Thursday, July 17, 2008

Fair Tax

I just finished reading The Fair Tax Book today. I had heard about the fair tax before and have visited the website but I still learned a lot.

For those that don't know, the Fair Tax is a law in congress, HR 25 and S 1025, that aims to eliminate all personal income, estate, FICA, medicare and corporate taxes, abolish the IRS and replace them with an inclusive national sales tax of 23%. This means that if you buy a $100 item, the retailer keeps $77 and sends $23 upstream to the federal government. Because the taxes and cost of compliance with federal tax laws are already embedded in the cost of every item you buy (estimated to be around 23%) prices for the consumer are expected to remain the same or slightly decrease. Imagine the ability to take home all of your pay every two weeks and only pay tax when you choose to spend it.

Some of you may be wondering about those with little to no income, but not to worry the plan takes care of that by "prebating" every head of household in the US with the amount of sales tax on a twelfth of the inflation adjusted poverty level for the size of their family. This means that the poor's tax burden is removed entirely and still receive goods and services from the federal government.

I'm on board, but a ground swell of support is required to convince congress that this is a desired course of action. I encourage you to investigate the plan and then contact your friendly neighborhood congress critter with your opinion.

I consider this to be compatible with the Change Congress movement as the simplification of the tax law to a point where there are no loop holes or exceptions for anyone will lead to a congress more beholden to their constituents.


Lefty said...

The Fair Tax is a great idea that definitely deserves more love...

marnanel said...

A high sales tax generally results in an increase in tax avoidance: people find every possible way to get the goods into their own hands without actually completing the final transaction. To some extent this is helped by using a value-added tax instead of a sales tax, but I'm surprised I haven't heard this suggested in all the talk about this idea.

Is the idea of "prebating" merely to reduce the regressive effect of a sales tax? In the current system, refundable income tax credits (those which potentially make a person's income tax liability negative, which would clearly not exist in a system without income tax) are used as a politically acceptable way of passing government money to the working poor. I haven't heard how this would happen in a system such as you describe; the prebate below a certain income level would have to be considerably higher than the tax which the government expected to collect from you in a year.

Adam said...

It's hard to avoid a tax that's levied at every retail location. There's also no incentive to avoid the tax when items cost no more than they used to. VAT's just hide the amount of tax you're actually paying on an item.

I'll have to look a bit for the answer to the second question. It's a good point especially when you consider that many of those would also be receiving some kind of assistance, which would be taxed when they spend it and then would be prebated so that they only recieved the original amount assuming they were assisted to the poverty level. I guess the answer is that the Fair Tax is tax reform and additional reform is needed elsewhere but somethings need to get passed first.

You've intrigued me and I'll keep looking to see if I can find anything.

lurgy said...

I'm unfamiliar with but interested in this fair tax idea. Can you elaborate on how prices would stay the same? My naive speculation (with no economics backround to speak of) would have been that retailers and manufacturers would raise prices as far as the market would allow to maintain the same level of income as before the tax was levied.

Adam said...

The same level of income is maintained as when the companies have to pay the cost of compliance, they simply pass it on to the customer.

Here's someone's paraphrase of the real life example given in the book

What if none of the corporations and businesses selling us the goods and services lower their prices by 25%

First off, great question! I mean, why, if there is no clause in this proposed tax system ordering and policing the policy of getting every single business in America to lower all prices of goods and services by (approximately) 23%, would any American business do so?

There they are... No more portions of income taxes for each employee... No more huge corporate taxes at the end of each year they are planning for... Employees coming in with big grins and working harder than ever with no income taxes and FICA withheld from each paycheck... Making record profits because it costs them 25% less to produce each widget.

Well, it cost them 25% less to make each widget, but now the people at the store who want to buy a widget are eyeing that price tag and thinking, "Man, that's like 123% of what this thing cost me last week."

We have documented proof of economics like this in action in the US in recent years. Congress repealed a certain tax on airplane fuel to give a boost to a majorly depressed airline industry. All of a sudden, it cost every single Airline buying their airline fuel in the US something like 15% less to do so.

For a minute, the airlines all looked around at each other nervously as the reports started filling the boardrooms. Sure enough, steady sales and everything cost 15% less. Profits are up 15% immediately. These airline folks love the profit, but they spend every minute of every day trying to figure out how to get you to fly their planes over the next guys. Within a few hours, one airline lowered all of their ticket costs by about 15% and snatched up everyone who was looking to buy a ticket. Only hours later, every other airline had responded in kind, passing that 15% tax break onto the consumers for fear of loosing market share.

