FairTax would be an Unmitigated Disaster

We can and should simplify the personal Income tax (See more on that...)

FairTax Analysis

Note: The Report of the bipartisan Tax Reform Panel appointed by President Bush supports my independent analysis and conclusions which follow.    See the Tax Reform Panel report.

The FairTax (HR 25) proposal calls for the removal of the Personal Income, Social Security, Medicare, Corporate Income,  Excise, and Estate Taxes.  It will replace them with a 23% national sales tax.

The 23 % is an "inclusive tax".  That is,  the tax represents 23% of the total of item cost and tax.  For example, if the actual item cost is $1.00, the customer would pay $1.30.  The $ .30 is 23% of the $1.30 total cost.   The equivalent "exclusive tax"  rate is then 30%.  Current state and local sales taxes are exclusive.  If state and local sales tax is 7% and is applied on top of the $1.30, the total cost of the $1.00 item will be $1.39.

The FairTax will apply to food, services, houses, medicine, automobiles, and virtually everything else.  However,  the FairTax will not apply to used items.  Used items, including collector items such as antique automobiles, diamonds, and expensive paintings will not be taxed.  A new and an existing house of the same $200,000 value will cost $260,000 (new) and $200,000 (existing) - sending the home construction industry into depression.  

No provision is made for savings which have been previously taxed under the income tax system.  So, previously saved money will be double taxed with the second tax being 39%.

FairTax provides for a 'prebate' to be sent to all families to cover the tax on income up to the poverty level.  The annual amount varies from $2201 for a single person to $5,902 for a family of 4 to $8,901 for a family of 8.  This prebate  will cost a minimum of $500 Billion.

FairTax advocates declare that it will be "revenue neutral". That is, they say it will generate the same income as the taxes it replaces.  Note, that, if this can be true, we will still have the $400 to $600 Billion deficit which we can't maintain indefinitely without going bankrupt.  But, as the tables below show, FairTax will result in more than $1 Trillion in additional budget deficit.

Tables 1a and 1b calculate the revenue which will be generated.  It is based on current  income data from the IRS (IRS.gov).

Table 1a  FAIRTAX REVENUE

TOP 10%

 * I this is an estimate of the portion of the income which will be spent in a manner that subjects it to the sales tax. The fifth column is the number of returns times the amount taxed times .23.  This also applies to Table 1b.

** See the note on the same column of Table 1b.

Table 1b FairTax Revenue

Bottom 90% 

*FairTax provides for prebates of  $2201 (single person) to $8901 (married couple /family of 8).  If we guess that the average return is for a married couple with no children ($4402),the cost of the prebate would be 131,300,000 returns times 4402 = $578 Billion.

** The effective tax rate on the average income for the row shown in column 3.  An average prebate of $4402 is accounted for in column 6.

Table 2  Total Revenue Comparisons 

Table 3   Distribution of Tax Load by Percentage

Table 3 shows the distribution of income and tax load for FairTax versus the current income tax.  Compared with the current income tax, the FairTax greatly relieves the tax burden on the top 10% and top 1% and nearly doubles the burden on the bottom 90%.  This is an understatement of the situation since FairTax removes the Estate Tax (which is imposed on the rich) and the Corporate Income Tax which primarily affects the rich.  This is in keeping of the right wing goal of increasing the wealth of the rich while letting the poor suffer the fate they deserve as inferior beings. 

What would the FairTax Advocates Say?

FairTax advocates would say that the above analysis is flawed in that it does not include income which evades the income tax system.  Some indicate that this evading income amounts to 25% of the total income.  We can account for that by increasing the estimated FairTax income by 33% ($1113Billion x 1.33 = $1483 Billion - $578 Billion = $905 Billion).  The result is an $828 Billion shortfall (1733-905). 

However, we have to consider that FairTax will also be subject to evasion - much more massive.  With a tax rate of 39% (exclusive), the incentive to evade will be strong.  Black markets will thrive.  A large part will be run by organized crime.  But, ordinary citizens will create their own methods of tax evasion.  The only way to attempt to stop it would be to create an enforcement organization which would dwarf the IRS.  Even then, it would be like trying to stop leaks from a sieve one hole at a time.

FairTax Advocates' Alternative Analysis

FairTax advocates put forth a figure of $7.6 Trillion as the the annual non-government consumption.  23% of $7.6 Trillion is $1748 Billion.  That would approximately cover the taxes replaced.  But, what about the used item exclusion?  What about the prebate checks?  What about evasion?   Would there be any left at all?

Can They Adjust It to Make It Work?

The only ways they can tweak the system are by adjusting the rate upward, reducing or removing the prebates, and dropping the used item exclusion.  If the $7.6 Trillion figure is reliable, and they eliminate the prebates and they drop the used item exclusion, it would appear that they have met the revenue neutral goal ($7.6 Trillion x .23 =  $1748 Billion.).  But, this assumes that there will be no evasion.  This is totally beyond reason!  Suppose, after dropping the prebates and the used item exclusion,  we assume the unlikely stance that evasion will be only 25%.  The rate will have to be increased from 23% to 30.5%.  The exclusive rate would then be 44%  (30.5/69.5).  With state and local sales tax  of 7% applied, the total sales tax rate would  be 54%.  At that rate, participation in the black market would approach 100% of the population. 

If you drop the prebates and used item exclusion and insist, beyond all reason, that there will be no evasion, remember that revenue neutral leaves us with the $400 - $600 deficit which we can't maintain without going bankrupt.  Covering $400 Billion would require the same 44% (54 total) rate.  The short answer is NO!

Where Did This Idea Come From?

The idea of a national sales tax was proposed in the 1920's by Andrew Mellon who was the Secretary of Treasury in the Hoover administration.  He said that, as the productive class, the wealthy should not pay taxes.  Taxes should be collected from the common people.  The current FairTax campaign originated with a group of businessmen in Houston, Texas.  The Texas group is still funding and directing the "grassroots" organization pushing it.  The obvious hidden objective was (and is) to markedly reduce the taxes on the ultra rich.  

The apparent genesis of the FairTax plan is as follows:  The 23% figure came from dividing the 2003 total tax revenue ($1.75 trillion) into their estimate of the total non-government sales ($7.6 trillion).    To mute criticism that Fairtax would unfairly burden the poorest Americans, the prebate idea was added.  However, there was no rate adjustment for the $500 to $700 billion cost of the prebate.   The used item exemption was similarly added with no adjustment of the rate. 

FairTax advocates say that the tax would be offset by the elimination of hidden taxes on goods.  They estimate these hidden taxes at 22%.  This is simply a contrived/fictitious figure chosen to be a little less than the 23% figure in order to appear reasonable.  Similar scheming is applied when they 'reasonably' say that FairTax would not result in higher revenue ( just be revenue neutral) when in fact that it would fall up to $1 trillion short.   These are common con-artist tactics.  They appeal to our self interest by telling us that we, the tax payers, would be getting away with not paying taxes while the government would miraculously survive.   This is something everyone would like to believe and the gullible will.  The problem is that there is no truth to it.  In actuality, the middle class would pay more tax while the rich would pay much less and the government (and the country) would not survive.