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FairTax

2007 Schools Wikipedia Selection. Related subjects: Politics and government

   The FairTax (H.R.25/S.25) is a proposal for changing United States tax
   laws to replace the Internal Revenue Service (IRS) and all federal
   income taxes (including AMT), payroll taxes (including Social Security
   and Medicare taxes), corporate taxes, capital gains taxes, gift taxes
   and inheritance taxes with a national retail sales tax, to be levied
   once at the point of purchase on all new goods and services. Apart from
   funding, the legislation would not change government programs such as
   Social Security, Medicare, and Medicaid. The proposal also calls for a
   monthly tax rebate to households of citizens and legal resident aliens,
   to "untax" purchases up to the poverty level. The sales tax rate would
   be 23% of the total register price when calculated the same way as
   income taxes, which is the same as a 30% traditional sales tax. Due to
   the rebate, the effective tax rate is progressive on consumption and
   could result in a tax burden of zero or less. Opponents assert that the
   tax would be regressive on income, and (based on modified sales tax
   studies) would shift the tax burden from those with a higher income to
   those with a lower income and primarily benefit wealthy individuals,
   while the plan's supporters argue that it would broaden the tax base,
   increase purchasing power, decrease tax burdens, and tax wealth.

   Because the income tax structure of the United States embeds multiple
   taxes in the costs of goods and services, the FairTax is expected to
   decrease production costs after business taxes and compliance costs are
   removed. This is predicted to offset a portion of the FairTax amount.
   Proponents expect the FairTax to have positive ramifications for
   savings and investment (not taxed), transparency (taxes are visible on
   each receipt), ease of compliance (no tax planning), economic growth,
   international business locality (businesses will be more inclined to
   produce in the U.S.), and U.S. international competitiveness (decreased
   U.S. production costs). However, critics argue that it could be
   difficult to collect, having challenges with an underground economy
   (avoiding the tax), and that it may not yield enough money for the
   government, resulting in cuts to governmental programs, increased
   deficit, or a higher tax rate. Additionally, it may be difficult to
   permanently eliminate income taxation, as it would require a
   constitutional amendment to aggressively repeal the Sixteenth Amendment
   to the United States Constitution.

Legislative history

   The FairTax plan was created by Americans For Fair Taxation, an
   advocacy group formed for this purpose. The group developed the plan
   and the name Fair Tax with economists based on interviews, polls and
   focus groups of the general public.

   Georgia Republican John Linder first introduced the FairTax Bill in
   July 1999 to the 106th United States Congress. He has reintroduced
   substantially the same bill in each subsequent session of Congress.
   While the bill attracted a total of 56 House and Senate cosponsors in
   2004 and 61 in 2006, it has not been voted on by any committee in
   either the House or Senate. In order to become law, the bill will need
   to be included in a final version of tax legislation from either the
   U.S. House Committee on Ways and Means or U.S. Senate Finance
   Committee, then obtain support from the Joint Committee on Taxation,
   and finally pass both the House and the Senate.

   The current FairTax legislation was introduced by Linder in the House
   and by Georgia Republican Senator Saxby Chambliss in the Senate. Its
   formal name is the Fair Tax Act of 2005. The bill is supported by
   Speaker of the House Dennis Hastert but has not received support from
   the Democratic leadership. Democratic Representative Collin Peterson of
   Minnesota and Democratic Senator Zell Miller of Georgia cosponsored and
   introduced the bill in the 108th Congress, but Peterson is no longer
   cosponsoring the bill and Miller has left the Senate. In the 109th
   Congress, Democratic Representative Dan Boren has cosponsored the bill.

   Other current attempts to replace the U.S. tax system have attracted
   fewer cosponsors. The Flat tax sponsored by Texas Republican Michael C.
   Burgess in the House has 6 cosponsors, and no other proposal has as
   many.

Tax rate

Sales tax rate

   The FairTax legislation would apply a 23% federal retail sales tax on
   the total transaction value of new retail goods and services purchases;
   in other words, consumers pay to the government 23 cents of every
   dollar spent (sometimes called tax-inclusive — as income taxes are
   calculated). The assessed tax rate is 30% if the FairTax is added to
   the pre-tax price of a good like traditional U.S. sales taxes
   (sometimes called tax-exclusive). The FairTax legislation uses total
   transaction value (tax-inclusive) in presenting the rate; with an item
   purchased for $100, the retailer receives $77 and the remaining is
   collected for the federal government. However, American sales taxes
   have historically been expressed as a percentage of the original sale
   price (tax-exclusive); items priced at $100 pre-tax cost $130 with the
   tax added. The use of the tax-inclusive number in presenting the rate
   has been criticized as deceptive by the plan's opponents. Proponents
   argue that the 23% number represents a better comparison to income tax
   rates, which are presented as inclusive rates (see Presentation of tax
   rate). Critics also argue that the sales tax rate would need to be
   higher in order to be revenue neutral (see Revenue neutrality).

   A good would be considered "used" and not taxable if a consumer already
   owns it before the FairTax takes effect or if the FairTax has already
   been paid on the good. The FairTax would tax all services provided at
   the retail level. Personal services such as health care, legal
   services, haircuts and auto repairs would be subject to the FairTax, as
   would renting apartments and other real property. State sales taxes do
   not generally tax such services. Education, training, saving and
   financial investing would be considered an investment (rather than
   final consumption) and therefore would not be taxed.

