FairTax – What you should know

One of the benefits of a presidential election is that even people who don’t stand much of a chance of winning get to make some of their beliefs and policies known.  This is the case with Ron Paul.  I’m not voting for Ron Paul, but that doesn’t mean that I don’t think he has made some very valid points during his campaign.  One of those points (in fairness other candidates also ran on this issue) is about FairTax, which I hadn’t really heard about before now.

After hearing about this tax program, I decided to do some research myself and learn more about how it works.  I started by searching online and found the FairTax.org website.  It gives a good overview of the program.  I then decided to buy the FairTax book on iTunes and give it a listen.  After going through the book I looked for people speaking out against FairTax to see what were their complaints.  Here is what I learned.

FairTax is the idea of replacing our current tax system (income, capitol gains, estate, etc…) with one tax inclusive sales tax of 23%.  Individual tax payers would no longer have to fill out complicated tax forms, and the IRS (at least as we know it) would be shuttered.  The key piece of making the tax “fair”  is the “prebate”  part of it.  Every tax paying citizen would be given a monthly prebate check to offset the sales tax up to the poverty level.  In other words, if you are a single person, you don’t pay any taxes on the first $10,290 of your spending.  The chart below demonstrates how much of a prebate you would receive.  But, you will notice it’s not based on income.

The big feature of FairTax is that you don’t pay taxes based on income, but rather on consumption.  So in theory, someone who makes $25,000 per year could pay the same as someone who makes $250,000 per year, assuming the higher level earner didn’t spend more than the lesser income person, which is of course highly unlikely.  More likely, the person who makes 10x the money would spend a lot more, thus paying a lot more in taxes.  Which I have to agree seems fair.

Another important piece of the FairTax idea is that corporations wouldn’t pay taxes.  I think that may throw some people off, but keep an open mind as to why that’s not a bad thing.  Currently, corporate taxes make up less than 10% of this country’s tax income.  This is because corporations have figured out many ways around taxes.  Also, from a tax payer perspective, the U.S. is one of the worst countries in the world to have a company.  That’s why major corporations like Stanley Tools, Tyco and Dhamler/Chrysler have moved offshore in recent years, taking with them many jobs.  By eliminating taxes from corporations, we see little difference in the overall taxes collected, but the U.S. becomes a tax haven for businesses, bringing more of them and their jobs to the U.S.  According to both the proponents and opponents of FairTax, this will have a major impact on our economy.  It’s estimated that the average American would end up making about 10% more income.

Let me list out a few benefits that I found, and then list a few objections so that people can form their own opinions.

The Benefits of FairTax

No more IRS!   Let’s face it, the IRS are bullies and we are all a little afraid of them, no matter how much attention we pay to our taxes.  The amount of paperwork involved in taxes is mind blowing, and the amount of fear we have of screwing it up borders on paranoia.  Obviously, those who live in states that have state income tax would still have paperwork, but I’m guessing if FairTax was to become law, you would likely see the states move in that direction as well.

Helps lower illegal immigration, and taxes those who are here.    A big issue in this election has been illegal immigration.  When you think about why we care, three issues come up; they take jobs (but so do legal immigrants), it poses a national security issue, and they don’t pay taxes.  FairTax directly fixes the last of these concerns, and has an indirect impact on the other two.  Illegal immigrants will be paying federal taxes every time they eat out, go to a grocery store, buy a CD, etc…  This is obviously applicable to everyone living off under-the-table wages.  Add to that the fact that illegal immigrants will not be eligible for prebates, and this country becomes a lot less attractive.  Take away the financial incentive, and you have a lot fewer people crossing into our borders, which makes stopping the remaining people much easier.

Closes tax loopholes.    Another big issue in this election is closing tax loopholes.  It’s very easy for people to set up offshore corporations through the Internet, and funnel cash through those accounts.  And, it’s also nearly impossible for the government to crack down on these activities.  FairTax eliminates the benefits of these types of loopholes.  Since there is no capital gains or other taxes to drive these people to seek financial refuges offshore, they won’t do it.  Since people are taxed when they spend the money, they will just keep their money here, thereby bringing 100’s of billions of dollars back to American banks where they belong, and these people will have no choice but to pay taxes.

Lower costs.    Since corporations no longer pay taxes, the cost of good should go down significantly.  Of course, corporations always try to pocket as much as they can as profit, but competition drives the market place.  So prices will go down.

More higher paying jobs.    As I mentioned above, the U.S. essentially becomes a tax haven for corporations, so you will not only see American companies return to the U.S., but a whole set of foreign companies would likely move their operations here, bringing with them millions of high-paying new jobs.

