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by Ian Tartt

The “FairTax” is popular idea among some conservative and libertarian circles. Supporters of the tax seek to replace federal income, payroll, business income, estate, and capital gains taxes with a national consumption tax. Eliminating the IRS and the tax code, raising wages, letting individuals choose their level of taxation through how much they spend, growing the economy, and raising the same revenue under the current system are other assumed benefits of the FairTax. This all sounds good on the surface, but actually implementing the FairTax will likely not work out in reality as it works on paper.

The first problem with the FairTax is the name. Calling it “fair” sidesteps the question of the morality of taxation. Libertarians believe taxation is theft as it is the removal by force or threat of force of justly acquired property without necessarily having permission from the owner of said property, and therefore oppose it as immoral. Thus, anyone with this basic view of taxation sees all taxation as inherently unfair; to say that taxation can be made fair is like saying murder can be made fair. The name avoids this discussion by assuming taxation is fair or can be fair if done a certain way and keeping people focused on how a tax is levied rather than the morality of taxation, in addition to making anyone who opposes a “fair” tax appear to support an “unfair” tax. The name may be the first problem with the FairTax, but it’s hardly the worst.

Eliminating the IRS is something practically everyone in the general populace apart from IRS employees can support. What could be better than getting rid of the organization that invades your privacy, forces your employer to take money from your paycheck before you even get it, makes you fill out forms each year certifying that the “proper” amount was stolen from you, further invades your privacy if it thinks you made a mistake, and can steal other property of yours besides your paycheck? And then you add in all the money that’s spent hiring accountants or tax preparation specialists to help the average person navigate the 70,000+ pages of the tax code, as well as the gas spent getting to these places and the opportunity cost of everything else that could be done instead during this time, and the case is even more convincing. However, a fundamental aspect of the FairTax is the “prebate”, which is a check given to every individual to help them cover, or “detax”, the necessities every month. Surely some organization would be needed not only to collect the revenue obtained through the consumption tax, but also to return some of that money in the form of the “prebate”. Would it make sense then to eliminate the IRS or simply shift its responsibilities from dealing with income taxes to dealing with consumption taxes? The case against the IRS is strong both from a moral and a practical viewpoint, but the FairTax could require it sticking around. Perhaps the “prebate” could be substituted with tax exemptions on the necessities. Although some bureaucracy would still likely be necessary for sorting out what is taxed and what isn’t, it would be less convoluted than sending money back and forth as the current idea proposes.

The idea that eliminating the income tax would result in an immediate increase in wages is certainly true. No matter what the level of taxation on income is, its mere existence lowers wages, so eliminating the income tax would raise them to what they really are. However, one phrase supporters of the FairTax use is “keep your entire paycheck”. While this is true for receiving the paycheck, having some tax in place, even if it’s just a consumption tax, negates it. If the government takes any money from you, regardless of how or where that money is taken, you’re not keeping your entire paycheck. Eliminating the income tax and replacing it with nothing would give everyone a boost in their wages without resulting in additional lost money elsewhere, which is one of the problems with the FairTax. Further, while the FairTax would be about 23% (or 23 cents out of every dollar spent), there’s no guarantee it would stay there. Look at how the income tax has changed since its inception in 1913. The rates, brackets, and people who pay it have all changed drastically over time, as have the schedules, exemptions, deductions, etc. Originally, only a few people were paying income tax, and the highest rate was very low. Who can say the FairTax wouldn’t be increased to 50% or 70% over time? An important but often overlooked fact about government is that giving the government the power to do X only more often than not results in the government having the power to do X plus Y, and that is certainly a possibility with the FairTax.

Another idea FairTax supporters promote is “Choose how much and when to pay federal taxes”. This sounds good at first, considering that every paycheck is currently taxed while the FairTax wouldn’t be applied to every purchase, and those who consume less would pay less than those who consume more. However, there is no option under the FairTax to not pay taxes on goods that aren’t covered by the “prebate”, so you really don’t get to choose whether or not to pay federal taxes unless you purchase only goods that are covered. This flies in the face of the idea of a “voluntary tax”, which many seem to think a consumption tax is. If you don’t have the option to not pay it, it’s not voluntary. Further, if one needed to consume more non-covered goods for whatever reason, they would end up paying more in taxes. Supporters recognize and even champion the fact that this makes it a “progressive” tax, rather than a “regressive” tax. Why not opt for a “flat” tax instead, in which everyone pays the same percentage every year? “Progressive” taxation is hardly a conservative or libertarian idea, so why are many conservatives and libertarians supporting the FairTax?

FairTax supporters say that by eliminating the IRS and raising wages, the economy will flourish. It’s possible that this could happen, most likely as a result of individuals having more money to spend or save as they see fit, and the end of lost time and money spent complying with the massive tax code, although it likely wouldn’t work as well as they’re hoping. There would still be the hassle of the “prebate” and the bureaucracy that would entail, as well as additional time and money spent by those who would collect the tax at the point of sale. Prices would have to be adjusted to reflect the additional tax, some paperwork that proves the tax was collected would be in order, and some response (for lack of a better word) to those who violate the procedures involved in collecting, transferring, or reporting the tax would be necessary. Would the cost of all this be higher or lower than the cost of the current system? Probably lower initially, but over time it could increase as the system inevitably changed due to new politicians coming in and proclaiming they have a “better” or “fairer” way to get things done.

