NTF Issue Paper: fairtax3.doc.  3-07.





BACKGROUND.  Cong. John Linder (GA.) has re-introduced HR 25, the Fair Tax Act of 2007, as a bill in the 110th Congress. He has introduced basically the same bill each congressional session since 1999.  HR 25 will repeal all individual and corporate federal income taxes, payroll taxes, self-employment taxes, Social Security and Medicare taxes, capital gains taxes, and estate and gift taxes.  The Center on Budget and Policy Priorities declares that 3/4ths of taxpayers pay more in payroll than in income taxes.  It will abolish the IRS.  Replacing all these onerous taxes is the Fair Tax, a personal consumption tax, administered primarily by states that remit the tax collected minus administrative fees of of 1% and where resides the most practical experience and expertise in sales tax administration. Businesses that collect and remit this tax will receive equitable compensation for costs incurred.  This 23% national retail sales tax will apply to sales of all new consumer property, goods, and services only once, at the final destination for consumption.  Every American taxpayer will pay the identical rate, without exception.  It would decrease overall tax burdens by broadening the tax base and more efficiently taxing wealth. Nebraskans will keep 100% of their paychecks, pensions, and Social Security checks, allowing us to save more money, invest in business, and stimulate our economy by job creation.  The legislation would take effect on Jan. 1, 2009.  The tax would add to import duties but would not apply to wholesale exports.  Personal services such as health care, legal services, haircuts, and auto repairs would fall subject to tax, also renting apartments or condos and other property.  Inventories held by businesses at the end of the workday on 12-31-2008 will qualify for Fair Tax inclusion if sold within the next year.  Illegal immigrants would pay this tax.  Many free market economists and tax experts believe that this tax would positively impact savings and investment, ease tax compliance, increase economic growth, and offer incentives for international business conglomerates to locate in the U.S.  
Cong. John Linder  (7th Dist. GA.)

ITS PROGRESS.  This bi-partisan bill has 52 co-sponsors from 24 states.  Several congressional committees have heard testimony on this tax, but neither chamber has voted on it.  To become a law, a lawmaker must include it in the final version of tax legislation from the House Ways and Means Comm. or the Senate Finance Committee, then gain support from the Joint Committee on Taxation and finally win passage again in both House and Senate.  Conservative Sen. Saxby Chambliss (GA.) has introduced an identical bill into the Senate.   The Fair Tax would require a constitutional amendment to become implemented, a high hurdle. 


POSITIVE EFFECTS.  The number of individuals required to file taxes drops from about 145 million to 25 million, an 80% drop. This bill will prevent duplicative taxation, simplify the federal tax code, and reduce compliance and adminis- trative costs.  It will show the true cost of everything we buy.  Lowered are costs of employment.  No longer will heirs have to sell family businesses and farms to pay estate taxes.  High tax planning costs on small businesses and farms will disappear.  Small, family-owned businesses and farms and ranches will thrive. HR 25 will encourage capital formation and entrepreneurship.  It will spur productivity and international competitiveness.  Because our current tax system has a hidden effect on prices, the Fair Tax would decrease production costs by the removal of business taxes and compliance costs.


TAX COLLECTION.  Sellers impose the tax separately from the purchase.  Sellers of taxable property and services will collect and remit the tax. For taxable property or services bought outside the U.S. and imported, the buyer will remit the tax.  For wages and salaries paid by a taxable employer for taxable services, the employer will remit the tax.  Consumers will get credit for amounts paid in excess of amounts due after filing a monthly report.  They will get refunds within 60 days with no interest; balances due not paid within 60 days will bear interest.  All tax and taxpayer information is confi- dential except to other Fair Tax administering authorities and congressional committees in closed session.  The number of tax collection points would greatly drop under the Fair Tax, as only retailers would file a tax return, not each income earner, with filing complexity reduced to a simple state sales tax form. Simplified tax system means greater compliance.  The lesser number of collection points will permit tax administrators to investigate tax fraud with greater scrutiny.  Increased business audits would make tax evasion more risky.  The International Monetary Fund revealed that Russian transition to a flat tax increased income reporting from 52% to 68% in 1 yr.  Similar results happened in Slovenia.  Businesses would submit monthly or quarterly reports, depending upon sales volume, of taxable sales and sales tax collected. Retail outlets would keep of 1% as collection fees.  45 states and the District of Columbia levy sales taxes, accounting for 97% of our population and economic output.  Most states collect a host of  county, city, and state sales taxes.  Therefore, our nation has a large infrastructure currently to collect a sales tax.  The underground economy would suffer, because tax evasion under the present system only needs the payer to lie on tax forms.  Evasion under the Fair Tax requires collusion from both payer and payee.  The Fair Tax contains fines and penalties for non-compliance and authorizes a means for reporting tax cheats and getting a reward. 


