Right now, the average price of a loaf of bread is around $1.87. Under a new law proposed by House Republicans, that price would rise to over $2.50. That would be the result of the Fair Tax Act, a bill proposed by about 30 House Republicans. House Speaker Kevin McCarthy (R-Calif.) promised to bring it to the chamber for a vote, though he didn’t say when or under what terms.
The Fair Tax Act is the latest incarnation of an idea that has been around for more than a generation. The proposed law would eliminate the IRS entirely and with it all federal taxes, including income, payroll, estate, and corporation taxes. In its place, Congress would pass a flat 30% sales tax on all goods and services nationwide.
Although this proposal is unlikely to pass, it may be a good idea to partner with a free licensed financial advisor to help you with your tax needs.
National Sales Tax – A Historical Overview
National sales taxes are an idea as old as tricorns. In the 18th and 19th centuries, modern income taxes did not exist. Instead, like most governments, the United States funded itself primarily through tariffs and sales taxes. Permanent income taxes were authorized by a constitutional amendment in 1913, and the system we know today was not established until after World War II.
Today, no major economy depends exclusively on sales taxes for its revenue. While a handful of small or oil-fueled economies have no income tax, the main exceptions to this rule are sub-jurisdictions like US states or cities.
Yet the idea remains a darling of the American conservative movement. Over the past 30 years, it has come back time and time again. Part of the reason is historical, with many on the political right advocating a form of constitutional law rooted in the form of the 18th century document. But most of the reasons have to do with the superficial fairness of a flat sales tax. Everyone would pay the same on everything they bought, no matter what.
Proponents say that would be better than the 3,000-page tax code America currently uses. Tax experts disagree, however, citing numerous problems with a national sales tax.
Gaps in the Fair Tax Act
First, proponents argue that the mere fact of complication is not an indictment of the system. America is a big country with a $23 trillion economy. His taxes will almost certainly be complicated to one degree or another. Moreover, the underlying basis of the US tax code is very simple. The more a household earns, the more taxes it pays. Each year, the IRS publishes income tables that detail how much a taxpayer owes based on their income.
However, Congress also uses the tax code to incentivize certain behaviors (like owning a home or joining the military) and purchases (like solar panels). It is this web of credits and deductions that complicates the tax code, not the concept of a graduated income tax itself.
It’s a problem. The next problem is scale.
As written, the Fair Tax Act is misleading. It proposes a rate “including tax” of 23%, that is to say that it applies to the cost excluding tax of goods and services. Most, if not all, of today’s sales taxes are calculated on a pre-tax basis, which means that the tax rate applies to the pre-tax cost of goods and services.
As a result, while the Fair Tax Act as written proposes an inclusive 23% tax, it would be a 30% tax the way virtually all taxpayers calculate sales taxes.
Even this large round of price increases, most economists agree, would still be far too small to fund the national government. A Brookings Institute study published in 2005 suggested that the correct rate would need to be closer to 44% to replace current government revenues. It also assumes that the sales tax would not have a significant impact on economic activity, meaning that people would continue to buy and spend as normal even in the face of a price increase of 30% to 44% for all goods and services.
To put it mildly, economists are skeptical of this suggestion. Instead, many are warning that this kind of economy-wide price hike would almost certainly slow consumer activity despite a wealthier consumer base because they don’t pay income taxes. .
Experts also agree that the Fair Tax Act’s main selling point, its simplicity, is also inaccurate. As a Tax Policy Center briefing noted, while the bill would abolish the IRS in the name of simplicity, it does so by simply forcing states and cities to collect taxes on behalf of the federal government. This, the briefing notes, “only outsources the work to the states (and the District of Columbia)…If we optimistically assume that the FairTax brings in roughly the same amount of revenue (as a share of the economy) than the current tax code, the annual collection costs per year for states would approach $10 billion. By comparison, the IRS has spent about $13 billion a year over the past decade.
In addition to requiring states to collect taxes on its behalf, which the federal government may not even have the power to do, the Fair Tax Act would create two new agencies to replace the abolished IRS. The Excise Tax Office and the Sales Tax Office would oversee the administration of the new sales tax and work with the states and cities responsible for collecting these taxes.
Finally, the main concern of most tax experts is that a national sales tax would reduce taxes for the wealthy while skyrocketing them for low-income households. This is due to the disproportionate nature of sales taxes in general. The less money a household earns, the more it spends on living costs, all of which would be subject to the new 30% tax. Wealthier households save more of their money in bank accounts and investments, none of which would be taxed under the Fair Tax Act.
A 2011 study found that the results of a 30% sales tax, as proposed under the Fair Tax Act, would significantly shift the country’s tax burden. A national sales tax, according to the study, would reduce taxes on top earners by about 40%. Meanwhile, the poorest households would see their tax burden increase from 200% to 1,000%.
To manage this disproportionate impact, the Fair Tax Act proposes sending monthly checks to households to compensate for this problem. These so-called “prebate” checks would be equal to 23% of the cost of living at the federally assessed poverty level. All households would receive this money, regardless of income level.
Once again, this proposal has been the subject of almost universal criticism from tax practitioners. While a prebate would soften the regressive impact of a national sales tax, the proposed bill would further reduce taxes on the wealthy while raising taxes on low and middle incomes. It would also require administration and oversight, again eliminating the proposed simplicity of a flat sales tax.
The Fair Tax Act is the latest iteration of an idea that has been around since at least the mid-1990s, and arguably much longer. Proponents argue that a national retail sales tax would be simpler and fairer than income tax and would give Americans more money to spend, leading to significantly greater economic growth.
Virtually every third-party expert to study the idea found the opposite. A national sales tax would be complicated to administer, with huge potential for loopholes and evasion. This would significantly reduce taxes for high-income households and increase them even more for low-income people. And, on the contrary, it would probably slow down the economy, as consumers would adjust their purchases to higher prices.
No vote is yet scheduled on this bill. President Biden has said he would veto it even if it passes.
House Republicans have proposed eliminating income taxes and the IRS and replacing them with a 30% national sales tax. Virtually every tax expert who has studied the issue agrees that it would complicate the tax code and act as a massive tax cut for the wealthy.
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