FairTax

Not to be confused withIllinois Fair TaxorFairtex.

FairTaxis afixed ratesales tax proposal introduced as bill H.R. 25 in the United States Congress every year since 2005. TheFair Tax Actcalls for elimination of theInternal Revenue Serviceand repeal the 16th Amendment to the Constitution. H.R. 25 would eliminate allfederal income taxes(including thealternative minimum tax,corporate income taxes,andcapital gains taxes),payroll taxes(includingSocial Security and Medicare taxes),gift taxes,andestate taxes,replacing federal taxes with a singleconsumption taxlevied on retail sales.

TheFair Tax Act(H.R. 25/S. 18) would apply a fixed rate sales tax at the point of sale on all new, finalgoodsandservicespurchased 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 theregressivenature of a sales tax up to the poverty level.First introduced into theUnited States Congressin 1999, a number of congressional committees have heard testimony on thebill;however, it did not move from committee. A campaign in 2005 for the FairTax proposalinvolved Leo E. Linbeck and the Fairtax.org.Talk radiopersonalityNeal BoortzandGeorgiaCongressmanJohn LinderpublishedThe FairTax Bookin 2005 and additional visibility was gained in the2008 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 inclusiverate based on the total amount paid including the tax, which is the method currently used to calculate income tax liability.In subsequent years the rate could adjust annually based on federal receipts in the previous fiscal year.With the rebate taken into consideration, the FairTax would beprogressiveonconsumption,but would still beregressiveonincome(since consumption as a percentage of income falls at higher income levels).Opponents argue this would accordingly decrease thetax burdenonhigh-income earnersand increase it on thelower classearners.Supporters contend that the plan would effectively taxwealth,increasepurchasing powerand decrease tax burdens by broadening the tax base.

Advocates expect a consumption tax to increasesavingsandinvestment,easetax complianceand increaseeconomic growth,increase incentives forinternational businessto locate in the US and increase US competitiveness ininternational trade.The plan would provide transparency for funding the federal government. Supporters believe it would increasecivil liberties,benefit theenvironment,and effectively taxillegal activityandundocumented immigrants.Critics contend that a consumption tax of this size would be extremely difficult to collect, would lead to pervasivetax evasion,and raise less revenue than the current tax system, leading to an increasedbudget deficit.The proposed Fairtax might cause removal oftax deductionincentives, transition effects on after-tax savings, incentives on credit use and the loss of tax advantages tostate and local bonds.It also includes a sunset clause if the16th Amendment to the US Constitutionis not repealed within seven years of its enactment.

Legislative overview and history

RepJohn Linderholding the 133 pageFair Tax Act of 2007in contrast to the then-current U.S.tax codeandIRS regulations

The legislation would remove theInternal Revenue Service(after three years), and establish Excise Tax and Sales Tax bureaus in theDepartment of the Treasury.Thestatesare granted the primary authority for the collection of sales tax revenues and the remittance of such revenues to the Treasury. The plan was created byAmericans For Fair Taxation,anadvocacy groupformed 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.The FairTax legislation has been introduced in the House by GeorgiaRepublicansJohn Linder(1999–2010) andRob Woodall(2011–2014),while being introduced in the Senate by Georgia RepublicanSaxby Chambliss(2003–2014).

Linder first introduced theFair Tax Act(H.R. 2525) on July 14, 1999, to the106th United States Congressand a substantially similar bill has been reintroduced in each subsequent session of Congress. The bill attracted a total of 56 House and Senate cosponsors in the108th Congress,61 in the109th,76 in the110th,70 in the111th,78 in the112th,83 in the113th(H.R. 25/S. 122), 81 in the114th(H.R. 25/S. 155), 51 in the115th(H.R. 25/S. 18), 33 in the116th(H.R. 25), and 30 in the117th(H.R. 25). FormerSpeaker of the HouseDennis Hastert(Republican) had cosponsored the bill in the 109th–110th Congress, but it has not received support from theDemocraticleadership.Democratic RepresentativeCollin Petersonof Minnesota and Democratic SenatorZell Millerof Georgia cosponsored and introduced the bill in the 108th Congress, but Peterson has left the House of Representatives and Miller has left the Senate.In the 109th–111th Congress, RepresentativeDan Borenwas the only Democrat to cosponsor the bill.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 PresidentGeorge W. Bushand hisSecretary of the TreasuryHenry M. Paulson.

To become law, the bill will need to be included in a final version of tax legislation from theU.S. House Committee on Ways and Means,pass both the House and the Senate, and finally be signed by thePresident.In 2005, President Bush established anadvisory panel on tax reformthat 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.The panel did not examine the FairTax as proposed in the legislation. The FairTax received visibility in the2008 presidential electionon the issue of taxes and the IRS, with several candidates supporting the bill.A poll in 2009 byRasmussen Reportsfound 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 unaffiliateds.PresidentBarack Obamadid not support the bill,arguing for moreprogressive changesto the income and payroll tax systems. PresidentDonald Trumpproposedto lower overall income taxation and reduce the number oftax bracketsfrom seven to three.