Effective tax rate

   Effective tax rate comparison graph
   Enlarge
   Effective tax rate comparison graph

   The effective tax rate for any household would be variable due to the
   fixed monthly tax rebates. The rebates would have the greatest impact
   at low spending levels, where they could lower a household's effective
   rate to zero or a negative rate. At higher spending levels, the rebate
   has less impact, and a household's effective tax rate would approach
   23% of total spending. For example, a household of three spending
   $30,000 a year on taxable items would devote about 6% of total spending
   to the FairTax after the rebate. A household spending $125,000 on
   taxable items would spend around 19% on the FairTax. The total amount
   of spending and the proportion of spending allocated to taxable items
   would determine a household's effective tax rate.

   The lowest effective tax rate under the FairTax could be negative due
   to the rebate. This could occur when a household spends less and pays
   less in taxes than the average poverty level spending for a similar
   household size. Buying or otherwise receiving used items can also
   contribute towards a negative rate. Here, the household's rebate would
   exceed actual taxes paid by that household. To determine the effective
   tax rate for consuming all income on new goods and services: ((income *
   tax rate) – rebate) / income = effective tax rate.

Monthly tax rebate

   2006 FairTax prebate schedule
   Enlarge
   2006 FairTax prebate schedule

   Under the FairTax, households would receive a monthly tax rebate (known
   as a "prebate" as it would be paid in advance) equal to the estimated
   total FairTax paid on poverty level spending according to the poverty
   guidelines published by the U.S. Department of Health and Human
   Services. The poverty level guidelines vary by family size and
   represent the cost to purchase household necessities. The rebate would
   be paid in twelve monthly installments equal to 23% of poverty level
   spending for each household size and is meant to eliminate the taxation
   of necessities and make the plan progressive. The formula used to
   calculate rebate amounts would be adjusted for inflation. To become
   eligible for the rebate, households would register once a year with
   their sales tax administering authority, providing the names and social
   security numbers of each household member. The Social Security
   Administration would disburse the monthly rebate payments in the form
   of a paper check via U.S. Mail, an electronic funds transfer to a bank
   account, or a “ smartcard” that can be used much like a bank debit
   card. The National Taxpayers Union estimated that the annual cost of
   mailing monthly rebate checks via the U.S. Post Office would be
   approximately $225 million.

   The President's Advisory Panel on Federal Tax Reform cited the rebate
   as one of their chief concerns with the FairTax, calling it "the
   largest (entitlement program) in American history," and contending that
   it would "make most American families dependent on monthly checks from
   the federal government for a substantial portion of their incomes."
   However, if "substantial" was defined as a rebate that increased family
   income by 23% or more, according to the U.S. Census Bureau income
   statistics for 2005, "most American families" (claimed by the Tax
   Panel) would only equate to 12.6%. Based on the advisory panel's tax
   rate and base (which differs from the FairTax legislation by creating
   exemptions not defined in the proposal), "the Prebate program would
   cost more than all budgeted spending in 2006 on the Departments of
   Agriculture, Commerce, Defense, Education, Energy, Homeland Security,
   Housing and Urban Development, and Interior combined." The Beacon Hill
   Institute estimated the rebate cost to be $489 billion (assuming 100
   percent participation). Proponents point out that income tax
   deductions, tax preferences, loopholes, credits, etc. under the current
   system was estimated at $945 billion by the Joint Committee on Taxation
   and that the IRS itself sent out $270 billion in refund checks for
   2005. This is $456 billion more than the FairTax "entitlement" would
   spend to enable taxpayers to buy the necessities of life free from
   government tax.

Revenue neutrality

   A key component of the FairTax rate is the ability to be
   revenue-neutral — that is, it would not result in an increase or
   reduction in overall federal tax revenues. However, this is a matter of
   dispute, as economists, advisory groups and political advocacy groups
   disagree about the tax rate required for the FairTax to be truly
   revenue-neutral. Different researchers use different time frames and
   methodologies that make direct comparison among estimates difficult.
   The choice between static or dynamic scoring further complicates any
   estimate of revenue-neutral rates. The rates presented below are based
   on a static scoring analysis and adhere to the legislative framework of
   the FairTax bill in rate presentation, which is calculated as a
   percentage of total spending, sometimes called a tax-inclusive rate. To
   adjust any rate below to that of a traditional sales tax, divide the
   rate by 1 minus the rate (refer to Presentation of tax rate for
   calculations).

   Americans For Fair Taxation (AFFT) claim that Dale Jorgenson, a
   professor of economics at Harvard University and past President of the
   American Economics Association, helped develop the FairTax and
   estimated the revenue-neutral rate to be 22.9%. However, Dr. Jorgenson,
   in his 2002 book, indicated that he believes the revenue-neutral rate
   would need to be much higher (it is unknown what assumptions, changes,
   or tax base he was considering when he made this statement). Jim
   Poterba of the Massachusetts Institute of Technology estimated a rate
   of 23.1% using assumptions provided to him by AFFT. Laurence Kotlikoff
   of Boston University purportedly found a rate of around 24%. AFFT
   states that researchers at Stanford University, The Heritage
   Foundation, The Cato Institute, and Fiscal Associates have calculated
   revenue-neutral rates between 22.3% and 24%. However, AFFT funded this
   research and has not made these studies public. The studies are also
   not published by the economists that conducted those studies. Economist
   William Gale of the Brookings Institution published a detailed analysis
   that estimated a ten-year revenue-neutral rate of around 31% (on a
   tax-inclusive basis) assuming full taxpayer compliance. The Argus Group
   and Arduin, Laffer & Moore Econometrics both published analyses that
   defended the 23% rate. A detailed study published in 2006 by Beacon
   Hill Institute found the FairTax rate to be 23.82%.

