Fair Tax and Universal Basic Income

One thing I enjoy doing is trying to find policies that can appeal to both liberals and conservatives. This can often be impossible to do but sometimes you can find really interesting and unique compromises. Even if the proposed policy isn’t politically viable it can be interesting to discuss it with people on either side because it can bring out new arguments. People have a bad habit of just arguing the default position for their party without really thinking too deeply about it. If you present them with a policy that is outside normal politics it forces them to think about the policy and come up with their own arguments. This can help illuminate what things they really care about and what things they might be willing to compromise on.

The compromise I want to discuss today is a mix of Universal Basic Income and the Fair Tax. I have always liked the idea of the Fair Tax as a means of simplifying the tax code as well as a means of encouraging saving over consumption. Conservatives generally push for the Fair Tax because it eliminates tax loopholes and lets people get all their income and therefore have more freedom on what to do with their money. They also really like that it gets rid of the IRS (it moves tax collection to the states and only taxes business for sales). Recently I have also become interested the concept of Universal Basic Income (or UBI) as a means of helping the less fortunate without creating a disincentive for work. This is more of a liberal or libertarian idea and many conservatives are uncomfortable with the idea of giving people free money even if they aren’t working. I want to take the concept of UBI and build it on top of the concepts of the Fair Tax to see if it would be more palatable to conservatives without losing support for liberals or libertarians. I think we can come up with a plan that is better than either Fair Tax or UBI on their own. I will call this plan The Fair and Generous Tax or the FGT. I don’t think that is a particularly good name but it is better than saying “my proposed tax plan” throughout the whole post.

Current System

Before discussing the politics let’s do some research on the current tax system and determine what the tax rate would have to be for the Fair and Generous Tax to work. Once we have a good understanding of our current tax system we can start to understand what will change under the FGT.

The website National Priorities has good data and charts on the revenue and spending for the US. I think they use these charts to try to convince people we spend too much on military but we can ignore their goals and just use their data and nice graphics.

In 2015 the U.S. government had a revenue of $3.8 trillion. For context, that is a three and an eight followed by 11 zeros. Of that $3.8 trillion, $1.5 trillion was from income taxes, $1.1 trillion was from trust funds and $0.3 trillion was from corporate taxes. Income taxes are the taxes you are probably well aware of and are based on your income and tax bracket. Trust fund taxes include Social Security and Medicare (sometimes called payroll taxes) as well as things like excise taxes (for example the gas tax) and customs. At first glance I am actually surprised how little corporate taxes are compared to the income and payroll. We recently had a national debate on whether or not we should reduce the corporate tax rate so I had sort of assumed it was more than the 9% of our total revenue.

In terms of spending, Medicare and Social Security each get almost $1 trillion. We spend $0.6 trillion on the military and then the rest of our spending is spread across many different things the government does.

Proposal

Now that we understand the federal budget a little better let’s start detailing how the FGT is going to work. The FairTax doesn’t make any significant changes to Social Security and Medicare but a lot of the UBI proposals eliminate them. For the FGT plan I am going to eliminate them. Later I will get into why I think this is a good idea. So if we get rid of the payroll taxes that are specific taxes for Medicare and Social Security the government loses $1.1 trillion of tax income. Once we eliminate income taxes ($1.5 trillion) and corporate taxes ($.3 trillion) we decrease tax receipts by $2.9 trillion. We will also stop spending the money on the “Mandatory Spending” items which on top of Social Security and Medicare includes Medicaid, SNAP and unemployment benefits. These Mandatory Spending items total $2.5 trillion. After eliminating all these it would mean the government would raise $0.4 trillion than it does now.

As part of the FairTax plan the government would determine the level of consumption for someone at the poverty level and calculate the amount of tax at that level of spending. The government then would send this amount to every American citizens at the start of each month. The idea is that if you are spending at the poverty level the “prebate” you get each month will completely cover the amount of sales tax you are paying and you essentially pay no tax. This helps make sure the consumption tax is progressive. As you spend more money the prebate covers a smaller and smaller percentage of your taxes and your tax rate goes up. You can see the proposed 2015 FairTax prebate schedule in the chart below.

