Fair Tax Fouls

What's good and bad in Huckabee and Cain's favorite proposal


The last time we heard about a national sales tax was 13 months ago, when former Federal Reserve Chairman and current Obama Administration advisor Paul Volcker proposed augmenting the federal revenue armory with a value-added tax.

That idea failed to capture the nation's imagination, but at the first Republican Party presidential debate, the national sales tax returned, under the flag of Luntz-focus-group-winner Herman Cain. Cain, former CEO of Godfather's Pizza and 2008 TARP supporter, calls the national sales tax the Fair Tax.

So does Mike Huckabee in his own stumping for the national sales tax. And so does Rep. Robert Woodall (R-Georgia), sponsor of the Fair Tax, H.R. 25, "To promote freedom, fairness, and economic opportunity by repealing the income tax and other taxes, abolishing the Internal Revenue Service, and enacting a national sales tax to be administered primarily by the States." According to Woodall, who has been joined by more than 60 co-sponsors in the U.S. House of Representatives, the Fair Tax will change the structure of the American economy. From Woodall's site

Fair Tax isn't about simply taxes; it is about freedom, jobs, smaller government and the economy. It is about returning power to the people and finally finding a way to ensure America's economic growth. It is about completely abolishing the IRS and stripping the Federal government of the opportunity to dig deeper and deeper in the American people's personal pocketbooks.

The Fair Tax laid out in H.R. 25 [pdf] would surely change the structure of wealth formation, dollar savings, and consumption in U.S. tax jurisdictions. If it were coupled with an actual repeal of the 16th Amendment (an extremely long shot, as H.R. 25's escape clause in Section 401 acknowledges), the Fair Tax in its current form would discourage retail consumption and potentially bring personal savings rates (which are currently a little above five percent) back to much higher historic levels. The St. Louis Fed only has data going back about 50 years, when the savings rate averaged around eight percent—but eliminating the income tax could encourage an approach to savings not seen since 1913, when the 16th Amendment (which enshrines Congress' power to seize income, but did not originate it) was adopted. 

Fair Tax supporters insist it is a different animal than the VAT, which behaves more or less the way you would expect a national sales tax to behave. The VAT taxes sales at every level of production. In the language of "I, Pencil," it taxes the sale of the tree to the miller, then taxes the sale of wood chips to the manufacturer, the sale of brass to the maker of the ferrule, and so on—resulting in a radically more expensive retail product that ultimately goes on sale (with tax) at Rite-Aid. 

The Fair Tax is meticulously constructed to avoid doing that. This is why H.R. 25 comes in at a length of 131 pages and takes terrible pains to describe how the sales tax would be recorded and collected. There are provisions for cases wherein a sale is made to a producer, but the producer within a designated time period changes his or her mind about how to use the asset, and whether the sale should then be taxed (it should) and whether penalties should be applied (under certain circumstances). The Fair Tax tells us whether taxable property or services purchased by an insurer on behalf of an insured shall be treated as used to produce, provide, render, or sell taxable property or services. (They shall, but only if the premium for the insurance contract giving rise to the insurer's obligation was subject to tax pursuant to financial intermediation services.) The bill decides whether incarcerated prisoners are eligible for the family consumption allowance (they're not) and what will happen as the circumstances of family members change. (A revised registration is permissible, subject to certain restrictions.) 

The Fair Tax goes on to specify what interest rate state tax collectors must pay on collections remitted to the federal government after a five-day deadline has passed (payment of interest at 150 percent of the Fed short-term rate). It specifies the destination on rental and lease payments for land vehicles, aircraft, and water craft. It specifies fines for individuals who file late ($50 or 0.5 percent of gross payments). It specifies the language to be used in a document describing the administrative appeals process and the authority of the Problem Resolution Office (plain English). The Fair Tax tells us how to determine principal and interest components of a financing lease for tax purposes. (Just examine the contemporaneous sales price or prices of property the same or similar as the leased property.) 

I am not going to say no to the Fair Tax outright, because there are things in it to like. Putting federal taxing authority into the hands of the states creates some interesting prospects for federalism and interstate competition. I suspect an item on page 21 may create a loophole that would make all secondary market sales tax-free. Taxing consumption instead of income has the potential to end federal efforts at behavior modification via the tax code and raise revenues for the legitimate functions of the state in ways that are less morally corrosive than the current tax system. 

But laws and novels get worse as they get wordier. The Fair Tax proposal, at least as documented in H.R. 25, doesn't even have the admirable pith and brevity of Amendment XVI: 

The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.

Leave aside the very low probability that the 16th Amendment could be repealed and the IRS abolished. The point is to get rid of the income tax and replace it with nothing. Fair Tax proponents would get rid of the income tax and replace it with another tax that rings in at 23 percent of retail value, creates complicated new bureaucracies, and gives people money for staying in poverty. That last part is the family consumption allowance, or "prebate." Cain explains the principle of the prebate: 

Always be concerned when somebody is proposing not just a new law but new language to describe it. My 10-pound dictionary has no entry for "prebate." It does have "prebasic molt," the process by which birds replace 100 percent of their feathers within a period of time, and "prebend," an allowance for church officials. I'm pretty sure that prebends would cause less damage to the U.S. economy than prebates, and that our fiscal system needs a prebasic molt a lot more than it needs a Fair Tax.

In Reason's new opinion poll, two-thirds of Americans turn thumbs down on the idea of a national sales tax. They're right to oppose it, and adopting the progressive language of "fairness" does not change that. 

Tim Cavanaugh is a senior editor at Reason magazine.