The Fair Tax is a proposal that is picking up steam. It calls for replacing all federal taxes on income (income, payroll, estate, capital gains, and gift taxes) with a 23% national sales tax. Anything you would buy in a retail store would be subject to the tax, including food. If you live in a state that has a sales tax, anything subject to your state's sales tax would be subject to the Fair Tax. Lower income people would get a rebate (they call it a prebate) each month so their basic needs are met without completely impoverishing them.
Determining if the Fair Tax is a good idea depends on your goals. If you want to end the excessive consumerism in American society, the Fair Tax is great. Slapping a 23% tax on everything people buy will get them to buy less things. Buying less things would have environmental benefits as well. I can see environmentalists and people who hate America's consumer culture advocating the Fair Tax.
But judging from the material on the Fair Tax website, most of the supporters of the Fair Tax don't care much about the environmental or social benefits of having people buy fewer things. Their main concern is eliminating all taxes on income. They feel income taxes punish successful people. A sales tax taxes people's lifestyle choices. But the proponents of the Fair Tax ignore make three false assumptions, which could lead to huge economic problems.
Assumption 1: Income and Sales are not Related
Fair Tax advocates assume people's income exists in a vacuum. But in the private sector, people's incomes are directly or indirectly tied to sales. An auto worker's income depends on people buying new cars. A Target cashier's paycheck depends on people shopping at Target. If people stop buying new cars and stop shopping at Target, the auto worker and the cashier will eventually be unemployed, no matter how good a worker they are.
The major problem with the Fair Tax is it's a job killer. Proponents of the Fair Tax probably believe repealing the Bush tax cuts is a job killer. But a 23% national sales tax would kill many more jobs than repealing the Bush tax cuts. When you raise sales taxes, people buy fewer things. When people buy fewer things, companies make fewer things. When companies make fewer things, they need fewer employees so workers lose their jobs. But at least the unemployed won't have to pay any taxes on their $0 income.
Assumption 2: Spending Habits Won't Change
In making their calculations on the effects of the Fair Tax, Fair Tax proponents assume people will spend as much under the Fair Tax as they currently do. They don't take the possibility of reduced consumption into account. On their website they have a graph that shows consumption has been more stable than income over the past 35 years. This graph is their proof that consumer spending won't change much. But in the past 35 years there hasn't been anything like the FairTax that increased the price of everything by 23%. There's no evidence that says consumption will stay the same when prices increase. The chances are much greater of people buying less when the price of everything increases.
With a 23% sales tax, people's spending priorities will change. They will still spend money on necessities like food, clothing, and medicine because necessities are by definition necessary. You can't choose to not eat. But with the price of necessities rising, less money is available for other things. Add in the sales tax and people are going to delay buying big-ticket items like furniture and appliances, which will hurt companies that produce those items.
The Fair Tax would be especially devastating to the automobile industry. Who would buy a new car under the Fair Tax? A $20,000 car would have an additional $4600 in taxes. Used cars would have no tax under the Fair Tax proposal. Most people would buy a used car or keep the car they have instead of buying a new car. New car sales would plummet and auto workers would lose their jobs.
People's spending habits staying the same is a major assumption the Fair Tax proponents make in getting their numbers to add up. 23% of current consumption is what's needed for the federal government to take in the amount of money it currently does with income and payroll taxes. But if people cut their spending because of the Fair Tax, the federal government takes in less money, which will mean higher deficits. Remember that the Fair Tax has to bring in enough money to pay senior citizens' Social Security and Medicare benefits as well as everything else the government funds. Baby boomers are starting to retire, which means the federal government is going to have to shell out more money in retirees' benefits than it currently does. Couple that with lower consumer spending, and you run the risk of massive deficits.
Assumption 3: Wealthy People Spend a High Percentage of Their Income
One common complaint people have with the proposed Fair Tax is that it would be regressive. Wealthy people spend less of their income than lower income people so the 23% sales tax would hit the poor and middle class harder than the wealthy. The prebate would ease the sting on the poor, but Fair Tax proponents assume the wealthy spend a large percentage of their income.
In one of their examples they have a billionaire spending $10 million a year. Maybe entertainers and athletes spend that kind of money, but most people don't get wealthy by spending all their money. With a 23% sales tax, the wealthy would hold off on buying things like luxury cars, yachts, and jewelry. A more accurate example of how the Fair Tax would effect the wealthy is someone who earns $1 million a year in income and spends $200,000 of it on goods and services. Under the Fair Tax, the person would pay 4.6% of their income in taxes.
200,000 * .23 = 46,000
46,000 / 1 million = .046 = 4.6%
My example shows what the flat tax is really about, reducing the tax burden on the wealthy. The Fair Tax is about eliminating the taxes that affect wealthy people more than everyone else (income, capital gains, and estate taxes) and replacing them with a tax that affects wealthy people less than everyone else.
