There is seemingly no end to calls for tax reform in the United States. This is not without cause, as the current income tax system could be considered as broken. The Internal Revenue Code is over 71,000 pages long, or over 24 megabytes. There are over 800 IRS forms. The tax industry is one roughly the size of Wal-Mart in terms of revenues. Some have called for simplification of the code, others trumpet a value added tax (VAT). Still others have called for a national sales tax. One recent proposal that has been introduced in Congress is the Fair Tax.
The basic component of the Fair Tax is a national sales tax, calling for a rate of 23%. The proposal taxes some items that are not presently subject to sales taxes. The Fair Tax would tax purchases of new homes, rent, food, medications, doctor bills, interest on loans, utilities, gasoline, and legal fees. One’s first reaction to this is that the Fair Tax would be an extreme burden on those in the lower income brackets with taxes paid on virtually every consumer purchase. Proponents claim this is not true. Here is where the innovative aspect of the Fair Tax comes into play.
All valid Social Security cardholders who are United States residents would receive a monthly check from the government, referred to as a “prebate.” This prebate is touted as being roughly equivalent to the amount of Fair Tax paid on essential goods and services. For example, a single adult with no dependents would get a monthly check of $208. A couple with two dependent children would receive $559. This feature removes the Fair Tax from the realm of flat taxes, as it becomes a progressive tax with higher income citizens paying a higher percentage of their income in taxes.
The Fair Tax would completely abolish the federal income tax for individuals and corporations. In addition, estate, gift, Social Security, and Medicare taxes would also be eliminated. Of course, with no income tax, the IRS would also be abolished. Social security and Medicare programs would be unaffected, just financed in another manner.
According to the proponents of the Fair Tax, it is revenue neutral, meaning that it would collect the same amount of tax as is currently being collected. There are those who disagree with this, saying that a rate of 30-34% would be necessary to make it truly revenue neutral. In all likelihood, the truth lies somewhere in between. One factor that must be considered is that the Fair Tax would probably reduce the tax gap, as opportunities to evade the Fair Tax would probably be fewer than under the present system. However, one should not discount the fact that with a sales tax of 23 -34% there will be a strong incentive for a black market to develop in which people attempt to evade paying the tax. So the tax gap would remain, but hopefully it would be less.
The Fair Tax would be transparent, meaning that people would realize the extent of their tax burden rather than having it “obscured” as under the current system. There would be no loopholes, special exemptions, payroll taxes, embedded costs, or other factors that contribute to hide the true amount of our tax burden.
Sounds pretty good, so far. However, the Fair Tax has some other negatives associated with it. First among these is that the price of new goods and services would increase. A $150,000 house becomes a $195,000 house. Gasoline would increase $1 per gallon at present prices. Proponents argue that prices would not really increase, just the visible cost would change. Another thought is that since companies are not paying income, payroll, or other taxes, they would lower the price of their goods. Nonetheless, prices are likely to increase. This “sticker shock” of higher prices could have a negative effect on the economy.
Critical to the success of the Fair Tax is the repeal of the Sixteenth Amendment. Unless this occurs, there is nothing to stop a future Congress from reinstating the income tax in some form, leaving us with the Fair Tax and an income tax. Having both would be a disaster to our economic freedom.
Another negative factor is that people who have paid into social security or other savings plans would be taxed on these funds when they purchase goods and services after already paying income tax under the current system.
Some have observed that it would give the government the power to discourage the purchase of certain goods or services by raising the rate on that product. For example, if the government determined that tobacco products were undesirable, they could be subject to a higher rate to discourage consumption.
There are both positive and negative aspects of the Fair Tax proposal. As with any change in our tax system, there will be elements of unfairness. Such a change will also create displacements, as much of the present tax industry would cease to exist. There is no doubt that our tax system needs reforming. Is this the best way to go about it? I think not. I still favor an income tax. To tax individuals and companies on their earnings seems more equitable than taxing consumption.