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I DON'T THINK HE LIKES THE 'FAIR' TAX

June 02, 2005

The "Fair Tax," a proposal for a national retail sales tax, has gotten some attention in the tax reform debate. Joseph Thorndike, a columnist for Tax Analysts, isn't quite sold on it:

First, though, we have to sort through an embarrassment of riches: How can we identify the worst quality of a tax that has so many? As numerous critics have pointed out, the Fair Tax would raise too little revenue and prompt too much evasion. Its popularity depends on unreasonable assumptions and misleading descriptions. It would never work as advertised -- a fact that many of its supporters either choose to ignore or secretly celebrate.

But other than that, maybe he likes it.

WHAT IS THE REAL RATE?

Mr. Thorndike points out that the 23% rate touted by Fair Tax supporters is misleading, because it is a "tax inclusive" rate. The 6% tax rate we Polk Countians are accustomed to is "tax exclusive" - it isn't included in the sales tax rate.

Example:

Wally buys a new computer for $1,000, and he pays $60 in sales tax. His "tax exclusive" rate is 6%. His "tax inclusive rate" is 5.66% (60/1060 = 5.66%).

If you compute the "Fair Tax" the way we are used to talking about sales tax rates - tax exclusive - it will apply at a 30% rate. That's a real difference.

Perhaps we are biased, being income tax consultants, but the Fair Tax seems to have some huge practical problems. Two come immediately to mind.

WHEN RATES GET TOO HIGH, PEOPLE CHEAT

Sales taxes are only likely to work if rates are low enough to not interfere with commerce. When combined with state and local taxes, the Fair Tax would burden every trip to Git 'n Go with a 36% or higher surcharge. This is high enough to push many transactions into the E-bay economy.

HIGH SALES TAX RATES THREATEN BUSINESSES THAT COLLECT SALES TAXES

Taxpayers going through their first sales tax audit are astounded at how big the assessments can be. They also know that they aren't as simple as many folks believe. While income taxes are only a problem to the extent your business is profitable, sales taxes apply even when you are losing money, and they apply based on gross receipts - a much larger base than taxable income.

Because sales taxes are computed on a big base, a small error in determining what transactions are subject to tax can lead to a stiff assessment over three years, even at a "low" 6% rate. At a 36% rate, even little errors would be ruinous.

FAIR TAX PROSPECTS?

Mr. Thorndike doesn't think the Fair Tax will survive the tax reform process:

And the winner of this year's prize for Worst Idea in a Serious Public Policy Debate: the Fair Tax. In all likelihood, this plan for a national retail sales tax has already exhausted its 15 minutes of fame. Sometime later this summer, President Bush's commission on federal tax reform will probably put it out of its misery.

Link: Thorndike Article (Tax Analysts subscribers only)

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