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The FairTax Book, co-authored by Neal Boortz and John Linder, was published on August 2, 2005, as a tool to increase public support for the FairTax Plan.

The FairTax (H.R.25/S.25) is a proposal for changing United States tax laws to replace all federal personal income taxes, payroll taxes, corporate taxes, capital gains taxes, self-employment taxes, gift taxes and inheritance taxes with a national retail sales tax and monthly tax rebate to households of citizens and legal resident aliens. The FairTax would be levied once at the point of purchase on new goods and services. The plan would abolish the Internal Revenue Service (IRS) and create a federal "Sales Tax Bureau" to oversee collection of the tax by existing state sales tax administrations.[1][2] While the FairTax replaces taxes like FICA, it does not remove or change government funded programs such as Social Security, Medicare, and Medicaid.

The legislation would apply a 23% federal retail sales tax on the total transaction value of new retail goods and services purchases; in other words, consumers pay to the government 23 cents of every dollar spent (sometimes called tax-inclusive). The assessed tax rate would be 30% if the FairTax were added to the pre-tax price of a good like traditional sales taxes (sometimes called tax-exclusive). The FairTax is designed to be revenue-neutral — that is, it would not result in an increase or reduction in overall federal tax revenues. However, the tax rate required for revenue-neutrality is disputed. Goods and services contain embedded taxes in the current tax structure. Prices are expected to decrease after these taxes and compliance costs are removed.[1]

The effective tax rate for any household would be variable due to the fixed monthly tax rebate. Monthly payments in advance would compensate for the taxation on the purchase of necessities and could reduce the effective rate to zero or a negative rate. The FairTax's allocation of the tax burden is a point of significant dispute. The plan's supporters argue that it would broaden the tax base, be progressive and start taxing wealth, while opponents argue that a national sales tax would be inherently regressive and would decrease tax burdens paid by high-income individuals. The FairTax is expected to have positive ramifications for tax burden visibility, tax compliance cost (efficiency), economic growth, international business locality, U.S. international competitiveness, and could have challenges with an underground economy and the permanent repeal of income taxation.

Legislative history

The FairTax plan was created by the Americans for Fair Taxation, an advocacy group formed for this purpose. The group developed the plan and the name Fair Tax with economists based on interviews, polls and focus groups of the general public.[3][4]

Georgia Republican John Linder first introduced the FairTax Bill in July 1999 to the 106th United States Congress. He has reintroduced substantially the same bill in each subsequent session of Congress. While the bill attracted a total of 56 House and Senate co-sponsors in 2003 and 58 in 2005, it has not been voted on by any committee in either the House or Senate. In order to become law, the bill will need to be included in a final version of tax legislation from either the U.S. House Committee on Ways and Means or U.S. Senate Finance Committee, then obtain support from the Joint Committee on Taxation, and finally pass both the House and the Senate.

The current FairTax legislation was introduced by Linder in the House and by Republican Senator Saxby Chambliss in the Senate. Its formal name is the Fair Tax Act of 2005. The bill is supported by Speaker of the House Dennis Hastert, but has not received support from the Democratic leadership.[5][6][7] Democratic Representative Collin Peterson of Minnesota and Democratic Senator Zell Miller co-sponsored the bill in the 108th Congress, but Peterson is no longer co-sponsoring the bill and Miller has left the Senate.

Other current attempts to replace the U.S. tax system have attracted fewer cosponsors. The Flat tax sponsored by Texas Republican Michael C. Burgess in the House has 5 cosponsors, and no other proposal has as many.[8]

Tax rate

In its current form, the FairTax legislation would apply a 23% federal retail sales tax on the total transaction value of new retail goods and services purchases; in other words, consumers pay to the government 23 cents of every dollar spent (sometimes called tax-inclusive — as income taxes are calculated).[2] The assessed tax rate is 30% if the FairTax is added to the pre-tax price of a good like traditional sales taxes (sometimes called tax-exclusive).[1] The FairTax legislation uses total transaction value (tax-inclusive) in presenting the rate; when one goes to the store and purchases an item for $100, the retailer receives $77 and the remaining is collected for the federal government. However, American sales taxes have historically been expressed as a percentage of the original sale price (tax-exclusive); items priced at $100 pre-tax cost $130 with the tax added.[9] The use of the tax-inclusive number in presenting the rate has been criticized as deceptive by the plan's opponents. However, proponents argue that the 23% number represents a better comparison to income tax rates.[1] (See Comparison of tax rates.)

A good would be considered used and not taxable if a consumer already owns it before the FairTax takes effect or if the FairTax has already been paid on the good. The FairTax would tax all services provided at the retail level.[3] Personal services such as health care, legal services, haircuts and auto repairs would all be subject to the FairTax, as would renting apartments and other real property. Current state sales taxes do not generally tax such services. Education, training, saving and financial investing would be considered an investment (rather than final consumption) and therefore would not be taxed.[2]

Revenue neutrality

A key component of the FairTax rate is the ability to be revenue-neutral — that is, it would not result in an increase or reduction in overall federal tax revenues.[10] However, this is a matter of some dispute, as economists, advisory groups and political advocacy groups disagree about the tax rate required for the FairTax to be truly revenue-neutral. Different researchers use different time frames and methodologies that make direct comparison among estimates difficult. The choice between static or dynamic scoring further complicates any estimate of revenue-neutral rates.[11] The rates presented below adhere to the legislative framework of the FairTax bill, which calculates rates as a percentage of total spending, sometimes called a tax-inclusive rate. To adjust any rate below to that of a traditional sales tax, divide the rate by 1 minus the rate (refer to Comparison of tax rates for tax rate calculations).