Less political maneuvering from politicians.    How many times have we heard political candidates tout their ideas about taxes, only to be left feeling a little screwed.  A certain speech about “Read my lips, no new taxes”  comes to mind.  I doubt anyone understands, or has even read, the 60,000+ page tax code.  There are tax breaks being given in so many different ways, it’s impossible to understand it.  Another big issue in this election has been to eliminate (or at least greatly reduce) lobbyists from our political process.  Well, guess what many of those lobbyists are lobbying for.  FairTax would get rid of a lot of lobbyists and give politicians less control over manipulating our taxes.

Arguments against FairTax

Some of these are valid, but many are just from people who haven’t read the FairTax plan, which by the way is 130 pages vs. 60,000+ pages of our current tax code.

This adds a sales tax, so we pay more money.

This isn’t true.  We do get a sales tax, but we no longer have an income tax, nor do we have withholdings for social security and medicare.  Also, each American receives thousands of dollars in prebates to offset the sales tax up to poverty level.  This means that a single person with no kids pays no taxes on the first $10,290 of spending.

The fair tax is really 30%, not 23%.

This is kinda true, and it’s something I don’t like about the way proponents state the plan.  It’s a little complicated, so I’ll try to illustrate it here.  Let’s say you buy an iPod for $100.  The store will get $77 of that money, and $23 will go to the government under FairTax.  The tax is included in the sales price, so the consumer sees a tax of 23%.  But, the store may look at it as they are having to mark this item up 29% to get their $77 off this product.  To be honest, I agree that the 23% number is misleading.  But, I also agree that prices should go down at least 20% for most items since neither the store nor the manufacturer (or shipping company, or anyone else) is paying any taxes.  I honestly believe if FairTax is passed, we would be seeing at least a 12% dip in prices for goods and services.  So even if you add 30% to these prices, it’s still pretty good.

FairTax was created by a Scientologist.

This one is just goofy.  A guy named Bartlet first declared this when he accused Fred Thompson of “channeling L. Ron Hubbard”  for his tax plan.  It’s not true.  The big connection Bartlet has here is that one of the people (someone who is not a Scientologist or has even been one) involved early on with FairTax had a conversation with two people, who later became Scientologists, about a national sales tax.  I cannot find anything from Scientologists taking credit for FairTax.  They don’t like the IRS because the IRS doesn’t want to recognize their religion.  While the rest of us don’t like the IRS for normal reasons.

FairTax is a Republican tax plan.

This is not really true, but has some veracity to it.  FairTax is a non-partisan tax plan, but it does appear that a lot more Republicans support it than Democrats.  But you have to keep in mind that Democrats often run for office based on taxing big corporations, so you shouldn’t look for wide support until more people know how the plan works.  FairTax doesn’t sound-bite well.

FairTax will hurt charities.

This argument does have some logic behind it.  The idea is that people give to charity so they can get tax deductions.  The truth is that most people don’t line item charity items off their taxes.  And since you’re giving the money away, and not really spending it, those dollars are pre-taxed just like your deductions are now.  But there is no doubt that big companies often do give money to charity to offset their taxes, and now they wouldn’t have an incentive to do that.  I also wondered if non-profits would have to pay taxes under FairTax.  I did some checking and found that they would no longer have to pay payroll taxes, which they do currently, and they would be treated like a company when they buy goods for the charity, so they wouldn’t have to pay the sales tax.

The cost of transitioning would be too much for retailers.

This is a pretty silly argument.  Retailers have electronic cash registers that are always being altered to fit for different taxes.  On top of that, retailers would be compensated for having to make the update.  Also, retailers would be able to sell their existing inventory in a way to not incur additional taxes.  There would be no real costs of transition to retailers.

FairTax would hurt the lower and middle class.

This is completely untrue.  Here’s an example; let’s say you have a waitress who makes $20,000 per year.  Let’s say she is paying taxes on about 15% of her income.  That would be $3,000. She is taxed on that money even if she saves it, or whatever.  Under FairTax, she would receive her whole check, plus she would not be taxed on the first $10,210.  So, that leaves a remaining $9,790.  She is only taxed on the amount she spends.  So lets say she spent most of that money, $6,000.  She would be charged $1,380 in taxes.  That lowers her taxes to less than half as before.  Let’s say she spent just about everything she made, $19,000.  She would be taxed $2,005.60.  About 2/3 of her current tax bill.  Try these calculations on your income.  Just look at your check and remember to add everything that was withheld.  Then add in your prebate and see how much you would spend to see how much you would be taxed.

Education would go up 30%.

This is 100% untrue.  Education does not get the sales tax applied.  On top of that, schools no longer pay taxes, so education will in fact go down in price.

Government would pay taxes to itself.  

