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The Fairtax Plan: The Right Plan For Tax Reform

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The FairTax Plan: The Right Plan for Tax Reform

The FairTax Plan: The Right Plan for Tax Reform

April 15th of any given year is the most dreaded day for most taxpaying Americans. This one day is more stressful than the day the taxpayer turns 50 years old or the day of his daughter’s wedding. April 15th is tax day. Every American who earns a wage has the unenviable duty of filing a form 1040 and sending it to the Internal Revenue Service (IRS). Many do so without question because that is what they have been told they must do. There are those who have chosen not to file a return and not pay taxes that are due to the IRS. They have paid for that decision with everything they own, and many have done time in prison. Some say the current way Americans pay taxes is unconstitutional and many more are calling for reform. There have been many plans introduced into Congress to fix the broken code of the IRS, but none have been able to get the backing it needs to pass. Tax reform is needed, and the FairTax plan is the plan that will be most fair to all Americans.

The FairTax

The FairTax Bill (H.R. 25) was introduced by Congressman John Linder of Georgia in the summer of 1999. This plan is a consumption based plan that will tax all consumers at the point of purchase for all new goods and services. Currently all Americans who earn a wage are taxed on those wages before they even see their paycheck. This practice often leads to the wage earner paying more taxes than they are required to giving the government the free use of their overpayment until a form 1040 is filed and a refund is disbursed by the IRS. With the total of overpayments added to the credits and deductions given freely by the IRS to those who qualify, many Americans end up not paying taxes at all. That is the unfair part of the current tax system. All people want to be treated fairly regardless of age, sex, race, creed, religion, sexual orientation, handicap and anything else the American Civil Liberties Union can think of. So why is the payment of taxes not being thought of the same way? Why are some getting huge checks while others are writing them?

The FairTax Plan

Under the FairTax plan no tax will be withheld from anyone’s paycheck (Boortz & Linder, 2005). If an employee makes $1085 per week, they will take home $1085. Under the current plan, the same employee will relinquish $116 in Federal tax, $63.62 in Social Security tax, and $14.88 in Medicare tax. Their paycheck just became $891, and that is before health insurance payments are deducted. At that amount the taxes paid by this employee is just under 18%. Now when the employee becomes a consumer he will pay another six to eight percent sales tax at the point of sale. That employee is paying approximately 25% of his earned wages in taxes. The more an employee makes the higher the withholding taxes are and the higher his tax liability is once he gets to the checkout counter. The opposite is true for those who make less, they have less held from their paychecks therefore their tax liability is going to be less. What is fair about that? Under HR 25 “. . . the consumers will pay an embedded personal consumption tax in the amount of 23 percent on all goods and services sold at the retail level.”(Boortz and Linder, 2005, p 76).

What makes the FairTax fair is the prebate. The prebate is a monthly allowance given by the government to families who apply for it. The function of the prebate is to help alleviate the 23% tax on the necessities of life. The prebate amount is based on the poverty level established by the department of Health and Human Services (HHS) and is given to all households regardless of income. For a family of five the poverty level is marked at $29,800. The prebate amount for that family is $6,854 per year (Boortz & Linder, 2005, p 86). This makes the yearly income for this family jump to $36,654, which is an increase of 23%. A family of five that earns $40,000 per year receives the same prebate taking them to an income level of $46,854, an increase of 17%. The family of five earning $100,000 per year will receive the same prebate as other families of five taking them to an earnings level of $106,854 per year for an increase of 7%.

Figure 1. An increase of income for a family of five at different salary levels. The prebate is meant to reduce the tax burden on necessities.

Note. From The FairTax Book, 2005.

As illustrated, a family at poverty level will not have to bear the burden of the 23% tax on the necessities of life and the same family at different income levels will have their burden lightened as well. Remember that the FairTax is a tax on new goods and services, meaning if a purchase is made on a secondhand item it will not be subject to the 23% tax. Making this type of purchase will not lessen the prebate dollars in any way and will leave the amount of prebate money saved in the pockets of the recipients.

Using the same example from above, a wage earner with a family of five making a salary of $1085 per week will net $56449 per year. By adding the prebate amount to the net salary, the total income for this family becomes $63303. This is an increase in income of 10.82%. The new tax liability for this family is only 12.18% under the FairTax. This is a reduction of 12.82% in tax liability when compared to the current tax system. The question here is not if tax reform is needed, but rather why would any wage earner turn down the opportunity to benefit from this type of reform.

The Opposition

Dick Armey, a former US Representative from Texas, has a plan he thinks will solve the woes of the people. He proposes the flat tax.

The flat tax will replace the current tax code with a flat-rate income tax that treats all Americans equally. All income is taxed only once and at one rate. There are no breaks for special interests and no loopholes for powerful lobbies, just a simple tax system that treats every American the same. (Armey, 2005, Ð'¶ 4)

The paperwork nightmare will be reduced to a mere one page form only as big as a standard 4x6 index card. This seems easy enough and fair to boot, but when compared to the FairTax there are some notable differences. The flat tax is still a tax on income, while the FairTax is a tax on consumption. There are far more consumers than wage earners in America. Taxing each consumer will generate more revenue for the US than taxing only the wage earner. Under the FairTax only the consumption of new goods and services is subject to being taxed

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