Dale Jorgenson, a professor of economics at Harvard University and past President of the American Economics Association, helped develop the FairTax, and has estimated the revenue-neutral rate to be 22.9%.[3] Jim Poterba of the Massachusetts Institute of Technology estimated a rate of 23.1%. Laurence Kotlikoff of Boston University found a rate around 24%. Researchers at Stanford University, The Heritage Foundation, The Cato Institute, and Fiscal Associates have calculated revenue-neutral rates between 22.3% and 24%.[3] However, Americans for Fair Taxation funded this research and have not made these studies public. Economist William Gale of the Brookings Institution estimates a rate around 31% assuming full taxpayer compliance.[12][13]

Additional studies have been performed on National Retail Sales Tax plans that do not conform to the tax base as defined in the FairTax legislation but are often considered when discussing FairTax rates. These studies claim the tax base or rate calculation methods used in the legislation is flawed or likely to be modified by congress before passage. The President's Advisory Panel for Federal Tax Reform found the rate to be 25%.[14] However, according to the Treasury Department, this rate could only offset income taxes - all payroll, estate and gift taxes would remain. The panel explained that this discrepancy was due to several flaws it found in the FairTax proposal - including the counting of taxes government would pay to itself as revenues without similarly increasing the amount of government expenditures to pay these taxes, and an assumption of zero-evasion, which it considered unrealistic.[14]

The tax panel reported "For example, if a retail sales tax imposed a 30 percent tax on a good required for national defense, either the government would be required to pay that tax, thereby increasing the cost of maintaining current levels of national defense under the retail sales tax, or, if the government was exempt from retail sales tax, the estimate for the amount of revenue raised by the retail sales tax could not include tax on the government’s purchases. Failure to properly account for this effect is the most significant factor contributing to the FairTax proponents’ relatively low revenue-neutral tax rate. Second, FairTax proponents’ rate estimates also appear to assume that there would be absolutely no tax evasion in a retail sales tax. The Panel found the assumption that all taxpayers would be fully compliant with a full replacement retail sales tax to be unreasonable. The Panel instead made assumptions about evasion that it believes to be conservative and analyzed the tax rate using these evasion assumptions."[14]

The Treasury Department estimates excluded government consumption from the base, which is about 18% of consumption. This significantly alters the tax base and therefore the tax rate.[14] Proponents point out that the current system is also counting taxes the government would pay to itself as revenues from income and payroll taxes that are paid to government employees/contractors and counted as part of the total government revenue.[15] Since government is taxed today, proponents state that we need to keep the same level of taxation when we shift from taxing income to consumption. In addition, proponents assert that government needs to be taxed to keep a level playing field between government goods/services and private sector goods/services.[15][16] Dr. Karen Walby, Director of Research for the Americans For Fair Taxation, discussed a recent study by Young & Associates on evasion and enforcement that identifies certain key variables which influence the level of compliance (marginal tax rates, likelihood of audit, severity of penalties, etc) and concludes the FairTax is superior on most/all of these and would therefore have lower rates of evasion than alternatives.[17] While the FairTax studies did not consider tax evasion, neither did it consider the increased economic growth that economists and FairTax supporters believe would occur.[18]

Congress’s bipartisan Joint Committee on Taxation evaluated a proposal similar to FairTax that included additional exemptions and estimated a revenue-neutral rate of around 36%.[19][15] In a 2004 study, the Institute on Taxation and Economic Policy examined the FairTax proposal and contends that by excluding certain levels of taxation it calls "phantom" (sales to the government, church and nonprofit transactions, etc.), a national sales tax rate would have to be upwards of 36% to be revenue-neutral.[20] Proponents charge that the Presidential Tax Panel, the JCT, and ITEP are motivated to maintain the "status quo" and modify the tax base from the proposed legislation to achieve higher rates.[21] It is circular logic as they modify the tax base to create a higher rate, to then justify greater evasion, making an even higher rate ,which also makes the rebate much more expensive. Proponents claim that since they could not kill the FairTax proposal based on merits or lack thereof; they create their own plan with an exaggerated rate to make it politically not feasible.[22]

Effective tax burden

File:Effectiverate.jpg
Effective tax rate comparison graph, source: Americans for Fair Taxation
File:Prebatechart.jpg
2006 FairTax Prebate Schedule, source: Americans for Fair Taxation

The effective tax rate for any household is variable due to the fixed monthly tax rebate checks. The checks have the greatest impact at low spending levels, where they can lower a household's effective rate to zero or a negative rate. At higher spending levels, the rebate has less impact, and a household's effective tax rate approaches 23% of total spending.[23][24] For example, a household of three spending $30,000 a year on taxable items would devote about 6% of total spending to FairTax after the rebate. A household spending $125,000 on taxable items would spend around 19% on FairTax. The total amount of spending and the proportion of spending allocated to taxable items determine a household's effective tax rate.[10]

The lowest effective tax rate under FairTax could be negative due to the rebate checks. This could occur when a household spends less and pays less in taxes than the estimated average spending for similar households. In this case, the household's rebate check exceeds actual taxes paid by that household.[10] To determine the effective tax rate for consuming all income on new goods and services: ((income * tax rate) – rebate) / income = effective tax rate.

Monthly tax rebate checks

Under the FairTax, households would receive a monthly tax rebate (known as a "prebate" as it would be paid in advance) equal to the estimated total FairTax paid on poverty level spending according to the poverty guidelines published by the U.S. Department of Health and Human Services.[2] The poverty level guidelines vary by family size and represent the cost to purchase household necessities. The rebate would be paid in twelve monthly installments equal to 23% of poverty level spending for each household size and is meant to eliminate the taxation of necessities.[2] The formula used to calculate rebate amounts would be adjusted for inflation. To become eligible for the rebate, households would register once a year with their sales tax administering authority, providing the names and social security numbers of each household member. The Social Security Administration would disburse the monthly rebate payments.[2]

The President's Advisory Panel on Federal Tax Reform cited the rebate as one of their chief concerns with the FairTax, calling it "the largest (entitlement program) in American history," and contending that it would "make most American families dependent on monthly checks from the federal government for a substantial portion of their incomes."[14] Based on the advisory panel tax rate and base (which differs from the FairTax legislation), "the Prebate program would cost more than all budgeted spending in 2006 on the Departments of Agriculture, Commerce, Defense, Education, Energy, Homeland Security, Housing and Urban Development, and Interior combined."[14] Proponents would state that enabling taxpayers to buy the necessities of life free from government tax is not an "entitlement".

