Thursday, August 25, 2005

Tax Simplification: Flat Tax or "Fair Tax"?

Representative Steve Urquhart (R-St. George – who is running for the U.S. Senate seat currently occupied by perma-Hatch) has an interesting post about the necessity for tax simplification.

Good laws and legal systems are simple and transparent; people readily can know the law, follow the law, and watch how elected officials propose to tamper with the law. By contrast, the mess that is our current tax system creates a grotesque scene where lobbyists and elected officials can cut marginal deals in the tax code without the public having much real opportunity to weigh in. The deals only add to campaign coffers and taxpayers' burdens. The system must be simplified.
Steve discusses the two major camps on this issue: the flat tax (see my previous post) and the fair tax initiatives. The defining difference between the systems is that the flat tax is an income tax on both personal and corporate income (17%), while the fair tax is a national sales tax (23%) that is collected at the final point of sale on goods and services.

I see pros and cons to both systems. However, I see the following problems with the fair tax initiative.

  • It is highly regressive up front. The poorest people would be hardest hit at the point of sale and would be forced to file for a refund proving their poverty after the government has held their sorely needed money for up to a year. Many poverty level people that are due a refund under today's system fail to file. I doubt it would be any different under the new system.

  • A national sales tax would distort the market costs of goods and services. If you bought a home for $180,000 your end price would be $221,400 with a 23% sales tax. Imagine what that would do to the real estate market. A $20,000 car would cost $24,600. Ouch!

  • History shows that it is easier to pass a sales tax increase than an income tax increase. How many of us fall for the “It will only cost you one tenth of a cent more on every dollar spent” argument time after time.

  • As has been demonstrated in other countries, it would spawn a new black market system and a new national sales tax collection bureaucracy. At least the flat tax would leverage its collection system from the current system where we already have sunk costs.
I think that if either of these proposals actually receive serious consideration we should push to require a supermajority vote to pass any increase while retaining a simple majority vote to pass any decrease. Experience shows that we need to provide a strong disincentive for our representatives to increase government spending.

1 comment:

Russel said...

Dear Scott,

You raised some concerns about FairTax, and they are valid concerns, but I hope I can address them here. If you have further questions you can email me at utahvalleyfairtax@gmail.com

I will treat your points of concern as questions in a little Q&A session.

Q:
"It is highly regressive up front. The poorest people would be hardest hit at the point of sale and would be forced to file for a refund proving their poverty after the government has held their sorely needed money for up to a year."

A:
Under the FairTax proposal no one needs to prove their poverty to the government. Every American household would receive a monthly prebate check based on the size of that household. This accomplishes two things;
(1) It ensures that no one spending less that the official poverty level has to carry the burden of taxes. For example, I am a single man with no dependents, and my corresponding poverty level is $9,570 annually. I would receive a monthly prebate check of $183 ($2,201 annually) to cover the 23% tax on all my purchases up to $9,570.
(2) It makes the otherwise flat-rate tax progressive, because no matter how much I earn or spend I receive the same monthly prebate check. If I spend $9,570 in one year I pay 0% in taxes, if I spend $19,570 in one year I pay $2,300 (23% of $10,000 and 11.75% of $19,570) in taxes, if I spend $59,570 in one year I pay $12,500 (23% of $50,000 and 20.98% of $59,570) in taxes, and if I spend $209,570 in one year I pay $46,000 (23% of $200,000 and 21.95% of $209,570) in taxes.

Q:
"A national sales tax would distort the market costs of goods and services. If you bought a home for $180,000 your end price would be $221,400 with a 23% sales tax."

A:
Only retail goods and services will be taxed. So you will not pay a tax when purchasing a used home or car. A new home will be subject to the 23% sales tax, but on further request I could show you that the price of new homes will drop by about 20%, so there’s only a 3% increase in total price. But if you’re not paying payroll taxes (which you wouldn’t under FairTax) you’d be able to afford that small price increase.

Q:
"History shows that it is easier to pass a sales tax increase than an income tax increase."

A:
That is more likely because sales tax increases are on the order of 0.05%-0.1% while income tax increases are on the order of 1%-5%

Q:
"As has been demonstrated in other countries, it would spawn a new black market system and a new national sales tax collection bureaucracy."

A:
No system comparable to FairTax has been tried in any other country, so I’d like to see some evidence of that claim. On the contrary, gasoline taxes are as high as 26% and there is no black market system for gasoline.

I hope that answers a lot of your questions. I also hope that you’ll research the FairTax proposal a little more and maybe even become a supporter. Feel free to visit my blog as well.

Sincerely,
Russel Fugal