During a Presidential debate, Gov. Huckabee referred to the “Fair Tax”, and I didn’t know what it was so I looked it up. I came across FairTax.org, which has done research for its plan to make the tax code more efficient and fair.
Generally, this approach is a consumption tax. The “fair tax” charges a sales tax of 23% on all final goods and services. Used items would have no sales tax. There would be no income tax or any other kind of federal tax. Each person would receive a “prebate” (an early rebate) each month so that all spending up to the poverty line would be tax-free. If the poverty line were set to $15K, the prebate checks would total $3,450 during the year.
Supporters claim the plan is more efficient than the current tax code, which I believe is true. Obviously, if the tax code shrank from over 9,000,000 words down to the 130 pages they suggest this would save a lot of money on tax compliance. The group also states that this plan could eliminate the IRS, and end Congress’ love affair with lobbyists. Unfortunately, the devil is in the details.
A glaring problem is crossing borders to buy big-ticket items in Canada and Mexico. I live several hours from Mexico, but if I were going to buy a $25K car that had a 23% tax on it ($5,750), I would definitely buy it in Mexico. People living further away from the border could still save thousands by flying there to purchase a car, boat, jewelry... Only a fool would buy any big-ticket item inside the U.S.
The phrase “final goods and services” may be short, but the definition of “services” could run as long as the current tax code. The definition of “services” is vague and left up to interpretation. A link to their definition is here.
Would a company that currently provides services now have to pay a 23% tax on all the services it performs? Let’s say ABC Services Inc. earns $10 million in revenue per year, and makes $1 million profit. Currently they would pay 35% tax on $1 million, which yields $350K in taxes. If they had to pay 23% tax on their services that would mean $2.3 million in taxes ($1.3 million more than their profits). This means a whopping 757% tax increase that would drive the company into bankruptcy. Maybe this type of “service” does not count as a taxable service, but that would be up to Congress and an army of helpful lobbyists to decide.
Because of the high tax rate, every industry would constantly be lobbying to remove all or part of their output from the definition of “Final Goods and Services”. The “FairTax” would not end the IRS nor would it end lobbying.
This is not to say that a simple tax code is not a noble cause. The Tax Foundation projects that tax compliance for 2007 in the United States will cost around $305 Billion. A study by them on a Flat Tax proposal by then Texas Congressman Dick Armey in 1996, predicted it would reduce tax compliance costs by 94%. Adding up all the government workers, private tax accountants, and the corporate attorneys who work to calculate and avoid taxation it adds up to hundreds of thousands of workers. All of these people could be doing much more productive things.
However, this presents the last and greatest problem with enacting a simplified tax system. The massive upheaval of changing the system would cause many problems. Those whose entire career depends on a complicated tax code do not want to see it go away overnight. If you were 50 years old and all you knew how to do was give advice on the tax code what other kind of job could you hold? Would people give to charity as much if they did not have that pull of a tax deduction? Our current tax code affects our behavior in many ways and completely dropping it might change it in ways that we do not like.
Even though I am a big fan of the Flat Tax, the move to a simplified tax system should be a gradual one. We should have a series of what I dub “Tax Switches”. Those in the highest income brackets who own most corporate stock indirectly pay corporate taxes, which is a 35% tax on profits made by corporations. This tax should be eliminated and switched to an increase in the marginal income tax rates.
If done right, the average person would be no better or worse, and it is one less tax to have to fool with. The countless hours companies spend coming up with ways to reduce taxes are less productive for society as a whole. By doing it slowly and in one sector of the tax code, mass layoffs are avoided.
This may be oversimplified and if someone sees some holes in my logic let me know. I am suggesting this general idea.
Over say ten to twenty years, other taxes would be eliminated in the movement towards a flat tax. Tax deductions would also be eliminated while lowering the marginal income tax rates across the board.
A radical switch in the tax structure sounds good, but it is not feasible when everyone starts to realize how much stress it will cause in the short run. It is also not enough to complain about the size of the tax code and hope Congress does the right thing. We need specific policies that will help us take steps towards a simplified tax code like a Tax Switch.