July 18, 2012

A Fair Look at the Fair Tax

Credit: FreeDigitalPhotos.net
In July of 1999, Georgia Congressman John Linder introduced a little something called the Fair Tax Act to the U.S. Congress. Since then, the legislation has been introduced to every subsequent session of Congress, sometimes by Republicans and sometimes by Democrats. Perhaps you are more familiar with the Fair Tax because of the publicity generated by talk radio personality, Neal Boortz, or perhaps you’ve seen the T-shirts and bumper stickers. Whether you’ve memorized The Fair Tax Book written by John Linder in 2005 or this is your very first taste, I think this Fair Tax idea has become popular enough to take the time to evaluate.

A few weeks ago, one of my readers asked me if the Fair Tax was actually fair. I could tell you my thoughts, but why don’t you decide for yourself…

The Fair Tax is a single-rate federal sales tax. The tax would be added to the price of new goods (not used) and services upon purchase. All U.S. residents would receive a monthly payment from the government equal to the amount of tax that would have been paid for essential goods and services at the poverty level. The tax would eliminate individual, estate, gift, capital gains, alternative minimum, Social Security, Medicare, self-employment, and corporate taxes.

Sounds great, but what’s the rate? The proposed rate is the rate that would be needed to roughly generate the tax revenues that would be lost by the elimination of all the taxes mentioned above. Some sources will tell you that rate is 23%. Some sources will tell you 30%. It depends on how you look at it. Let me explain:
  • Suppose you want to purchase a $100 widget. That seller clearly wants $100 because that’s the price, but the 23% Fair Tax has now become law. What’s the seller going to charge you now - $77 ($100-$23), and eat the taxes for you? I think not. The seller still wants his money and wants to pass the new 23% tax on to you, so the seller is going to have to charge you $130 (because 23% of $130 = $30 worth of tax) in order to get his $100. See why mischievous proponents of the Fair Tax say 23% and misleading opponents of the Fair Tax say 30%?
Whatever the rate, what are the pros of a Fair Tax system? Well for starters, a sales tax on consumption is a lot simpler than the Internal Revenue Code. With the Fair Tax, you wouldn’t have to worry about preparing your taxes or having the Internal Revenue Service on your back. There would be no taxes on investments, so potentially more people could choose to invest in markets. Illegal immigrants would get to pay their share of taxes, and black market funds, such as the proceeds from an illegal drug sale, would also face taxation as soon as their owner bought anything. The Fair Tax might even help sustain financially-struggling government programs like Social Security and Medicare, as they could now be funded by everyone’s consumption on American soil - not just by taxes on the current workforce.   

What about the cons of a Fair Tax system? As recently as 2009, more than half of American households paid no income tax, so would it be good for those households to start paying taxes now? 23%/30% is also a fairly hefty tax rate for most people to swallow, and it might be just enough to deter some from buying goods and services. Can you imagine how it would feel for everything to cost 23%/30% more over night? What would that even do to our economy? A Fair Tax system might also spawn more underground markets as our friend, the seller, would have the incentive to illegally sell that pre-Fair Tax $100 widget to you for $105, keep the change, and never report the sale or remit the taxes to the government.

So what do you think? Is the Fair Tax fair?

What I think is that the current tax system is broken. Any system’s code that is longer than War and Peace, any system that is so confusing and painful that people are willing to pay premiums to accountants to save them from having to think about it, and any system that has become so polluted by the work of lobbyists and special interest groups can be improved. On one hand, the Fair Tax seems fair if it effectively replaces all current tax revenue by taxing everyone the same way, at the same rate, and reimburses people for the essentials. On the other hand, taxing more than half of a population that is currently untaxed, taxing a majority of people at an effective tax rate much higher than they are used to, and raising prices on everyone at once doesn’t seem so equitable.

I think the Fair Tax could be fair and could work. I just don’t currently see how the U.S. could smoothly convert to a Fair Tax system, or quite frankly, how a majority of Americans would ever be in support of the Fair Tax system. What do you think?



  1. I agree that our tax system is definitely broken. Perhaps the Far Tax system could be gradually introduced on products or maybe services and then added to other taxable items over the years. I don't know, but something has to be done... Thanks, Tom!

  2. AnonymousJuly 19, 2012

    Tom, you only scratched the surface as to why the Fairtax isn't fair!
    (1) How is it fair to double tax everyone's after tax savings/wealth?

