The ‘Fair Tax’ Act Would Radically Restructure the Nation’s Tax System in Favor of the Wealthy
The ‘Fair Tax’ Act Would Radically Restructure the Nation’s Tax System in Favor of the Wealthy
The Fair Tax Act would replace federal income and payroll taxes with a national sales tax, slashing federal revenues and cutting taxes on the wealthy.
As part of his wheeling and dealing to secure the speakership, House Speaker Kevin McCarthy (R-CA) reportedly agreed to allow the so-called Fair Tax Act of 2023 (H.R. 25) to come to a vote on the floor of the House.* If passed, the Fair Tax Act would radically restructure the nation’s tax system, replacing individual and corporate income taxes, the estate tax, and the payroll taxes dedicated to Social Security and Medicare with a national sales tax.
[The Fair Tax Act] would allow the nation’s wealthiest families to accumulate even greater intergenerational wealth, thereby widening the nation’s already sizable wealth gap.
This column provides a brief overview of the Fair Tax Act and its impact on American families. As proposed, the measure raises numerous policy and administrative questions that are beyond the scope of this initial analysis—such as its implications for the long-term solvency of the Medicare and Social Security programs. However, even a cursory examination shows that the proposal is deeply flawed and would dramatically shift the costs of government away from the wealthy and onto seniors and low- to middle-income families.
The Fair Tax Act would impose a 30 percent national sales tax
Beginning in 2025, H.R. 25 would impose $30 in tax on each $100 purchase.** Proponents call this a “23 percent tax” because the $30 tax payment is 23 percent of the tax-inclusive price of $130. Yet described in more conventional terms—such as those used for existing state sales taxes—the $30 paid in tax is, in reality, a 30 percent tax on the cost of the goods or services purchased.
The new tax would apply broadly to nearly everything Americans buy, including goods and services often exempt from state sales taxes, such as housing, health care, and groceries.*** The Fair Tax Act includes a “family consumption allowance” that would provide families with a “prebate,” calculated as a percentage of the federal poverty level, designed to offset the taxes due on a baseline level of necessities. Yet it would also eliminate the earned income and child tax credits that currently lift millions of families out of poverty.
By shifting the foundation of the federal tax system from income to consumption, the Fair Tax Act would cut taxes for the wealthy while increasing taxes paid by low- and middle-income retirees who live off of Social Security and savings, as well as families who would be forced to pay more taxes on everyday goods and services. Meanwhile, high-income families who spend less of their income on consumption and who have sufficient earnings to save a substantial fraction of their income would pay a smaller share of their income in tax.
As proposed, the Fair Tax Act would dramatically reduce federal revenues, requiring deep cuts in public services
The “Fair Tax” was first introduced in the late 1990s. While comprehensive analyses of H.R. 25 are not yet available, prior analyses of similar plans have estimated that replacing the revenue raised by the taxes eliminated by the plan would require a much higher tax rate—potentially 50 to 60 percent—to raise the same amount of revenue. A higher, revenue-neutral rate would impose an even greater burden on low- and middle-families who spend all or nearly all their income on goods and services that would be subject to the radical new tax.
The Fair Tax Act would increase taxes for working families while slashing taxes on the wealthy
The following examples illustrate how the Fair Tax Act would affect American families at different income levels and stages of their lives. Each example assumes that the Fair Tax Act’s 23 percent tax-inclusive rate is in effect in 2023, replacing the federal income and payroll taxes those families would otherwise owe for that year. To estimate the impact, this analysis first calculates the federal income and payroll taxes owed by each family and then, using federal Bureau of Labor Statistics consumer expenditure survey data, estimates the amount the family would pay under the new law. (see Methodology) The analysis then estimates the amount each family would owe at a tax-exclusive rate that is closer to that needed to replace the revenues that would be lost by the taxes repealed by the bill—49 percent—in order to provide a more realistic comparison to current law.
A retired couple living in Michigan with an income of $60,000 from Social Security, pensions, and savings who currently owes no federal income or payroll taxes would pay $7,088 under the Fair Tax Act’s 30 percent tax-exclusive rate and $13,041 under a 49 percent tax-exclusive rate that approximates the rate needed for revenue neutrality.
- Federal income/payroll taxes owed currently: $0
- Taxes owed under Fair Tax Act’s 30 percent rate: $7,088
- Taxes owed under 49 percent revenue-neutral rate: $13,041
A single parent in Arizona with one child and earnings from wages of $37,896 who currently owes $1,324 in federal income and payroll taxes would pay more than five times as much ($7,300) under the Fair Tax Act’s 30 percent rate and nearly 10 times as much ($12,930) under a 49 percent rate that approximates the rate needed for revenue neutrality.
- Federal income/payroll taxes owed currently: $1,324
- Taxes owed under Fair Tax Act’s 30 percent rate: $7,300
- Taxes owed under 49 percent revenue-neutral rate: $12,930
A Wisconsin family with two children and earnings of $73,376 who owes $6,083 in federal income and payroll taxes under current law would pay $7,566 under the Fair Tax Act’s 30 percent rate and $14,322—more than twice what they currently pay—under a 49 percent rate that approximates the rate needed for revenue neutrality.
