Rep. Earl Carter (R-Ga.) introduced a new tax proposal called the “fair tax.” Predictably, Democrats politicized the proposal. Sen. Catherine Masto (D-Nev.), for example, posted a typically uninformed statement on Twitter:
“On average, Nevadans are paying nearly $6 for a carton of eggs. If House Republicans passed their 30 percent national sales tax proposal, our families would have to pay over $7.80 per dozen. That’s ridiculous. We need to lower costs, not raise them.”
The first thing you need to know about Ms. Masto’s logic is that it is woefully flawed. She applied to the issue accounting principles instead of the principles of economics. This misuse of logic can cause you to make bad decisions. Her statement ignores the fact that the price of eggs isn’t fixed. It’s derived from supply and demand in the market. It’s also derived from regulations that are passed that affect raising chickens and getting their eggs to market—and a massive outbreak of avian flu. I wouldn’t rely on Senator Masto for financial or economic advice.
It’s clear our progressive tax system is broken. The very wealthy and corporations spend millions of dollars per year to avoid taxes. Interestingly, you don’t hear much about former President Donald Trump’s taxes anymore since everything he did was within current tax law.
The proposed fair tax eliminates personal taxes, capital gains taxes, alternative minimum taxes, corporate taxes, estate and gift taxes, payroll taxes, and eliminates the entire Internal Revenue Service. It replaces them with a national sales tax. Business investment is exempt, so it is a tax on what you consume. If you are poor, each household would receive a monthly check so that purchases up to the poverty line are not taxed. The United States would have to repeal the 16th Amendment to institute the fair tax. The tax rate being proposed is tax inclusive rate of 23 percent which is a tax exclusive rate of 29.8 percent. Either way, it sounds like a lot!
To understand the difference between the tax inclusive rate and the tax exclusive rate, here is an example. Suppose an item costs $100 before tax and is subject to a $30 sales tax. The tax-exclusive tax rate would be 30 percent, as the tax is 30 percent of the pretax selling price. The tax-inclusive rate would be about 23 percent, which is obtained by dividing the $30 tax by the total cost to the consumer ($100 + $30). The difference is whether or not the tax paid is included in the denominator when calculating the tax rate. The tax-inclusive rate is always lower than the tax-exclusive rate. The difference increases as rates rise.
- Gross annual salary: $100,000.00
- Total federal income tax: $14,260
- [insert state income tax]: [—]
- Social Security tax: $6,200.00
- Medicare: $1,450.00
- Salary after tax and deductions: $78,090
- Gross annual salary: $100,000
- [insert state income tax): [—]
- Salary after tax and deductions: $100,000 (assuming you live in a zero percent tax state)
For example, retirees might be affected more than others. They have already paid tax on their savings, so they’d be taxed again. Implementation of the fair tax would have to recognize that and give them abatement. For other retirees, they might have saved in a 401(k) plan or a self-directed plan. They paid no tax on the gains in those plans, but under the fair tax plan, they will pay no tax when they pull the money out of them.
A national sales tax is a far more economically efficient way to tax people. The wealthy won’t be able to employ accountants and lawyers to figure out ways to avoid taxation.
In academic circles, they have debated the positives and negatives of implementing a fair tax for years. There is no doubt there would be some short-term events that might be very beneficial and some that might be challenging. One study projects that GDP growth would increase by 10.5 percent with the fair tax. Increased growth would increase employment, increase stock market value, raise standards of living, and salaries. Another academic article postulates that it would take 20–25 years for the full effect of the change in the tax code to work its way through the entire economy.
It is also important to note that the fair tax is different from a flat tax. A flat tax is a tax on income. The fair tax is a tax on consumption. When it comes to business decisions, and decisions you make for yourself as a consumer, the fair tax is more efficient than a flat tax. Not only is it more transparent and simpler, it also helps you make better choices for yourself. Here are important charts to consider when you think about the fair tax:
As you can see based on the academic models cited in the study, the poor and middle classes benefit greatly from the fair tax when compared to keeping our current system of taxation. Their standards of living and well-being rise at a faster rate than the wealthy. The very wealthy would benefit as well. Who would lose? Based on the cited academic models, people who made $50,000–75,000 would lose in the short run. However, in the long run, they’d benefit as well because their incomes would increase enough to cover the difference between the fair tax and current income taxes. A switch to the fair tax would be best for everyone in the entire country, regardless of income levels 20-25 years into the future because all incomes would rise—and capital stocks and business investment would rise as well.
The fun parlor game would be to envision how individual states and citizens would respond to the fair tax. Currently, we see flight from high-tax states to no income-low tax states. If all states followed suit and ended their income taxes, where would people choose to live?
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