FAIR Tax Abolishes IRS – Then What?

 

Fair Tax Fan

Originally published on Forbes.com Aug 6th, 2014

I’m always annoyed when I hears somebody arguing that if we made some tweaks in the tax system, we could abolish the IRS.  Then we come to the FAIR tax, which actually explains, in detail, how its enactment allows for the abolition of the IRS.  FairTax.org has quite a bit of information about the various aspects of the program, I’d suggest that you take a good look at it.  It is probably worth studying.  Here is the nutshell version of the Fair Tax Plan:

The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR 25 / S 122) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Socia Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax – administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system.

But You Still Need To Collect It

They’ve got that covered.  The collection of the national sales tax will be handed off to the states, which will be paid a percentage.  Most states already know how to collect sales taxes.  So the abolition of the IRS is accomplished by substantially ramping up 50+ revenue departments (Besides the states, you have DC, the territories, and maybe some of the 500+ sovereign Indian nations).  So when you hear that enacting the FAIR tax will save all that money we are spending on the IRS, it is not really happening.  In an article available on the site Tax Administration and Collection Costs: The FairTax vs. The Existing Federal Tax System, the authors estimate that it will cost the states $9.66 billion to collect the Fair Tax and there will be a net federal savings of $9.38 billion.  So there is actually a small increase in the government tax administration.  The big savings projected are in the private sector compliance costs, which they estimate as being reduced by over $340 billion.

Progressive?

The proponents claim that the “prebate” concept makes the Fair Tax progressive.  The “prebate” would be a monthly check on the amount of tax that would be paid by someone spending a poverty level income.  They peg that at just over $11,490 per adult and $4,020 per child.  So a single person who went through the proper registration would get a check for $220 monthly based on 2013 numbers. The check goes up by $77 per child.  So all those Tax Court cases about who gets the exemption, child credit and head of household status – now we can have them about who gets the kid’s prebate.

That makes the tax progressive when it comes to consumption (at least overtly), but it is highly regressive when using income as a measure. Superficially, this system is Thomas Piketty on steroids. Most people spend most, if not more than their income, so among them, thanks to the prebate, the tax is progressive.  Different story for the 1% who can invest most of their income.  As a percentage of income, the amount they pay in sales tax will be much, much lower.

There is another odd quirk that adds a touch of regressivity to the Fair Tax.  The social security tax will be repealed, but the wage reporting and benefit calculations will remain in place (although, there are hints that there might be other things in the works).  Let’s imagine two guys, call them Joe and Harry.  They each spend $80,000 per year, so they pay the same in sales tax.  Joe makes $80,000 per year and Harry makes $90,000.  Harry saves the other $10,000 for his retirement.  Harry will also have a higher social security payout than Joe.

It is worth noting that the progressive income tax and the estate tax were put into place in response to Gilded Age inequality when the government was funded mainly by consumption taxes.

Simpler?

Of course, the Fair Tax is simpler than the current income tax, but it would probably be easier to prune the bells and whistles from the income tax, if you can forgive a mixed metaphor, than to pass the Fair Tax.  With an income tax, though, there remains a core complexity-  What expenditures are being made to produce income, making them deductible in arriving at income?  That core complexity remains in the Fair Tax.  Vendors of all types collect the 23% on everything they sell, goods, services and rentals.  They pay the tax on everything they buy, but then take a credit for the things that were used in the business.  OK.  So will the moderately sociopathic who own businesses ever buy anything that they don’t take credit for?  Here is what the proponents have to say about that issue

Also, as registered sellers, they are subject to the possibility of being audited by the state. During such an audit, they will have to produce the invoices for all the “business purchases” that they did not pay sales tax on and will have to be able to show that they were bona fide business expenses. If they cannot prove this, then they will have to pay the taxes that should have been paid when the items were purchased, plus interest and penalties. The probability of being audited will be much greater than it is under the current system with its over 140 million tax filers. Under the FairTax, there will be less than 20 million businesses that will be filing sales tax returns and thus subject to the possibility of being audited. Thus, the probability of tax cheats getting caught will be much greater than it is today, making tax evasion riskier than it is today. Additionally, while the FairTax has much stronger taxpayer rights than does the current tax system, the FairTax legislation provides for a number of fines and penalties for noncompliance. It also authorizes a mechanism for reporting tax cheats and obtaining a reward.

So all the litigation that we have about deductible business expenses will remain relevant with the Fair Tax.  Only the audits will not be conducted by one agency.  There will be fifty or more with a possible race to the bottom in terms of how aggressive they are in order to make their states more business-friendly.

Finally, one of the things that makes the Fair Tax simple is its comprehensiveness.  All final consumption by everybody is subject to the tax.  The income tax would be vastly simpler if Congress did not use it as the Swiss Army Knife of social policy using income tax credits and deductions to encourage various things, like research and historic preservation.  What will stop them from doing this with a national sales tax?  Gee, I could afford to pay $100 for that life-saving drug, but I can’t afford $123.  Let’s exempt prescription drugs, but not birth control, unless it’s needed for some other condition – on and on and on.

And In The End?

Most of the cases that I read would still be matters of controversy under the Fair Tax. Who’s kid is this? Is that really a business expense? You flat out did not pay, so we are taking your stuff.  With fifty plus different revenue departments doing the enforcement, how likely is it to be consistent across the country?

Fifty plus revenue departments implementing a federal tax is a recipe for massive inconsistencies.  Eventually, after horror stories about the aggressive New York and California auditors and the way too easygoing ones in Alaska, it will occur to somebody, that collecting federal taxes consistently across the country probably requires federal employees.  Somebody feeling nostalgic might propose calling the resulting agency the IRS, but that probably will not happen.

 Correction/Clarification

In the example I give for a hypothetical argument for a prescription exemption, I wrote that somebody would argue they could afford $100 but not  $123.  Actually, with the proposed Fair Tax it would be $130.  The Fair Tax site keeps citing 23% to make it apples to apples to apples with an income tax, but as a sales tax the rate is 30%.  The argument is that if you made $100 and paid 23% income tax you would have $77 to spend, so having no income tax and paying 30% on the $77 you spend works out to the same thing.