Fair Tax Proposal

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I just finished reading Neil Bortz's book on the Fair Tax proposal. What do some of you think about the Fair Tax proposal? I kind of get the feeling that EVERYONE wins on this except lobbyist and politicians who are primarily dependent on extreme campaign financing.

For those of you who don't know much about this, A group known as Americans for Fair Taxation proposes replacing income taxes with a national sales tax. The idea to replace the income tax with a sales tax is not new. Federal sales taxes are widely used in other countries around the world, and given the low tax burden compared to Canada and Europe it is at least plausible that the federal government could obtain enough revenue from a sales tax in order to completely replace federal income taxes. The FairTax movement has come up with a scheme where income, estate, and payroll taxes could all be replaced with a 23 percent national sales tax. It is not hard to see the appeal of such a system. Since all taxes would be collected by businesses, there would be no need for private citizens to fill out tax forms. We could abolish the IRS! Most states already collect sales taxes, so a federal sales tax could be collected by the states, thus reducing administrative costs. There are a lot of apparent benefits to such a change.

One of the largest effects a change to a national sales tax system such as FairTax would have is to change people's working and consumption behavior.People respond to incentives, and tax policies change the incentives people have to work and to consume. It is unclear if replacing an income tax with a sales tax would cause consumption within the United States to rise or fall. There will be two opposing forces at play: The Effect on Income and Changes in Spending Patterns.

Because income would no longer be taxed, the incentives to work have changed. Many workers can choose the amount of overtime they work. Take the example of someone who would make an extra $25.00 if he worked an hour of overtime. If his marginal income tax rate for that extra hour of work is 40%, he would only earn $15.00 and pay $10.00 in income taxes. If income taxes have been eliminated, he would get to keep the whole $25.00. If an hour of free time is worth $20.00, then he would work the extra hour under the sales tax plan, but not work it under the income tax plan. So a change to a sales tax plan reduces the disincentives to work, so workers as a whole will end up earning more. If workers earn more, they'll spend more. So the effect on income suggests that the FairTax plan will cause consumption to increase.

Now some of you may be wondering who would win under a national sales tax. Right? Well, people who are inclined to save. A consumption tax can be avoided by not consuming. So it makes sense that people who do not consume a lot will benefit from the plan. I'll admit that there are savings for a large portion of the population. If households are classified by consumption level, a somewhat different pattern would emerge. Households in the bottom two-thirds of the distribution would pay less than currently, households in the top third would pay more. Still households at the very top would pay much less, again receiving a tax cut of about $75,000. Who else might benefit from this fair tax proposal, people who can shop in other countries. This includes people who take a lot of overseas vacations and Americans living near either the Canadian or Mexican border who can do their shopping in those countries to avoid taxes. Still, other people who would benefit from the Fair Tax proposal would be people who own businesses. The sales tax will only be charged on goods bought by individuals and not by firms. Owning a business gives you an advantage as you can buy some goods for personal use and claim that they are for business use. The wealthiest one percent of american will also benefit. As previously stated they will see an average tax cut of $75,000 per person.


For all the bleeding liberals out there who are wondering who will lose on this; to put it plainly : Seniors. People do not earn income at a steady rate during their lifetime. The bulk of most people's earnings occur before the age of 65. People over the age of 65 have vastly reduced incomes and live off the savings they earned while employed. A switch to a sales tax will be in effect taxing them twice. They've already paid a lifetime of income taxes and now they have the opportunity to live off of their savings and consume, they'll be taxed on that consumption. Unless special consideration is given to the current generation of seniors, they will end up paying a disproportionate share of taxes.

The other people who might lose under this proposal are the the Poor. Generally the working poor pay very little (if any) income tax. However, everybody needs to consume to survive. The poor get hit twice under such a scheme. Currently the poor pay little tax, where now they'll have to pay taxes on their consumption, so their total tax bill will rise dramatically. The poor also spend a larger proportion of their income on consumption goods to survive, so they'll pay a larger percentage of their income in taxes than wealthier individuals. The FairTax advocates realize this, so their plan includes sending each American family a rebate or "pre-bate" check each month to cover the necessities of life. The size of the checks will be designed so that a family right at the poverty line would not pay a cent in taxes. Of course, the higher the allowance made for the poor, the higher the tax rate everyone else will pay in order to cover federal spending.

Still others who might be hurt by this proposal would be families. Currently the income tax has all sorts of deductions for small families such as earned income credits and child care credits. These would disappear with the elimination of the income tax. A sales tax, other than for purposes of the rebate, would not distinguish between families and individuals. The enactment of a broad-based, flat-rate consumption tax like the sales tax would hurt families with incomes less than $200,000, because of the loss of tax preferences, but would help families with income above $200,000, due to the dramatic reduction in the top tax rate. Given that the rebates are given based on the poverty line, and the poverty line does not dramatically increase between a one-person and two-person family, this is not surprising.

And for all you accounting majors out there....this proposal would kill IRS Employees and Income Tax Lawyers. Part of the appeal of the proposal is that it will make the IRS irrelevant.