And the real winner? The consumer. Cheaper tickets. We flew more starting immediately. The airlines did a little better. The tax relief for the industry worked.</quote>

Note that the prices went back up after the tax was reinstated.

marnanel said...

It's hard to avoid a tax that's levied at every retail location.

The reason I mention it is that however people could avoid it in particular (such as petty theft, undeclared imports from areas not subject to the tax, i.e. smuggling) becomes a lot less worthwhile if the tax saved goes from a drop of 23% to 0% to a drop of 23% to 23% reduced by whatever tax the place you're stealing from paid on it.

There's also no incentive to avoid the tax when items cost no more than they used to. VAT's just hide the amount of tax you're actually paying on an item.

Taken together, these two statements would appear to show that VAT removes incentive to avoid taxation.

Joe said...

This proposal was something Mike Huckabee was talking about for a while.

The sales tax rate being proposed is 30%, not 23%. They fool you by specifying the fraction in an unconventional way: you pay 23 cents on a purchase of 77 cents, not on a purchase of a dollar. But everything you buy would suddenly cost 30%, not 23%, more.

You'd see the same kind of tax avoidance you see in places like Italy: small business owners, contractors, and the like will offer a 30% discount if you pay cash.

For the honest, those that have to spend every dime of their income pay it all to the feds, while the wealthier pay nothing on their savings. This could be made better by payments to the worse off, and extending the tax to cover services and other items not covered.

Also, it's unclear whether this is supposed to work like a value-added tax (where the tax paid is only on the added value, for example the retail price minus the wholesale price), or whether the tax is due at every point in the retail chain.

Since neither charitable contributions nor home mortgage interest would be deductible any more, homeowners and charities could find themselves in financial trouble.

andy said...

The "Fair Tax" concept is great because it sounds great. It has a great title. It is also a great thing for the very wealthy. Consider this for three families.

#1 Earning $40K/yr spends pretty much everything, and so their effective tax rate is the 23%

#2 Someone earning $100K, spends almost all, saves a little, effective tax rate is say 20%

#3 Someone earning $1M, spends $500K, invests $500K.Effective tax rate is 11.5%

If, due to your wealth you spend a month or two outside the country, then you can drop your effective tax rate even more.

It's only a fair tax, IF, everyone spends 100% of their income in the US. And poorer people are more likely to do that. Richer people, although they spend more, are more likely to not spend all their income, and that lowers their effective tax rate.

Although it has a title that people can buy into easily, it is yet another scheme to screw the middle class and to reduce the taxes for high income earners.


Adam said...

Marn: Do you feel that a gov't should have to hide how much its citizens are paying to fund it in order to avoid tax fraud? The truth is there's plenty of tax fraud right now and we all enable it in little ways (paying workers in cash, not reporting tips fully, not reporting sales tax, etc.). The question is: is it harder to find everything you need on the black market to evade tax or to play with complex loop holes even the IRS sometimes doesn't understand or just plain old lie?

Joe: The 23% is for an inclusive tax, which is exactly what income tax is now unless you consider your income to only be your take home pay. In an inclusive system, the expected sticker price would remain $100 and $23 of that amount would be tax, in an exclusive system, the expected sticker price would fall to $77 and the $23 would be tacked on at the register at the 30% figure you quoted.

Andy: You neglected to figure in the "prebate" into your calculations which removes the tax burden on anyone that purchases only the essentials. Also, in the case of your wealthy individual, they have lots of money, but usually very little earned income. Most of their incoming money gets taxed at the much lower capital gains rates. The fair tax would also encourage saving and wealth generation across the board as people become aware of just how truely send the gov't each year. Increased saving would boost our economy, lower interest rates and possible end some of the credit crunch.

Rob J. Caskey said...


At this point I really hate to see any mention of the FairTax. Without fail, it attracts people who have not spent any time thinking about the tax code and certainly haven't bothered to check out both sides of the story from themselves.

I'd also like to mention the following:

1. It is by nature fundamentally more just because it is a law that people can understand. Noone understands the entirity of the current tax code.

