Paying taxes, as the saying goes, is one of two inevitable parts of life. But our current tax code, as administered by the IRS, has become so complex and unwieldy that a growing number of critics are calling for the abolishment of both. One group that favors this solution has proposed a substitute plan known as the Fair Tax. This simplified tax structure would effectively eliminate all current taxes and replace them with a consumption-based levy that its proponents claim will substantially boost our economy and revitalize governmental revenues. Of course, this system also has some drawbacks, and Americans will have to thoroughly examine this plan from all sides to determine whether or not it can function as a viable replacement for what we have now.
What is the Fair Tax?
The Fair Tax was first conceived by a group known as The Americans for Fair Taxation in 2003. This system would bring sweeping changes to our current tax system by replacing the income, gift, estate, payroll and corporate taxes that we pay now with a single sales tax that would serve as the sole source of revenue for our government and completely abolish the IRS by repealing the 16th Amendment to our Constitution. The Fair Tax appears to be a simple flat tax in many ways, but most flat tax proposals currently require the retention of income and payroll taxes as well, which allow for the full eventual conversion back to our current system, if necessary.
How it Works
The Fair Tax would assess a uniform 23% sales tax on all retails goods purchased by consumers in the U.S. This tax would be collected by all retail merchants from the purchase of new goods and services. Imported goods, goods that are used by businesses to produce other goods and used items will be excluded from this tax. All taxpayers who live at or below the poverty level will also receive a monthly “prebate” check that reimburses them for the tax paid on their monthly expenditures. The amount of the prebate is calculated by multiplying one-twelfth of the annual amount that is spent each year by poverty level households as published every year by the Department of Health and Human Services. This means that those who live in poverty are effectively exempted from paying any tax under this system. In 2014, a family of four would receive a monthly prebate of $1,983.33 for a total of $23,800. The Fair Tax is also designed to be revenue neutral, which means that it will not draw any more money out of the overall economy than the government is taking.
Advantages of the Fair Tax
Implementation of the Fair Tax will provide several obvious immediate benefits. The major advantages include:
- Encourages the wealthy to spend their money on things other than consumer or luxury goods, such as factories, businesses, charities and other tax-free avenues that foster economic growth.
- Eliminates the need for people to file an income tax return each year.
- Abolishment of all other types of taxes, including gift, trust, estate, capital gain, inheritance, excise and payroll taxes.
- Reduction in government spending from the abolishment of the IRS.
- Economic stimulation from increased consumer spending and saving.
- Economic stimulation from overseas business that left to escape corporate taxation returning to the U.S.
- Enormous potential job growth.
- Substantial growth in the financial, agricultural, real estate, construction and retail industries.
- Additional revenue generated from the taxation of foreigners and aliens.
- Automatic penalization of illegal immigrants who will not be eligible for prebates.
- Assurance that Social Security will be adequately funded for years to come
- People will have the power to choose how much tax they pay (to some extent) depending upon what they decide to purchase
Florida and Texas currently use a state tax system that closely resembles the Fair Tax structure, and they are two of the most affluent states in the union. History also shows that England enjoyed unprecedented prosperity when it adopted a sales tax system after the Napoleonic wars - a period that ended when the country once again switched to an income tax structure.
Of course, the Fair Tax is by no means a perfect system. It will be at least somewhat detrimental to those who earn no income and live off their savings. The first generation of those in this category will face a double whammy because they paid income taxes all of their lives and will still have to pay sales tax on their retail purchases for the rest of their lives.
Taxation at the state level exposes one of the chief drawbacks of the Fair Tax. Most states will probably also adopt this structure since there will be no way to determine taxpayer income without a federal tax return, and the taxes they assess on top of the federal rate could bring the total tax as high as 45%. And if some exemptions are made, such as for food and healthcare, then the rate on the remaining taxable goods could climb to an astronomical 67%.
Enforcement of this tax among those who figure out ways to avoid it may also be very difficult and costly, and a new tax collection agency will have to be created to deal with this problem, as well as to process payments and collect revenue from the states … no easy task in many cases. Retailers will not be the only ones who will have to be policed in this system; any business that buys goods or services from retailers will also have to be audited to ensure that purchases are being reported appropriately. Goods and services that are purchased from one household to another are also exempt from taxation, which would lead to an explosion of neighborhood bartering and trade. Current statistics indicate that for income that has no tax withheld and is not reported to the IRS by a third party, the evasion rate is estimated to hover around 50%. The Fair Tax system will have to implement a much more comprehensive program of reporting to keep evasion limits at reasonable levels. Advocates who claim that the Fair Tax system will eliminate tax evasion by forcing criminals to pay sales tax on the goods they buy from their illegal enterprises must understand that these criminals, such as drug dealers, will not impose reportable sales taxes on the goods they distribute to their clientele or other associates.
William Gale of the Brookings Institute published a study in March of 1998 that calculates the estimated impact of the Fair Tax on the current population. His study indicates that the additional state taxes would result in higher overall taxes for about 90% of the population than what they pay under our current system. The top third of consumers would pay more in tax than what they pay now, while those under them would pay less. But the wealthiest 10% would also pay less than they do now, with the top percent getting the largest break, paying an average of $75,000 less per year under the Fair Tax.
Finally, those who work in the current tax preparation, computation and collection industries will have to find other ways to make a living (although many of them would likely move to a position in the new administration). Of course, all of this means that there will still be the much-maligned tax man.
The Bottom Line
The true impact of the Fair Tax is somewhat difficult to predict, and the changes that it brings would impact individuals in different ways. Many people would lose the benefits that they had from the tax-deferred status of their retirement savings accounts, but they will also enjoy the growth in their investments from a presumably revitalized economy. Voting in the Fair Tax will not be an easy proposition. It will take an effort equal to previous efforts required to amend the constitution, and Congress will not be eager to give up its power to dictate tax laws - one of its most cherished abilities. Proponents face a steep uphill battle to achieve their goal, but growing public dissatisfaction with the IRS and the federal government may make this alternative more attractive to voters in the future.