Is the "national sales tax" bill Fair?

Republicans dig out the Fair Tax, get hammered by Democrats

One of the newest discussions online revolves around a proposed Republican bill that would drastically change the federal tax structure. Many Democrats, such as Elizabeth Warren in this tweet, are claiming that the proposal represents a 30-percent tax hike through the implementation of a national sales tax. That is partly true, but these claims don’t tell the whole story.

What is being proposed isn’t just a national sales tax, although that is part of the plan. The full proposal is much more broad, repealing the national income tax and other forms of federal taxation and abolishing the IRS, replacing the current tax system with a consumption tax. The package of tradeoffs has actually been around for about three decades and is called the Fair Tax.

Photo by The New York Public Library on Unsplash

I first became aware of the Fair Tax when I was living in Atlanta and listening to Neal Boortz’s talk show on WSB. I was intrigued enough to look into the details of the plan and write two articles about the proposal for my blog in 2011.

I didn’t think much about the Fair Tax for the next 12 years or so, but suddenly the idea is back in the news in a big way. There is a lot of talk online about the Republican “national sales tax” proposal and Democrats are hammering Republicans for what they say is a gift to the rich at the expense of the poor.

So what’s the truth?

Let’s start at the beginning. The Fair Tax has been proposed in Congress in the past, but the new bill was sponsored by Rep. Buddy Carter (R-Ga.) and seems to stem from one of Kevin McCarthy’s secret deals with the Freedom Caucus that enabled him to finally garner enough votes to become Speaker. Apparently, McCarthy agreed to allow a vote on the Fair Tax in exchange for votes for the speakership. There is definitely overlap between Carter’s original cosponsors and the anti-McCarthy holdouts that include Andrew Clyde (R-Ga.), Bob Good (R-Va.), Scott Perry (R-Pa.), and Ralph Norman (R-S.C.).

The Fair Tax Act of 2023 begins by repealing the federal income tax, payroll taxes, estate taxes, and gift taxes. The bill would also begin the process to repeal the 16th amendment which established the federal income tax. These taxes would be replaced by a consumption tax of “23 percent of the gross payments for the taxable property or service” in 2025. A formula is detailed to calculate the rate for subsequent years. This tax would be levied on the end users of goods and services and not business-to-business transactions.

While 23 percent seems high, Fair Tax proponents point out that it replaces taxes that are embedded in our current pricing structure. In theory, there would be little change in the end cost, but I’d like to see a CBO score on the proposal that includes both the effect on pricing and federal revenues.

On the other hand, critics say the true rate is higher than 23 percent. As the Institute on Taxation and Economic Policy (ITEP) explains, the tax on a $100 purchase would actually be $130 instead of $123. The “gross payment” would include both the cost of the item and the tax, so the tax is figured in a backward sort of way. Twenty-three percent of the gross payment of $130 is $29.90. That would be the tax paid on a $100 purchase.

There are some exceptions built in as well. One that I noticed was that the sales tax would be levied in addition to import duties. Tariffs are one tax that won’t be going away under the Fair Tax.

But wait! There’s more.

Each person is allowed a monthly credit that can be calculated in a variety of ways, and there is also a Family Consumption Allowance that pays families a monthly rebate up the federal poverty level. These mechanisms are used to offset an increase in taxes for low-income families.

As of 2022, the federal poverty level was $13,590 for an individual or $27,750 for a family of four. Using the these numbers, the monthly payment for individuals would be $1,133 and $2,313 for the family of four. As you might guess, paying these rebates out to every American family every month would require a staggering outlay. To Fair Tax proponents, this is a bit like priming a pump to start the flow of water.

Another key point in the Fair Tax plan is that used goods are excluded from taxation. This provision would be a boon to the poor because they would be able to buy used cars, clothes, furniture, and anything else tax-free. This aspect of the plan makes the Fair Tax much more progressive than a typical sales tax, which often carries a high burden for low-income consumers.

One of the most interesting aspects of the Fair Tax is that taxation largely becomes voluntary. If you choose not to buy new items, you pay no tax. That’s a libertarian’s dream.

Of course, we can’t avoid buying new items in all cases. For example, there is not a large market for used food. If there was, it would be disgusting. That’s where the Family Consumption Allowance comes in.

The Family Consumption Allowance was called the “prebate” in the original Fair Tax plan and would allow poor families to receive a monthly payment that would cover the cost of the tax on necessities. In essence, the idea is to make the tax neutral on the low-income end of the scale unless these people choose to purchase new items.