Comparison of tax rates

The current tax system imposes taxes primarily on income. The tax base is a household's pre-tax income. The appropriate income tax rate is applied to the tax base in order to calculate taxes owed. Under this formula, taxes to be paid are included in the base on which the tax rate is imposed. If an individual's gross income is $100 and income tax rate is 23%, taxes owed equals $23. The tax base of $100 can be treated as two parts—$77 of after-tax spending money and $23 of income taxes owed. The income tax is taken "off the top", so the individual is left with $77 in after-tax money.[10]

Traditional sales tax laws impose taxes on a tax base equal to the pre-tax portion of a good's price. Unlike income taxes, sales taxes do not include actual taxes owed as part of the base. A good priced at $77 with a 30% sales tax rate yields $23 in taxes owed. Since a sales tax is added "on the top", the individual pays $23 of tax on $77 of pre-tax goods.[10]

Since sales and income taxes behave differently due to differing definitions of tax base, direct rate comparisons between the two can be confusing. For direct rate comparisons between sales and income taxes, one of the rates must be manipulated to look like the other rate. However, this can cause some confusion when not explained properly. A 30% sales tax rate approximates a 23% income tax rate after adjustment. From the example above, an individual pays $23 of tax on $77 of goods. Total spending (pre-tax price and taxes owed) for that transaction equals $100. The $23 of taxes on $100 of total spending yields a 23% rate. By including taxes owed in the tax base, a sales tax rate can be directly compared to an income tax rate.

The FairTax rate, unlike most sales taxes, would be calculated on a tax base that includes the amount of FairTax paid. In this manner, the FairTax more closely resembles an income tax instead of a sales tax. A final price of $100 includes $23 of taxes. Like the income tax example above, the taxes to be paid would be included in the base on which the FairTax is imposed. FairTax is often presented in this manner as a 23% tax rate for easy comparison to income tax rates. If you're in a 25% income tax bracket, you will pay $25 in federal income taxes out every $100 you earn. With the 23% FairTax, you will pay $23 in taxes out of every $100 you spend.[1]

The plan's opponents call this deceptive - Laurence Vance of the Ludwig von Mises Institute goes so far as to call it a "lie". According to Vance, "Boortz's 'mathematical equivalent of a game of semantics' still results in a FairTax rate of 30 percent. This is why Boortz prefers the national sales tax to be included in the price of each item—so the consumer doesn't realize that he is really paying an extra 30 percent in sales tax, not Boortz's new math amount of 23 percent."[9] When looking at other rate studies that report a 36% rate, the equivalent traditional sales tax rate would be 56%.

Comparison to a typical sales rate:
Let be the FairTax rate. i.e. if the rate was 30%, then
Let be the FairTax rate in terms of a typical sales tax.
Let be the price of the good.
Then, the amount that goes to the government is:
This means the amount remaining for the company is:
In a traditional sales tax system, sales tax is calculated as the fraction of the money going to the company that must be paid to the government. For example, with a traditional 10% sales tax, the government would receive $10 when a company receives $100. Thus, to convert the tax we divide the money going to the government by the money the company nets:

This means that to adjust any rate below to that of a traditional sales tax, one can divide the given rate by 1 minus that rate.

Distribution of tax burden

File:Fairtax-dollars.png
President's Advisory Panel for Federal Tax Reform's analysis of FairTax impacts by income percentile
File:Fairtax-percentile.png
President's Advisory Panel for Federal Tax Reform's analysis of FairTax impacts by income level

The FairTax's impact on the distribution of taxation is a point of significant dispute. The plan's supporters argue that it would broaden the tax base, be progressive and start taxing wealth, while opponents argue that a national sales tax would be inherently regressive and would decrease tax burdens paid by high-income individuals.

In a Congressional committee hearing, Congressman Linder stated that "the President's Advisory Panel for Federal Tax Reform, with the help of the Treasury Department, concluded that the FairTax is the only reform proposal that completely untaxes the poor."[25] However, that bipartisan panel's final report to the President rejected a National Sales Tax.[14] The panel's evaluated plan differs from the FairTax legislation in many areas but with their modified plan they reported that with the rebate, the overall tax burden on middle-income Americans would increase while the tax burden on on the very rich would drop. According to the report, the percent of federal taxes paid by those earning from $15-$50,000 would rise from 3.6 to 6.7 percent, while the burden on those earning more than $200,000 would fall from 53.5 to 45.9 percent.[14] The report states, "Families with the top 10 percent of cash incomes would benefit substantially from the retail sales tax. Their tax burden would fall by 5.3 percentage points – from 70.8 percent to 65.5 percent. Middle-income Americans, however, would bear more of the federal tax burden. A typical married couple at the bottom 25th percentile of the income distribution earns $39,300 per year and would pay $5,625 dollars in federal taxes in 2006. Under the retail sales tax with a Prebate, the same family would pay $7,997 in net federal taxes after the Prebate of $6,694, resulting in a tax increase of $2,372, or 42 percent."'[14] These calculations only compare the income tax to a sales tax as the Panel was not allowed to consider reforming payroll taxes.[26]

FairTax supporters argue that the tax burden shifts to those who do not pay taxes under the current system. The FairTax would dramatically broaden the tax base to include all 295 million Americans and an estimated 30 million to 40 million foreign tourists and visitors. This more than doubles the federal government's tax base.[27] Dr. Carl Milsted suggested that the FairTax would be a significant tax break for high net-worth individuals, so it should be combined with a wealth tax. Such a system would allow a lower tax rate on consumption while maintaining current levels of taxation on high net-worth individuals.[28] Proponents offer that the FairTax is a tax on wealth unlike the current system that taxes income.[29]

Economist William G. Gale at the Brookings Institution writes: "Under the AFT proposal, taxes would rise for households in the bottom 90% of the income distribution, while households in the top 1% would receive an average tax cut of over $75,000." Gale continues, "If households are classified by consumption level, a somewhat different pattern emerges. Households in the bottom two-thirds of the distribution would pay less than currently, households in the top third would pay more."[30] Gale is referring to absolute tax dollars—ranked by income, households at the lower end of the distribution will tend to pay more in absolute taxes, while households at the higher end will tend to pay less in absolute taxes. Ranked by spending or consumption, households that currently spend less on consumption would pay less total taxes, while households that currently spend more would pay more. A low income family may spend $25,000 on goods and services consuming 100% of their income. A higher income family making $100,000 may spend $80,000 on goods and services and save $20,000. The higher income family is consuming only 80% of their income on taxable goods and services. When presented with an estimated effective tax rate, the low income family above would pay a tax rate of 0% on the 100% of consumption and the higher income family would pay a tax rate of 15% on the 80% of consumption.

