Growing up in Grand Rapids, Mich. Aaron Schutte saw first-hand America’s manufacturing industries gradually erode as globalization and recessions took their toll on his community. In part because of a federal tax policy he believes cripples American industry. Now as the national grassroots coordinator for Americans for Fair Taxation, he organizes volunteer efforts in all 50 states with the focus of changing America’s tax system to a consumption-based tax.
“A lot of people at home were left without work when jobs moved overseas,” said Schutte. “I did my research on the Fair Tax, and I said to myself, ‘This makes too much sense not to work.’”
The Fair Tax plan calls for the elimination of the federal income tax and replacing it with a 23 percent national sales tax on all goods and services, and would simplify the tax code. According to fairtax.org, if the system was to be implemented it could raise $2.5 trillion, or nearly $360 billion more, than the system it would replace. It would also eliminate the need for the massive Internal Revenue Service and its $82 billion operating expense, according to Fair Tax.
The Fair Tax would work with state agencies that collect state sales taxes and would only build on current state laws, according to Schutte. As part of the plan, a federal tax bureau would need to be established to oversee state compliance and to audit the states if necessary he said. According to Fair Tax this bureau could perform its functions with only 5 percent of the current IRS budget.
“You have over 72,000 pages of tax code that just tells people how to send their money to Washington,” Schutte said. “ You would wipe out the $400 million Americans spend annually just to figure out their income taxes. This would be a fair, progressive tax that would greatly expand the economy.”
According to the World Bank roughly 70 percent of the U.S. Gross Domestic Product (GDP), is derived from household consumption of goods and services. A consumption tax would make the tax base every single final purchase of a good or service in the economy, which is something done millions of times a day. Schutte said that instead of citizens trying to navigate and comprehend the thousands of pages of tax code, the Fair Tax is visible and simple. Consumers only pay taxes on the goods they buy and keep their income tax dollars in their pocket.
Revenue neutrality in the tax system was a hot-button issue in the past election. This would not be a concern with a consumption tax. For people living in poverty, the Fair Tax includes provisions that would allow them to buy items of necessity like food and medicine tax-free. According to Fair Tax this would come in the form of a monthly “prebate,” which would allow citizens to spend up to the poverty line without paying the 23 percent national tax. If they spend twice as much as the poverty line consumers would pay an 11 percent rate for items and a 15 percent rate for items bought at three times the poverty line and so on.
In practice however, the use of a national consumption tax leaves many unanswered questions that would probably not be resolved until implementation. For small business owners like Joamil Rodriguez, there remains a degree of skepticism in changing the status quo of taxes. His shoe-store, Laced, located in the South End of Boston, is registered with the IRS as a sole-proprietorship. That means his income earned from his business is taxed as his standard income. He believes a national sales tax structure would create a disincentive for consumers to buy.
“I honestly think with the way things are if you have to add a penny to the price of anything you’re hurting everyone,” said Rodriguez. “My consumer looks forward to what is in their income tax return, and not so much the money they are paying back. A lot of families and businesses are tapped out after Christmas, and they need that return to go spend on consumer products.”
Rodriguez is not alone with this sentiment, but on the macro-economic level some economists and politicians are raising sustainability concerns regarding the current tax system.
Currently, according to Fair Tax, there are 70 members of the House of Representatives and eight senators who co-sponsor the Fair Tax plan, in addition to the sponsors Rep. Rob Woodall and Sen. Saxby Chambliss, both Georgia Republicans.
With a small but dedicated political support, is now the time to have a serious talk about serious tax reform? According to Boston-based tax attorney, Edward DeFranceschi of DeFranceschi & Klemm, P.C., now may be as good a time as ever with the looming “fiscal cliff” in addition to the Bush tax cuts scheduled to expire at the end of the year.
“The bottom line is that the current tax system doesn’t generate sufficient revenue to pay for what we need. We get a dollar-and-a-half of government and we pay a dollar for it,” he said. “Collections are at a historic low in terms of the amount that taxes take out of our society. Now we have another opportunity to deal with the Bush tax rates, which you have to remember, 90 percent of the tax cuts went to the top 10 percent of the people. Not everybody can be middle class.”
The United States owns over a $16 trillion national debt, and is running an annual budget deficit of $1 trillion according to Congressional Budget Office. Part of President Obama’s plan that got him re-elected included raising tax rates for top income earners as a means of increasing revenue. But with fewer and fewer taxes getting paid, the equity issue has gone so far that it has made more and more people doubt the current system.
“There is a big string of thought that has gone on for awhile driving the Fair Tax people is that the income tax had to have an amendment added and it’s not in the original intention of the Constitution,” said Doug Kellogg, communications director of the National Taxpayers Union. “Aside, from just the economic damage of an income tax system and the invasiveness the IRS sort of exercises over people to this point, it’s just a better constitutional fit to have a national sales tax.”
Although this would be a departure from 99 years of a progressive income tax, the time may be now more than ever because politics in Washington are interfering with the harsh financial realities the country is facing. The Simpson-Bowles report found multiple layers of, “backdoor spending hidden in the tax code,” as a result of loopholes costing an estimated $1 trillion in uncollected revenue. This is because the government is attempting to appear as though it is spending less money because new government spending must be approved in the annual budget.
The government spending money is the same as the government granting a “tax exemption” to a private entity for a determined amount of money. The only difference between the two is that once a tax exemption has been granted it becomes permanent tax law and does not require an annual budget vote, according to a report on Fareed Zakaria’s program GPS. So, in return for favorable tax exemptions corporations, lobbyists and special interests will donate funds to the cooperative politicians’ re-election campaigns.
The other strong case for a consumption tax is that most modern economies have adopted some form of a consumption tax. According to the United States Council for International Business (USCIB), 70 countries and 26 territories including the likes of China, Canada, Germany, Great Britain and many others use some form of consumption taxes or Value-Added Tax (VAT). A VAT is a different form of a consumption tax in which at each stage on the supply chain that adds value to a product, a flat tax rate is factored into the price each time the product is sold, including the final sale of the good.
“If you were to start a country from scratch and you were trying to create a perfect tax policy, a value-added tax may be better than many of the other taxes. It’s better than taxes on production and innovation because those taxes can discourage those things,” said Barbara Anderson, executive director of Massachusetts-based Citizens for Limited Taxation. “So, a tax on consumption is on the consumer end; they have a choice whether or not to consume certain things.”
Any possible change to consumption tax would cause an initial shock to the American economy. In the long run it may be a more sustainable way for the government to tax society.
“Part of the problem with 2008 economic collapse was that it showed that Americans don’t save enough and that we are perfectly content burying ourselves in debt.” said Cameron Eide, a double major in economics and international affairs at Northeastern University. “This way the government taxes you for what you buy and nothing more. If you don’t want to get taxed, don’t buy as much.”
The tax reform issue certainly will not solve itself. That is why concerned citizens like Schutte of Fair Tax are challenging 99 years of conventional thinking that comes with the income tax. And with an annual trillion-dollar deficit, it may be time to try something new.
“We want taxation to be open and visible, and that is what the Fair Tax does,” Schutte said. “Our system taxes in a way that does not compress the economy and keeps everything open. It is a simple pay as you go system for individuals.”