   Additional studies have been performed on National Retail Sales Tax
   plans that do not necessarily conform to the tax base as defined in the
   FairTax legislation but are often considered when discussing FairTax
   rates. These studies often claim the tax base or rate calculation
   methods used in the FairTax legislation is flawed or likely to be
   modified by Congress before passage. The President's Advisory Panel for
   Federal Tax Reform found the rate would need to be 25% in order to
   replace the income tax alone (i.e., it would need by be substantially
   higher to replace payroll taxes and the estate tax). However, the
   Chairman of the President's Advisory Panel, former U.S. Senator Connie
   Mack, stated that "the panel did not score H.R. 25” (the FairTax). The
   panel was not allowed to consider reforming regressive payroll taxes
   and they reduced the tax base by adding large exclusions. The panel
   explained that the tax base change and the higher rate was required due
   to several flaws it found in the FairTax proposal - including the
   counting of taxes government would pay to itself as revenues without
   similarly increasing the amount of government expenditures to pay these
   taxes, and an assumption of zero tax-evasion - which it considered
   unrealistic. FairTax proponents, including the Beacon Hill Institute,
   disagree with those conclusions.

   The tax panel reported "For example, if a retail sales tax imposed a 30
   percent tax on a good required for national defense, either the
   government would be required to pay that tax, thereby increasing the
   cost of maintaining current levels of national defense under the retail
   sales tax, or, if the government was exempt from retail sales tax, the
   estimate for the amount of revenue raised by the retail sales tax could
   not include tax on the government’s purchases. Failure to properly
   account for this effect is the most significant factor contributing to
   the FairTax proponents’ relatively low revenue-neutral tax rate.
   Second, FairTax proponents’ rate estimates also appear to assume that
   there would be absolutely no tax evasion in a retail sales tax. The
   Panel found the assumption that all taxpayers would be fully compliant
   with a full replacement retail sales tax to be unreasonable. The Panel
   instead made assumptions about evasion that it believes to be
   conservative and analyzed the tax rate using these evasion
   assumptions."

   The Treasury Department estimates excluded government consumption from
   the base, which is about 18% of consumption. This significantly alters
   the tax base and therefore the tax rate. Other studies point out that
   the current system is also counting taxes the government would pay to
   itself by including matched payroll taxes of government employees, in
   addition to covering the corporate and payroll tax expenses of its
   contractors and their suppliers. The tax panel included large
   expenditures to local and state governments for the FairTax burden,
   however, the Beacon Hill Institute suggested a flaw in this logic and
   showed that the FairTax imposes no additional real fiscal burdens on
   state and local government. A similar level of taxation is required
   when shifting from taxing income to consumption in order to maintain
   the tax burden on government. Proponents assert that government needs
   to be taxed to keep a level playing field between government
   enterprises and private enterprises. Dr. Karen Walby, Director of
   Research for the Americans For Fair Taxation, discussed a recent study
   by Young & Associates on evasion and enforcement that identifies
   certain key variables which influence the level of compliance (marginal
   tax rates, likelihood of audit, severity of penalties, etc) and
   concludes the FairTax is superior on most/all of these and would
   therefore have lower rates of evasion than alternatives. While the
   FairTax studies did not consider tax evasion, neither did they ignore
   it. The studies have implicitly incorporated a significant degree of
   tax evasion in calculations simply by using National Income and Product
   Account based figures that understate total household consumption. In
   addition, the studies did not consider the increased economic growth
   that economists and FairTax supporters believe would occur.

   Congress’s bipartisan Joint Committee on Taxation evaluated a proposal
   similar to FairTax that included additional exemptions and estimated a
   revenue-neutral rate of around 36%. In a 2004 study, the Institute on
   Taxation and Economic Policy examined the FairTax proposal and contends
   that by excluding certain levels of taxation it calls "phantom" (sales
   to the government, church and nonprofit transactions, etc.), a national
   sales tax rate would have to be upwards of 36% to be revenue-neutral.
   Proponents charge that the Presidential Tax Panel, the JCT, and ITEP
   are motivated to maintain the "status quo" and thus modify the tax base
   from the proposed legislation to achieve higher rates. Proponents claim
   that it is circular logic for critics of the FairTax to modify the tax
   base to create a higher rate and to then justify greater evasion,
   making an even higher rate, which also makes the rebate much more
   expensive. Proponents further state that since opponents could not kill
   the FairTax proposal based on merits or lack thereof; they create their
   own plan with an exaggerated rate to make it politically not feasible.

Presentation of tax rate

   The current tax system imposes taxes primarily on income. The tax base
   is a household's pre-tax income. The appropriate income tax rate is
   applied to the tax base to calculate taxes owed. Under this formula,
   taxes to be paid are included in the base on which the tax rate is
   imposed. If an individual's gross income is $100 and income tax rate is
   23%, taxes owed equals $23. The tax base of $100 can be treated as two
   parts—$77 of after-tax spending money and $23 of income taxes owed. The
   income tax is taken "off the top", so the individual is left with $77
   in after-tax money.

   Traditional sales tax laws impose taxes on a tax base equal to the
   pre-tax portion of a good's price. Unlike income taxes, U.S. sales
   taxes do not include actual taxes owed as part of the base. A good
   priced at $77 with a 30% sales tax rate yields $23 in taxes owed. Since
   the sales tax is added "on the top", the individual pays $23 of tax on
   $77 of pre-tax goods.

   Since sales and income taxes behave differently due to differing
   definitions of tax base, direct rate comparisons between the two can be
   confusing. For direct rate comparisons between sales and income taxes,
   one rate must be manipulated to look like the other. However, this can
   cause some confusion when not explained properly. A 30% sales tax rate
   approximates a 23% income tax rate after adjustment. From the example
   above, an individual pays $23 of tax on $77 of goods. Total spending
   (pre-tax price and taxes owed) for that transaction equals $100. The
   $23 of taxes on $100 of total spending yields a 23% rate. By including
   taxes owed in the tax base, a sales tax rate can be directly compared
   to an income tax rate.

