FairTax vs. Flat Tax: Seven Reasons to Support The FairTax
By James M Bennett on 01/23/2013 in Congress, consumption-based tax, FairTax, flat tax, IRS, Sixteenth Amendment, tax reform, VAT tax with 21 CommentsRead Time: 4 - 6 minutes
I “graduated” several years ago from the flat tax to the FairTax and, if you are currently a fan of the flat tax, you should too. This discussion is important because tax reform will take center stage in Congress this spring. The three leading tax reform proposals before Congress are:
- The FairTax,
- A flat-rate income tax, and
- Today’s tax code, but eliminating loopholes and deductions.
Let’s dismiss proposal three. Today’s tax code — even if simplified — remains murky, inefficient, costly to economic growth, and unfair.
President Reagan tried to reform the tax code in 1986, but he was unsuccessful. The code was simpler for a while, but it quickly grew to a new colossus of over 70,000 pages of statutes, regulations, and revenue rulings. Nobody could have tamed it. This is reason number one of seven why I became a flat tax “alumnus.”
First, however, we need a primer on what the remaining two tax reforms are. The flat tax is an income tax with a flat rate of 17 percent on wages, salaries, and business income. Estate and gift taxes go away.
Earlier versions of the bill taxed investment income, but only to businesses. In these versions the FICA/FUTA and Medicare taxes stayed in place. These taxes were eliminated in one of last year’s versions. Businesses can expense out capital goods rather than depreciate them. Deductions that are not “business inputs” are eliminated. To be fair to low-income people, the flat tax features high exemptions.
The FairTax is a bill in Congress with 58 sponsors. The measure repeals all income taxes, both corporate and individual, payroll and self-employment taxes — which are some of the most regressive taxes today — and estate, gift, and generation-skipping taxes.
The FairTax replaces these taxes with a national retail sales tax on consumption of new goods and services, without exception, but once and only once.
FairTax vs. Flat Tax
To make the tax fair, the FairTax features a prepayment from the Social Security Administration to citizens and lawful residents. Based strictly on household size and not on income, the prepayment cancels out tax on consumption of necessities. The FairTax also phases out the Internal Revenue Service.
The flat tax retains the institution of the IRS and can easily morph back into today’s income tax. After the IRS is phased out under the FairTax, the income tax no longer can come back.
Reason number two for preferring the FairTax is related. The flat tax would invite a VAT or a sales tax as an add-on as Congress will certainly cast about for new revenue sources.
The FairTax not only repeals Subtitles A, B, and C of the Internal Revenue Code and phases out the IRS, it also sunsets if the Sixteenth Amendment to the U.S. Constitution — providing for an income tax — is not repealed in seven years. Therefore, both income and consumption taxes are an unlikely result of the FairTax.
The third reason for preferring the FairTax is that it stops taxing exports and reinvested earnings. The FairTax lets the economy grow. The flat tax imposes a tax on both these items.
Additionally, the FairTax captures the shadow and underground economy. Criminals and undocumented non-citizens have to buy food, shelter, clothing and medicine, and the FairTax taxes these groups when they consume these items. The flat income tax does not.
The FairTax also helps governments control their spending. Based on consumption, the FairTax has a more stable and growing revenue base than the flat tax has. Revenue rises less in times of economic expansion and curbs the appetite of governments to spend. Revenue then falls less in times of recession, when demands on social services increase.
The sixth reason for preferring the FairTax is related to the last reason. The FairTax helps Social Security and Medicare in two ways:
- By stabilizing and growing revenue streams.
- The FairTax helps workers by eliminating the payroll tax.
The final reason speaks to those politicians who contend the flat tax is easier to do. It isn’t. The flat tax, albeit for worthy reasons, hands detractors the argument that it is a tax break for the rich. The flat tax taxes wages but leaves investment income and estates alone.
Other flat-tax critics bewail the loss of favored deductions, such as the mortgage interest deduction. For that reason, the National Association of Realtors opposes the flat tax but is neutral on the FairTax.
For those seven reasons, I “graduated” from the flat tax. So have fifty-eight members of Congress by last count.
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21 Comments
Lucas Eaves
01.23.2013
@lucaseaves
Good arguments. I still have not made my mind on that issue.
Alex Gauthier
01.23.2013
@alexg
i think its best to look at what direct impacts each tax structure has on the individual. In terms of acting in my own self interest, any system whereby I’ll pay less in taxes is preferable.
