The states would be required to collect this new tax, thus allowing for abolition of the Internal Revenue Service. To prevent poor and middle-class people from being overly burdened, Americans would be sent monthly checks as a partial rebate of the tax.
Unfortunately, like all things in life that are too good to be true, so is this one. Here are a few problems with the FairTax. True rate. When people hear about a 23 percent national sales tax, they naturally equate it to the state sales taxes they are familiar with. If a state sales tax is 5 percent, then this means that if someone buys something for $1 they will pay $1.05 at the checkout. Thus they assume that the FairTax would cause a $1 product to cost $1.23 if it were to be enacted.
In fact, the rate is not 23 percent, but 30 percent. The 23 percent rate is arrived at by treating the tax as if it were already part of the price instead of being on top. Thus if a product were to sell for $1 and the FairTax added 30 percent, the 30-cent tax comes to 23 percent of $1.30. This is how a 30 percent rate is deceptively turned into a 23 percent rate.
Governments must also pay. The FairTax would apply to all government purchases at every level. Only education spending is exempted.
States would have to pay 30 percent more on every highway and bridge they build, local governments would have to pay 30 percent more for police and fire protection, and even the federal government would have to pay the tax to itself when it buys weapons and ammunition for troops.
Taxes would have to be increased at the state and local level to pay the FairTax to the federal government. The FairTax rate would also have to be higher to pay for the additional federal spending it will require. However, FairTax supporters exclude this higher spending from their calculations. The 23 percent rate is designed only to be revenue-neutral, not spending neutral. Thus the federal deficit would either rise by more than $200 billion per year or spending would have to be cut by this much.
Rebate problems. The FairTax rebate would also add $600 billion to federal spending annually. Although its supporters say it is just like the one we get when our tax withholding exceeds the taxes we pay on our tax returns, the FairTax rebate is more like Social Security because it comes in a monthly check.
Although FairTax supporters tout the generosity of the rebate, it is extremely modest because it is based on the poverty level income - a figure that bears no relationship to the actual cost of living. As a consequence of the way the poverty rate is calculated, childless couples would get a monthly rebate of $391 per month, but a single mother with two children would only get $329 per month.
Prices will rise. Finally, FairTax supporters assume away many of the problems with their plan by asserting that prices will fall by 22 percent once all income taxes are abolished. Prices at the checkout would be about the same with the FairTax as they are now, they say, but everyone would come out ahead because their net wage will now equal their gross wage.
If this were so, it's hard to see why the rebate is needed, since there seems to be only winners and no losers under the FairTax. In reality, for prices to fall by 22 percent, business costs would also have to fall by 22 percent, which means that all workers would have to take a 22 percent pay cut.
It's unlikely that workers would agree to this. It is far more likely that the FairTax will raise the price of everything by 30 percent. This has been the case in every country and every state with a sales tax. The idea that prices will fall is just a pipe dream.
The FairTax is unworkable. It is a fantasy to think otherwise.
Bruce Bartlett was deputy assistant secretary of the Treasury for economic policy from 1988 to 1993.