The Fair Price of Civilization?

"Taxes are the price we pay for civilization" ... Justice Oliver Wendell Holmes.
The U.S. Tax Code is a perennial whipping boy, and rightly so. It's unfair and monstrously complex.

Some would like to replace the entire Tax Code and the IRS with a totally new system. One such idea is the so-called FairTax, which is essentially a national retail sales tax. Although Bruce Bartlett in "FairTax, Flawed Tax" and others have roundly criticized this idea, here are my main reservations about the FairTax:

The FairTax treats savers badly. Under the current system, savings have already been taxed. But with the enactment of the FairTax, pre-existing savings will be taxed a second time -- when they're spent. How fair is that?

And remember, your pre-existing savings will be taxed that second time NOT by just another dinky sales tax, but by the replacement tax for the largest sources of revenue to the federal government, including the income tax and the payroll tax. So, to replace all that revenue, the tax rate of the FairTax would need to be fairly high. As Hugh Hewitt and Hank Adler put it in their new book, The FairTax Fantasy:

Seniors who had planned on a low tax lifestyle via the rigors of planning and investing -- and after paying taxes on their income for entire lives and saving for retirement -- would suddenly be facing a huge new federal tax, taking the place of the income tax they had long labored under. Talk about bait-and-switch. This would be the most dramatic instance of double taxation in our history. Imagine all of one's savings for retirement being effectively reduced in value by almost 30 percent, in a single day, as the result of a new "FairTax" on all purchases (Chapter 4, page 32).

One of the selling points of the FairTax is that it is a discretionary tax; you don't pay the tax unless you buy something. So under the FairTax, the feds will be waiting around for folks to buy something so they can get their tax revenue. What would happen to federal revenue if America again became a nation of savers?

As the recession rages the government urges citizens to be just like government: Get out there and spend, folks. And take out more loans, too. But folks know in their bones this is imprudent. Here we get into the paradox of thrift: What's good for the individual isn't necessarily good for the economy, and therefore for tax receipts. There is already a movement afoot to rotate back to being a nation of savers. George Will recently wrote about this development: "If Americans' new sobriety -- more saving, less spending -- survives the first tantalizing green shoots of recovery, can the recovery continue?" How does this all work out for the FairTax?

Reagan believed that if you tax something, you get less of it. Since consumption drives 70% of the U.S. economy, the FairTax taxes our economy's main engine. The FairTax might well dampen down consumption, resulting in less tax revenue, necessitating rate hikes, creating a nasty "negative feedback loop". How we tax and what we tax affects folks' behavior.

Lastly, the FairTax fails at simplification. True, you won't have to wrestle with the dread 1040 anymore. But the FairTax has replacement complexities, such as the "prebate" and making the nation's retailers into tax collectors. Also, there's the little matter of repealing Amendment XVI, lest the feds hit us with both the FairTax AND the income tax.

Another tax reform idea is the Flat Tax. The Flat Tax retains the current system of the income tax but eliminates exemptions and installs a single tax rate. Whereas the FairTax fails at simplification, the Flat Tax can be criticized for fairness, as it shifts the burden to the middle class. However, those in the bottom would continue to pay no income taxes.

I've always felt that everyone should be paying something for the blessing of living in America. But the fact is: 44 million households pay no income tax at all. That's why I've supported capitation, the head tax (Article I, Section 9 (4)). Capitation is the ultimate in fairness; everybody pays the same. If every American paid a mere $10 in capitation, it would amount to $3 Billion a year. But with Congress spending so many Trillions of the grandkid's dollars, capitation can wait until Congress balances the budget, if ever.

Despite all its problems, our current tax system does have certain virtues that go unsung.

For starters, the current system is "in place"; all the compliance and collection mechanisms of the IRS are up and running, and have been since ratification of the Amendment XVI in 1913. So we wouldn't incur the cost of changing to a new system.

Also, we know the current system works, as it brings in a mountain of revenue to the federal treasury. For fiscal 2007, the current system brought in $2.56 Trillion. And fiscal 2008, a year almost entirely in recession, is estimated to see $2.52 Trillion. But as for the revenue that new systems would bring in, that's entirely speculative.

Another virtue of the current system: It collects taxes "up front", when the taxpayer receives his income, not when he spends it. That is, every payday your employer sends your withholding to the IRS, or you make quarterly payments. With the feds running an estimated $1.84 Trillion deficit this year, "up front" collection of taxes is quite a virtue.

With such considerable virtues going for it, it would be a shame if there weren't some way to improve the current system to make it a "fair tax".

Jon N. Hall is a programmer/analyst from Kansas City.
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