The tentative deal over the fiscal cliff did not end the ongoing discussion over the need for Congress to get its fiscal house in order. Among the many issues being debated is tax reform and many House Republicans would like to see the current tax system replaced with a 23 percent national sales tax — also known as the FairTax.
The intended goal of the FairTax system is to eliminate the need for the Internal Revenue Service (IRS) by doing away with many burdensome taxes on the national level. By eliminating all other taxes, everyone — regardless of income — would pay the same consumption-based tax rate.
Sounds fair, doesn’t it? When certain factors are not considered, the tax system is received as ideal reform.
However, those who argue in favor of the FairTax either fail to acknowledge or willfully ignore the fact that the amount high income earners pay for new goods and services, in terms of percentage of income, is significantly lower than what low and middle income households pay.
While it is true that the goods wealthier Americans buy are of higher cost, it doesn’t negate the fact that the FairTax, as a direct tax on consumers, is a severely regressive tax system.
Higher income earners spend, on average, just over sixty percent of their take home on consumer goods and services. Middle income households spend over eighty-five percent of their take home on products and services that would be taxable under a consumption-based tax like the FairTax.
The less a household earns, the higher this percentage is and the more the household would likely be taxed.
In addition, a national sales tax would be added to state and local sales taxes that already exist. It would not and cannot eliminate these taxes because states have a sovereign right to implement their own taxes. So, in many places, people would end up having to pay over thirty percent in taxes whenever they go to the store.
The FairTax website argues that the tax burden would be put in the hands of the individual. The less a person spends on new goods and services, the less that person will be taxed. Not only does the FairTax encourage people to remain within their realistic means, it also encourages people to be thrifty in order to avoid the tax altogether.
However, this inadvertently defeats an important purpose of a consumption-based tax system. Taxing households on consumption rather than income ideally should increase economic activity and lower the amount of activity that doesn’t happen because of the tax. By charging the consumer a 23 percent upfront sales tax, the FairTax system discourages an increase in consumer spending on new goods and services.
Not only does the FairTax not live up to its name and would inevitably fail to achieve its purpose, it would not help in a slow-to-recover economy. If consumer spending remains flat or lowers, businesses will continue to act cautiously, which means the labor market will also not see the dramatic improvement it needs.
There is a need to reform the current tax system, but the debate over what route the nation turns to deserves better consideration than what it is currently getting.