Tax rate

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).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.

Theeffective tax ratefor 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.The tax would be levied on all U.S. retail sales for personal consumption on newgoodsandservices.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 thebudget deficit,unless government spending were equally reduced.

Sales tax rate

During the first year of implementation, the FairTax legislation would apply a 23% federalretailsales tax on the total transaction value of a purchase; in other words, consumers pay to the government 23 cents of every dollar spent in total (sometimes calledtax-inclusive,and presented this way to provide a direct comparison with individual income and employment taxes which reduce a person's available moneybeforethey can make purchases). The equivalent assessed tax rate is 30% if the FairTax is applied to the pre-tax price of a good like traditionalU.S. state sales taxes(sometimes calledtax-exclusive;this rate is not directly comparable with existing income and employment taxes).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.

Effective tax rate

Further information:Distribution of the FairTax burden

A household'seffective tax rateon 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.The lowest effective tax rate under the FairTax could be negative due to the rebate for households with annual spending amounts belowpoverty level spendingfor 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.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

Proposed 2015 FairTax Prebate Schedule

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 2015DHHS Poverty Guidelinesas published in theFederal Register,January 22, 2015. There is nomarriage penaltyas 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,familyhouseholdsof 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 onpovertylevel spending according to thepoverty guidelinespublished by theU.S. Department of Health and Human Services.The FCA is a tax rebate (known as a "prebate" as it would be an advance) paid in twelve monthly installments, adjusted forinflation.The rebate is meant to eliminate the taxation of household necessities and make the planprogressive.Households would register once a year with their sales tax administering authority, providing the names and social security numbers of each household member.TheSocial Security Administrationwould disburse the monthly rebate payments in the form of a paper check via U.S. Mail, anelectronic funds transferto a bank account, or a "smartcard" that can be used like adebit card.

Opponents of the plan criticize this tax rebate due to its costs. Economists at theBeacon Hill Instituteestimated the overall rebate cost to be $489 billion (assuming 100% participation).In addition, economistBruce Bartletthas argued that the rebate would create a large opportunity forfraud,treats children disparately, and would constitute awelfarepayment regardless of need.

ThePresident's Advisory Panel for Federal Tax Reformcited the rebate as one of their chief concerns when analyzing their national sales tax, stating that it would be the largestentitlement programin American history, and contending that it would "make most American families dependent on monthly checks from the federal government".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."Proponents point out that incometax deductions,tax preferences,loopholes,credits,etc. under the current system was estimated at $945 billion by theJoint Committee on Taxation.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.

Presentation of tax rate

Mathematically, a 23% tax out of $100 yields approximately the same as a 30% tax on $77.

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 astax-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 astax-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.$0.23/(1-0.23)=0.23/0.77=0.30$).

The FairTaxstatutory 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.The legislation requires the receipt to display the tax as 23% of the total.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 thesemanticsdeceptive.FactCheckcalled the presentation misleading, saying that it hides the real truth of the tax rate.Bruce Bartlettstated that polls show tax reform support is extremely sensitive to the proposed rate,and called the presentation confusing and deceptive based on the conventional method of calculating sales taxes.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

Main article:Revenue neutrality of the FairTax

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 differenttax ratesmaking direct comparison among the studies difficult. The choice betweenstaticordynamic scoringfurther complicates any estimate of revenue-neutral rates.

A 2006 study published inTax Notesby theBeacon Hill Instituteat Suffolk University and Dr.Laurence Kotlikoffestimated the FairTax would be revenue-neutral for the tax year 2007 at a rate of 23.82% (31.27% tax-exclusive).The study states thatpurchasing poweris 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 samereal revenuesfrom their taxpayers.TheArgus GroupandArduin, Laffer & Moore Econometricseach published an analysis that defended the 23% rate.While proponents of the FairTax concede that the above studies did not explicitly account fortax 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 usingNational Income and Product Accountbased figures, which is argued to understate total household consumption.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 nominalU.S. government debt.Nor did these studies account for any increasedeconomic growththat many economists researching the plan believe would occur.

In contrast to the above studies,William G. Galeof theBrookings Institutionpublished a study inTax Notesthat 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 theBush tax cutsexpire on schedule and accounts for the replacement of an additional $3 trillion collected through theAlternative Minimum Tax).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 theBaker Institute For Public Policyconcluded that a 28% (38.9% tax-exclusive) rate would be revenue neutral for 2006.ThePresident's Advisory Panel for Federal Tax Reformperformed a 2006 analysis to replace the individual and corporateincome taxwith 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.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.

