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FairTax Is Pure Fantasy

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By BRUCE BARTLETT

Published: October 1, 2007

Rep. Gus Bilirakis is a cosponsor of House Resolution 25, which would abolish all federal taxes - personal and corporate income taxes, the payroll tax for Social Security, and the estate and gift tax. These would be replaced by something called the FairTax, a 23 percent national retail sales tax on virtually everything you buy, including many things that are not presently taxed by state sales taxes.

The states would be required to collect the FairTax, thus allowing for abolition of the Internal Revenue Service. To prevent poor and middle class people from being overly burdened by this new tax, every American with a Social Security number will be sent a partial rebate monthly.

This sounds like a good deal to many people, and the FairTax has garnered wide support. However, it is doubtful that this support would be as high if people fully understood the details of the FairTax. Following are a few problems that tax experts have identified.

True Rate. When people hear about a 23 percent national sales tax, they naturally equate it to the state sales taxes they are familiar with. If a state sales tax is 5 percent, then this means that if one buys something for $1 they will pay $1.05 at the checkout. Thus they assume that the FairTax would cause a $1 product to cost $1.23 if it were to be enacted.

In fact, the rate is not 23 percent, but 30 percent. The 23 percent rate is arrived at by treating the tax as if it were already part of the price instead of being on top. Thus if a product were to sell for $1 and the FairTax added 30 percent, the 30-cent tax comes to 23 percent of $1.30. This is how a 30 percent rate is deceptively turned into a 23 percent rate.

It is obvious why this subterfuge is maintained. Polls have long shown that support for flat rate tax schemes falls sharply at a rate higher than 23 percent. Furthermore, the vast majority of taxpayers pay less than 23 percent in federal income taxes now, so support for the FairTax would likely evaporate if people generally understood that the rate is 30 percent instead of 23 percent.

Governments Must Also Pay

But this is just the beginning of the FairTax's deceptions. In order to make it seems as if a 23 percent rate is high enough to equal current federal revenues, the FairTax would apply to all government purchases at every level. Only education spending is exempted.

States will have to pay 30 percent more on every highway and bridge they build, local governments will have to pay 30 percent more for police and fire protection, and even the federal government will have to pay the tax to itself when it buys weapons and ammunition for our troops.

Taxes will have to be increased at the state and local levels to pay the FairTax to the federal government. The FairTax rate would also have to be higher to pay for the additional federal spending it will require. However, FairTax supporters dishonestly exclude this higher spending from their calculations.

Rebate Problems

The FairTax rebate also will add $600 billion to federal spending annually. Although its supporters say the rebate is just like the one we get when our tax withholding exceeds the taxes we pay on our tax returns, in fact the FairTax rebate is more like Social Security because it comes in a monthly check.

Although FairTax supporters tout the generosity of the rebate, in fact it is extremely modest because it is based on the poverty level income - a figure that bears no relationship to the actual cost of living. As a consequence of the way the poverty rate is calculated, childless couples would get a monthly rebate of $391 per month, but a single mother with two children would only get $329 per month.

Prices Will Rise

Finally, FairTax supporters assume away many of the problems with their plan by asserting that prices will fall by 22 percent once all income taxes are abolished. Prices at the checkout will be about the same with the FairTax as they are now, they say, but everyone will come out ahead because their net wage will now equal their gross wage.

If this were so, it's hard to see why the rebate is needed, since there seems to be only winners and no losers under the FairTax. In reality, for prices to fall by 22 percent, business costs would also have to fall by 22 percent, which means that all workers would have to take a 22 percent pay cut.

It's extremely unlikely that workers would agree to this. It is far more likely that the FairTax will raise the price of everything by 30 percent. This has been the case in every country and every state with a sales tax. The idea that prices will fall is just a pipe dream.

For this and other reasons, virtually every serious tax expert has concluded that the FairTax is completely unworkable. It is a fantasy to think otherwise.

Bruce Bartlett was deputy assistant secretary of the Treasury for economic policy from 1988 to 1993 and has written extensively on the economics of taxation.

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