Sunday, February 18, 2007

Fair Tax?

There is a fair tax movement afloat in the land. Fair tax? Is that an oxymoron? I thought the only fair tax is one my neighbor pays but I don’t. LOL.

But, really, what is this fair tax stuff? I’m always a little suspicious when somebody labels something as “fair.” It’s sort of a propaganda ploy. It’s like conservatives labeling the federal estate tax as the “death” tax. Or a former candidate and then governor of the Commonwealth labeling a portion of our property tax as the “car” tax. Of course, there is no “death” tax or “car” tax. But, it surely helps to convince people by using this kind of labeling. Who could possibly object to a “fair” tax?

Let me first explain the fair tax proposal. It would eliminate all federal income-type taxes—individual and corporate income tax, payroll tax, self-employment tax, capital gains tax, gift tax, alternative minimum tax—and replace them with a twenty three percent federal sales tax on new retail sales of goods or services in the United States. In essence, the fair tax proposal would substitute a tax on consumption for our current taxes based on income. The twenty-three percent is the level at which the sales tax must be set to produce the same revenue for the federal government as the income-type taxes that are being eliminated.

So, if the proposed new tax is fair, I must assume that the old income-based tax is unfair. But, is it? The Internal Revenue Code is huge; it contains hundreds of pages, thousands of sections. The implementing regulations, issued by the Internal Revenue Service, are bigger still. Our federal tax system is an adversarial game between the taxpayers and the IRS. The taxpayer’s goal in the game is to pay as little tax as possible; the IRS’s goal is to make the taxpayer pay as much as possible. And, because the rules of the game—the Code and regulations—are so complex, the taxpayer who has the best accountant, tax lawyer, tax service, or tax preparation software, ends up paying the lowest tax. The basic unfairness in the system is that two taxpayers can have identical incomes but will pay different amounts of taxes depending on how well they (and their people) play the tax game. So, if the fair tax proposal eliminates the tax game, it’s got to be fairer than the current system, right?

Wait, wait, wait! Twenty three percent seems like an awful high sales tax. That means for every dollar I spend, I have to pay another twenty-three cents to the federal government. But it’s not that high, the fair-taxers tell me. For one thing, under the current system more than fifteen percent of the retail cost of the goods and services I buy represents federal taxes paid by the manufacturers, middlemen, and retailers. With the federal income and related taxes gone, these costs will be saved, and the pressures of the market will guarantee that these savings are passed on to me, the consumer. That means that the effective rate of the federal sales tax will be only about eight percent. And, don’t forget that I will no longer be paying federal income-type taxes so my take-home pay will be significantly higher. So, an eight percent sales tax is not that high.

Okay, but I thought that a sales tax is very regressive. Since economically disadvantaged people spend a much higher proportion of their income on subsistence consumption, charging everybody the same sales tax rate results in a regressive tax. Poor people will necessarily pay a larger part of their income on the sales tax than will wealthier people. Does the fair tax program provide an exemption for food and other subsistence items to reduce the inequity of the regressive rate? No, there are no exemptions for any kind of purchase. That would make the system too difficult to administer. Instead, the fair tax proposal includes a "prebate" for poor people. In my opinion, this is the weakest part of the fair tax proposal.

Under the prebate, the Social Security Administration will mail to every family in the country with an income lower than the poverty level a monthly check to offset the costs of the sales tax it pays for subsistence consumption. The amount of the prebate is based on an annual consumption allowance that varies with the size of the family. For example, a single-adult household with three children has a consumption allowance of $20,650, while a two-adult household with four children has a consumption allowance of $34,340. The first of these families would receive a monthly prebate of $396; while the second would receive a monthly prebate of $658. According to Americans for Fair Taxation, if the fair tax proposal was enacted now, 113 million United States households would qualify for prebates in 2007.

In the opinion of this maven, the prebate constitutes a serious flaw in the fair tax proposal. For one thing, it is an invasion of privacy; it requires families to publicly declare and prove their poverty. Worse than that, however, is the fact that the federal government will be disbursing 113 million payments per month. Although the fair taxers were smart enough not to create a new agency to administer the program, payment of prebates will place a significant extra administrative burden on the Social Security Administration. It is a needless burden, because it would be much simpler to simply exempt food and other subsistence consumption from the federal sales tax than to collect the tax and then return part of it to 113 million households in the form of a monthly check.

Doesn’t the fair tax proposal have loopholes? Can’t an American citizen avoid paying the tax by making purchases outside the United States? If I were a rich man, and I wanted to buy a $5,000,000 yacht, I could avoid paying the federal tax by purchasing my yacht in Italy and then sailing it home. This loophole must be plugged.