Taxable items and exemptions

The tax would be levied once at the final retail sale for personal consumption on new goods and services. Purchases of used items,exportsandall businesstransactions would not be taxed. Also excluded are investments, such as purchases ofstock,corporatemergers and acquisitionsandcapital investments.Savingsandeducation tuitionexpenses would be exempt as they would be considered an investment (rather than final consumption).

A good would be considered "used" and not taxable if a consumer already owns it before the FairTax takes effect or if the FairTax has been paid previously on the good, which may be different from the item being sold previously. Personal services such ashealth care,legal services,financial services,and auto repairs would be subject to the FairTax, as would renting apartments and otherreal property.Food, clothing, prescription drugs, and medical services would be taxed. (Statesales taxes generally exempt these types of basic-need items in an effort to reduce the tax burden on low-income families. The FairTax would use a monthly rebate system instead of the common state exclusions.)Internetpurchases would be taxed, as would retail international purchases (such as a boat or car) that are imported to the United States (collected by theU.S. Customs and Border Protection).

Distribution of tax burden

Main article:Distribution of the FairTax burden

Working paperby Kotlikoff and Rapsonof the FairTax. Lower rates claimed on workers from a larger tax base, replacing regressive taxes, andwealth taxation.

President's Advisory Panel'sanalysis of a hybrid National Sales Tax. Higher rates claimed on the middle-class for an income tax replacement (excludes payroll, estate, and gift taxes replaced under the FairTax).

The FairTax's effect on the distribution of taxation ortax incidence(the effect on the distribution ofeconomic welfare) is a point of dispute. The plan's supporters argue that the tax would broaden the tax base, that it would beprogressive,and that it would decrease tax burdens and start ta xing wealth (reducing theeconomic gap).Opponents argue that a national sales tax would be inherentlyregressiveand would decrease tax burdens paid by high-income individuals.A person earning $2 million a year could live well spending $1 million, and as a result pay a mere 11% of that year's income in taxes.Households at the lower end of the income scale spend almost all their income, while households at the higher end are more likely to devote a portion of income to saving. Therefore, according to economistWilliam G. Gale,the percentage ofincometaxed is regressive at higher income levels (as consumption falls as a percentage of income).

Income earned and saved would not be taxed until spent under the proposal. Households at the extreme high end of consumption often finance their purchases out of savings, not income.EconomistLaurence Kotlikoffstates that the FairTax could make the tax system much more progressive and generationally equitable,and argues that ta xing consumption is effectively the same as ta xingwagesplus ta xingwealth.A household of three persons (this example will use two adults plus one child; the rebate does not consider marital status) spending $30,000 a year on taxable items would devote about 3.4% of total spending ([$6,900 tax minus $5,888 rebate]/$30,000 spending) to the FairTax after the rebate. The same household spending $125,000 on taxable items would spend around 18.3% ([$28,750 tax minus $5,888 rebate]/$125,000 spending) on the FairTax. At higher spending levels, the rebate has less impact and the rate approaches 23% of total spending. Thus, according to economistLaurence Kotlikoff,the effective tax rate is progressive onconsumption.

An unreviewed paper by Kotlikoff and David Rapson states that the FairTax would significantly reduce marginal taxes on work and saving, lowering overall average remaining lifetime tax burdens on current and future workers.A study by Kotlikoff and Sabine Jokisch concluded that the long-term effects of the FairTax would reward low-income households with 26.3% morepurchasing power,middle-income households with 12.4% more purchasing power, and high-income households with 5% more purchasing power.TheBeacon Hill Institutereported that the FairTax would make the federal tax system more progressive and would benefit the average individual in almost all expenditures deciles.In another study, they state the FairTax would offer the broadest tax base (an increase of over $2 trillion), which allows the FairTax to have a lower tax rate than current tax law.

Gale analyzed a national sales tax (though different from the FairTax in several aspects) and reported that the overall tax burden on middle-income Americans would increase while the tax burden on the top 1% would drop.A study by the Beacon Hill Institute reported that the FairTax may have a negative effect on the well-being of mid-income earners for several years after implementation.According to thePresident's Advisory Panel for Federal Tax Reformreport, which compared the individual and corporate income tax (excluding other taxes the FairTax replaces) to a sales tax with rebate,the percentage of federal taxes paid by those earning from $15,000–$50,000 would rise from 3.6% to 6.7%, while the burden on those earning more than $200,000 would fall from 53.5% to 45.9%.The report states that the top 5% of earners would see their burden decrease from 58.6% to 37.4%.FairTax supporters argue that replacing the regressivepayroll tax(a 15.3% total tax not included in the Tax Panel study;payroll taxes include a 12.4%Social Securitytax on wages up to $97,500 and a 2.9%Medicaretax, a 15.3% total tax that is often split between employee and employer) greatly changes the tax distribution, and that the FairTax would relieve the tax burden on middle-class workers.