(From: https://en.wikipedia.org/wiki/FairTax)

For the FGT I want to cover the poverty level tax and give everyone an additional $1,000 per month basic income.

Because we are giving people a lot more per month than the FairTax does we are going to need a larger sales tax. In order to calculate this let’s throw some light algebra in here to see if it scares any readers away. We want a sales tax rate set so that we raise enough money to pay for the $1000 a month UBI amount and include the amount of taxes that would be spent at the poverty level. According to Investopedia the poverty level in 2017 for 1 person was about $12,000. The last bits of information we need are how many citizens would get the check and how much there are in sales in the US. There were 320 million US citizens in 2015, of which 250 million were over 18 and 70 million were under 18. To keep things simple I will plan on giving parents an additional half of a prebate check for each child under 18 that they have. The total US sales were about $16 trillion in 2015 according to YCharts¹. We also need to make sure we account for the $0.4 trillion deficit we had in the budget because we eliminated some taxes and expenditures.

The math looks like this:

($16 trillion) * X tax rate = ($1,000 a month UBI * 12 months + ($12,000 poverty line * X tax rate)) * (250 million adults + 0.5 * 70 million children) + $0.4 trillion budget deficit.

Running the numbers we get a sales tax rate of 30%. This rate proposed by the FairTax is 23% so 30% sounds reasonable to pay for everything the FairTax would plus the UBI. This would lead to a $1,300 a month check.

Tax-inclusive vs Tax-exclusive.

Unfortunately, the way people talk about tax rates can get confusing so I want to do a quick side bar here to discuss how to talk about this rate. Rates are different depending on whether you are looking at the tax-inclusive rate or the tax-exclusive rate. Tax-inclusive means the price of a the good or service includes the tax rate, for example you pay a gas tax on every gallon of gas but probably don’t realize it since it is built into the price you pay at the pump. Tax-exclusive means the tax is in addition to the item, for example when you get a candy bar for a dollar and have to pay $1.15 because of local sales tax. Proponents and opponents have a habit of presenting the number whichever way makes their argument look stronger but either one can be useful depending on which existing tax you are comparing your number to. The 30% I have calculated here is tax-inclusive. If something costs $100 then $30 of that is tax and $70 is going to the seller. This is comparable to a 30% income tax where 30% of your income goes to taxes. But if we are going to compare it to existing state sales taxes, which use a tax-exclusive rate, we need to modify the number. If you buy something for $70 and the tax is tax-exclusive you need to pay an additional $30 to cover the tax rate. The 30% tax-inclusive consumption tax would be comparable to a 43% tax-exclusive sales tax ($30 is 43% of $70). Another way to think of it is that with a 30% consumption tax we are going to ask business to pay taxes on 30% of their total sales. This would logically lead to prices increasing 43% so business can cover the new tax. (In a similar vein if someone was paying a 30% income tax eliminating it would increase their take-home pay by 43%).

Plan Summary

Here is a quick summary of the FGT plan now that we have all the numbers. Every US citizen will receive a check of $1,300 each month, regardless of income. Income, corporate, Social Security and Medicare taxes will all be eliminated. The benefits from Social Security, Medicare, Medicaid, SNAP and unemployment will also be eliminated. Business that sell to consumers will have to pay taxes equal to 30% of total sales, which will likely raise prices 43%. The amount of revenue and spending from other programs will remain unchanged.

I want to get a sense of how this will impact people’s income. Even though consumers would no longer pay any taxes directly I am going to assume 30% of their “consumption” is going to taxes and 70% of their “consumption” is going to products and services. This will make it easier to compare how much people would be able to consume with the FGT to how much they are consuming today. Assume the amount of money I am listing as “products and services” is how much stuff they would get with that amount of money at today’s prices.

Someone with no income would receive $16,000 a year from the government. If they spend all the money they receive they will be consuming $11,000 in products and service and spending $5,000 in taxes.

Someone making $20,000 a year would receive an additional $16,000 a year from the government. If they spend all the money they earn/receive they will be consuming $25,000 in products and service and spending $11,000 in taxes.

Someone making $37,000 a year would receive an additional $16,000 a year from the government. If they spend all the money they earn/receive they will be consuming $37,000 in products and service and spending $16,000 in taxes.

