Since we are on the subject of the US Presidential elections, we thought it’d be a good idea to follow up our blog post on the Flat Tax with one looking at the Fair Tax.
In few words, the Fair Tax is a national consumption tax on all new goods and services that would replace federal income, payroll, gift and estate taxes. This tax would be collected each time a person purchases a product or service, and family households are eligible to receive a monthly “prebate” or advanced rebate for purchases up to the poverty level. The proposed rate for the first year is 23 percent and it would be adjusted on an annual basis depending on federal revenue collected.
This proposal, which was first submitted to the US Congress in 1999, has picked up steam thanks to the lobbying work of Americans for Fair Tax, radio personality Neal Boortz’s New York Times bestseller The FairTax Book, and its promotion by multiple GOP and Libertarian personalities.
Today, it’s back on the agenda thanks to campaigning by Mike Huckabee, a Republican Presidential hopeful who’s pushed for it as an alternative to the tax proposals of other GOP Presidential candidates.
What’s so special about the Fair Tax? What are its main drawbacks? Would it actually work?
Advantages of the Fair Tax
Pay Based on Your Expenses: With a fair tax, each individual would have direct control over what he or she pays in taxes. If you buy something, you pay tax. If you decide to save up instead, you don’t. This concept is bound to cut down on the use of credit cards and the racking up of mortgage debts.
Income Untouched: Since income and payroll taxes would be eliminated with the implementation of a fair tax, families would see a boost in their monthly income. This, in turn, would help boost savings and allow both individuals and businesses to invest more money in the economy. Plus, even those individuals who are involved in illegal activities such as tax evasion would be contributing to federal revenue by simply buying things.
Refund to Cover Low-Income Families: Under this plan, low-income families would receive a monthly advanced refund to cover their expenses up to the poverty level. This “prebate,” a welfare system of sorts aimed at helping out those in need, lessens the burden on the poor.
No More Tax Authority: The idea is that since retailers would be collecting the federal consumption tax and then passing it along to the US Department of Treasury, the Internal Revenue Service or any sort of tax agency would be deemed obsolete.
This, in turn, means that paying one’s taxes would no longer involve drawn-out processes, dealing with complex and endless forms, and becoming a bundle of nerves on a yearly basis.
Disadvantages of the Fair Tax
Hurtful to the Economy: Under this system, the only way to save money is by limiting spending. If everyone opted to cut spending to pay less in taxes, the economy, which essentially survives on things being bought and sold, would be negatively affected.
At the same time, companies, in an effort to avoid paying these taxes, might move their business to other countries. Trading and buying products in other countries would diminish federal tax revenue and hamper domestic spending.
Burden Transferred to Businesses: According to Kelly Phillips Erb, author of the Tax Girl blog on Forbes, this sort of tax would place added burdens on small businesses. She writes, “since the burden for collection shifts from the federal government to individual businesses, some of which are not currently collecting taxes (those which sell exempt goods, businesses in states where there are no sales taxes and businesses currently not subject to taxes on providing services), there’s a concern about the added burden that would place on those businesses, specifically small businesses.”
Burden Transferred to Middle Class: Another Forbes piece, this one by Len Burman, the Director of the Tax Policy Center, argues that the middle class would bear the brunt of the fair tax. Burman says, “The problem is that very high-income households spend only a fraction of their income, while low- and middle-income people spend all or most of what they make. A sales tax, by design, exempts a large share of income at the top. If it includes a prebate to protect people at the bottom and doesn’t add to the deficit, then it must raise taxes on people in the middle.”
Prebates Are Challenging: Burman also writes that setting up a system of prebates would be very challenging. He says, “the prebate would be extremely expensive, hard for taxpayers to manage, and complex for the IRS to administer.”
More specifically, according to website and personal finance blog Money Crashers, the prebate “is the most expensive element of the entire plan, would be the largest entitlement program in American history, and would constitute a welfare payment, even for those without a need. In other words, a two-parent billionaire household with two kids would receive the same monthly prebate as a two-parent, two-child household struggling to get by on $20,000 per year.
Question: What are your thoughts on the fair tax? Would it actually work in your jurisdiction?