Predicted effects

Main article:Predicted effects of the FairTax

The predicted effects of the FairTax are a source of disagreement among economists and other analysts.According toMoneymagazine, while many economists and tax experts support the idea of aconsumption tax,many of them view the FairTax proposal as having serious problems with evasion and revenue neutrality.Some economists argue that a consumption tax (the FairTax is one such tax) would have a positive effect oneconomic growth,incentives for international business to locate in the U.S., and increased U.S. international competitiveness (border tax adjustment inglobal trade).The FairTax would be tax-free on mortgage interest (up to a basic interest rate) and donations, but some lawmakers have concerns about losing tax incentives onhome ownershipand charitable contributions.There is also concern about the effect on the income tax industry and the difficulty of repealing theSixteenth Amendment(to prevent Congress from re-introducing an income tax).

Economic

Further information:Predicted effects of the FairTax § Economic effects

Americans For Fair Taxation states the FairTax would boost the United States economy and offers a letter signed by eighty economists, includingNobel LaureateVernon L. Smith,that have endorsed the plan.TheBeacon Hill Instituteestimated that within five years real GDP would increase 10.7% over the current system, domestic investment by 86.3%, capital stock by 9.3%, employment by 9.9%,real wagesby 10.2%, and consumption by 1.8%.Arduin, Laffer & Moore Econometricsprojected the economy as measured by GDP would be 2.4% higher in the first year and 11.3% higher by the 10th year than it would otherwise be.EconomistsLaurence Kotlikoffand Sabine Jokisch reported the incentive to work and save would increase; by 2030, the economy'scapital stockwould increase by 43.7% over the current system, output by 9.4%, andreal wagesby 11.5%.Economist John Golob estimates a consumption tax, like the FairTax, would bring long-term interest rates down by 25–35%.An analysis in 2008 by theBaker Institute For Public Policyindicated that the plan would generate significant overallmacroeconomicimprovement in both the short and long-term, but warned of transitional issues.

FairTax proponents argue that the proposal would provide tax burden visibility and reduce compliance and efficiency costs by 90%, returning a large share of money to the productive economy.The Beacon Hill Institute concluded that the FairTax would save $346.51 billion in administrative costs and would be a much more efficient taxation system.Bill Archer,former head of theHouse Ways and Means Committee,askedPrinceton UniversityEconometrics to survey 500EuropeanandAsiancompanies regarding the effect on their business decisions if the United States enacted the FairTax. 400 of those companies stated they would build their next plant in the United States, and 100 companies said they would move their corporate headquarters to the United States.Supporters argue that the U.S. has the highest combined statutory corporate income tax rate amongOECDcountries along with being the only country with no border adjustment element in its tax system.Proponents state that because the FairTax eliminates corporate income taxes and is automatically border adjustable, the competitive tax advantage of foreign producers would be eliminated, immediately boosting U.S. competitiveness overseas and at home.

Opponents point to a study commissioned by theNational Retail Federationin 2000 that found a national sales tax bill filed byBilly Tauzin,theIndividual Tax Freedom Act(H.R. 2717), would bring a three-year decline in the economy, a four-year decline in employment and an eight-year decline inconsumer spending.The Wall Street JournalcolumnistJames Tarantostates the FairTax is unsuited to take advantage ofsupply-sideeffects and would create a powerful disincentive to spend money.John Linder states an estimated $11 trillion is held in foreign accounts (largely for tax purposes), which he states would be repatriated back to U.S. banks if the FairTax were enacted, becoming available to U.S.capital markets,bringing down interest rates, and otherwise promoting economic growth in the United States.Attorney Allen Buckley states that a tremendous amount of wealth was already repatriated under law changes in 2004 and 2005.Buckley also argues that if the tax rate was significantly higher, the FairTax would discourage the consumption of new goods and hurt economic growth.

Transition

Further information:Predicted effects of the FairTax § Transition effects

Stability of the tax base: a comparison ofpersonal consumption expendituresandadjusted gross income

During the transition, many or most of the employees of the IRS (105,978 in 2005)would face loss of employment.The Beacon Hill Institute estimate is that the federal government would be able to cut $8 billion from the IRS budget of $11.01 billion (in 2007), reducing the size of federal tax administration by 73%.In addition, income tax preparers (many seasonal), tax lawyers, tax compliance staff in medium-to-large businesses, and software companies which sell tax preparation software could face significant drops, changes, or loss of employment. The bill would maintain the IRS for three years after implementation before completely decommissioning the agency, providing employees time to find other employment.

