The FairTax Solution for U.S. Unfunded Liabilities

If you watch or read the news, you have certainly seen the buzzwords “budget deficits” and “national debt.” While these two subjects demand debates, I would like to focus on a less discussed issue: U.S. federal unfunded liabilities.

These unfunded liabilities of the U.S. government are essentially the future costs of Medicare, Medicare Part D (prescription drug coverage for seniors), and Social Security that the government does not currently have funds to pay for moving forward. According to the U.S. National Debt Clock, these unfunded liabilities are close to $113.8 trillion, which is slightly above $1 million per taxpayer. Considering that this is unsustainable and a huge drain on future economic growth, it is important to shed light on this issue and provide a few possible solutions on paying for these unfunded liabilities, which includes the FairTax.

A great explanation about our debt crisis is from Lawrence Kotlikoff and Scott Burns’ book The Coming Generational Storm. They begin by noting the calculation of these unfunded liabilities is equal to the net present value of expected future federal expenditures minus the net present value of projected future federal taxes received. The lack of revenue to pay for expenditures is primarily due to our generational accounting problem, where the dependency ratio of those 65 and older to those 20 to 64 is declining from an aging population. Specifically, the authors note that “today there are about 4 payees for every 1 beneficiary, but by the year 2030 there will only be 2 payees for every 1 beneficiary. Simple arithmetic will note that this is not sustainable over the long run.”

In order to pay for a debt of this size, the authors propose one option to balance this future debt: “raise income taxes by 17 percent, raise payroll taxes by 24 percent, cut federal purchases by 26 percent, and cut Social Security and Medicare benefits by 11 percent.” In the current political and social environment, these changes seem highly unlikely.

What appears more likely are the following: increase the retirement age to 70 or higher, expand health saving accounts, allow individuals the choice of putting part of their income into a private savings account instead of the general fund for Social Security, and scrap the progressive marginal income tax system and switch to a flat consumption tax, such as the Fairtax that only taxes new goods and services by 23 percent and is revenue neutral.  

There are a number of benefits from the Fairtax. Including allowing Medicare and Social Security to be solvent, giving people more choices on what they do with their hard earned money, closing down the Internal Revenue Service, taxing the underground economy, and providing workers with more incentives to increase their productivity without moving into higher tax brackets. Since every worker would not have any federal taxes taken out of their paycheck, they could use those extra funds to consume or save. Even if consumption did increase, which would increase economic growth and job creation; there would certainly be an increase in savings as well. For more details about the Fairtax, please check out my blog post.

Transitioning to a consumption tax would be difficult to achieve because it would require a change or repeal by Congress of the Sixteenth Amendment, which allows for a direct tax on wages and salaries. Another argument against a consumption tax has been that it is regressive, meaning that it taxes lower income earners at a higher rate than upper income earners because lower income earners consume a larger share of their income.

While this is true, consider a situation where a single mother is working and has a baby. The federal government will take taxes out of her paycheck and then disperse the rest to the mother. This automatically reduces her ability to decide on how she will spend or save the money, and it leaves her with fewer dollars to spend on baby formula, diapers, and other goods and services that she may need.

Although this may be an extreme case, it is an example of the unconstitutionality of our current income tax system, one in which our private property rights are rejected. In addition, we should allow for individuals to make choices with their income and not automatically assume that they will not spend the money as the government deems appropriate, as is the case with our current tax system. Therefore, it may seem regressive in the sense that lower income earners will pay a larger share of taxes relative to their income than upper income earners, but they will have the choice on how to allocate their income and upper income individuals will still pay the majority of taxes to the government since they consume more expensive goods and services.

Transitioning to a FairTax and reforming Medicare and Social Security are paths that should be pertinent in our current economic climate. Difficult choices are ahead because of the unsustainable and excessive expansion of the federal government. We must begin to change this direction now. Many will argue that this is not the right direction and significant changes are not needed, but as President Reagan once said, “If not us, who? If not now, when?” Let us be the generation that makes the sensible changes that will provide prosperity in the future.

Photo CreditWikimedia Commons