The FairTax Debate

by VM1
Last Update: March 20, 2016
Is the FairTax fair? Many questions remain regarding the consequences of a consumption tax (FairTax). Some people see the name “FairTax” and believe that it is more fair than any other method of taxation. People who describe this as the best method for a tax system probably have not investigated the effects of moving from an income tax to a consumption tax.

Our current “progressive” tax system punishes small business owners and people in the upper income brackets who often work two or three jobs and consequently have a higher annual income but rewards those at the lower income level and often gives refunds to people who have not even paid any income tax. The FairTax would do the opposite by increasing taxes on those at the lower and middle-income brackets.

Contemporary Economics by Milton H. Spencer describes the Personal Income (PI) as the total income received from all sources before taxes are taken out. Disposable Personal Income (DPI) is the amount of money that people have left to spend after taxes. Currently, the United States uses a Progressive Tax System, which means that people who make more money have a larger tax burden than a family with a low income.

The progressive tax rate increases as the PI increases until the “maximum tax bracket” is reached. The FairTax is a regressive tax which means that the percentage of income that is actually taxable decreases as the tax base (PI) increases so the method taxes a larger share of income from the low-income taxpayer than from the high-income tax payer.

Actually, a regressive tax is “a tax whose percentage rate decreases as the tax base increases.” But “if we compare the rate structure of the tax with the taxpayer’s net income (PI) rather than with the actual base, the term regressive applies to any tax that takes a larger share or percentage of income from the low income taxpayer than from the high income taxpayer.” With this in mind, most taxes such as consumption tax, value added tax, and other sales taxes have a regressive effect on the taxpayer.

The claim is that the FairTax would be 23%. This number is achieved by falsely calculating the tax. If a product costs $1.00 at retail and the FairTax adds 30 cents then the total cost is $1.30 under the FairTax rule. This is a total cost increase of 30% (30% of $1.00 is $0.30; add that to the $1.00 and you have $1.30). The FairTax divides the increase by the total to achieve the lower rate which is MATHEMATICALLY INCORRECT ($0.30/$1.30)*100=23%. A 23% tax on $1.00 would yield a total cost of $1.23 NOT $1.30.

A 30% FairTax could be applied to all taxpayers so everyone would pay the same rate. However, since the low income families spend most or all of their available money on goods and services, a large percentage or all of their income would be taxed and the high income families would spend a smaller percentage of their income on goods and services so only a small percentage of their income would be taxed. In this sense, the consumption tax is viewed as a regressive tax.

As an example, consider a Family of four who has a PI of $500,000. Using the current Federal Income Tax requirements, this family would probably pay around $145,000 after reducing the taxable income to compensate for savings plans, medical, donations, etc. A family of four who has a PI of $100,000 may pay around $10,000 in Federal Income Tax.

The “FairTax” or Consumption Tax would tax the money actually spent on goods and services. The family making $100,000 per year (or less) would probably spend all of their disposable personal income on goods and services so this means that 100% of their DPI is taxed. However, the family making $500,000 per year would most likely not even spend half of their income on goods and services so a smaller percentage of their income would be taxed.

Let’s assume the higher income family spent $200,000 per year for food, clothing, etc.: This means the family making $500,000 per year is taxed on 40% of their personal income and their tax would be $60,000 (a savings of $85,000 compared to the current progressive tax). The family making $100,000 per year would pay $30,000 if they spent all of their income on goods and services. The $100,000 per year family would be taxed on 100% of their DPI and would pay three times the amount they currently pay.

In this second example, assume the FairTax was set at 50%; the family making $500,000 per year would pay $100,000 in taxes (50% of $200,000) instead of $145,000 (a tax savings of $45,000). The family making $100,000 per year would pay $50,000 in taxes (50% of $100,000), which would be 5 times as much as they currently pay.

The regressive consumption tax is really the most unfair taxing method of all the available choices. It places the largest burden on the poor and middle class with a tidal wave of taxes while the rich only see a ripple in their budget, which amounts to a large decrease in taxes compared to the current income tax. The consumption tax penalizes the poor and middle class and gives enormous tax breaks to the rich. The rich will use only a fraction of their income on taxable goods and the taxable percentage of their income just gets lower as the PI increases.

Supporters of the consumption tax suggest that the tax rate on goods and services would only be around 23% (30% if you do the math right). However, a tax rate of 40 to 60 percent is more likely in order for the government to receive the same revenue as the current progressive tax. In addition, to make this process work, services such as medical, rent, food, and many other things that are not currently taxed would have to be taxed in order to pay for the ever-expanding government appetite for money.

There are many unintended consequences to consider with the consumption tax. As an example, people who currently purchase a new car every two or three years will probably delay that purchase and keep the car for five to ten years or keep it until it doesn’t run anymore. This would have a disastrous effect on the auto industry and also on other industries that sell high value equipment. Corporations would delay purchasing new vehicles and capital equipment because of the large tax burden, which would continue to damage the economy.

As Bruce Bartlett (economist associated with supply-side economics) explained, the government would have to tax itself when purchasing tanks and other military equipment. The government would also have to tax itself when purchasing ships, aircraft, and all the small things that are needed to keep the government running. But the increased revenue from taxing purchases is exactly canceled by increased costs in the federal budget so this is something that the FairTax folks need to re-think. This government taxation may also be applied to the state and local governments, which would in turn add another burden on the taxpayer by increasing the state and local taxes.

