The Unfair Tax

The Unfair Tax

Jan 20
The Unfair Tax

For a long time I have been a big advocate of the “Fair Tax,” a national sales tax that replaces the current income tax.  Based on some things I have read recently I have changed my mind.  I am now opposed to the “Fair Tax.”  It is a sales tax and I have come to believe that all sales taxes are unfair.

The idea of a sales tax is simple:  if you buy something then you pay the government a percentage based on the purchase.  Basically, you pay the government so that you can have the opportunity to buy something.  Suppose a government charges a 10% sales tax.  For a $100 purchase you would actually pay $110.  Very simple.  Very straightforward.

And very unfair.

On the surface it sounds about as fair as anything can get.  Everybody who makes purchases pays the same percentage in taxes for their purchases.  To put it another way, a sales tax “punishes” spending and “rewards” saving.  The more you buy, the more you pay in taxes.  The more you save, the less you pay in taxes.

There is a huge flaw inherent in the idea of a sales tax.  The assumption is that the people with more money will spend more.  This is true…to a point.  Wealthy people do not become wealthy by spending all of the money they bring in.  They become wealthy by NOT spending.  A sales tax effectively rewards those who save money and don’t spend it.

In other words, sales taxes favor those who are trying to grow their wealth.

Suppose that you and I each make the same amount of money every year.  For simplicity, let’s say $50,000 (after income tax).  Let’s say the sales tax rate is 10%.  If you spend all of your money on purchases, saving nothing, then 10% of your money went to sales taxes.  On the other hand, I like having money in the bank so I only spend $45,000 while saving the other $5,000.  I will spend $4,500 in sales tax compared to your $5,000.

I paid 9% of my income in taxes while you paid 10%.  Effectively, I received a tax break by not spending money.  While we pay the same tax rate, I paid less in taxes.

Now, let’s bring in another fellow citizen.  This one makes $75,000 a year.  She has a slightly better lifestyle than you or I, but she doesn’t spend everything she makes.  Let’s say she spends $60,000 – more than you or I make – and she saves the other $15,000.  She will pay $6,000 in sales taxes – again, more than you or I pay because she spent more.  Fair, right?

She only paid 8% of her income in taxes, despite having purchased more than either you or I.  She made more money, spent more, built more wealth through savings, and effectively paid less in taxes.

To reiterate what I said earlier, wealth is built by saving.  One cannot simply assume that because someone is wealthier that they will spend proportionately more than those who make less.  If anything, the opposite is true – people who make less money are more likely to spend more of their income.  Who has the greater opportunity to save money:  someone who makes $20,000 a year or someone who makes $50,000?

For a sales tax to be “fair” it would have to require that each individual spend the same percentage of their income.  Suppose we say it’s 80% — everyone spends 80% of their income.  In the earlier example, you and I (with incomes of $50,000) would spend $40,000 (paying $4,000 in sales taxes) and our wealthier friend would spend $60,000 (paying $6,000 in sales taxes).  We would all be paying the same effective tax rate of 8% of our income.  If we had a less wealthy friend with an income of $20,000 then our friend would have to live on $16,000 a year to pay the same effective tax rate – if he spends more than that then he is paying a higher portion of his income in taxes than the rest of us.

As I understand it, economies are driven by spending.  Saving is the opposite of spending.  Sales taxes “reward” saving and “punish” spending.

To put it another way, sales taxes punish behaviors that help the economy and reward behaviors that hurt the economy.  In addition, sales taxes favor individuals with higher incomes.  Individuals with higher incomes have more “room” to save and thus pay less in taxes.  Individuals with lower incomes have less “room” to save, requiring more of their income in order to maintain a minimal lifestyle – they have to spend a higher percentage of their income and thus pay a higher percentage in taxes than citizens with a higher income.

Personally, I would like to see all sales taxes go away and be replaced with income taxes.  I feel like it is far more fair.  With an income tax, you would pay taxes based on how much you made rather than how much you spent.  Even if we maintained a flat income tax of 10%, then our lower-income friend would pay $2,000 in taxes, you and I would pay $5,000 in taxes, and our wealthier friend would pay $7,500 in taxes.  For the people who spend most or all of their income, nothing changes.  But for those who are growing wealth, who are saving and not spending (and not helping the economy), they would pay taxes on money that isn’t taxed under a sales tax system.

It has the added benefit that if the sticker says something costs $100 then $100 is all you pay.  You aren’t “punished” for spending or “rewarded” for saving.  Instead, you are “punished” for having a higher salary.

I’m sure I’ve oversimplified all of this — economics is far more complicated.  But I believe the reasoning behind what I’ve shared is sound.  Sales taxes hurt the poor.  Sales taxes punish people for spending, despite spending being important for an economy.

The “Fair Tax” is a sales tax.  It is anything but fair.

7 comments

  1. Scott

    Chris, you miss one big point of the “fair” tax that most of its advocates push: Each family would receive a check from the government each year that was essentially the tax for a basic family income worth of stuff. So, John Q. Public who makes and spends $40k per year would receive a rebate/”pre-bate” of 10% of $30k (or whatever number the government chose) and Richie Rich (making $500k per year) would also receive the pre-bate of 10% of $30k. John Q. Public would likely end up spending nothing in taxes (maybe even coming out ahead) because $10k of his spending is on rent, utilities, debt payments, and other things that are not taxable while Richie Rich would likely spend $100k per year on taxable items and hence pay a significantly greater amount.

    The pre-bate means that it is not over-taxing the poor and under-taxing the rich, but you appear to have left that out of your calculation.

    • I disagree, Scott. I think a fundamental flaw of the concept is the idea that people with higher incomes will spend more. One does not accumulate wealth by being a big spender. One accumulates wealth by being a big saver. I spend far less than my income, meaning that the percentage of my income that would actually be taxed is less than someone who makes less but spends the same amount.

      • Scott

        Chris, whenever you (or your heirs, or whoever) spends that money, it will be taxed. Unless, that is, the point of your money is to never, ever, ever be spent by anybody but to sit there in an account looking pretty for the rest of eternity. Not only that, but the pre-bates make it so that the poorest folks have a net tax rate of zero (or less).

        That is the beauty of this proposal, you can accumulate all the wealth you want, but if you EVER choose to use it, it is caught by the tax.

    • If I’m following you, then John Q. Public will spend $40,000 (the $10,000 pre-bate plus another $30,000). So he will be taxed on $30,000 of his $40,000 in earnings (75%). Let’s say Richie Rich spends three times as much on his lifestyle ($120,000 minus the $10,000 pre-bate) — he’ll be taxed on $110,000 of his $500,000 earnings (22%).

      Is that correct?

  2. Julie Trivitt

    You are equating proportional with income and fair. Why is that? Why not proportional with consumption? There are many logical ways we can define “fair” and none of them is inherently right or wrong. If I save consistently and then quit working to live off my savings I will have high consumption but pay zero taxes under your plan because I have zero earnings. Is it still fair?

    Also, spending may increase GDP this year, but saving makes it possible for investment to be made which makes the economy more productive in the long run. By saying spending is good and saving is bad you are discounting all long run growth.

    • I don’t disagree with you on any point, Julie. I was just struck by the idea that a sales tax likely impacts lower incomes more than higher ones. I find it difficult to imagine a low income family that is capable of living off of savings. Or even saving, for that matter. I can’t help but feel like a consumption tax will continue to hold them down.

      • Julie Trivitt

        But if tax dollars are spent disproportionately on programs that benefit lower income folks we may still get considerable income mobility.

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