The FairTax Act, GOP plan for 30 percent national sales tax, explained

Kevin McCarthy had a hell of a time getting elected as House speaker, and a list of all the concessions he made to the most conservative members of his party wouldn’t fit here. But one of the more important was a concession to hold a vote about a radical tax reform proposal known as the FairTax.

The FairTax, at its heart, is simple enough: it would take almost every federal tax and replace them with a fat 30 percent sales tax on everything. Virtually every American would get a monthly check from the government to cover the cost of paying the tax on essentials. It’s a radical idea, but one which since its first introduction to Congress in 1999 has been a favorite of conservative Republicans. Rep. Buddy Carter (R-GA) already has 23 cosponsors for the current iteration. Prominent party figures like Ted Cruz, Mike Huckabee, John McCain, Rick Perry, and Herman Cain have all championed the idea over the years.

Not surprisingly, liberal groups who judge the proposal regressive are against it. But so are many enthusiastic conservative tax-cutters, like the Wall Street Journal editorial board and Grover Norquist. Here’s what the National Review’s Ramesh Ponnuru had to say about it:

“Any House Republican who backs this bill can accurately be accused of voting for … raising the price of everything by a huge amount at a time when inflation is already high; shifting more of the tax burden to the middle class; instituting a large new wealth tax on senior citizens; increasing federal spending by a massive amount; increasing the deficit; and creating large black markets.”

Otherwise, it’s a great idea.

There’s something oddly comforting to me about the return of FairTax discourse. I’ve been following the idea since 2004 or so, when I was 14, because I was not an athletic child. It somehow just keeps coming back again and again, despite its obvious and many weaknesses.

I’m here to help. Here’s everything you ever wanted to know about the FairTax but were afraid to ask.

So, how big is this FairTax?

It’s 30 percent! And it would apply to just about everything, from groceries to health care to rent and home purchases to interest on your credit card.

Sales taxes are regressive, right? Won’t this hurt poor people?

Flat sales taxes like the FairTax are probably regressive on their own. Most economists’ view is that rich people spend less of their income, and save more, so as a share of income a sales tax takes less from them than it does as a share of poor people’s income. (Some recent research disputes this in the US context, mostly because sales taxes often exempt spending that makes up a bigger share of low-income people’s budgets, such as rent and groceries.)

But sales taxes can still be good policy if used to fund progressive programs, as the Nordic countries do. The FairTax, for its part, tries to offset some of the negative impact on poor people by including what it calls a tax “prebate.” Each household would get a monthly check worth 23 percent of the poverty threshold for a household their size.

In 2023, that’s $279.45 a month for a single adult, with an extra $98.52 per month for each additional person in the house. For a family of four, this adds up to $6,900 in no-strings-attached cash payments every year.

Those checks are just for poor people, right?

No, they’re for everyone! Or at least every citizen and most legal residents. Everyone with a Social Security number would be eligible. It would instantly become one of the largest programs in the entire federal government. If you multiply the number of households in the US by the rebate size for the average household of 2.6 people, you get a total annual cost of about $650 billion. That’s around the size of the defense budget, and about what Medicare cost before the Covid-19 crisis. The $1,400 checks that the Biden administration sent out in March 2021 only cost $402 billion.

So the government would just be mailing checks to people with no strings attached. Isn’t that a basic income?

I think so, yes. The FairTax would create the first permanent, unconditional cash program for which all Americans are eligible. That’s an enormous step toward basic income, even if it’s not enough money to live on.

That’s pretty neat. So this prebate, it makes the FairTax progressive?

Lol, no, it does not. The FairTax gets rid of the personal and corporate income taxes, and the estate tax, which are the three most progressive taxes in the federal code. For most poor people, the personal income tax already gives them money through provisions like the Earned Income Tax Credit or the Child Tax Credit. Getting rid of it means all those benefits go away.

At the top end, the rich go from paying a top rate of 40.8 percent on their wages, as well as 23.8 percent on their income from investments, to just paying the 30 percent tax on everything they buy. But wealthy people save more of their income than non-wealthy people do, and everything they save would be tax-free. By one measure, rich people in the 2010s saved 8.5 percent of their income, while the bottom 90 percent had a negative savings rate, spending 2.8 percent more than they earned.

I know of no credible estimates of the distributional impact of the FairTax, if it were to replace income and payroll taxes, but when the Bush administration appointed a panel to study tax reform proposals, it concluded that using the tax to replace the income tax alone would sharply raise taxes on the middle class.