   The FairTax rate, unlike most U.S. state-level sales taxes, would be
   calculated on a tax base that includes the amount of FairTax paid. In
   this manner, the FairTax, like European sales taxes, more closely
   resembles an income tax calculation. A final price of $100 includes $23
   of taxes. Like the income tax example above, the taxes to be paid would
   be included in the base on which the FairTax is imposed. The FairTax is
   presented as a 23% tax rate for easy comparison to income tax rates. If
   you are in a 25% income tax bracket, you will pay $25 in federal income
   taxes out every $100 you earn. With the 23% FairTax, you would pay $23
   in taxes out of every $100 you spend.

   The plan's opponents call this deceptive - Laurence Vance, writing for
   the Ludwig von Mises Institute, goes so far as to call it a "lie".
   According to Vance, "Boortz's 'mathematical equivalent of a game of
   semantics' still results in a FairTax rate of 30 percent. This is why
   Boortz prefers the national sales tax to be included in the price of
   each item—so the consumer doesn't realize that he is really paying an
   extra 30 percent in sales tax, not Boortz's new math amount of 23
   percent." When looking at other rate studies that report a 36% rate,
   the equivalent traditional sales tax rate would be 56%.

          Comparison to a typical sales rate:

     * Let r be the FairTax rate. i.e. if the rate was 30%, then r = 0.30

     * Let a be the FairTax rate in terms of a typical sales tax.

     * Let p be the price of the good.

     * The revenue that would go to the government is:

                r \times p

          This means the revenue remaining for the seller of the good is:

                p - r \times p

          In a traditional sales tax system, sales tax is calculated as
          the fraction of the money going to the company that must be paid
          to the government. For example, with a traditional 10% sales
          tax, the government would receive $10 when a company receives
          $100. Thus, to convert the tax we divide the money going to the
          government by the money the company nets:

                a = \frac{r \times p}{p - r \times p} = \frac{r}{1 - r}

   This means that to adjust any rate below to that of a traditional sales
   tax, one can divide the given rate by 1 minus that rate.

Distribution of tax burden

   President's Advisory Panel for Federal Tax Reform's analysis of a
   hybrid National Sales Tax - impact by income percentile
   Enlarge
   President's Advisory Panel for Federal Tax Reform's analysis of a
   hybrid National Sales Tax - impact by income percentile

   The FairTax's impact on the distribution of taxation is a point of
   significant dispute. The plan's supporters argue that it would broaden
   the tax base, be progressive and start taxing wealth, while opponents
   argue that a national sales tax would be inherently regressive and
   would decrease tax burdens paid by high-income individuals. Sales taxes
   are normally considered regressive, however, the FairTax provides a
   rebate that supporters argue would create a progressive effective rate
   on consumption. Under the FairTax, a low-income family may spend
   $25,000 on goods and services consuming 100% of their income. A higher
   income family making $100,000 may spend $80,000 on goods and services
   and save $20,000. The higher income family is consuming only 80% of
   their income on taxable goods and services. According to Economist
   William G. Gale, the percentage of income taxed is regressive. However,
   when presented with an estimated effective tax rate, the low-income
   family above would pay a tax rate of 0% on the 100% of consumption and
   the higher income family would pay a tax rate of 15% on the 80% of
   consumption. The effective tax rate is progressive on consumption.

   Households at the lower end of the income scale spend almost all their
   income, while households at the higher end are more likely to devote a
   portion of income to saving; households at the extreme high end of
   consumption often finance their purchases out of savings, not income.
   This savings would be taxed when it becomes a purchase. Income earned
   and saved would not be taxed immediately under the proposal. In other
   words, savings would be spent at some point in the future and taxed
   according to that consumption. FairTax advocates state that this would
   improve taxing of wealth. Economist Laurence Kotlikoff stated that the
   FairTax could make the tax system much more progressive and
   generationally equitable. "Their view that taxing sales is regressive
   is just plain wrong. Taxing consumption is effectively the same as
   taxing wages plus taxing wealth." The payroll tax system is regressive
   on income with no standard deduction or personal exemptions taxing only
   the first $94,200 from gross wages, and none earned from capital
   investments or interest. The Centre on Budget and Policy Priorities
   states that three-fourths of taxpayers pay more in payroll taxes than
   they do in income taxes. Under the FairTax, it would be eliminated.
   Kotlikoff finds that the FairTax significantly reduces marginal taxes
   on work and saving, substantially lowers overall average remaining
   lifetime tax burdens on current and future workers at all income
   levels.

   The President's Advisory Panel for Federal Tax Reform and Economist
   William Gale analyzed a National Sales Tax similar to the FairTax
   (though also different in several aspects) and reported that the
   overall tax burden on middle-income Americans would increase while the
   tax burden on the very rich would drop. FairTax supporters argue that
   the tax burden would shift to those who do not pay taxes under the
   current system. The FairTax would dramatically broaden the tax base to
   include all 300 million Americans and an estimated 30 million to 40
   million foreign tourists and visitors. This would more than double the
   federal government's tax base. A study on marginal and average tax
   rates found that the FairTax would reduce most households’ average
   lifetime tax rates and, often, by a lot. Economists at Boston
   University found that the FairTax rewards low-income households with
   26.7 percent more purchasing power, middle-income households with 10.9
   percent more purchasing power, and high-income households with 4.7
   percent more purchasing power.

