August 18, 2005
(Note, this is the first half of a two-part series. In this half, I will explain the plan, what I think is right about it, as well as some of my own reservations about the plan. In the second half, found here, I have rebutted some of the criticisms that I’ve found elsewhere.)
The Fairtax Plan – A primer
Given our current tax plan and tax structure, the question must first be asked whether it needs to be changed. I think the answer to that is an outright affirmative, but let me explain. First, the current structure is complicated. Billions of dollars are spent every year complying with that system, billions are spent trying to exploit it to reduce tax burdens of individuals and corporations, and billions are spent by companies to lobby politicians to change it in their favor. It is so complex that almost nobody understands it, and that works in the lobbyists and politicos favor, as nobody can pay attention to them when they game the system. But compliance is only a small part of the problem. The biggest problem is that it is punitive to businesses that want to operate here. The tax component of the price of goods makes our goods uncompetitive compared to foreign imports, and uncompetitive in our export markets. This, coupled with the high corporate income tax, one of the highest in the industrialized world, gives our businesses an incentive to flee this country as fast as they can. These businesses take jobs with them, making us all poorer. Our individual income tax structure is not horrible compared to other countries, but individuals leaving this nation aren’t a problem. Our high corporate taxes, and easily-refunded VAT taxes other countries put on exports, cause businesses to avoid operating in the US. The businesses that leave are a big problem. The current system serves nobody except politicians, lobbyists, and tax accountants, and presents a tremendous drag on everyone else. It needs to be changed, the question is how.
Enter the Fairtax. The first thing to note is that this is not a tax cut, it is a tax reform. It is designed to be revenue neutral. The FairTax replaces all income, corporate, payroll, estate, capital gains, and other taxes (excise taxes and import tariffs, I believe, will still exist). That means that when you get paid, you have absolutely zero taxes withheld! In each paycheck, you receive 100% of the money you earn. The FairTax is a 23% sales tax rate, targeted on retail goods and services. (Note, please wait for part 2 to question me about the 23% vs. 30% rate issue, rest assured that I will address it) Spend $100 on a new coat? $23 of those dollars go to the feds. Spend $100 on a used coat? None of it goes to the feds. That’s right, it is purely on new goods, not used. You’re an audio company, and you buy screws from your supplier for use in a product? No tax. Sell that product to an end customer? The tax is paid. THIS IS NOT A VAT! It only comes at the final stage of sale. The product is imported from China? The tax is applied! The product is manufactured here and sold in Europe? No tax! Invest $5,000 in the stock market and double it? That money isn’t taxed. Put it in a bank account earning interest? No tax. You don’t need a 401K or other tax-deferred investment, because there’s no tax to defer. Last, but not least, this also applies to services? You’re a massage therapist, and you charge your customer $200 for a massage? $46 of that goes to the feds. Services are taxed.
But it’s a lot more complex than that. The first question popping into most people’s heads is “well, for the drop in taxes I see, all the goods I buy will be 23% more expensive, so how does this benefit me?” These goods will not be more expensive. Rough estimates show that about 22% of the cost of every product you buy, every service you consume, is taxes. Sure, you don’t see those taxes, so it’s difficult to quantify. But each step of the manufacturing, procurement, marketing, shipping, sales force, human resources, accounting, and all other business processes have taxes as a component of their cost. This cost component is passed on and built into the price of every good and service you buy. Take out all that cost, and you will see an immediate decrease in prices, offsetting the sales tax. I’ll leave the math to the experts, but economists projections show the embedded taxes and the FairTax will result in products roughly the same cost to the end consumer.
The next objection that comes up (well, not for us heartless Libertarians) is that this will put an undue burden on the poor. How letting someone keep their entire paycheck, and then not see any real increase in the end cost of goods is a burden, I do not understand. But to sweeten the pot, the FairTax has another treat: the prebate. The government keeps records of the costs of goods and services for households living at the poverty level. Every month, the government will give every head of household a check equal to the FairTax paid on goods and services up to the poverty level for a household of that size. So the tax burden on the poor is zip. Zero. Nada. The poor pay absolutely no tax whatsoever.
Sounds like a pretty sweet deal to me. Sure, I’ve completely oversimplified the FairTax in the last 3 paragraphs. For a full explanation, read the book or visit fairtax.org.
