Various FairTax Position Papers
** These represent unofficial analysis by various FairTax volunteers **
Position Papers by
Rebuttal To a Critical Review by Laurence Kotlikoff
Answers to Critics by FairTaxWarrior
The FairTax replaces all the revenue from current income and payroll taxes with a rate of just 23% on new goods and services. If you think that’s too high, you are probably in much higher tax brackets today; it’s just hidden from view. In fact, lets look at an example.
Assume you’re a average family earning $50,000 with 2 children. Your house payment is $850 a month, $700 of which is for interest. You have two cars with total payments of $400 a month. You pay $200 a month of your employer provided health insurance premium and you contribute $5,000 (10%) to your 401-k. You tithe an additional 10% ($5,000) to your church.
Your total taxes for 2003 would be $5,104. (An effective tax rate of 10.2%).
This includes your portion of federal payroll taxes but not your employers. It also does not include the hidden cost of taxes embedded in the prices of all goods and services purchased today. Adding these costs would raise your effective tax rate to over 20%!! (Assumes 10% embedded costs)
Professor Dale Jorgenson, former chair of Harvard’s Economic Department, estimates total embedded costs of the current system of taxation averages 22% to 25%.
Under the FairTax, your entire $50,000 would be free from federal taxation, your current home and car payments as well as your 401-k savings and charitable gifts would not be taxable. The prebate would prepay taxes for you up to the poverty level of $24,240. When added to the non-taxable spending detailed above, your effective tax rate would be .45%! (less than ½%).
Even if you bought 2 new cars and a newly built home subject to the FairTax, your net taxes would only be $4,897 for an effective tax rate of 9.79%!! (Assumes same payments and average implicit mortgage interest fees – May 2005).
And remember, the FairTax abolishes all hidden taxes! Other tax reform plans claim to have lower rates, but keep payroll taxes of over 15% and actually increase the federal taxes hidden in the prices of things you buy. When you count all taxes, no tax plan has a lower rate than the FairTax.
The FairTax is a consumption tax, i.e. a national retail sales tax on all new (not used) goods and services sold at retail. Taxes are paid only when someone purchases something (except education and charitable contributions -- education is an investment in human capital and not taxed, and contributions are not consumption but giving).
All businesses that sell goods and services at retail (whether they are sole proprietorships, S corporations or C corporations) will be required to charge sales tax on their retail sales. They will have to register as sellers and report taxable sales and sales tax collected (to the state sales tax authority who will administer the FairTax) on a monthly basis.
Business to business sales (or the purchase by business of inputs necessary to produce, render, sell etc a good or service) are not taxable. With a consumption tax, as the FairTax is, you don’t tax intermediate sales. Why? To keep taxes from being embedded in the retail price of goods and services, and then having the national sales tax be a tax on a tax. This is for the benefit of the consumer – to make sure there are no hidden taxes increasing the sales tax that they pay.
The text of the bill states:
PRODUCE, PROVIDE, RENDER, OR SELL TAXABLE PROPERTY OR SERVICES-
`(A) IN GENERAL- A taxable property or service is used to produce, provide, render, or sell a taxable property or service if such property or service is purchased by a person engaged in a trade or business for the purpose of employing or using such taxable property or service in the production, provision, rendering, or sale of other taxable property or services in the ordinary course of that trade or business.
Here are the provisions to make sure that only bonafide business purchases are exempt from tax.
1) To qualify as a purchase for business purposes the item has to be used at least 95% for business purposes (i.e. it allows for incidental nonbusiness use). If the item does not meet this criteria, then the transaction is taxable, and the provision for mixed use (business and personal use) applies. This provision allows the business to apply for a credit of the sales taxes paid on the portion of the property that is used for business purposes.
Mixed use property or services are taxable property or services purchased both for taxable use or consumption and for a business purpose. An example would include a home office or a car used for both business and personal purposes. Mixed-use property or services are subject to the FairTax unless said property or service is used more than 95 percent for business purposes during each calendar year (or portions thereof) it is owned. The purchase of the property is taxed but a registered seller is entitled to a business use conversion credit. This credit is equal to the mixed-use property amount times the business use ratio times the FairTax tax rate. Example: A sole proprietor spends $30,000 (including tax) for an automobile that he or she uses 80% for business purposes and 20% for personal purposes. This person would be entitled to a business use conversion credit of the price including FairTax times 80% times 23% ($30,000 x .8 x .23) or $5,520.
There are detailed and, unavoidably, somewhat complex rules for calculating these amounts. For example, the mixed-use amount and the business use ratio are calculated differently for real property, tangible personal property, and vehicles. A person entitled to a credit amount for mixed use on a calendar basis may file for the credit in any month following the calendar year giving rise to the credit. These rules are, however, simpler than income tax rules governing the same problem. Those who wish to avoid the application of these rules would need to not use property for both business and personal purposes.
2) There is also an anti-tax avoidance provision in the FairTax to prevent businesses from buying personal consumption items on behalf of their employees to escape taxation. If a business buys taxable property and services for its employees that would have been taxable if the employees purchased the taxable property and services directly, then the FairTax is still due. The employer/business would be responsible for remitting the tax. In addition, to prevent employers from providing huge employee discounts to avoid taxation, the FairTax treats employer provided employee discounts over 20 percent as taxable. Again, the employer would be responsible for the tax.
