FairTax
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FairTax is a fixed rate sales tax proposal introduced as bill H.R. 25 in the United States Congress every year since 2005. The Fair Tax Act calls for elimination of the Internal Revenue Service[1] and sets the stage for repeal of the Sixteenth Amendment to the United States Constitution. H.R. 25 would eliminate all federal income taxes (including the alternative minimum tax, corporate income taxes, and capital gains taxes), payroll taxes (including Social Security and Medicare taxes), gift taxes, and estate taxes, replacing every extant federal taxes with a single consumption tax levied on retail sales.
The Fair Tax Act (H.R. 25/S. 18) would apply a fixed rate sales tax at the point of sale on all new, final goods and services purchased for household consumption. The proposal also specifies a monthly payment made to all households based on household size. Called a "prebate," the monthly payment offsets the regressive nature of a sales tax up to the poverty level.[2][3] First introduced into the United States Congress in 1999, a number of congressional committees have heard testimony on the bill; however, it did not move from committee. A campaign in 2005 for the FairTax proposal[4] involved Leo Linbeck and the Fairtax.org. Talk radio personality Neal Boortz and Georgia Congressman John Linder published The FairTax Book in 2005 and additional visibility was gained in the 2008 presidential campaign.
As defined in the proposed legislation, the initial sales tax rate is 30% (i.e. a purchase of $100 would incur a sales tax of $30, resulting in a total price to the consumer of $130). Advocates promote this as a 23% tax inclusive rate based on the total amount paid including the tax, which is the method currently used to calculate income tax liability.[5] In subsequent years the rate could adjust annually based on federal receipts in the previous fiscal year.[6] With the rebate taken into consideration, the FairTax would be progressive on consumption,[3] but would still be regressive on income (since consumption as a percentage of income falls at higher income levels).[7][8] Opponents argue this would accordingly decrease the tax burden on high-income earners and increase it on the lower class earners.[5][9] Supporters contend that the plan would effectively tax wealth, increase purchasing power[10][11] and decrease tax burdens by broadening the tax base.
Advocates expect a consumption tax to increase savings and investment, ease tax compliance and increase economic growth, increase incentives for international business to locate in the United States and increase U.S. competitiveness in international trade.[12][13][14] The plan would provide transparency for funding the federal government. Supporters believe it would increase civil liberties, benefit the environment, and effectively tax illegal activity and illegal aliens present in the country, as well as tourists' expenditures.[12][15] Critics contend that a consumption tax of this size would be extremely difficult to collect, would lead to pervasive tax evasion,[5][7] and raise less revenue than the current tax system, leading to an increased budget deficit.[5][16] The proposed Fairtax might cause removal of tax deduction incentives, transition effects on after-tax savings, incentives on credit use and the loss of tax advantages to state and local bonds. It also includes a sunset clause if the 16th Amendment to the U.S. Constitution is not repealed within seven years of its enactment.
Legislative overview and history
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The legislation would remove the Internal Revenue Service (after three years), and establish Excise Tax and Sales Tax bureaus in the Department of the Treasury.[17] The states are granted the primary authority for the collection of sales tax revenues and the remittance of such revenues to the Treasury. The plan was created by Americans For Fair Taxation, an advocacy group formed to change the tax system. The group states that, together with economists, it developed the plan and the name "Fair Tax", based on interviews, polls, and focus groups of the general public.[5] The FairTax legislation has been introduced in the House by Georgia Republicans John Linder (1999–2010) and Rob Woodall (2011–2014),[18] while being introduced in the Senate by Georgia Republican Saxby Chambliss (2003–2014).
