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Open Tax Day Thread on LP Blog Sparks Debate

April 15th, 2007

Since today is April 15, the infamous “Tax Day” here in the USA, Stephen Gordon over at the LP Blog has decided to declare an open thread for this weekend so that we could discuss various tax-related issues. Perhaps not surprisingly, much of the debate thus far has centered around the so-called Fair Tax, a proposal to replace the current income tax scheme with a uniform national sales tax.

The Fair Tax proposal has been a very controversial issue for the Libertarian Party as well as the libertarian movement generally. Many Libertarians support the Fair Tax because it would finally get rid of the troublesome IRS and all of the ancillary corruption and abuses that have come with it. This would allow people to actually keep all of the money that they earn while also making the overall system of taxation much simpler because it would eliminate all of the loopholes, exemptions, and other complicated provisions of the current tax code in one fell swoop.

Other Libertarians oppose the current Fair Tax proposal because the tax rate itself would be fairly high, and the language that Fair Tax proponents are using to promote the idea is actually quite deceptive. The Fair Tax proponents claim that the national sales tax rate on purchases of new items would be “only” 23%, but after unraveling the fuzzy math involved, we discover that the true sales tax rate would be 30%. The reason behind the claim of 23% is that their calculations are done by taking the amount of actual tax paid and dividing it by the total amount of the final purchase rather than dividing it by the original price of the item. For example, if an item was purchased for $100, you would wind up paying $130 at the register because the actual tax rate would be 30%. But the Fair Tax proponents are able to claim that the rate is only 23% because they are taking that $30 of tax and dividing it by the total amount of the purchase, in this case $130. That is what gives us the figure of 23% (actually 23.08% according to my calculator).

Opponents of the proposal also point out that the “prebate” that would be given to all Americans in order to avoid taxing basic necessities under the plan could be used as a form of “free” welfare for low-income people similar to the way in which the Earned Income Credit (EIC) program functions currently. In other words, it would effectively put all of America on the dole by granting payments to people who are not actually working to produce their own income (or working very little), and this could set a bad precedent by encouraging too much of a “free lunch” mentality.

The current proposal also does not really address the issue of excessive government spending and assumes full funding of all entitlement programs such as Social Security, Medicare, and the like. While this might make the proposal more politically popular, it could become a significant problem in the future because the growth of these programs, along with the growth of the overall national debt may necessitate increases in the national sales tax rate.

Finally, while the Fair tax proposal currently contains a provision to repeal the 16th amendment and eliminate the federal income tax, this could prove to be difficult to achieve in actual practice. Amending the U.S. Constitution in this manner would require not only passage by Congress, but also ratification by three-fourths of the states. Nevertheless, it is certainly still possible; the repeal of the 18th amendment (alcohol prohibition) by the 21st amendment provides a solid historical precedent.

In order for any version of this proposal to gain my full support, this last provision is absolutely essential. While I can live with the idea of a national sales tax as an alternative to the income tax (I realize that we cannot realistically have “anarchy next Wednesday”, as Timothy West would say), we need to be certain that the income tax is eliminated before any new national sales tax is imposed. Otherwise, we could wind up with a nightmare scenario of having a national sales tax AND an income tax. And no Libertarian worth his/her salt is going to want that!

UPDATE 8/27/08: I have removed a broken link to the LP blog. Meanwhile, you can find out more about the FairTax by reading the article that I wrote on the day after this one called Fair Tax Pros and Cons.


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