A major selling point is how the Fair Tax would affect the economy at large. Proponents argue that streamlining the tax code would encourage growth and stimulate the economy. As the economy grows and wealth is created, people would buy more new goods and services and more tax revenues would be collected.

Even though I'm somewhat versed in the details of the Fair Tax, I don’t consider myself to be an advocate. The plan is intriguing, but I’m skeptical that it would replace all the revenue generated by all the other assorted federal taxes.

Back in 2007, FactCheck.org looked at the Fair Tax plan and noted that the bipartisan Advisory Panel on Tax Reform had concluded that a 34-percent tax-exclusive rate would have been required to be revenue-neutral. That number was in the middle between estimates of 39.3 percent rate by the Brookings Institution and the 31.2 percent rate calculated by Boston University economist and Fair Tax proponent Laurence Kotlikoff.

These assumptions need to be rechecked under the new proposal because, as much as I dislike taxes, we don’t need to reduce revenues at a time when the US national debt is over $31 trillion and we already have a $1.3 trillion annual deficit. Republicans often talk of cutting spending to reduce the deficit but increasing revenues (or at least not decreasing them) is also important.

As to the charge that low-income Americans would bear the brunt of the Fair Tax, FactCheck’s numbers show otherwise. Back in 2007, the analysis showed that Americans who earned less than $15,000 would see their share of the federal tax burden decline from -0.7 percent to -6.3 percent.

There is some truth to the claims that the tax is regressive, however, because the tax burden was also estimated to decrease for those who earned more than $200,000. That means that the burden on the middle class would increase to maintain revenue neutrality, although as I mentioned above, how much tax any individual pays is largely a matter of choice.

The FactCheck piece ends with the curious line, “It is possible that the FairTax would make most people better off, but much of that gain would be a direct result of making the tax code less fair.”

That begs the question of whether the purpose of the tax code, along with generating revenue, should be fairness or making more people better off. I’m not sure I’d share their conclusion.

Having said all that, I have a couple of big objections to the Fair Tax. The first is that, like the ranked-choice voting that I discussed last week, it’s a big change that would require an adjustment in the way Americans think about taxes. Right now, Democrats are killing the Republicans in the public relations battle surrounding the Fair Tax. I don’t even hear anyone from the GOP answering the charge that this is a simple tax hike that adds a 30-percent national sales tax to existing taxes. If Republicans aren’t going to try to sell the plan to voters, having Congress vote on the bill is a waste of time.

The second objection is related to the first. The Fair Tax would tax a lot of services that Americans are not used to paying sales taxes on. These include real estate, rent, doctor bills, utilities, and interest to name a few. Again, this is going to take education and explanation if Republicans want people to accept the changes.

Finally, there is the question of whether the sales tax could be implemented and then Congress could decide to keep the income tax. Carter’s bill addresses this concern by calling for the repeal of the 16th amendment. The bill also contains a sunset clause that would make the sales tax null and void if the Constitution is not amended within seven years.

In my opinion, this poison pill makes the whole idea of the Fair Tax unworkable. In our divided state, any amendment to the Constitution is dead in the water. The amendment process only requires 13 states, one-fourth of the country, to block any proposed amendment. That is true regardless of whether the amendment is proposed by Congress or a convention of states. When you start counting states, it quickly becomes apparent that either party has plenty of votes to block an amendment proposed by the other.

The bottom line here is that it seems pointless to force the Fair Tax through Congress only to have it disappear seven years later. Even worse is the possibility that Americans would end up with both a national sales tax and an income tax. Democrats are quick to attack Republicans over the sales tax proposal, but I’m sure that if it became law they’d be happy to take advantage of the new source of revenue and hesitant to scrap the income tax.

In the end, the Fair Tax has both advantages and disadvantages, but it doesn’t really matter because it isn’t going to become law. McCarthy may have promised his caucus a vote, but I’d be surprised if the bill even passes the House. In the unlikely event that it does, it will die in the Senate, and there is no chance in Heaven that President Biden would ever sign it into law.

Proposing the bill amounts to an unforced error (although McCarthy may have been forced into it) because it gives Democrats an opportunity to beat Republicans about the head and shoulders with claims that the GOP wants to enact a 30-percent sales tax over the whole country. Those claims are only partly true but with no Republicans out there explaining the proposal to voters (and voters not having very long attention spans to listen if they did), the Fair Tax bill looks like a liability for Republicans.