How did this idea come about, then?

The origins of the FairTax lie in that strange period of time called the mid-90s. Republicans had retaken the House of Representatives for the first time in 40 years, in part by campaigning hard against President Bill Clinton’s 1993 budget plan, which included massive tax hikes on top earners. The richest taxpayers had seen the tax they pay on the next dollar they earn (their “marginal” rate) grow by about 12 cents, which made conservatives in Congress very, very mad.

Their response in 1995 and 1996 was a flurry of dramatic tax reform proposals from Republicans in Congress and in the 1996 presidential race (or both). Almost all of these ideas attempted to move the US away from taxing income, and toward taxing consumption. House Majority Leader Dick Armey and presidential contender Steve Forbes championed a 17 percent “flat tax” designed by Stanford researchers Robert Hall and Alvin Rabushka.

The flat tax sounds vaguely familiar…

Yeah, the flat tax. The flat tax looks superficially like an income tax, but is really a sales tax in disguise.

Exciting disguise!

Do not taunt me. The way the Hall-Rabushka flat tax would work is that businesses would pay a form of sales tax called a “subtraction-style value-added tax,” which is most notably used in Japan and the state of New Hampshire. The way subtraction VATs normally work is that businesses add up their sales, and subtract all their payments to other businesses, and pay a tax on the difference; the sum of the taxes paid by each business in this way is equivalent to if it had been levied as a sales tax when a consumer ultimately bought the product.

Hall and Rabushka’s version let businesses also deduct wages they paid. Then individuals would pay a flat tax on their wages, with a standard deduction to make it slightly more progressive. Income from capital gains or dividends would be totally exempt. The net effect is that you’re taxing the same consumption that a sales tax does.

They totally exempted all capital income? That seems a bit extreme.

Mike Mergen/Bloomberg via Getty Images

Yeah, but it was very much in vogue. Even the otherwise moderate Sen. Arlen Specter (R-PA), who would switch parties in 2009 and vote for Obamacare in 2010, wanted a 20 percent flat tax.

But straight-up sales taxes, which effectively exempt capital income as well, were popular in this period too. Figures like then-House Ways and Means Committee chair Bill Archer (R-TX) and senator/presidential candidate Richard Lugar (R-IN) proposed replacing all personal and corporate income taxes with a single retail sales tax. And into this mix, a group of Texas businessmen launched Americans for Fair Taxation, which offered an even more ambitious plan to replace not just income taxes, but Social Security and Medicare payroll taxes, with one big 30 percent sales tax.

So that’s the FairTax! Did actual politicians embrace it too?

Yes, many!

FairTax wound up having much more staying power than its peers from 1995-96 like the flat tax, or alternative sales tax plans. AFT sought to build an actual movement around the idea, and got a congressional champion in Rep. John Linder (R-GA), later joined by Sen. Saxby Chambliss (R-GA). Linder’s 2005 book on the idea with talk radio host Neal Boortz was a bestseller.

By 2008, former Arkansas Gov. Mike Huckabee was running for the Republican presidential nomination on the idea, while rivals like former Sen. Fred Thompson (R-TN) and Sen. John McCain (R-AZ) offered at least tepid support. Former Gov. Gary Johnson (L-NM) touted it in his 2012 and 2016 presidential runs as a Libertarian. The idea even got a Democratic backer in 2008: longshot former Sen. Mike Gravel (D-AK), who quite possibly made history as the first person to support both the FairTax and single-payer health care.

Man, the tax must raise a lot of money if it can pay for single-payer.

Mike Gravel

This may shock you, but Mike Gravel did not really know what he was talking about.

Unfortunately, we don’t have any super-recent estimates of what the FairTax would bring in revenue-wise. One of the reasons I hope the House winds up voting on the idea is that would mean the Joint Committee on Taxation will have to “score” the bill, producing estimates of how much money it would bring in, how it would affect the deficit, and which taxpayers would pay less or more. That’d be exciting!

Your life depresses me.

Yeah, I know. For the time being, the most recent estimates we have of what the FairTax specifically would do come from Brookings Institution economist William Gale, who ran the numbers in 2005.

Assuming a reasonable amount of tax evasion (20 percent) — and the question of evasion is important, as you’ll see — he found that the FairTax would increase the deficit by about $10.6 trillion over 10 years. In order to avoid increasing the deficit 10 years later, the FairTax would have to be set at 64.4 percent.

Are you kidding me?

