Debunking the Major ‘Pitfalls’ of the FAIRtax

IVN readers need to hear the other side to the article, 3 Pitfalls of the Fair Tax Proposal, published by David Yee on April 16. By way of background, the FAIRtax® is a bill in Congress with 74 sponsors that repeals Subtitles A, B, and C of the Internal Revenue Code and phases out the IRS over a three-year period.

That last feature should be welcome news for those of you who just filed tax returns and did not receive a refund. Tax collection devolves to the states.

Subtitles A, B, and C are business and individual income taxes, payroll and self-employment taxes, and estate, gift, and generation-skipping taxes. The FAIRtax® replaces these taxes with a national tax on all services and new tangible goods sold at retail to a consumer in the United States.

There is no business-to-business tax. There are also no exceptions, thus tapping the shadow and underground economies for the first time through purchases of food, clothing, and rent.

To assure that no one pays tax on consumption of essentials up to the poverty level, every household whose members are lawful residents of the United States receives a tax-cancelling allowance from the Social Security Administration. This so-called “prebate” reimburses the household for tax on consumption up to the poverty level — as determined by HHS.

There is no income-measuring or means testing. The government is now out of the income-measuring business. Because of the absence of means-testing, people who work to improve themselves are not penalized.

Now to Mr. Yee’s arguments. Mr. Yee points out correctly that the tax-inclusive FAIRtax® rate of 23 percent is not the way in which sales taxes are normally expressed. Expressed tax-exclusively, the rate is indeed 29.87 percent.

In other words, if a pencil at Staples® sells for $1.00, 23 cents of the price, or 23 percent of the dollar, is the tax, and 77 cents of the price, or 77 percent of the dollar, is the pre-tax cost of the pencil. The law requires both the cost of the item and the tax to be shown on the sales slip. If we take 23 cents as a percentage of 77 percent, we get 29.87 percent.

So why is the rate expressed tax-inclusively? How are income, payroll, and estate taxes expressed? That’s correct, tax-inclusively. It’s not that difficult.

Mr. Yee’s larger argument is that the FAIRtax® imposes a higher marginal rate than today’s tax code. Compared correctly, a 23 percent tax-inclusive rate compares favorably with the combined marginal rate most people pay on their salaries if we include the FICA tax — 7.63 percent employee share, 15.3 percent combined.

Remember that employers pay 7.63 percent in addition to what they pay you in order to employ you. And you still owe income tax if you make more than the exemptions and standard or itemized deductions.

Why is the FAIRtax® rate relatively low? Because it has a larger tax base than income and payroll taxes. If the FAIRtax® is measured by average remaining lifetime tax rates instead of year-over-year income, the gain in well-being to people at the lower end of the spectrum over people at the higher end of the spectrum becomes stark.

Year-over-year income is often a poor proxy for economic well-being because it does not consider, for example, the welfare loss from earning the next dollar and losing the Earned Income Credit. Year-over-year income does not consider the tendency of people to smooth out consumption over their lifetimes, the effect of going into savings or debt. Finally, year-over-year income does not consider voluntary consumption of wealth.

Mr. Yee goes on to argue that the FAIRtax® would put American families one medical calamity from financial ruin. Indeed this is the case today, even with the Affordable Care Act. Under the FAIRtax®, tax is payable on health insurance premiums, whether paid by the employer or by the individual. But the medical service covered by insurance does not again pay tax because the tax was already paid with the premium.

But there is a larger argument. Why is medical care in America so high today? Why does medical care bankrupt families? One of the answers is the overutilization of medical services due to insurance. When you go to the service station to fill up your tank, does the attendant ask for your automobile insurance card? Of course not! If routine visits to the gas station were partially covered by insurance, gasoline would be guaranteed to cost $30 a gallon.

The FAIRtax® equalizes the tax treatment between employer-provided health insurance and individually-purchased health insurance.
What areas of medicine have gone down in price and become more available? If you said cosmetic and LASIK surgery, you would be correct. Notably, these two areas of medicine are generally not covered by insurance.

So what does this discussion have to do with the FAIRtax®? The FAIRtax® equalizes the tax treatment between employer-provided health insurance and individually-purchased health insurance. This equalization gives individuals incentive to participate more meaningfully in the cost of their own health care. People become better consumers of health care services. Over time, the cost of health care comes down — as it did with cosmetic and LASIK surgery.

Finally, Mr. Yee criticizes the Sunset Clause of Title IV of the FAIRtax® bill. This provision was added for good reason. To impose a consumption tax without eliminating income, payroll, and estate taxes would bring about an economic tsunami.

Congress and the states react more readily to pressure than to inspiration. If Congress and the states are threatened with a cutoff of funding, they would be more likely to act and repeal Amendment XVI (that allowed the income tax without apportionment). The provision is by design.

Mr. Yee mentions President Bush’s Advisory Panel for Tax Reform, which did not look at the FAIRtax® at all. It disregarded government consumption in making its observation about the rate, and it disregarded the “prebate” when it discussed fairness.

Analyzed correctly, the FAIRtax® is actually more progressive than today’s income and payroll taxes, and it addresses Mr. Yee’s perceived “pitfalls.” In addition, the FAIRtax® is transparent, efficient, conducive to economic growth, neutral in application, and is not intrusive.

 

Photo Source: FAIRtax® / Facebook