Linder first introduced the Fair Tax Act (H.R. 2525) on July 14, 1999, to the 106th United States Congress and a substantially similar bill has been reintroduced in each subsequent session of Congress. The bill attracted a total of fifty-six House and Senate cosponsors in the 108th Congress,[19][20] sixty-one in the 109th,[21][22] 76 in the 110th,[23][24] 70 in the 111th,[25][26] 78 in the 112th,[27][28] 83 in the 113th (H.R. 25/S. 122), 81 in the 114th (H.R. 25/S. 155), 51 in the 115th (H.R. 25/S. 18), 33 in the 116th (H.R. 25), and 30 in the 117th (H.R. 25). Former Speaker of the House Dennis Hastert (Republican) had cosponsored the bill in the 109th–110th Congress, but it has not received support from the Democratic leadership.[22][23][29] Democratic Representative Collin Peterson of Minnesota and Democratic Senator Zell Miller of Georgia cosponsored and introduced the bill in the 108th Congress, but Peterson has left the House of Representatives and Miller has left the Senate.[19][20] In the 109th–111th Congress, Representative Dan Boren was the only Democrat to cosponsor the bill.[21][23] A number of congressional committees have heard testimony on the FairTax, but it has not moved from committee since its introduction in 1999. The legislation was also discussed with President George W. Bush and his Secretary of the Treasury Henry M. Paulson.[30]
To become law, the bill will need to be included in a final version of tax legislation from the U.S. House Committee on Ways and Means, pass both the House and the Senate, and finally be signed by the President. In 2005, President Bush established an advisory panel on tax reform that examined several national sales tax variants including aspects of the FairTax and noted several concerns. These included uncertainties as to the revenue that would be generated, and difficulties of enforcement and administration, which made this type of tax undesirable to recommend in their final report.[9] The panel did not examine the FairTax as proposed in the legislation. The FairTax received visibility in the 2008 presidential election on the issue of taxes and the IRS, with several candidates supporting the bill.[31][32] A poll in 2009 by Rasmussen Reports found that 43% of Americans would support a national sales tax replacement, with 38% opposed to the idea; the sales tax was viewed as fairer by 52% of Republicans, 44% of Democrats, and 49% of Independents.[33] President Barack Obama did not support the bill,[34] arguing for more progressive changes to the income and payroll tax systems.
Tax rate
[edit]The sales tax rate, as defined in the legislation for the first year, is 23% of the total payment including the tax ($23 of every $100 spent in total—calculated similar to income taxes). This would be equivalent to a 30% traditional U.S. sales tax ($23 on top of every $77 spent—$100 total, or $30 on top of every $100 spent—$130 total).[5] After the first year of implementation, this rate is automatically adjusted annually using a predefined formula reflecting actual federal receipts in the previous fiscal year.
The effective tax rate for any household would be variable due to the fixed monthly tax rebate that are used to rebate taxes paid on purchases up to the poverty level.[3] The tax would be levied on all U.S. retail sales for personal consumption on new goods and services. Critics argue that the sales tax rate defined in the legislation would not be revenue neutral (that is, it would collect less for the government than the current tax system), and thus would increase the budget deficit, unless government spending were equally reduced.[5]
Sales tax rate
[edit]During the first year of implementation, the FairTax legislation would apply a 23% federal retail sales tax on the total transaction value of a purchase; in other words, consumers pay to the government twenty-three cents of every dollar spent in total (sometimes called tax-inclusive, and presented this way to provide a direct comparison with individual income and employment taxes which reduce a person's available money before they can make purchases). The equivalent assessed tax rate is 30% if the FairTax is applied to the pre-tax price of a good like traditional U.S. state sales taxes (sometimes called tax-exclusive; this rate is not directly comparable with existing income and employment taxes).[5] After the first year of implementation, this tax rate would be automatically adjusted annually using a formula specified in the legislation that reflects actual federal receipts in the previous fiscal year.[6]
Effective tax rate
[edit]A household's effective tax rate on consumption would vary with the annual expenditures on taxable items and the fixed monthly tax rebate. The rebate would have the greatest effect at low spending levels, where they could lower a household's effective rate to zero or below.[10] The lowest effective tax rate under the FairTax could be negative due to the rebate for households with annual spending amounts below poverty level spending for a specified household size. At higher spending levels, the rebate has less impact, and a household's effective tax rate would approach 23% of total spending.[10] A person spending at the poverty level would have an effective tax rate of 0%, whereas someone spending at four times the poverty level would have an effective tax rate of 17.2%. Buying or otherwise receiving items and services not subject to federal taxation (such as a used home or car) can contribute towards a lower effective tax rate. The total amount of spending and the proportion of spending allocated to taxable items would determine a household's effective tax rate on consumption. If a rate is calculated on income, instead of the tax base, the percentage could exceed the statutory tax rate in a given year.
