What Is the Fair Tax Plan?:
A group known as Americans for Fair Taxation developed the Fair Tax Act of 2003 which would abolish all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes. It would replace them with a federal retail sales tax of 23% to be administered by existing state sales tax authorities. The sales tax would not apply to imports, goods used by businesses to produce other goods, or used goods.
The Fair Tax would require the repeal of the 16th Amendment. The IRS would be disbanded and defunded.
Normally, a 23% sales tax would impact the poor the most. Therefore, the Fair Tax Act proposes that a prebate be paid equivalent to 23% of the poverty level. According to the Department of Health and Human Services, the poverty guideline for a family of four in 2008 is $21,200. The Fair Tax act adds an amount to remove the marriage penalty, which raised the income level to $27,380. This means a family of four would receive a check for $525 per month, or $6,297 a year, to cover the cost of the sales tax. (Source: FairTax Prebate Explained)
What Are the Advantages of the Fair Tax?:
The most obvious advantage is the elimination of the annual income tax headache and cost of tax preparers. Government spending would be reduced by eliminating the IRS. Proponents argue that, since workers would keep 100% of their wages, the increased consumer spending would lead to an increase in GDP, jobs, productivity, and wages.
Studies That Support the Fair Tax:
The Beacon Hill Institute calculated that the base for the Fair Tax would be 81% of 2007 GDP, or $11.2 trillion. A 23% sales tax would collect $2.6 trillion, which is $358 billion more than the income tax that it would replace.
The study also uses a model that shows:
- GDP increase 7.9% in year 1 on up to 10.3% year 25.
- Domestic investment is 74.5% higher in year 1, on up to 65.2% higher in year 25.
- Consumption drops slightly in the first two years (0.6% and 0.8%) but is 6% higher by year 25. Spending is fueled by an average 1.7% increase in disposable income.
What Are the Disadvantages of the Fair Tax?:
The Fair Tax could be unfair to those not earning an income, such as seniors. For the first generation of seniors, it will especially unfair as they have paid income taxes all their lives, and now must pay higher sales taxes as well. However, the advantage for seniors is that they won't have to pay taxes on their withdrawals from savings.
Although the IRS would no longer be needed, an agency would still need to send out the rebate checks, settle disputes, and collect taxes from the states.It would also need to enforce the tax, and go after cheaters. For example, business expenses that are used to create the final product would not be taxed. Small business owners could declare a purchase a business expense to avoid the sales tax. Compliance could become very expensive to monitor and enforce.
Studies That Don't Support the Fair Tax:
William Gale of the Brookings Institute noted that the Fair Tax rate of 23% would translate to a 30% sales tax. FairTax quotes that the tax would be "$.23 out of every dollar spent". That means a $.77 item would have a tax of $.23 - or 30% sales tax. He adds that states would also have to abolish their income tax, since there would be no IRS to determine wages. This would add another 10% to the sales tax.
He also adds another 5% that would have to be added to recoup revenue from those who have figured out how to avoid the sales tax (such as declaring more purchases as business expenses, which wouldn't be taxed). The result is retail purchases actually taxed at 45%. If there were an outcry and food and healthcare were exempted from the sales tax, the effective rate could skyrocket to 67%. Enforcement would be difficult, unless an agency like the IRS were kept intact, raising costs.
His calculations show that taxes would rise for 90% of all households. Only those in the highest 10% of incomes would get a tax cut, with those in the top 1% receiving an average tax cut of over $75,000.
If households are classified by consumption level,then those in the bottom two-thirds of the distribution would pay less, while those in the top third would pay more. However, those at the very top would pay much less, again receiving a tax cut of about $75,000. (Source: Brookings Institute, Don't Buy the Sales Tax, William Gale, March 1998)
How Will the Fair Tax Affect the U.S. Economy?:
Without being able to closely examine the calculations and assumptions of each study, it is difficult to determine how the Fair Tax will affect the economy. If the Fair Tax act is ever passed, implementation would need to be slow and consistently evaluated. Perhaps the best approach is a gradual shift from income tax to the Fair Tax. Or perhaps a small state could be used as a test market to iron out the problems. The scale of the change alone would probably make this plan unworkable unless a great deal more research is done. (Article updated November 30, 2011)