Should we replace the income tax with a national sales tax? Some commonsense on the FairTax by the Tax Policy Center:
The tax is designed to protect low-income people from higher taxes via a large new cash transfer program called a “prebate.” Every household would get a cash transfer equal to the amount of tax that a family at the poverty level would owe. (Ironically, this would be the largest welfare program in history.)
The problem is that very high-income households spend only a fraction of their income, while low- and middle-income people spend all or most of what they make. A sales tax, by design, exempts a large share of income at the top. If it includes a prebate to protect people at the bottom and doesn’t add to the deficit, then it must raise taxes on people in the middle.
A decade ago, President George W. Bush’s Tax Reform Panel considered a sales tax as a revenue-neutral replacement for the income tax. It rejected the idea after concluding that the rates would have to be much higher than promised by the FairTax people. It also calculated the tax would be very regressive as the [above chart] shows.
The Panel also found that the prebate would be extremely expensive, hard for taxpayers to manage, and complex for the IRS to administer. In addition, the panel was concerned a federal retail sales tax rate of 30 percent or more would result in widespread evasion and create real problems for states that rely heavily on their own sales taxes. FairTax advocates counter that their proposal would also replace regressive payroll and excise taxes (as well as highly progressive estate taxes), but the bottom line is that tax burdens on middle-income households would surely rise while high-income families would get a big tax cut.
This very much syncs with what AEI’s Alan Viard told me awhile back:
Pethokoukis: Whenever I write about tax reform, I always get people asking about the FairTax, which is kind of a national sales tax. What do you think about the FairTax as tax reform?
Viard: I think the supporters of the fair tax have their heart in the right place because they’re trying to find a consumption based tax system that avoids the penalty on saving and in investment that’s built into the income tax. The specific proposal they’ve put forward, though, really does have a number of problems. And many, many economists have pointed them out. First of all, a retail sales tax at that high of a rate is really likely to have a lot of enforcement and compliance problems. And countries that impose consumption taxes at that high of a rate, they tend to use a value added tax structure, which is really economically the same as a sales tax, but administratively is different because you collect it at multiple stages. And that just helps with the enforcement and the compliance.
So it would be a pretty modest change, actually, to say let’s do it in a value added tax administrative mode instead of a sales tax mode. But that’s I think the first change you need to make to their plan.
The rate is also not revenue neutral. They’re proposing a 30% sales tax rate and that’s not enough to replace revenue. And I think, given our deficit environment, obviously a tax reform is not going to be viable if it lowers revenue. So – and of course, there you could just raise the rate.
A bigger problem is that, there’s no progressivity in this and they – well, they have pre-bate that introduces some progressivity, but compared to the taxes they’re replacing, this would be a big shift in the tax burden, away from high-income groups towards middle-income and lower middle-income groups. And whatever you think about that politically, I think that’s just not viable.
So you really have to do something different. You either need to adopt a progressive consumption tax, which could be the Bradford X tax, or a personal expenditure tax, or you have to bring in a consumption tax to replace only part of the income tax and it’d probably be a value added tax in that case.
I really don’t think I ever need to write another blog post about the FairTax. I’ll just tweet a link to this one. Like many novelty tax plans bandied about on the right, the math of the FairTax is simply unfair to middle-income America and conflicts with fiscal reality.
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