Monthly tax rebate
[edit]| One adult household | Two adult household | ||||||
|---|---|---|---|---|---|---|---|
| Family Size |
Annual Consumption Allowance |
Annual Prebate |
Monthly Prebate |
Family Size |
Annual Consumption Allowance |
Annual Prebate |
Monthly Prebate |
| 1 person | $11,770 | $2,707 | $226 | couple | $23,540 | $5,414 | $451 |
| and 1 child | $15,930 | $3,664 | $305 | and 1 child | $27,700 | $6,371 | $531 |
| and 2 children | $20,090 | $4,621 | $385 | and 2 children | $31,860 | $7,328 | $611 |
| and 3 children | $24,250 | $5,578 | $465 | and 3 children | $36,020 | $8,285 | $690 |
| and 4 children | $28,410 | $6,534 | $545 | and 4 children | $40,180 | $9,241 | $770 |
| and 5 children | $32,570 | $7,491 | $624 | and 5 children | $44,340 | $10,198 | $850 |
| and 6 children | $36,490 | $8,393 | $699 | and 6 children | $48,500 | $11,155 | $930 |
| and 7 children | $40,890 | $9,405 | $784 | and 7 children | $52,660 | $12,112 | $1,009 |
| The annual consumption allowance is based on the 2015 DHHS Poverty Guidelines as published in the Federal Register, January 22, 2015. There is no marriage penalty as the couple amount is twice the amount that a single adult receives. For families/households with more than 8 persons, add $4,160 to the annual consumption allowance for each additional person. The annual consumption allowance is the amount of spending that is "untaxed" under the FairTax. | |||||||
Under the FairTax, family households of lawful U.S. residents would be eligible to receive a "Family Consumption Allowance" (FCA) based on family size (regardless of income) that is equal to the estimated total FairTax paid on poverty level spending according to the poverty guidelines published by the U.S. Department of Health and Human Services.[2] The FCA is a tax rebate (known as a "prebate" as it would be an advance) paid in twelve monthly installments, adjusted for inflation. The rebate is meant to eliminate the taxation of household necessities and make the plan progressive.[5] Households would register once a year with their sales tax administering authority, providing the names and social security numbers of each household member.[2] The Social Security Administration would disburse the monthly rebate payments in the form of a paper check via U.S. Mail, an electronic funds transfer to a bank account, or a "smartcard" that can be used like a debit card.[2]
Opponents of the plan criticize this tax rebate due to its costs. Economists at the Beacon Hill Institute estimated the overall rebate cost to be $489 billion (assuming 100% participation).[36] In addition, economist Bruce Bartlett has argued that the rebate would create a large opportunity for fraud,[37] treats children disparately, and would constitute a welfare payment regardless of need.[38]
The President's Advisory Panel for Federal Tax Reform cited the rebate as one of their chief concerns when analyzing their national sales tax, stating that it would be the largest entitlement program in American history, and contending that it would "make most American families dependent on monthly checks from the federal government".[9][39] Estimated by the advisory panel at approximately $600 billion, "the Prebate program would cost more than all budgeted spending in 2006 on the Departments of Agriculture, Commerce, Defense, Education, Energy, Homeland Security, Housing and Urban Development, and Interior combined."[9] Proponents point out that income tax deductions, tax preferences, loopholes, credits, etc. under the current system was estimated at $945 billion by the Joint Committee on Taxation.[36] They argue this is $456 billion more than the FairTax "entitlement" (tax refund) would spend to cover each person's tax expenses up to the poverty level. In addition, it was estimated for 2005 that the Internal Revenue Service was already sending out $270 billion in refund checks.[36]
Presentation of tax rate
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Sales and income taxes behave differently due to differing definitions of tax base, which can make comparisons between the two confusing. Under the existing individual income plus employment (Social Security; Medicare; Medicaid) tax formula, taxes to be paid are included in the base on which the tax rate is imposed (known as tax-inclusive). If an individual's gross income is $100 and the sum of their income plus employment tax rate is 23%, taxes owed equals $23. Traditional state sales taxes are imposed on a tax base equal to the pre-tax portion of a good's price (known as tax-exclusive). A good priced at $77 with a 30% sales tax rate yields $23 in taxes owed. To adjust an inclusive rate to an exclusive rate, divide the given rate by one minus that rate (i.e. ).