Someone making $100,000 a year would receive an additional $16,000 a year from the government. If they spend all the money they earn/receive they will be consuming $81,000 in products and service and spending $35,000 in taxes.

Someone making $200,000 a year would receive an additional $16,000 a year from the government. If they spend 80% of their income and save the other 20% they will be consuming $121,000 in products and service and spending $52,000 in taxes while saving $43,000 a year.

Someone making $1,000,000 a year would receive an additional $16,000 a year from the government. If they spend 80% of their income and saves the other 20% they will be consuming $569,000 in products and service and spending $244,000 in taxes while saving $203,000 a year.

Now let’s compare these tax rates to today’s current income rates. The person earning $20,000 is paying a negative 25% tax rate (receiving $5,000 from the government), the person earning $37,000 is paying a 0% tax rate, the person earning $100,000 is paying a 19% tax rate, the person earning $200,000 is paying a 18% tax rate (helped by their savings) and the person earning $1,000,000 is paying a 23% tax rate.

Here is a chart

Income	Prebate	Spending %	Saving %	Total consumption	Taxes	Net Taxes	Percentage of Income
$0	$16,000	100%	0%	$11,000	$5,000	-$11,000	N/A
$20,000	$16,000	100%	0%	$25,000	$11,000	-$5,000	-25%
$37,000	$16,000	100%	0%	$37,000	$16,000	$0	0%
$100,000	$16,000	100%	0%	$81,000	$35,000	$19,000	19%
$200,000	$16,000	80%	20%	$121,000	$52,000	$36,000	18%
$1,000,000	$16,000	80%	20%	$569,000	$244,000	$228,000	23%

At first a 23% tax rate for a millionaire feels a little low, especially given that it has to pay for the new $4.4 trillion needed to pay all the prebates. However, remember that Warren Buffett claimed he only pays 16% of his income in taxes. If we look at the numbers Warren Buffett provided here we see that he paid $1.8 million of his $11.6 million income. Note that he gave about 30% of his income to charity and that isn’t taxed in either the current system or the FGT. If we assume he saved another 20% of his income then in the FGT system he would have paid $1.7 million in taxes or about 15% of his income. Given this it makes sense that we only need a millionaire to pay 23% of her income to afford additional cost of the monthly prebate checks.

Politics

So where does this leave us politically?

I think there are some really strong aspects of the FGT plan.

1. Both the tax code and the “welfare” system are greatly simplified by eliminating most taxes and eliminating systems like Social Security and Medicare.
2. Poverty is essentially eliminated since all people will be getting enough from the government to have an income over the poverty threshold².
3. Consumption is taxed rather than income which will somewhat encourage work and greatly encourage saving which are both good for the long-term health of the economy.
4. It provides people who are out of work due to a layoff or out of work from having to take care of a family member something to live off. And it provides this without people feeling the shame of taking a “government handout for the poor”.

I also think there are a few issues that I will call out here but not go too deep into:

1. It is not clear how much this will cause people to reduce consumption. If there is a large reduction in purchases this would negatively impact the economy and require the tax rate to increase.
2. Tax evasion could be an issue. A large sales tax would encourage people to find ways to claim their sales were low. Examples include service providers accepting cash and not reporting the sale or business giving away products in exchange for “donations”. One improvement could be replacing the sales tax with a Value Added Tax (VAT) which would increase complexity a little but would likely improve tax compliance.
3. This tax scheme could negatively impact industries relying on international tourism. International tourists would have to pay the large consumption tax but would not receive the prebate so international tourism would likely decline.
4. This might also negatively affect illegal immigrants who would find the costs of products and services increase but wouldn’t receive the prebate checks that are sent only to US citizens. However, it might have an interesting effect on the immigration debate since it will eliminate the argument that “illegal immigrants come to this country to live off our generous welfare state”.

Next let’s dive deep on some of the objections that will likely come from the left and the right.

Liberal Objections

What are some arguments liberals will make against this plan?

Argument 1: Why does the FGT give a cash benefit to wealthy people who do not need it. Couldn’t that money be better spent elsewhere?