3) In order to qualify to purchase items tax free for business purposes, the person/business will have to be registered as a seller and will be liable for reporting taxable sales and sales taxes collected from customers each month. They will also be subject to audit by the state sales tax authority. To make tax-free purchases, they will have to have their tax-exempt certificate on file with the vendor and make the purchase through a “wholesale register”. This will be a supplier who only makes sales to other businesses or through a register at a retail outlet through which only business to business sales are conducted. For example, if a business only was to purchase a business item through Wal-mart and didn’t want to pay the tax, they would need to have their tax-exempt certificate on file at that store and make the purchase through a register set up only for wholesale transactions. Otherwise, the business would pay the tax upfront and file for a tax credit.
Keeping business sales separate from retail sales starts an easy to follow audit trail. Keep in mind that all the records the IRS uses today to verify income tax reports (purchase records, inventory reports, sales receipts, bank records, etc) will still be available for verification under the FairTax. But businesses will no longer need to file all the complex annual reports connected to the income tax system with the possibility of being penalized for making a mistake. By contrast, the FairTax is extraordinarily simple.
How about small service businesses? First, the FairTax has deminimus provisions that remove any person with sales under $1,200 from the FairTax. So we aren’t concerned with a teenager mowing lawns during the summer or baby-sitting for neighbors. The first thing to always consider is how the current system addresses a certain group. The FairTax should not be compared with an impossible ideal, but with the current system.
Currently, small service businesses are often paid in cash. The customer has no way or knowing whether or not that cash is reported as income by the business owner. Basically, it only takes one to cheat the system. With over 130 million points of collection under the current system, the audit rate is less than 1%.
Under the FairTax, even if the business owner takes cash, it will be clear to every customer whether or not the business owner is collecting the tax. Every customer becomes a potential witness against the business owner if he is cheating on the collection. Consider also that competitors will likely know if a business owner is cheating since they will not be able to compete on price. As the competitor tries to obtain business, one of the customers are very likely to mention this fact and the business owner in short order will be audited.
Whether we are looking at taxation from an individual or a business perspective, their will always be those who attempt to cheat, no matter how simple the system. Most Americans though are honest and have no problem paying their “fair” share. That is part of the problem today. The tax system is too complex. There is a sense that the “other guy” is not paying their “fair share” because the tax system has divided us into hundreds of special interest. The odds of getting audited are small and therefore the reward is worth the risk.
Under the FairTax, the system is very visible and straightforward. We will be moving from 130 million points of collection to about 14 million so the risk of audit for those collecting the tax will be much greater. There is no personal reason for a business owner not to collect the tax from their customers, as there is no personal savings to them, only to their customer…and they would be taking the risk of sanction and penalties if they did not collect it.
Will there be some who attempt to cheat the system. Absolutely! There is no perfect system, But with a greater sense of fairness, less complexity, simple audit trail, less reward for cheating and greater risk of audit, the compliance rate under the FairTax will be much greater than under any form of income tax.
The Fair Tax plan is the only proposal that completely untaxes the poor. Our income tax system today seeks to add progressivity by personal exemptions (which have failed to keep up with inflation), by the earned income tax credit (which is ripe with fraud), by steeply progressive rates (which punish those that have fluctuating income or who are trying to improve their lot in life). But the poor and middle class pay heavily in four ways.
· The poor and the middle class today pay regressive payroll taxes targeted solely at “wages” (sweat equity), the means by which those without personal wealth earn income. Payroll taxes are 15.3% on the first dollar of wages, up to about $90,000; thereafter, the payroll tax rate drop to 2.9 percent.
· The poor and the middle class pay significant income taxes, despite personal exemptions and standard deductions. For example, a single person will pay at least a 10% rate for each dollar earned beyond $8,200 in taxable income.
· The poor and the
middle class pay hidden taxes when they buy any good or service. That is because taxes imposed upstream are
buried in the price of
· The poor also pay because the tax system today stifles upward mobility. It does so by: (1) taxing wages heavily and regressively, (2) by imposing steeply progressive rates if one chooses to work harder, (3) by taxing savings and investment twice or three times, and (4) by confiscating a family’s income before they have determined whether to spend or save.
· Because programs such as the EITC are steeply phased out as incomes rise, the marginal tax rates on the poor with children can be higher (47%) than that of the richest Americans (35%)
Our tax system should be based on the “ability to pay.” One must be able to attend to their own needs before the government burdens them in taxes. The Fair Tax untaxes the poor by:
· Repealing the regressive payroll taxes.
· Repealing upstream taxes hidden in goods and services.
· Providing a monthly rebate in advance equal to 23% times the HHS poverty level so that no one pays taxes on the necessities of life.
· Giving people ultimate choice over their destiny – save and don’t pay taxes or spend and pay taxes.
· Stimulating economic growth – the poor are the first to be laid off in bad times and the last to be rehired.
The Fair Tax “rebate” allows one to consume tax free up to the poverty line. As an example, a family of four’s poverty limit is 25,660 in 2005, meaning that the annual rebate would be $5,902 under the AFFT Fair Tax plan. Only when an individual or household consumes beyond the Health and Human Services poverty limit is the tax applied.
