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Pros and cons of the Fair Tax Act

Tax law

Most people are probably aware of the fact that there are several major proposals to dramatically overhaul the U.S. tax code.  The major reasons for a push to overhaul the current system are that it is too complex, requires too much effort to comply with, rewards too many people with exemptions and deductions and penalizes businesses with one of the highest tax rates in the world.  One such proposal for tax reform is the Fair Tax which would replace all national income tax with essentially a national sales tax.

“Fair Tax” is a short title of proposed legislation to reform the U.S. Internal Revenue system by replacing federal income taxes with one nationwide consumption tax on most retail sales transactions.  It would be applied as a single lump sum added onto the base price of new products and services paid at the time of initial purchase by end users.

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The Fair Tax Act (FTA) is presently drafted to impose a national consumption tax rate of 23% for one year after taking effect, which is reported to approximate the historically average annualized U.S. income tax rate.  That percentage would then fluctuate annually based on gross federal revenue intake during the prior fiscal year.  FTA also provides for monthly “prebates” or advance rebates paid to all legal U.S. households with gross income that falls at or below federal poverty levels.

Since their first introduction in 1999, Fair Tax proposals have been prime targets for Congressional Committee inquests but have had very little impact on U.S. public policy.   However, that same legislative agenda has become the main catalyst the drives the call for full-scale federal tax collection overhaul during recent years.  Efforts began to make a comeback in 2005 when “The Fair Tax Book” co-authored by Congressman George Linder (GA-Rep.) was published, and gained progressive momentum ever since the 2008 U.S. Presidential campaign debate.

Reasons against the FTA

Critics portend FTA would let the highest-income earners pay less, while the middle-class would bear an even greater load by creating a wider tax base.  For instance, someone earning $3 million annually might live quite well on 1/3 of that gross income, or $1 million.  But another who earns just 1% of the former sum, or $30,000, must spend a huge percentage of their income just to survive.

Further opposition cites the extremely difficult collection of such a huge consumption tax revenue base that would lead to correspondingly widespread tax evasion.  This seems unlikely given that sales taxes are already collected and reported automatically in most states.

Opponents argue that FTA would decrease federal tax revenue and thus increase budgetary deficits.  Other stated grounds for concern are 16th Amendment repeal and disincentivized tax deductions.  Likewise, tax-advantaged bonds issued to fund governmental public works projects would be eradicated by the FTA.

Reasons for an FTA

By stark contrast, FTA advocates contend that the proposed reforms are an effective wealth tax that will enhance all U.S. consumers’ buying power via a wider tax base with low-income prebate subsidies.  As people earn more money they tend to spend more money.  Just look at all the shows that profile the lifestyles of the rich and famous and it’s easy to see how wealthy people will pay far more in taxes if there were a national sales tax.

Moreover, supporters opine that a consumption-based tax will create new incentives for personal savings and investing; facilitate legal compliance because it would eliminate income tax return filing; and, stimulate economic growth by incentivizing new foreign business investments in the U.S.

Right now, if you earn a lot of money and decide to invest or save it you will have to pay income taxes on any money that you earn from your investment.  However, if you decide to spend that money instead, you are not taxed on any purchases you make.  This creates an incentive for you to spend the money instead of save or invest it.  The FTA would remove all taxes on investment income and savings.

The FTA is expected to dramatically increase U.S. competitiveness in global trade marketplaces by eliminating corporate income taxes with automatic border adjustment that impart huge tax advantages to both foreign and domestic producers.  Instead all businesses that sell in the U.S. would have to pay a national sales tax on their goods or services.  They would not have to pay income taxes on revenue they earn internationally.  The impact of this change is expected to be dramatic and is one of the major reasons to consider the FTA.

FTA proponents further posit the plan would make federal budgetary process and costs more transparent and enhance civil liberties and environmental quality.  These positive effects are expected to ensue from streamlined tax collection that enables more direct payer control over specific recipients of revenue via fewer bureaucratic layers. 

Yet another major alleged FTA benefit is more effectively imposed tax on criminal activity and illegal immigrants.  This dynamic will emerge as emphasis shifts from gross income to consumption-based commercial market tariffs.  Actual gross revenues of illegal aliens and narcotics dealers are grossly underreported for self-evident reasons.  However, whenever illegal immigrants or criminals purchase goods or services they will automatically pay the national sales tax.

A Fair Tax would dramatically simplify paying and collecting taxes, stimulate investment and saving and make U.S. businesses more competitive.  Too bad it isn’t as simple to switch to a Fair Tax as it is to pay one.