Recently, I’ve seen an advertisement being passed around FaceBook regarding a proposed “Fair Tax.” It is a proposed simplified tax on sales that would replace both the personal and corporate income tax and (supposedly) eliminate the Federal Internal Revenue Service. I’m not sure how widely it’s been publicized, but it’s apparently been debated in Congressional committee discussions and was part of the presidential debate in at least 2008 in addition to being promoted by various libertarian candidates and talk host Sean Hannity. (Note that it is a federal proposal and would not affect state level income taxes.)
One key feature of the so-called “Fair Tax” is that would be a tax on retail sales. It would not be a value added tax. It would be a tax on the sales of new items (including new housing) and not used items. And it would tax services and rent (including maintenance services, consulting services, payment for medical services, and rental payments on housing and other real estate and equipment.) And it would tax any new items that are sold over the internet. But investments and education would not be taxed.
The proposal is for a 30% tax on top of existing prices for all rent, retail products, and all services.
Note that this same percentage is sometimes stated as “23%” by promoters of the tax. But this is a feature of the arithmetic that is used to state it in terms equivalent to the income tax percentage. The “23%” is the percentage of the total including the original price plus the added tax. The percentage stated in terms that you normally see for a sales tax is, in fact, 30% on top of the original price. Items would have their prices increased by this amount which would be collected by the seller and paid to the Federal government in the same way that sales taxes are collected and paid to state governments today.
Also note that this is a Federal proposal. Existing state sales taxes would not be affected and would presumably remain intact.
There would be an automatic monthly “rebate” to everyone, regardless of their income or actual spending level, to account for the purchases that they would most likely make according to a presumed “poverty level” spending amount.
Benefits that are touted by promoters of this new tax scheme are that Federal taxes are simplified and “loopholes” are eliminated and that the tax burden is much more fairly placed upon people who choose to spend money. Promoters claim that the tax burden is thus shifted to more wealthy people.
Now, I’m all in favor of reforming Federal spending and taxation schemes.
But there are some problems with this so-called “Fair Tax.”
First of all, contrary to the claim that it would eliminate the IRS, it would merely shift the responsibility and focus of government audits of the people’s financial activities and create the need for a different kind of massive Federal agency as it highly incentivized a huge black market in pretty much everything.
The most obvious thing is that it would not eliminate the need for income tax filing, income tax paperwork, and income tax audits. It would merely push the responsibility for much of the existing Federal income tax bureaucracy down to those states that have income taxes. It does not mandate anything about the taxation structure of the states. And if any Federal law attempted to do so, that would be a horrendous violation of the sovereignty of the various states.
But one of the biggest effects is that it would very highly incentivize a huge black market in almost all kinds products and services and thus would require a huge Federal agency to quash this new problem.
Current state and local combined sales tax rates are between about 3% and 8% of the price of items. This doesn’t provide much of an incentive to avoid paying the tax. But imagine putting another 30% on top of that and effectively telling people that they can save up to nearly 40% on all of their purchases if they can find a way to avoid the tax.
That’s a huge incentive. And here’s how to do it:
Remember that the “Fair Tax” is not a Value Added tax. It does not tax all sales. It only taxes sales of retail items. It taxes you 30% of the price when you buy a brand new house. But it does not tax the 2X4 studs the plywood or roofing materials or the floor tiles or the stove or washer or dryer that Home Depot (or whoever) sells to the contractor who built the thing.
Or maybe you want to be the guy who repairs computers and also assembles them to sell them to people. He doesn’t collect or pay tax on the components that he buys to assemble the things with or to use in his repairs. He collects from his customers 30% on top of his price and pays that to the government.
Now, you might not be able to find a small time contractor or street corner computer repair guy in your area who wants to make a few extra tens of thousands of dollars once in a while. But I think those people do exist in some places. And all they have to do is to sell some computer parts or lumber or stoves or whatever to people and split the 30% to 40% tax savings.
Do the same for any industry – furniture, car parts, pretty much anything. Even most services and rent.
But, “They’ll get caught!” you say.
You just eliminated the IRS and its army of auditors.
Or, rather, you claimed that you were going to eliminate the IRS and its army of auditors to get your populist “Fair Tax” passed through Congress. And then, just like every other government promise throughout all of history, the government does a “bait and switch” after the realization that it does, in fact, need auditors to “take care of a few problems with the new system.”
And it starts hiring its army of auditors back.
And not only that, but it needs to hire a bigger army of auditors and the Marine Corps and Special Ops, too. Because now it doesn’t just need to process the annual tax returns that everyone submits, it needs to look into the line-by-line expenditures of every private citizen, contractor, small business owner, retailer and wholesaler in the entire country for every single line-item that they buy or sell to reconcile their totals to what they claim that they need to pay in the new “Fair” tax. Because “cheating on your taxes” is no longer fudging a particular line item on your annual form, it’s anything that you might buy anywhere – incentivized by at least 30% in savings – and a lot easier to do and harder to find than it ever had been with the Income Tax.
Another problem is that it does a major shift of the tax burden to lower income earners.
Yes I know it claims that it shifts the burden up to rich people. But that’s only for those things that they choose to buy. And they always have a choice. An old guy, retired from a long career and living on a fixed income doesn’t have those choices. He gets the “annual consumption allowance” for up to $11,770 per year for his necessities (in the form of a government check for $2,700 – according to tables published by the “Fair Tax” promoters). But that doesn’t even pay the rent in a lot of our major cities.
But he needs to buy a new car. That’s liable to cost him twice what the government has graciously mandated that he needs to spend annually – all taxed at 30%.
And that brings us to another huge problem for the economy which would be the biggest unknown factor in any change in modern history: There would be a huge disincentive for anyone to spend money to buy anything. Especially on large and and/or complex and expensive discretionary items such as cars, boats, new houses, even computers or phones, etc. All the things that require companies to employ people.
And remember that claim of a 30% tax rate? Also remember that the original IRS income tax rate was only 1%. As soon as Congress has a rate, they’ll adjust it at their whim to whatever they want it to be.
But mostly, for people who oppose government taxation, this “Fair Tax” scheme does nothing at all to solve the problem of big government and big government inefficiency. Because it doesn’t even look at the government’s main problem, which is excessive spending.
Also, and this is really just a minor addendum: The person who first sent me an article on this “Fair Tax” scheme said that their main goal in all of this was to eliminate the Federal Reserve.
Pretty much my only thought about that is: WTF??
The Federal Reserve is the center of the banking system.
The Federal Reserve has nothing to do with the IRS or taxation.
The “Fair Tax” would definitely NOT eliminate the Federal Reserve. Nothing in any of the “Fair Tax” literature that I have seen would do anything at all to the Federal Reserve. And nothing in the anti-Federal Reserve book that the person sent me at the same time even mentions the IRS or the federal taxing authority.
If anything, implementation of the Fair Tax would cause the Federal Reserve to suddenly mess with the money supply in drastic and unpredictable ways in order to attempt to adjust for the drastic and unpredictable effect this change would have on all areas of savings, investment, spending, and manufacturing and production of goods and services in the economy.
So, the bottom line is:
Yes, we should make reforms to our Federal government’s taxation and spending policies. To promote that idea is one of the main purposes of talking about economics on this site. But changes have to make sense.
If something is made to look like a magic solution by its promoters, that’s when you really ought to take the closest look at what it really consists of.
It’s kind of cliché, but: If it looks too good to be true, then it probably is. (not really “true” that is.)