Federal Sales Tax
The purpose of the proposed Fair Tax Act of 2003 is "to promote freedom, fairness and economic opportunity by repealing the income tax and other taxes, abolishing the Internal Revenue Service, and enacting a national sales tax to be administered primarily by the states." (Boortz, 2003). Unfortunately, there are a lot of beliefs about the proposed legislation that simply aren't true. Fears range from inflation, lower economic growth, unpredictable revenue shortfalls and unfairness to the poor. This paper explains that these concerns are not only false, but that the exact opposite is true in most instances.
One of the common misperceptions of the Fair Tax Act is that it will fuel inflation and dramatically impact the demand for goods with high price elasticities. However, it's likely that the sales tax will have minimal impact on prices. This is because there are already embedded taxes on all products and services that are purchased at the retail level that are estimated to be around twenty-two percent of their costs (Boortz, 2003). This twenty-two percent represents the payroll taxes and corporate business and income taxes paid by manufacturers, shippers, wholesalers, merchandisers and retailers. So, with regard to prices, all The Fair Tax Act really accomplishes is a replacement of embedded taxes with an equivalent direct sales tax, producing no significant change in the prices of goods and services for the consumer.
Any change in prices would indirectly come from the lower interest rates that The Fair Tax Act is expected to produce. Economic researchers predict that interest rates would drop in the direction of the current tax-free interest rate as the tax differential between the pre-tax and the after-tax rates of return was removed (Burton and Mastromarco, 1997). It is difficult to estimate exactly how much interest rates would fall because demand for credit would rise as well,...
The standard prediction is that interest rates will experience a 200 basis point decline. This would mean that federal borrowing costs would be lowered by as much as $75 billion annually and would make it cheaper to individuals and businesses to borrow money. Thus, business investment would likely increase.
Some fear that a consumption type tax would lower the overall demand for goods and services, thus harming businesses and our country's growth. Although savings and investment may increase while domestic consumption falls, many other factors must be factored into the productivity equation. In 1995, businesses and individuals in the United States spend more than $150 billion to comply with the federal income tax system (Burton and Mastromarco, 1997). Compliance costs averaged an estimated twenty to fifty percent of the total revenue raised by the tax system and 1.9 to 4.1% of the Gross Domestic Product. Small businesses disproportionately bear the burden, enduring compliance costs 3.8 times the tax actually collected from them. By replacing income taxes with a national sales tax compliance costs for businesses and workers would fall by more than ninety percent. This means that The Fair Tax Act would remove the cost of corporate taxes and compliance costs from the cost of American exports, putting them on a level playing field with foreign competitors (Thumbnail sketch of the FairTax a comprehensive plan to replace income and payroll taxes). Lower prices would increase demand for exports from the United States, thereby increasing job creation in United States manufacturing sectors.
Most likely, a national sales tax would also increase international capital flows to the United States (Burton and Mastromarco, 1997). Tremoval of all taxation of non-consumed income would increase the attractiveness of the…
