Wednesday, September 29, 2004

Tax what people consume, not what they contribute

One of the interesting things about the FairTax is the way it recasts taxation ethically. For most people their income is a measure of what they contribute to society. One can clearly point to instances where this is not so, but on average it's much closer to true than to false. The current income tax system therefore taxes people on what they contribute to society. The FairTax, as essentially a consumption tax, taxes people on what they take from society.

It just somehow feels more right to be taxing taking rather than contributing.

Family Consumption Allowance

When you speak of the impact of taxes you tend to talk about whether they are progressive or regressive. Progressive taxes tend to tax the rich more than the poor, regressive taxes tend to tax the poor more than the rich. Sales taxes are usually seen as regressive because the poor must spend a greater percentage of their income on necessities than the rich, and thus have a greater portion of their income subject to taxation. In the past state governments have tried to overcome the regressivity of sales taxes by exempting necessities (like food). This inevidibly has led to market distortions and political manuevering for businesses to get their goods in a 'necessity' category. The FairTax takes a different approach to eliminating the regressivity of a sales tax.

The FairTax introduces a Family Consumption Allowance (FCA). The FCA is a check sent each month to each household registering to receive it (registration is voluntary) to reimburse the amount of sales taxes paid if that household spent up to the poverty level as specified by the department of Health and Human Services. This is how the FairTax 'exempts' necessities. It presumes that every household must spend up to the poverty line in order to purchase necessities and then refunds that portion of tax. The FCA would be administered by the Social Security Administration, which is quite proficient at sending out monthly checks. Complete details on the FCA can be found in the bill HR25 Chapter 3.

Below is a table showing how the FCA would work for household of various sizes:

2004 Rebate Calculations
Family sizeHHS annual poverty levelFairTax annual consumption allowance (single person)Annual rebate (single person)Monthly rebate (single person)FairTax annual consumption allowance (married couple)Annual rebate (married couple)Monthly rebate (married couple)
2 $12,490 $12,490 $2,873 $239 $18,620$4,283 $357
3 $15,670 $15,670 $3,604 $300 $21,800 $5,014 $418
4 $18,850 $18,850 $4,336 $361 $24,980 $5,745 $479
5 $22,030 $22,030 $5,067 $422 $28,160 $6,477 $540
6 $25,210 $25,210 $5,798 $483 $31,340 $7,208 $601
7 $28,390 $28,390 $6,530 $544 $34,520 $7,940 $662
8 $31,570 $31,570 $7,261 $605 $37,700 $8,671 $723

Tuesday, September 28, 2004

Inclusive vs Exclusive tax rate

The FairTax is a 23% inclusive sales tax. It's important to understand what that "inclusive" means so that you understand what the rate really means. When you compute a tax on a dollar you can either compute it inclusively or exclusively.

For example, the sales tax you are used to at the cash register today is an exclusive rate. The rate is applied to the price you pay exclusive of the tax applied. So if you are used to a state sales tax rate of 8% and you purchased something that was worth a dollar you would pay $1.00 + 8% of $1.00 = $1.08.

The income tax you pay is usually computed as an inclusive rate, it is applied against the dollar you earn inclusive of the amount you are paying in taxes. So if your income tax rate is 25% and you earn $1.00 then your tax is $0.25 and you get to keep $0.75.

The FairTax 23% sales tax rate is an inclusive rate. What this means is that I hand the cashier $1.00 to pay for something then $0.77 goes to pay for the good, and $0.23 of goes is paid in taxes. This is different than the way you are used to thinking about sales taxes. The reason the FairTax rate is quoted this way is to assist in comparison with current payroll and income taxes.

If you earn $1.00 but pay 15.3% in payroll tax and 10% in income tax, but have no federal sales tax then your purchasing power per dollar earned is $0.747.

If you earn $1.00 under the FairTax but and pay 23% inclusive in sales tax for a retail purchase of a new good or service then your purchasing power per dollar earned is $0.77. Please note however that your purchasing power per dollar earned for used goods is $1.00. Also remember that for every dollar that you earn and choose to save or invest you get $1.00 worth of savings and investment.

So quoting the FairTax rate inclusively makes it easier to compare the FairTax with the existing income tax, but makes it harder to compare it with the existing sales taxes. Just to make things clear, the exclusive rate for the FairTax is 30%.

What the FairTax would mean for you

The FairTax would mean that the federal government will no longer be withholding income taxes, FICA, or medicare taxes from your paycheck. If you live in a state with no income tax like Florida or Texas this means you will take home your whole paycheck. It also would mean you will not have to ever file your federal taxes again.

Additionally every month you would get a check to reimburse you for the federal sales taxes you paid for spending up to the poverty level for your household (the Family Consumption Allowance).

These are the upsides.

On the downside every time you purchased a new good or service you would be paying a 23% inclusive sales tax. Any purchase of an old good you make would be tax free. So if you bought a used car, you would pay no sales tax. If you bought used clothes at Goodwill, no sales tax. If you bought an existing house, no sales tax. If you buy land (all land is definitionally used) you would pay no sales tax.

Welcome and Intro

Welcome to the FairTax Blog! I'll be using this space as a venue for education on and critical discussion of the FairTax.

The FairTax is a tax reform proposal for tax replacement embodied by HR 25. The FairTax proposes to replace all of the existing federal income, payroll, dividend, capital gains, and business taxes with a single national retail sales tax. This sales tax would fall on all retail level new goods and services. Used goods would not be taxed. Business to business purchases would not be taxed as long as they were used for business purposes. The stated objective is to tax all goods and services once and only once.

In order to overcome the intrisic regressivity of a sales tax the FairTax proposal provides for a Family Consumption Allowance (FCA). The FCA is a payment sent out monthly to each household by the Social Security Administration refunding to each household the amount of federal sales tax they would pay if they were to spend up to the Health and Human Services Departments poverty level for a household of their size.

More details on the proposal will be provided in follow up posts. Please feel free to ask questions or raise objections in the comments section. I will attempt to address questions and objections either in the comments section or in subsequent posts or both.