Recently, I’ve been seeing a lot of news about the so-called Fair Tax, which is being championed in one form or another by people like Mike Huckabee and Ron Paul. All of this talk about overhauling the federal income tax system has gotten me to thinking about what effect such a system would likely have on our consumer-oriented economy.
I will start by admitting that I haven’t read about the Fair Tax in depth. I should also note that I’m not necessarily against the idea of changing our tax system — it’s pretty archaic as it is, and could stand a good bit of improvement. I should also note that I’m not an economist. But, at least on the surface, there are some things that worry me about the Fair Tax.
The Fair Tax
For starters, here’s a (very) brief synopsis of the Fair Tax, as I understand it:
Under the Fair Tax, the current tax code would be scrapped and replaced with a federal sales tax. Things like income tax, Social Security tax, and Medicare tax would no longer exist. Same goes for the Alternative Minimum Tax (AMT), capital gains tax, and estate tax. Instead, everyone would pay a flat sales tax of 30% on nearly everything that they buy, including food, clothes, and health care.
It should be noted here that Fair Tax proponents like to think of the percentages in a slightly different way. Rather than viewing it as the additional percentage charged, they prefer to think about things as a percentage of your spending. Since a $1.00 purchase would cost you $1.30 (ignoring state sales taxes), this is sometimes referred to as a 23% tax since $0.30 is 23% of $1.30.
Anyway, because sales/consumption taxes are inherently regressive (i.e., they hit those that live paycheck-to-paycheck harder because 100% of their income is subjected to the tax), every household in the United States would receive a check to cover their taxes up to the poverty level. The argument here is that, for most people on the lower end of the economic scale, this would result in a more progressive tax system, with people closer to the poverty line spending less on taxes than people with higher incomes (and thus more spending).
The (Possible) Problem
Setting aside the issue of whether or not the Fair Tax is actually fair (this has been the subject of a lot of debate), let’s talk about the downstream impact on our economy. For better or worse, we live in an extremely consumer-oriented culture, and our economy is driven by one thing above all others: spending.
Think about that for a minute… Right now, our economy is stalling out and, in recent years, economic slowdowns have been dealt with in two major ways: (1) slashing interest rates, and (2) offering stimulus checks. Both of these moves are intended (at least in part) to stimulate spending, thereby helping to get the economy back on track.
Taking that at face value (i.e., that increased consumer spending is what keeps the economy humming), I find it hard to imagine that we’d be able to transition to something like the Fair Tax without doing serious damage to our economy, at least in the short term. Why? Because American consumers are highly price-sensitive, and our current income tax system is relatively invisible when it comes to making day-to-day purchases. But if you start adding to the cost of an item at the checkout counter, people will think twice before buying a random geegaw or doodad.
Given that consumer spending is so central to our economy, anything that has the potential to put the damper on our spending seemingly has the potential to drag the economy down. This isn’t to say that less spending (and thus more saving) would be bad for individual Americans — quite the opposite. But I’d imagine that, at least at first, there could be a good deal of economic pain if we were to overhaul the tax system in this way.
What do you think?