The Fair Tax system is a tax system that eliminates income taxes (including payroll taxes) and replaces them with a sales or consumption tax. The 23% sales tax would apply to all retail and service transactions.
Under the Fair Tax system, individuals would no longer be required to file taxes. Individuals simply pay tax each time they purchase something from a store or a service provider.
Although the IRS would no longer be required to collect money from individuals, an enforcement agency would be required to ensure businesses appropriately collect taxes from consumers. Keep reading to learn about how the Fair Tax would work.
What Is The Fair Tax?
The Fair Tax System most commonly refers to abolishing income taxes and replacing them with sales taxes. The system is deemed fair because people are taxed based on their spending rather than the money they earn.
Americans for Fair Taxation is a policy group dedicated to promoting the Fair Tax plan within the United States. According to its research, a 23% sales tax could effectively replace all income and payroll taxes.
It is important to know that the 23% sales tax is a “tax-inclusive” rate. If you buy something for $1,000 you’ll pay a 30% or $300 tax on it. Your total price will be $1300. Since $300/$1300 is 23%, it is “fair” to call this a 23% rate. However, the effective sales tax rate would be 30% of the purchase price.
One of the first objectives of this sales tax relates to people living near or in poverty. Those individuals can barely afford food and rent as it is. A fair tax system would put them into indigence. The Americans for Fair Taxation propose a monthly “prefund” which proactively gives each individual some money. Every person would receive a monthly check from a government agency. This money could be used to offset taxes up to the poverty level.
While the Fair Tax system is not part of the US tax code, proponents of the law drafted bill H.R.25. The 2017 bill calls for a massive overhaul of the United States tax code. It would replace all income and payroll taxes with a single consumption tax.
Do We Have Any Fair Tax Systems In The United States?
The federal tax system in the United States is primarily a progressive income tax system. By and large, the more money you earn, the higher rate you’ll pay. The exact rate you pay depends on your tax bracket, how many deductions and credits you qualify for, and other factors.
While the federal tax system is not a “Fair Tax” system, consumption taxes (also called sales taxes) are typically applied in line with the fair tax ideals. In general, all people pay the same sales tax rate. Certain products, such as alcohol or tobacco may be taxed at a higher rate while other products like food may be taxed at a lower rate.
But all people who buy those products pay the same rate. Typically, state agencies are responsible for collecting sales tax from various business organizations.
Related: Effective Tax Rates: How Much You REALLY Pay In Taxes
Pros And Cons Of The Fair Tax System
While the Fair Tax System has some great marketing (it’s fair!), the system has both advantages and disadvantages. Here are a few key things to consider.
Pros Of A Fair Tax System
Cons Of A Fair Tax System
Final Thoughts
The fair tax system would replace complex payroll and income taxes with one simple sales tax on all consumption. It would reduce the headache of tax prep, and incentivize saving and investing.
However, it's unlikely to become law anytime soon. That means, for the foreseeable future, filing taxes is going to be significantly more complicated than paying 30% more for your morning latte.
Thankfully, you can minimize tax hassles and headaches by choosing the right software program for your situation. Our guide digs into all the details so you can find the most cost-effective and easy-to-use software for you.
Editor: Clint Proctor Reviewed by: Chris Muller
Robert Farrington is the founder of The College Investor and is widely recognized as one of the nation’s leading voices on student loan debt and saving for college. He holds an MBA from UC San Diego Rady School of Management and has spent over 15 years researching, writing, and advising on student loans, 529 plans, financial aid programs, and saving and investing for young professionals.
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