The FairTax statutory rate, unlike most U.S. state-level sales taxes, is presented on a tax base that includes the amount of FairTax paid. For example, a final after-tax price of $100 includes $23 of taxes. Although no such requirement is included in the text of the legislation, Congressman John Linder has stated that the FairTax would be implemented as an inclusive tax, which would include the tax in the retail price, not added on at checkout—an item on the shelf for five dollars would be five dollars total.[30][40] The legislation requires the receipt to display the tax as 23% of the total.[41] Linder states the FairTax is presented as a 23% tax rate for easy comparison to income and employment tax rates (the taxes it would be replacing). The plan's opponents call the semantics deceptive. FactCheck called the presentation misleading, saying that it hides the real truth of the tax rate.[42] Bruce Bartlett stated that polls show tax reform support is extremely sensitive to the proposed rate,[38] and called the presentation confusing and deceptive based on the conventional method of calculating sales taxes.[43] Proponents believe it is both inaccurate and misleading to say that an income tax is 23% and the FairTax is 30% as it implies that the sales tax burden is higher.
Revenue neutrality
[edit]A key question surrounding the FairTax is whether the tax has the ability to be revenue-neutral; that is, whether the tax would result in an increase or reduction in overall federal tax revenues. Economists, advisory groups, and political advocacy groups disagree about the tax rate required for the FairTax to be truly revenue-neutral. Various analysts use different assumptions, time-frames, and methods resulting in dramatically different tax rates making direct comparison among the studies difficult. The choice between static or dynamic scoring further complicates any estimate of revenue-neutral rates.[44]
A 2006 study published in Tax Notes by the Beacon Hill Institute at Suffolk University and Dr. Laurence Kotlikoff estimated the FairTax would be revenue-neutral for the tax year 2007 at a rate of 23.82% (31.27% tax-exclusive).[45] The study states that purchasing power is transferred to state and local taxpayers from state and local governments. To recapture the lost revenue, state and local governments would have to raise tax rates or otherwise change tax laws in order to continue collecting the same real revenues from their taxpayers.[39][45] The Argus Group and Arduin, Laffer & Moore Econometrics each published an analysis that defended the 23% rate.[46][47][48] While proponents of the FairTax concede that the above studies did not explicitly account for tax evasion, they also claim that the studies did not altogether ignore tax evasion under the FairTax. These studies presumably incorporated some degree of tax evasion in their calculations by using National Income and Product Account based figures, which is argued to understate total household consumption.[45] The studies also did not account for capital gains that may be realized by the U.S. government if consumer prices were allowed to rise, which would reduce the real value of nominal U.S. government debt.[45] Nor did these studies account for any increased economic growth that many economists researching the plan believe would occur.[45][48][49][50]
In contrast to the above studies, William G. Gale of the Brookings Institution published a study in Tax Notes that estimated a rate of 28.2% (39.3% tax-exclusive) for 2007 assuming full taxpayer compliance and an average rate of 31% (44% tax-exclusive) from 2006 to 2015 (assumes that the Bush tax cuts expire on schedule and accounts for the replacement of an additional $3 trillion collected through the Alternative Minimum Tax).[5][16][51] The study also concluded that if the tax base were eroded by 10% due to tax evasion, tax avoidance, and/or legislative adjustments, the average rate would be 34% (53% tax-exclusive) for the 10-year period. A dynamic analysis in 2008 by the Baker Institute For Public Policy concluded that a 28% (38.9% tax-exclusive) rate would be revenue neutral for 2006.[52] The President's Advisory Panel for Federal Tax Reform performed a 2006 analysis to replace the individual and corporate income tax with a retail sales tax and estimated the rate to be 25% (34% tax-exclusive) assuming 15% tax evasion, and 33% (49% tax-exclusive) with 30% tax evasion.[9] The rate would need to be substantially higher to replace the additional taxes replaced by the FairTax (payroll, estate, and gift taxes). Beacon Hill Institute, FairTax.org, and Kotlikoff criticized the President's Advisory Panel's study as having allegedly altered the terms of the FairTax, using unsound methodology, and/or failing to fully explain their calculations.[36][45][53]
Taxable items and exemptions
[edit]The tax would be levied once at the final retail sale for personal consumption on new goods and services. Purchases of used items, exports and all business transactions would not be taxed. Also excluded are investments, such as purchases of stock, corporate mergers and acquisitions and capital investments.