Some Thoughts on Tax Reform

As predictable as the sun rising in the East, this April 15th brought a pronouncement from the President that he and his administration will be working to simplify the administration of the income tax. Heard that one before from other Presidents, and I’m still waiting.

One “reform” being championed is the so-called Fair Tax, promoted as being a way to replace the income tax and payroll taxes with no revenue loss to the government. Facially simple, it provides a national sales tax, currently pegged at a 23% rate, to be assessed against purchases of new goods (and services, I believe). Each taxpayer would pay this tax, and each household would receive a “prebate” in the form of a check from the government in an amount calculated to provide the household with a monetary equivalent to what exempting certain basic necessities from the tax would save. This amount takes into consideration the size of the household, and the federal poverty level for such household.

Immediately, the following comes to mind. What constitutes a “household”? Should two adult individuals living under the same roof be a household, or should this combination be counted as two households? Determining the answer to this question and monitoring compliance therewith will, IMHO, not reduce the costs of administration of the tax system as is promoted by the proponents of the Fair Tax.

Then, what are basic necessities? Do prescription pharmaceuticals qualify? If so, how does the proposed prebate take into account the need for the purchase of drugs by a “household” where one or more of the members thereof suffers from a chronic illness, where the Fair Tax being paid on the needed prescriptions exceeds the amount of the prebate?

What about internet sales? Will the current exemption from sales taxes be abolished? If so, how will these be monitored for compliance? Seem like additional administrative costs will be needed.

My favorite is the exemption of the sales of used goods from imposition of the tax, on the basis of the goods already being taxed. Does this not guarantee that there will be a booming market for used “stuff”, to the detriment of sales of new? Is this not contrary to the idea that replacing the current tax system with the Fair Tax will encourage the creation of more manufacturing jobs in the U.S.?

Then, what about the components that go into finished products? Current sales tax laws generally allow an exemption for those components that are not sold to the ultimate end users of the products of which the components are a part. The pure Fair Tax would impose a tax on each such component, as I understand it; and to be “fair”, that should be the result. Otherwise, if these kind of exemptions are enacted, the application and collection of the tax will become as complex as the current system, as exemptions are monitored, distinctions made, compliance assured.

Finally, for purposes of this post, we are assured that as the “rich” purchase big ticket items, the burden will be borne more by them. Hogwash; if they are truly “rich”, they will purchase what they want from other countries with lower effective tax rates. This could be avoided, to some extent, by adoption of a Fair Tax Compensating Use Tax to be sure that the 23% is paid; but again, does this not increase the costs of administration, etc., to levels similar to or higher than the current costs of administering the present system?

There is a certain basic sense of simplicity with the idea of the Fair Tax, and its appeal is based on this. Like all proposals for reform, however, it raises more questions than it answers. And, as with all proposals for reform, it creates additional employment opportunities for accountants and lawyers. To pretend otherwise ignores reality.