FairTax Facts

COMMENTARY from The Wall Street Journal Online, p. A10


Much has been written lately about the FairTax, the proposal to replace the current federal income tax with a national retail sales tax. Unfortunately, much of it is wrong.

This country needs a spirited and wide-ranging debate about fundamental tax reform. But that debate is not advanced by misimpressions and distortions of the FairTax. Let us then clear up a few.

One assertion about the FairTax is that it began as a project of the Church of Scientology at a time when it was seeking tax-exempt status. This is false. The FairTax actually comes to us from market research conducted more than a decade ago by a handful of business leaders. Their goal was to determine what type of tax system would be most acceptable to the American public. The studies they paid for cost millions of dollars, included hard economic research by respected scholars, and were subjected to critical peer review. The result is a proposal, since introduced as legislation in Congress, now known as the FairTax.

What emerged from this research is that a national retail sales tax is a preferred method of taxation among most Americans surveyed. Another is that the tax would have significant benefits for the nation's economy.

Why? Because it eliminates income taxes and payroll taxes (for Social Security and Medicare), which are costly to collect and end up as "embedded" in the price of everything we buy. Along with getting rid of the Internal Revenue Service and the complexities of the income tax code, the FairTax would eliminate the distorting effect that income and payroll taxes have on the economy.

Research on the price of consumer goods reveals that up to 20% of all prices today represent hidden income taxes and payroll taxes. Once these taxes are repealed and replaced with the FairTax, it is likely that market pressure would force retail prices to fall.

Eliminating embedded taxes will also do something else -- it will remove significant price disadvantages suffered by American producers competing with tax-free imports. Eliminating corporate income taxes and capital gains taxes, which the FairTax would do, would likely make the American economy the most desirable place in the world to do business.

Another benefit of the FairTax is that, unlike other sales taxes, it would not hit the poorest Americans the hardest. The FairTax proposal calls for sending every American a "prebate" check to offset the cost of the national sales taxes paid by those living in poverty. This feature would effectively exempt those living below the poverty line from paying taxes to the federal government, and provide all taxpayers with a reimbursement of a portion of taxes paid.

The FairTax rate is 23% on retail sales when calculated "inclusively," as are income tax rates. It will, in a fairer, more transparent and less-expensive way, raise the same amount of money the federal government now collects through the income and payroll taxes. Because it would be levied on consumption at the final point of sale, instead of on earnings, it would dramatically expand the tax base. The FairTax would collect revenue from the underground economy. Even illegal immigrants and the 40 million foreign tourists who visit the U.S. each year would pay it.

The distributional effects of the FairTax have been extensively studied, and although the proposal has distinct advantages for investors and wealth creation across the income spectrum, the greatest benefit of the FairTax is to low- and moderate-income Americans. The effect of eliminating regressive payroll taxes is commonly overlooked when analyzing the FairTax, but it would have a very significant impact, as these taxes represent the single largest tax burden on these income earners.

Significantly, the FairTax eliminates all loopholes, gimmicks, exemptions and deductions from the federal tax system. Under the FairTax, Congress would no longer be able to reward friends, punish enemies or manipulate behavior through the tax code. The FairTax would also eliminate the lucrative tax lobbying practices that represent more than 50% of all lobby dollars spent annually in Washington.

It's no surprise, then, to see that vested interests have argued against the FairTax and in favor of keeping the mortgage interest deduction. But wouldn't it be better for everyone to stop the IRS from withholding from paychecks; to see the price of new homes -- and all other goods -- drop by removing embedded costs; and to have interest rates fall as the savings rate increases? Is it really in everyone's interests to keep the income-tax system so that one-third of taxpayers can go on deducting a portion of their mortgage interest from their federal taxes?

There have been many tax reform proposals over the years, but most of them simply call for reforming around the margins of the existing tax system. The President's Advisory Panel on Tax Reform was assembled by the Bush administration and concluded its work a few years ago. Instead of seriously looking at the FairTax, the panel looked at a very different type of consumption tax, riddled with exemptions, and then declared that it would be too expensive and that the rate would have to be far higher than the FairTax rate.

Politically, the FairTax will only become law once enough citizens demand that it be enacted, overcoming the self-interest that members of Congress and others have in holding onto the current system. It is debatable whether a modern, citizen-led tax revolution is possible. But the growing popularity (even among presidential candidates) of the FairTax suggests that another Boston Tea Party may be at hand.

Mr. Linbeck is CEO and cofounder of Americans for Fair Taxation.

This commentary was originally published by The Wall Street Journal Online: http://online.wsj.com/article_email/SB119863013677849835-lMyQjAxMDE3OTI4NjYyMzYwWj.html

 

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