Perhaps the most curious claim about the FairTax is that it would raise the same revenue as the current tax system. Before answering whether or not it would raise the same amount, why would that be a desired goal? Many people believe the government taxes and spends too much money now and wish to reduce both. These people would not be drawn in by a claim that the FairTax would allow the same reckless abandon that’s occurring now to continue. Only those who want the government to spend as much or more than it’s currently spending would be attracted by this claim, and those people tend to vote Democrat. So why is a tax that would be more likely to attract leftists being marketed to conservatives and libertarians? As for whether it would raise the same revenue as the current system, chances are it would not. The way humans act is dependent on a number of conditions, and changes to those conditions results in changes in their behavior. This is one of the fundamental laws of economics. Consider “sin” taxes, which are applied to cigarettes and alcohol. The purpose of levying these taxes is to both discourage consumption of those goods and to raise revenue from those who still imbibe. Proof that these taxes, especially higher taxes in places like New York, discourage consumption can be found in the illegal smuggling and sale of loose cigarettes from places with lower taxes to places with higher taxes. Those who illegally sell and purchase cigarettes would not risk all that that entails if the taxes were not acting as a disincentive. Tariffs, or taxes on imported goods, are another widely understood example of how taxes can discourage consumption, in this case consumption of foreign goods. With that in mind, a national consumption tax can absolutely act to discourage consumption of goods that aren’t covered by the “prebate”.

Another thing to keep in mind is that the national tax would be added on top of local or state consumption taxes, adding further difficulty for those who live where these taxes are already burdensome. This would most likely result in decreased demand for non-covered goods, leading to reduced employment in industries that provide such goods. A relatively modern example of this is a luxury tax President George H.W. Bush levied on luxury boats above $100,000. A massive downturn in boat purchases followed, resulting in increased unemployment and failure of boat-building businesses. And very little revenue was raised compared to what was predicted. That was from a tax on one specific good. Imagine what could happen if a national tax were applied on nearly all goods. Naturally, if the tax discourages consumption of certain goods and leads to reduced employment in industries that produce those goods, then less revenue than is expected will be raised. The response to this would likely be to add additional taxes elsewhere or raise existing taxes to make up for the lost revenue. This is the opposite of what we hope to accomplish through tax reform.

These predictions about the unintended consequences of the FairTax are just that, predictions. But they are predictions that, based on economic law and governmental theory, might very well occur. Whether or not they will, and whether or not they will result in a worse system than currently exits, can only be known if the FairTax is implemented. The purpose of this essay is to point this out to anyone interested in tax reform so that they may consider these points and do further research on the subject. Being informed, though it might not prevent disaster, can still help one better prepare for the disaster. And since “disaster” is an excellent word for describing the state of modern politics, there can never be too much preparation.

  • dutchman3

    Ian,

    Good article. In future articles, you might consider the following:

    (1) The rate in terms we all understand is 30%, not 23%. The merchant has to add 30% to his costs in order to arrive at a 23% tax inclusive price. Not clear to most readers!

    (2) The prebate exempts nothing! It is a cash grant entitlement that can be spent on anything or saved. The cost of the prebate is estimated to cost $600 billion annually, and we can’t stand any more of the federal budget to be placed on autopilot!

    (3) No one has ever asked the States if they would be willing to act as the federal tax collector.

    (4) The Fairtax base includes the federal government not only taxing State and Local government operations, but also taxing itself, a totally idiotic proposal. Federal taxation of S/L governments would be inappropriate if not unconstitutional under our Constitutional Republic form of government. Sovereign government powers can not tax each other without the consent of both!! Remove government taxation from the base and the sales tax rate would rise from 30% to 42%. Add an allowance for legal avoidance or illegal evasion and the rate could rise to 60%. How high is too high?

  • Eugene Patrick

    Rich people don’t understand the unintended consequences. The prebate is just another form of welfare for everyone. With a 30% sales tax rate the poor will buy used goods to avoid the tax – clothing, toys, electronics, furniture, apliances, etc. This will decrease the demand for used goods and decrease economic growth.

  • gzizzle

    “However, there is no option under the FairTax to not pay taxes on goods
    that aren’t covered by the “prebate”, so you really don’t get to choose
    whether or not to pay federal taxes unless you purchase only goods that
    are covered.”

    The prebate does not take into consideration the “type” of goods. It simply is a rebate in advance of all taxes paid up to the poverty level. So if the poverty level is $1,000 a month for example, and the tax rate is 23%, then the prebate would be $230 a month per individual (with no dependents or spouse). It isn’t based on what you purchase at all.

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