This presentation is intended to review and raise issues with respect to Federal legislative proposal H.R. 25 (109^th): Fair Tax Act of 2007, the “Fair Tax”. Because the title of the proposed legislation prejudices the discussion, this presentation refers to this proposed legislation as H.R. 25.

Summary of H.R 25:

*       Elimination of all Federal individual and corporate income taxes, payroll taxes, and the Federal estate and gift taxes

*       Implementation of a tax exclusive flat rate national sales tax of 30% on all goods and services sold at retail (ensuring that goods and services are only taxed a single time).[1] Exports would be exempted from the national sales tax. Property purchased for investment would be exempted from the sales tax. Retail purchases of goods and services by government would be subject to the 30% sales tax.

*       The flat rate national sales tax would be administered by agencies organized in the individual states, sales tax administrating authorities. If a state or states choose not to administer the flat rate national sales tax, the Federal Department of the Treasury would become the sales tax administrating authority in such states. In all events, Treasury would have general rule making responsibilities.

*       All lawful residents would receive a monthly “prebate” intended to be equal to the sales tax on cumulative expected monthly purchases at the poverty level. Unlawful residents would not receive the prebate. The prebate would be paid by the Social Security Administration acting upon information provided by sales tax administrating authorities.

*       H.R. 25 significantly revises the definition of self employment income for social security benefit calculation purposes.

H.R. 25 – Conclusions

• With all of its complexity, the current Internal Revenue Code is a more evenhanded approach to collecting necessary Federal revenues than H.R. 25. This is not to say that the author believes the current Internal Revenue Code is the right long term answer for the United States; it is to say that H.R. 25 is not the right long term answer.

Impacts on Taxpayers

• H.R. 25 eliminates any differential in the rate of taxation between the first dollar purchase over the poverty line by low income Americans and the last dollar purchase by the richest Americans.
• In any state where there is a decision to eliminate their state income tax, the combined Federal, State, and local flat sales tax rate could easily exceed 43%.
• H.R. 25 would result in an immediate reduction in purchasing power upon implementation for existing savings which have previously been subject to U.S. income taxes (double taxation).
• H.R. 25 would result in a very significant competitive purchase price advantage given to an investor purchasing a new residence over a couple wishing to purchase the same property as a home.
• H.R. 25 would result in an on-going and significant reduction in purchasing power for many social security recipients with other sources of income or savings.
• H.R. 25 would result in the elimination of the safety net provided by the Internal Revenue Code in reducing Federal taxes for victims of disease and disaster, the elimination of incentives to save through pension plans or investment retirement, and the elimination of credits and deductions for child care.
• H.R. 25 would result in an increase in purchasing and investing power for very high wage earners and the ability of the wealthy to earn profits from investments and reinvest without taxation while low income Americans are paying an H.R. 25 designated 30% Federal sales tax on food. The ability of the wealthy to pass along exceptional levels of never taxed wealth, tax-free, generation to generation, seems a prescription for a feudal system.
• Under H.R. 25, while there could be a reduction of compliance requirements for wage earners and retirees, compliance activity for the self-employed and service providers would increase. If a state did not eliminate their state income tax, there would be no compliance reductions for wage earners or retirees.

Impacts on Social Security Benefits – Self Employed

• H.R. 25’s proposed change in the definition of self employment income for the ultimate receipt of social security benefits is bizarre, unfair and unworkable. Under the language of H.R. 25, many self employed individuals currently earning social security benefits would no longer be earning any social security benefits.

Administrative Decisions & Impacts

• H.R. 25 anticipates that virtually every state will willingly agree to become a sales tax administrating authority.  Given the proposed fee for this administrative task and the political risk that would accompany this decision, it is possible that not a single state would decide to become a sales tax administrating authority.
• The administration required to implement and thereafter continuously administer H.R. 25 might be beyond the capability of Federal and state government. It may also be far more expensive than administration of the current Internal Revenue Code. (The proposed collection fees alone under H.R. 25 approximate the total annual budget for the Internal Revenue Service.)

The very notion of initially and annually registering 300,000,000 lawful citizens, providing a monthly check to each and believing this can be accomplished confidentially, efficiently and without fraud has at least a touch of unreality to it.