- Federal income/payroll taxes owed currently: $6,083
- Taxes owed under Fair Tax Act’s 30 percent rate: $7,566
- Taxes owed under 49 percent revenue-neutral rate: $14,322
A single woman in Pennsylvania with earnings of $49,660 who currently owes $7,891 in federal income and payroll taxes would pay somewhat less ($6,875) under the Fair Tax Act’s 30 percent rate but would owe $11,985 under a 49 percent rate that approximates the rate needed for revenue neutrality. The woman in this example would have modest savings under the Fair Tax Act’s lower initial rate; however, as noted above, this rate would also require massive reductions in public services that would likely affect all aspects of daily life.
- Federal income/payroll taxes owed currently: $7,891
- Taxes owed under Fair Tax Act’s 30 percent rate: $6,875
- Taxes owed under 49 percent revenue-neutral rate: $11,985
A North Carolina family with two children and an income of $1 million, including $900,000 from wages and $100,000 in investment income, who currently pays $318,157 in federal income and payroll taxes would receive a huge tax cut, paying just $41,408 under the Fair Tax Act’s 30 percent rate. Even using the 49 percent rate that approximates the rate needed for revenue neutrality, the millionaire family would pay just $69,838. This estimate reflects the fact that high-income families typically save a large share of their earnings, while middle- and low-income families spend what they earn to make ends meet.
- Federal income/payroll taxes owed currently: $318,157
- Taxes owed under Fair Tax Act’s 30 percent rate: $41,408
- Taxes owed under 49 percent revenue-neutral rate: $69,838
Lastly, the tax shift from the wealthy to working families would be exacerbated by the Fair Tax Act’s repeal of the federal estate tax. This would allow the nation’s wealthiest families—less than 0.1 percent of the 2.8 million people expected to die in 2020 paid the estate tax—to accumulate even greater intergenerational wealth, thereby widening the nation’s already sizable wealth gap.
The Fair Tax Act would shift the cost of tax administration to the states
The Fair Tax Act would eliminate the IRS and turn most tax administration responsibilities over to the states. While the bill implicitly assumes that states could use existing state sales tax structures to administer the new tax, the proposed “Fair Tax” is radically different from existing state sales tax laws. Only 13 of the 45 states with sales taxes, for example, tax groceries, which would be taxed under the Fair Tax Act. And only two states—Hawaii and New Mexico—impose broad-based taxes on health care services, which would also be subject to the new tax.
Differences such as these would make it difficult and costly for states to implement the proposed tax and would likely impose costs that far exceed the 0.25 percent administrative fee provided as part of the proposal. States would also experience an increase in income tax administration costs. Thirty-two states and the District of Columbia, for example, use federal adjusted gross income as the starting point for their state income tax, and many states piggyback on the IRS’ enforcement efforts through information-sharing agreements.
The Build Back Better Act’s Investments in the IRS Will Substantially Reduce the Tax Gap
The Fair Tax Act is a radical proposal that, if enacted, would likely undermine the federal government’s ability to support basic public services, from Medicare and Social Security to health care and the nation’s defense. Making matters worse, it would do so by raising taxes on seniors and working families and by slashing the amount paid by the wealthy.
This analysis compares the amount of taxes that would be owed by a representative set of families in tax year 2023 versus what they would owe under the tax-inclusive rate of 23 percent specified in the Fair Tax Act of 2023, equaling a 29.87 percent tax-exclusive rate, as well as a 49 percent tax-exclusive rate that an advisory panel—formed under former President George W. Bush to evaluate a similar proposal—suggested would be needed to raise the same amount of revenue raised by the taxes that would be repealed. That panel assumed that 30 percent of the taxes owed would not be paid and assumed a broad tax base, similar to the current proposal. To calculate the amount of tax owed, each example in this analysis subtracts out consumption expenditures that would not be taxed under the Fair Tax Act, along with the family consumption allowance or “prebate,” which is dependent on family size and marital status.
The incomes for the three moderate-income families reflect the median income or per-capita incomes for their given area of residence or age, indexed for inflation using Congressional Budget Office projections for 2023, if needed.
It should be noted that this analysis assumes that the elderly and high-income families own their homes while the rest of families are renters, using 2023 rent data. Federal taxes owed under current law were calculated using the TAXSIM 35 tax model and include the employee’s share of payroll taxes plus federal income taxes owed. Additionally, tax credits were adjusted to 2023 levels. Expenditure calculations are based on U.S. Bureau of Labor Statistics consumer expenditure survey (CES) tables, which provide consumption expenditure data by income, household size, and age. Data for years 2020 to 2021 are adjusted to only include those goods and services that would be taxed under H.R. 25 and are indexed using 2023 inflation projections from the Congressional Budget Office.
This analysis assumes that education; mortgage interest and charges; property taxes; used cars and trucks; vehicle finance charges; cash contributions; and contributions to retirement, pensions, and Social Security would not be subject to tax. In places where a CES category includes a substantial share of nontaxable goods and services and taxable items, this analysis excludes the entire category when estimating the amount of taxes owed.
*Authors’ note: McCarthy later backtracked, saying he only promised that the Fair Tax Act would get a hearing in committee.
**Authors’ note: After the initial year, the 30 percent rate would rise to 43.3 percent, consisting of a general revenue rate of 14.91 percent; the old-age, survivors, and disability insurance rate; and the hospital insurance rate.
***Authors’ note: H.R. 25 would not tax primary, secondary, or postsecondary school tuition; interest payments on mortgages or vehicles below the Treasury rate; retirement savings; or used goods.
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