Many people say they favor the income tax over the FairTax when it comes to home interest deductibility. This is due to a misunderstanding of the advantages under the current income tax system. There are four main components to examine in comparing the two tax systems as they pertain to home ownership: Principle payments, interest payments, capital gains when sold, and the current and future value of the home. Let’s look at each separately.
Income Tax: Principle is paid with after-tax dollars and is not deductible
FairTax: Principle is only taxed if it is a new structure built for non-business use
New homes are treated equally under both the income
tax and the FairTax while the principal of existing housing is not taxed
under the FairTax. ADVANTAGE: FAIRTAX
New homes are treated equally under both the income tax and the FairTax while the principal of existing housing is not taxed under the FairTax.
Income Tax: Interest is deductible, however to take the interest deduction you must itemize (only 27% of Americans take a home mortgage interest deduction). To itemize you must give up the Standard Deduction, which was $10,000 in 2005 (married couple filing jointly). This means the net gain from the mortgage deduction is the interest paid minus the Standard Deduction. Other itemized expenses may help raise the level of deductibility, but the net is always the total itemized expense minus the Standard Deduction. One must keep many records and receipts when they itemize as they increase their chances of being audited.
As an example, assume an average homeowner has a total mortgage payment of $15,000 a year ($1,250 a month). The interest portion of the payment is $11,000 and they have no other expenses they can itemize. To claim the $11,000 interest expense, they must remove the Standard Deduction of $10,000 (2005) and their net gain in deductibility is $1,000. Although some homeowners may have interest expense in excess of this, (expensive homes, multiple homes, etc.) they then start running up against the AMT. They also have accountant and record keeping fees.
FairTax: Interest is not a taxable expense, whether the home is new or “used”. Non-taxable interest payments beat tax-deductible interest, as there is no reporting necessary. The entire interest in not taxed (any implicit services charges would be taxed) and you don’t have to give up the rebate to receive the benefit.
Under the income tax, interest is only deductible if
you itemize and then, only to the extent it (and other itemized items)
exceeds the “standard deduction.”
Interest is never taxed at any level under the FairTax and you don’t
lose the rebate. ADVANTAGE: FAIRTAX
Under the income tax, interest is only deductible if you itemize and then, only to the extent it (and other itemized items) exceeds the “standard deduction.” Interest is never taxed at any level under the FairTax and you don’t lose the rebate.
CAPITAL GAINS ON RESALE:
Income Tax: When a home is resold, the seller may exclude up to $250,000 of the gain from the sale of their primary residence if they have lived there at least two years. The exclusion is $500,000 for a married couple. Once again, there is still the record keeping and reporting expense.
The new purchaser on the other hand must pay the principle of the home they just bought with after-tax dollars again. This essentially amounts to double taxing the same gain on the property (capital gains to the seller and income tax to the buyer). In effect, the TOTAL home value is taxed again and again on resale as the principle is always paid with after-tax dollars.
FairTax: Used property is not taxed, so regardless the amount of the gain, there will be no tax to the seller or the buyer.
Just like with the principal, under the income tax,
there is a tax deduction sometimes, under certain circumstances (that are
always changing), and you must report to the Government to get it. Under the FairTax, it simply is not
taxed. ADVANTAGE: FAIRTAX
Just like with the principal, under the income tax, there is a tax deduction sometimes, under certain circumstances (that are always changing), and you must report to the Government to get it. Under the FairTax, it simply is not taxed.
Home Values: The cost of new construction will be reduced (accordingly to the research paper, up to 25%). To the point that after tax prices of new homes would increase, existing home owners will enjoy additional capital gains as the values of those homes adjust. Other changes in the economy will work to increase both home values AND home affordability simultaneously, such as:
Increased take-home pay
Lowering of Home Interest Rates
Increased time and freedom (no compliance efforts)
Every study has shown
increased productivity, economic growth and job opportunities under the
FairTax. When combined with lowered interest
rates and the removal of embedded cost, this empowers more Americans into
home ownership. ADVANTAGE: FAIRTAX
Every study has shown increased productivity, economic growth and job opportunities under the FairTax. When combined with lowered interest rates and the removal of embedded cost, this empowers more Americans into home ownership.
Standard Deduction vs Fairtax Exclusion:
Now consider the Standard Deduction ($10,000 for a couple filing jointly in 2005 and $5,000 for an individual) under the income tax and the personal exemption ($3,100 for 2005). I am not considering the Earned Income Tax Credit here as this discussion is on mortgage interest expense deductibility and it is unlikely that many claiming the EITC itemizes on his or her tax form. Here is a comparison of the Standard Deduction plus the Personal Exemption to the FairTax Exclusion based on family size. Keep in mind, the FairTax exclusion (rebate base) applies whether you spend money on new items or not. You don’t loose it, just because you purchase non-taxed items. For family sizes over 1, I’m assuming joint filers.
(Income Tax System) (FairTax System)
1 $ 8,100 $ 9,570
2 $16,200 $19,140
3 $19,300 $22,400
4 $22,400 $25,660
5 $25,500 $28,920
6 $28,600 $32,180
All filers receive a
greater exemption under the FairTax.