These conclusions are contradictory according to Gale. The FairTax proposal is regressive on income and progressive on sales. Classical economic analysis indicates that the marginal propensity to consume (MPC) decreases as income increases. Households at the lower end of the income scale are spending almost all of their income, while households at the higher end are more likely to devote a portion of income to saving. However, MPC and income elasticity of demand tend to increase as wealth increases. These facts explain the apparent contradiction in the data; households at the extreme high end of consumption often finance their purchases out of savings, not income.[30] This savings would be taxed when it becomes sales. Income earned and saved would not be taxed immediately under the proposal. In other words, savings are spent at some point in the future and taxed according to that consumption. FairTax advocates state that this improves taxing of wealth. Economist Laurence Kotlikoff of Boston University stated that the FairTax could make our tax system much more progressive and generationally equitable.[29] "Their view that taxing sales is regressive is just plain wrong. Taxing consumption is effectively the same as taxing wages plus taxing wealth." Kotlikoff continues, "But what about saving one's wages and wealth and spending these funds plus accumulated interest in the future? Doesn't this avoid the consumption tax? No. You end up paying consumption taxes not just on the original sums, but also on the accumulated interest."[29] The payroll tax system is regressive on income with no standard deduction or personal exemptions taxing only the first $90,000 from wages, and none earned from capital investments or interest. The Center on Budget and Policy Priorities states that three-fourths of taxpayers pay more in payroll taxes than they do in income taxes.[31] Under the FairTax, it would be eliminated.

Predicted effects

Main article: Predicted effects of the FairTax
U.S. Rep John Linder holding the 132 page FairTax Act in contrast to the more than 50,000 pages of tax code laws and regulations currently in effect.

The FairTax proposal would have effects in many areas that impact the United States. FairTax supporters assert that the proposal would provide tax burden visibility and reduce compliance costs. The cost of federal government will be highly visible as consumers will see most of the cost of the federal government in a single tax paid every time they purchase a good or service.[1] Under the current tax system, the federal government collects revenue through a wide variety of taxes on individuals and businesses which may not be fully visible to individual citizens.[32] The efficiency cost of the current tax system — the output that is lost over and above the tax itself — is between $240 billion and $600 billion every year according to a 2005 report from the U.S. Government Accountability Office.[33][34] Supporters argue that the FairTax system will reduce these compliance and efficiency costs by 90% and return a larger share of that money to the productive economy.[35]

A number of economists have stated that a national retail sales tax would boost the United States economy.[18] According to the National Bureau of Economic Research and Americans for Fair Taxation, GDP would increase almost 10.5% in the year after the FairTax goes into effect.[35] In addition, the incentive to work would increase by as much as 20%, the economy’s capital stock would increase by 42%, labor supply by 4%, output by 12%, and real wage rate by 8%. Further, studies of the FairTax at Boston University and Rice University suggest the FairTax will bring long-term interest rates down by as much as one third.[36] As falling tax compliance costs lower prices, exports would increase by 26% initially and remain more than 13% above present levels.[35] According to Professor Dale Jorgenson of Harvard University’s Economics Department, revenues to Social Security and Medicare would double as the size of the economy doubles within fifteen years after passage of the FairTax.[10] Opponents offer a study commissioned by the National Retail Federation in 2000 that found a national sales tax would bring a three-year decline in the economy, a four-year decline in employment and an eight-year decline in consumer spending.[37] Proponents point out that the study done by the NRF does not take into account the drop in prices that will occur when corporate income taxes are removed.

Global corporations consider local tax structures when making planning and capital investment decisions. Lower corporate tax rates and favorable transfer pricing regulations can induce higher corporate investment in a given locality. The United States currently has the highest combined statutory corporate income tax rate among OECD countries.[38] Bill Archer, former head of the House Ways and Means Committee, asked Princeton University econometricists to survey 500 European and Asian companies regarding the impact on their business decisions if the United States enacted the FairTax. 400 of those companies stated they would build their next plant in the United States. 100 companies said they would move their corporate headquarters to the United States.[39] In addition, the U.S. is currently the only one of the 30 OECD countries with no border adjustment element in its tax system. Proponents state that because the FairTax is automatically border adjustable, the 17% competitive advantage, on average, of foreign producers is eliminated, immediately boosting U.S. competitiveness overseas and at home.[10] In The FairTax Book, Boortz and Linder assert that an estimated ten trillion dollars is currently held in foreign accounts, largely for tax purposes and predict a large portion of those funds would become available to U.S. capital markets, bringing down interest rates, and otherwise promoting economic growth in the United States.[1]

The current federal tax law allows individuals to deduct the home mortgage interest costs and donations, to certain charities, from taxable income. Someone paying a 25% income tax rate would receive $250 back from the government for a $1,000 donation or interest deduction. The FairTax is tax free on mortgage interest up to the basic interest rate as determined by the Federal Reserve and donations are not taxed.[2] The FairTax may also affect State and local government debt as the federal income tax system provides tax advantages to state and local municipal bonds.[40] Other areas affected may be law enforcement as avoidance of income tax is sometimes used to prosecute members of organized crime syndicates to convict on charges of tax avoidance and tax evasion when insufficient direct evidence exists for other crimes. Under the FairTax proposal, this avenue of law enforcement would disappear as there would be no income tax and, therefore, no income tax evasion. However, areas such as illegal immigration may benefit as there would also be no federal tax savings to companies that hire illegal immigrants.[2] Advocates claim the FairTax would provide incentive for illegal immigrants to legalize as they would otherwise not receive the FairTax rebate. Illegal immigrants would pay the maximum effective tax rate.[1]

Changes in the retail economy

Implementation

Like other firms, retailers will enjoy a zero corporate tax rate. Under the FairTax, however, retailers would be required to collect the federal sales tax on all sales occurring within the United States. Retailers will receive a collection fee of .25% on federal funds collected.[2] States that choose to conform to the federal base will have the added advantage of information sharing and clear interstate revenue allocation rules.