Positive Effects of the FairTax
First and foremost is the effect on business. Our politicians vilify those companies who outsource as “Benedict Arnold CEOs”. They hem and haw over low-tax countries as “tax havens”, stealing businesses away from the USA. It is their own policies, however, that send those CEOs packing. Once America is the biggest, most stable tax haven in the world, the foreign investment and economic growth will be incredible. As Boortz suggests in his book, economists have predicted economic growth of over 10% the first year. Instead of businesses fleeing our shores, they’ll be coming in droves to set up shop in the US. Right now, our government is finding its only way to compete, whether it is textiles from China, or steel, is through protectionism and tariffs. In one fell swoop we can accomplish the same goal of competing by liberalizing our system and cutting out the punitive anti-growth policies. In addition to removing the competitive barriers the tax system causes, it will remove the dead weight of compliance costs. We won’t have lobbyists fighting for unfair changes to the tax code, we won’t have all our decision making tied up in schemes to reduce our tax burden.
Next, it will finally give Americans encouragement to save and invest. Bush’s “ownership society” will be much easier to accomplish if we no longer have punitive taxes on savings and investment. Taxes are only paid when you choose to purchase new goods on the retail level, so you can voluntarily control your tax burden as you see fit. Removing the embedded taxes will affect mortgage companies just as much, which will result in plummeting interest rates and lowering the cost of home ownership, furthering that ownership society.
The positive effects of the FairTax will transform our society. It will finally unleash the latent, wasted potential our current tax system has crushed. And the best part? We will no longer have a government that thinks they own the fruits of our labor and lets us keep what they think is enough for us. We will no longer live in fear of an audit by the IRS. April 15 will just be another day.
Downsides to the FairTax
There are, of course, a few problems. And, of course, they were glossed over or not covered at all in the FairTax book.
First, is the claim that once the FairTax goes into effect, you’ll start getting 100% of your paycheck, but goods won’t increase in price. The idea, of course, is that once the embedded taxes are gone, that prices will drop roughly 22%, offsetting the 23% tax. There’s one major problem with this hypothesis: taxes on labor will disappear, but employees will expect their pre-tax earnings to stay constant. When I spoke the other day about the principle of TANSTAAFL, this is the false free lunch that I saw. If you’re making $40K per year, you’ll probably clear $30K or so after taxes. If your employer tells you that your income and payroll taxes are going to disappear, but he’s dropping your compensation by $10K a year, you’re going to be pretty upset. The crucial point is that while that money will not be collected as taxes, it won’t just disappear from companies’ costs. In the short run, prices will have to increase, and wages and salaries, while they may not go down, will stagnate while the economy grows. This, more than anything, is the major benefit of the prebate. For the poor, or those on fixed incomes, the prebate will allow them to survive this intermediate step when the market adjusts.
This brings me to my second issue. This is a major change to the way that taxation and commerce will occur in the US. For a period of time, there will be confusion, wild price fluctuations, and general instability. Of course, as the market is known to do, it will settle, probably in the span of a few months, and almost certainly within the first year. We can see how things are now, and can get a general estimation of where they would be after everything stabilizes. But we don’t know the path in between. Are we going to see a month where milk sits at $4/gallon? Perhaps. Are we going to see a temporary drop in the new car market or housing market as people adjust to the new system, and are reluctant to make big purchases? It can happen. Such things are a definite possibility, and will make that transition period a lot more uncomfortable than is being suggested.
Last, the writers of the FairTax book suggest that tax avoidance will be highly unlikely. The reason for this, they surmise, is that it will be a lot harder for two people to come together and cheat than it would be for one person. But how many people now work on a strictly cash basis? How many people now get paid under the table, and don’t exist on the IRS’ radar? Quite a few. And that is a willing buyer and willing seller of labor who are working outside the system. That will continue to occur. It may not occur in the major retail or highly visible service markets. But if you have someone come in and clean your house every week, how are you to know whether they’re giving that 23% to the government? If you purchase baked goods at a Mom & Pop bakery in your town, how do you know they’re reporting all their sales? Fraud will still exist. The writers acknowledge this, but downplay its possible effects. I think the effects will be larger than they are claiming. Of course, it exists just as much in our current system as it will in the new system, but we shouldn’t be Pollyanna’s and think it won’t occur as often under the FairTax.
But all this, in my opinion, is not a reason to reject the FairTax. Any tax system will have benefits and downfalls. The real question is how the FairTax compares to our current systems, and how it would compare to alternative systems. I think when all is said and done, the FairTax is the most beneficial tax system that we can have in this country, and thus I support it. Sure, it has a few problems, but show me a tax system that doesn’t? The benefits to the economy and to personal savings will more than make up for those problems. As I can see, the time for tax reform is now, and I’m tossing my vote in with the FairTax.
(As mentioned, this is the first of a two part series. The second part will consist of my response to another blogger’s well-thought-out concerns about the FairTax. I would prefer, if you have objections that I have not raised, please wait until part 2 before you bring them up. For anything related to what I’ve said, however, flame away…)
(Note: part 2 is now available here. Open season on Brad.)
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