1 An Analysis of the FairTax as a Solution to the U.S. Debt Crisis University of Florida Alex Bianco Monica Ho Lee Milam Sahil Patel
2 Introduction The United States debt ceiling crisis highlights the need to reduce government spending and debt. The crisis arose out of the July 2011 debate regarding the debt ceiling, or the maximum amount the Treasury can borrow. T he government typically raises the debt ceiling whenever it comes close to reaching its limit to avoid defaulting on interest payments to creditors ; the debt ceiling can only be raised if Congress votes to do so Potential consequences of defaulting include an increase in the interest rate the United States would have to incur to borrow more, along with missed, incomplete, or late payments to federal pensioners, Social Additionally en tering a sovereign default would create an international crisis in financial markets. Although the debt ceiling has already been raised 68 times since 1960, the recent debate over raising the debt ceiling has drawn a n especially significant amount of atte ntion due to the magnitude of the federal budget deficit and the growing national debt. Specifically, the debt equal s 40 percent recorded deficits that are the largest as a share of the economy since 1945 (Manchester ix). The significant increase in debt is attributable to both lower tax revenues and higher fede ral spending. In order to prevent deficits and debt from reaching unsustainable levels, revenues as a percentage of GDP will have to increase while spending decreases considerably. There are various aspects of spending in need of reform including M edicare, Medicaid, and Social Security, defense and other discretionary spending etc. For instance, entitlement reform sh ould maintain the existing level of benefits for current retirees, and then gradually reduce the system until it is sustaina ble for the under 55 population (Douthat) Although such
3 spending reform is necessary the focus of this paper will be on reforming the current tax system T he system is flawed with regard s to raising revenues and its effects on the economy. The United States tax system currently determines income tax by applying a tax rate, which depends on the amount of income, to taxable income. The taxable income depends on who is earning it corporations and individuals are taxed directly while partne rs of partnerships are taxed on their shares of the income. The current income tax system has four main problems : (1) Americans are forced to pay money to the government; (2) filing tax forms is somewhat an invasion of privacy in that it forces people to disclose how much money they have, how they acquired their money, and how they spent it; (3) keeping records of taxes is a hassle; and (4) tax exemptions and deductions discriminate against certain people depending on lifestyle and spending choices (Sipoe). Income tax is highly complex and thereby inefficient because it has an excessive amount of provisions that allow taxpayers with similar incomes to pay different amounts, thereby creating perceptions of unfairness (Prante). In addition to the expensive federal bureaucracy required to administer and enforce the tax, t he federal income tax system is so complicated that most people have to seek professional help in order to comply with all of the provisions ; it costs $10 billion to operate the Internal Revenue Service and over $265 billion to account for the cost of complying with the tax code, which implies that a significant portion of the documenting, and filing annual income (Walby). The complexity of the income tax and its overwhelming costs create the perception that the tax system is unfair and inefficient which has led people to believe that it discourages working and earning higher income, and penalizes investments and savings, thereby adversely affecting the economy
4 An alternative to the current tax system is a F air T ax system Georgia Republican John Linder initially introduced the Fair Tax legislation to the House on July 14, 1999 to the 106 th United States Congress, and has also reintroduced similar bills in each of the following sessions of congress. In order for the Fair Tax bill to become law, the bill needs to be incorporated in a the House and the Senate, and signed by the President. Although the legislation has been reintroduced several times, there are still various concerns and uncertainties A mong these concerns are the amount of revenue the fair tax would generate, and how the fair tax would be enforced and administered (Mack). Americans for Fair Taxation, an advocacy group centered around tax reform, created the a way to simplify taxes. The Fair Tax is a product of extensive market research conducted by business leaders determined to find a tax system th at would be most acceptable to the American public (Linbeck) The research revealed that Americans prefer a national retail sales tax, and that the Fair Tax would benefit the economy because it would eliminate income and payroll taxes. Further research o n the price of consumer goods revealed that up to 20 percent of prices are comprised of hidden income taxes and payroll taxes, which implies that the removal of these taxes would allow retail prices to fall (Linbeck). The Fair Tax is a consumption tax, which is designed to make saving and investing more attractive to companies and people, which would hopefully spur economic growth (Reginer). With a consumption tax, people are only taxed when they spend money on services and retail goods. Essentially, the Fair Tax Act suggests that all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self
