First of all let’s be clear, with a name like “fair tax” it’s difficult to argue against it. “Fair tax” is a term like “Change we can believe in.” What does it really mean? Nothing. Instead think of the Fair Tax as a tax on consumerism (Consumer Tax). It is simply a glorified sales tax of about 23%, not including your sales tax.
But first a little background. The idea behind the fair tax was born out of the desire to have a simplified tax code. The current taxation system is over 60,000 pages across multiple volumes. Only Yoda could perhaps ever understand everything. The fair tax as presented to Congress is just 132 pages. Instead of a complicated systems with loopholes and back doors, the fair tax is a straight rate. The fair tax eliminates the income tax as well. So if you make $50,000 a year, you actually make $50,000 a year. The tax benefits the poor at the expense of the wealthy as well, to which most people enjoy. The less money you make, the less you’ll spend. The less you spend, the less tax you. Wealthier individuals tend to spend much more money, so they will have to pay taxes on those yachts, planes, jewels, and cars.
What are the pros of this system?
The number one advantage to this system is the elimination of the income tax. No longer will we need a bloated IRS, accountants can go do something more useful, and since you pay the tax at time of purchase, it will be much harder to actually screw up your own taxes.
Since the fair tax eliminates the current system, the loopholes often only exploited by the wealthy will be closed. They are happy to pay for their lifestyles, now they are taxed on that lifestyle. This applies to the middle class as well. So many of us are fighting to become wealthy, that we often get ahead of ourselves and take on too much debt. I might could afford a $30,000 car, but I’ll think twice if I have to pay another $9,000 in taxes to get in the driver’s seat. We’ll be encouraged to save and invest our money, as long as we aren’t buying useless crap, we aren’t taxed. This means you’ll pay less in taxes. Right now you are taxed for every dollar you make. Under the fair tax you are only taxed for every dollar you spend. For those of us that save money, it works out better this way.
The fair tax hasn’t forgotten the poor either. Currently low-income families pay little or no income tax in order to help make ends meet. 23% tax rates would wipe them out, but the fair tax has addressed this. There is a rebate system, that is actually a prebate system. The government reimburses the fair tax you pay on a certain amount of taxable items over the year. Say you make $30,000 a year and consume $20,000 in taxable goods. At the 23% federal rate (excludes state taxes) you would be forced to pay $4,600 in taxes. So you are left with $30k – $20k – $4.6k = $5,400. Once you include the monthly prebates you qualify for (about $2,400) you are instead left with $7,800. Your effective taxes due are only $2,200, or 7.3% of you income. 7.3% is the actual tax rate someone making $30,000 and consuming $20,000 in taxable goods (before state sales tax).
That was a bit confusing, so instead think of it this way, a single person with no kids doesn’t actually pay taxes on the first $10,400 of goods they consume but they do for every dollar after that. When you throw in a few kids for extra rebates, some people will actually get more money back from the government than they put in. You can refer to this as a negative tax rate. This link will take you to a great chart that shows estimates on the expected tax rate for a family of 4 based on how much consumption they do.
What are the cons to the Fair Tax?
Despite there being no known implementation of this system on a vast scale, we can still anticipate the underlying problems associated with the Fair Tax.
The 23% quoted in the pros can be conceived as a teaser rate. The rate they would actually charge is closer to 30-34%, or more. This is a numbers game that I didn’t understand until I actually wrote it myself. I’m going to try to explain it though.
You are familiar with seeing the price of an item ($100) and calculating in your head what the sales tax would be ($5 at 5%). The $100 is known as a tax exclusive price. $105 is the tax inclusive price. There are two ways to state what the taxes are in this case. You could say the sales tax is 5% of the price of the item tacked on, or you could say it’s 4.8% of the total price you pay at the register. That is to say $5 is 4.8% of $105. So your state could advertise that your sales tax is 5% of the tax exclusive price or 4.8% of the tax inclusive price. In the interest of public relations, it would appear the proponents of the fair tax quote the equivalent of the 4.8%, which is the 23% number discussed already. When you convert the 23% tax inclusive number into the exclusive number (like 5%, a number we can actually relate to) the actual Fair Tax rate is 30%.
That was a mouthful. But we’re looking at an actual sales tax of 30%, which does not include your state sales tax. I liken this to the teaser rate you get when shopping for mortgages. You’re told the rate is 4.5%, but you actually pay 4.73%. Both numbers are right, it just depends on the way you do the math.
But the criticism doesn’t stop there. Estimates by people smarter than myself say that you must actually tax at a higher rate than the 23/30 in order to replace the current income of the government. After the conversion to a tax on the sale price, the government will need to charge 34% instead of 30% to replace the income. We’re not done, that calculation does not include the increased costs the government will pay when buying things. Since government purchases are technically taxing themselves, the net effect on revenue is $0. To thusly compensate for that loss, estimates (by again, smarter people than me) push the effective tax rate to 40%.
That’s all for math and adjustments, but we aren’t done with the fair tax. You’ll pay the fair tax on items you aren’t used to paying a sales tax for. Buying a house, the interest on credit cards, doctor bills, utilities, even your rent. All of this is considered consumption. That $200,000 house might instead be $280,000. $500 rent would be $700. That is not something we are used to, and the adjustment would take time.
Lest we forget, there is an entire industry devoted to supporting the current tax system. Moving off our system isn’t like switching from a PC to a Mac, millions will lose their jobs. Companies will go bankrupt, your CPA will throw himself in front of a train. The IRS would be reduced to less than 5% of it’s current size, and the Big 4 accounting firms will become and Tiny 2 or something.
Special thanks to FactCheck.org for their argument against the fair tax.