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The FairTax would be a Huge Improvement

[The following is a chat that I had about the FairTax with one of my students.]

Student: I've been reading your book [Tradng Away Our Future], I like it alot.

Me: Thank you!

Student: So I assume you're a FairTax advocate because you gave it such higher ratings.

Me: Yes, though I want one change to be made in the plan -- to avoid tax cheating. I want it to be collected like the Value-Added Tax.

Student: That is/was my case so far, but (while I think its a great idea) seems to have too many loopholes....like tax cheating

Me: Well, collecting it like a Value-Added Tax ends that. The experience in Europe is that there is not much tax cheating because businesses all along the supply chain keep each other honest.

Student: How could you have the FairTax collected as a VAT?

Me: A sales tax is collected by retailers only. A VAT is collected all along the supply chain. Each business pays it like a sales tax, except that they get to deduct the tax paid by their suppliers. So each business has an interest in making sure its suppliers paid the tax. So businesses keep each other honest.

Student: Yeah, this makes sense, it's hard to see a NRST (National Retail Sales Tax) collected that way because it is only at the final point.

Me: Yes. It's a small change. The tax would still appear on every receipt, as is true of sales taxes. And businesses just need to total how much tax they collected and how much tax they paid, and just send in the difference.

Student: Ok. The problem I've encountered with running a FairTax case, is there are so many "easy targets."

Me: OK, but I think I could defend every one of them, if the method of collection is like the VAT. And the FairTax has some tremendous advantages, especially for a country running trade deficits, or a country that needs savings for growth.

Student: Ok, I'm sorry, but I get how a VAT is collected, but if a FairTax is only on retailers how could you collect it the same way.

Me: You change it. All businesses would pay it, not just retailers. And it would be collected on imports and rebated to exports at the borders also.

Student: Then that would make it a VAT, just with a prebate.

Me: Yes, but a VAT is usually hidden on sales receipts. This would not be hidden.

Student: That might be a good idea.

Me: Also, the idea of replacing payroll taxes and the corporate income tax and estate taxes, etc, is very appealing. And the prebate is quite brilliant in and of itself.

Student: Yes, one tax, for all to see.

Me: In my opinion, it allows for the elimination of the entire welfare system. Nobody would starve. Everybody would at least get the prebate to live on. Two adults living together would make it higher, so it encourages marriage. There are no tax traps such that if you work you lose benefits.

Student: The problem though (and I love that point you made in your book about helping people out of poverty, an amazing idea!) but what's to say it won't turn into another bankrupt entitlement like SS and Medicare?

Me: You mean the prebate would get raised and raised?

Student: Yeah.

Me: Why would that happen? Right now, the politicians get to play the game of pretending that if they raise the tax rate, only the rich will pay it, but under the FairTax, if they raise the rate, everybody pays the higher rate.

Student: In my opinion, that is the course of government -- to grow! History is overflowing with examples (actually every government), more spending, (bigger prebate), bigger government.

Me: So, sure, the prebate would go up, but there would be plenty of incentive in a simple one-tax system to keep the overall rate lower.

Student: True, it is a better idea than the current system. I just don't think it's fool proof. Nothing is.

Me: Yes, but the more issues you take off the table for politicians to deal with, the better the government.

Student: Very true.

Me: Eliminating the income tax, payroll tax, estate tax, capital gains tax, corporate income tax. and all of the many many many many many loopholes means that none of that is any longer the province of government. Hence we are much more free.

Student: Yes! But  I especially love the fact that there would be no tax on business, which would make us more competitive.

Me: The only issues that remain are: (1) tax rate, (2) prebate rate. So there will be pressure from the more poor to raise the prebate and pressure from the more rich to lower the tax rate, and so those things will go back and forth a bit.

Student: Yeah, that could work, except the rich don't seem to win in tax rates (maybe in exemptions).

Me: It's not just the rich, it's the more rich. And everybody has an incentive to keep the rate low.

Student: Yeah that is true.

Me: So a balance will be struck, and it will change. But if we can eliminate the entire welfare system, there would be plenty of money for the prebate.

Student: Actually, would it be so radical to eliminate the Social Security system and replace it with just the prebate?

Me: Well, I wouldn't suggest that. People are counting on Social Security who have paid into it all their lives. Social Security benefits would have to continue to exist for those who have paid into it. But the system could be gradually phased out.

Disclosure: No Positions