I understand where this criticism is coming from. I can picture liberals arguing “Why are we creating a system that sends Jeff Bezos a check every month? How does that help poor people?” However, I think there are three good arguments for why Jeff Bezos should get the same check as everyone else.

1. Having everyone get the same check completely eliminates the “work disincentive” that is inherent in many welfare systems. If people get the same check no matter their income level, people won’t be afraid to take a risk on a new job. Today, people are afraid to start part-time work because it might move them out of the income bracket that gets SNAP or Medicaid. Or people don’t want to work extra hours because the increase in pay is only a little more than the decrease in government benefits. Why do extra work for a small amount? With the FGT these decisions become easier. You will always have the benefit and will always be rewarded for working more.
2. The second argument is that making this a program for everyone removes any stigma of getting the check. Current programs like SNAP (“food stamps”) are seen as programs for the poor and people who use them feel ashamed to not be self-sufficient. If the check is something all Americans receive then no one will feel ashamed of using it but it will still give similar benefits to the poor.
3. And for the third argument I want to point out this plan is designed to be a long-term tax plan. The reason you give the check to everyone is that you want people to vote to enact this plan and vote to keep it around after it is enacted. If the plan is seen as just for poor people than it will be pretty early in the list of programs to cut when people want to reduce the size of government. If instead it is a program all are involved in and all benefit from then it will be kept around. If you can get 70% or 80% of American citizens to approve of a plan then no politician will ever even suggest eliminating it. Building a plan that helps the poor and isn’t at risk of being eliminated is much better than building a plan that helps the poor that could be eliminated after one bad election.

Argument 2: This is a good plan but it would be better if we kept programs like Social Security and Medicare and added the UBI benefit as an additional benefit.

The obvious answer is that a plan that added UBI to the existing benefits would not be politically feasible. But I also want to discuss how this change will impact people who are currently on these programs.

First, let’s quickly discuss the programs not directed at senior citizens: Medicaid, SNAP and unemployment. SNAP grants about $1,500 a year³ and unemployment usually gives 50% of your previous income so replacing both of these with a $16,000 yearly income will be a clear improvement for low-income people. Medicaid numbers are complicated because there are a lot of variables but Wikipedia says the average cost is $5,563 a year per enrollee⁴ so again it is an improvement to get $16,000.

Things do get trickier when talking about the elderly. The average benefit from Social Security is $14,760 a year⁵ but the calculation is based on your salary during your career so it will be lower for low-income people and higher for high-income people. Retirees who earned a lot during their career will see a reduction if we move to the FGT. I don’t think liberals will be object to wealthy people getting less retirement benefits and I don’t object either. I will note that we should plan a gradual transition to the FGT so that people who put into Social Security and are expecting to get that money in retirement would still get their benefits. I will also note that the current Social Security system has a cap in payments so high income people stop paying the payroll tax by the middle of the year. So by the end of the year Social Security is being mostly paid into by low and middle class workers. Under the FGT the checks senior citizens receive each month would be paid for by wealthy consumers rather than the middle class.

The trickiest is Medicare. Medicare is even more complicated than Medicaid. Taking some very rough numbers I estimated that on average people get about $10,000 a year from Medicare. Obviously people with significant health issues will be getting a much larger benefit. Also, I think one of the benefits of Medicare is that the government is able to negotiate medical prices down which would obviously be lost if we went to a system where everyone paid with their medical care from the money they got from the prebate. I am willing to admit that it is likely medical care is not something that can be easily replaced with a monthly check. Maybe an improvement to the FGT is to leave Medicare in place (or create a universal health care system) and increase the tax rate slightly to cover the cost of Medicare. If we did leave the cost of Medicare in the FGT plan, the consumption tax would have to be raised to 38% and the monthly check would be $1,380.We can leave this discussion for another post. For now let’s just call the lack of medical care for the elderly out as a potential flaw in the FGT and move on.

Argument 3: A consumption tax is bad for the poor. Low-income people spend most of their money on consumption while wealthy people invest most of their money and only spend a small amount of it.

It is true that low-income people spend more of their income on consumption than wealthy people. But remember that wealthy people also get more of their income from investment income which is taxed at a lower rate so wealthy people have a similar advantage in the current system.