In the period before the FairTax is implemented, there could be a strong incentive for individuals to buy goods without the sales tax using credit. After the FairTax is in effect, the credit could be paid off using untaxed payroll. If credit incentives do not change, opponents of the FairTax worry it could exacerbate an existing consumer debt problem. Proponents of the FairTax state that this effect could also allow individuals to pay off their existing (pre-FairTax) debt more quickly,and studies suggest lower interest rates after FairTax passage.

Individuals under the current system who accumulated savings from ordinary income (by choosing not to spend their money when the income was earned) paid taxes on that income before it was placed in savings (such as aRoth IRAorCD). When individuals spend above the poverty level with money saved under the current system, that spending would be subject to the FairTax. People living through the transition may find both their earnings and their spending taxed.Critics have stated that the FairTax would result in unfair double taxation for savers and suggest it does not address the transition effect on some taxpayers who have accumulated significant savings from after-tax dollars, especially retirees who have finished their careers and switched to spending down their life savings.Supporters of the plan argue that the current system is no different, since compliance costs and "hidden taxes" embedded in the prices of goods and services cause savings to be "taxed" a second time already when spent.The rebate would supplement accrued savings, covering taxes up to the poverty level. The income taxes on capital gains, estates, social security and pension benefits would be eliminated under FairTax. In addition, the FairTax legislation adjustsSocial Securitybenefits for changes in the price level, so a percentage increase in prices would result in an equal percentage increase to Social Security income.Supporters suggest these changes would offset paying the FairTax under transition conditions.

Other indirect effects

Further information:Predicted effects of the FairTax § Other indirect effects

The FairTax would be tax free on mortgage interest up to thefederal borrowing ratefor like-term instruments as determined by theTreasury,but since savings, education, and other investments would be tax free under the plan, the FairTax could decrease the incentive to spend more on homes. An analysis in 2008 by theBaker Institute For Public Policyconcluded that the FairTax would have significant transitional issues for thehousingsector since the investment would no longer betax-favored.In a 2007 study, the Beacon Hill Institute concluded that total charitable giving would increase under the FairTax, although increases in giving would not be distributed proportionately among the various types of charitable organizations.The FairTax may also affect state and local government debt as the federal income tax system provides tax advantages tomunicipal bonds.Proponents believe environmental benefits would result from the FairTax throughenvironmental economicsand the re-use and re-sale ofused goods.Advocates argue the FairTax would provide an incentive for illegal immigrants tolegalizeas they would otherwise not receive the rebate.Proponents also believe that the FairTax would have positive effects oncivil libertiesthat are sometimes charged against the income tax system, such associal inequality,economic inequality,financial privacy,self-incrimination,unreasonable search and seizure,burden of proof,anddue process.

If the FairTax bill were passed, permanent elimination of income taxation would not be guaranteed; the FairTax bill would repeal much of the existingtax code,but theSixteenth Amendmentwould remain in place. Preventing new legislation from reintroducing income taxation would require a repeal of the Sixteenth Amendment to theUnited States Constitutionwith a separate provision expressly prohibiting a federal income tax.This is referred to as an "aggressive repeal". Separate income taxes enforced by individual states would be unaffected by the federal repeal. Passing the FairTax would require only a simple majority in each house of the United States Congress along with the signature of the President, whereas enactment of aconstitutional amendmentmust be approved by two thirds of each house of the Congress, and three-quarters of the individual U.S. states. It is therefore possible that passage of the FairTax bill would simply add another taxation system. If a new income tax bill were passed after the FairTax passage, a hybrid system could develop; albeit, there is nothing preventing a bill for a hybrid system today. To address this issue and preclude that possibility, in the111th CongressJohn Linder introduced a contingentsunset provisionin H.R. 25. It would require the repeal of the Sixteenth Amendment within 8 years after the implementation of the FairTax or, failing that, the FairTax would expire.Critics have also argued that a tax on state government consumption could beunconstitutional.

Changes in the retail economy

See also:Tax § Economics of taxation,andEffect of taxes and subsidies on price

Since the FairTax would not tax used goods, the value would be determined by thesupply and demandin relation to new goods.The price differential/margins between used and new goods would stay consistent, as the cost and value of used goods are in direct relationship to the cost and value of the new goods. Because the U.S. tax system has a hiddeneffect on prices,it is expected that moving to the FairTax would decrease production costs from the removal of business taxes and compliance costs, which is predicted to offset a portion of the FairTax effect on prices.

Value of used goods

Since the FairTax would not tax used goods, some critics have argued that this would create a differential between the price of new and used goods, which may take years to equalize.Such a differential would certainly influence the sale of new goods like vehicles and homes. Similarly, some supporters have claimed that this would create an incentive to buy used goods, creating environmental benefits of re-use and re-sale. Conversely, it is argued that like the income tax system that contains embedded tax cost (seeTheories of retail pricing),used goods would contain the embedded FairTax cost.While the FairTax would not be applied to the retail sales of used goods, the inherent value of a used good includes the taxes paid when the good was sold at retail. The value is determined by the supply and demand in relation to new goods.The price differential/margins between used and new goods should stay consistent, as the cost and value of used goods are in direct relationship to the cost and value of the new goods.

