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A Better Way to Tax

Justin Wong

If you’ve ever worked for pay, like for a UROP or an internship, you are familiar with the statements that arrive in regular intervals, detailing the numerous taxes withheld from your pay. The government knows that we can’t miss what we never had, and so the withholding mechanism helps us forget the magnitude of our tax burden (and its direction — towards Washington).

Those who get a refund might think the current system is an awesome deal, but the refund conceals how much is still kept by the government. For example, the government always keeps the Social Security and Medicare taxes. Don’t get me wrong, we must fulfill our duty to fund the federal government, but surely there must be a less insidious and more transparent way to do so. Is there a way to do it that also lets us keep 100 percent of our paychecks?

Yes. We can get rid of all current federal taxes: personal and corporate income taxes, the capital gains tax, the death tax, the alternative minimum tax, the Social Security tax, the Medicare tax, etc. We then replace them with a single national retail sales tax. The price of goods will actually drop dramatically once the cost of taxes added in each stage of production disappears.

Consider a loaf of bread. The wheat farm has to pay the payroll tax for its workers and income tax on its profits when it sells the wheat to a mill. The factory that bakes the bread must pay payroll and income tax. The distributor that ships the bread, the grocery stores that sell you the bread, and the farm equipment manufacturer, electricity provider, etc.

All these taxes are passed on to you and embedded in the final retail price, and you pay this price with income that has already been taxed. Removing all those taxes would lower the price of goods by 20 to 30 percent, according to the Americans for Fair Taxation (AFT). Even if you slap a national sales tax on it, at worst you’d be paying the same as before, but the net benefit is keeping all of your paycheck.

The new plan is revenue neutral; it will fund the federal government at current revenue levels, including Social Security and Medicare. To do so, the sales tax rate would be about 23 percent, according to the AFT. If you earn between $29,000 and $70,000 a year, your total tax rate in the present system is about 31 percent (25 percent income tax and 6 percent Social Security tax). Even if you spend all your income and maintain a zero bank account balance, you wouldn’t be worse off. If you’re even slightly frugal, the sales tax would save you on taxes and would also be more transparent.

What about the lowest wage earners? The AFT plan for implementing the sales tax would actually translate to a huge tax cut for them. Right now, they still have to pay the Social Security and Medicare tax. Under the new plan, they wouldn’t have to pay any of those taxes, and their sales tax gets refunded through a prebate. The government would send every American, regardless of income, a monthly prebate equal to the sales tax on an average person’s typical consumption of life’s necessities.

Some worry that the rich-poor gap would increase under the new plan, because the rich spend a smaller percentage of their income on goods. It is the current income tax, however, that actually causes the rich-poor gap. It penalizes people when they earn more, lowering the incentive for upward mobility. To bring people up, it makes so much more sense to reward earning and to discourage unnecessary spending. The new plan does both.

In fact, by levying the same tax rate on everyone, the new plan unites the interests of the rich and poor. A decrease in the tax rate benefits everyone. The new plan gets rid of the income tax code, whose complexity and size has made it easy for politicians to hide the favored tax treatment given to wealthy special interests. The transparency of the new system will make it difficult for politicians to dole out favors to the greedy at the expense of the needy.

If the new plan is such a tax boon for everyone, how is it really revenue-neutral? It isn’t the sales tax rate that matters so much as the dollar amount it multiplies. Rich people buy more expensive things. The new plan would tax spending in an economy whose growth rate would quadruple without the shackles of an income tax, according to AFT experts. The sales tax also broadens the tax base, reaching parts of the economy the current income tax can’t reach. Drug dealers don’t pay income tax on their profits right now, but the sales tax makes them pay their share when they buy their bling. Tourists who don’t currently pay income tax in the U.S. would also be taxed under the new plan when they buy souvenirs, stay in our hotels, etc.

No income tax, no tax return, and thus no more IRS. The national sales tax would be administered through the states, which are already tooled to collect a sales tax. Re-programming cash registers is easy; it’s done all the time. The federal government would reimburse the states for administrative costs.

This bold proposal is already a bill in both houses of Congress. It’s called the FairTax, and Rep. John Linder, who is the primary sponsor of the bill in the House (H.R. 25), wrote the FairTax book with Neal Boortz. This column doesn’t do justice to the book, which makes a far more comprehensive case, even explaining how eliminating the income tax attracts jobs and investments back to America, and makes American products competitive overseas. You can also find out more at Say goodbye to the IRS.