Further, the proposal will be disruptive of the planning of many American families. Millions of families, in purchasing homes, have counted on a yearly tax deduction for the mortgage interest they will be paying. Under the fair tax proposal there will be no federal income tax and therefore no deduction for homeowners. This will make home-ownership more expensive because the federal government will no longer be subsidizing part of the monthly payment.

The proposal may also have disastrous effects on the ability of charities to raise funds. Will people continue to make contributions to charities if the federal government is no longer providing a subsidy in the form of a tax deduction? Fair taxers say it won’t make much difference. I’m not sure.

If you want to know more about the fair tax proposal go to, the website of Americans for Fair Taxation. The site has plenty of propaganda explaining why the fair tax proposal will save America.


Roger Mc Cauley said...

The Maven has introduced a very important subject for discussion.
First, I admit I am a proponent of the FTP.
Comments. Every household would have to declare annually the number in the household. This would not apply only to the poor, but to all. The"prebate" applies to all families. With the prebate the poor would pay no taxes(net) and benefit from lower prices.
Next, there would be no filing of tax returns (ever).
Next next, the current cost of running the IRS is about $600 Billion annually.
The savings to business would be enormous.No payroll taxes,no income taxes less internal paperwork. Maybe even higher wages.
Goods for export would be cheaper. Overseas manufacturers would return and bring back jobs.

Roger Mc Cauley said...

These are an add ons to my previous comments.

There has been introduced into the House, HR-25 which is the Fair Tax Plan. It currently has 52 co-sponsors from both parties. Three of the eleven Members from Virginia have signed on. The former Speaker has signed on as well.

Second. If this Legislation is enacted at the Federal level. it will make it economically feasable for similar legislation to be enacted by the States. Eleven State have it under consideration currently. Some are even discussing the possibility of incorporating the elimination of the Real Estate Tax which the Maven has challenged in another of his messages.

Jim RusselL said...

Of several imprssion you have of the Fair Tax some are correct and some are patentedly false. The prebate will be paid to everyone in the country who has a social security number so the nobody pays the sales tax (federal) on goods and services below the proverty level. This includes you and me and Bill Gates behind the tree.
Thanks Jaxtar

jeff said...

It is clear that you have not studied the plan very well. Here are some comments.
1. Everyone, from Bill Gates on down to Joe sixpack will get the prebate so that no one will pay the tax on the basic necessities of life. Since wealthy people spend more than the poor this makes the tax very progressive. Liberals should be jumping all over this proposal.
2. Exempting thing such as food. this is not such a good idea. Lets say i want to have a New Years party and I go to the grocery store to buy the food. there is no way that the store would know if it for a party or for personal consumption. This defeats the basic premise of the prebate.
3. As for the invasion of privacy issue, don't you think that the income tax reporting system as it currently exists is even more of an invasion?
4. As for the embedded tax, not only would that go away but so would the cost of comliance, the total being about 22%. so the Fair tax is a break even event. Also without the embedded tax the USA will become the world biggest tax have. Jobs will be created so fast that you would have to hide under a rock to avoid employment.

There are many more comments I could make about your lack of knowledge on the subject. I must say that when I first heard the proposal I was as sceptical as you are and I have a degree in econimics. After further reflection and some serious study I came around to embracing the Idea of the Fair Tax.

I would suggest you go to to read more about this proposal. Better yet, buy the Fair Tax book and i believe your eyes will be opened. I never thought a book on taxes could be a page turner, but boy was I wrong.

Anonymous said...

I do not like the idea of a prebate, but compared to today---it's a good plan. Here are a couple of my questions/comments (and I have spent a lot of time at the Fair Tax site, where I did not ask them to avoid vested interest answers).
1. Illegal immigrants with false SSNs--they will get a monthly check--thus we encourage ilegal immigration even more??
2. Not my question but--a fellow blogger says--he has no corporate pension plan and no 401k or other tax benefit savings plan. He is very close to SS collecting age--After retirement,each dollar he spends from his personal savings account that is above the earned interest amount winds up being a double taxed dollar since his savings plan was built from after tax money..
Any answers????
3. Merchants now receive money for collecting taxes in my state--trrue for Fairtax?? How much??

Anonymous said...

To anonymous:
1. Illegal immigrants
- Every head of household fills out a card with the names and SS#'s of the people living there. If there are any duplicate SS#'s in the nation, a flag will certainly go up and they'll address the situation.
- Also, you have to realize, with the FairTax, nobody can cheat their way out of taxes, because every new purchase in the nation sends $$ to the Fed. Illegal immigrants, drug dealers, prostitutes, and tourists from other countries will all pay into our new tax system. I think this just about eliminates tax cheating.
2. Your friend will be collecting a prebate check every month to cover basic necessities. He'll also enjoy prices on everything new 22% (average) cheaper than now with our embedded taxes. And he can pay as little tax as he chooses by not spending a ton on new stuff.
3. I know states will be compensated like a quarter of 1% of their collections. Don't know about merchants.