Supporting theories of effect

Proponents of the FairTax state that the cost of domestic goods and services could decrease by approximately 22% on average after embedded taxes and compliance costs are removed leaving the sale nearly the same after taxes. This is based on a study paid for by AFFT and conducted by Dr. Dale Jorgensen, who found that producer prices will drop between 15 and 26% after the switch to a consumption-based tax.[1] However, Jorgensen's research included income and payroll taxes in the embedded tax estimation. This means that it was assumed that businesses would keep the savings from the payroll tax and income tax withholding, resulting in employee take-home pay (net income) remaining unchanged from pre-FairTax levels.[4][41] If businesses instead provided employees with their gross income (income taxes and their half of payroll taxes), prices are estimated to fall closer to 10%.[42] These embedded costs include the other half of payroll taxes, corporate taxes, and compliance costs (see Effect on tax compliance costs). Purchasing power for buying consumer goods and services in either situation remains essentially the same.[1]

These predicted price drops will increase consumer demand. But, while offering lower prices, retailers will be able to maintain their current profit margins.[1] This would only slightly apply to imported products, so, according to proponents, it would provide tax advantages for domestic production and increase U.S. competitiveness in global trade. Such logic is endorsed by a recent letter to the commission on tax reform by dozens of economists, including Nobel Laureate Vernon L. Smith.[18]

A study prepared by Nathan Associates for the National Retail Institute, which made many adverse assumptions, represents supporters' worst case scenario for a consumption tax. The study predicts that the economy will grow only three percent more in ten years than it would have under the income tax and that the increase in consumption will be 1.15% less in the first year relative to what it would have been under the income tax. This study concludes that consumption will be higher in the fourth year and every year thereafter than it would have been under the income tax.[43]

Effects on tax code compliance

FairTax supporters state that black market or illegal economic activity is largely untaxed under the current tax system. Economists estimate the underground economy in the United States at approximately $1 trillion annually.[44] By imposing a sales tax, underground economic activity will be significantly taxed when proceeds from such activity are spent on legal consumption. For example, the sale of illegal narcotics will remain untaxed, but drug dealers will face taxation when they use drug proceeds to buy consumer goods such as food, clothing, and cars. By taxing this previously untaxed money, FairTax supporters state the black market will be paying more of their share of what would otherwise be uncollected income and payroll taxes.[1]

Most economists believe retail prices are inflated due to embedded taxes and compliance costs passed to the consumer by producers and suppliers. The FairTax will eliminate almost all federal taxation costs from the supply chain, which could lower retail prices by up to 30% (refer to Supporting theories of effect for embedded cost estimations).[35] Proponents believe the addition of the FairTax will roughly counteract the removal of embedded costs, resulting in relatively minor changes in purchasing power.[1]

However, if there is no net change in retail prices or tax burdens, the licit consumption of goods and services by the underground economy will continue to bear the same tax burden as before. Legal purchases under the current tax regime carry the hidden cost of implicit taxes. When those taxes are replaced by an explicit tax, the consumption purchases will still bear the same tax burden.

Tax compliance

The current income tax system fails to collect on a significant percentage of taxes owed. The IRS estimates there are twenty additional cents of taxes owed on unreported income for every tax dollar collected. In 2001, the IRS estimated this shortfall to be over $312 billion.[45] These figures do not include taxes lost on illegal sources of income, such as drug-dealing.

Proponents assert that the transparency and simplicity of the FairTax will subject much of this unreported income to taxation. The number of tax collection points would significantly reduce as only retailers would file a tax return compared to every income earner. Some research supports the claim that simplified tax systems lead to greater compliance. The IMF found that Russia's transition to a flat tax increased income reporting from 52% to 68% in one year. Similar results have occurred in Slovenia.[45] The FairTax would reduce the number of tax filers by 80% and reduce the filing complexity to a simplified state sales tax form.[46][35] In addition, 80% of tax collection would be concentrated on less than 15% of retailers. Retailers would receive 1/4 of 1% as compensation for compliance costs.[2]

FairTax opponents believe that tax compliance rates decrease when taxes are not automatically withheld or collected as tax liability is incurred. Compliance rates also fall when taxed entities, rather than a third party, self-report their tax liability. For example, ordinary personal income taxes can be automatically withheld and are reported to the government by a third party. Taxes without withholding and with self-reporting, such as FairTax, can see evasion rates of 30% or more. William Gale has estimated that an evasion rate of 20% would require a FairTax rate of 39% in order to replace revenue lost through evasion.[12][13] This would be a 65% rate when presented as a traditional sales tax.