William Payne
01.23.2013
Considering your third reason, I would add that, by taxing illegals; the shadow and underground economies (pimps, pushers, prostitutes, etc) as well as visitors to the USA, the Fair Tax broadens the tax base to include 70 million new taxpayers, thereby lightening the load on the rest of us. Everyone pays, so everyone pays less. As Mr. Bennett says, the flat tax ignores those potential taxpayers, requiring the rest of us to pay more.
Shawn M. Griffiths
01.23.2013
@shawntx
Some economists argue that the FairTax would benefit from being a Value Added Tax (VAT) because the current plan under the FairTax places the full tax burden on the consumer, while a VAT would collect the same rate, but over different steps throughout the sales chain (manufacturer, wholesaler, retailer) and would place little burden on the consumer. This would also limit any kind of fraud that could occur under the FairTax since all steps are held accountable.
The FairTax also can’t eliminate sales taxes on state, county, and/or local levels. So, you add the 23 percent national sales tax on whatever sales tax people already pay because state and local governments have a right to implement their own taxes, which would further discourage an increase in consumer activity.
Taxing based on consumption rather than income is a preferred route, but we need to look at the options for effective tax reform.
The FairTax is still a regressive tax system even if you include the prepayment, because of the huge gap between how much higher income households spend on consumer goods and services in terms of percentage of income and how much middle and low income households spend in terms of percentage of income. This is a direct tax on the consumer so that is an important point to consider. The prepayment wasn’t fully explained and it sounds like something that could easily be manipulated.
One of the main talking points for FairTax advocates is that the tax burden is put in the hands of the consumer. If people don’t want to be taxed that much then they can limit how much they spend on NEW goods and services, which means they will turn to used goods and resold goods. The tax encourages people to be frugal and only spend on necessities, which, based on family size, would be exempt under the prepayment.
The purpose of the FairTax is to encourage economic activity, but it doesn’t because people are not going to want to spend over 30 percent (depending on where one lives) on taxes when they go to the store.
James M Bennett
01.24.2013
@jbennettatty
A VAT would be arithmetically the same as the FairTax and place the same burden on the consumer, except that mark-up during the interim steps would tend to be higher with a VAT. Interim sellers tend to base mark-up prices on the tax-inclusive price to them. The FairTax requires all business to register and thus has the same anti-fraud controls built into it as a VAT.
The argument about state and local sales taxes is a diversion because state and local sales taxes exist already (except in five states). In the case of New Jersey, there could actually be a state-level FairTax replacing current taxes (including the current sales tax), and the rate would go down from 7% to 5.52% due to expansion of the base. The federal FairTax legislation gives states a mild incentive to enact “conforming state taxes.” States would probably enact mini-FairTaxes on their own because states tend to base their system off the federal system.
If you accept the premise that savings represent deferred gratification to the saver and economic benefit to society, the FairTax is very progressive. Those at the lower and middle segments of the economic spectrum benefit disproportionately from the FairTax.
Two different economic models indicate that consumption under the FairTax rises over baseline no later than Year Three despite the relative incentive to buy used goods. One model makes the increase in consumption immediate as the efficiencies of consumption taxation take hold.
Shawn M. Griffiths
01.24.2013
@shawntx
I wouldn’t say the state/local sales tax argument is a diversion, because there is no guarantee states will adopt a “mini-FairTax.” In fact, I would wager that most states wouldn’t unless the federal government offered one hell of an incentive. “Mild incentive” doesn’t sound encouraging.
I am sure you are aware of the dead weight principle. A tax is considered to have more dead weight the more economic activity is not occurring because of the tax. This is why a consumption-based tax is considered to be ideal because, in theory, a consumption-based tax should have less deadweight than an income tax. That is the goal.
However, when you place such a high direct tax on consumers its counterproductive because people don’t want to pay the tax, so they will look for ways to avoid it. It essentially promotes a grey economy. That is until companies stop selling used, refurbished, or resold goods and then people will cut back as much as they can thus not contribute.
What agency are businesses registering with? What agency is monitoring this to make sure fraud is not occurring. The FairTax wants to eliminate the IRS, so that is gone. What measures are in place to counter fraud? Under the VAT, you eliminate essentially all the taxes you would under the FairTax, but likely keep an agency like the IRS because each link in the sales chain has to submit paperwork. Since each step is held accountable by the other steps it provides better safeguards against fraud than the FairTax.
We both argue for a consumption-based tax system. We just disagree on application of such a system, because I believe the FairTax would be more practical as a VAT.