5 employment taxes be replaced by one simple, federal retail sales tax of 23 percent at the point of pur chase for new goods and services The purposes of the Fair Tax are to raise the amount of revenue needed by the Federal Government, tax all consumption of goods and services once, simplify tax law, increase the role of State governments, and i ncrease coordination and cooperation among State tax administrators th Existing state sales tax authorities would administer this new tax. The Fair Tax proposal integrates progressive features such as dollar for dollar revenue replaceme nt and ensuring that no one will pay federal taxes up to the poverty level by issuing a rebate (Walby) The Fair Tax will allow people to keep 100 percent of their paychecks, minus any state income taxes, end corporate taxes and the compliance costs assoc iated with retail cost of goods and services, while fully funding the federal government and fulfilling Social Security and Medicare promises (Walby). The seller of the taxable goods or services will typically be responsible for the collection and remittance of the Fair Tax. The seller will usually hold this liability, but there are certain circumstances under which the tax would be remitted by the purchaser; if the goods or services are imported into the United States, the purchaser will remit the tax, and if wages or salary are th For other types of transactions such as the conversion of business, exporting property or services, and barter transactio ns, there are specific guidelines for tax collection. In recognized at the time of the conversion, and subject to the tax at that point; the amount of tax w ill depend on the fair market value of the property at the time of the conversion, and the person th Barter
6 Transactions occur when payment for services or taxable property is in a form other than money, the person who collects and remits the tax is responsible for remitting the tax to the sales tax th Benefits of the Fair Tax Additionally, w hile not a perfect plan, the FairTax would be a much easier and more efficient way to levy taxes in this country. By taxing consumption instead of income and investments, there would be a much higher incentive for individuals to save and invest their money. The U.S at this point There will be a large incentive for foreign companies to relocate to the United States. By the combination of business friendly laws and no corporate taxe s in the largest economy in the world, there will be many reasons for companies to relocate operations back to the United States instead of the current trend of outsourcing abroad to cheaper locations. On top of this, according to the Beacon Hill Institut e, the implementation of the FairTax will cause an increase in charitable donations as well. The FairTax will also more appropriately tax wealth instead of income to combat growing antagonism against the wealthiest of Americans who pay very little money e ach year in taxes through the capital gains tax Finally the FairTax has proven to be an overall more stable source of value over the long term in comparison with income. This is because consumption is less affected by downturns in the economy than employment prospects which are quick to diminish as companies face smaller revenues during a period of economic slump All of these reasons illustrate why the implementation of the FairTax will allow a more just and appropriate level of taxation for a ll Americans and will the U.S. economy to grow to even higher levels than it has with the current tax system.
7 The FairTax would incentivize United States residents and corporations to increase their investments and savings while decreasing their cons umption. The current tax system while very complicated does not have any incentives for people to save their money. They are already taxed by the time that the paycheck is put into their account, and at this point they can spend the money on goods and services or they can invest the money to have the value grow, but then be taxed again on any gains in the value of the money. Under the FairTax, this would not be the case, because the money from a paycheck would not be taxed until it was spent on non es sential goods and services. Any increase in price of these goods and services would be equally offset by the increase in money taken home with each paycheck. (FairTax) Many people are complaining today about the huge wealth disparities within the United States, and the continuous growth of this disparity (Dougherty) One of the reasons for this disparity is because the extremely wealthy families have made their money in years past when there were lower tax rates and now enjoy the relatively smaller cap ital gains tax on the increase in value instead of the income taxes that most workers pay for their active jobs. The FairTax would put a much higher tax burden on these extremely wealthy families, because through their lavish lifestyles, their consumption would cause them to pay more money to the federal government than the usual 15% capital gains rate which they are currently paying. As Warren Buffet continues to tell Congress, the extremely wealthy are paying very little money on their income, oftentimes at a lower effective rate than even their own secretaries. (Novack) This new tax on consumption would address this issue as anyone who wanted to maintain a lavish lifestyle could do this, but would have to pay much higher taxes on their consumption of t hese goods and services. This large wealth disparity is causing protests throughout the country
