The trouble with the ‘fair tax’
Greg Sargent has been doing some great reporting on Rick Perry’s walk-back on his past support for repealing the 16th amendment, which enables the federal governments to levy income taxes, and enacted the “Fair Tax” proposal for a national sales tax. The fair tax plan has been around for a while now, and it got a boost during the last presidential cycle when Mike Huckabee embraced it, and Herman Cain is touting it this time around. The proposal claims it would replace almost every federal tax, including payroll, personal and corporate income, and estate taxes, with a 23 percent national sales tax.
The first problem is with that number. The actual proposal could impose a tax of 30 percent of the cost of a given purchase. Advocates for the fair tax claim that this amounts to a 23 percent tax, because if one is purchasing an item that lists for $1, the total cost will be $1.30, and 30 cents divided by $1.30 is a little over 23 percent. So if one uses the same terminology that is commonly used in discussing state and local sales taxes, the fair tax is actually a 30 percent national sales tax.
But even a 30 percent national sales tax probably won’t raise as much revenue as the taxes the fair tax replaces. The Institute on Taxation and Economic Policy estimates that the rate would have to be between 45 to 53 percent to raise as much as the income taxes, payroll tax, estate tax and so forth. What’s more, ITEP found that the change would be highly regressive, despite the fair tax’s inclusion of a lump-sum payment to all households, which is meant to cover the cost of taxes on basic goods such as rent or food. ITEP found that the bottom 80 percent of earners would pay an average of $3,200 more in taxes, or a 51 percent bump. The top 1 percent would see an average tax cut of $225,000. Of course, Rick Perry has called for higher taxes on poor and middle-income Americans, and wrote in his book (page 183) that he supports a fair tax because it “provides only the modest revenue needed to perform the basic constitutional functions of the federal government.” So the fair tax’s low revenues and regressivity could be features, not bugs, for him.
The tax also has enforcement issues. Many difficult-to-tax items that traditional sales taxes exclude would be subject to the fair tax, including rent, health care and even government spending. So when the Pentagon buys a tank, it will pay sales tax to the federal government, which will then be used, in part, to pay for the Pentagon’s tanks. What’s more, the potential for tax evasion is high. William Gale, a tax expert at the Brookings Institution, estimates that, if current income tax evasion rates hold, the fair tax would lose 20 percent of its tax base, forcing rates even higher than ITEP’s 45 to 53 percent range. However, Gale notes that evasion is likely to be much higher than it is for the income tax, because the sales tax depends on honest collection by businesses, and cannot use withholding to ensure compliance.
“Other countries have attempted to implement some variant of a national retail sales tax with little success on the enforcement front when rates climb to more than 10 percent,” Gale notes. And any plausible fair tax rate will be several times that cutoff.
So the fair tax will cut revenue and increase the deficit, make the tax code more regressive, and could be very difficult to enforce. If Rick Perry really is revoking his support for it, good for him.