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The FairTax Scam

The FairTax proposal HR25 in the US House of Representatives(S.296 in the Senate)calls for the replacement of all current taxes (income tax, Social Security, Medicare, corporate income taxes, excise and estate tax) with a 30% national sales tax. They bill it as a 23% inclusive tax. But, a $1 item will be assessed $.30 in sales tax (.30/1.30 =.23). FairTax would provide a "prebate" to all households based on the tax on poverty level income.  The Treasury Department's cost estimate for the prebate was $780 billion annually.

The FairTax would apply to food, services, houses, medicine, automobiles, and virtually everything else. However, the FairTax would not apply to used items. Collector items such as antique automobiles, diamonds, and expensive paintings would not be taxed. A new and an existing house of the same $200,000 value would cost $260,000 (new) and $200,000 (existing) - sending the home construction industry into depression. They also say that local, state, and federal governments will be charged the tax for purchases.

I present two independent analyses here - my own independent study and the analysis of 2005 bipartisan panel appointed by President G W Bush . Both come to the same general conclusions:

  • FairTax is highly regressive, transferring much more of the tax burden from the wealthy to the middle class. It would remove a large amount of money from the retail market damaging business, costing jobs and putting the economy on a downward spiral.
  • While FairTax proponents claim it is revenue neutral (producing the same amount of revenue as current taxes), it is far from that. The Treasury Department determined that a 34% tax would be required to replace the income tax (54% of federal revenue) alone if there is low evasion (15%). To replace all taxes (93% of federal revenue), as proposed with FairTax, would require a 58% sales tax (34%x.93/.54) under low evasion conditions and up to 84% with more realistic evasion (30%). My own analysis predicted that FairTax at the 23/30% rate would result in $1 trillion additional annual deficit - a similar conclusion. FairTax people surely know this.  Their plan is undoubtedly to create a massive deficit and cure it by cancelling "entitlements" starting with Social Security.  In his 1986 book, David Stockman, architect of Reagonomics, said that was the plan with the Reagan tax breaks for the rich (70%->28%).  He was upset that they didn't follow through with cutting Social Security.
  • The FairTax proponents count on no tax evasion while evasion under the current income tax is 25%.  The Treasury Department says low evasion is experienced when there are two independent entities reporting the same income as when the individual and the employer report the income of the individual.  Higher evasion rates result when there is only one report (such as tips to a waiter) and the reporter benefits from under reporting.  With FairTax, most reports will be from retail sales companies which pay the tax to the government and which will benefit from under reporting.  Small retail operations would be less likely to fully report sales. Thus, it is likely that evasion rates will be higher with the FairTax than with the current income tax. The 2005 bipartisan panel uses 15% for the low evasion rate and 30% for the higher evasion rate.
  • The FairTax pitch is replete with many unsubstantiated claims. All are designed to convince people that there will be a free lunch. They claim that 22% of hidden taxes would disappear from the cost of goods with FairTax, making the tax almost free. They identify those hidden taxes as the employer part of the payroll tax (7.65%) and the corporate income tax (23%).  The payroll tax would typically apply to half of the cost of producing goods for 3-4%.  Corporate income tax is on corporate profit, not gross sales. If corporate profit is four to five percent of sales, the corporate income tax part of sales would be about 1%.  This would peg the typical hidden tax savings at 4 - 5%.  (And, if one could believe the 22% figure, they are saying that virtually all of the 23/30% sales tax is needed to cover the elimination of the corporate income tax and the employer part of the payroll tax.  That would leave the personal income tax, employee part of the the payroll tax, excise taxes, and estate taxes uncovered by FairTax.)
  • They claim that FairTax will rejuvenate the economy when it will actually draw substantial money from the retail market hurting business sales.  That will cost jobs further hurting sales and losing more jobs, starting a downward economic spiral.
  • FairTax.org presents a study (for which they say they spent $22 million) to substantiate the 23/30% tax figure as replacing all of the taxes.  It is a convoluted mess of intended complexity and contradictions. It has the governments, local, state and federal, paying the tax and counts that as revenue.  But, it doesn't include those taxes in government costs.  This study deteriorates into a mass of inscrutably complex contrived equations. Using rough, largely unsubstantiated estimates for input into their pseudo analysis, their conclusion from all of this is that the 23/30% tax would fail to cover the current revenues by just a little bit, requiring precisely a 2.73% reduction of "non Social Security" expenditures.   See that study.
  • FairTax proponents claim that there would be substantial savings with the elimination of the IRS.  The Treasury Department says that a larger organization would be required to track the sales tax and to administer the prebate. And, since most states have an income tax (which depends on IRS return processing), the IRS would have to be recreated at the state level or state sales taxes would have to double. A much better way to reduce the size of the IRS would be to simplify the calculation of the taxable income income. The 25,000 pages of personal income tax code should be reduced to 100 or less - more on this.
  • FairTax proponents claim that their program is nonpartisan when it is thoroughly right wing Republican.  The idea originated with Hoover Secretary of the Treasury, Andrew Mellon, who said that the wealthy are the productive class and should not pay taxes; taxes should be collected from consumers.  The current FairTax group was created by Tom Delay (recently sent to prison for election fraud) and is funded by wealthy Texas businessmen. Sponsors in the House (HR 25) include 65 Republicans and one Blue Dog.  The Senate bill (S.296) is sponsored by 5 right wing southerners (Burr [NC], Coburn[OK], Coryn[OK], DeMint [SC], and Isakson[GA]).   More moderate Republicans (including Hobson) have opposed it.  Austria supports it but is not a sponsor. 
  • The one area which gets some nods from economists is that consumption taxes encourage savings/growth.  That is, high sales taxes will discourage spending and encourage saving.  But, at the same time, it decreases the retail market for business, causing the lower-sales-lost-jobs-lower-sales downward economic cycle.  The better course is to bring more money into the the retail market by higher progressive income tax rates (taxing the wealthy), infrastructure spending with resulting jobs, and encouraging saving by IRAs and Keoghs.   The higher progressive personal income tax rates will encourage the growth of small businesses because the owners can avoid personal income tax by keeping that money in the business and promoting long term business growth.  The larger picture is then that, with the current income tax system and higher progressive rates, money which would have largely stayed on the sidelines or have been diverted to foreign investment is invested in American infrastructure, jobs, business growth leading to more jobs.  With a FairTax system, money will be taken from the retail market causing a downward economic spiral and more money will be diverted to the sidelines in the hands of the wealthy.