The unFair Tax
By John D. Turner
31 May 2009

For years now, there has been a movement in the country to do something about the federal income tax, which is perceived by many as unfair, un-decipherable, and responsible for the growth of a gargantuan, unaccountable, unauditable, and unresponsive bloated federal bureaucracy unlovingly known as the IRS, to administer it. Two main efforts have been proposed.

One, the flat tax, would retain the current income tax, but levy a single, flat rate with few or no deductions on everyone. The idea here is simplicity and fairness. Everyone pays the same rate, and the return can be filed on a postcard. Countries that have tried it, such as Russia, which has a 13% flat tax, have experienced enormous increases in economic production and increased tax revenues.

Progressives hate this idea, since the very thought of everyone “paying the same” is anathema; to them it is axiomatic that the rich should “pay more”. They can afford to, after all, while the poor should pay less, because they need every nickel they can find.

Supporters on the other hand quite correctly point out that the rich do pay more under the flat tax. The percentage may be the same, but the dollar amount is certainly more. A person making $10,000 would pay $1,000 in tax, assuming a 10% rate, while a person making $100,000 would pay $10,000 in taxes. Since $10,000 is more than $1,000 so they are undeniably paying more. Or looking at it another way, the person making 10 times as much money pays 10 times as much tax. Seems reasonable to me.

For some reason, progressives don’t see it this way. Their complaint is that the person making $10,000 can’t afford to pay any tax, while the person making $100,000 is making much more than they “need”, and therefore can “afford” to subsidize the person making $10,000 so that they don’t have to pay any.

Quite aside from the fact that I and many others have a problem with an outside agency telling me what I do and don’t “need” or can or cannot “afford”, most of the flat tax proposals I have seen do preserve one exemption – the personal exemption. Indeed, they usually increase it substantially. Which means that, like the current system, income under a certain amount is not taxed. For example, if the personal exemption was $20,000, you would pay no tax on income of $20,000 or less, and then the flat rate would be applied to income above that amount. This results in the flat rate being higher than it otherwise would be, but also provides a safety net for those earning at or near the poverty level.

The other idea is called the “Fair Tax”. It comes in various flavors, but is essentially a national sales tax which would replace completely the current income tax, capital gains taxes, social security tax, and medicare tax. You would get to keep everything you earn. You would be taxed on consumption, a flat rate on all new items you purchase. The main one I have looked into (the Fair Tax), also includes a “prebate”, which is an inflation-adjusted check the government sends to you each month to rebate back the estimated cost (based on family size) for household necessities (food, medicine, etc). The estimated tax rate would be 23%, although I have seen this reported as 30%.

It all depends on how you are looking at it. Proponents typically use the 23% number while opponents trumpet the 30% figure. If you look at it as the fraction of the total payment for a good or service, it is 23% ($23 of every $100 spent in total, which is the way you currently look at income taxes; if I make $100, and the government takes $23, my tax rate is 23%. If you look at it the way people normally look at sales taxes (I spend $77, and pay $23 in sales tax for a total of $100 spent), the tax rate is equivalent to a 30% traditional U.S. sales tax.

Due to the prebate, the effective tax rate varies; for lower income families, the effective tax rate is less than for higher income families. In fact, if you are at the poverty level or below, your prebate check will actually be larger than the taxes you will pay. However, most people don’t understand such “esoteric” concepts as “effective tax rate”. They just hear that the cost of goods and services will go up 30% (on top of their local sales tax rate), and panic.

They also typically don’t consider that they will be taking home much more than before because they won’t have income tax, social security tax, or Medicare/Medicaid tax withheld from their paycheck every payday. Many people don’t even know what their gross pay truly is. The money is all withheld automatically and the net is direct deposited to their account. As far as they are concerned, the net is what they are paid, and they base the sales tax off that.

Both plans have their good points and their bad. The Flat Tax is simple and easy to understand. It does not do away with the IRS, but it would shrink it significantly. And it does not require anything other than a sweeping change to current tax law. On the down side, we have tried tax simplification before – and it doesn’t work.

Under President Reagan, the code was simplified to two brackets, 15% and 25%, and many exemptions were eliminated or greatly curtailed. Here we are 30 years later, and we are back up to six brackets again. There is nothing that keeps Congress from changing the flat tax back to a multi-tiered progressive system whenever they like. And now we have sacrificed all our remaining exemptions, which, like the ones we gave up before, will never come back.

The Fair Tax on the other hand, totally eliminates the IRS. Gone for good. It also totally eliminates the income tax and all payroll taxes. It piggybacks on the existing sales tax systems (with the exception of the few locations, such as Oregon, that currently have no sales tax). And it is highly visible; any changes to the tax rate will be up-front and cannot be hidden. Unlike the current tax code, there are no tax breaks that congress can bestow to favored friends, and no penalties they can unleash on those that meet with their disapproval.