Predicted effects

   The FairTax proposal would have effects in many areas that influence
   the United States. FairTax proponents assert that the proposal would
   provide tax burden visibility and reduce compliance costs. The cost of
   federal government would be highly visible as consumers would see most
   of this cost in a single tax paid every time they purchase a good or
   service. Under the current tax system, the federal government collects
   revenue through a wide variety of taxes on individuals and businesses,
   which may not be fully visible to individual citizens. The efficiency
   cost of the current tax system — the output that is lost over and above
   the tax itself — is between $240 billion and $600 billion every year
   according to a 2005 report from the U.S. Government Accountability
   Office. Supporters argue that the FairTax system would reduce these
   compliance and efficiency costs by 90% and return a larger share of
   that money to the productive economy.

   In an open letter to the President, the Congress, and the American
   people, seventy-five economists, including Nobel Laureate Vernon L.
   Smith, stated that the FairTax would boost the United States economy.
   According to the National Bureau of Economic Research and Americans For
   Fair Taxation, GDP would increase almost 10.5% in the year after the
   FairTax goes into effect. In addition, the incentive to work would
   increase by as much as 20%, the economy’s capital stock would increase
   by 42%, labor supply by 4%, output by 12%, and real wage rate by 8%.
   Further, studies of the FairTax at Boston University and Rice
   University suggest the FairTax will bring long-term interest rates down
   by as much as one third. As falling tax compliance costs lower
   production costs, exports would increase by 26% initially and remain
   more than 13% above present levels. According to Professor Dale
   Jorgenson of Harvard University’s Economics Department, revenues to
   Social Security and Medicare would double as the size of the economy
   doubles within 15 years after passage of the FairTax. Opponents offer a
   study commissioned by the National Retail Federation in 2000 that found
   a national sales tax would bring a 3 year decline in the economy, a 4
   year decline in employment and an 8 year decline in consumer spending.

   Global corporations consider local tax structures when making planning
   and capital investment decisions. Lower corporate tax rates and
   favorable transfer pricing regulations can induce higher corporate
   investment in a given locality. The United States currently has the
   highest combined statutory corporate income tax rate among OECD
   countries. Bill Archer, former head of the House Ways and Means
   Committee, asked Princeton University econometricists to survey 500
   European and Asian companies regarding the impact on their business
   decisions if the United States enacted the FairTax. 400 of those
   companies stated they would build their next plant in the United
   States, and 100 companies said they would move their corporate
   headquarters to the United States. In addition, the U.S. is currently
   the only one of the 30 OECD countries with no border adjustment element
   in its tax system. Proponents state that because the FairTax is
   automatically border adjustable, the 17% competitive advantage, on
   average, of foreign producers would be eliminated, immediately boosting
   U.S. competitiveness overseas and at home. In The FairTax Book, Boortz
   and Linder assert that an estimated ten trillion dollars are held in
   foreign accounts, largely for tax purposes and predict a large portion
   of those funds would become available to U.S. capital markets, bringing
   down interest rates, and otherwise promoting economic growth in the
   United States.

   The current federal tax law allows individuals to deduct the home
   mortgage interest costs, and donations to certain charities, from
   taxable income. Someone paying a 25% income tax rate would pay $250 in
   taxes on a $1,000 donation or mortgage interest payment, and then
   receive $250 back from the government as the $1000 deduction is removed
   from taxable income. The FairTax is tax free on mortgage interest up to
   the basic interest rate as determined by the Federal Reserve and
   donations are not taxed. The FairTax may also affect State and local
   government debt as the federal income tax system provides tax
   advantages to state and local municipal bonds. Other areas affected may
   be law enforcement as avoidance of income tax is sometimes used to
   prosecute members of organized crime syndicates to convict on charges
   of tax avoidance and tax evasion when insufficient direct evidence
   exists for other crimes. Under the FairTax proposal, this avenue of law
   enforcement would disappear as there would be no income tax and,
   therefore, no income tax evasion. However, individuals such as illegal
   immigrants may benefit as there would also be no federal tax savings to
   companies that hire illegal immigrants. Advocates claim the FairTax
   would provide incentive for illegal immigrants to legalize as they
   would otherwise not receive the FairTax rebate, paying the maximum
   effective tax rate.

Changes in the retail economy

Implementation

   Like other firms, retailers would enjoy a zero corporate tax rate.
   Under the FairTax, retailers would be required to collect tax on all
   sales occurring within the United States. Retailers would receive a
   collection fee of .25% on federal funds collected. States that choose
   to conform to the federal base would have the added advantage of
   information sharing and clear interstate revenue allocation rules.

Value of used goods

   Since the FairTax would not tax used goods, there is a common
   misunderstanding that this would create a differential, equal to the
   FairTax, between the price of new and used goods. Such a differential
   would certainly impact the sale of new goods like vehicles and homes.
   However, like the income tax system that contains embedded tax cost
   (see Supporting theories of effect), used goods would contain the
   embedded FairTax cost. While the FairTax would not be applied to the
   retail sales of used goods, the inherent value of a used good includes
   the taxes paid when the good was sold at retail. The value is
   determined by the supply and demand in relation to new goods. The price
   differential / margins between used and new goods would stay consistent
   as the cost and value of used goods are in direct relationship to the
   cost and value of the new goods.