EXEMPTIONS.  Dues, contributions, and other payments to nonprofit organizations, like religious and community groups, are exempt.  Taxable property and services purchased by nonprofits also are exempt. Mortgage interest up to the basic interest rate determined by the Federal Reserve would be tax-free. Intra-business purchases for the production of goods and services would not face taxation.  No tax on taxable property or service bought for an investment purpose and held only for such purpose. Education, training, savings, and financial investing would identify as investments and therefore not face taxes.



Effective tax rate comparison graph


The tax rate paid by households would vary according to spending habits and monthly rebates.  A family of 3 spending $30,000 per year on taxable items would pay about 6% of total spending in Fair Tax, whereas a household spending $125,000 on taxable items would pay about 19% in Fair Tax.  Total amounts of spending and the proportion of spending on taxable items would determine a household effective tax rate.  Buying or receiving used items would contribute towards a negative rate. The Fair Tax would broaden the tax base and actually tax wealth and foreign tourists and visitors.  Regular sales taxes many consider regressive, taxing the poor more, but the prebate would create a progressive effective rate on consumption.  A poor family would pay a rate of 0% on 100% of consumption, while a high income family might pay a tax rate of 15%. The Fair Tax would broaden the tax base and actually tax wealth and foreign tourists and visitors.  Regular sales taxes many consider regressive, taxing the poor more, but the prebate would create a progressive effective rate on consumption.  A poor family would pay a rate of 0% on 100% of consumption, while a high income family might pay a tax rate of 15% on its 80% of consumption while saving 20%.  Families at the lower end of the income scale spend almost all their income.  Households at the high end usually save some money and finance purchases from savings, not income.  Savings would face tax when it buys something.  Income earned and saved would not face tax immediately, but spent in the future and taxed accordingly.  The Fair Tax greatly reduces marginal taxes on work and savings and greatly lowers overall average remaining lifetime tax loads on present and future employees at all income levels.[1]  A study on marginal and average tax rates discovered that the Fair Tax would reduce most family average lifetime tax rates greatly.2  Boston U. economists found that this tax gives poorer households 26.7% more purchasing power, middle class folks 10.9% more, and higher income households 4.7% more.


Boston University study of the FairTax - Average Remaining Federal Lifetime Tax Rates of married households


REBATES.  Lower income families, at or below the monthly poverty level and lawful U.S. residents, will receive a consumption tax rebate, determined by the rate of tax and monthly poverty level, by filling out a form. This rebate means that the tax rate is progressive on consumption, leading to a tax burden down to zero for some, and thus increases purchasing power for lower incomes.  Received in advance, it is called a prebate.  It would equal the estimated total Fair Tax paid on poverty level spending according to guidelines published by the U.S. Dept. of Health.  These poverty level guidelines vary according to family size and represent the cost to buy household necessities.  The prebate would arrive in 12 monthly installments equal to 23% of poverty level spending for every household size and eliminate taxation on necessities. This formula would adjust yearly for inflation.  To become eligible for a prebate, a family would register once each year with their sales tax administering authority, and the SS Administration would disburse monthly rebate checks by mail or electronically to a bank account.  The National Taxpayers Union estimates the yearly cost of mailing these checks at $225 million.  The Beacon Hill Institute, a prestigious research institute, figures the rebate cost at $489 billion.  However, Fair Tax experts state that income tax deductions, tax preferences, loopholes, credits, etc. under the present system costs $945 billion.  The IRS actually mailed out $270 billion in refund checks in 2005.


2006 FairTax prebate schedule


Source: Ross Korves, chief economist (retired), American Farm Bureau Federation.

The Fair Tax rate is revenue neutral, not increasing or reducing total federal tax revenues, according to experts like Prof. Dale Jorgenson, economics professor at Harvard U. and past president of the American Economic Association, and Jim Poterba of the Mass. Institute of Technology.  Also advocating such are researchers at Stanford U., the Cato Institute, the Beacon Hill Institute, and the Heritage Foundation.  Beacon Hill also found that this tax imposes no additional fiscal burdens on state and local government entities. 