Theories of retail pricing

Asupply and demanddiagram illustrating taxes' effect on prices

Based on a study conducted byDale Jorgenson,proponents state thatproduction costof domestic goods and services could decrease by approximately 22% on average after embedded tax costs are removed, leaving the sale nearly the same after taxes. The study concludes that producer prices would drop between 15% and 26% (depending on the type of good/service).Jorgenson's research included all income and payroll taxes in the embedded tax estimation, which assumes employee take-home pay (net income) remains unchanged from pre-FairTax levels.Price and wage changes after the FairTax would largely depend on the response of theFederal Reservemonetary authorities.Non-accommodation of themoney supplywould suggest retail prices and take home pay stay the same—embedded taxes are replaced by the FairTax. Full accommodation would suggest prices and incomes rise by the exclusive rate (i.e., 30%)—embedded taxes becomewindfall gains.Partial accommodation would suggest a varying degree in-between.

If businesses provided employees withgross pay(including income tax withholding and the employee share of payroll taxes),Arduin, Laffer & Moore Econometricsestimated production costs could decrease by a minimum of 11.55% (partial accommodation).This reduction would be from the removal of the remaining embedded costs, including corporate taxes, compliance costs, and the employer share of payroll taxes. This decrease would offset a portion of the FairTax amount reflected in retail prices, which proponents suggest as the most likely scenario.Bruce Bartlett states that it is unlikely that nominal wages would be reduced, which he believes would result in a recession, but that the Federal Reserve would likely increase the money supply to accommodate price increases.David Tuerck states "The monetary authorities would have to consider how the degree of accommodation, varying from none to full, would affect the overall economy and how it would affect the well-being of various groups such as retirees."

Social Securitybenefits would be adjusted for any price changes due to FairTax implementation.The Beacon Hill Institute states that it would not matter, apart from transition issues, whether prices fall or rise—the relative tax burden and tax rate remains the same.Decreases in production cost would not fully apply to imported products; so according to proponents, it would provide tax advantages for domestic production and increase U.S. competitiveness in global trade (seeBorder adjustability). To ease the transition, U.S. retailers will receive a tax credit equal to the FairTax on their inventory to allow for quick cost reduction. Retailers would also receive an administrative fee equal to the greater of $200 or 0.25% of the remitted tax as compensation for compliance costs,which amounts to around $5 billion.

Effects on tax code compliance

One avenue for non-compliance is the black market. FairTax supporters state that theblack marketis largely untaxed under the current tax system. Economists estimate theunderground economyin the United States to be between one and three trillion dollars annually.By imposing a sales tax, supporters argue that black market activity would be taxed when proceeds from such activity are spent on legal consumption.For example, the sale of illegalnarcoticswould remain untaxed (instead of being guilty of income tax evasion,drug dealerswould be guilty of failing to submit sales tax), but they would face taxation when they used drug proceeds to buy consumer goods such as food, clothing, and cars. By ta xing this previously untaxed money, FairTax supporters argue that non-filers would be paying part of their share of what would otherwise be uncollected income and payroll taxes.

Other economists and analysts have argued that the underground economy would continue to bear the same tax burden as before.They state that replacing the current tax system with a consumption tax would not change the tax revenue generated from the underground economy—while illicit income is not taxed directly, spending of income from illicit activity results in business income and wages that are taxed.

Tax compliance and evasion

"No, No! Not That Way" —political cartoonfrom 1933 commenting on a generalsales taxover anincome tax

Proponents state the FairTax would reduce the number of tax filers by about 86% (from 100 million to 14 million) and reduce the filing complexity to a simplified state sales tax form.TheGovernment Accountability Office(GAO), among others, have specifically identified the negative relationship between compliance costs and the number of focal points for collection.Under the FairTax, the federal government would be able to concentrate tax enforcement efforts on a single tax. Retailers would receive an administrative fee equal to the greater of $200 or 0.25% of the remitted tax as compensation for compliance costs.In addition, supporters state that the overwhelming majority of purchases occur in major retail outlets, which are very unlikely to evade the FairTax and risk losing their business licenses.Economic Census figures for 2002 show that 48.5% of merchandise sales are made by just 688 businesses ("Big-Box" retailers). 85.7% of all retail sales are made by 92,334 businesses, which is 3.6% of American companies. In the service sector, approximately 80% of sales are made by 1.2% of U.S. businesses.

