction system is a very regressive tax, placing a heavy burden on low/middle-income taxpayers and a similar burden on the self-employed.

Exploring something else about regressive taxes: The regressivity of a particular tax often depends on the propensity of the tax payers to engage in the taxed activity relative to their income. In other words, if the activity being taxed is one more likely to be carried out by the poor and less likely to be carried out by the rich, then the tax is regressive.

Since the Fair-Tax is designed to tax the act of spending money on goods and services above the minimum requirements for adequate survival--the poverty line--which is an action that is, by definition, only carried out by the more well-off. That is, the poor, by definition do not have money to spend on "luxuries"; but under the FairTax, those same poor people have a net tax rate of 0% (or less!).

It certainly also seems that people who have more money, are also likelier to have a "propensity...to engage in the taxed activity relative to their income".