Also consider the 55 year-old and older people who have been paying income tax all their lives. Even though they retire and no longer make wages, they will get hit with the consumption tax, which amounts to double taxation. The “FairTax” is not at all fair to the low-income or middle class families. The FairTax would however, remove the burden of extreme taxation on the wealthy.

The FairTax supporters claim that all Americans that hold a valid Social Security Card and who are U.S. residents will receive a “prebate”. This prebate is not restricted to low-income families but is given to everyone regardless of annual salary. The CEO’s of companies such as EXXON and Chevron who make over 4 million dollars a year in salary would also receive a “prebate”.

The word “prebate” is not a real word but was made up by the FairTax followers to disguise the real meaning which is WELFARE and would cost around $800 billion in the first year and would only increase with time. This new entitlement of 800 billion dollars a year is not considered in the FairTax proposal. Think about it: Americans would start off the year with close to a trillion dollar debt before one cent of revenue (tax) is received by the government.

The FairTax is supposed to replace just about all current federal taxes and some services:

1. Income Tax
2. Social Security Tax
3. Medicare Tax
4. Corporate Tax
5. IRS
6. Save 300,000 trees a year (no joke)
7. Eliminate 401Ks and IRAs
8. Eliminate deductions for charitable donations
9. No reporting of where you work or your salary
10. Encourages the purchase of “tax-free pre-owned cars, clothes, furniture, houses, etc.” (Isn’t this what they do in Cuba?)

“When something seems to be too good to be true, it isn’t true”. The list above is only a small sample of what the FairTax people claim to accomplish. Now consider the fact that they claim to remove all the taxes with a 23% consumption tax but still run the government, fund Medicare, fund Social Security, and the rest of the services currently provided by the government. They also want to dismantle the IRS and fire 100,000 workers. Now someone would have to be around to manage the FairTax policies and ensure taxes are collected from the companies offering the products and services. I expect they would create a new bureaucracy and hire the IRS folks back since they already know how the process works.

The United Kingdom pays an income tax that is similar to the U.S. tax with the maximum tax bracket of around 40% (currently, the maximum tax bracket in the U.S. is 35% although the progressives in Congress would like it to be near or above the 40% range). However, the Brits also pay a Value Added Tax (VAT). Value Added Tax is a general consumption tax assessed on the value added to goods and services, which is really a consumption tax “because it is borne ultimately by the final consumer. It is not a charge on companies”. The VAT rate in 2008 was 17.5%. It dropped to 15% in 2009 but in 2010 it was back to 17.5%. Most people pay the 17.5% VAT plus the standard income tax. If the United States were to implement the FairTax, we would most likely end up in the same situation as the U.K., paying a consumption tax and, re-instating the progressive income tax.

The FairTax would place most of the tax burden on low-income families and give large tax breaks to high-income families. Don’t forget about the state income tax, county tax, property tax, and city taxes that will be in addition to the consumption tax. The FairTax would crush the low-income family, destroy the economy, and provide an enormous tax break to the wealthy.

The FairTax would require the 16th amendment to be repealed. We know how difficult it is to get an amendment to the Constitution passed and it is virtually impossible to get it repealed once in place. What this means is there is little chance of repealing the 16th amendment and if the FairTax ever became law and the income tax was ended, congress could re-instate the income tax any time they wanted and you can depend on congress when it comes to increasing taxes. The end result would be that we have a national sales tax called the FairTax at somewhere between 40 and 60% and we would also have the old and honored progressive income tax – the progressive liberal dream.

There are ways to simplify the current tax code such as a “flat tax”. The flat tax would be an income tax and would only have one or maybe two tax rates. The tax rate could probably be lowered to ten or fifteen percent with a flat tax. The flat tax would be fair to everyone and not have the disastrous effect of the FairTax. The current tax system does need work but the FairTax is not the answer.

The following is from a 2012 study by the Tax Foundation using data from 2010:

The top 1% of taxpayers paid 37.38% of all federal taxes.
The top 5% of taxpayers paid 59.07% of all federal taxes.
The top 10% of taxpayers paid 70.62% of all federal taxes.

This leaves us to conclude that the bottom 90% of taxpayers only paid 29.38% of all federal taxes.

Some Unintended Consequences

For this example, we will use the 30% FairTax although as shown above, it would be much higher:

Purchase a $500,000 house and pay $150,000 in sales tax.
Purchase a $30,000 automobile and pay $9,000 in sales tax.
Get a hospital surgery bill for $20,000 and pay $6,000 in sales tax.
Spend $200.00 on groceries and pay $60.00 in sales tax.
A large portion of the population will stop purchasing new houses and new cars and buy used goods so they won't have to pay the harsh FairTax. What will this do to the building and automobile industries? 

As you begin to see some of the unintended and intended consequences of the FairTax, you can understand it is just a bad idea.

But what if the tax was increased to 50% which is a likely scenario?

Purchase a $500,000 house and pay $250,000 in sales tax so now the price is $750,000.
Purchase a $30,000 automobile and pay $15,000 in sales tax so now the price is $45,000.
Get a hospital surgery bill for $20,000 and pay $10,000 in sales tax.
Spend $200.00 on groceries and pay $100.00 in sales tax.

Although the current tax system is unfair to those who earn a higher income, the bottom line is that the FairTax will not work and it is definitely not fair.  We do need something to replace the current tax code but is the FairTax really the answer?


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