What is the FairTax plan?

The FairTax plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue neutrality, and, through companion legislation, the repeal of the 16th Amendment.

The FairTax Act (HR 25, S 296) is nonpartisan legislation. It abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax  administered primarily by existing state sales tax authorities.

The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system.

The FairTax:

  • Enables workers to keep their entire paychecks
  • Enables retirees to keep their entire pensions
  • Refunds in advance the tax on purchases of basic necessities
  • Allows American products to compete fairly
  • Brings transparency and accountability to tax policy
  • Ensures Social Security and Medicare funding
  • Closes all loopholes and brings fairness to taxation
  • Abolishes the IRS

The FairTax Myths

The gloves are off as critics try to pick apart the FairTax. Trouble is, it’s just a replay of the same  myths:

“The FairTax will not be enforceable and evasion will be rampant”

The truth: More than 80% of all tax returns are eliminated under the FairTax–every individual filing. What remains are retail outlets collecting the FairTax. Of these, 80 percent of all retail sales now occur at large retail chains like Wal-Mart. The point is oversight will still reside under the Treasury Department but the government’s responsibility will be over a far smaller “universe” of tax collection points making compliance oversight far less costly and far more effective than the current system which costs $265 billion a year in compliance costs and still comes up $350 billion a year short of what is owed.

Read more information about compliance in the FairTax white paper: FairTax Reduces Complexity, Compliance Costs and Noncompliance.

“The FairTax will not be revenue neutral (i.e. bring in the same revenue as the current system) at 23%”

The truth: The FairTax rate of 23% (when calculated inclusively like income tax rates) has been thoroughly researched to provide all the revenues now collected under both the income tax system and through FICA payroll taxes. Reports otherwise are largely based on the President’s Advisory Panel on Tax Reform which declared the rate would have to be much higher. What the Panel failed to make clear in an amazingly shameless sleight-of-hand is that they never studied the FairTax legislation as it exists in pending legislation. They ignored $22 million of FairTax research and, instead, quietly devised their own national consumption tax which they loaded with the exemptions and deductions they felt were “politically realistic”. They also failed to calculate the effects of elimination of the FICA tax on annual taxpayer burdens or on the distributional effects of the FairTax across the income spectrum. Upon completion–and after declaring a national consumption tax flawed–they then refused to publish their underlying assumptions.

For more information on this topic, see these research papers.

“The FairTax is not politically viable”

The truth: Great public policy changes do not happen easily. We believe, however, in the promise of the Founding Fathers that this is a nation, “of, by and for the people”. In the last year we have seen more Congressional co-sponsors come on board faster than ever before. We have seen five of eight GOP candidates and one Democratic candidate embrace the FairTax. With increased media coverage, as at least one candidate has made this a central plank of his campaign, more and more Americans have come to understand the powerful benefits the FairTax offers the nation. They are, in turn, joining our growing citizen army and are beginning to communicate their wishes to their elected officials. All of this progress is a consequence of the body politic first learning about and then accepting the FairTax. As our ranks grow such pressure will increase on Members of Congress and at some point, the voice of the people will eclipse the voices of the relatively small number of Washingtonians who profit working the income tax system at great cost to the nation. Enactment of the FairTax will require an activist citizenry and a resurgence of what has been too often forgotten–public policy can and should be driven by the public. All that is required is that we all dare to be fair and remind our elected officials that they work for their constituents–not for the narrow self-interests of the tax writing committee, the lucrative tax lobby business or the academicians who have built careers around the complexity of the tax code.

For more information on this topic, see these research papers:

“The FairTax is regressive and shifts the tax burden onto lower and middle income people”

The truth: The FairTax actually eliminates and reimburses all federal taxes for those below the poverty line. This is accomplished through the universal prebate and by eliminating the highly regressive FICA payroll tax. Today, low and moderate income Americans pay far more in FICA taxes than income taxes. Those spending at twice the poverty level pay a FairTax of only 11.5 percent — a rate much lower than the income and payroll tax burden they bear today. Meanwhile, the wealthy pay the 23 percent retail sales tax on their retail purchases.