James M Bennett
01.24.2013
@jbennettatty
The adage that you get less of what you tax is generally correct, and a consumption tax without offsets is a deadweight. However the deadweight is offset by the relief from income and – more importantly – payroll taxes. If the average effective tax rate on taxable income is 13% (a blend of the 10% bracket and the 15% bracket), and if prices under the FairTax rise on average, once-only, by 12.5%, the typical American who works gains 12% in purchasing power.
Evasion under the FairTax is less of a problem for several reasons. First, collection points decline by 90%. Second, cheating under the FairTax requires collusion by a willing seller and a willing buyer. Third, most retail sales in the United States are from large chain stores, where evasion would be unlikely. Fourth, voluntary compliance rises, and good-faith errors decline, because the FairTax is understood and perceived as fair. Finally, the registration of all businesses, whether or not in retail, provides an audit trail to make it difficult for retailers to cheat. Eventually people buy new stuff and pay the tax.
The federal FairTax is administered by state sales tax authorities where states agree to enter into a compact with the federal government. States with no current sales tax can enter into a compact with a sister state. States choosing to do neither sit back, and the federal government goes in and sets up the infrastructure.
State sales tax authorities receive 25 basis points for TIMELY remitting tax to the newly-created federal Sales Tax Bureau. Merchants, by the way, also receive 25 basis points for their trouble if they remit tax collections TIMELY to the state sales tax authorities. Thus, the administration of the tax before it reaches Uncle Sam costs half a percent, but it is far more efficient than an income tax.
You are right. Whether a state chooses to have its own state-level FairTax is its business. The equalizer comes about because states that choose not to lose out to states electing to have a state-level FairTax.
JJ
01.25.2013
The VAT system you advocate for is worse than a Fairtax because for some reason you seem to think a consumer will cease buying because of a high Fairtax rate, yet not in your scenario where goods are taxed VAT on every level of production, resulting in a much higher price of goods for everyone. People stop consuming at price levels, not tax rate levels, so it makes more sense that goods will sell better at a lower price post tax, but at a higher Fairtax rate rather than a lower VAT tax processed at every step.
Eugene Patrick Devany
01.23.2013
In 2010 total individual income in the U.S. was $12.5 trillion. The federal individual income tax produced $898 billion and the combined 15.3% payroll tax generated another $865 billion (Social Security and Medicare). Tax revenue from the income base was 14.1% of total income. Typical wage earners below the $110,000 payroll tax limit pay the 15.3% payroll tax plus about 10% more in income tax. If workers all pay above the 14.1% average, high earners pay much less.
The $1.3 trillion in annual tax expenditures is greater than the amount collected by the income tax (and exceeds twice the total net wealth of the poorer 50% of the population). Because an elimination of even 15% or 20% of the tax expenditures would cause the affected high earners to pay two or three times their current tax liability, real tax reform cannot be achieved with the simplistic logic of cutting the tax expenditures to lower the rates. It also explains why the well-to-do would oppose a flat 14.1% tax for all if it meant giving up all tax perks. A true tax rate on income well under 14% is needed to justify elimination of all tax expenditures.
It is time to broaden the tax base with a tax blend. A “revenue neutral” 2% net wealth tax (excluding $15,000 cash and retirement funds) could replace the job killing payroll taxes, fund Social Security and enable an income tax rate of just 8% for all (because no tax break for anyone can be justified at an 8% rate). Read more at TaxNetWealth.com
James M Bennett
01.24.2013
@jbennettatty
Interestingly, the FairTax does exactly what you call for. It broadens the tax base by eliminating “tax expenditures,” and it gets at wealth because wealth is spent when consumed. It replaces job-killing payroll taxes and funds Social Security from a stable and ever-expanding tax tax base. One of many benefits of the FairTax over income taxes is that the FairTax eliminates uncertainty and discussion about the identity of the tax base and the timing of the taxable event, which would still remain, even with a no-deduction income tax.
John Linder
01.24.2013
This is one of the better explanations of the FairTax I have seen. The responses indicate that people are becoming better informed. Thanks!
V. Kroon
01.26.2013
I am curious about the Fair Tax will mean, if enacted, for persons who have 401k deferred income. Will this become a windfall for them? If so, this could be a huge boost for those in retirement or about to retire, taking some of the pressure off some of the social security reform proposals to extend the age of retirement to 70.
