WHY THE FAIRTAX WON'T WORK

February 15, 2008

One solution to the nation's long-term fiscal problems that has gained support in recent years is the idea of replacing all federal taxes with a 23 percent national retail sales tax called the FairTax.  Unfortunately, the administrative problems inherent in this proposal make it impossible to take seriously, says Bruce Bartlett, former deputy assistant secretary for economic policy at the U.S. Treasury Department.

For example, under a FairTax scheme:

  • A worker now netting $800 per week would immediately get a $200 raise and start taking home the full $1,000 gross wage that he is paid; instead of paying income and payroll taxes, workers would pay their taxes when they buy things.
  • The FairTax would impose a 23 percent tax on all goods and services (this is not really correct, but for now we'll accept it at face value for analytical purposes).

Whether he is better off or not depends on what his effective tax rate is:

  • Assuming he spends all his income and no more than that, he will be no worse off if he now pays 23 percent of his income in taxes.
  • That is, his effective tax rate is 23 percent; in this case, the FairTax is a wash, the worker is no better off or worse off in terms of taxes than he is now.

But what if the worker is now paying less than 23 percent of his income in federal taxes?  In this case, he is clearly worse off, says Bartlett:

  • The prices of the things he buys will rise by more than his income rises from the elimination of income and payroll taxes. 
  • Conversely, if one is wealthy and in a tax bracket above 23 percent, that person would be much better off. 
  • His income and payroll taxes would fall by much more than the prices of goods and services he consumes would rise.

Source: Bruce Bartlett, "Why the FairTax Won't Work," Tax Notes, December 24, 2007.

For text:

http://taxprof.typepad.com/taxprof_blog/files/bartlett_fair_tax.pdf

 

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