8 as lower income residents pay much higher taxes as a percentage of their incomes than do billionaires because the billionaires are much more likely to gain mor e of their income through capital gains taxes which are at a lower 15% rat e. This is in comparison to employees working for a paycheck who can pay a top marginal rate of 35% as well as another 7.65% in payroll taxes which may be completely avoidable by investors who only receive income through capital gains on their investments. Another great reason for the use of the FairTax is that there is a mandatory provision which would shut down the IRS after a 3 year period. (FairTax) The IRS consists of a g iant bureaucracy of over 100,000 workers with a budget of over $11 billion. It has been estimated by the implementation of the FairTax would reduce tax filers by 86%. This equates to 14 million filers in comparison to the current 100 million. (Kotlikoff) The price of compliance with the current tax codes is a much larger burden on small businesses as a percentage of income than it is for large corporations. The FairTax should remedy this situation by paying companies a fee for collecting the tax as well as removing any taxes that they need to pay at the corporate level. So not only will companies not have to pay the tax for business to business expenses, but if these companies do have to collect the tax to pay to the local governments, they will rec eive a monetary benefit for doing so. This means that a very large number of accountants working for the IRS can be reallocated to more important industries throughout the country which can use their high intelligence for more value added type positions With the estimated large increase in corporations relocating to the U.S. to make use of the removal of the corporate income tax, there will be large openings for these accountants to work as auditors to ensure proper care is taken to
9 ensure that they a re following the appropriate accounting regulations. I therefore think that any layoffs from the IRS will be offset by an increase in hiring from these companies which have relocated their business onshore. One of the most important aspects of the b ill is that it will incentivize companies to relocate their businesses to the United States. The U.S. economy is already the largest and one of the most stable economies in the world, and if the corporate tax is removed then there will be huge incentiv es in companies to relocate and make the best use of the lack of corporate income taxes on top of business friendly laws. According to the World Bank, the U.S. is already the (Ease) When this is added with the removal of corporate taxes, the U.S. w ould be the highest ranked country A number of smart accountants in the curre nt system go to tax advisory specialists whose only job is to advise companies in the best way to avoid corporate income taxes. While they are paid good salaries for this position, these individuals could be used as instrumental individuals in other corpo rate finance, consulting, and advisory roles to name a few. In much the same way that laid off IRS employees should be able to have new opportunities with the influx of businesses, these tax advisory specialists will be able to use their financial skills in many other industries including as tax auditors and financial analysts. The tax advisory profession is a zero sum game for society, because while this allows the one company to pay fewer taxes, it also means that the rest of the society no longer has t does not get the use of their tax dollars. It has also been shown that on average larger companies pay a much smaller percentage of their revenues in taxes because the smaller companies cannot
10 afford to pay for these tax advisory specialists (Kocieniewski ) The implementation of this tax will therefore allow a much greater efficiency in the overall market. In a 2007 study, the Beacon Hill Institute concluded that total charitable giving would increase (Tuerck) Some critics had argued that because there is no longer a tax incentive to give charitable donations that these donations ma y fall off precipitously. (Giuliani) However, according to this study, this would not be the case which is excellent news for all of the nonprofit organizations which rely so heavily on these funds in order to continue their operations helping others. Th is is also rather logical as people will have more money coming in through their paychecks to spend. While the goods and services they will be buying will cost more than under the current system, the majority of residents will actually have a decrease in their realized tax rates which will allow for more money to be given to these charitable organizations (FAQs) Figure 1 It has been shown by the Beacon Hill Institute that over the long term, consumption has proven to be a much more stable value than has the income throughout the United States.