I am not! And in fact, that’s probably too low. Gale is assuming there that, as the FairTax proponents suggest, the tax would apply to purchases by the government, which would effectively force state and local governments to cough up hundreds of billions of extra dollars to the federal government every year. If government purchases were exempted, as is normal for sales taxes, the revenue-neutral rate would be 81.6 percent.

The point is that at a 30 percent rate, it’s reasonable to expect the FairTax to increase the federal budget deficit by trillions of dollars a year.

I assume the FairTax people have … a response to this.

They do. For one thing, they don’t like it when you refer to their tax rate as “30 percent.” While it increases the cost of, say, a $10 item by 30 percent, or $3, they argue that because $3 is 23 percent of the $13 post-tax cost, it’s actually a 23 percent tax.

Wait … seriously?

Yes, it’s stupid. More substantively, Laurence Kotlikoff, a Boston University economist and avowed FairTax partisan, and a team of co-authors wrote a working paper responding to Gale and the Bush tax reform panel, and insisting that a rate of 31.27 percent (23.82 percent “tax-inclusive”) would make the proposal revenue-neutral. That is, the FairTax proposal would barely increase the deficit as written.

But the paper implicitly assumes no, or very little, tax evasion under the plan, which seems absurd to me. It’s a sales tax of 30 percent or more; people will have very strong incentives to evade it. To take just one example: the FairTax wouldn’t apply to transfers of used goods; state sales taxes tend not to hit small yard sale-style sales of used goods, but they do apply to things like used cars, which would be totally exempt under the FairTax. The tax would hit newly constructed houses, but not existing ones. Obviously this is going to result in evasion schemes taking advantage of the wild discrepancy in how new and used goods are treated.

Business-to-business transactions are also totally exempt, unlike under a European-style value-added tax. (This is going to be fun when my wife and I found Scammin’ Inc., a small business headquartered in our apartment that, as a business, can purchase all our groceries tax-free.)

Perhaps the biggest problem is that FairTax proponents insist they want to tax more sales than just about any sales tax currently existing in the real world. Gale estimates that about 91 percent of household spending would be hit by the FairTax. Meanwhile, a recent Tax Policy Center study found that state sales taxes in the US only cover 39 percent of spending; most states tax much less than half of spending, with California taxing 36 percent and Texas 38 percent. Value-added taxes in other rich countries, which generally work better than retail sales taxes because they also tackle business-to-business transactions, only hit 56 percent of consumption.

It’s of course possible that Congress would pass the FairTax without including a multitude of exemptions for things like food and medicine and cars and other things that people don’t like to see taxed. However, this is Congress we’re talking about, so this will not happen.

It seems like a federal sales tax is a bad idea that will never happen?

Matt Cardy/Getty Images

When it comes to FairTax, yes. I expect the Congressional Budget Office and the Joint Committee on Taxation to report that it will increase the deficit by trillions of dollars every year, and increase taxes on the middle class, and I expect these findings to kill it in Congress. Much less ambitious tax reforms with many fewer problems have died for much worse reasons (for example). The FairTax is never happening.

But I wouldn’t be so quick to reject sales taxes more broadly. There’s a reason every rich country except the US has a value-added tax: it’s a very efficient, easy-to-administer way to raise lots of money for progressive social programs like universal health care, child allowances, long-term care, and more.

Gale, the FairTax critic, is actually a vocal advocate for adopting a VAT in the US. I like his idea of pairing a 10 percent VAT with a small universal basic income to make sure low-income people come out ahead. He estimates the bottom 20 percent of earners would see their incomes rise by nearly 17 percent as a result, while households with income above $90,000 or so would pay more. If you use some of the revenue to pay for the now-expired expanded child tax credit, the net effect would likely be a substantial reduction in poverty.

You could also, as Columbia professor Michael Graetz and Sen. Ben Cardin (D-MD) have proposed, use the VAT to exempt all but the wealthiest individuals from the income tax, by creating standard deductions of $50,000 or $100,000 for couples. This isn’t as progressive as using it for a UBI, but it would vastly simplify income tax collection and enable the large majority of Americans to not worry about filing taxes ever.

Economist Larry Summers once noted that a VAT has not been adopted in the US because “liberals think it’s regressive and conservatives think it’s a money machine” that’s a little too good at raising revenue. But if conservatives realized it’s regressive and liberals realized it’s a money machine, he quipped, maybe it could happen. The popularity of the FairTax suggests conservatives understand very well that sales taxes are regressive. But their plan is extremely half-baked. Maybe if they let liberals use it as a bit of a money machine, we might get somewhere.