Supporting theories of effect

   Diagram illistrating taxes effect
   Enlarge
   Diagram illistrating taxes effect

   Retail prices are inflated due to embedded taxes and compliance costs
   passed to the consumer by producers and suppliers. John Linder states
   the FairTax would eliminate almost all federal taxation costs from the
   supply chain, which could lower production costs by up to 30%.
   Americans For Fair Taxation has claimed that the production cost of
   domestic goods and services could decrease by approximately 22% on
   average after embedded taxes and compliance costs were removed, leaving
   the sale nearly the same after taxes. This is based on a study
   conducted by Dr. Dale Jorgensen, who found that producer prices would
   drop between 15% and 26% (depending on the type of good/service) after
   the switch to a consumption based tax. However, Jorgenson's research
   included all income and payroll taxes regardless of whether they were
   paid by employees or employers in the 22% embedded tax estimation. (It
   is also important to note that the Jorgenson model did not capture any
   reduction in the cost of compliance associated with changing from a
   complex income tax system to a simpler consumption tax.) This means
   that Jorgenson assumed that businesses would pass on all the cost
   savings from the repeal of payroll taxes and income tax withholding to
   consumers in the form of lower prices. Mathematically, this would have
   to result in employee take-home pay ( net income) remaining unchanged
   from pre-FairTax levels.

   If businesses instead provided employees with their gross pay as
   expected (including income tax withholding and the employee share of
   payroll taxes), Arduin, Laffer & Moore Econometrics estimated
   production costs would decrease by a minimum of 11.55%. This decrease
   would offset a portion of the FairTax amount reflected in retail
   prices. These embedded costs include corporate taxes, compliance costs,
   and the employer share of payroll taxes (see Effect on tax compliance
   costs). The Beacon Hill Institute shows that it wouldn't matter whether
   prices fall or rise – the relative tax burden remains the same because
   if prices increased with the addition of the FairTax, wages would also
   rise accordingly; or if the federal reserve did not decide to
   accommodate (does not increase the money supply), then prices would
   fall and wages would remain at their net rates. Purchasing power for
   buying consumer goods and services in either situation would remain
   essentially the same, and the FairTax rate would be the same.

   The decrease in production cost would only slightly apply to imported
   products, so, according to proponents, it would provide tax advantages
   for domestic production and increase U.S. competitiveness in global
   trade (see Border adjustability). Such logic is endorsed by a recent
   letter to the commission on tax reform by dozens of economists,
   including Nobel Laureate Vernon L. Smith. A study prepared by Nathan
   Associates for the National Retail Institute, which made many adverse
   assumptions, represents supporters' worst-case scenario for a
   consumption tax. The study predicts that the economy will grow only
   three percent more in ten years than it would have under the income tax
   and that the increase in consumption will be 1.15% less in the first
   year relative to what it would have been under the income tax. This
   study concludes that consumption will be higher in the fourth year and
   every year thereafter than it would have been under the income tax.

Effects on tax code compliance

   FairTax supporters state that black market or illegal economic activity
   is largely untaxed under the current tax system. Economists estimate
   the underground economy in the United States at approximately $1
   trillion annually. By imposing a sales tax, black market activity would
   be significantly taxed when proceeds from such activity are spent on
   legal consumption. For example, the sale of illegal narcotics would
   remain untaxed (instead of being guilty of income tax evasion, dealers
   would be guilty of failing to submit sales tax), but drug dealers would
   face taxation when they used drug proceeds to buy consumer goods such
   as food, clothing, and cars. By taxing this previously untaxed money,
   FairTax supporters state the black market would be paying part of their
   share of what would otherwise be uncollected income and payroll taxes.

   It has been argued that if there were no net change in retail prices or
   tax burdens, the licit consumption of goods and services by the
   underground economy would continue to bear the same tax burden as
   before. Legal purchases under the current tax regime carry the hidden
   cost of implicit taxes. When an explicit tax replaces those taxes, the
   consumption purchases would still bear the same tax burden. However,
   the cost paid by the underground economy through embedded taxes is the
   cost associated with those paying into the income tax base. If black
   market activity was taxed today, the tax burden on the rest of the
   population would decrease from the larger base. Likewise, the large
   base of consumption would have illegal activity paying into the FairTax
   base.

Tax compliance

   The current income tax system fails to collect on a significant
   percentage of taxes owed. The IRS estimates there are twenty additional
   cents of taxes owed on unreported income for every tax dollar
   collected. In 2001, the IRS estimated this shortfall to be over $312
   billion. These figures do not include taxes lost on illegal sources of
   income, such as drug dealing.

   Proponents assert that the transparency and simplicity of the FairTax
   would subject much of this unreported income to taxation. The number of
   tax collection points would significantly reduce as only retailers
   would file a tax return compared to every income earner. Research
   supports the claim that simplified tax systems lead to greater
   compliance. The IMF found that Russia's transition to a flat tax
   increased income reporting from 52% to 68% in one year. Similar results
   have occurred in Slovenia. The FairTax would reduce the number of tax
   filers by 80% and reduce the filing complexity to a simplified state
   sales tax form. The federal government would also be able to
   concentrate its entire tax enforcement efforts on a single tax – the
   FairTax. In addition, the overwhelming majority of purchases of goods
   and services occur in major retail outlets that would comply with the
   FairTax. Retailers would receive 1/4 of 1% as compensation for
   compliance costs.

   FairTax opponents believe that tax compliance rates decrease when taxes
   are not automatically withheld or collected as tax liability is
   incurred. Compliance rates also fall when taxed entities, rather than a
   third party, self-report their tax liability. For example, ordinary
   personal income taxes can be automatically withheld and are reported to
   the government by a third party. Taxes without withholding and with
   self-reporting, such as the FairTax, can see evasion rates of 30% or
   more. William Gale has estimated that an evasion rate of 20% would
   require a FairTax rate of 39% to replace revenue lost through evasion.
   This would be a 65% rate when presented as a traditional sales tax.