11 (FAQs) ( Figure 1) With the current system, the U.S. deficit grows greater during every economic downturn as more employees are laid off and the tax receipts fall greatly Because consumption consists of a g reater percentage of consumer staples, this value has shown to be a much more stable potential source of revenue. Even in economic downturns, people still need to buy food, gas, clothing etc. While these values may temporarily decrease in response to less income, they will move back up to their former levels than the income levels from former employees who have lost their jobs. Especially in an economic downturn such as the one that we are currently involved with, it is taking laid off employees many months to find new work, which means many months before the government begins to receive taxes from that citizen once more. This will allow less worries of creating huge budget deficits which c annot be forecasted as it is unknown how the economy will do, and the current tax system relies very heavily on prosperous economic times when there are much higher tax receipts which are received from employee paychecks. Issues with the FairTax A though t he FairTax system provides many benefits, it also presents several obstacles. A s with any proposed legislation, the FairTax is not a perfect solution and does have some issues that could be used to argue against implementing the FairTax. We will attempt t o analyze the effects of the many issues One should bear in mind that the economic and financial costs of the FairTax are much lower than those of the current tax system One major issue that has arisen is the supposed cost of the requires. T he rebate is intended to prevent those who live below the poverty line
12 from having to pay the taxes on consumption. They receive their money in the form of a check or direct deposit at the beginning of the month, which then covers the consumption tax they would be expected to pay that month. An argument against this is that it would end up being the entitlement, one must remember that in theory, the money will be returning into the hands of the federal government when the citizens purchase their goods. The Federal Government will then use that money for the next series of rebate payments It forms a cycle that h as an infinite life. The prebate also helps to make the tax a progressive one. The Beacon Hill Institute estimates the total cost of the rebate to be $489 billion because such are lost revenues of the current system ( Panel Report ). These estimates are a few years old, but, nonetheless, they still give us insight into the c omplexities of the current tax system and how the costs to be incurred by the FairTax are much more transparent provide for a fairer and more equal taxation amongst American citizens. We must also mention that the prebate allows for a method of providing zero percent tax rate for those living below the poverty line in a simple way and not reliant upon any reported income. Social Incentives For decades, Congress has used the tax code as a mechanism for implementing its social policies and giving tax incent ives for certain behaviors Under the FairTax, these incentives that have been implemented over time will no longer be in effect. There is still opportunity for Congress to tax certain things at lower or higher rates (i.e. higher rate for cigarettes o r alcohol), although this goes against the underlying principles of the FairTax.
13 Although many imposed incentives would disappear, implementing the FairTax may preserve the effects of some of them. For instance, take the home mortgage interest deduction. It allows taxpayers to reduce their amount of taxable income by the amount of interest paid on a loan secured by their principle residence ( Publication 936 ). This encourages home ownership by making ownership (or securing a loan to pay for the home) mor e affordable. Under the FairTax, there will be similar incentive to own a home because purchasing most homes (those that are not new and considered used) will be tax free ( The FairTax: Fundamentals and Facts ). Therefore, the same tax shelter creates the same incentive. As stated previously, and as with any tax code, Congress could enact legislation to make all home sales tax free, or new homes taxed at a lower rate to encourage the sale of new homes. Tax P reparation and Services Industry Enacting a new tax system sounds great until you consider the multi billion dollar industry that surrounds the current tax system. Tax preparation and other tax services are professions that stand to be demolished by the FairTax As already stated, o ne can argue that this industry does not actually provide any real value to the nation. The minds and skills that are dedicated to these services are ones that could be used to create economic value elsewhere Actually, many employers in this industry provide financial planning and investment services that could see increases in demand as Americans have significantly more disposable income. The individuals, with their talents and technical skills can be used to create r eal social and psychological value in other industries. Also, with the economic growth that the FairTax is predicted to bolster, there will be many opportunities for employment for those out of a job. The three year transition period also provides time f or such individuals to seek new employment.
