Why fair tax is bad

A flat tax makes it far harder for politicians to raise taxes. A progressive income tax allows politicians to divide and conquer. They can segment Illinoisans into small income groups and increase taxes on each, one at a time. They can hold taxes constant for the majority in any given year, while gradually raising taxes on everyone — one group at a time.

They can go after retirees. Division allows lawmakers to skirt backlash from voters. The flat tax encourages political accountability. Many of the politicians who voted for the tax hike were either forced to retire or voted out of office. In the 32 states with progressive income taxes, 18 of them subject middle-class families to the highest tax rate.

All of them tax retirees. Reality: Income inequality is higher in progressive tax states, and the gap between rich and poor in those states has not been shrinking. Sales taxes already exist in 45 states, the District of Columbia, and over 6, localities. State tax rates range from 3 percent to 7 percent.

While state sales taxes are widely viewed as successful, they are very poor models for federal reform. States only tax about half of private consumption of goods and services.

Many states exempt goods such as food, electricity, telephone service, prescription medicine and so on. Most states do not tax services very well, if at all. In addition, between 20 and 40 percent of state sales tax revenue stems from business purchases, which are not retail sales. This causes cascading of the sales tax, which distorts relative prices in capricious ways and gives firms incentives to merge with other firms in order to avoid the tax.

States often do not require their own government to pay sales taxes. And states do not provide demogrants; instead they help the poor by exempting specific items like food. These findings suggest that running a pure, broad-based sales tax as envisioned by S-T and AFT could be quite difficult in practice.

Determining the appropriate tax rate in a national sales tax can be tricky. For example, if a there is zero tax evasion, b state and local taxes do not change, c the tax base is not reduced by political or other factors, d nominal government spending is held constant, and e transition issues and economic growth are ignored, the AFT proposal would require a 23 percent tax on a tax-inclusive basis, or a 30 percent tax rate in the more familiar tax-exclusive approach.

All of the following rates are tax-exclusive. But realistic adjustments for each of the stringent conditions listed above raises the estimated tax rate. The tax evasion rate under the income tax is between 15 and 20 percent. Evasion issues are discussed in the next section; here we simply note that a 15 percent evasion rate in the sales tax, which is probably conservative, would raise the rate to 35 percent.

In the absence of federal income taxes, states would likely have to convert their own income taxes to sales taxes and conform closely to the federal tax base.

Add in the revenues from existing state sales taxes, and the combined federal and state sales tax rate would climb to 45 percent. Suppose the tax base were reduced by one-third from the pure consumption tax proposed. In light of all the preferences in the current income tax, and the exemptions in state sales taxes, this is probably not an unreasonable assumption. It would come about, for example, if just food and health were exempted, or if just government expenditures were exempted.

Cutting the base like this would raise the required rate to 67 percent. Since a sales tax would likely raise prices, nominal government expenditures on goods and services consumed by government and on transfer payments would have to rise to hold constant the inflation-adjusted effects of government policy. This could add another 10 percentage points to the required tax rate.

Any transition relief provided to households would reduce the tax base and raise the required rate further. For example, the S-T plan would make payments to those on fixed annuity incomes to account for any increase in prices. Economic growth could reduce the required tax rate, but as discussed below, probably not by very much. And if saving rises following the implementation of a sales tax, consumption would have to fall, which would reduce the tax base and raise the required tax rate further.

The clear result, then, is that any realistic sales tax plan would have tax rates much higher than the 23 percent rate promised by the AFT. Sales taxes at such high rates raise crucial questions about enforceability. Tax simplicity and tax enforcement should be analyzed together—any tax can be simple if it is not enforced. If it could be enforced, the sales taxes would be quite simple for the typical household, but problems would arise for businesses.

The likely rate of evasion in a sales tax is a key issue. Sales tax advocates admit that evasion would be a certainty, yet make no account for it in their estimates and hope that sentiments of fairness will induce taxpayers not to cheat. They also point to low marginal tax rates as an inducement not to cheat, but as shown above, the tax rate would not likely be low. Another claim is that detection of cheating would rise dramatically since only retailers would have to be audited, but this is misleading.

Under the sales tax, businesses that make retail sales would be responsible for sending tax payments to the government, unless the buyer used a business exemption certificate, in which case no tax would be due. But the buyer would have the legal responsibility for determining whether the good is used as a business input or a consumption item. This means that auditing and enforcement would have to focus not just on retailers, but also on all businesses that purchase from retailers, to ensure that business exemption certificates were used appropriately.

One study found that, in Florida, where sales taxes have never exceeded 6 percent, 5 percent of all purchases made with business exemption certificates were used inappropriately to exempt personal consumption from taxes.

At the much higher tax rate needed in a federal sales tax, a much larger percentage of sales to businesses might be expected to fall into this category. Most importantly, the sales tax would generate tremendous opportunities for evasion. The prebate — or advanced tax refund — is designed in part to relieve poverty-level Americans by providing a monthly check that would essentially offset all their sales tax expenditures.

The amount of the allowance would be based on the U. Similar to a universal basic income, the prebate is geared toward poorer families. But everyone would receive monthly checks, regardless of income. The prebate brings up yet another point of contention between critics and supporters. It is the most expensive element of the entire plan, would be the most extensive entitlement program in American history and would constitute a welfare payment, even for those without a need.

The FairTax plan may be advantageous to many groups, especially the wealthy and those at or below the poverty line. Significant benefits include:. While the FairTax plan sounds reasonable in theory, some economists say it would wreak havoc upon the middle class.

That includes Alan Viard of the American Enterprise Institute, who studies federal tax and budget policy and sat for an interview about the subject with AEI. The FairTax is gaining traction because many people feel our current income tax system is needlessly complex and unfair. Assuming they claim the standard deduction, we can estimate their federal income tax bill as follows:.

Take a look at your tax return to find your effective tax rate. How much more or less would you pay under the FairTax plan? Almost everyone agrees that our current income tax system is too complicated. The Panel also found that the prebate would be extremely expensive, hard for taxpayers to manage, and complex for the IRS to administer. In addition, the panel was concerned a federal retail sales tax rate of 30 percent or more would result in widespread evasion and create real problems for states that rely heavily on their own sales taxes.

FairTax advocates counter that their proposal would also replace regressive payroll and excise taxes as well as highly progressive estate taxes , but the bottom line is that tax burdens on middle-income households would surely rise while high-income families would get a big tax cut.

Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.

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