And remember, the Fairtax only taxes new
items. Most items that are income
tax deductible today ONLY for those keeping detailed records and reports
are naturally tax free consumption under the FairTax, such as interest
payments (all interest, not only housing) retirement savings and charitable
giving. Unlike the current system
where you must give up the standard deduction to claim many of the “tax
deductible” provisions, there is no loss of the prebate
in receiving this treatment. Those
items are just simply not considered consumption. ADVANTAGE: FAIRTAX
All filers receive a greater exemption under the FairTax. And remember, the Fairtax only taxes new items. Most items that are income tax deductible today ONLY for those keeping detailed records and reports are naturally tax free consumption under the FairTax, such as interest payments (all interest, not only housing) retirement savings and charitable giving. Unlike the current system where you must give up the standard deduction to claim many of the “tax deductible” provisions, there is no loss of the prebate in receiving this treatment. Those items are just simply not considered consumption.
No tax forms! No filing! No penalties! No IRS intimidation! As a nation, we save approximately $250 billion in compliance costs and 6.1 billion hours a year in wasted effort.
The FairTax is superior on every point. Add to this the increased freedom, and privacy and it is a win all the way around. It’s time to change the initials of the IRS to INS and to send them to the borders to terrorize terrorists instead of working American citizens.
Rental inputs will not be taxed, but rent payments will be.
As a landlord, the purchase of the rental units, the material and service for upkeep, the insurance for the units, etc. will be business inputs and will be tax free. From the business perspective, your costs will be reduced substantially and you will no longer have the complexity of the tax code to deal with.
From your personal viewpoint as a taxpayer, your own income of course will also be tax free. You will only be taxed if you buy taxable goods and services about the poverty level.
You will collect the tax on the rental payments made by the tenants (unless they are business rentals which are not taxed) and be paid 1/4 of 1% of the collected amount for your effort. This will be forwarded to the State taxing authority.
From the renter's perspective, nothing much changes from today. Rental payments today are made with after tax dollars so for someone in a 15% marginal tax bracket, they must earn $130 to have $100 left to pay towards the rent. (That includes their portion of payroll taxes, but not their employer's).
Under the FairTax, if they earn $130, they will take it all home to apply to the rent. Even if you do not pass any of your business savings to them in the form or lower pre-tax rent as a result of your reduced business cost, they will still be no worse off than today. ($100 in rent would be $130 after adding in the FairTax and they will have the full $130 from wages to pay it.) If you also decide to lower pre-tax rents to pass a little of your business tax savings to them, they will be better off.
This is only from the rental viewpoint. When you factor in the prebate, the growing economy and opportunity, and the increased personal freedom, they and everyone else are truly better off.
Laurence J. Kotlikoff
Professor of Economics,
In his Ludwig von Mises Institute
December 13, 2005 review of The Fair
Tax Book by Neal Boortz and Congressman John Linder, Laurence Vance
identifies what he believes are 3 "lies" in the book and 17 "problems"
surrounding the FairTax. Being a fan of both the FairTax and
Congressman Linder as well as a student of consumption taxation, I offer
here a point-by-point response.
First, the alleged lies:
Kotlikoff Response to FairTax Critic Vance
"Lie" #1 -
"Taxes would be voluntary under the FairTax."
Vance argues that everyone needs to buy goods and services and,
therefore, everyone is, in fact, forced to pay the FairTax. This is
obviously correct. But declaring that Boortz and Linder are "lying" on
this point is wrong. The authors were simply saying that the public
would have more discretion in the timing and amount they pay in taxes
than under the current system. Today, income and payroll taxes are paid
as soon as we earn money. Under the FairTax, no tax would be due until
we spend what we earn.
Yes, calling the FairTax "totally voluntary," as the authors do, is
pushing literary license, but not beyond common practice. Indeed, the
IRS touts the voluntary nature of our current tax system stating that
"The U.S. income tax system is built on the idea of voluntary
arycompliance> compliance. Compliance is voluntary when taxpayers
declare all of their income. Taxpayers also voluntarily comply through
obtaining forms and instructions, providing complete and correct
information, and filing their income tax returns on time."
No impartial reader of the book would come away thinking that the
FairTax represents, in effect, the establishment of a voluntary charity
for the government.
Kotlikoff Response to FairTax Critic Vance
"Lie" #2 - "The FairTax rate would be 23
Vance claims that the FairTax's rate is really 30 percent. He's both
wrong and right at the same time. The tax-exclusive rate we'd pay at
the store would, indeed, be 30 percent, but the rate that matters - the
tax-inclusive rate - would be only 23 percent.
To see this, consider spending $1.00 under the FairTax on a good or
service (e.g., a candy bar) whose price is 77 cents in the absence of
the FairTax. In spending the $1.00, one pays 77 cents for the good or
service and 23 cents (30 percent of 77 cents) in taxes. Hence, the
$1.00, whether it represents a dollar of income or wealth, ends up
delivering only 77 cents of consumption and, consequently, is being
taxed at a 23 percent rate.
By analogy, the same can be said for the income tax. If wages of $1.00
were taxed at 23 percent, the taxpayer would have only 77 cents left to
spend on consumption. Suppose we were to tax everyone's wages at 30
percent, but also subsidize their wages at seven percent. Anyone
looking at such a tax structure would say there is a 23 percent
effective tax on wages.