The FairTax is a national retail sales tax, but can be administered by the states rather than a federal agency.[2] This has a bearing on compliance as the states' own agencies could monitor and audit businesses within that state. The .25% paid to the states amounts to 5 billion dollars the states will have available for enforcement. As an example, California should receive over $500 million for enforcement. According to the California 2004-05 budget analysis, this is more than the $327 million California is currently spending enforcing its own much more complex sales tax and excise taxes.[47] The FairTax is simpler, but extends to cover services which are not currently subject to the California sales tax. Because the federal money paid to the states for enforcement is a percentage of the total revenue collected, the states will have an incentive to maximize collections.[1]

University of Michigan economist Joel Slemrod argues, however, that states would face significant issues in enforcing the tax. "Even at an average rate of around 5 percent, state sales taxes are difficult to administer. Apparently the authors (of the FairTax) have not talked much to administrators who have to deal with, among other things, ineligible people declaring themselves to be businesses to qualify for the business exemption."[48]

Underground economy

Opponents of FairTax argue that imposing a national retail sales tax will drive transactions underground, creating a vast underground economy.[49] Under a retail sales tax system, the purchase of intermediate goods is not taxed, since those goods are supposed to be used to produce a final, retail good that will be fully taxed. Individuals and businesses may be able to manipulate the tax system by claiming that purchases are for intermediate goods, when in fact they are final purchases that should be taxed. Proponents point out that a business is required to have a registered seller's certificate on file, and must keep complete records of all transactions for a period of 6 years. Businesses must also record all taxable goods bought for a period of 7 years. They are required to report these sales every month (see Personal vs. business purchases).[50]

In addition, problems arise with the use of a retail sales tax rather than a value added tax (VAT). A VAT imposes a tax at every intermediate step of production, so the goods reach the final consumer with much of the tax already implicit in the price. Thus the retail seller has little incentive to conceal retail sales, since he has already paid much of the good's tax. Retailers are unlikely to subsidize the consumer's tax evasion by concealing sales. In contrast, a retailer has paid no tax on goods under a sales tax system. This provides an incentive for retailers to conceal sales and engage in "tax arbitrage" by sharing some of the illicit tax savings with the final consumer.[51]

India is undergoing the transition from a national sales tax to a VAT tax due to nationwide non-compliance. It is estimated that only 30% of Indian sales tax administers comply with the national sales tax, and that after the transition to a VAT tax this level will be near 60%.[52]

Proponents respond to the underground economy argument by pointing out that, whereas tax evasion under the current income tax system requires only one person (the payor) to lie on their tax forms, tax evasion under the FairTax requires collusion of both the payor (the retail purchaser) and the payee (the retail seller). Furthermore, the number of individuals required to file taxes drops from approximately 135 million to 25 million. This 84% drop in the number of collection points will allow the federal tax administration to view tax fraud with greater scrutiny.[46]

Personal vs. business purchases

In order for an individual to purchase items tax-free for business purposes, the business must be a registered seller with the state sales tax authority who can collect the FairTax along with the state sales tax. The state will issue the business a registered seller's certificate. This will enable the business to purchase tax free from wholesale vendors, but they must give a copy of their registration certificate to the vendor to leave an audit trail. When an item is purchased for business use from a retail vendor, the business will have to pay the tax on the purchase and take a credit against the tax due on their sales tax return. Businesses will be required to submit monthly or quarterly reports (depending on sales volume) of taxable sales and sales tax collected on their retail sales to the tax authority.[10]

During audits, the business will have to produce the invoices for all of the "business purchases" that they did not pay sales tax on, and will have to be able to show that they were bona fide business expenses. Since 130 million individuals will no longer be filing tax returns, there will only be about 25 million businesses that could be audited.[46] Advocates claim that this will greatly increase the likelihood of business audits, making tax evasion behavior much more risky. Additionally, the FairTax legislation has a number of fines and penalties for non-compliance and authorizes a mechanism for reporting tax cheats and obtaining a reward.

In order to prevent businesses from purchasing everything for their employees, in a family business for example, goods and services bought by the business on behalf of the employees that are not strictly for business use will be taxable. Health insurance and/or medical expenses would be an example where the business would have to pay the FairTax on these purchases.

Transition effects

Source: Ross Korves, chief economist (retired), American Farm Bureau Federation.

Because the FairTax proposal replaces various taxes with a single sales tax, several areas may experience unique effects through the transition.

Repeal of 16th amendment

If the FairTax bill is passed, permanent elimination of income taxation is not guaranteed; the FairTax bill repeals much of the existing tax code, but the 16th amendment would remain in place. Furthermore, cases decided by the United States Supreme Court after the ratification of the Sixteenth Amendment have established that Congress has the power to enact an income tax even if the Amendment did not exist.[53] The elimination of the possibility that income taxation would return (through a separate Congressional bill), requires a repeal of the Sixteenth Amendment to the United States Constitution along with expressly prohibiting an income tax.[10] This is refered to as an "aggressive repeal". The United States Constitution, however, does not require an income tax, it only allows one. In addition, many states also have separate income taxes and these would be unaffected.

Since passing the FairTax would only require a simple majority in each house of Congress and the signature of the President, and enactment of a Constitutional Amendment must be approved by two thirds of each house of Congress, and three quarters of the individual U.S. states, it is possible that passage of the FairTax bill will simply add another taxation system. If a new income tax bill was passed after FairTax passage, a hybrid system could develop. However, there is currently nothing preventing the addition of a national sales tax, or VAT tax, on top of today's income tax system. The Americans For Fair Taxation plan is to first pass the FairTax and then to focus grassroots efforts on HJR 16, sponsored by Congressman Steve King (R-IA), that calls for the repeal of the 16th amendment.[10]

Effect on savers

Individuals under the current system who accumulated savings from ordinary income (by choosing not to spend their money when the income was earned) paid taxes on that income before it was placed in savings. When individuals spend above the poverty level with money saved under the current system, that spending would be subject to the FairTax. People living through the transition may find both their earnings and their spending taxed.

Critics have claimed that the FairTax would result in unfair double taxation for savers and suggest it does not address the transition effect on some taxpayers who have accumulated significant savings from after-tax dollars, especially retirees who have finished their careers and switched to spending down their life savings.[54][49]

Supporters of the plan argue that the current system is no different, since compliance costs and "hidden taxes" embedded in the current prices of goods and services cause savings to be "taxed" a second time already when spent. The rebate checks would supplement accrued savings, covering taxes up to the poverty level. In addition, the income taxes on capital gains, social security and pension benefits are eliminated under FairTax. The FairTax would also eliminate the double taxation on savings that is currently part of estate taxes. Supporters suggest these changes would mostly offset paying the FairTax under transition conditions.[1]

In contrast to ordinary savings, money in tax-deferred savings plans such as IRA, 401k, etc. would be withdrawn tax free. There is currently $11 trillion in such accounts. This represents future tax revenue owed to the Federal government under the income tax system which has been estimated at $3 trillion.[55] This revenue would then fall under the FairTax system for collection.

