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What Is The Fair Tax? How It Would Work And Its Pros And Cons

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The Fair Tax system is a tax system that eliminates income taxes (including payroll taxes) and replaces them with a sales or consumption tax. The 23% sales tax would apply to all retail and service transactions. 

Under the Fair Tax system, individuals would no longer be required to file taxes. Individuals simply pay tax each time they purchase something from a store or a service provider. 

Although the IRS would no longer be required to collect money from individuals, an enforcement agency would be required to ensure businesses appropriately collect taxes from consumers. Keep reading to learn about how the Fair Tax would work.

What Is The Fair Tax?

The Fair Tax System most commonly refers to abolishing income taxes and replacing them with sales taxes. The system is deemed fair because people are taxed based on their spending rather than the money they earn.

Americans for Fair Taxation is a policy group dedicated to promoting the Fair Tax plan within the United States. According to its research, a 23% sales tax could effectively replace all income and payroll taxes.

It is important to know that the 23% sales tax is a “tax-inclusive” rate. If you buy something for $1,000 you’ll pay a 30% or $300 tax on it. Your total price will be $1300. Since $300/$1300 is 23%, it is “fair” to call this a 23% rate. However, the effective sales tax rate would be 30% of the purchase price.

One of the first objectives of this sales tax relates to people living near or in poverty. Those individuals can barely afford food and rent as it is. A fair tax system would put them into indigence. The Americans for Fair Taxation propose a monthly “prefund” which proactively gives each individual some money. Every person would receive a monthly check from a government agency. This money could be used to offset taxes up to the poverty level.

While the Fair Tax system is not part of the US tax code, proponents of the law drafted bill H.R.25. The 2017 bill calls for a massive overhaul of the United States tax code. It would replace all income and payroll taxes with a single consumption tax.

Do We Have Any Fair Tax Systems In The United States?

The federal tax system in the United States is primarily a progressive income tax system. By and large, the more money you earn, the higher rate you’ll pay. The exact rate you pay depends on your tax bracket, how many deductions and credits you qualify for, and other factors.

While the federal tax system is not a “Fair Tax” system, consumption taxes (also called sales taxes) are typically applied in line with the fair tax ideals. In general, all people pay the same sales tax rate. Certain products, such as alcohol or tobacco may be taxed at a higher rate while other products like food may be taxed at a lower rate. 

But all people who buy those products pay the same rate. Typically, state agencies are responsible for collecting sales tax from various business organizations.

Related: Effective Tax Rates: How Much You REALLY Pay In Taxes

Pros And Cons Of The Fair Tax System

While the Fair Tax System has some great marketing (it’s fair!), the system has both advantages and disadvantages. Here are a few key things to consider.

Pros Of A Fair Tax System

  • Eliminates IRS filings. Individuals would not need to file tax returns each year.
  • Incentivizes saving and investing. The tax is only applied to spending. More productive options like saving and investing can be done tax-free.
  • Less tax evasion at an individual level. Individuals have fewer options to evade taxation. You pay taxes when you buy an item. That’s all there is to it.
  • Potentially boosts economic performance. With more money going into savings and investments, more people and businesses may have the funds to build new businesses that can produce new goods and services.

Cons Of A Fair Tax System

  • Raises incentives for private businesses to cheat. Businesses who want to undercut the competition may decide to cut out sales tax collection. This issue could be especially rampant when businesses deal with cash or checks rather than electronic payments.
  • Tax rates may fluctuate over time. Changes to consumption may drive up the tax rate over the long-term.
  • Middle-income families may see higher taxes. While “prebates” may keep taxes low for people with low incomes, those with middle incomes may see higher tax rates overall. This is especially true for families paying for childcare and other large expenses out of pocket.
  • Potential dampening effect on overall economic growth. With prices higher, many individuals may choose to “insource” their consumption rather than spending on haircuts, meals out, childcare, or fixing cars. This could lead to a slowdown in GDP.

Final Thoughts

The fair tax system would replace complex payroll and income taxes with one simple sales tax on all consumption. It would reduce the headache of tax prep, and incentivize saving and investing. 

However, it’s unlikely to become law anytime soon. That means, for the foreseeable future, filing taxes is going to be significantly more complicated than paying 30% more for your morning latte.

Thankfully, you can minimize tax hassles and headaches by choosing the right software program for your situation. Our guide digs into all the details so you can find the most cost-effective and easy-to-use software for you.



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