In my opinion someone shouldn’t be taxed on the money they invest. Putting money in a bank account or the stock market enables businesses to get loans or cash and this enables business to innovate and create better products. Investing also gives the investor money in the future so they have a safety net if they lose their job or have a medical issue. If they consumed all of their income each month they would have no safety net and might need to rely on the government if something goes wrong. All in all, encouraging investment is good for the economy.

People might argue that it isn’t fair that someone can make money from their investments when they aren’t actually adding value to anyone. Wealth begets wealth feels inherently unfair. I agree with this instinct. But I believe the reason it feels unfair to us is that wealthy people are able to use that “free” money to consume more and have a better life. The issue is the increased consumption allowed by that “free” money. Therefore, we want to target the consumption not the savings.

Let me argue this a different way. Imagine someone, we will call her Carol, who has a large income but a modest living and only uses 1% of her income for herself. Carol saves the other 99%. Assume Carol does this her entire life and even in retirement she spends very modestly. She then leaves her extremely large savings to charity in her will. I don’t think someone like Carol should be taxed at a high rate. Even though she has a large amount of income and a large amount of wealth it feels wrong to charge her a high tax rate. Carol has been lucky to be able to get a large income and large wealth and she is doing exactly what we would like people like her to be doing with their money.

Now imagine another wealthy person, who we will call Eric. Eric has a decent income but also large investments given to him from his father. Each month Eric spends his entire income and dips into his investments to pay for things like expensive meals at restaurants and purchasing things like yachts and private jets. Eric is exactly who we want to be taxing at a high rate. And because Eric is actually spending more than his income each month the FGT will tax him at a very high rate, much higher than the current tax system would.

In my opinion the fact that the consumption tax makes someone like Eric pay much more in taxes than Carol is a huge pro of this system. I am hoping liberals agree that this makes up for the fact that it might not tax the savings of wealthy people as heavily as the current tax system does.

Conservative Objections

Ok, now let’s turn to conservative objections.

Argument 1: This is a large government spending program and we can’t afford it.

One way to look at this proposal is it is increasing government spending from $3.8 trillion a year to $5.7 trillion a year. Looked at from this perspective it does sound like a massive government spending program. But I think we need to have a discussion on why people think a large government is bad.

As a basic principle, I do believe a large government is bad for the people. The standard argument, which I agree with, is that individuals with free choice will make better decisions than a top-down government program trying to make decisions. A large government takes a large portion of the economy, runs it inefficiently and we end up with a slower growing economy. I think this argument is very valid.

Notice that this argument doesn’t really apply to the FGT. The $4.4 trillion of “government spending” in the FGT is going directly to American citizens to spend how they want. This isn’t government picking winners and losers, this is government transferring wealth to citizens. You might object to large transfers of wealth but I don’t think the argument is nearly as strong that transfers of wealth will lead to inefficiency and a slower economy. I think when discussing plans like the FGT “government spending” on things like government salaries, military equipment and infrastructure should be distinguished from “wealth transfers” which is money given directly to people. If looked at that way “government spending” will not change with the FGT. “Government spending” would likely go down slightly with the FGT plan because you could close the agencies that run programs like Social Security, Medicare and SNAP.

Argument 2: Creating a government income with no work requirement will mean a large amount of lazy people will stop working and live off the government check.

I understand this criticism and I do think there will likely be some people who stop working when they start getting the $1,300 check each month. But I think this group of people will be small. Conservatives are also afraid that this money will be spent on alcohol and drugs. To that later point, studies have shown that when you give people a UBI check there is no increase in alcohol or drug use.⁶ One reason why I think people will still plan to work is that we are a species obsessed with status. $1,300 a month is a decent amount of money in some places but in many places it is barely enough to get by. Many people who are “lazy” will still work so that they can get a better car and house than their neighbor. Some will even work simply so they aren’t seen as a “lazy unemployed person living off the government”.

There are also situations where we might consider someone stopping work a good thing. Imagine a family of four that is struggling to get by and both parents need to work in order to make enough. If both parents started receiving a prebate check each month it could be enough for the woman to be able to stay home and take care of the kids. A woman who wants to be a stay-at-home mom being able to stay home with her kids should be considered a benefit of the FGT.