14 Cyclicality of Tax Revenue Stream Tax revenues are generally cyclical under the current U.S. tax system especially for the income tax. W hen the economy is growing, so are tax revenues. When it shrinks, reven ues fall. This is due to the taxable base growing or shrinking. Under the FairTax, revenues will follow directly the trends in consumption. If consumption falls, so will revenues. Therefore, in a time when the economy is booming and consumption is stro ng, tax revenues will be strong. When comparing Real Personal Income with Real Personal Consumption Expenditures (Figure 1 and Figure 2 below, respectively), it is clear that Income and Consumption Expenditures follow very similar paths, and Consumption E xpenditures actually appear to be less volatile. Therefore, any concerns over the cyclicality of the tax revenues under the FairTax should be equally applied, if not more, to the current income tax system. Figure 1
15 Figure 2 One of the aspects of any sales tax that is unavoidable is the perception by the consumer that they are paying higher prices for items than they did before the sales tax existed. With the FairTax, the elimination of the income tax and other taxes leaves c onsumers with 100% of their income to be used as disposable income. The problem here would be a psychological one in which the consumer must understand that they have more money to spend even though the final cost of items may in fact be higher, due to th e additional tax. The Beacon Hill Institute estimates that if the FairTax were implemented in 2007, there would be an initial decrease in consumption by 0.6% and 0.8% in 2007 and 2008 respectively ( The Economic Effects of the FairTax ). The years follo wing see a steady increase in consumption. These estimates were made during a time of economic growth, therefore, in the current economy, we would likely see slightly higher decreases. It also must be noted that the removal of the employer payroll taxes, corporate
16 income taxes, and associated compliance costs will drive down the price of goods because those costs are hidden in the price. As an overall easing into the FairTax and to lessen the negative effects on consumption, we propose a three year trans ition to the FairTax from the current system, where progress can be evaluated on a yearly basis. The transition process will be discussed in more depth later. Collection by States Some opponents to the FairTax have argued against having the responsibility of collecting the tax with the state governments. They claim that doing so would be less efficient ; however this argument is fundamentally flawed. As of now, 45 of the 50 states have some sort of sales tax. That means that they have the personnel and systems required for collecting such taxes. As for the 5 states and the District of Columbia that do not currently have the means for allows for these states to rely on other states to administer and collect Tax Administration and Collection Costs ). Therefore, these states are not forced to incur extra costs. It can also be assumed (for the sake of economic analysis) that over time, if the states decide to implement their own sales ta x collection, they will eventually reach the efficiency level of the states that currently to collect sales tax. One point that needs consideration is that the elimination of the federal personal and corporate income taxes will increase the costs of st ate governments in collecting their income taxes (if applicable). The intuitive weakness of this concern is the fact that the state employees who are responsible for collecting the income taxes should not, overnight, lose knowledge of what their tax base is and, therefore, they should not need any extra resources to collect the tax. The costs of collection should remain the same. It is true that states that do have an income tax
17 will most likely have to reform their tax codes to become more simplified if the nation wants to experience the true savings that the elimination of the federal income tax provides. As estimated by the Beacon Hill Institute, the total cost of collecting the tax on the part of state and local governments is only $0.84 for every $1 00.00 of tax revenue collected ( Tax Administration and Collection Costs ). Double Taxation of current savings Another argument against the implementation of the FairTax is that it will effectively double tax the current savings that have already been taxed through the current taxation mechanisms. This could be considered a generational argument. Consider those who are younger and do not have as much accumulated savings. Those individuals are not going to be as affected by the double taxation. You could argue that this is fair because they are not as responsible for the current federal debt, as it is the older generations who have generated the debt, experienced the benefits, and who should therefore be held more responsible for paying it off. It should also be noted that under the FairTax, the estate tax is abolished, therefore, those savings will not be taxed at the historically large rates of that the estate tax provides for. Also, Americans will be exiting the workforce and thus will be paying significantly less taxes. These Americans still benefit a political one, and there is no perf ect solution to it. Other Issues There are a few issues that have been brought to the table but lack enough merit to own tax revenues through sales taxes bec ause any additional tax on sales could adversely affect
