The Fair Tax

Opposing the income tax is a proud tradition in America, but I'm not sure there is such a thing as a "good" tax. That is, taxes generally lead to unpleasant outcomes of some kind and tend to make some unlucky individual lives much worse. We have taxes because the alternative to having them seems worse for society as a whole, but the direct effects of taxation are never pleasant for anyone. If we consider all the types of taxes that have ever been levied on the citizenry of the world by good and bad governments, I don't think the progressive income tax is the worst of the lot. However, I'd be very reluctant to call the American system of taxation in its present form the best because I refuse to believe there is no alternative to having a tax code that is so complex and confusing that it causes anguish to millions of individuals and creates an industry devoted to finding loopholes intended to subvert its progressive nature. Much good could come from reforming the present tax system, but some convincingly argue that a fundamental change in the way taxation works would actually be the best thing to do given what they consider to be the inherent flaws of the current system.

Perhaps the most sophisticated and widely supported alternative tax plan is the "Fair Tax." Individuals as diverse as Mike Gravel and Mike Huckabee (notice the obvious pattern there, even if their politics are very different!) have publicly voiced their support for a national, progressive sales tax which is basically what the Fair Tax claims to be. Traditionally, most sales taxes are not considered to be progressive because they are thought to heavily impact the poor whose budgets can least manage to absorb higher prices for goods and services. The Fair Tax attempts to avoid being regressive by offering prebates to all Americans; these are monthly payments designed to cover the sales tax costs on basic necessities. In effect, no one who signs up for the prebate will end up paying any net tax on basic necessities, though the necessities will still be subject to the national sales tax like other goods and services.

The Fair Tax has two features that seem particularly appealing when compared to other systems of taxation. First and foremost, the Fair Tax gives individuals much greater choice in determining how much tax they pay because it taxes consumption rather than income. The vicissitudes of life naturally encourage people to continually seek to augment their incomes, so the progressive income tax and the capital gains tax end up punishing people who are striving to put their kids through college or retire with financial security; the Fair Tax would not interfere with personal financial goals like this because savings and investments would not be taxed. The extent that people have the freedom to consciously consume less depends on their income, but there is an important and intentional "loophole" in the Fair Tax system which makes taxation slightly more voluntary: the sale of used goods would not be taxed, including used homes. Thus, if you ever want to escape paying taxes on something, you'd need only buy it used and you would not pay any at all. Not everything can be bought used, of course, and this is part of the reason why I don't think the Fair Tax is truly a progressive tax although it is certainly not as regressive as a straight sales tax. Secondly, the Fair Tax would in the blink of an eye end the IRS as we know it and do away with complicated yearly tax forms for individual consumers. This would constitute a major reduction in both government expenses and citizen anguish.

The Fair Tax is far from perfect, however. If taxing income discourages work and saving, taxing consumption ought to discourage spending which is also not "good" for an economy. Advocates for the Fair Tax argue that the hidden costs created by the current tax system are reflected in the actual prices of goods and services today; thus, they argue that the elimination of these hidden costs would more than offset the effect of the new sales tax. I'm skeptical that the hidden costs are more than the sales tax price effect, but this is nonetheless a good counter-argument which has at least some validity. Perhaps a more damning argument against the Fair Tax is that it is too harsh on those in difficult circumstances. An income tax will only demand a portion of the income a person has earned recently, but a sales tax will tax whatever money happens to be spent by a person whether or not that money is savings or recently earned income. Thus, someone in desperate straits who is forced to dip into his or her savings to handle emergency spending will be taxed just the same as someone spending at the same rate but earning a healthy yearly income. Again, it could be argued that this person will in fact suffer no less under the present system due to the hidden costs of the income tax, but it is no credit to the Fair Tax that it fails to rectify the errors of our present system, and even the smallest across-the-board increase in price would be tough for some people to absorb. Another thing I'm concerned about is the ability of the Fair Tax to fund the government. Unfortunately, both individual consumption and government spending are unpredictable; understandably, then, there is much disagreement concerning what the rate of the Fair Tax would have to be to meet the government's spending requirements. A Fair Tax that is high would certainly not be fair in practice, and would certainly encourage the growth of black markets for goods and services.

Ultimately, I cannot say that the Fair Tax is worse than the current system of taxation; rather, I think the former is actually better overall in theory. However, the present system has the significant advantage of being a known quantity. If consumption is affected too much by the Fair Tax, then the result of its enactment will be insufficient government revenue and an economic downturn, so it's hard for me to just trust the predicted numbers that some economists have come up with without researching their methodologies. If you, too, want to do some research, there is a fantastic web site (http://www.fairtax.org) put out by the Americans For Fair Taxation that has a tremendous amount of information on the Fair Tax. That web page -- and Mike Gravel -- inspired this post, and I suspect it will inspire me to write a couple more in the future.