The Fair Tax: Is It Too Good To Be True?

by Joe Plemon on April 7, 2010

Close your eyes and dream for a moment. Ready? OK. The IRS was just dissolved. No more federal income taxes. No Social Security/Medicare taxes either. Or capital gains taxes or gift taxes or estate taxes or self-employment taxes or corporate taxes.

Could this ever become a dream come true? If the advocates for the Fair Tax have their way, yes. The concept has been around for several years, but has become more refined and has recently been gaining bi-partisan grassroots support. I wonder…”Is Fair Tax an oxymoron or could there really be such an animal?”

What is the Fair Tax?

The definition, according to FairTax.org , is “The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment."

I have to say that a national sales tax which replaces all current federal taxes and provides the same federal revenue piques my interest. I am thinking, “It seems way too simple…what are the catches?" Explore this with me. I will share some advantages of the Fair Tax plan (found at the FairTax.org site) and then dig into any “catches".

What are some advantages of the Fair Tax?

Americans take home 100% of their paychecks.

The exception would be state income taxes, but there will be no federal payroll deductions of any kind.

Retail prices will no longer hide corporate taxes or their compliance costs.

According to Dr. Dale Jorgenson of Harvard University, hidden income taxes are currently passed on to the consumer in the form of higher prices for everything we buy, boosting those retail prices by 20%. Because the Fair Tax puts an end to corporate taxes, retailers can be totally transparent in their pricing, bringing about clean competition and lower prices.

No taxes on used goods.

With the Fair Tax, you are only taxed once on goods and services. Used goods (used car, used home, used appliances, etc.) will not be taxed.

The Fair Tax is transparent and simple.

It will be charged just as sales taxes are charged today: whatever you buy and however much you spend, you will see exactly how much of your purchase goes to support the federal government. In contrast to our current system, one might not even need to be concerned about how long to keep their tax information.

The Fair Tax brings jobs home.

Because the FairTax removes the cost of corporate taxes and compliance costs from the cost of U. S. exports, these exports will be on a level playing field with foreign competitors. Lower prices means more demand for U. S. exports which translates into more American jobs.

The Fair Tax will make honest taxpayers out of tax evaders.

Although the number could be higher, the IRS admits to 16% noncompliance with the code. However, this does not factor in the criminal, drug and porn economy which is estimated conservatively at one trillion dollars of untaxed activity…all of which will be taxed when paying retail for anything. Furthermore, illegal immigrants who duck income taxes will not be able to avoid the FairTax.

What are the “catches" to the Fair Tax?

Repealing the 16th Amendment.

As already mentioned, the 16th Amendment, which authorizes Congress to levy an income tax, would need to be repealed. This could be difficult.

It might be cost prohibitive, especially to lower income families.

A sales tax rate of 23 percent would need to be imposed in order to generate $2.586 trillion dollars ($358 billion more than it replaces). Is 23 percent prohibitive? Not according to FairTax.org. Because the Fair Tax is not applied to necessities (via the distribution of “prebates”), the actual percent paid is less than 23 percent for all income levels. The following chart shows the effective percent rate of taxes paid by a family of four with two children, and this is if they spend all of their income! Notice that this family would need to spend over $29,140 before paying one dollar of taxes.

FAQ 2007 figure 2 - effective tax rates

Wouldn’t it penalize retailers who have to raise prices to cover the cost of the Fair Tax?

Not really. All retailers would be need to be making allowances for the Fair Tax, so the playing field would be level. And there would be some savings to offset the Fair Tax, such as no employer match for Social Security and no corporate taxes. Also, retailers will be paid for administering the tax.

Couldn’t Congress simply raise the Fair Tax rate once it goes into effect?

Certainly. But shame on tax payers who would allow them to do so. Because the Fair Tax is highly visible and at a single tax rate, Congress will not be able to raise it without the accompanying publicity and disclosure.

Summary

The Fair Tax, in my opinion, is a great way to simplify the federal tax system in an equitable and transparent way. Although I admittedly could have dug deeper into this concept, there seem to be no obvious downsides to it (my Google search for disadvantages of the Fair Tax found very few objections). I like the idea of being penalized for spending money instead of earning money. The more I think about it, the more sense it makes. In fact (excuse the cynicism), it just makes too much sense for me to believe there is a chance that Congress will pursue it.

My prediction is that our legislators, in their ever increasing search for funding, will keep the current behemoth IRS system in place and implement a VAT (Value Added Tax) in addition to it. I hope I am wrong.

Readers: Help me out here. What have I missed? Are there downsides to the Fair Tax that I overlooked? Do you think it has a chance of ever becoming reality?

 

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