In describing the FairTax rate as 23 percent, Boortz and Linder are
quoting the rate in terms that are not only economically honest, but
also permit ready and appropriate comparison with our prevailing income
and payroll tax rates. Let's assume taxable income of a sole-proprietor
was $72,000, so that that taxpayer pays taxes of 28 percent plus 15.3
percent payroll taxes for a combined tax-inclusive rate of 43.3 percent.
Unless Vance wants to refer to the 43.3 percent as actually a 77 percent
rate, he really can't compare that rate to the FairTax.
Vance owes the authors an apology on this one.
"Lie" #3 - "The FairTax would abolish the IRS."
Vance reiterates what the FairTax legislation states, namely that a
federal agency would be required to oversee and ultimately enforce the
collection of the FairTax. If one were to call this agency the IRS, the
IRS would not, in fact, be abolished. But here, again, the authors are
engaging in reasonable literary license in suggesting that the FairTax
would abolish the IRS.
Whether or not the tax collection agency retains the initials I, R, and
S, it would be completely different from the current enforcement
apparatus. For starters, we'd no longer have more than 100,000
government bureaucrats enforcing 17,000 pages of federal tax law.
Second, we'd no longer have to file individual income tax returns.
Third, the IRS would no longer be in a position to know virtually every
detail of our financial affairs. Fourth, tens of thousand of
accountants, tax attorneys, and lobbyists would no longer spend their
working lives trying to decipher, comply with, modify, and avoid tax
laws and IRS regulations.
So the FairTax would abolish the IRS for all practical purposes. And,
more importantly, the nation would save $250 billion plus in direct
compliance costs and an even larger sum in efficiency costs from
eliminating the current federal tax system. Yes, the FairTax would
entail collection and efficiency costs, but much lower ones. State
governments, most of whom are already collecting and administering their
own state sales taxes, would be charge and compensated for collecting
"Problem" #1 - "The FairTax hides the amount of tax being paid."
Vance claims that the FairTax hides the amount of sales tax being paid.
Not so. The receipts one would receive in making purchases would
clearly indicate the price of the commodity purchased as well as the
amount of FairTax imposed on that commodity. In my $1.00 expenditure
example, the receipt would say Snicker's Bar 77 cents and Tax 23 cents.
In contrast to the FairTax, the current tax system makes it very hard to
understand the extent to which we're being taxed. The current tax
system constitutes not one tax system, but four - the payroll tax, the
federal personal income tax, the corporate income tax, and the estate
and gift tax. The later three tax systems are extremely complex. Even
the payroll tax is very hard for most workers to appreciate. How many
workers, for example, understand that they are, in fact, paying the
employer as well as employee portions of the 15.3 percent FICA tax?
The complexity of our tax system makes it extremely difficult for any of
us to understand the full extent to which we are taxed on working and
saving. The need, in the end, to guess what incentives we're facing
further distorts economic choices. The costs of these distortions are
significant. Indeed, they may far exceed the roughly 2 percent of GDP
direct costs of complying with the current tax system.
Thus, Vance has the issue of hidden taxes completely backwards. The
FairTax is the most transparent of any tax system. The current tax
system, in contrast, is specifically designed to and thrives on hiding
"Problem" #2 - "The FairTax is progressive."
Leaving aside the rebate, the public generally views sales taxes as
regressive. They reach this conclusion by comparing sales tax payments
with current income. Since someone with zero current income still has
to buy food to eat, the ratio of that person's sales tax payments to his
current income is infinite. In contrast, the ratio of sales taxes paid
to income in the case of someone with a $1 million in current income is
much smaller. So the "poor" person with zero income is paying a much
larger share of his current income than is the rich person in sales
The problem with this analysis is that people don't pay for their
consumption simply out of their current income. (If they did the person
with zero current income would starve.) People also pay for their
consumption out of their private wealth and out of the welfare benefits,
Social Security benefits, unemployment benefits, and other government
transfers provided by the government. Indeed, the "poor" person just
mentioned might well be billionaire Warren Buffet. How so? Well
capital losses on his investments during the current year. This
wouldn't prevent him from using his billions in assets to pay for steak
dinners over the course of the year in his favorite
Rather than consider progressivity on an annual basis, economists
consider progressivity on a lifetime basis by comparing the present
value of remaining lifetime tax payments to the present value of
remaining lifetime resources. Remaining lifetime resources includes the
present values of future labor earnings and government transfer payments
as well as the amount of current net financial and tangible wealth.
From a lifetime perspective, a sales tax (with no rebate) is viewed as
neither progressive nor regressive, but rather as proportional. The
reason is that the present value of a household's remaining lifetime
spending must equal the present value of its remaining lifetime
resources. If it didn't, the household would be able to spend more over
its lifetime than it earns.
Because spending equals resources on a present value basis, taxing
spending is equivalent to taxing resources. And doing so at a
proportional (fixed) rate means you are taxing resources as a
proportional rate. This is what the FairTax does. But the FairTax
adds in a rebate, making it not proportional, but progressive overall.
So Vance is right. The FairTax is progressive. But this is a plus, not
a minus. Unlike Vance, the vast majority of Americans, including the
vast majority of the rich, favor a progressive tax system.
Income Redistribution Scheme
"Problem" #3 - "The FairTax is an income redistribution scheme."
Under the FairTax households with the same demographics will receive the
same rebate. But as a share of remaining lifetime resources, the
FairTax is progressive, as indicated above. But this is not a problem.