On the down side, it would require a constitutional amendment repealing the 16th amendment, the one enabling the current income tax, or else you would run the risk of ending up with both an income tax, and a national sales tax.

We may end up with that situation anyway.

The government has been spending money like it is going out of style these days (I would say like a drunken sailor, except I don’t think even a drunken sailor could spend this much), and is now finally coming to the realization that eventually they are going to have to find a way to pay it all back. That means taxes. And when it comes to paying back trillions of dollars, any and every sort of tax you can think of is being sought and evaluated.

One kind of tax that is popular in Europe (at least in as far as it’s usage – not that the people in general like it) is the Value Added Tax, or VAT. In Canada, they call this a goods and services tax (GST), but it is essentially the same thing. The VAT is a kind of sales tax, and there are those in government that think that along with European style socialized medicine, a European style VAT might be just the right sort of medicine to help pay for it.

To the consumer, there may appear to be no difference between a VAT and a conventional sales tax. Both are consumption taxes, and from the point of view of the consumer, are paid when you purchase a good or service.

But there is a difference. A VAT is actually levied on the value added to a good or service at each stage of production, whenever value “is added”. So, for example, there would be a tax when copper is mined, paid by the miner. Then the ore would be sold to the smelter, where another tax is added. Then when the copper is put to use for whatever purpose (say, making a power cord), another tax is levied. There may be other steps along the way that are taxes as well; when things are transported, packaged, etc. Then net result to you, the consumer is that the final price you pay for the good or service is typically higher than it would be under a straight sales tax system.

It is also a less transparent tax. You the customer have no idea what the tax rates were at each stage; you only see the end result. This allows the government to play tax winners and losers with the VAT in the same manner as they do with the current tax code. It is also more complex to administer.

On the other hand, from the government’s point of view it is superior because it raises more money than a straight sales tax. Tweaking the tax rates generates more revenue. And just as with federal withholding for income tax, you don’t really notice. Over time you may notice that things cost a bit more, but prices go up anyway. And the invisible hand of government stays invisible. They can still blame price increases on “greedy businessmen”, with their involvement neatly hidden.

If I had to choose between the two, I would rather have the sales tax than the VAT. My personal preference; I like to see what is going on. Just as I do not know what all the myriad of tax breaks and penalties exist in the current income tax code, there is no way I would ever be able to know what the myriad of taxes on each individual component of the VAT were either. Nor would I care, since there would be little or nothing I could do about it except pay for the finished product if I needed or wanted it. I could complain, but that’s about it.

With the sales tax, there is a fixed number that I and everyone else can point to and complain about. And it’s the same for everyone, rich or poor, no matter what business or occupation. We can debate whether or not the sales tax rate should be 20% or 20.153% and everyone can agree or disagree and understand the argument. On the other hand, whether the tax on fish filleting should be 5% or 5.03% is something that won’t stir the blood of most Americans, as it is something that not everyone can relate to.

It is something that congresscritters can use as a quid-pro-quo however. “Hey Senator A”, says Senator B. “I will support your raising the VAT on those nasty oil refineries from 6.3% to 7% if you support my lowering the VAT on the folks making ethanol from 3% to 1.5%.” Or perhaps congressman C tells business D, “Thanks for those campaign contributions to my last campaign! I agree with your proposal that the VAT you are paying on turning pulp into paper is too high. How does 0.75% sound to you?”

It is an environment that is just as potentially corrupt as the current system, except that it is even more dark and murky, since not only would we need to understand all the tax rates in the system, but all the interactions in the economy to really understand the impacts. It would be even more Byzantine and labyrinthine than the current tax code.

And the politicians, for the most part, would love it.

It would be bad enough if the government were talking about replacing our current system with a VAT. But no, they instead are discussing keeping the existing system and adding a VAT – to pay for health care, of course. So, how does being in the 25% tax bracket (or higher) and paying an additional 25% or so for everything you buy strike you?

The number currently being batted around is 25%. Who knows, it could go higher. In Europe, the VAT is closer to 40% in some countries. 25% is just what economists are saying would be required to pay for current estimates. One thing I know for sure, having lived for 52 years in this country, government estimates are usually low. When all is said and done, it usually ends up costing more than they originally told us it would.

A corollary to this is that there is never a pile of money big enough that politicians can’t spend all of it and then some. There is always a new “worthwhile” project to fund. There is always someone in need. And there is always another election coming up. So while they may tell us that this will be sufficient to pay for everything, and solve our debt problem, take it to the bank; it won’t be. They will continue to charge up more debt until we take away the credit cards and cut them up.

We hear the same story time and again; “It will be painful, but it needs to be done.” “I’ve worked harder than I ever have before in my entire life, but I can’t see any other alternative.” It’s not my fault; I inherited the problem from the previous administration.”


Just one question everyone. How much are you willing to pay for “free” healthcare?