Thursday, September 18th, 2014

Adding up the Fair Tax

SUMMARY: Mike Huckabee says a national Fair Tax will be like a "magic wand." We say magic wands don't exist.

Mike Huckabee has won support from a segment of the Republican Party that avidly supports what it calls the Fair Tax, a national sales tax that would replace the traditional income tax. So what is the Fair Tax, and is it a good idea?

For starters, the Fair Tax is a federal sales tax on all new goods and services. Sometimes it is called a flat tax, but that's not really correct terminology. A flat tax means taxing all incomes at the same rate with limited deductions. (In 2000, candidate Steve Forbes advocated a flat tax, saying people could file their income taxes on a postcard.)

The Fair Tax would be a sales tax that would replace a number of income taxes: the individual income tax, the alternative minimum tax, business and corporate income taxes, capital gains taxes, Social Security taxes and Medicare taxes. Legislation to create it is introduced annually in Congress; the latest version can be found here .

Proponents say the Fair Tax would spur savings and create economic growth because people would be allowed to keep all of their paychecks and decide by their spending choices how much tax to pay.

Critics of the Fair Tax are legion: The harshest say the idea is ridiculous nonsense; the mildest say it's an interesting thought experiment that can't work in practice. Few mainstream economists find the idea a worthwhile policy proposal for several reasons.

There are a few primary arguments against a national sales tax: It's regressive; it's not enforceable; it's not politically feasible. Let's take these arguments one by one.

A regressive tax means it impacts people with lower incomes more than it does those with high incomes. For example: People who earn a poverty-level wage are likely to spend all of their wages every year, so they are taxed on 100 percent of their earnings. Rich people, though, might only spend a fraction of their annual income, and are only taxed on that portion. So the wealthy person pays a lower tax rate than the poor person.

Fair Tax proponents answer this problem with what they call the prebate. Under this plan, the federal government will mail checks to all U.S. citizens as a refund on the sales taxes they pay for basic necessities. For a single person, that would be $183.43 per month, according to The FairTax Book by Neal Boortz and John Linder that advocates for the Fair Tax. (Linder is a U.S. congressman.)

Bruce Bartlett, a former Treasury Department official, says the prebate does little to change the regressive nature of the tax, because people will spend their prebate and it will be taxed at the same 23 percent rate.

"Even with the rebate counted the way the Fair Tax supporters want it calculated — as a reduction in tax liability rather than an increase in income — there would be an enormous shift in the tax burden from the wealthy to those with lower middle incomes," Bartlett wrote in a story for the magazine Tax Notes.

Enforcement is also a significant concern for the Fair Tax. The 23 percent tax rate supported by the Fair Tax proponents assumes that most people would pay the taxes they owe. Economists say that when sales taxes reach that level, the incentive for people to cheat rises. People will try to buy things off the books, and underground economies will develop. To compensate for tax evasion, the tax would have to be raised even higher, which would lead to more evasion. Abolishing the Internal Revenue Service would exacerbate this problem, said economist Dean Baker, co-director of the Center for Economic and Policy Research in Washington, D.C.

"At the end of this story, when you add in some state sales taxes, we could be close to 50 percent," Baker said.

Finally, political opposition to the Fair Tax is likely to be intense, and even the plan's proponents acknowledge this. One of the most popular tax deductions, the home mortgage interest deduction, will go away under the Fair Tax. Retirees, who already have paid taxes on their income, will strongly oppose the Fair Tax on the grounds they are in effect being charged twice.

The transition process alone could cause economic disruptions as people across the country stock up on goods before the sales tax takes effect.

"The economy would experience a surge in demand for goods as the switchover date approached and then demand would collapse," wrote David Cay Johnston in his book on tax evasion and enforcement, Perfectly Legal.

Even Huckabee seems to admit the Fair Tax will be a hard sell. "I recognize that passage of the Fair Tax will not happen overnight. In the meantime, I will eliminate the Death Tax, and seek to reduce counterproductively high personal and corporate marginal tax rates," he said in a statement from his campaign.

It's hard to tell how many supporters of the Fair Tax are out there. Americans for Fair Taxation, the group that runs the Web site www.fairtax.org, says on its site that it has "hundreds of thousands of members and volunteers nationwide." It seems fair to say, though, that the Fair Tax has a vocal group of adherents within the Republican Party. (For an example of their robust defense of their plan, check out their response to Factcheck.org's take on the FairTax here .)

It appears Huckabee is winning the votes of at least some of the Fair Tax proponents since he has taken up their cause. Americans for Fair Taxation is a nonprofit group that does not endorse political candidates. This led Huckabee to declare recently at a South Carolina rally, "I realize that the Fair Tax organization does not endorse candidates, but let me be very clear: I endorse you."