Why Consumption Based Tax is Better Than Income Tax
Income tax has been the primary taxation scheme in the United States for nearly 100 years. During that time, the tax code has become more and more complex, to the point where it is now almost impossible for the average person to even begin to comprehend all the requirements and loopholes it contains.
A consumption-based tax, on the other hand, is infinitely simpler. The current proposal for a consumption-based tax, HR 25, otherwise known as the Fair Tax, means that purchases of new goods would be taxed at a roughly 30% exclusive rate (23% inclusive). This tax would replace ALL income-based taxes, including social security, medicare/medicaid, capital gains, self-employment taxes, estate taxes, gift taxes, and taxes on interest and dividends.
The immediate effect of this would be that ever American would effectively get a pay raise. There would be no more withholding from workers' paychecks. Retirees would no longer have to make tax payments on their pensions and social security incomes.
Many have argued that this kind of tax scheme would unfairly tax the poor. After all, don't people in lower income brackets spend more of their income on purchasing things, while the rich spend less? But a provision has already been made for this. Under the Fair Tax bill, every American, regardless of income, would receive a prebate (likely on a monthly basis) to offset taxes spent on necessities. This would be based on the poverty level and family size. For example, if it is determined that a family of four needs $24,000 per year to cover necessities, they would receive a prebate of $5,520 per year ($460/month). This offset means that, in effect, that family would have a yearly income of $29,520 per year.
Others argue that the Fair Tax would mean goods would become much more expensive. This isn't necessarily true, though. First of all, there would be significant savings for companies. Currently, employers pay half of the taxes for employee social security and medicare (7.5% of the worker's wages). This cost would be eliminated. In addition, companies spend huge amounts of money on tax compliance each year, both for payroll and their own corporate income taxes. These costs would also be eliminated. It also means it would be much, much more difficult for companies to find loopholes in the tax code. They would pay their suppliers the same tax that consumers pay for new goods. While the cost of consumer goods would likely go up some, the overall effect would be that the majority of people would still pay lower taxes than they are under an income tax scheme.
The cost of tax collection would also be greatly reduced. Because the number of people and businesses actually making tax payments would be greatly reduced, oversight costs would also be reduced. Business owners would be more likely to think twice about tax fraud when the tax code is greatly simplified and punishment much more likely.
Consumption-based tax also has environmental benefits. Because only new purchases are taxed, there is incentive for people to purchased used goods. Everything from cars to homes to clothing would be exempt from taxes if purchased second-hand. This would help to keep goods out of landfills and reduce the need for new goods (which, of course, have to be manufactured).
One of the greatest benefits to the Fair Tax, though, is the benefit it would have on the stability of the nation's economy. Once upon a time, interest rates and loans were based upon the rate of savings among the American people. Banks paid savers a small amount of interest on their deposits and charged borrowers a higher rate of interest. If banks wanted to lend more money, they'd incrementally raise interest rates to depositors. When savings were up, interest rates on loans were low and it was easier to get loans. When savings were down, interest rates on loans rose and loan requirements were more stringent. This type of savings-based lending program is much more stable, as all the loans are backed by actual money, not just promises.
Another major trend in recent decades is the increase in consumer debt. Families have stopped saving money for the future and started relying more on credit cards and loans for sudden, unexpected expenses. But the Fair Tax would encourage people to save their money. After all, money put into savings wouldn't be taxed. Interest on those savings also wouldn't be taxed.
The Fair Tax would also promote investment. Money invested in stocks, bonds, and the like wouldn't be taxed. Americans would be rewarded for investing in fellow Americans and growing the economy. Since dividends and stock sales wouldn't be taxed, investors would also be rewarded for continuing their investments or reinvesting (or saving) their profits. This would have a markedly positive effect on the economy and economic stability going forward.
The largest drawback to the Fair Tax would be the decrease in jobs in preparing income taxes. Companies that currently specialize in income tax preparation would find themselves suddenly without clients. Internal corporate accounting departments, however, might also find themselves with less work, though they'd probably be reassigned to finding more ways for the company to save money. Overall, I'd say this is a small price to pay for a tax code that is, over all, more fair and equitable to the majority of Americans.