Time arbitrage

In the period before the FairTax is implemented, it would create a strong incentive for individuals to buy goods without the sales tax using credit. After the FairTax is in effect, the credit could be paid off using untaxed payroll. Opponents of the FairTax worry it could exacerbate an existing consumer debt problem.[56] On the other hand, proponents of the FairTax note that this effect will also allow individuals to pay off all their existing (post-FairTax) debt quicker.[1]

Grassroots movement

Orlando, Florida FairTax Rally on July 28, 2006

The FairTax has generated a large grassroots tax reform movement in recent years. This movement has been lead by the Houston, Texas based non-partisan political advocacy group Americans for Fair Taxation. The internet, blogsphere, and electronic mailing lists like Yahoo! Groups have contributed to informing, organizing, and gaining support for the FairTax. Much support has been achieved by talk radio personality Neal Boortz. His latest book (co-authored by Georgia Congressman John Linder) entitled The FairTax Book, explains the proposal and spent at least two weeks atop the New York Times bestseller list. Neal donated his share of the proceeds to charity in order to further promote the book.[57] It is also one of his most frequent topics of discussion and is a common free gift to callers. Many FairTax grassroots web sites have been created by supporters to help promote the plan.

See also

Notes

  1. ^ a b c d e f g h i j k l m n o p Boortz, Neal (2006). The Fair Tax Book (Paperback ed.). Regan Books. ISBN 0060875496. {{cite book}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  2. ^ a b c d e f g h i j k "H.R. 25: Fair Tax Act of 2005". govtrack.us. 109th U.S. Congress. 2005-01-04. Retrieved 2006-07-20.
  3. ^ a b c d Ose, Al (2002). America's Best Kept Secret Fairtax: Give Yourself a 25% Raise (Paperback ed.). Authorhouse. ISBN 1403391890.
  4. ^ a b Regnier, Pat (2005-09-07). "Just how fair is the FairTax?". Money Magazine. Retrieved 2006-07-20.
  5. ^ Bender, Merrill (2005-06-01). "Economists Back FairTax Proposal". Budget & Tax News. The Heartland Institute. Retrieved 2006-07-20.
  6. ^ "H.R. 25 Cosponsors". THOMAS (The Library of Congress). Retrieved 2006-07-20.
  7. ^ "S. 25 Cosponsors". THOMAS (The Library of Congress). Retrieved 2006-07-20.
  8. ^ "H.R. 1040 Cosponsors". THOMAS (The Library of Congress). Retrieved 2006-07-20.
  9. ^ a b Vance, Laurence (2005-12-12). "There is No Such Thing as a Fair Tax". Ludwig von Mises Institute. Retrieved 2006-07-20.
  10. ^ a b c d e f g h i j "FairTax Frequently Asked Questions". Americans for Fair Taxation. Retrieved 2006-07-24.
  11. ^ Gingrich, Newt (2005-09-26). "Doesn't Anyone Know the Score?". Institute for Policy Innovation. Wall Street Journal. Retrieved 2006-07-20. {{cite web}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  12. ^ a b Gale, William (2005-05-16). "The National Retail Sales Tax: What Would The Rate Have To Be?" (PDF). Tax Break. Tax Analysis. Retrieved 2005-06-15.
  13. ^ a b Burton, David (1998-03-16). "Rebuttal of the William Gale papers" (PDF). The Argus Group. Americans for Fair Taxation. Retrieved 2006-07-22. {{cite web}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  14. ^ a b c d e f g h i "National Retail Sales Tax" (PDF). President's Advisory Panel for Federal Tax Reform. 2005-11-01. Retrieved 2006-07-23. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  15. ^ a b c Burton, David (1998-02-04). "Rebuttal of the Joint Committee on Taxation (JCT) letter" (PDF). The Argus Group. Americans for Fair Taxation. Retrieved 2006-07-23. {{cite web}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  16. ^ "Debate on the Fair Tax - Graetz Rebuttal" (PDF). Americans for Fair Taxation. 2006-04-16. Retrieved 2006-07-23. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  17. ^ Walby, Karen (2005-12-18). "Phil Hinson's Tax Reform Hour". Radio Sandy Springs. Hoosiers for the FairTax. Retrieved 2006-07-20. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  18. ^ a b c "Economists' Endorsement" (PDF). An Open Letter to the President, the Congress, and the American people. Americans for Fair Taxation. Retrieved 2006-07-23. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  19. ^ Bartlett, Bruce (2004-08-09). "A National Sales Tax No Vote". National Review Online Financial. Retrieved 2006-08-07. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  20. ^ "The Effects of Replacing Most Federal Taxes with a National Sales Tax: A State-by-State Distributional Analysis" (PDF). Institute on Taxation and Economic Policy. 2004-09. Retrieved 2006-07-23. {{cite web}}: Check date values in: |date= (help); Cite has empty unknown parameter: |coauthors= (help)
  21. ^ Linbeck, Leo. "Tax Reform Group Blasts Presidential Tax Panel". Foster Friess. Retrieved 2006-07-23. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  22. ^ Burton, David. "A response to Institute on Taxation and Economic Policy" (PDF). The Argus Group. Americans for Fair Taxation. Retrieved 2006-07-23. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  23. ^ "The FairTax Calculator". National Retail Sales Tax Alliance. Retrieved 2006-07-23.
  24. ^ "FairTax Effective Tax Rates" (PDF). Americans for Fair Taxation. 2000. Retrieved 2006-07-23.
  25. ^ Linder, John (2005-07-25). "Testimony Before the Subcommittee on Select Revenue Measures". House Committee on Ways and Means. Retrieved 2006-07-23.
