FairTax: Too Good To Be True?

FairTax advocates point out that every household would receive a monthly "prebate" check equal to 30% of the federal poverty level to offset the tax burden for low-income families. But as presently defined, poverty level considers both family income and family size. Without an annual tax filing by employees or employers, the government would have no sure way of knowing either one. Self-reporting would not be reliable (and it might swell the U.S. population to about a billion people overnight!).

An inadequate solution might be to base the "prebate" on average household size. The average American household contains three people so the poverty level in the lower-48 states is $18,310 a year (source: Department of Health and Human Services). Thus, the average "prebate" check might be about $458 a month. For Tony, that would come to $1.88 per person per day. He may appreciate that but it won't do him much good.

As I see it, FairTax has the potential to eliminate Social Security and Medicare as we know them. This scheme proposes to eliminate all payroll deductions, including those for Social Security and Medicare. Instead of having those amounts withheld from your paycheck and credited to you, Social Security and Medicare would be funded through FairTax collections. Since corporations would pay no taxes, employers would no longer make contributions: consumers would have to fund the whole system themselves.

I see three major problems with this approach. First, without payroll deduction and employer reporting, workers can never get credit with the Social Security Administration for the amount of money they pay in. How could they? Everybody would pay the tax at retail points of sale, even people who are not eligible to collect Social Security.

Second, without knowledge of how much a worker paid in, there will be no way to compute that worker's Social Security benefits at retirement. In effect, Social Security stops being a Trust Fund and becomes just another general revenue-funded discretionary government program. Over time, FairTax thus has the potential to gradually but dramatically reduce Social Security benefits for millions of people.

Third, people who participate in state- or union-managed retirement programs (such as many states' Teacher Retirement Systems) instead of Social Security will be forced to pay into the Social Security fund even though they are ineligible to receive SSI retirement benefits. Thus, government and union workers would have to fund their own retirement plans and everybody else's, too.

FairTax makes (indeed, it relies on) the Panglossian assumption that if corporations pay no taxes, then they will reduce prices accordingly and pass the savings on to their customers. As a result, prices will go down across the American economy.

After witnessing the behavior or large corporations over the past three years, can there be anyone left in America who naà ¯ve enough to believe that would actually happen? No, corporations will not reduce prices; they will make more money than ever before, pocket their increased profits, congratulate themselves on their ingenuity, and take even more outsized bonuses.

Just as they do today, people will go to great lengths to minimize their tax liability. And the easiest way to do that is to buy goods and services through "non-traditional" channels. If sales are never reported, then a tax on sales can never be collected and remitted.

It's likely that if FairTax is adopted, we will see black markets, offshore and overseas fulfillment centers, bartering networks, and many more novel tax-avoidance schemes emerge and thrive. These days, such trading mechanisms are referred to as an underground economy. Under FairTax, they will become a full-blown alternative economy.

As proposed, FairTax revenues would be collected by the states and remitted to Washington. Presently, states have no mechanisms for collecting federal taxes so, even as the I.R.S. is dismantled, 50 mini-I.R.S.s would have to be created in the states. This is likely to be a difficult, expensive, and time-consuming requirement imposed on states at a time when they can least afford it. (This one's for you, Tenthers.)

Without credible information on family size or family income, it will be effectively impossible to determine the amount of prebate checks. Beyond that, though, there is the scope and expense of depositing or mailing more than 112 million prebates monthly.

The difficulty of creating, implementing, and managing the systems needed to take FairTax from theory to reality make it unlikely that FairTax will be adopted by the Congress any time soon.

FairTax is deeply flawed system, conceptually and operationally. It favors corporations and the wealthy at the expense of middle- and lower-income working families. It does not fully fund the government. It is highly regressive. And it has a discriminatory effect on families.

It proposes a "revenue neutral" system when only a "revenue positive" approach will address budget deficits and the national debt. It threatens the viability of Social Security and Medicare. It encourages formation of black markets and the migration of US operations offshore.

What's more, it encourages bad behavior. It fails to consider that corporations may not do the right thing, given the chance to boost profits instead. It fails to acknowledge that people will go out of their ways to avoid tax liability. It fails to recognize that elected officials probably will not have the political will to cut programs and reduce spending.

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