Monday, February 25, 2008

Understanding the Fair Tax

I am not a proponent about the fair tax. I am a proponent of the flat tax, but that would likely mean I will pay a lot more in taxes. If there were a fair tax, DH and I would be raking in the dough.

A fair tax system basically occurs where you pay on what you consume. It enables everyone to keep their paychecks, but charges a 23%tax on goods you purchase. Sounds great right? You are sitting thinking if I'm a frugal miser, I'll save a ton. Maybe.

Problem? It will be an unfair tax on the poor. But the poor will get "prebates" to allow them to purchase food and medicine. It will also scale up for family size. Sounding better and better right?

Well wrong. What's wrong? Consider this, a family of four (2 adults, 2 kids) will get a monthly prebate of $537 or $6440/year. But it doesn't account for income. So if you make the median $48k, you get the same as if DH and I make $200k with our 2 children. There is no difference in prebate for people of different incomes but same family size.

Now for those of you who think, well you'll consume more because you make more. Really? Reading this blog, I'm pretty frugal and so are others who blog income non-withstanding. So out of my $200k income, I might consume annually $25k (extrapolating what I spend now) and equivalent to the $48k family. So I will be taxed on 12.5% of my income. But the $48k family will be taxed on 50% of their income if they spend $25k/year. However if they only want to spend 12.5% then have to spend less than $6000/year or $500/month. How realistic is that?

So whose family will come out ahead? Do people who make $200k really spend proportionally more consuming? Or do they spend more $, but a smaller % of their income?

As I've previously calculated someone with 2 kids, making $48k will pay 1.6% in federal income tax (assuming standard deduction and 2 - $1000 child tax credits). Hmm...why would they want to move to a consumption (fair) tax, when they pay literally nothing in federal taxes?

Fair tax supporters, explain to me why someone who pays nothing now should support the fair tax? I don't because it's unfair to the poor and would widen the gap between the rich and poor faster.

But if it were to pass (thank you huckabee), I'd be on the side of the "rich" and getting richer faster because we're savers. DH and I love to save money, we drive our cars for 10 years, and spend less than $500/year on clothes. We also carefully shop for food, and enjoy eating out. But percentage wise it's a smaller portion of our income than others because of our income.

So a fair tax would be awesome for us. Our tax liability would go down substantially. And other people making 6 figure incomes would agree. Suddenly they are able to keep their entire paycheck? And they can still consume at the same level and pay a smaller percentage instead of the current graduated system?

Hence, for real reform we probably need a flat tax. Which will mimic the Alternative Minimum Tax currently in effect, getting rid of deductions and setting a flat tax rate equal for everyone.

But no one likes to hear that it will cost more the fair tax. They like to think they don't consume many goods. But the truth is if we all consume about the same amount. The people with large disposable incomes will be able to save more money and use a smaller percentage of their income for basic life goods.


Jim said...

I really like the concept of a fair tax system. The fair tax system enables the consumer to choose what they are taxed on, not letting the government take taxes from their income. A 23% tax on goods and services is the only fair balance between low, middle, and upper classes. The system cannot create special rules to exclude basics because that would not be fair, so the solution to this is prebate.

The prebate helps balance out the fair tax on the basics like food and such. It doesn't matter what kind of income you make, the same size family should spend about the same amount of money on basic like food. Sure for a family making $200k food is very little out of pocket, but for the family making $48k it's going to be a much larger percentage, even if the dollar amounts do not differ. I wouldn't rush to judgment in saying just because you make more, you'll spend more. What I do see is that if you make more, you get to keep more instead of paying more in taxes on the extra money you have earned.

I guess I just don't see your reasoning in that it would widen the gap between poor and rich when I see that this would effectively eliminate that gap. You claim that a family who pays nothing in taxes should not support fair tax because they'll be paying more in taxes, yet at the same time have more of their own money to spend under such a system? It breaks down that wall that we feel when we earn more money that we’ll just pay more taxes on it, so why even try. Rich people have always had the ability grow their wealth which by virtue is why they have become rich, regardless of the tax system in place.

