TOS Blog: Daily Commentary from an Objectivist Perspective

Saturday, October 1, 2011

“Fair Tax” Looks Ugly in the Details

Posted by Ari Armstrong at 12:05 pm

US-InternalRevenueService-SealNo wonder so many Americans want to abolish the income tax and the IRS along with it. The IRS pries into our earnings, our daily spending habits, even our mileage records. The nightmarishly indecipherable tax code imposes huge compliance costs, along with the risks of arbitrary persecution for innocent errors. Pandering to special interests, politicians endlessly complicate the code with deductions, exemptions, and special breaks, distorting the economy.

Hoping for a simpler, less-meddlesome tax system, some call for replacing all income-related taxes with a national sales tax. Those championing the idea include author and financial advisor Peter Schiff and Republican Presidential hopeful Gary Johnson. (Another candidate, Herman Cain, advocated a sales tax some months ago and then adopted a proposal blending a sales tax with an income tax.) The Texas-based group Americans for Fair Taxation offers the most mature proposal with its “Fair Tax.” However, there is nothing about a sales tax that is inherently more fair than an income tax, and the Fair Tax would impose a new set of burdens on businesses and consumers.

The Fair Tax would replace income-related taxes with a 30 percent sales tax added to most consumable goods and services (an amount that would fluctuate over time with entitlement spending). The tax’s sponsors tout a 23 percent “tax-inclusive” rate, but that just means that a $30 tax on a $100 purchase represents 23 percent of the total price. The 23 percent figure comes from the revenue-neutral level for 2007; notably, federal spending has increased about 40 percent since then. Congress would determine the initial rate as well as future hikes, and no doubt Congress would treat the 23 percent figure as the floor. We can only guess at how large a black market such a high sales tax would encourage.

The Fair Tax applies to services as well as goods, whether sold or bartered, adding dramatically to the tax’s compliance costs. Today, most states do not charge sales taxes on common services such as hair styling, massage, and lawn care (though a federal sales tax on services might encourage states to follow suit). Notably, many service providers work alone or in small shops, and each business would need to “register as a ’seller’ with the sales tax administering authority” and make regular payments. The compliance burden may encourage some service providers to join larger corporations to handle the paperwork.

The Fair Tax does offer some exceptions to service providers remitting the tax. If you earn less than $1,200 “not in connection with a trade or business” and “in connection with a casual or isolated sale” (as determined by the taxing authority), then the purchase is exempt. Also, if you work as a “domestic servant,” a category that apparently includes maids, nannies, and gardeners, then you don’t have to remit the tax; your employer does.

Those hoping they’d never need to remit another federal tax under the Fair Tax, then, should check again. If you sell goods, provide services that are taxable (and most are), or hire help at home, you must remit the tax. If you spend more than $400 per year on foreign goods or services, you must remit the tax. And if you file something incorrectly (say, by improperly listing a purchase as “95 percent for business purposes”) the taxing authority can fine you and throw you in prison for up to a year. That the taxing authority no longer operates under the banner of the IRS may offer less comfort than imagined.

The Fair Tax intentionally taxes people in different circumstances different percentages of their predicted spending. The Fair Tax becomes progressive by offering a “prebate” to all families in an amount meant to offset the typical sales taxes paid by those beneath the poverty line. In practice, that means the federal government pays each family of four over $500 per month, regardless of how much the family actually pays in taxes. Moreover, the tax exempts education and job-related training and offers nonprofits special breaks.

Even if passed in ideal form, the Fair Tax would create myriad problems. But when does Congress ever pass a bill in ideal form? In the reality of Washington politics, a national sales tax likely would supplement the income tax rather than replace it, enabling future sessions of Congress to increase both. Even if by some miracle Congress managed to replace the income tax with a sales tax, special interests would perennially plead for more exemptions, tax favoritism (as for “green” energy), and higher taxes on “sin” and “luxury” items. One can imagine future activists pleading to replace the complex, burdensome sales tax with a simpler, more “fair” income tax.

For the same political effort required to pass the Fair Tax, existing taxes could be significantly reformed. The income tax could be made simpler and flatter, eliminating its double-taxation and impediments to investing. Criminal penalties could be reduced and taxpayer protections added.

All this is not to argue that a national sales tax is necessarily worse than a national income tax; depending on particulars, it could be better or worse. But passing the Fair Tax would require enormous political effort, and at best it would offer a small step toward protecting our liberties. Certainly it is no panacea.

To a large degree, the debate over the sales tax versus the income tax misses the more fundamental issue of spending levels. How the federal government collects our money matters, but how much the government forcibly confiscates matters far more. So long as the federal government spends massive amounts of the citizens’ wealth on “bailouts,” corporate welfare, and handouts to individuals, any resulting tax necessarily grows onerous.

Yes, advocates of liberty should look at strategies to make tax collection less burdensome. But fundamental tax reform, which must include serious cuts in net taxes collected, becomes possible only with significant cuts to federal spending. Above all, advocates of liberty must persuade their fellow Americans to support individual rights, including each person’s right to use his own earnings as he judges best. Only then will genuine tax reduction and simplification become possible.

