Most people would agree that the current income-based tax system of the United States is confusing, time consuming, and contains far too many loopholes. Support for abolishing the current tax code is growing, not only in Congress, but in the Bush administration as well. There are several tax plans being discussed as alternatives. One plan suggested by Representative John Linder of Georgia is the FairTax Act of 2003 (H.R. 25), which proposes a national sales tax instead of an income tax. While this plan would solve many of the problems of our current tax system, such as its complexity, it is my opinion that the FairTax Plan would be disastrous for Americans and destructive to the American economy.
The FairTax plan currently before Congress, and backed by Americans for Fair Tax, would replace the current federal income-based tax system. Businesses would no longer pay any federal taxes and individuals would no longer file any tax returns. Federal taxes, including Medicare and Social Security, would no longer be withheld from any employee paychecks. A national sales tax, or "consumption tax", would fund the federal government, including Social Security and Medicare. The individual, or consumer, who purchased the final product, would pay the national sales tax. However, the tax would not be charged on any re-sale items.
One of the first responses people have to a national sales tax is "how much will the interest rate be?" The sales tax would need to be high enough to cover all federal spending, Social Security, and Medicare, or the "tax base". Different organizations have many different view points on the amount of sales tax needed to cover the "tax base". According to Americans for Fair Tax, the national sales tax will be between 17-23% tax-inclusive. This is a very confusing way to figure a sales tax, since most people figure sales tax as tax-exclusive. William G. Gale of the Brookings Institute explains the difference here:
"Suppose a good costs $100 and there is a $30 sales tax placed on the item. Most people would probably consider that to be a 30 percent sales tax, since the tax is 30 percent of the selling price. This is known as the tax-exclusive tax rate. An alternative would divide the $30 tax payment by the total cost to the consumer ($100+$30), making it a 23 percent rate. This is known as the tax-inclusive tax rate."
The FairTax plan also includes a rebate "equal to the tax rate times the poverty level". Each person who has a social security number would receive this rebate, regardless of income, to cover the taxes paid on any necessary items such as food, clothing, shelter, transportation, and medical care up to the poverty level. According to Fairtax.org, a family of four, which includes a married couple and two children, would receive a monthly rebate of $479. However, according to Gale, any exemptions or "transition relief provided to households would reduce the tax base and raise the required rate". He suggests that the rate could go as high as 67%. When added to any state taxes, Americans could see a tremendous price increase in everything they purchase.
Of course, these price increases will affect the poor and middle classes the hardest. Americans for Fair Tax suggests that the FairTax Plan will encourage Americans to save their money. The problem is that households that already have problems saving money will have even more problems saving money when prices increase by 30 percent. Also, the poor will pay a much higher percentage of their income in sales tax than the rich. Dave Lowitzki gives the following example to explain:
"Person A makes $18,000 a year ($1500/month) and person B makes $180,000 a year ($15,000/month). Both people need $12,000 ($1,000/month) worth of essential goods. Both people pay 25% sales tax, which comes out to $250 a month. A is paying 16.66% of their income to taxes, while B is paying 1.66 % of their income" (2004)
The FairTax Plan would also give the rich a tax cut while raising taxes for the poor. William G. Gale says "Under the AFT proposal, taxes would rise for households in the bottom 90 percent of the income distribution". However, he also notes that "households in the top 1 percent would receive and average tax cut of over $75,000". Since corporations would no longer pay any taxes, the difference must be made up by the individuals who are least able to pay it. The FairTax plan will cause a larger gap between the classes and could destroy the middle class completely.
Another problem with this plan is the amount of jobs it will affect. Americans for FairTax called for completely abolishing the Internal Revenue Service. They plan for states that collect a state tax to collect the new national sales tax. This means that anyone whose job relates to the current tax system would probably lose their jobs. The IRS employed 113,786 people in 2003. Not only with this affect these government employees, but it will also affect other companies. According to the US Department of labor, there were approximately 1.1 million accounting and auditing jobs held in the US. For example, H&R Block is one of the largest tax preparation businesses in the US. They served over 19 million customers and prepared over 15 million tax returns in 2003. They have an estimated 15,300 full-time and 96,000 seasonal employees. However, under the FairTax plan, Americans would no longer have to fill out tax returns. Most, if not all, of the employees at H&R Block would not be needed any longer.
The FairTax Plan would also affect other industries. The Housing and Construction Industries would be one of the hardest hit. Without the incentives of the tax deductions on the mortgage interest, less people will decide to buy houses. Also, since people will have to pay sales tax on new houses, but not on re-sales houses, the market for new housing would decrease significantly. This would affect the automobile industry in the same way. Consumers would have to pay the sales tax on new cars but not on used cars. If given the choice between paying up to 30% more for a new car and buying a used car, the average American would probably buy used. In fact, the FairTax Plan will affect any industry where consumers have a choice between buying new and buying used.
The FairTax Plan would also cause a decrease in the value of the American dollar. Before the plan would be put into effect, there would be a surge in spending by most Americans, who would try and buy as much as possible before the price increases. After the plan was put into effect, the economy could see either a recession or depression, since spending would suddenly decrease. Americans would also find other ways to buy things that would get around paying the tax. One way would be to declare purchases as business expenses, since these would not be taxed. Another way would be to spend as much money as possible outside the US. This will definitely cause a decrease in the value of the American dollar since many Americans would need to exchange the American currency to be able to buy in other countries. Mike Moffat also suggests that more people will buy bonds which will cause the interest rate to decrease. With a decrease in interest rates and a decrease in spending, the value of the American dollar would continually decline.
The purpose of changing the American tax system is to make it simpler and fairer. Many Americans agree that our current system does need changing. The idea that workers would receive their whole paycheck and no one would ever have to file taxes again is very inviting to many Americans. However, this plan will cause price increases of at least 30 percent; increase the taxes on the poor; cause a loss of up to 1.1 million jobs; destroy the housing, construction, and auto industries; and decrease the value of the American dollar. When they look at the FairTax Plan closely, most Americans would agree that it will cause tremendous problems for Americans and the American economy.