The FairTax is a national tax, but can be administered by the states rather than a federal agency,which may have a bearing on compliance as the states' own agencies could monitor and audit businesses within that state. The 0.25% retained by the states amounts to $5 billion the states would have available for enforcement and administration. For example,Californiashould receive over $500 million for enforcement and administration, which is more than the $327 million budget for the state's sales and excise taxes.Because the federal money paid to the states would be a percentage of the total revenue collected, John Linder claims the states would have an incentive to maximize collections.Proponents believe that states that choose to conform to the federal tax base would have advantages in enforcement,information sharing,and clear interstate revenue allocation rules.A study by theBeacon Hill Instituteconcluded that, on average, states could more than halve their sales tax rates and that state economies would benefit greatly from adopting a state-level FairTax.

FairTax opponents state that compliance decreases when taxes are notautomatically withheldfrom citizens, and that massivetax evasioncould result by collecting at just one point in the economic system.Compliance rates can also fall when taxed entities, rather than a third party, self-report their tax liability. For example, ordinary personal income taxes can be automatically withheld and are reported to the government by a third party. Taxes without withholding and with self-reporting, such as the FairTax, can see higher evasion rates. Economist Jane Gravelle of theCongressional Research Servicefound studies showing that evasion rates of sales taxes are often above 10%, even when the sales tax rate is in the single digits.Tax publications by theOrganisation for Economic Co-operation and Development(OECD), IMF, andBrookings Institutionhave suggested that the upper limit for a sales tax is about 10% before incentives for evasion become too great to control.According to the GAO, 80% of state tax officials opposed a national sales tax as an intrusion on their tax base.Opponents also raise concerns of legaltax avoidanceby spending and consuming outside of the U.S. (imported goods would be subject to collection by theU.S. Customs and Border Protection).

Economists from theUniversity of Tennesseeconcluded that while there would be many desirablemacroeconomiceffects, adoption of a national retail sales tax would also have serious effects on state and local government finances.Economist Bruce Bartlett stated that if the states did not conform to the FairTax, they would have massive confusion and complication as to what is taxed by the state and what is taxed by the federal government.In addition, sales taxes have long exempted all but a few services because of the enormous difficulty in ta xing intangibles—Bartlett suggests that the state may not have sufficient incentive to enforce the tax.University of MichiganeconomistJoel Slemrodargues that states would face significant issues in enforcing the tax. "Even at an average rate of around five percent, state sales taxes are difficult to administer."University of Virginia School of Law professor George Yin states that the FairTax could have evasion issues with export and import transactions.ThePresident's Advisory Panel for Federal Tax Reformreported that if the federal government were to cease ta xing income, states might choose to shift their revenue-raising to income.Absent theInternal Revenue Service,it would be more difficult for the states to maintain viable income tax systems.

Underground economy

Opponents of the FairTax argue that imposing a national retail sales tax would drive transactions underground and create a vastunderground economy.Under a retail sales tax system, the purchase of intermediate goods and services that arefactors of productionare not taxed, since those goods would produce a final retail good that would be taxed. Individuals and businesses may be able to manipulate the tax system by claiming that purchases are for intermediate goods, when in fact they are final purchases that should be taxed. Proponents point out that a business is required to have a registered seller's certificate on file, and must keep complete records of all transactions for six years. Businesses must also record all taxable goods bought for seven years. They are required to report these sales every month (seePersonal vs. business purchases).The government could also stipulate that all retail sellers provide buyers with a written receipt, regardless of transaction type (cash, credit, etc.), which would create a paper trail for evasion with risk of having the buyer turn them in (the FairTax authorizes a reward for reporting tax cheats).

While many economists and tax experts support a consumption tax, problems could arise with using a retail sales tax rather than avalue added tax(VAT).A VAT imposes a tax on thevalue addedat every intermediate step of production, so the goods reach the final consumer with much of the tax already in the price.The retail seller has little incentive to conceal retail sales, since he has already paid much of the good's tax. Retailers are unlikely to subsidize the consumer's tax evasion by concealing sales. In contrast, a retailer has paid no tax on goods under a sales tax system. This provides an incentive for retailers to conceal sales and engage in "tax arbitrage"by sharing some of the illicit tax savings with the final consumer. Citing evasion,Tim Worstallwrote inForbesthat Europe's 20-25% consumption taxes simply would not work if they were a sales tax: that's why they're all a VAT.Laurence Kotlikoffhas stated that the government could compel firms to report, via1099-type forms,their sales to other firms, which would provide the same records that arise under a VAT.In the United States, a general sales tax is imposed in 45 states plus the District of Columbia (accounting for over 97% of both population and economic output), which proponents argue provides a large infrastructure for ta xing sales that many countries do not have.