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Image: Wikipedia Commons

Posted in: Business and Economics, Individual Rights and Law

Comments are welcome so long as they are civil.
  • R. George Dunn

    This is not an honest assessment tot he fact that FairTax is a neutral tax structure change. This article fails to tell you that income and other production taxes the current IRS code has, including perrys flat tax, leaves federal taxes embeeded in price of domestic product, the reason we have lost US Industry over the past 30 years. Read here to understand why FairTax is the ‘Saving USA Fiscally’  http://rgeorgedunn.blogspot.com/p/america-where-did-we-go-wrong.html

  • http://www.facebook.com/profile.php?id=761545009 Paul Wheaton

    If you are going to say that the FairTax is a “30 percent” sales tax, then that’s not correct when compared to an income tax. The income tax is always quoted on a tax inclusive basis (e.g. 25% of income), so the FairTax to compared on a similar apples to apples basis should be quoted at 23%–a tax inclusive basis. Since one’s income is typically larger than one’s consumption, it would be better still to quote tax rates on either an income basis or a consumption basis, but never to mix the two as was done in this article.  

    Retail businesses collect and remit the tax which consumers pay. Government employers and domestic employers are end-use consumers of employee services when those services are not resold to the public and are thus taxable just like any other end-use consumer. However, what sets them apart is that the people they employ are not independent contractors who are registered to collect and remit those taxes themselves. The idea is to level the playing field. On the one hand, say, a wealthy household hires a law service business which collects and remits the tax within their fee for services. Another wealthy household hires an employee to perform essentially the same tax. If that latter household does not remit the tax then there is no equal treatment of consumers under law. It should not matter if a end-use purchase is made from an employee or a registered business in terms of the tax that is due. When governments buy goods and services from outside vendors, typically those goods and services come loaded with embedded taxes on labor and materials in the price paid. So, it makes sense that governments continue to pay the FairTax when such goods and services are for the government’s consumption. If the purchases are for resale, then it’s treated like a business to business transaction and not subject to the tax. However, when government employs people for end-use consumption by the government, then that consumption should be treated just like any other consumption and subject to taxation. However, educational services are never subject to the FairTax.

    The FairTax applies the same flat tax rate at the point of consumption purchase–treating each purchaser equally under law at the point of taxation. The FairTax allows each lawful resident not in long term incarceration to apply for an exemption to the tax paid on the purchase of necessities. The method is to rebate the tax up to the poverty level of income assuming that all of that income up to the poverty level is spent on new goods and services. The application of these two features creates a progressive effective consumption tax rate that rises as consumption spending on new goods and services rises. The effective consumption tax rate never exceeds the flat rate. The amount rebated may create a temporary situation where it appears that a household has a “negative” effective tax rate as would happen if the household saves for a costly purchase in some future accounting period. However, when the purchase is made, then the same full flat tax rate is collected which means over a longer term view, the rebate worked exactly as intended–to offset the tax upon necessities–without forcing the government’s view of what is a necessity upon every household in the process.

    The observation that legislation is rarely passed in its ideal form    is a valid observation. However, that’s not a valid argument against passing the FairTax in its ideal form, but an argument to do nothing and settle for the slavery and tyranny of the current income tax system. There’s a reason why the income tax is the 2nd plank of the Communist Manifesto and it is so that the government can limit your freedom. Countering that with the FairTax is perhaps the very best argument for passing the FairTax as written in H.R. 25 / S. 13 of 2011. 

    The argument over spending levels is completely irrelevant to the discussion of the best tax collection system. I would certainly argue that the government’s spending should be restrained, but if I was to make an irrelevant argument about how the FairTax helps restrain government spending it would be two-pronged:

    1) Without an income tax and the power to take from the people whatever amount of property the government desires at a whim, the government would need to spend more frugally because raising a consumption tax rate too high leads to less revenue for the government.

    2) With 307 million people constantly seeing how much of each purchase their government costs them on a nearly daily basis might lead a majority of them to insist that their representatives cut spending or maintain current spending levels.

    Conversely, it cannot be said that the current tax regime has done anything to restrain government spending and that very well might be traced to the fact that politicians have hidden the cost of government in the price paid for consumption goods and services–and the notion that if a person does not get to take home the amount withheld from pay that it was never really their property to begin with. 

    Perhaps a consumption tax . like the FairTax, that is highly visible, plays no favorites, allows no loopholes, and that would grow the economy faster than any other tax proposal made to date is worth a look. That tax rate is more easily lowered when there is less government spending, but tax reform proposals that do not pay the current bills shift the tax burden to future taxpayers–our children and grandchildren. Let’s fix the tax collection system with the FairTax and end the class warfare. Let’s restrain our politician’s appetite to rob the future by squandering their resources today by voting career politicians out of office. We can both walk and chew gum at the same time. Enact the FairTax and make America safe for business and jobs again. 