2. The codes strength lies in its consistancy. Find something everyone needs where demand is inelastic and tax it, everything else will work out. In fact, the fewer places we tax the better, because it reduces chances for fraud and administrative costs. The goal here is to find a taxation choke-point that is satisfactorally progressive/regressive for the electorate to support.

People get all tied up with trying to figure out if the FairTax is really "fair" by taxing every type of good identically when that really isn't important. We could probably end up with a better tax code than the one we have now if we did nothing but tax chairs. Sure, each dining room chair woul cost $8,000, and some people would skirt the tax code by sitting on the ground, but it would all work out in the end.

And finally, if someone spends cash under the FairTax they get taxed. If a dollar is handed down from father to son and is never spent it might as well have been burned for most purposes, in effect by not spending their dollar they have done the same thing as inflating the rest of the money supply. They could have done a very similar thing by giving a fraction of that dollar to every person in the economy. If there is a rich guy not bidding in an auction, the other buyers get what they came for cheaper, so when money goes unspent it helps everyone except the person who doesn't spend it. Same goes for the interest earned by investing, it is either taxed or unspent.

Rob J. Caskey said...

Sorry, an unspent dollar effectively deflates the money supply increasing the value of other dollars, it is way too late, and I should have gone too bed :(

Tore said...

Fair Tax is an idea that, with a name like that, definitely deserves more skepticism. There is no way of getting around the fact that it is a highly regressive tax that effectively cuts taxes for the rich. Obviously the "prebate" thing is not going to change that. The result would be increased inequality.

pel said...

Interesting idea.
The main problem I see is that it puts breaks on the economy.

Simply put: Money does little good just sitting around. In a healthy economy money makes the world go around and they (i.e. the money) do this through changing hands (commerce).

By only taxing sales it gives an incentive to spend less.

Oh, and then there are issues with other forms of commerce that isn't taxes and only further other injustices - but that would stray into a political territory and be subject to opinion.

Adam said...

Pel: Money would not just be sitting around, because only spending money at the retail level is taxed. Investment would be untaxed and should spur the economy forward. It would also decrease the cost of American goods to foreigners abroad because the embedded tax is gone from the cost of the item. In fact, some foreign companies would move their manufacturing operations to the US to avoid embedded taxes when selling to the US. Also, companies that have moved off shore will return because there will be no tax haven with the (in general) stability of the US.

Tore: I'm a grad student that does well, but doesn't make what anyone would call a lot of money nor do I spend it all. However, using the calculator at, my effective inclusive federal tax rate goes from 18.4% to 9.8%. That's without trying to account for the embedded tax in every item I purchased.

Rob: I agree with your two points and should have mentioned them. Simplicity, decreasing the number of collection points and eliminating the drag on the economy due to compliance costs are big advantages.

marnanel said...

Do you feel that a gov't should have to hide how much its citizens are paying to fund it in order to avoid tax fraud?

Seriously, I don't know why you think I should think that; I don't see where I said anything remotely suggesting that.

There is no necessary connection between whether the price shown at the checkout includes tax, and whether this tax is a sales tax or a value-added tax.

At least in the UK, although shops usually show prices including VAT, there are many transactions which don't: it's up to the retailer. (For example, my colo fees used to attract VAT but were shown without it.) Including taxes reduces the amount of maths needed at the checkout; it's not some kind of government plot.

Leaving aside the question of whether a scheme such as the one you're advocating would place an unfair portion of the tax burden on the poor, since many other commenters are ably handling that, I also note that there is no necessary reason that the abolition of a country's income tax system would preclude the existence of a VAT; until 2005 the VAT system in the UK was run by the government department which managed import duty, not the department which managed income tax. (I take it that you propose to retain import duty, otherwise the scheme creates a great incentive to buy abroad.)

If there are advantages in your system, they will only be increased by encouraging people not to buy things under the table by the use of a VAT.

Mark said...

rob j. caskey,

It is by nature fundamentally more just because it is a law that people can understand.

"For every complex problem there is an answer that is clear, simple, and wrong."
- H. L. Mencken

Find something everyone needs where demand is inelastic and tax it, everything else will work out.

The AFFT tax is supposed to tax everything but necessities.

People get all tied up with trying to figure out if the FairTax is really "fair" by taxing every type of good identically when that really isn't important.

It doesn't tax every type of good identically, and that isn't why people call it unfair.