Personal versus business purchases

Businesses would be required to submit monthly or quarterly reports (depending on sales volume) of taxable sales and sales tax collected on their monthly sales tax return. Duringaudits,the business would have to produce invoices for the "business purchases" that they did not pay sales tax on, and would have to be able to show that they were genuine business expenses.Advocates state the significant 86% reduction in collection points would greatly increase the likelihood of business audits, makingtax evasionbehavior much more risky.Additionally, the FairTax legislation has severalfinesandpenaltiesfor non-compliance, and authorizes a mechanism for reporting tax cheats to obtain a reward.To prevent businesses from purchasing everything for their employees, in a family business for example, goods and services bought by the business for the employees that are not strictly for business use would be taxable.Health insurance or medical expenses would be an example where the business would have to pay the FairTax on these purchases. Taxable property and services purchased by a qualifiednon-profitorreligious organization"for business purposes" would not be taxable.

FairTax movement

A FairTax rally inOrlando, Floridaon July 28, 2006

The creation of the FairTax began with a group of businessmen from Houston, Texas, who initially financed what has become the political advocacy groupAmericans For Fair Taxation(AFFT), which has grown into a large tax reform movement.This organization, founded in 1994, claims to have spent over $20 million in research, marketing, lobbying, and organizing efforts over a ten-year period and is seeking to raise over $100 million more to promote the plan.AFFT includes a staff inHoustonand a large group of volunteers who are working to get the FairTax enacted.

In 2007Bruce Bartlettsaid the FairTax was devised by theChurch of Scientologyin the early 1990s,drawing comparisons between the tax policy and religious doctrine from the faith, whosecreation mythholds that an evil alien ruler known asXenu"used phony tax inspections as a guise for destroying his enemies."Representative John Linder told theAtlanta Journal-Constitutionthat Bartlett confused the FairTax movement with the Scientology-affiliatedCitizens for an Alternative Tax System,which also seeks to abolish the federal income tax and replace it with a national retail sales tax. Leo Linbeck, AFFT Chairman and CEO, stated "As a founder of Americans For Fair Taxation, I can state categorically, however, that Scientology played no role in the founding, research or crafting of the legislation giving expression to the FairTax."

Much support has been achieved by talk radio personalityNeal Boortz.Boortz's book (co-authored by Georgia CongressmanJohn Linder) entitledThe FairTax Book,explains the proposal and spent time atopThe New York TimesBest Seller list.Boortz stated that he donates his share of the proceeds to charity to promote the book.In addition, Boortz and Linder have organized several FairTax rallies to publicize support for the plan. Other media personalities have also assisted in growing grassroots support including former radio and TV talk show hostLarry Elder,radio host and former candidate for the 2012 GOP Presidential NominationHerman Cain,Fox News and radio hostSean Hannity,and Fox Business HostJohn Stossel.The FairTax received additional visibility as one of the issues in the2008 presidential election.At a debate on June 30, 2007, severalRepublican candidateswere asked about their position on the FairTax and many responded that they would sign the bill into law if elected.The most vocal promoters of the FairTax during the 2008 primary elections were Republican candidateMike Huckabeeand Democratic candidateMike Gravel.The Internet,blogosphere,andelectronic mailing listshave contributed to promoting, organizing, and gaining support for the FairTax. In the 2012 Republican presidential primary, and his ensuingLibertarian Partypresidential run, former Governor of New Mexico and businessmanGary Johnsonactively campaigned for the FairTax.Former CEO ofGodfather's PizzaHerman Cainhad promoted the FairTax as a final step in a multiple-phase tax reform.Outside of the United States, theChristian Heritage Party of Canadaadopted a FairTax proposal as part of their 2011 election platformbut has never been close to winning a seat in any election.

See also

• Americans For Fair Taxation
• Consumption tax
• Debates within libertarianism
• Georgistland value tax
• Hall–Rabushka flat tax
• Optimal tax
• Single tax
• Tax reform
• Tax shift

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Further reading

• Kotlikoff, Laurence; Burns, Scott (2004).The Coming Generational Storm: What You Need to Know about America's Economic Future.MIT Press.ISBN0-262-11286-8.
• McCaffery, Edward, J. (2006).Fair Not Flat: How to Make the Tax System Better and Simpler(Paperback ed.). University of Chicago Press.ISBN0-226-55561-5.{{cite book}}:CS1 maint: multiple names: authors list (link)
• Zodrow, George R.; Mieszkowski, Peter (2002).United States Tax Reform in the 21st Century(Hardcover ed.). Cambridge University Press.ISBN978-0-521-80383-0.

External links

• H.R.25: "FairTax Act of 2013"Archived2013-06-15 at theWayback Machine:Text of House bill H.R.25
• S.122:Fair Tax Act of 2013Archived2014-12-18 at theWayback Machine:Text of Senate bill S.122
• Rob Woodall on the Fair Tax:Rob Woodall, The current sponsor of the Fair Tax, on his bill