Fair Tax

Fair tax advocates argue that the American system of taxation is overly complex, impenetrable, beyond comprehension, and unfair, and that what would be fair would be to tax only what people spend, not their entire income. The fair tax is a national sales tax that would replace the income tax and payroll tax.

The existing system is a progressive income tax, with higher tax rates for higher income brackets and margins. Taxable income also varies due to capital gains or qualified exemptions and deductions. The federal tax code is a document containing over four million words. The highly complex system promotes the proliferation of tax experts and both honest and dishonest mistakes. The National Taxpayers Union (NTU) notes that the Internal Revenue Service (IRS) admits to a 25 percent noncompliance rate. Some critics find the progressive aspect to be unfair to the wealthy and a deterrent to economic growth.

Advocates claim that a 23 percent fair tax on purchase of new goods and services, with exclusions for necessities under a “prebate” that returns flat tax paid by impoverished families, could create revenue equal to that produced by the combined payroll tax of 7.65 percent and the lowest income tax bracket of 15 percent.

Background

Before the Sixteenth Amendment (1913), the US federal government depended on a sales tax. However, the idea of fair tax dates back only to the mid-1990s. It would repeal the Sixteenth Amendment and abolish the IRS. With elimination of the IRS, another agency would be created to enforce tax laws, pursue tax evasion, distribute checks, collect taxes from the states, and mediate disputes such as which purchases are business expenses and are thus tax exempt.

Taxes eliminated by the fair tax would include income, payroll, personal, gift, estate, capital gains, self-employment, corporate, alternative minimum, Medicare, and Social Security taxes. A national sales tax of 23 percent would replace them all, and it could be adjusted in future years. It is progressive because the prebate would consider consumption by those up to the poverty line to be tax exempt. The fair tax would exempt business purchases, eliminating the pass through of corporate tax costs to retail sales.

Since 1998 the NTU has backed the fair tax as an enhancer of “freedom, fairness, and economic opportunity.” It would abolish other taxes and place tax administration primarily at the state level. The fair tax proposed by Libertarian Party presidential candidate Gary Johnson would replace all federal taxes with a 23 percent sales tax on only new goods and services. Groceries would be included, but used cars and secondhand clothing would be exempt. Every legal household would receive a prebate check each month.

The Fair Tax Act of 2003 was the brainchild of the group Americans for Fair Taxation, and it called for elimination of all federal taxes, to be replaced with a state-administered federal retail sales tax of 23 percent, exempting imports, used items, and goods used by businesses to produce other goods.

Overview

Fair tax proponents tout the elimination of federal income and payroll taxes and claim that the consumption tax will better support Social Security and Medicare because it taxes not the relatively small number of wage earners but everyone, because everyone consumes. The Beacon Hill Institute calculates that a 23 percent tax would bring in $2.6 trillion, $348 billion more than the personal income tax. It would also increase gross domestic product (GDP) by 7.9 to 10.3 percent, increase domestic investment, and after a temporary drop, increase consumption due to a 1.7 percent increase in disposable income. A prebate eliminates the disparate impact of the flat rate sales tax on the poor.

The fair tax would raise the 2008 poverty rate of $21,200 for a family of four to $27,380, to cover the marriage penalty. A family of four at the poverty rate would receive $6,297 per year to cover the sales tax total. The fair tax eliminates corporate taxes and capital gains, and both fair and flat tax advocates claim their plans will promote corporate investment and economic growth by eliminating double taxation, which they think discourages job creation and productivity enhancement.

Those who may be adversely affected would be seniors and others not earning an income. Seniors would have paid income tax all their lives and then endure higher sales taxes. However, seniors would benefit from the lack of taxes on savings withdrawals.

Critics such as Tim Worstall claim that the rate is prohibitive for a sales tax and would lead to massive tax evasion. Hitting the buyer with a 25 percent tax at the point of sale would dampen sales, encourage an underground economy that disregards the tax entirely, or produce long-term frauds—the setting up of dummy companies that disappear after selling the goods with no intention of collecting or submitting the tax.

The Brookings Institute’s William Gale estimates that a fair tax rate of 23 percent out of every dollar spent would actually be a 30 percent sales tax because a 77-cent item would have a 23-cent tax, which would be a rate of 30 percent. If the IRS was no longer in operation to determine income, states could not impose local income taxes. The sales tax would have to rise another 10 percent to compensate for this, and another 5 percent would be required to compensate for revenues lost to fraud. The real rate of the sales tax, then, would theoretically be not 23 percent but 45 percent. The exemption of food and health care would raise the “real” rate to 67 percent, and only the top 10 percent of households would see a real tax break from the supposedly fair tax.

Fair tax critics anticipate consumers will buy on credit without paying sales tax and then pay off the debt with untaxed income—a major tax avoidance. The nonpartisan Tax Foundation believes that the benefits are worth the transition costs, but congressional support is lacking.

In 2015 Republican presidential candidate and former Arkansas governor Mike Huckabee supported the fair tax. Other Republican presidential hopefuls including Senator Rand Paul, former Pennsylvania senator Rick Santorum, and former Texas governor Rick Perry supported what they call a “fair and flat tax” rather than a tax on consumption.

Bibliography

Burton, David. “A Response to Institute on Taxation and Economic Policy.” Argus Group. Institute on Taxation and Economic Policy, 2004. Web. 18 Dec. 2013.

Clark, Ken. The Pocket Idiot’s Guide to the FairTax. New York: Penguin, 2010. Print.

Cormier, Milton J., and Mark Cormier. The Fair Tax: A Quick Guide. Kindle Edition. Seattle: Amazon Digital Services, 2012.

“How the Plan Works: NTU’s FairTax Information Hub.” National Taxpayers Union. NTU, n. d. Web. 18 Dec. 2013.

Krugman, Paul, and Robin Wells. Microeconomics. New York: Worth, 2012. Print.

Matejcak, Peter R. “Framing the FairTax for the American Consumer: Tax-Inclusive? Tax-Exclusive? Why Not Both?” Loyola Consumer Law Review 22.3 (2010): 391–417. Print.

McLaughlin, Seth. “‘Blow Up the Tax Code’: Rand Paul Introduces ‘Fair and Flat’ Plan.” Washington Times. Washington Times, 18 June 2015. Web. 19 June 2015.

Worstall, Tim. “Why the Fair Tax Will Fail,” Forbes. Forbes, 22 Aug. 2012. Web. 4 Jan. 2014.