Imagine if you got paid in cash on payday and got to hold every dollar earned. There's a suit standing at the exit wanting you to put a % of your money in it and you get to keep the rest to spend as you wish. I think most would try to make a dash for the exit. The fair tax would let you take home the money you earned and you’re allowed to spend it as you wish. Society has become so numb in that we have allowed so much of our earned income to be taken from us without ever seeing it. The IRS has turned into such a control over our lives that people and businesses now base some of their decisions on tax implications. I'm all for a fair tax system where if you earn it, it's yours to do with as you please.

Living Almost Large said...

The gap will widen simply because you said it yourself. The $200k family will spend little out of pocket but for the $48k family it will be a larger percentage. And yes if you make more, not necessarily will you spend more on a basic like food.

Now how is that fair?

Jim said...

The point of the fair tax system is only regarding taxes, not income. It doesn't matter how much money you make, the idea is that when you spend money you are taxed, but basics like food are covered with the prebate. The gap you claim has more to do with the amount of money someone has and very little to do with the amount of tax they pay. The point of fair tax is that everyone pays the same amount of tax, the system is fair that way. This system was not designed to balance the difference in the amount of income or money people make, which income is directly linked to one's potential earning ability. The thing I cannot understand is why you feel that if a family making 200k should be taxed more than a family making 48k that's barely taxed at all. It almost is like you want to pay someone else’s tax burden for them, which is no more than redistribution of wealth.

Living Almost Large said...

It's not fair is the problem. You aren't paying based on your consumption because everyone consumes about the same! You just use less income. So the fairest tax is a flat tax. Everyone gets no deductions and everyone pays say 10% of income. So you just pay the same as the next guy. No deductions, etc.


Anonymous said...

My understanding is that you pay taxes on EVERYTHING you consume, not just basic necessities. The people who make more, consume least most of the time. New cars, new furniture, new clothes, expensive electronics and toys. This is where they would be paying a greater chunk in fairtax than the family making less money. Fairtax also includes money spent on all consumed goods by people who earn money illegally, whether its drug dealers or illegal immigrants - so it gets a huge chunk of money into the tax system that we would otherwise NEVER see. Illegal immigrants would not be included in those "prebates" that are done at the beginning of the month either, thus ending their free ride.

Living Almost Large said...

Anonymous, I doubt I consume more than a family making less than half. We are pretty non-consumer. So it would be nice.

So not all people who make a lot, spend a lot. Especially if they have student loans or mortgage.

Libertarian Girl said...

These are not the only problems with the fair tax.

The tax, first of all, is really 30%, not 23%. If something costs $1, it will now cost $1.30, which to most people computes as a 30% tax.

It will create a huge black market in goods to get out of the tax (think expensive electronics, etc.)

It will mean that every business in the US must register and comply with the bureaucracy of the federal government (now they only deal with the state and the feds in regards to the IRS, not regular dealings every day.) This is an added burden on small businesses and a bureaucracy they probably don't want to deal with.

The IRS would be replaced with another huge taxing bureaucracy; if we're really unlucky, we might just end up with BOTH an income tax and a sales tax (they can take four years to get rid of the IRS under the fair tax, so just imagine the bureaucrats saying they need more money for education or something and keeping BOTH once a fair tax is instituted).

Things that the federal government decided they didn't like at that moment could be taxed 200% or some outrageous number to keep the coffers high to fight in Iraq and to discourage people who don't do whatever it is at the moment that the gov doesn't want them to do. Think cigarettes, cigars, candy, fireworks, guns.

It would create a type of welfare for every household in this nation-- receiving their government check every month. It would create a sense of entitlement on the part of everyone that they relied/depended on the government each month for their rebate check (when really the money was always theirs in the first place). This could allow taxes to be increased while everyone goes along with it-- if taxes increase, their welfare check might go up too!

There are additional problems, but these are a few off the top of my head.