  • Anonymous

    TOS published my rebuttal to Mr. Armstrong’s article in which I dismantled his arguments one by one.  Mr. Armstrong then wrote a response to my rebuttal which TOS published again.  My response to that article is posted underneath Mr. Armstrong’s article as a comment in which I provide a complete dismantling of Mr. Armstrong’s arguments and detail a thorugh and overwhelming list of the amazing benefits of the Fair Tax. Just search on Fair Tax in the TOS search field to see my article and comments to Mr. Armstrong’s second article.

    One of the best blows we can strike against omnipotent government and the insane tax code is to abolish the IRS and the code via Fair Tax enactment.  What have we got to loose when there is everything to gain?  There just is no downside.  I think people’s biggest fear is that the 16th admendment, which establshed the income tax, will not be abolished as proposed since it is a separate bill from the FT bill.  But government can raise taxes as high as they want now so it doesn’t make sense that government will raise taxes, even if they could, after enactment of the FT abolishes the IRS and IRS code., just because a FT has been enacted.  Moreover, there would be no agency to enforce an income tax and no code to base it on.  We absolutely cannot let this stop us! 

    The other common argument against the FT is, “the real problem is spending so don’t waste time reforming the collection system”.   The people who make this argument agree that the IRS has to go but somewhere down the road. They also make the argument that individual rights are the most important issue (which I agree with).  Therefore, I could make this argument: “Don’t waste your time fighting for spending cuts when individual rights are the real issue”   As one commenter said below, “we can walk and chew gum at the same time”!

    One huge argument for the FT is the ecomomic boom it would create.  Embedded in America’s products is an estmated 22% due to corporate income tax, payroll taxes and the related compliance costs.   The FT would completely eliminate these taxes and make us much more competetive on the world markets.  EU countries currently rebate all VAT on exports putting us at a huge disavantage.  Foriegn producers are sure to relocate facilities here to take advantage of the new US tax enviornment.  This would create such demand for labor that a labor shortage would occur instead of the current miserable employment so many suffer.

    The FT is a no brainer!

  • http://www.facebook.com/people/Daniel-Johnston/100000692200525 Daniel Johnston

    Mr. Armstrong, it seems like you are writing the same redundant arguments that I have read before.  The one thing that I have noticed is that most people that write columns against the FAIR TAX are those that have something to lose by implementing FAIR TAX.  These stealth writers end up being CPA people and tax attorneys that are afraid of the loss of personal income with the FAIR TAX. I’m just an average low income American that has been raked over the coals by a highly unjust and vicious Federal Agency called the IRS.  The people that write negative things about FAIR TAX know how to work the system to their advantage and end up of the paying little or no income tax.  But us little folks who cannot afford a fancy tax attorney or CPA get ambushed with unwarranted “notice of levy” and “notice of liens”.  Naturally for a lien to be valid, there needs to be due process of law.  The IRS doesn’t want to bother with that so they tell the credit reporting agencies that there is a “lien” on a person’s property where in reality there isn’t.  The person’s credit is destroyed and so is the person financially.  And the person has not done anything wrong to deserve that treatment. He just didn’t know how to work the system.  The FAIR TAX would be life saver for me.  The prebate would help me financially and I wouldn’t have to pay a Federal Sales Tax on a used vehicle.  When you support the IRS you also support Communism.  Is that what you wish to do?  Please collect your facts and get them straight before you write your next tax article.

  • Greg Hadaller

    One point against the Fair Tax is that converting to it would cause many people to pay tax twice on the money they saved. First, as an income tax as they earned it in the years before the Fair Tax. Second, as they spend it in the years after the Fair Tax.

    Of course, if you’ve saved nothing this will not affect you. But this one fact would keep me from ever supporting a switch from income to sales tax.

  • http://www.facebook.com/people/Henry-Salo/1394713777 Henry Salo

    Mr. Armstrong is telling the truth. The Fair Tax would be very unfair for retirees, seniors disable people. Some retirees rely only on S.S. as their source of income. These people pay very little or no Fed. income tax. Fair Tax taxes food, clothing, rent, utilities, housing, everything medical, doctor visits, hospital stays, auto repairs, gas, prescriptions and so on. Fair Tax.org has their own calculator. I noticed the calculator has a flaw in it. This calculator only works for people who are working but not for retirees. When a person retires. FICA and Medicare deductions are eliminated. A retiree can apply for Medicare parts and it is deducted from their S.S. checks. I don’t want to hear comments from any Fair Tax supporter saying Fair Tax is good for retirees and that person isn’t retired and doesn’t know what a retiree goes through, living on a fixed income. You said buying a used vehicle, you do not have to pay any Federal Sales Tax? You still have to pay any state sales tax on the used vehicle. Fair Tax does not eliminate them or any state income tax. Also there is no such thing as used food, used gas, used rent, used medical, used services. Read: The Pros of a Federal Sales Tax by Joel Prudhomme. It is in the Grand Junction Free Press. It just shows Joel’s version what the Federal Sales Tax should look like. No tax on basic necessities and no prebates. You said supporting the IRS, you support Communism. You don’t know what Communism is. Talk to somebody who escaped Communism from Eastern Europe and the former Soviet Union. They will tell you what Communism is. If you said the IRS is Communism, then the Fair Tax system is more like National Socialism.