18 their economies. This issue is equally applies to the income tax, which many states use to generate their revenues in equal proportion to the sales tax ( Excerpts from the FairTax Response to the Mack /Breaux Tax Panel Report and Recommendations ). For years, states have piggybacked off of the federal income tax with their own income taxes. Another issue is that once the FairTax is in the process of being implemented, consumers may decide to use debt to purchase goods before the consumption tax takes effect, and then pay down the debt using untaxed earnings once the FairTax is implemented. This could worsen the current consumer debt problem, but there is also truth that this may not be a big issue bec ause the untaxed earnings will make it easier for consumers to pay down all of their previous debts. This gives rise to what some may consider a fundamental flaw of the FairTax, while others may consider it proper capitalism at work. The government, in e ffect, is the last entity in line to be paid by citizens, as they will use their earnings to first pay off debts first and then purchase goods that will contribute to the tax revenue. Depending on how you look at it will determine if this is in fact a fla w or a favorable quality. Because consumers have the option to pay off their debts with their earned dollars first, they will be more likely to have the capability to do so and it could lead to less risk and greater certainty in debt markets. At the end of the day, consumers will need to pay off their debts somehow, and having the ability to do so in one year, will leave them with additional dollars in the next year to purchase goods. Thus, the government will effectively be earning the same revenue, jus t at a later date. Trans i tion Another one of the main issues facing the FairTax system is how we will make the switch from our current tax system. Transitioning from our current tax system to a fair tax system would include a variety of requisite steps. The transition would certainly not happen overnight and
19 would instead take place gradually over three years. After three years the IRS wo uld be decom missioned (Bill ). Such a period would allow time for individuals in the tax field to find system. A rate substantially less than the stated 23% would first be intro duced and as the size of the current income tax system decreased, the fair tax rate would increase to the 23% level. This would allow for a seamless transition from taxing income to taxing wealth. 3 Year Transition The primary purpose of the 3 year transit ion period is to allow for businesses and individuals to adjust to the new tax system. The biggest adjustment will have to be made by those who work in the tax related fields such as accountants, tax lawyers, and tax specialists. Professionals in the tax r elated fields will either have to adapt their skill sets to the new tax system or find different work altogether. The IRS for example will downsize as there will no longer be a complex tax code to enforce. As a result, some current IRS employees will have to find new work. Nevertheless, the transitional period will allow for all affected pa rties to adjust to the new fair t ax system, and enjoy the many benefits that come along with it. The chart below shows the projected positive effect of the FairTax progr am on the United States economy according to the Americans for Fair Taxation.
20 ( Tuerck ). The chart shows how much hig her the metrics would with the f air t ax plan as opposed to with the current system. According to the Americans for Fair Taxation the incr eases in consumption, GDP, and other metrics can all be attributed to the increase in disposable income that individuals would have under the f air t ax system. The growth i n disposable income would in turn increase consumption and therefore increase GDP. Th e higher take home pay would also incentivize people to work and therefore increase employment ( Tuerck ). Overall, the f air t ax plan would stimulate the entire economy and promote long term growth. Cost Savings Once the transition is complete the cost savings to the government will be substantial. The reduction of the IRS and the employment, enforcement, and compliance costs that come along with it will lead to savings. The current tax code is complicated and as a result it is expensive to enforce and understand. The IRS spends large amounts of government funds to enforce the code while accountants, tax specialists, and corporate accountant s are paid large amounts to understand the code on behalf of others. Add itionally, corporations and business es spend time and money figuring out tax loop holes that will allow them to pay as little tax as possible. Wealthy individuals and investors have much of their wealth tied up in investments and thus primarily pay a capit al gains tax which is much less than the income tax rate. The fair tax plan does away with the capital gains tax and more importantly simplifies the entire concept of tax collection as it is just a tax on consumption. Such a simplification of the tax syste m will reduce the cost and money associated with enforcing and evading the current tax system. The cost savings that are projected to come with the fair tax system are substantiated by a study done by the Beacon Hill Institute. The Institute conducted an analysis of how much the fair
21 tax system would have saved the United States in 2005 and the resu lts are shown in the table below: (Tuerck). The chart shows that the savings associated with the Fair Tax would have been much greater than the collection costs and as a result the plan would have saved at total of $346.51 billion in 2005 when compared to the actual tax system that was used. Thus, due to the comparatively simple nature of the Fair Tax system, collection costs will decrease. The revenues will also increase because taxing consumption as opposed to income leads to a much larger tax pool. In order to estimate the cost savings for 20 10 we can take the overall 2005 savings projected by The Beacon Hill Institute of $346.51 billion dollars and divide it by the 2005 US GDP of $12.4 trillion (GeoHive) According to the calculation, savings as a percentage of GDP in 2005 was 2.8%. Applying the 2.8% to the 2010 GDP of $14.6 trillion (Data) gives an estimated 2010 savings of $407.02 billion. Thus, the savings that come with the FairTax system are substantial and would fre e up money to be spent on value creating activities. The decrease in compliance costs will not only lead to savings for the government and businesses, but it will also increase the efficiency and ease with which business can be carried out here in the Un ited States. The simpler tax code and reduced bureaucracy that comes along