FIGURING COSTS.  The Fair Tax would make the cost of federal government very visible, as consumers would see this cost every time they bought something.  The tax would reduce compliance and efficiency costs by 90% and return more of those dollars to the productive sector.1  Moreover, about $11 trillion held in foreign accounts to avoid taxes holders would return to banks on our shores, becoming available to U.S. capital markets and lowering interest rates.2  Boston U. and Rice U. studies both confirm that long-term interest rates would drop by as much as 1/3.  According to the National Bureau of Economic Research, GDP would rise almost 10.5% in the year following Fair Tax implementation, productivity output would rise by 12%, capital stock would increase by 42%, and real wages increase by 8%.  As dropping tax compliance costs lower production costs, exports would increase by 26% initially and remain over 13% above current levels.3  Prof. Dale Jorgenson estimates that revenues incoming to Social Security and Medicare would double as the size of our economy doubles within 15 yrs. after passage.  Global companies consider tax structures when planning capital investment decisions.  Lower corporate tax rates induce higher corporate investment in specific countries.  The U.S. now has the highest combined statutory corporate income tax rate among developed nations.  Princeton U. economists surveyed 500 European and Asian companies about the impact on their business decisions, if we enacted the Fair Tax.  400 of these corporations stated that they would build their next plant here, and 100 declared that they would move their corporate hq here. Beacon Hill estimates that the feds could cut $8 billion from the IRS budget of $11.01 billion in 2007, shrinking the size of fed tax administration by 73%.  Moreover, tax preparers, lawyers, and software employees of companies that sell tax preparation software will face large losses in employment.  The IRS would not disappear until 3 yrs. following enactment, providing employees with time and marketable skills to find alternative jobs as the economy grew by 10.5% during the first year of the tax. The tax would sweep almost all fed taxation costs of goods and services from the supply chain, lowering production costs by up to 30%, leaving price almost the same after tax paid.  If businesses paid employees with gross pay, production costs would decrease by 11.55%, according to Arduin, Laffer, and Moore Econometrics.


REPEAL OF INCOME TAX.  The Fair Tax would not automatically repeal the federal income tax.  Repeal would require a separate congressional bill together with legislation expressly forbidding such tax. 


SOCIAL SECURITY.  Fair Tax legislation would adjust SS benefits for changes in price level, so a percentage hike in prices would mean an equal percentage hike in benefits. 


ILLEGAL ALIENS.  The Fair Tax would give illegal aliens incentive to legalize; otherwise they would not receive the prebate.  Illegals would pay the maximum effective tax rate.  No federal tax savings for companies that hire illegals. 


USED GOODS.  The Fair Tax would not tax used goods, so opponents claim that such would create a differential between the price of new and used goods.  Such differential might affect the sale of new goods and homes.  However, the inherent value of a used good includes taxes paid when the good sold at retail.


BLACK MARKET BLUES.  Fair Tax proponents declare that black market illegal economic activities go mostly untaxed under our current system.  Economists state this underground economy at between $1 trillion-$3 trillion annually.1  Imposing this tax would significantly tax this activity, when crooks spend proceeds on legal consumption.  The present income tax system fails to collect a heap of tax.  The IRS estimates 20c additional tax is owed on unreported income for each dollar collected.  In 2001, this shortfall reached over $312 billion.  These figures do not include taxes lost on illegal sources of income, like drug peddling.  The transparency and simplicity of the Fair Tax would make much of this unreported income taxable.  Agencies within states could monitor and audit businesses, and the collection fees kept by states would amount to $5 billion, all available for enforcement and administration.  California would receive over $500 million, which, according to the CA. 2004-05 budget analysis, is more than the $327 million it spends to enforce the state complex sales and excise taxes.2

BOOSTERS.  The following organizations have endorsed the Fair Tax:  National Taxpayers Union, the American Farm Bureau Federation, Associated General Contractors, Heritage Foundation, National Bureau of Economic Research, and National Retail Sales Tax Alliance.


Research and documentation for this issue paper done by Nebraska Taxpayers for Freedom , with express prior permission granted for its use by Citizens for Local Control, Cherry County Taxpayers, Dawes County Taxpayers,  and other groups in the Tax Freedom Network.  3-07.  C



[1] Laurence Kotlikoff, Comparing Average and Marginal Tax Rates, 2006.

2 Laurence Kotlikoff, Would the Fair Tax Raise or Lower Average and Marginal Tax Rates?  2005.

1 John Linder, The Fair Tax, 2006.

2 John Linder Fair Tax Updates, 1-30-07.

3 John Linder, The Fair Tax, 2006.

1 Mike Moffatt, Simplifying Tax Systems, 2005.

2 California Sales Tax Enforcement Costs, 2005.