    (2) How is it fair to force retirees to resume paying for their government retirement benefits with their sales tax dollars?

    (3) How is it fair to allow lower income workers to pay no net federal tax due to the prebate, yet still let them qualify for full government retirement benefits?

    (4) How is it fair--or constitutional-- to propose that the federal government tax the consumption of State and Local governments under our constitutional republic form of government?

    (5) How is it a good idea to create a $600 billion annual cash grant entitlement known as the prebate, and coming at a time when entitlements are squeezing out discretionary spending in the federal budget?

    (6) How is it fair to force new home buyers to come up with not only a 20% down payment but also the 30% sales tax? Federal sales taxes have no collateral value!

    (7) How is it fair to lay on a huge implicit service tax on investment instruments such as CD's and debt instruments such as credit cards and mortgages?

    (8) How is it fair to propose to implement the Fairtax scheme "cold turkey" when no other nation has ever successfully funded their central government with such a broad based national sales tax?

    As for your post, I'm not aware that any Democrat ever introduced HR25? And, it doesn't matter how you describe the sales tax rate, the only thing you need to know is that retail merchants will have to add 30% to their costs in order to come up with the 23% tax inclusive price.

    The Fairtax as described in HR25 is a very bad idea, and because you asked, I would much prefer a 10% VAT which replaced just the income tax. Leave Social Security alone, don't tax governments, and consider a targeted prebate at around the same cost as the current EITC. I call it Fairtax-Lite.

    1. Thanks for your comment!

      Looking back, I can see why you might say I only scratched the surface as to why the Fair Tax could be considered unfair. It’s really easy to say and explain how a tax that charges everyone the same rate on a new good or service seems fair, but it would have taken a much longer and technical blog post to dive into all of the ways the Fair Tax could seem unfair. I was simply going for a short, informative, and hopefully, thought-provoking piece. I also think I purposefully steered away from some of the areas you bring up because this blog is not intended to be a political sounding board. Unfortunately when you get into what is fair and what is not fair, sometimes it can be more based on personal philosophy than sound financial analysis. All that being said, let’s take a look at your comments/questions…

      1) Some of my readers might even say it’s not fair to be taxed once, let alone twice! You are quite correct that people with substantial savings or wealth would essentially have those savings or assets taxed twice (once when they acquired them under the current tax system, again under the Fair Tax when they used those assets to purchase a new good or service). The Fair Tax would only tax everyone once on every dollar that was earned (and later spent consuming) after it was enacted (should it ever be enacted). Fair or not, I think it’s worth noting that many of the people with substantial savings and wealth are familiar with double taxation whether from corporate dividends (taxed at the corporate level and then again at the shareholder level) or the estate tax (taxed upon earning, potentially taxed upon death).

      2) I don’t think it’s fair to promise someone something and give them something else. Retirees were promised if they paid into the Social Security system they would receive a relative amount of benefits and wouldn’t have to pay anymore in retirement. If you’ve been following the news, you probably know how much trouble several government social programs like Social Security are in. I’m just not sure how much more unfair taxing retirees to raise additional revenue to help Social Security is than cutting a retiree’s benefits to lower costs and help Social Security. Realistically, if the Social Security program is going to continue, something is going to have to change.

      3) Remember, the prebate (the monthly payment the government would send everyone for the amount of goods that would have to be purchased at the poverty level) would be given to everyone, not just lower income workers. As to the fairness of paying no or little tax and receiving government benefits, that has been an ongoing political issue for quite a while, and the answer on whether it is appropriate or not depends on your own political philosophy.

      4) We are a federal constitutional republic and Section 8, Clause 1 of the U.S. Constitution (often referred to as the taxing clause) states that: “The Congress shall have Power to lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States.” Because the Fair Tax is a sales tax ( and those are excise taxes), the Fair Tax would not tax state exports, and the Fair Tax would also be uniform throughout the United States, I personally see it as constitutional. That being said, many people do not. I’m sure if the law were ever enacted, it would make its way to the Supreme Court where people a lot smarter than me could decide whether it is constitutional or not!

