The voices of Tax Policy Center's researchers and staff
The idea of replacing all major federal taxes with a national sales tax – and using the opportunity to “abolish” the IRS – has been around for decades. But the newest iteration, which House Republicans insist will get a floor vote this session, suffers from the same problems as its predecessors. It is regressive, more complex than its sponsors claim, and likely would reduce federal revenues.
The FairTax Act of 2023 would eliminate federal taxes on individual and corporate income, capital gains, payroll, and estates. Instead, revenue would come from a 23 percent tax on “gross payments for the taxable property or service.”
Keep in mind, this does not mean the national sales tax rate would be 23 percent. It’s a tax-inclusive rate, meaning every dollar paid on a purchase would include 23 cents that gets sent to the US Treasury. In the more traditional sense, the FairTax rate would be closer to 30 percent, and even that could fall well short of making this plan revenue neutral.
Starting with the obvious, it would be more regressive than the current tax system. That could be partially offset with a “prebate” – a monthly cash allowance to households determined by the federal poverty level and family size.
Nevertheless, middle-class households would likely see a net tax increase, while wealthier households would receive a sizeable cut. That’s what a Tax Policy Center analysis from the 2012 Republican presidential primary found, as did a 2005 Treasury study during the Bush administration.
The Cost of Compliance
Promoters also claim the FairTax would simplify federal taxes to the point where the IRS is no longer necessary. Instead of lamenting the increase in the IRS budget from the Inflation Reduction Act of 2022, FairTax supporters vow to do away with the agency entirely. There are several problems with this promise, to put it mildly.
The FairTax still would require tax compliance and enforcement. This bill just outsources the work to the states (and District of Columbia). For their effort, they’d be allowed to retain 0.25 percent of what they collect.
If we optimistically assume that the FairTax brings in roughly the same amount of revenue (as a share of the economy) as the current tax code, annual collection fees per year for states would approach $10 billion. By comparison, the IRS spent about $13 billion per year over the last decade. The bill would also allow businesses to retain 0.25 percent of what they collect to cover their own administrative costs.
Some states already compensate vendors for sales tax administration, so it’s not a new idea. But the alleged savings from dismantling the IRS disappears in a hurry upon closer inspection.
Whether or not setting aside that precise amount of revenue is appropriate, it’s necessary. States have sales tax compliance and enforcement staff for a reason, as do other countries that impose a value-added tax.
And the bill assumes administration of a very simple retail sales tax. But real-world sales taxes and VATs include various exemptions. For instance, state sales taxes often exempt some foods and many services. More exemptions mean less revenue and more administrative costs.
State sales taxes and the national levy would not fully align since each entity would determine its own tax base. State revenue officials essentially would have to either defer to the federal base or administer two different sales tax systems.
As the Bush-era study and others have noted, at a tax rate of 30 percent or more the incentive for avoidance or evasion would be quite high. It wouldn’t take long for businesses to find gray areas that put tax enforcement officials (state or otherwise) to the test.
Perhaps nothing else speaks to the complexity involved with a national sales tax than the fact that the legislation currently clocks in at 132 pages.
Posts and comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.