Argument 3: I still think taking a large amount of money from the wealthy and giving it to people not working will disincentivize work and reduce overall growth.

I see two reasons why the FGT could actually increase growth. The first is that rather than taxing income it is taxing consumption. This will no longer discourage hard work and earning more money. Instead, it will start encouraging people to save rather than consume. People working more is good for growth and people saving more is good for the long-term health and stability of the economy.

There is another way the FGT can help the economy. It will make it more likely that unemployed and low-income people are able to add to the economy rather than be a drain. Someone who barely has enough money to get food and housing will spend all of their time and energy making sure they get food and housing. However, if they have the safety net of a $1,300 check each month they might be able to afford to take some risks. Studies of UBI have shown that when people are given money some of them start getting an education. Some of them start a business. If someone is well-educated or running a small business they are able to add more to the economy than if they are poor and struggling to get by. Helping people off that bottom rung of the economy will help them succeed and help the economy succeed.

My final thoughts

The idea of a consumption tax really speaks to me. When debating taxes, the left usually argues that we should tax the rich more because they can afford it. The right counters that taking money from the rich will reduce the incentive to work and will reduce investments. The consumption tax seems to solve this problem. I think it makes sense that someone who has a high income but gives most of her money to charity should not pay a high tax. And I think it makes sense that someone who is spending most of his money on yachts and lavish parties should be taxed a lot.

Normally, the major downside of a straight consumption tax is that it is regressive. Taxing everyone at the same rate ends up being much tougher on poor people than on wealthy people. Also, lower and middle class people spend more of their income on consumption than wealthy people do. Putting in a large prebate flips this issue and makes the tax plan very progressive; turning one of the main issues of a consumption tax into a benefit.

I also like the UBI aspects of this policy. Someone with no income will be getting enough income to be roughly at the poverty level. The idea that a government policy can immediately end poverty for all American citizens is very appealing to me. I do believe that some people who are currently below the poverty line would be able to get an education or move to find a better job and this would have long-term benefits for our economy and our country.

I also like the simplicity of the program. No one will have to fill out forms or prove they are in a situation where they deserve a government hand out. No more worrying about if a “welfare” plan is targeted correctly. If you are an American citizen you get a check each month, simple as that. Also, the requirement to pay taxes is removed from citizens and put on to businesses. Businesses are better able to handle the paperwork and cash flows associated with paying taxes. Never having to fill out a tax form again sounds wonderful.

Conclusion

The thing I most like about this proposal is that it challenges people’s positions in interesting ways. Will people on the left approve of a plan that gives money to the poor if it also gives money to the rich? Will conservatives who push for a smaller government accept a plan that increases the inflows and outflow of the government but reduces the ability of government to choose winners and losers? How will people who push for programs that encourage work will feel about a system that gives non-working people money if it also eliminates the tax burden on income and gives the money in a way that there is no disincentive to work? There is a chance I have built a system that is hated by all sides. But I am still curious to hear people’s thoughts. Even if all I am able to do is get people off of their default talking points like “tax the rich” or “make government smaller” I would consider this proposal a success. So let me know what you think in the comments. Hopefully we can have a unique and interesting discussion.

¹To double check the $16 trillion number I also found an estimate for how much would be taxed in the Fair Tax. According to a paper by the think-tank Beacon Hill Institute the taxable base for the Fair Tax in 2007 is $11.244 trillion. This is a little lower than $16 trillion but is also 8 years earlier so we are in the right ballpark.

² The poverty threshold is $12,060 for one person and the poverty threshold is calculated after taxes. If you take out the amount of consumption that is taxed for someone only living off the prebate they actually only receive $11,000 a year. However, when you look at a family with 2 adults it does eliminate poverty since the poverty threshold doesn’t scale linearly. Two adults would get $24,000 a year from the FGT and the poverty threshold for a household of 2 people is $16,240. So I am comfortable saying “poverty is essentially eliminated” by the FGT.
³ https://en.wikipedia.org/wiki/Supplemental_Nutrition_Assistance_Program

⁴ https://en.wikipedia.org/wiki/Medicaid#Features

⁵ https://en.wikipedia.org/wiki/Social_Security_(United_States)#Benefit_payout_comparisons

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