   The FairTax is a national retail sales tax, but can be administered by
   the states rather than a federal agency. This has a bearing on
   compliance, as the states' own agencies could monitor and audit
   businesses within that state. The .25% paid to the states amounts to 5
   billion dollars the states would have available for enforcement. For
   example, California should receive over $500 million for enforcement.
   According to the California 2004-05 budget analysis, this is more than
   the $327 million California is spending to enforce the state's more
   complex sales and excise taxes. The FairTax is simpler, but extends to
   cover services which are not currently subject to the California sales
   tax. Because the federal money paid to the states for enforcement would
   be a percentage of the total revenue collected, the states would have
   an incentive to maximize collections.

   University of Michigan economist Joel Slemrod argues, however, that
   states would face significant issues in enforcing the tax. "Even at an
   average rate of around 5 percent, state sales taxes are difficult to
   administer. Apparently the authors (of the FairTax) have not talked
   much to administrators who have to deal with, among other things,
   ineligible people declaring themselves to be businesses to qualify for
   the business exemption." This statement, however, is based on the
   understanding of state sales taxes, which differs from what would be
   allowed for personal and business purchases under the FairTax (see
   Personal vs. business purchases).

Underground economy

   Opponents of FairTax argue that imposing a national retail sales tax
   would drive transactions underground and create a vast underground
   economy. Under a retail sales tax system, the purchase of intermediate
   goods would not always be taxed, since those goods would produce a
   retail good that will be taxed. Individuals and businesses may be able
   to manipulate the tax system by claiming that purchases are for
   intermediate goods, when in fact they are final purchases that should
   be taxed. Proponents point out that a business is required to have a
   registered seller's certificate on file, and must keep complete records
   of all transactions for 6 years. Businesses must also record all
   taxable goods bought for 7 years. They are required to report these
   sales every month (see Personal vs. business purchases).

   While the superiority of consumption taxes is evident to many
   economists and tax experts, problems could arise with using a retail
   sales tax rather than a value added tax (VAT). A VAT imposes a tax at
   every intermediate step of production, so the goods reach the final
   consumer with much of the tax already in the price, along with some
   extra overhead. The retail seller has little incentive to conceal
   retail sales, since he has already paid much of the good's tax.
   Retailers are unlikely to subsidize the consumer's tax evasion by
   concealing sales. In contrast, a retailer has paid no tax on goods
   under a sales tax system. This provides an incentive for retailers to
   conceal sales and engage in "tax arbitrage" by sharing some of the
   illicit tax savings with the final consumer.

   In the United States, a general sales tax is imposed in 45 states plus
   the District of Columbia (accounting for over 97 percent of both
   population and economic output). Most states also collect a variety of
   local sales taxes including county, city, and transit taxes. The United
   States has a large infrastructure for taxing sales that many countries
   do not have. Proponents respond to the underground economy argument by
   pointing out that, whereas tax evasion under the current income tax
   system requires only one person (the payer) to lie on their tax forms,
   tax evasion under the FairTax requires collusion of both the payer (the
   retail purchaser) and the payee (the retail seller). Furthermore, the
   number of individuals required to file taxes drops from approximately
   135 million to 25 million. This 84% drop in the number of collection
   points will allow the tax administration to view tax fraud with greater
   scrutiny. Proponents of the FairTax see a substantial amount of
   additional tax revenue from those engaging in the black market, as a
   sales tax would require all who consume to be taxed (see Effects on tax
   code compliance).

Personal vs. business purchases

   In order for an individual to purchase items tax-free for business
   purposes, the business would be required to be a registered seller with
   the state sales tax authority, who could collect the FairTax along with
   the state sales tax. The state would issue the business a registered
   seller's certificate. This would enable the business to purchase tax
   free from wholesale vendors, but they must give a copy of their
   registration certificate to the vendor to leave an audit trail. When an
   item is purchased for business use from a retail vendor, the business
   would have to pay the tax on the purchase and take a credit against the
   tax due on their sales tax return. Taxable property and services
   purchased by a qualified non-profit or religious organization 'for
   business purposes' would not be taxable.

   Businesses would be required to submit monthly or quarterly reports
   (depending on sales volume) of taxable sales and sales tax collected on
   their retail sales to the tax authority. During audits, the business
   would have to produce invoices for the "business purchases" that they
   did not pay sales tax on, and would have to be able to show that they
   were genuine business expenses. Since 130 million individuals would no
   longer be filing tax returns, there would only be about 25 million
   businesses that could be audited. Advocates claim that this would
   greatly increase the likelihood of business audits, making tax evasion
   behaviour much more risky. Additionally, the FairTax legislation has
   several fines and penalties for non-compliance and authorizes a
   mechanism for reporting tax cheats and obtaining a reward.

   To prevent businesses from purchasing everything for their employees,
   in a family business for example, goods and services bought by the
   business for the employees that are not strictly for business use would
   be taxable. Health insurance or medical expenses would be an example
   where the business would have to pay the FairTax on these purchases.

Transition effects

   Source: Ross Korves, chief economist (retired), American Farm Bureau
   Federation.
   Enlarge
   Source: Ross Korves, chief economist (retired), American Farm Bureau
   Federation.

   Because the FairTax proposal would replace various taxes with a single
   sales tax, several areas may experience unique effects through the
   transition.