22 with it will allow businesses to conduct their day to day operations much easier. As a result, domestic business activity as well as foreign direct investment will increase. The inv estment from foreign countries due to the simpler tax code and ease of doing business will support U.S economic growth and allow us to remain competitive in the global marketplace. Comparables Though the cost savings look impressive, it is important to ke ep in mind that these figures are projections of what could have happened or what will happen. Due to the fact that these figures do not represent reality, but rather an accurate forecast of what might be, another helpful tool one can use is comparables. I n the case of the FairTax, the most similar taxation model is the value added tax or VAT that is present in the European Union (VAT ). The VAT is a form of consumption tax in which the good, material, or service is taxed at the various stages of its manufa cture and distribution (VAT and at the time of purchase, the manufacturer is covered for the taxes previously paid on the inputs while the remainder of the price is given to the government. The defined as the sales price charged to the con sumer less the cost of inputs (VAT ). Thus, a VAT is like a sales tax in that the end consumer gets taxed but is different because unlike a sales tax, a VAT is collected at the various sta ges of production. The concept of accounts for nearly 50% of French stat e revenue (VAT ). The main benefit to the VAT is that it allows for easy collection and prev ents tax evasion because the main responsibility for collecting the tax falls on the seller. Since the tax is levied at the various stages of production, the seller must include the tax if they want to obtain the appropriate compensation for the goods or s ervices they sell.
23 The European Union value added tax, also referred to as the EU VAT is the system used by the EU member states f or value added tax collection (VAT ). The responsibility for collecting the tax is borne by the member states themselves but a portion of the tax goes to fund the EU. Thus, a major issue with the EU value added tax is figuring out exactly where consumption and production took place so that the appropriate member state will collect the tax. The location of the value added tax coll ection is also important because each membe r state has varying VAT rates (VAT ). The EU mandated minimum rate is 15% but there are exemptions to the tax such as, postal services, medical care, and financial lending. Additionally, while the system was being re was put in place to allow the member states to adjust ( VAT ). Thus, the value added tax system in the European Union provides a good model for the United States in t erms of overall logistics and implementation. Another important part of the EU VAT system is the exemptions on essential items such as fuel and medical care. The FairTax plan calls for a straight consumption tax but like the EU VAT, also has exemptions on certain products and services. The plan also eliminates several other taxes like estate and gift taxes so the overall tax system is simplified. There are a few key facts to keep in mind however, when looking at the EU model and how it differs from the si tuation we face here in the United States with the FairTax. First, the EU does not use the value added tax as their sole form of taxation, while the FairTax will entirely replace the current tax code we have currently. As a result the EU mandated minimum v alue added tax is 15% while the FairTax calls for a flat 23% because the fair tax must account for all the member states, which are comparable to the individual states in the U.S, are allowed to
24 charge varying rates for the value added tax as long as it is above the minimum requirement of 15%. As mentioned earlier, the FairTax calls for a uniform 23% across the entire nation. Having each state charge different ra tes would cause major problems in terms of collection and compliance. The EU can get away with such a model because the VAT does not make up all of their tax revenue and the member states are actually large countries which function much more autonomously t han the states here in the U.S. Finally, the FairTax is different from a VAT in that while the VAT is collected at the various stages of production and can be hidden from the final consumer, the fair tax is a straight tax at the point of purchase. Neverthe less, the basic concept of a consumption tax still holds true with both the FairTax and the value added tax and therefore the two can be compared in terms of implementation and effectiveness. Conclusion A fter analyzing the FairTax plan in detail, it evide nt that the re are many expected benefits that can provide a positive economic impact on the United States. Combined with responsible government spending, the FairTax woul d be very effective in helping the U.S. federal government work its way out of the current debt crisis The plan would spur economic growth and save the government billions in compliance costs. The increase in revenues and decrease in costs via the reduced compliance costs and fiscal responsibility would substantially help reduce th e deficit. As outlined earlier, the plan does present some obstacles and will require a transition period but the economic benefits it will provide should outweigh the costs.
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