FairTax's Plausible Solution

Opinion, published January 9, 2008 The New York Sun

Whatever happens to Mike Huckabee in the weeks ahead his "FairTax" deserves a serious look.

Mr. Huckabee proposes to substitute a national consumption tax for all existing federal taxes. Although Congress might not be ready for this drastic step, a move from taxing income to taxing consumption would be highly desirable.

New Yorkers paid $169 billion in federal taxes in 2005, the latest year available. Under the FairTax, taxes would be reduced to $132 billion, according to an estimate by the Institute on Taxation and Economic Policy. High income-tax states such as New York stand to benefit from the FairTax.

With a business-cycle slowdown on the way, tax reform is one way to strengthen the American economy. Mr. Huckabee's plan is based on "The Fair Tax Act of 2007," introduced in Congress by two Republicans from Georgia, Rep. John Linder and Senator Saxby Chambliss.

Mr. Huckabee suggests replacing all federal taxes — income, corporate, payroll, estate taxes — with a 30% sales tax, to be collected by the states and remitted to the Treasury. There would be no need for Americans' least favorite agency, the Internal Revenue Service, which would be eliminated in 2011.

Many objections have been made to the FairTax. A professor of economics and law at the University of Michigan, James Hines, jokes that America doesn't have consumption taxes because Democrats think that they hurt poor people and Republicans think that they make raising revenue too easy, thereby encouraging spending. America will only get them, he wrote, when Republicans realize that they hurt the poor and Democrats see that it's easy to use them for raising revenue.

Some say it's impossible for Congress to give up income taxes, that Congress would just tack a new federal sales tax on top of existing taxes. But it's certainly within Congress's power to eliminate income taxes, which were instituted only in 1913, and if the congressional spending beast gets a new source of revenue, it might be willing to make the change.

Others say that sales taxes hurt the poor. However, that problem would be resolved with monthly checks called "prebates" mailed to all households, depending on size. The prebate is meant to reflect the tax that a family would pay during that month if its consumption were at the federal poverty line. A family of four would receive about $500 at the beginning of each month as a rebate on taxes. Programs such as Medicare, Medicaid, Social Security, and Food Stamps would continue.

The ease of raising revenue with consumption taxes, sales taxes, and a variant of them, value-added taxes, has many people concerned. After all, what is the point of eliminating the IRS if the government is simply going to give itself another cash machine that facilitates spending?

The most commonly-used consumption tax is the value-added tax, which is used in over 125 countries in addition to income taxes. In fact, America is one of the few industrialized countries in the world that does not have such a tax. Rates in the 26 Organization for Economic Cooperation and Development countries in 2006 averaged 18%, ranging from 5% in Japan to 25% in Norway, Sweden, and Denmark.

Such value-added taxes have risen two or three percentage points during the last 20 years in many European countries. Rates in Nordic countries have gone to 25% from 22%, and in Britain they have gone to 17% from 15%. It's significant that Ireland, Europe's success story, lowered its rate to 21% in 2006 from 25% in 1986. Ireland's VAT rate, at 35% in 1983 and 1984, was the world's highest.

In spite of Europe's experience with sky-high taxes, if America could succeed in taxing consumption rather than income from work and investment, this would have substantial benefits for America's economy. Now, Washington raises most of its money from taxes on labor and capital income, thereby reducing incentives to work and save.

If eliminating income taxes is impractical, or if we don't trust Congress to do so, a better way to move from income to consumption taxes is to exempt all saved income from taxation, without new sales or value-added taxes.

We could expand the scope of our present tax-free savings accounts, such as individual retirement accounts, tax free college savings plans, health savings accounts, and flexible savings accounts, and at the same time allow expensing, such as 100% first year business deductions, for purchases of capital equipment. This would essentially make the federal revenue system a consumption tax, albeit without the advantage of eliminating the IRS.

In that vein, Rudy Giuliani, New York's former mayor and also a Republican candidate, proposes to expand tax-free savings accounts, although he does not specify how much. One idea would be to combine all the current tax-free accounts into one large one, increase the permissible amount, and allow it to be used for multiple purposes of retirement, medical care, and college, rather than having different accounts for different purposes.

If Congress could be persuaded to move to a de facto consumption tax by expanding both tax-free savings accounts and the expensing of business investment, the economy would be invigorated. Mr. Huckabee is doing a service by opening the discussion with his FairTax proposal.

Ms. Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute. She can be reached at dfr@hudson.org.

Click here to read the article as originally published by The New York Sun.


All active news articles