      5)I believe the thought was that the Fair Tax rate would be set at a high enough rate so that it made up all lost tax revenues of the repealed taxes and the additional expense of the prebate checks. As far as my thoughts on the potential dangers of future entitlement programs, I would refer you to a previous post:


    2. 6) You are right that taxes you owed and have paid (money you don’t have) cannot be considered collateral, but you certainly don’t have to put down 20% when buying a home. Putting 20% down on a home does get you out of having to pay private mortgage insurance (PMI) and is a great way to lower your monthly amount due! From a homeowner’s perspective, I’d be more initially worried about losing the benefit of the mortgage interest tax deduction that is part of the current income tax system than I would be the Fair Tax itself.

      7) There is some language in HR 25 that opponents of the Fair Tax occasionally cite as an implied tax on interest bearing investments and debt instruments. The text in the proposed bill is in my mind an implied tax, and I’m not a fan of those sections, but I believe there is a reason for it. I believe the logic behind the provision was based on the fear of timing arbitrage by consumers. What I mean by timing arbitrage is that you could potentially make a case that someone should max out their credit cards and go into as much debt as possible right before the Fair Tax kicked in because they would almost instantly be “saving” money based on the difference between the pre-Fair Tax prices and the pos- Fair Tax prices (of course they’d be in serious debt, too). Based on my readings, I believe this implied tax on long term investments and debt instruments was supposed to counter that potential incentive to spend a bunch of money trying to beat the system, a practice that could be quite destructive to someone’s finances.

      8) I share your concern on the implementation of the Fair Tax as I noted in my conclusion. I’m not sure anyone is entirely sure what would or could happen.

      The Fair Tax does stereotypically have more support from Republicans than Democrats, but it has had Democratic support. Minnesota Representative, Collin Peterson, a Democrat, co-sponsored the bill in the House of Representatives in 2000. Being from Georgia, I knew that Senator Zell Miller, a career Democrat, co-sponsored the bill in the Senate in 2003. As recently as 2010, Oklahoma Representative, Dan Boren, also a Democrat, publicly supported the Fair Tax. I think support for the Fair Tax has been growing not because it’s a perfect law, but because it’s an alternative, and people are getting more and more fed up with our current tax system that many feel is unfair, and almost all agree is inefficient. That’s why I wanted to do the post!

      Thanks again for your thoughts. If everyone looked at the Fair Tax as closely as you must have, surely someone would come up with an even better idea than the Fair Tax on how to reform our nation’s tax system.

  3. AnonymousJuly 21, 2012


    Thanks for your thoughtful responses. And, I did not wish to be known as Anonymous, but that is the only way I could sign in on your blog. I'm Hank Van Gieson, a retired Air Force pilot and computer Neanderthal, and I have been studying and debating the Fairtax and HR25 for almost eight years. My library contains almost every book and study written on the subject, both pro and con.

    Here is a bit more detail on some of my criticisms.

    Re #4. As strange as this may sound, my criticism has nothing to do with the wording in the Constitution that you described in your response. It is based on other facts as you presented them, specifically that we are a constitutional republic consisting of three sovereign powers, two of which are governmental and one is "we the people". Sovereign governmental powers do not tax each other, and there is a long held Supreme Court doctrine called intergovernmental tax immunity which has guided Court decisions from the very beginning. Perhaps these extracts from Justice O'Connor's dissenting opinion in S.C v Baker (485us505) will scope the issue? While the subject in 485 US505 was federal taxation of State/Local bond interest, you could just as easily substitute Fairtax for the bond interest.

    "Federal taxation of state activities is inherently a threat to state sovereignty. As Chief Justice Marshall observed long ago, "the power to tax involves the power to destroy." McCulloch v. Maryland, 4 Wheat. 316, 431 (1819). Justice Holmes later qualified this principle, observing that "[t]he power to tax is not the power to destroy while this Court sits." Panhandle Oil Co. v. Mississippi ex rel. Knox, 277 U.S. 218, 223 (1928) If this Court is the States' sole protector against the threat of crushing taxation, it must take seriously its responsibility to sit in judgment of federal tax initiatives. I do not think that the Court has lived up to its constitutional role in this case. The Court has failed to enforce the constitutional safeguards of state autonomy and self-sufficiency that may be found in the Tenth Amendment and the Guarantee Clause, as well as in the principles of federalism implicit in the Constitution. I respectfully dissent. [485 U.S. 505, 535]

    I think our republic would never have been launched if the founders ever thought their creation would wind up taxing the creator!