James M Bennett
01.27.2013
@jbennettatty
The FairTax actually would be a windfall to people who have accumulated 401k assets under the present system. Under the 401k plan, people contribute pre-tax dollars to a retirement account, which grows tax-free. Tax is paid under the current system when withdrawals are made at retirement,whether from corpus or income, when presumably the retiree is in a lower tax bracket. Under the FairTax there will be no income tax to pay, so that particular group will benefit during the transition.
Daniel Dyer
01.27.2013
You won’t have to calculate or report your federal tax
When the FairTax Act of 2013 (H.R.25/S.122) is enacted,
the FairTax will be the only federal tax you pay.
You won’t have to calculate or report the tax;
the retailer you buy from will do that, just like state sales taxes.
The IRS and 72,000 pages of tax code will go away.
The government won’t have to know whether you’re rich or poor;
it will send every household enough to pay the tax at the poverty level.
It will treat everyone the same; everyone will pay something.
The company you work for will not pay taxes. Its costs will go down.
You’ll keep your full paycheck.
Companies will bring jobs back to the U.S. and sell more overseas.
The economy will grow and benefit everyone.
….Learn 63 reasons for the FairTax at… http://www.youtube.com/watch?v=e8Gbm7uij4E
Mark Curran
01.29.2013
@markdc
To figure your fairtax fed tax obligation, use your calculator. List your taxable consumption. Do you know what your taxable consumption would be? Everything except tutition, and used products, essentially. All your consumption is taxed. Literally all consumption. Did you “consume” surgery or medical cost, paid by insurance or medicare? Guess what, the person using or consuming the goods or services is personally liable. Add all your consumption up, 30% of that is your fed tax.
Plus — they have th ose massive other taxes, w hich they admit, in fine print, that they “assume” your city county and state taxes will have to “rise appropriately” or “sufficiently” to to pay for the tax on city county and states.
Go on, all up all your consumption. Add up the increase they say will happen, on all state and local levels. Then, get back to me
James M Bennett
02.02.2013
@jbennettatty
Mr. Curren left out a few deductions from consumption which are not taxed under the FairTax, namely:
1. Total annual amount paid out for loan payments, including both principal and interest. (include existing mortgage, auto, and all other loan payments.)
2. All annual tuition payments made for education for any age, any level. Include annual student loan payments here.
3. The annual amount of all funds deposited to any savings account or retirement account through a government plan, through your employer, or privately, and all funds used to purchase any stocks, bonds, business, or investment vehicle of any kind.
4. The annual amount of all funds you have donated to any church, profit or non-profit charity or organization, or given to any individual through a gift, inheritance, donation, or court order, including child support.
5. The estimated annual amount of all taxes paid to any State, County, City, Municipal, Township, and other local governments. Include state income and sales taxes, property taxes, school district taxes, deed transfer taxes, occupational taxes. Include both State and Local taxes paid throughout the year, through payroll deductions and estamate those paid on your own, such as sales taxes.
6. Annual estimate of funds spent on purchases of used items (jewelry, clothes, used real estate, used cars, used furniture, antiques, etc.).
Medical expenses, including surgery, are subject to special rules. The FairTax over time actually makes medical care less expensive, more available and more affordable.
We undertook a calculation of state and local taxes, which are significant in New Jersey. New Jersey leads the nation in that item. Property taxes would rise 5 1/2%, one-time only, as a result of the FairTax. Most people would see more than an offsetting increase in income. And local governments would behave more responsibly because they can no longer give their residents a federal tax deduction.
Kurt Hanson
02.02.2013
The FairTax is an idea whose time has come. The current system is a relic and a monstrosity of complexity that hurts economic growth. Under the FairTax we would no longer have the IRS to threaten us.
Daniel Dyer
02.09.2013
For 63 reasons for the FairTax, go to
Andre King
02.26.2013
When I served in the military (early 90′s), I heard amateur “policy wonks” talking about the “Fair Tax”…back then, they called it a “Consumption Tax”. Generally, all I needed to do to shoot down the flat tax was to tell the truth about it, which is that it’s regressive…the less money you have, the higher percentage you pay in taxes…this, of course, is preferred by greedy bastards who just want more and more…
On to the “Fair Tax”…there are so many problems with it that it might as well be the “No Tax” plan. This “prebate” check, from whomever is supposed to send it, is pure nonsense. It’s based on the size of the household and not on income. Allegedly, the “Fair Tax” will not penalize the poor and middle class and would tax the rich more….ha! If you’re not going to base the “prebate” on income, how can you guarantee that rich people can’t “game” the system to pay little or no taxes?
