Neal Boortz and John Linder officially introduced their version of a national sales tax—the FAIRTAX—in 2005. It’s been one of the most demagogued political issues ever since. With the 2012 election season upon us, it’s certainly worth a second look.
The FairTax is a specific proposal, not a set of general principles; visit fairtax.org for all of the details. The idea is to replace our current income tax and corporate tax schemes with a single 23% national sales tax. Everyone gets a monthly “prebate” to cover the taxes they would pay on life’s necessities so that individuals and families living at the poverty line would pay a zero effective tax rate. Note that the FairTax is proposed to REPLACE other taxes, NOT as an additional tax.
The proposal is not that complicated, but there’s a lot of confusion around when it comes to the FairTax. Let’s look at a few basics.
1. What’s the difference between the FairTax and a flat tax? The term “flat tax” typically refers to a single INCOME tax rate that everyone pays after a limited number of deductions. The FairTax refers to a single SALES tax rate that everyone pays whenever they purchase a good or service.
2. Why tax sales instead of income? Taxing income discourages work because individuals know they’ll never see a big chunk of what they earn, especially those in punitive tax brackets. It also allows individuals complete control over earnings until such time that they are converted into tangible benefits (paper money is traded for a good or service).
3. Isn’t the FairTax really a VAT (value-added tax) like they have in Europe? No. A VAT inserts taxes at various points of production, whereas a sales tax is a single levy imposed at the retail level. This distinction is important because a sales tax is transparent. Unlike the VAT, you always know how much tax you’re paying in when it’s calculated at the end.
4. Does it really matter how we fund the government? YES IT DOES. Here are 4 basic factors I consider whenever anyone proposes an alternative tax scheme.
(1) Liberty: Does the system manipulate otherwise lawful behavior by giving “breaks” to those who meet Washington’s requirements (i.e., obtain a mortgage, buy an electric car, have more children, etc.)? Remember, tax “breaks” must be balanced with higher initial rates to obtain the same level of revenue. The current system gets an F here—just consider the vast array of tax reduction schemes available to those who are willing to work the system. The FairTax gets an A. You pay only when you spend.
(2) Growth: Does the code encourage entrepreneurial activity devoid of government interference? Both large corporations and small businesses consider their tax liabilities before they hire or invest. The current system gets a D here. While it includes a number of tax incentives for businesses, they are short term, largely unpredictable from one year to the next, and require specific business investments that are often inefficient. The FairTax gets an A. Businesses could examine the economic merits of a particular business decision without regard to tax implications. Moreover, savings associated with the elimination of other taxes would result in lower prices at the wholesale and retail levels (before the FairTax is applied). This would reduce the prices of our products abroad and make our exports MUCH more competitive.
(3) Equity & Redistribution: Do those who earn and spend more pay proportionally more in taxes, or is the system used as a means of wealth redistribution? The current system gets a F. Higher income earners pay more—a lot more. The top 10% of wage earners pay over 60% of the income taxes, while the bottom 47% either break even or take from the system. Such imbalance is punitive, not proportional. I’d give the FairTax a B here. The prebate effectively reduces the tax liability of those at the poverty level at the expense of other taxpayers, but some modest form of net wealth redistribution is probably required for a the proposal to receive serious consideration anyway.
(4) Simplicity: It doesn’t make sense to spend billions in productive resources every year simply to calculate taxes. The current system fails here as well; its complexity is mindboggling. In contrast, the FairTax gets an A. If you can multiply a price by 23%, then you can fully understand your tax liability.
So…if the FairTax is a better system across the board, why are so few in Washington willing to give it a fair hearing? Unfortunately, some politicians don’t understand how it works. However, most probably understand it all to well; they fear it because it restricts Washington’s ability to social engineer via the tax code. In lay terms, it gets the government out of the way in terms of tax collection efforts. Tax breaks for special constituencies would be severely hampered.
Some resist the FairTax because it eliminates the [fill in the blank] tax break. The mortgage interest deduction is a popular one, but keep in mind that this tax policy has artificially lowered the price of homes subsidizing them. Someone else is to pay, and we’ve all been paying for each other’s tax breaks for too long.
A few intellectuals have opposed the FairTax because they claim it won’t produce sufficient revenue. These detractors actually studied the plan, so at least some credit is due here. I’ll avoid a long academic discussion, but it’s worth noting that the models they employ to evaluate the FairTax are static, not dynamic. In other words, they assume that individual and business behavior would not change if a radically different tax code were introduced. This is simply not true.
The FairTax is an idea whose time is long overdue. It’s hard to imagine anyone except strict wealth redistribution types and social engineers preferring the current system. Then again, I probably just described most of the Democrat party.