Any tax system acceptable to the public must be progressive.
Creates New Tax Collectors
"Problem" #4 - "The FairTax creates new tax collectors."
Totally incorrect. Today, everyone who files an income tax return, more
than 200 million taxpayers, is a tax collector. The number of taxpayers
will diminish by more than 90 percent. And they will be the same tax
collectors as today. In one fell swoop, the FairTax reduces the number
of taxpayers at the same time it vests everyone in the tax system, by
making the price of government explicit. Here Vance argues that baby
sitters and similar providers of personalized services would need to
collect the FairTax and mail it into the government. This is true, but
it's no different under the current system. Anyone who is self employed
is required to pay self-employment tax as well as federal income tax
above a certain level of income.
Although the baby sitter will go from being a "taxpayer" to being a "tax
collector," nothing real will change. Apart from the change in words,
the baby sitter is in the same position of having to mail a check to the
Just a New Tax
"Problem" #5 - "The FairTax creates new taxes."
Wrong. Today, we tax returns on capital, we tax sales of capital
assets, we tax labor earnings, we tax estates, and we tax gifts. All of
these taxes are eliminated by the taxation of the final retail sale.
Yes, currently, there are no federal taxes directly levied on the
purchase of most final goods and services. But at the same time the
FairTax would institute these direct taxes, it would also eliminate
direct taxation of the labor and capital income received by American
taxpayers. Hence, the FairTax destroys old taxes at the same time it
establishes new ones. Depending on how one quantifies labor supply and
saving, the FairTax could be said to reduce, on balance, the number of
taxes. In any case, counting up the number of distinct taxes seems like
a silly and inherently arbitrary way to evaluate the FairTax. The
important point is not the number of things being taxed, but the number
of rates used to tax those things. Under the FairTax all goods and
services will be taxed at one and only one rate - 23 percent.
Creating New Taxpayers
"Problem" #6 - "The FairTax creates new taxpayers."
I sure hope so. I hope the 40 percent or so of Americans who pay no
income tax today have to pay the FairTax and see that they too are
vested in our government. I hope that criminals who have illegally
amassed wealth in the past will pay lots of sales taxes when they spend
What about churches and other non-profits? Their tax treatment is as it
is today. They'll pay no taxes on their income, and charge no FairTax
when those sales are substantially related to their exempt function. On
the other hand, if they sell consumer goods or services, they'll have to
charge and remit the FairTax on these sales.
Plus, individuals will be able to donate to their church or favorite
Ease Government Taxation
"Problem" #7 - "The FairTax makes it easier for the government to raise
Quite the opposite. Politically, if there is only one tax rate that
everyone needs to think about and keep track of, there will be lots of
interest in that one rate as well as opposition to raising it. One key
objection to the FairTax is that it is too visible, meaning that it
exposes the true costs of the government. This is at the same time its
major strength and weakness. Exposing the true cost of the government
ensures downward pressure on the size of government. But doing so makes
politicians who like to hide taxes wary. Moreover, as the public digs
in its heels on raising the single rate, as I suspect it would, federal
expenditures would have to be restrained to live within the 23 percent
rate budget. I.e., the 23 percent FairTax rate has the potential of
establishing a global budget for federal expenditures, something that
should be wholeheartedly supported by Vance.
Vance suggests that the rate would have to rise over time to adjust for
growth in the economy. This is (excuse the pun) off base in that the
FairTax tax base will itself rise with growth in the economy. Hence,
revenues will keep pace with overall economy-wide growth without
requiring a rise in the tax rate.
The major point he also misses is that the FairTax is global tax reform.
zero rate of tax on savings and investment and productive enterprise,
other nations will have to follow suit or lose their citizens'
investments to the
"Problem" #8 - "The FairTax makes it easier for state governments to
The states may adopt the FairTax's broader sales tax base, but would
likely cut their rates in so doing. What Vance ignores is the
competition across states in attracting business and workers. This
competition explains why state tax rates are relative low and are likely
to remain low.
"Problem" #9 - "The FairTax has unknown and potentially huge Transition
Saying so doesn't make it so. There is no reason to expect significant
transaction costs. The inventory transition valuation issue raised by
Vance can readily be sorted out.
Creates New Exceptions
"Problem" #10 - "The FairTax makes exceptions while claiming to have
Totally incorrect. Unlike today, where the tax code is used as an
effective second appropriation committee, the FairTax taxes every form
of consumption expenditure that can readily be taxed without exception.
The FairTax exempts educational expenditures, but educational
expenditures are viewed by economists as a form of human capital
investment, not a form of consumption.
Fraught with Fraud Potential
"Problem" #11 - "The FairTax has a great potential for fraud."
This is the major concern about the FairTax raised by economists and tax
practitioners, but it is not based on rigorous analysis. There is every
reason to believe the FairTax would reduce noncompliance from its
current $300 billion level.
First, much of the $300 billion stems not from fraud, or the intentional
violation of a known legal duty, but rather from mistake. The FairTax
eliminates virtually all potential for innocent mistakes, and it makes
it much more difficult to claim that noncompliance arises from mistakes;
i.e., the simplicity of the FairTax removes the plausible deniability of
Second, the vast majority of sales of consumer goods and services and
all of the sales of expensive consume goods and services is done in
retail stores, whose sales tax payments could readily be monitored. As
for the other transactions, we'd have the entire IRS or, whatever you'd
want to call it, available to enforce this single tax. By setting very
high penalties and using ad campaigns to indicate that cheating on the
sales tax hurts everyone, collecting the FairTax should be
Third, the FairTax reduces the effects of all known factors on fraud.