Seriously, people….if you can’t legitimately answer a fundamental question about how the “Fair Tax” would work, it doesn’t matter how many charts you put up.
The only reason that our current tax system is regressive is because of the Republican Party and GW Bush rammed through tax cuts and loopholes (TCLs) for the wealthy and big corporations in the biggest upward redistribution of wealth in world history. From 2001 to 2012, wealthy Americans and big US corporations were able to use those Bush 43 TCLs to avoid paying taxes on $33 trillion of income. Without the Bush 43 TCLs, the federal government would have realized $13.1 trillion in tax revenue. The increase in the national debt from 2001 to 2012 was $11.5 trillion, but the Bush 43 administration is on the hook for all of it because of the continuation of those Reverse Robin Hood Bush 43 TCLs….The two wars that were unpaid for didn’t help, either. If this upward redistribution of wealth and power to the wealthy and big corporations continues, there’ll be nothing left for those greedy bastards to “get” except revolution…
It is said that “those who don’t know of history are doomed to repeat it”. The GOP need to be smart enough to realize that the upward redistribution of wealth and power has been done before, usually to violent results. When the French monarchy and elites did this, it led to the French Revolution. Not only did those greedy bastards in France get a revolution, they got their heads separated from their bodies via guillotines. I’m not advocating that but the US revolution could be similar to the recent Icelandic Revolution. Icelanders noticed that greedy banksters were redistributing wealth and power upward and that corrupt government officials were helping (are you listening, GOP?). The Icelanders arrested them and are trying and convicting them. Elitism and greed can be dealt with by several means. Abolishing the upward redistribution of wealth and power is the best way to avoid revolution.
(full credit for this is given to a friend of mine, who shall remain nameless; that person has sources that confirmed the $33 trillion, $13.1 trillion and $11.5 trillion figures mentioned above)
Tom
04.02.2013
If you “graduate” one more time, you will arrive at The Neutral Tax. The Neutral Tax (www.neutraltax.com) lets the states set their own tax policy (Fair, flat, progressive, etc) and then the federal government gets a fixed percentage of the gross revenue from each state. This ends the IRS and puts complete control of tax policy into the hands of the states. The problem with implementing tax policy at the federal level is that is by definition monopolistic, thus it is best to keep that level very simple and let all the real tax policy debate happen at the competitive state level. If you implement the FairTax at the federal level, it will start at 23%/30% and only go up from there. States would have an incentive to lower tax rates over time to compete with other states (and in the process make the US hyper competitive internationally). NOTE: We’ll be on the IVN Tweetchat this Thursday to go over any questions people may have about The Neutral Tax.
Mike
05.18.2013
The author of this article fails to take into account that if properly implemented a Flat Tax is not only easier and fairer but would virtually eliminate the IRS by severely cutting personnel and paring down it’s responsibilities to just a few. The Fair Tax may tout that the IRS would be abolished but no matter what you call it, some government agency has to be in charge of collecting taxes. the Flat Tax should be automatically deducted from our payroll checks. If this is called a “Payroll” tax then so be it. This will insure that individuals will always be current with their taxes. If you allow the individual to be in control of their own taxes most people will overspend and not be able to pay their taxes. The Flat Tax should tax all income including capital gains or any other investment income. It should abolish estate taxes and inheritance taxes. Additionally, the argument that the fair tax would “capture” the shadow and underground economies is the main reason most people support the Fair Tax. But let’s be honest, the income on illegal transactions would amount to a fraction of the legally generated income. The criminal element and corporate interests (one in the same?) will always find a way to circumvent the government’s regulations. The income of undocumented workers is a function of the employer and the employer should be held accountable for collecting and submitting the taxes on undocumented workers’s income. Again, if properly implemented, the Flat Tax could and should prohibit the addition of VAT’s. Also, the author claims export and reinvestment income would not be taxed under the Fair Tax. Why not? Income is income and should be taxed accordingly. Claiming that economic growth would be stifled by the Flat Tax by taxing these revenues is misguided. Our economy has crashed and soared under the existing tax code and will continue to do so regardless of which tax system we implement. Finally, the Flat Tax is the fairest tax because all people will pay the same percentage on their income regardless of how much they buy. But each of these systems are dependent upon government curbing it’s spending and eliminating needless and redundant programs. Programs should also be eliminated or downsized based on a simple cost/benefit ratio template. But none of this will occur if the American people don’t unite and rise up against the current tax system.