Monday, May 9, 2011

FAIR tax v. Flat Tax

The FAIR tax and the flat tax are not the same thing. Not even close. I think this is a greatly confused issue so today I just wanted to kind of walk through

In a great generality I will say that the FAIR tax is a tax on consumption, not on income. The flat tax is a tax on income, not consumption. Basically, one is collected when you spend it, the other when you make it. Really what is similar about the two is based on the fact is it tax reform that is fairly major and they are both 4 letter F words.

I will interject that I believe that both are better than the current system we have but I prefer the FAIR tax to the flat tax if we are comparing them.

The FAIR tax is pretty straight forward, take sales tax as you know it on the state level and say there will be a 23% sales tax on whatever new items you buy. Now 23% sounds like a lot BUT you no longer have to pay income tax and people like me are in the 28% bracket. So when one bounces through the 10, 15, 25, 28 brackets I bet 23% would be about a break even on income v. sales tax rate wise. HOWEVER, and here is the great part of the FAIR tax in my opinion, you are not taxed at all on what you save. So lets for instance say I make 85,000 and only spend 60,000. I am FAIR taxed on 60,000 and get a tax free savings on the other 25,000. It benefits savings and I really like that.

Now to try and compare this let say I make 85,000 and via deductions I can get that down to a AGI of 60,000 (actually probably decent numbers there) and it looks like a pretty much breakeven. Until you consider that the FAIR tax also wipes out Social Security tax (another 7.5% you are used to paying), capital gain taxes, gift taxes, and estate taxes (things that I don’t really pay anyway) and NOW you are seeing the gain or the benefit of the system numerically. Basically I would get like a 7.5% savings, some who are better invested would get much, much more. Additionally, and I’m not a fan of this part of the FAIR tax, the plan calls for a prebate to basically pay this tax on living requirements (think food, shelter) and everyone gets a check for this every month. This is thrown in there as an answer to “overtaxing” the poor and on some level I can see that a 23% tax on food is way excessive but I am leery of building in exceptions for fear of others. There is also some exception built in for an education expense (which I admit I’m confused on), I don’t fully understand how “services” (think personal trainer) is considered for tax purposes.

Another great benefit of the FAIR tax (or consumption tax in general) is effective taxation of the underground economy. What I mean by this is all those things that are not taxed such as illegal drugs, illegal gaming, mechanics on the slide, tax cheats everywhere would lose their great loophole (unless they are just saving it up) because the taxing happens when one buys new rims for a Continental or that estancia in Prentiss, Mississippi
In simple what I like about the FAIR tax are: Many fewer exceptions, It promotes savings, It taxes the underground economy.

In simple my problems with the FAIR tax are: it opens up loopholes that can become slippery slopes to more exceptions, I’m not a huge fan of prebates

The flat tax is really, very simple. A number is picked (it usually ranges from 12.5 to 20 percent) and everyone pays that on their income. There are no exceptions, no deductions, no haggling, it is easy. The greatest benefit of this is that the idea is “fair” in that everyone pays the same tax. Another great benefit of this is how simple and absolute it is with no exceptions. This has great appeal in that once an exception is made then someone will always try for a second or a third and then we end up with the volumes of tax code that we have now. The flat tax idea would also obviously save quite a bit of governmental money that is spent on the IRS (but it is really not a game changer in the big picture).

In simple what I like about the flat tax are: No exceptions that mean no loopholes and shenanigans, does away with that “progressive” tax system, it greatly benefits the elderly who don’t make anything and just spend (and I like helping the elderly).

In simple my problems with the flat tax are: It is on income which penalizes savers (like me as compared to others), there are also some flat tax versions that do not have this absolute mentality that float around out there that I am scared of like Dick Armey and Steve Forbes have discussed which I think can lead to a situation much like we currently have.

Thoughts??? - I'm open to talking about this

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