A Chequer-Board of Nights and Days

In my initial post here I said that I explain why the "Fair Tax" is a bad idea.  It seems like I shouldn't have to.  The very phrase "23% sales tax" is so absurd that it should end the argument right there.  But it's even worse than it looks.

THE RATE IS TOO HIGH - AND HIGHER THAN IT LOOKS

For every tax, there is a practical limit to how high the rate can be before it becomes too hard to enforce.  The scarcity of sales taxes over 10% worldwide suggests that 10% is about the limit.

So a 23% rate is probably far beyond the rate where enforcement problems become overwhelming.  But even the 23% rate is misleading because it is "tax inclusive."  You wouldn't pay $23 dollars in "Fair Tax" on a $100 purchase; you'd pay $30. The 23% rate applies on the total purchase price including tax.  So the real rate is 30%.

Also, the repeal of the federal income tax would end state income taxes too.  Every state income tax system relies on the federal tax infrastructure; the states would be unable to continue taxing incomes if they could no longer free-ride off the federal system.  That would mean dramatic increases in state sales tax rates.  Most states would need to have their own sales taxes at rates of 10% or more.

Once every purchase is burdened with a 40% transaction fee, you have an enormous incentive to move into the cash economy.  Taxes would no longer be an annual annoyance for most Americans, but a daily challenge.  Vast amounts of time and effort would go into figuring out ways to avoid paying sales tax, pushing billions of dollars into the grey economy with huge costs in economic efficiency.

STATE ADMINISTRATION OF FEDERAL TAXES?  WE'VE BEEN THERE.

Another strange aspect of the Fair Tax is that it would rely on the states for collection and remittance.  That was tried once, under the Articles of Confederation, and it worked out badly.  The Constitution itself was largely a reaction to that system.  It wouldn't be long before some showboat governor would drag his feet on remittances to protest some government policy, or maybe just to use the money for awhile.  

As for those who argue that state administration of  the Fair Tax would make tax enforcement kinder and gentler - they clearly have never gone through a state sales tax audit.  When the tax is based on gross revenues, rather than net income, you'd be surprised at how expensive a little misunderstanding can be.  In my 20 years of tax practice, my worst experiences have been with state revenue officials.

But you can make up your own mind.  For further arguments against the Fair Tax, this Tax Analysts piece is a good place to start. Dick Armey has an older piece on a national sales tax here.  For pro-Fair Tax articles you can start with the Fair Tax Blog.

OK, I need to run, I hear Pejman coming.  It was very nice of him to invite me to help house-sit, and I hope some of you will stop by and see me at The Tax Update Blog occasionally.