Fair Tax or Foul?

The promise and peril of changing the way we pay for government

During the first Republican presidential debate in May, erstwhile Godfather's Pizza CEO Herman Cain was asked about expert projections that his proposal for a national sales tax would hurt poorer Americans and involve taxation of real estate and rental property. Cain got a round of applause for shooting back, "With all due respect, your experts are dead wrong." Although the rest of his reply avoided responding to the question, Cain's barb was the point: All discussion of the national sales tax must commence with the assertion that your interlocutor is either malicious or misinformed. Several Republican presidential candidates, 61 members of Congress, and six senators support a "Fair Tax" that would replace the income tax with a levy on retail sales. And very few of these people are lukewarm about the idea.

"Any politician or political group who claims or implies that the Fair Tax adds a 23 percent national consumption tax on top of [existing federal taxes] is either lying to you or is ignorant of the facts," activist Dale Johnson wrote recently at FairTax.org. According to one YouTube uploader, a Chris Matthews interview with a Fair Tax–supporting politician shows the MSNBC hothead is "trying to carry the water for the cause of statism with the usual distortions and fear mongering, but since he is doing so from a foundation of ignorance on the simple details of the Fair Tax, his statements come across as sad."

It's not just Fair Tax proponents but also detractors who presume their opponents are dishonest or ignorant. When I published a largely negative take on the Fair Tax bill H.R. 25 at reason online, several commenters disdained my assessment as insufficiently negative. "Tim, I am deeply disappointed in the shallow way you 'examined' Fairtax," wrote reader Mark Curran. "Fairtax is profoundly bogus, it is very much a literal farce. Someone of your 'critical thinking skills' should have spotted this long ago. Fairtax is based not just on one absurdity, but layers of absurdity."

To be fair, the Fair Tax proposal, in all its instantiations, provides plenty of room for ignorance. In sharp contrast to the 30-word 16th Amendment of 1913 (which established Congress' authority "to lay and collect taxes on incomes, from whatever source derived"), H.R. 25 is 131 pages long, going into microscopic specifics about circumstances under which taxes would or would not be levied.

Supporters reasonably argue that all this verbiage is necessary to distinguish the Fair Tax from a value-added tax, with which it is often confused. While the VAT lays taxes at every stage of production (and thus drives up the cost of the final retail product), H.R. 25 is painstakingly crafted to ensure that the sales tax is applied only at the retail level, which makes for highly prescriptive legislation. What happens, for example, when a manufacturer buys something with the intent of using it in production but then changes his or her mind? Would the sales tax apply at that point? (It would.) Would there be any penalties for this change? (Yes, under certain circumstances.)

What if you've been taxed on your health insurance premium and your insurance company pays for a doctor's visit on your behalf? Should the insurance company have to pay tax on that purchase? My reading of H.R. 25's Title II, Subtitle A suggests the doctor's fee, since it was "used to produce, provide, render, or sell taxable property or services" (i.e., the medical coverage provided by the insurer), would not be taxed. But what about your copayment?

This level of detail may be necessary to levy a retail tax without boosting the cost of doing business. But what to make of the family consumption allowance, or "prebate"? Fair Tax proponents would give qualified families a sales tax rebate each month, calculated as the product of the 23 percent national sales tax and the monthly poverty level. This is the "fair" part of the tax: Since taxing consumption rather than income is regressive, the prebate attempts to give lower-income Americans enough money up front to cover taxation on their monthly purchases. But in practice, it's hard to see how sending a monthly check to every household in the country would reduce the role of government in our lives.

Nevertheless, these are bold ideas in the stagnant debate on taxation in the United States. I suspect the high level of vituperation in the Fair Tax discussion comes from people's excitement at finding new ways to talk about how the government takes our money and for what purposes. 

The 16th Amendment has been with us for nearly a century, and to the extent that we can determine the income tax's effects on wealth formation and saving rates, there's a lot to be unhappy about. (Equity as a percentage of home ownership and personal saving rates have been falling more or less steadily during the more than 50 years these numbers have been tracked.) The current tax system also has taken tax policy far beyond the arguably legitimate function of raising necessary revenue and into a wide range of social engineering projects (for example, encouraging Americans to take on more real estate debt and rely on employer-provided health insurance). Shifting to a consumption tax could revive the long-neglected idea that you have a right to accumulate wealth without explaining it, justifying it, or finding clever ways to conceal it.

But these advantages rest on the assumption that a consumption tax would replace the income tax rather than supplementing it. H.R. 25 contains a sunset provision that takes effect if the 16th Amendment is not repealed within five years, but this safeguard would not provide much protection. Repealing an amendment is very hard. Renewing a bad law when its expiration date is up—as we've found through endless renewals of the USA PATRIOT Act—is easy. For this reason and others, Americans fear the Fair Tax. In the Reason/Rupe Public Opinion Survey conducted in May (see "Cut the Debt by Cutting Government," page 42), only 33 percent of respondents supported eliminating federal income taxes and replacing them with a national sales tax.

As long as the legislation is doomed, however, the debate over the Fair Tax is a good one to be having. The income tax, and the central banking system that is its handmaiden, are morally corrosive in ways that can't be reduced to dollars and cents. A sales tax may not be the solution, but it does help us understand that we have a problem.  

Tim Cavanaugh ([e-mail]) is a reason senior editor.