The three factors that economists have shown to affect compliance are
marginal rates, likelihood of being caught, and penalties. The FairTax
enhances all three:
1) The FairTax imposes much lower average taxes on working-age
households than does the current system. The FairTax's reduction in
average tax rates on the working age population reflects the broadening
of the tax base from what is now primarily a system of labor income
taxation to a system that taxes, albeit indirectly, both labor income
and existing wealth. Consider, as an example, a single household
earning $50,000. The household's average tax rate under the current
system is 21.1 percent. It's 16.2 percent under the FairTax."
2) The likelihood of being caught increases dramatically when the
collection points decrease from 140 million to 20 or so million.
3) The FairTax imposes significant penalties on those who would
commit tax fraud.
Churn out Tax Cheats
"Problem" #12 - "The FairTax will turn thousands of Americans into
criminals for not collecting the tax."
Thousands, if not millions, of Americans now cheat on their income
taxes. And we have more than 150 tax penalties, several of which are
criminal today. But we do perform audits and fine people for not
paying. The same would occur under the FairTax. People who cheat would
get caught and pay penalties. However, the FairTax has several
provisions enhancing taxpayer rights.
Repeal of 16th Amendment
"Problem" #13 - "The FairTax does not repeal the 16th Amendment."
The FairTax cannot repeal the 16th Amendment, which has to be done in a
separate piece of legislation. So, Vance's point is that we must live
with the income tax? Not so. The FairTax does repeal Subchapters A and
C of the 1986 Internal Revenue Code that implement the income tax.
Vance's concern here is that the income tax will be restored and that
we'll end up with both the income tax and the FairTax. But if the
popularity of the FairTax will, I believe, preclude that from ever
"Problem" #14 - "The FairTax doesn't repeal federal excise taxes."
True. But not a problem. We want to retain some flexibility to tax
goods, like cigarettes, the consumption of which can impose significant
costs on society at-large, at higher rates. These taxes serve a
different purpose than general revenues. They are in effect taxes on
"Problem" #15 - "The FairTax doesn't lower taxes."
Wrong. The FairTax dramatically lowers marginal rates and completely
eliminates the double taxation on returns to savings and investment.
And over time, the FairTax will stimulate growth and permit much lower
rates of taxation than would otherwise be the case.
Kotlikoff Response to FairTax Critic Vance
Root Problem - Taxation
"Problem" #16 - "The FairTax doesn't address the root problem that the
government has no fundamental right and should have no power to tax us."
The government has the rights we the people have given it through the
Constitution. This, again, is a Vance problem, not an American problem,
but he should read the Tenth Amendment of the
Constitution, which is part of the Bill of Rights. It states: The
powers not delegated to the
prohibited by it to the States, are reserved to the States respectively,
or to the people. If Vance wants to strike that Amendment, he has a
long way to go.
Increase in Welfare State
Problem # 17 - "The FairTax makes welfare universal through the
Wrong. The FairTax simply declines to tax Americans before they have
met their own sustenance in life. Nobody is taxed on the necessities of
life under the plan. And nobody is required to pay for the cost of the
government until they have met their own needs. I don't consider that
There should be little detrimental effect on new or used housing. Let’s look at some examples.
New House - $200,000 total price before Fair Tax should only increase slightly after Fair Tax
· Reduction in embedded costs reduce pre-tax price to $175,000.
· Retail sales tax on $175,000 $52,000.
· Total price increases to $227,000
¨ Represents 13.5% overall price increase ($200K à $227K)
¨ $52,000 represents approximately 23% of total price
¨ You pay for this 13.5% costlier new house with an estimated 25% greater income (remember: NO federal withholding)
Used House - $160,000 total price before Fair Tax will rise to between $180,000 and $190,000 after Fair Tax (approximately 13.5%)
· Price determined as level at which house competes against comparable new housing TOTAL price, and TOTAL price of new house increases approximately 13.5%
· You pay for this 13.5% costlier used house with an estimated 25% greater income (remember: NO federal withholding)
UN-TRUTHS critics try to throw out, I guess through ignorance or out-and-out lying
Price of used homes would need to compete against the before-tax price of new homes. In example shown, the used home would somehow need to be priced down to about $130,000 to be competitive. That would kill the new housing market. IT’S NOT THE CASE, THOUGH. IT’S A LIE, A SMOKESCREEN.
If that were the case, no one in their right mind would pay a total price of $227,000 for a new house. IT’S NOT THE CASE, THOUGH. IT’S A LIE, A SMOKESCREEN.
If that were the case, every homeowner would automatically lose approx 20% of their home equity after adoption of the Fair Tax. IT’S NOT THE CASE, THOUGH. IT’S A LIE, A SMOKESCREEN.
TRUTH critics don’t want you to consider
New AND used housing demand (especially for 1st-time buyers) is driven up as folks find it MUCH easier to save for a down-payment when they get ALL their paycheck under the Fair Tax
HR25 calls for substantial accounting of business-to-business (B2B) sales (ie wholesale sales exempt from sales tax). These B2B sales must be tracked closely to forestall attempts at retail sales tax evasion.