This is true.  Under FairTax, the government would indeed pay taxes.  I don’t like this idea for one main reason, it gives an artificial boost to the FairTax numbers.  Having the government pay money to itself doesn’t create new income.  This is something I think they should fix in the FairTax plan before it gets approved.

All my current post-tax savings would be taxed again.

This could be true.  If you are one of the smart few who have stashed away some cash over the years, your saving could again be taxed.  The only way I can see around this is to pre-pay bills before FairTax went into effect and then re-save the money.  For example, if you have $20k saved, and are making payments on a car, pay off the car and stash the future payments away in the bank, and they become untaxed until you use them.  Or, pre-pay your mortgage.

FairTax would hurt 401K or IRAs.

This is untrue.  401K and IRA’s were never tax exempt, they are tax  deferment  plans.  So you were always going to pay taxes on that money.  The only difference is that you will now only pay when you spend that money.  Another thought about retirees and FairTax is that they will not have to pay capitol gains tax on their homes if they sell them.  In other words, if a retiree sells his/her house and moves into something smaller, and wants to keep the difference in cash, they now wouldn’t pay capitol gains on that money, which is huge.  And of course, they wouldn’t have to invest in silly things to help lower their estate tax for family members before death, since that tax would no longer exist.

FairTax taxes the Internet.

This is untrue.  What is true is that you would now pay a tax for your ISP service, and you would pay taxes on all new goods and services purchased online.  So, for example, you would pay taxes on new books purchased through Amazon, but not used books bought on eBay.  But keep in mind that Amazon, UPS, and the other companies that are part of this transaction would no longer be paying taxes, so look for those prices to be lower.

Summary
I decided to research FairTax because I thought it was an interesting idea, but of course I was suspicious of the downside, admittedly in part because it’s roots lie in Republican soil.  But I reminded myself that I’m financially conservative and that economics is not a place where one party has a clear edge above the other.

What I found after my research is that FairTax is a plan that is not perfect, but way better than the current form of federal taxation.  The simplicity is one of the key selling points. Bringing the tax code down from 60,000 pages to 130 pages means that for once we could all familiarize ourselves with the tax code.  It would likely become a High School requirement that students read the entire tax code and pass a simple test.  Imagine a country where our president could recite the entire tax code, and where the IRS is no longer feared by individuals.

One thing that did surprise me was the amount of pure animosity the plan evokes in some.  I guess like all change, fear and anger are normal initial reactions.  But what I find offensive is the amount of false statements being issued about this plan.  I’m not asking you to take my word for anything, you can read the entire FairTax plan here.  But certainly don’t take anyone else at their word on this either.

A friend who is currently attending SOU brought up the FairTax during a break in her U.S. History class.  She was surprised at how many people were unaware of estate tax and other details about our current tax system.  But her professor had some strong feelings about FairTax and interjected his ignorance by first claiming that a gift tax wouldn’t be applicable unless it was over $750k.  He was adamant about this fact because he had spoken to an accountant.  Well, as you can see here, he is wrong.  The gift tax starts at $12k.  Even more freighting is that he felt the need to correct my friend on her citing of the 16th amendment, claiming that it was the 17th amendment that covered income tax, and that there was a limit on income taxation.  Once again, wrong and wrong.  It is in fact the 16th amendment, and there is no limit on what the government can take out.  It’s safe to assume that the limit is set just below the amount that would cause Americans to take up arms against our leaders.  If you think about the fact that a professor of U.S. History doesn’t even know his amendments, that’s scary enough, but then add to this his claim that he likes our current tax structure because he writes everything off.  How about you, do you like the IRS?

This is a good example of ignorance being the loudest voice in the room.  Ignorance is an easy fix, read up and make your own decisions.

One note about my research.  I found this site when doing research on FairTax.  You can see that the author doesn’t support the plan.  He bashes is all the way through the article.  But note the “update”  on the bottom where the author admits that he was operating under the assumption that only individuals below the poverty line would receive the prebate.  He notes the update, but he doesn’t think that the fact that every American receives thousands of dollars from the government each year is worth re-working his biased article.  More troubling is the level of his miscomprehension of the plan to start with, because if he had understood the plan he would have known there is no way for the government to know a person’s income level . . . there are no filings.  This is another loud voice of ignorance in the way of getting things done.  The world would be a much better place if the ignorant cracked a book.

I will conclude by saying that the word “change”  has been tossed around a lot during the current election.  Being a supporter of Barack Obama (who by the way doesn’t support FairTax, so shoot him a letter if you do), I take change to mean a few things.  A better, more diplomatic foreign policy.  An end to bi-partisan bickering that stops progress.  An end to lobbyists having more input in this country than its citizens.  But I would also like to see a big change in our economy and the ways Americans are taxed.  Please read the plan for yourself and make a decision.  And please leave your thoughts here for others to learn and debate.