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 fairtax.org, the website of Americans for Fair Taxation. The site has plenty of propaganda explaining why the fair tax proposal will save America.