If a small business (or any business) makes tax-free B2B purchases, that business better make appropriate sales (B2B or retail) that shows the B2B purchases were legitimate
For B2B sales, the accounting will track the ‘money trail’
For retail sales, the business owes sales tax to the federal government, probably via a state-administered sales tax collection entity
· The tax collection entity won’t care if the sales tax was actually paid explicitly by the consumer or not
If a small business (or any business) doesn’t wish to collect sales taxes itself, it better not try to make any tax-free B2B purchases for supplies, etc.
I think there is some room here for evading sales tax on services (ie landscaping, painting, etc) but if the supplies, etc were already taxed as RETAIL purchases then the evasion is pretty minor
UN-TRUTHS critics try to throw out, I guess through ignorance or out-and-out lying
Lawn mowing services, painters, dog-walkers would all be required to become involuntary tax-collectors. THAT’S NOT ENTIRELY TRUE, AND IT’S CERTAINLY NOT A BIG OR COMPLICATED ISSUE.
· IF these lawn mowers, painters and dog-walkers filed for and used tax-exemptions for B2B purchases then they would be expected to pay sales tax on an appropriate amount of ‘sales’ of their services.
· IF they instead paid RETAIL sales tax themselves on any supplies then it could be argued (but almost impossible to enforce) that they owed sales tax only on the ‘service-only’ portion of the ‘sales’ of their services.
¨ Tough to figure out what that amount is and I doubt anyone would actually expect it to be paid.
TRUTH critics don’t want you to consider
Under an income tax system, such small service providers don’t report most of their income anyway so all taxes are evaded. Under Fair Tax they can’t escape pay sales tax on all their RETAIL supplies plus sales tax on all their subsequent RETAIL purchases.
Fair Tax is vastly more effective at collecting such taxes than an income tax.
FANTASTIC for the POOR! The Fair Tax is sometimes criticized for being slanted towards the poor too much. The ability to pull-up the poor among us is maybe the greatest feature of this proposal.
· The poorer the taxpayer, the higher the dependency on weekly paychecks. Thus, the greater the importance of getting your ENTIRE paycheck in the first place.
¨ By contrast, the poorer the taxpayer the more insidious is the INCOME TAX (bumpy, flat, whatever). Remember, the FLAT TAX is still an INCOME TAX.
· The poorer the taxpayer, the more frugal the spending habits. Since the Fair Tax calls for monthly prebate checks that cover all sales tax on payments up to poverty level the POOR pay ZERO taxes.
¨ Under INCOME TAX they still get FICA and Social Security STOLEN from their paychecks.
· The poorer the taxpayer, as seen above, the greater is the benefits gained from the Fair Tax.
UN-TRUTHS critics try to throw out, I guess through ignorance or out-and-out lying
Since all retail sales (even food) have a sales tax on them the Fair Tax is regressive and punishes the poor who pay a higher percentage of income on food.
· THIS IS A TOTAL LIE.
· The monthly prebate checks cover all sales tax up to poverty level spending.
¨ If you use that prebate for purchases other than food and medicine then that’s your choice, but the point is that it should be YOUR CHOICE and not the Government’s.
TRUTH critics don’t want you to consider
By not allowing government to STEAL from your paycheck before you even get it, its easier for anyone (especially the poor) to
· Save for a housing down payment
· Build up a savings account and invest that savings to build WEALTH
There would be cheating, yes. Hard to imagine the cheating would be anywhere near as prevalent as under the current system though.
Current income-based tax system cheating methods
Individuals do not report income
· Usually requires collusion between wage-payer and wage-earner
Businesses under-report profits
· Usually requires a fancy accountant, phony books, etc
Fair Tax system cheating methods
Businesses sell un-reported goods at retail and don’t collect the sales taxes they are supposed to
· This assumes the businesses bought the goods or raw materials at wholesale themselves; if they didn’t then they had to pay the sales tax and no more retail sales taxes are due on the item
· For any business to even be allowed to buy at wholesale fairly severe accounting measures will be required so the IRS can track goods that still contribute to retail sales of goods or services.
¨ IRS doesn’t care if the final consumer pays the retail sales tax or the business does. Even if the business decides to sell goods it purchased at a wholesale price (without collecting sales tax) the IRS still knows some retail sales tax is owed. They don’t care where the business comes up with the money.
UN-TRUTHS critics try to throw out, I guess through ignorance or out-and-out lying
Businesses will buy wholesale and to attract customers will sell at wholesale also. They just won’t report the sale.
· HOW DOES THAT MAKE SENSE?
¨ The businesses who sell the items are responsible for the sales tax on the items they had in their (tracked) wholesale ‘inventories’. The government’s is going to get the money from the seller and not even going to really care what the customer paid for a final price.
TRUTH critics don’t want you to consider
Under income tax the IRS needs to watch over tens of millions of wage-earners and businesses. Under Fair Tax the IRS only needs to keep track of businesses who exercise their right to buy at wholesale and make sure appropriate sales tax is accounted for in the resultant business activity.
· This is an over-simplification, but the idea is that the IRS has a MUCH easier job of enforcing tax laws under the Fair Tax.