Under the federal income tax, slow economic growth and recessions have a disproportionately adverse impact on lower-income families. Breadwinners in these families are more likely to lose their jobs, are less likely to have the resources to weather bad economic times, and are more in need of the initial employment opportunities that a dynamic, growing economy provides. Retaining the present tax system makes economic progress needlessly slow and frustrates attempts at upward mobility through hard work and savings, thus harming low-income taxpayers the most.

In contrast, the FairTax dramatically improves economic growth and wage rates for all, but especially for lower-income families and individuals. In addition to receiving the monthly FairTax prebate, these taxpayers are freed from regressive payroll taxes, the federal income tax, and the compliance burdens associated with each. They pay no more business taxes hidden in the price of goods and services, and used goods are tax free.

How can the FairTax generate lower net tax rates for everyone and still pay for the same real government expenditures? The answer is two-fold. Firstly, the tax base is dramatically widened by including consumer spending from the underground economy (estimated at $1.5 trillion annually), and by including illegal immigrants, those who escape their fair share today through loopholes and gimmicks. In addition, 40 million foreign tourists a year will become American taxpayers as consumers here.  Secondly, not everyone’s average net tax burden falls.  For households whose major economic resource is accumulated wealth, the FairTax will deliver a net tax hike compared to the current system.

Consider, for example, your typical billionaire, of which America now has more than 400.  These fortunate few are invested primarily in equities on which they pay taxes at a 15 percent rate, whether their income comes in the form of capital gains or dividends.  In addition to having the income from their wealth taxed at a low rate, the principal of their wealth is completely untaxed either directly or indirectly.  Assuming they and their heirs spend only the income earned on the wealth each year, the tax rate today is 15 percent.  In contrast, under the FairTax, the effective tax rate is 23 percent.  Hence, the very wealthy will pay more taxes when the FairTax is enacted. In a nutshell, those who spend more will pay more but low, moderate and middle income taxpayers will benefit from the greatest gains in reduced tax liabilities.

For more information on this topic, see Why the FairTax Will Work.

“The 23% rate is misleading. It’s actually 30%”

The truth:

As the FairTax gains more national attention, questions have again arisen about whether the FairTax rate is 23 percent or 30 percent. In the toxic environment that often accompanies public policy debates, FairTax.org has even been accused by some of misleading the public, even though full descriptions of “tax-inclusive” and “tax-exclusive” calculations abound on our Web site. We hope the following explanation puts all such questions to rest — at last.

Let’s use an example to illustrate the difference between tax-inclusive and tax-exclusive tax rates.

Assume there is a worker named Joe who earns $125 and spends all of his earnings. Let’s further assume that the government requires him to pay $25 in taxes.

If the government put a tax on Joe’s income, he would earn $125 before tax and would have $100 after tax to spend at the General Store. Thus, Joe has to earn $125 to have $100 to spend. Joe would also have to file an income tax return.

If the government put a tax on what Joe spends, he would earn $125 and would have $125 to spend at the store. Of the $125 paid by Joe to the storekeeper, $100 would be for the goods he bought at the store and $25 would be taxes that the storekeeper would send to the government. Joe would not have to file a tax return, as the storekeeper sends the tax in to the government.

Either way, Joe pays $25 in taxes and the government gets $25 in taxes. With a tax on income, Joe pays the $25 directly to the government, and with the tax on spending (sales tax), he pays the $25 in taxes indirectly when he buys something from the General Store. The General Store sends the tax that Joe paid to the government.

chart - Joe's taxes - example

We  may report the tax rate as $25/$125 = 20 percent, which is the tax-inclusive rate (meaning that the tax is included in the base). Alternately, we may think of the tax rate as $25/$100 = 25 percent, which is the tax-exclusive rate (meaning the tax is excluded from the base). The 23 percent FairTax rate set out in HR 25/S 1025 is a tax-inclusive rate, as is the current personal income tax, whereas most state-level sales taxes are quoted on a tax-exclusive basis. For ease of comparison, FairTax.org gives the tax rate both ways. Both rates are relevant, since the FairTax is replacing an income tax system, and 23 percent correctly represents the tax burden compared to the current system.

To review some of the research that determined a 23% (inclusive) rate is correct, please read Taxing Sales Under the FairTax: What Rate Works? This paper is a collaborative effort of 5 respected and independent economists.