  26. ^ Kotlikoff, Laurence (2006-04). "Grading the President's Tax Reform Panel's Plan" (PDF). The Berkeley Electronic Press. Retrieved 2006-07-23. {{cite web}}: Check date values in: |date= (help)
  27. ^ Chambliss, Saxby (2005-09-27). "Revise the tax law". The Washington Times. Retrieved 2006-07-23. {{cite web}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  28. ^ Milsted, Carl (2005-05-15). "Towards a Truly Progressive Tax System". The Free Liberal. Retrieved 2006-07-23. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  29. ^ a b c Kotlikoff, Laurence (2005-03-07). "The Case for the 'FairTax'" (PDF). The Wall Street Journal. Retrieved 2006-07-23. {{cite web}}: Cite has empty unknown parameter: |coauthors= (help)
  30. ^ a b Gale, William (1998-03). "Don't Buy the Sales Tax". The Brookings Institution. Retrieved 2006-07-23. {{cite web}}: Check date values in: |date= (help); Cite has empty unknown parameter: |coauthors= (help)
  31. ^ Kamin, David (2004-09-13). "Studies Shed New Light on Effects of Administration's Tax Cuts". Center on Budget and Policy Priorities. Retrieved 2006-07-23. {{cite web}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  32. ^ Edwards, Chris (2005). Downsizing the Federal Government (Hardcover ed.). Cato Institute. ISBN 1930865821. {{cite book}}: Cite has empty unknown parameter: |coauthors= (help)
  33. ^ "Summary of Estimates of the Costs of the Federal Tax System". U.S. Government Accountability Office. 2005-08-26. Retrieved 2006-07-23.
  34. ^ Bartlett, Bruce (2005-10-11). "The Times is still wrong on taxation". Free-Market News Network. Retrieved 2006-07-23.
  35. ^ a b c d e Linder, John. "The FairTax". The Online Office of John Linder. Retrieved 2006-08-07.
  36. ^ Trowell, Christopher. "Clean out America's Economic Arteries". Committee on Ways and Means. Retrieved 2006-07-24.
  37. ^ Vargas, Melody (2005-03-03). "Retailers Question Greenspan on Consumption Tax". National Retail Federation. About. Retrieved 2006-07-24.
  38. ^ Hodge, Scott (2005-11-15). "The U.S. Corporate Income Tax System: Once a World Leader, Now A Millstone Around the Neck of American Business". The Tax Foundation. Retrieved 2006-08-03. {{cite web}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  39. ^ Wagner, Scott (2005-11-08). "Abolish the IRS". The Observer Online. Free Republic. Retrieved 2006-07-24.
  40. ^ "Types of Bonds". SmartMoney.com. Yahoo Finance. Retrieved 2006-07-24.
  41. ^ Boortz, Neal (2005-09-15). "The FairTax - Straightening out some confusion". Cox Radio. Retrieved 2006-08-04.
  42. ^ "Jorgenson Explodes FairTax Myth". Free Republic. 2005-08-25. Retrieved 2006-07-24.
  43. ^ "Why retailers should support the FairTax" (PDF). Americans for Fair Taxation. Retrieved 2006-07-24.
  44. ^ McTague, Jim (2005-04). "The Underground Economy". Barron's. The Wall Street Journal Classroom Edition. Retrieved 2006-07-25. {{cite web}}: Check date values in: |date= (help)
  45. ^ a b "Simplifying tax systems: The case for flat taxes". Barron's. The Economist. 2005-04-14. Retrieved 2006-07-25.
  46. ^ a b c "What the federal tax system is costing you – besides your taxes!" (PDF). Americans for Fair Taxation. 2005-04-14. Retrieved 2006-07-25.
  47. ^ "California Sales Tax Enforcement Costs - Analysis of the 2004-05 Budget Bill". Legislative Analyst's Office. 2004-02. Retrieved 2006-07-25. {{cite web}}: Check date values in: |date= (help)
  48. ^ Slemrod, Joel (2005-11-13). "'The Fairtax Book' and 'Flat Tax Revolution': 1040EZ — Really, Really EZ". New York Times. Retrieved 2006-07-25.
  49. ^ a b Wolfe, Claire (2005-05-19). "The FairTax: A Trojan Horse For America?". Jews For The Preservation of Firearms Ownership. Retrieved 2006-07-23. {{cite web}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  50. ^ "Evasion potential of the FairTax". The Fair Tax Blog. 2005-08-24. Retrieved 2006-07-25.
  51. ^ Franks, Dale (2005-08-25). "Fair Tax Supporters: Whistling Past the Graveyard". The QandO Blog. Retrieved 2006-07-25.
  52. ^ Manu (2005-02-02). "The Rediff Interview/Nishant Shah, tax expert". Rediff. Retrieved 2006-08-09.
  53. ^ "Brushaber v. Union Pacific R. Co., 240 U.S. 1 (1916)". U.S. Supreme Court. Findlaw. 1916-01-24. Retrieved 2006-08-07.
  54. ^ Moffatt, Mike. "FairTax - Income Taxes vs. Sales Taxes". About. Retrieved 2006-07-25.
  55. ^ Boskin, Michael (2003-01). "Future Income Tax Revenue from Deferred Accounts" (PDF). Stanford University. University of California, Berkeley. Retrieved 2006-07-25. {{cite web}}: Check date values in: |date= (help)
  56. ^ "Household Debt: A Growing Challenge for American Families and Federal Policy". OMB Watch. 2006-07-25. Retrieved 2006-08-07.
  57. ^ Boortz, Neal (2005-09-07). "Nealz Nuze". Cox Radio. Retrieved 2006-08-07.

References

  • Boortz, Neal (2006). The Fair Tax Book (Paperback ed.). Regan Books. ISBN 0060875496. {{cite book}}: Unknown parameter |coauthors= ignored (|author= suggested) (help)
  • Ose, Al (2002). America's Best Kept Secret Fairtax: Give Yourself a 25% Raise (Paperback ed.). Authorhouse. ISBN 1403391890.
  • McCaffery, Edward, J. (2002). Fair Not Flat : How to Make the Tax System Better and Simpler (Hardcover ed.). University Of Chicago Press. ISBN 0226555607.{{cite book}}: CS1 maint: multiple names: authors list (link)

Associations for FairTax

Associations against FairTax

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