H.R. 25 could not be implemented until (1) a sales tax administrating authority was established and successfully organized and staffed in every state, (2) every lawful resident given a legitimate social security card, (3) every lawful resident registered confidentially and without fraud, and (4) this information transferred to the Social Security Administration and reviewed for duplicate social security numbers and general fraud issues.

Economic Certainty & Likely Economic Impacts

• The economic risks, particularly in the immediate aftermath of implementation, are far too significant to the overall economy to chance.
• There are conflicting studies projecting the necessary tax rate required to achieve neutral tax revenues under H.R. 25.
• There have been no micro-economic studies with respect to the impact of H.R. 25. The lack of study with respect to the prices of high volume, low margin products (food) is especially worrisome.
• Taxing state and local governments on their purchases and providing no interest rate advantage to state borrowings must result in significant tax increases at the state level.
• Basic tax planning that would occur in the final year of the Internal Revenue Code and the first year of H.R. 25 would reduce Federal revenues by a very significant amount.

Legal Uncertainty

• H.R. 25 is fraught with legal uncertainty. There are constitutional arguments that H.R. 25 would be unconstitutional with respect to constitutional limits of Federal taxing power.
• There would be state and local challenges with respect to the exclusion of unlawful residents from the receipt of the prebate.
• The World Court could probably weigh in with respect to trading issues.

Other

• With every major conceptual change, there will be thousands of different interpretations of the rules. It would take years to sort these interpretations out. During that period, Treasury would issue volumes of rules and regulations.
• The opportunity for Social Security fraud would increase with respect to actual employment.
• Should U.S. products begin to appear in the world market place at prices significantly lower after the removal of Federal income taxes, tariff responses could be expected.
• With exports untaxed, U.S. goods could be 30% more expensive for Americans than the remainder of the world.

H.R. 25 – Intended Results & Apparent Philosophy of H.R. 25

H.R. 25 would replace the Federal income tax, payroll taxes and the estate and gift taxes with a flat rate national sales tax. After reimbursing (in advance) lawful citizens for the estimated sales taxes levied upon the dollar value of estimated necessary retail expenditures at the estimated national poverty level, all lawful citizens would pay a flat rate national sales tax on all purchases of retail goods and services. Unlawful citizens would not receive a prebate.

H.R. 25 represents a philosophy of tax collection without any attendant social or economic policies.

H.R. 25 – Purchasing Power vs. the Tax Rate

There has been a significant amount of discussion regarding the proposed sales tax rate in H.R. 25.

H.R. 25 proposes a 23% “tax inclusive” sales tax rate. Sales taxes are not traditionally described in a “tax inclusive” manner. Sales taxes are traditionally described in a “tax exclusive” manner. A “tax inclusive” sales tax rate is a percentage of the total register price. A “tax exclusive” sales tax is a tax calculated on the purchase price before the tax is added. As shown below, a 23% “tax inclusive” sales tax rate is equal to a traditionally described “tax exclusive” sales rate of 29.87013%.

This paper refers to the tax rate as proposed in H.R. 25 as 30% (rounding 29.87013% to 30%) so that the tax rate may be more accurately compared and contrasted with other sales tax rates which are traditionally described on a tax exclusive basis. Using the traditional “tax exclusive” rate of 30% will neither increase nor decrease the tax shown for any transaction; it provides only clarity in presentation.

The important point of this discussion is not to dwell on the appropriate description of the tax rate, but to understand the impact of H.R. 25 on purchasing power. The following chart contrasts the purchasing power to the individual buyer of his or her purchasing dollars of (1) H.R. 25 on income previously taxed under the current Internal Revenue Code, (2) the current Internal Revenue Code using three separate average tax rates, and (3) H.R. 25 on income after the implementation of H.R. 25:

                                               Purchasing Power                   Purchasing Power             Purchasing Power

                                                     Of Dollars                              Of Dollars Earned               Of Dollars Earned

                                                Earned & Saved                              Under The                             Under

                                           Before Implementation               Internal Revenue Code                H.R. 25