Repeal of Sixteenth Amendment

   If the FairTax bill were passed, permanent elimination of income
   taxation would not be guaranteed; the FairTax bill would repeal much of
   the existing tax code, but the Sixteenth Amendment would remain in
   place. Cases decided by the United States Supreme Court after the
   ratification of the Sixteenth Amendment have established that Congress
   has the power to enact an income tax even if the amendment did not
   exist. The elimination of the possibility that income taxation would
   return (through a separate Congressional bill), requires a repeal of
   the Sixteenth Amendment to the United States Constitution along with
   expressly prohibiting an income tax. This is referred to as an
   "aggressive repeal". The Constitution, however, does not require an
   income tax, it only allows one. Separate income taxes enforced by the
   State would be unaffected by the federal repeal.

   Since passing the FairTax would only require a simple majority in each
   house of Congress along with the signature of the President, and
   enactment of a constitutional amendment must be approved by two thirds
   of each house of Congress, and three quarters of the individual U.S.
   states, it is possible that passage of the FairTax bill would simply
   add another taxation system. If a new income tax bill was passed after
   the FairTax passage, a hybrid system could develop. However, there is
   nothing preventing the addition of a national sales tax, or VAT tax, on
   top of today's income tax system. The Americans For Fair Taxation plan
   is to first pass the FairTax and then to focus grassroots efforts on
   HJR 16, sponsored by Congressman Steve King (R-IA), that calls for the
   repeal of the Sixteenth Amendment.

   Congressman Linder, the bill sponsor, has stated "If the FairTax is
   enacted, I expect that the Congress and states would promptly begin
   consideration of legislation to repeal the Sixteenth Amendment. To make
   certain that occurs, however, I am in favour of adding language to H.R.
   25 during the 110th Congress that includes a sunset provision, meaning
   that either we succeed in repealing the Sixteenth Amendment within 5
   years after the implementation of the FairTax or the FairTax goes away.
   In my view, we simply cannot risk having both a national income tax and
   a national sales tax in place at the same time."

Effect on savers

   Individuals under the current system who accumulated savings from
   ordinary income (by choosing not to spend their money when the income
   was earned) paid taxes on that income before it was placed in savings.
   When individuals spend above the poverty level with money saved under
   the current system, that spending would be subject to the FairTax.
   People living through the transition may find both their earnings and
   their spending taxed.

   Critics have claimed that the FairTax would result in unfair double
   taxation for savers and suggest it does not address the transition
   effect on some taxpayers who have accumulated significant savings from
   after-tax dollars, especially retirees who have finished their careers
   and switched to spending down their life savings.

   Supporters of the plan argue that the current system is no different,
   since compliance costs and "hidden taxes" embedded in the prices of
   goods and services cause savings to be "taxed" a second time already
   when spent. The rebates would supplement accrued savings, covering
   taxes up to the poverty level. The income taxes on capital gains,
   social security and pension benefits would be eliminated under FairTax.
   The FairTax would also eliminate what some claim to be the double
   taxation on savings that is part of estate taxes. In addition, the
   FairTax legislation adjusts Social Security benefits for changes in the
   price level, so a percentage increase in prices would result in an
   equal percentage increase to Social Security income. Supporters suggest
   these changes would offset paying the FairTax under transition
   conditions.

   In contrast to ordinary savings, money in tax-deferred savings plans
   such as IRA, 401k, etc. would be withdrawn tax-free. There is currently
   $11 trillion in such accounts. This represents future tax revenue owed
   to the federal government under the income tax system, which has been
   estimated at $3 trillion. This revenue would then fall under the
   FairTax system for collection.

Time arbitrage

   In the period before the FairTax was implemented, there could be a
   strong incentive for individuals to buy goods without the sales tax
   using credit. After the FairTax was in effect, the credit could be paid
   off using untaxed payroll. Opponents of the FairTax worry it could
   exacerbate an existing consumer debt problem. On the other hand,
   proponents of the FairTax note that this effect could also allow
   individuals to pay off their existing (post-FairTax) debt quicker. With
   the retail inventory tax credit, and the removal of embedded taxes in
   the retail prices of goods and services, it is unknown whether this
   will be an issue.

Grassroots movement

   Orlando, Florida FairTax Rally on July 28, 2006
   Enlarge
   Orlando, Florida FairTax Rally on July 28, 2006

   While initially financed by a group of businessmen from Houston, Texas,
   the FairTax has generated a large grassroots tax reform movement in
   recent years. This movement has been led by the Houston based
   non-partisan political advocacy group Americans For Fair Taxation. This
   organization claims to have spent over $20 million in research,
   marketing, lobbying and organizing efforts over a ten year period and
   is seeking to raise over $100 million more to promote the plan. Besides
   its paid staff in Houston, AFFT also includes volunteers who are
   working to get the FairTax enacted. The internet, blogsphere, and
   electronic mailing lists like Yahoo! Groups have contributed to
   informing, organizing, and gaining support for the FairTax. Many
   grassroots web sites have been created by supporters to help organize
   the effort and promote the plan. Popular web sites, such as
   FairTaxGroups.com and FairTaxBlog.com, serve as a resource for
   grassroots efforts by providing news, forums for discussion, national
   calendars, and event organization. Much support has been achieved by
   talk radio personality Neal Boortz. Boortz's latest book (co-authored
   by Georgia Congressman John Linder) entitled The FairTax Book, explains
   the proposal and spent time atop the New York Times bestseller list.
   Boortz stated that he donates his share of the proceeds to charity to
   promote the book. It is also a frequent topic of discussion on The Neal
   Boortz Show and a common gift to callers. In addition, Boortz and
   Linder have organized several FairTax rallies to publicize support for
   the plan. Other media personalities have also assisted in growing
   grassroots support including radio and former TV talk show host Larry
   Elder, radio host and former Senatorial candidate Herman Cain, Fox News
   and radio host Sean Hannity, and ABC News co-anchor John Stossel.
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