FairTax Rate a Matter of Perspective

Is it 23% or 30%?

By Kaye A. Thomas
Posted January 27, 2008
Updated January 30, 2008

Huckabee support draws attention to proposal.

One of the more prominent proposals for a drastic overhaul of the federal tax system goes by the name FairTax. The program would replace all federal taxes based on income or payrolls with a national retail sales tax. Mike Huckabee has endorsed the plan, and his success in the Republican presidential primaries has drawn attention to the proposal.

Discussions of the FairTax at this point must be considered theoretical, as it is difficult to conceive how anything remotely resembling this proposal would be enacted in the foreseeable future even if Huckabee secures the presidency. If that situation changes we will of course offer extensive discussion of the proposal's features, and its merits and demerits. For now, we merely want to ask whether it's fair to call this, as supporters do, a 23% tax.

How much you pay

If the FairTax becomes law, any time you make a taxable purchase you will pay federal sales tax equal to 30% of the purchase price. Buy a TV for $1,000 and you'll pay $300 sales tax. This much is not in dispute. The question is how to describe the tax rate. It may seem obvious that this is a 30% sales tax. Supporters of the FairTax say no, the tax rate is actually 23%.

They arrive at the 23% figure by looking at the total amount paid. You have to come up with $1,300 to make this purchase. Of this amount, $300 goes to the government. The tax is 23% of the total.

The math works, of course, but that begs the question. Is it logical, or is it misleading, to describe this as a 23% tax? The answer: it's both logical and misleading.

It's logical

The FairTax is designed to replace the income tax and payroll taxes. These taxes apply by taking a percentage out of the total. If you earn $1,300, and you pay 23% in income tax and payroll tax, you're left with $1,000 of buying power. That's enough to buy that $1,000 TV if you don't have to pay sales tax. You end up in the same position either way.

Current law: earn $1,300, pay $300 in income tax and payroll tax, and use $1,000 to buy TV with no national sales tax.
FairTax: earn $1,300, pay no income tax or payroll tax, and use $1,300 to buy TV, including purchase price of $1,000 and $300 national sales tax.

FairTax supporters are correct in saying the tax is equivalent to income tax and payroll tax that take 23% out of your earnings — at least if we assume the amount you spend is the same as the amount you earn.

It's misleading

Despite this inherent logic, the frequent description of this proposal as a 23% sales tax is misleading. The vast majority of people hearing that description will assume it means they would pay $230 of tax on a $1,000 purchase. This is, after all, how sales tax rates are commonly understood. Someone paying $100 in state and local sales tax on a $1,000 purchase is said to be paying 10%, not 9.1%.

Supporters of this proposal face the difficult task of explaining to the public how paying a 30% sales tax can be equivalent to paying 23% in income tax and payroll tax on the same amount of money. Many people will tune out before grasping the logical equivalence. This problem doesn't justify the shortcut of calling it a 23% sales tax, an approach that will mislead many people — probably the vast majority — into believing the proposal would impose a far smaller tax than is actually the case.

Update

This article brought a strong negative reaction from FairTax supporters. The backlash was notable considering that the article doesn't say the FairTax is a bad idea. It doesn't even say the 23% figure is wrong (we say the logic behind it is good), only that many people will be misled when the FairTax is presented as a 23% sales tax. We can't help wondering what kind of reaction we would have received if we had actually criticized the proposal.