Fair Tax Versus VAT?

There has been a lot of ongoing discussion concerning Fair Tax versus the VAT versus the current IRS tax system. It is appropriate to take a closer look and compare them in order to better evaluate which kind of tax plan is better for Americans and their families.

The current national income tax was put into force by the 16th amendment and is overseen by the Internal Revenue Service.   It is the all too familiar tax due by April 15th every year – the bulk of which is taken out of every paycheck.  This tax is applied to individuals, corporations, the self-employed, capital gains, estate, gift, AMT and many more.  Income tax rates for individuals are 10% to 35%, while for corporations the rate is 15% to 39%.

Businesses in particular need to be aware of the changes for accounting periods that started on 1 January 2023 regarding a possible VAT penalty and late submissions.

The IRS has a budget of $11 billion dollars, over 100,000 employees and a tax code of over 70,000 pages.  An estimated six billion man-hours have been spent filling out 249 million forms in 2010.  Undocumented workers and people paid under the table by cash pay no taxes at all.  Half of the U.S. population pays 100% of the tax, which is viewed as unfair by many.

Under the current tax system, U.S. exports are taxed twice, which favors consumption of imports from places such as China, over domestic products.  It also imposes the highest corporate tax rate in the world.  This encourages companies to locate overseas before marketing their products back to the U.S.

The VAT is a “value added tax,” which has been proposed by President Obama.  The VAT would be in addition to the current taxes and would be imposed and collected at each stage in the production, distribution and sales of goods and services.  It would be controlled by the IRS.

In much of Europe, the VAT is 20% to 25%, making some economies financially unstable.  There have been some exclusions and rebates proposed, but much is unknown at this time.  Generally, VAT discourages consumption, as people end up buying less.  The poor would pay more as a percentage of income than the rich, with VAT on top of the current taxes already levied.

The Fair Tax is currently in the House Ways & Means committee review process with 55 House co-sponsors.  Under the Fair Tax proposal, within seven years of passage, the 16th amendment would be repealed and the IRS would be abolished.  The Fair Tax plan consists of a single rate national sales tax on the consumption of new goods and services only, making this tax a choice for each individual to manage.

The estimated base for the Fair Tax is the 2009 GDP consumption portion, which would equal 23.82%.  It would replace all federal income and payroll taxes, including FICA and Medicare, capital gains, self-employment, estate, gift, AMT and more.  Exclusions would be available for business to business purchases, used goods, exports and wholesale goods.

To offset any unfairness in income levels, each person would receive a “pre-bate” every month calculated to the annual poverty level.  Currently the pre-bate would be about $700 each month.  State agencies would handle the collection, and the pre-bates would be administered by the Federal Administration Agency — the “new” IRS.  The Fair Tax would also capture the non-filers and illegal immigrants, since it is assessed at purchase and not from paycheck.

Individuals would not have to file tax returns; employees would receive 100% of their paycheck.  After the first year, the pre-bates would be funded by the tax collected and the federal debt could theoretically be paid off within 10 years.

A portion of the tax will be dedicated to funding Social Security and Medicare.  The Fair Tax would ensure equality in taxation since it is based on consumption, and it would enhance upward mobility since it encourages productivity, savings and investments.

U.S. exports will not be taxed and imports would be taxed on an equal basis with U.S. produced goods.  The Fair Tax would make the U.S. the only advanced country in the world with a zero rate of taxation on income, creating the world’s largest tax haven for direct investment.

By Carla Bream
[email protected]

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  1. The author of the commentary is obviously a supporter of the Fair Tax (a.k.a. a national sales tax or consumption tax). The rosy picture that Stephen paints for the “Fair Tax” is overely simplistic and does not address three major falicies of the “Fair Tax.”

    First, if the tax code were to suddenly be transformed from a tax code base on income and one’s ability to pay to entirely consumption, the reveue generate from such a tax system would only amount to around $1 to $1.5 trillion to run the entire Federal Government. That might sound like a good thing, cutting the perverbial allowance of the Federal Government, but when you consider that just the Defense portion of the Federal Budget is now around $650 billion, there are a lot of things that don’t get the attention they deserve (i.e. transportation-which is the most critical thing needed for commerce and a consumer society).

    Second, how would we address critical national needs like transportation, Defense, Law Enforcement, and even education, if the entire Federal Tax code were based off of consumer spending and people stopped spending money like they have for the last 30 years? What then? Does that mean if people arn’t spending that we don’t need it? If course not, but that is the message that “Fair Tax” advocates profess. Also, what they don’t mention is that the actual bill for the “Fair Tax” is over 5,000 pages long. For such a simple fix, why is it so complicated?

    Lastly, in order to eliminate the Income Tax and the IRS means that another amendment to the Constitution is required, just like the repeal of Prohibition. That means 2/3rds of Congress would have to agree, the President would have to sign the bill and then 2/3rds of the 50 states would have to ratify it. So, in short, not an easy thing to do and there is no political will to do it.

    “Fair Tax” advocates can rail all they want until they are blue in the face, there will never be a repeal of the 16th Amendment and certainly no “Fair Tax.”

  2. Dan hits this spot on the money. If the fair tax is so “good” and the VAT so “bad”, why haven’t the 160+ countries around the world using a VAT type system all moved to a “fair” tax???

    A fair tax is only fair because it hits everyone. A VAT like the GST / HST in Canada has in built reliefs for basic necessities and government services such that the supply of these goods and services is not subject to the GST / HST (VAT). A VAT would favour exports and make US goods more competitive in world markets, while at the same time ensuring goods and services imported from Canada (and China) are subject to the same level of domestic tax as locally produced goods + services. Now thats what I call fair, but with an advantage!

  3. Not only is the information about VAT very limited, it is incorrect. Obama has not proposed a VAT. Many of those that have ties to the administration have done so, or have stated that it needs to be on the table.

    In regards to Europe, there is much that is known about their rebates and exclusions. Additionally the VAT is not the “cause” of their financial instability. There are many factors that have created their financial instability such as the same problems of easy credit and overleveraging that led to our current economic plight, as well as very large entitlement programs.

    One might want to look at our neighbors in Canada. They have been able to lower their VAT rate and maintain budget surpluses. They to have a federal system that necessitated the harmonization of their VAT rate with provincial taxes; much like we would need to do with our state taxes.

    Interesting idea for an article. The VAT portion of it would have been much better if it was factual and included more substance.

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