Congress to Vote on Whether to Abolish the IRS and Introduce One National Tax Rate

Right now, the average price for a loaf of bread is, approximately, $1.87. Under a new law proposed by House Republicans, that price would go up to more than $2.50. This would be the result of the Fair Tax Act, a bill proposed by around 30 House Republicans. House Speaker Kevin McCarthy (R-Calif.) has promised to bring it before the chamber for a vote, although he has not specified when or under what conditions.

The Fair Tax Act is the latest incarnation of an idea that has bounced around for more than a generation. The proposed law would eliminate the IRS entirely and with it all federal taxes, including the income, payroll, estate and corporate taxes. In its place, Congress would enact a flat 30% sales tax on all goods and services nationwide.

Though this proposal is unlikely to pass, it may be a good idea to match with a vetted financial advisor for free to help you with your tax needs.

National Sales Tax – A Historical Glance

National sales taxes are an idea as old as tricorner hats. In the 18th and 19th centuries, modern income taxes didn't exist. Instead, like most governments, the U.S. funded itself mainly through tariffs and sales taxes. Permanent income taxes were authorized by constitutional amendment in 1913, and the system we know today wasn't established until World War II.

Today, no major economy relies exclusively on sales taxes for revenue. While a handful of small or petroleum-fueled economies have no income tax, the main exceptions to this rule are sub-jurisdictions like American states or cities.

However the idea remains a darling of the American conservative movement. Over the past 30 years it has come up over and over and over again. Part of the reason is historic, with many on the political right advocating a form of Constitutional law rooted in the document's 18th-century form. But most of the reason has to do with the superficial fairness of a flat retail tax. Everyone would pay the same thing on everything purchased, no matter what.

This, proponents argue, would be better than the 3,000 page tax code America uses now. Tax experts disagree, however, citing numerous problems with a national sales tax.

Shortcomings of the Fair Tax Act 

First, proponents argue, the mere fact of complication isn't an indictment of the system. America is a large country with a $23 trillion economy. Its taxes will almost certainly be complicated to some degree or another. What's more, the underlying basis of the U.S. tax code is very straightforward. The more a household earns, the more it pays in taxes. Every year the IRS publishes income tables that detail how much a taxpayer owes based on how much they make.

However Congress also uses the tax code to incentivize certain behaviors (like owning a home or joining the military) and purchases (like solar panels). It's this network of credits and deductions that make the tax code complicated, not the concept of a progressive income tax itself.

That's one problem. The next issue is scale.

As written, the Fair Tax Act is misleading. It proposes a 23% "tax inclusive" rate, meaning it applies to the post-tax cost of goods and services. Most, if not all, current sales taxes are calculated on a tax exclusive basis, meaning that the tax rate applies to the pre-tax cost of goods and services.

As a result, while the Fair Tax Act as written proposes a 23% inclusive tax, it would be a 30% tax in the way that virtually all taxpayers calculate sales taxes.

Even this substantial series of price increases, most economists agree, would still be far too low to fund the national government. A Brookings Institute study published in 2005 suggested that the correct rate would have to be closer to 44% to replace the government's current revenue. This also assumes that the sales tax would have no significant impact on economic activity, meaning that people would continue to buy and spend as normal even in the face of a 30% to 44% price increase across all goods and services.

To put it mildly, economists are skeptical of this suggestion. Instead, many warn, this kind of economy-wide price hike would almost certainly slow down consumer activity despite a consumer base that's wealthier because they paid no income taxes.

Experts also agree that the main selling point of the Fair Tax Act, its simplicity, is also inaccurate. As a Tax Policy Center briefing noted, even though the bill would abolish the IRS in the name of simplicity, it does so by simply forcing states and cities to collect taxes on the federal government's behalf. This, the briefing notes, "just outsources the work to the states (and District of Columbia)… If we optimistically assume that the FairTax brings in roughly the same amount of revenue (as a share of the economy) as the current tax code, annual collection fees per year for states would approach $10 billion. By comparison, the IRS spent about $13 billion per year over the last decade."

Beyond requiring the states to collect taxes on its behalf, which the federal government may not even have the power to do, the Fair Tax Act would create two new agencies to replace the abolished IRS. The Excise Tax Bureau and the Sales Tax Bureau would oversee management of the new sales tax and work with the states and cities assigned to collect those taxes.

Finally, the main concern that most tax experts have is that a national sales tax would cut taxes on the wealthy while skyrocketing them on low-income households. This is due to the disproportionate nature of sales taxes in general. The less money a household makes, the more of its income it spends on costs of living, all of which would be subject to the new 30% tax. Wealthier households save more of their money in bank accounts and investments, none of which would be taxed under the Fair Tax Act.

One study from 2011 found that the results of a 30% sales tax, as proposed under the Fair Tax Act, would shift the nation's tax burden overwhelmingly. A national sales tax, the study found, would cut taxes for top earners by around 40%. Meanwhile, poorer households would see their tax burden increase by anywhere from 200% to 1,000%.

To manage this disproportionate impact the Fair Tax Act proposes to send households monthly checks to offset this issue. These so-called "prebate" checks would be equal to 23% of the federally assessed poverty-level cost of living. All households would receive this money regardless of income status.

Once again, this proposal has come under near-universal criticism by tax experts. While a prebate would mitigate the regressive impact of a national sales tax, the proposed bill would still lower taxes on the wealthy while raising taxes on low- and middle-earners. This would also require administration and oversight, again eliminating the proposed simplicity of a flat sales tax.

The Fair Tax Act is the latest version of an idea that has been around since at least the mid-1990's, and arguably much longer. Its proponents argue that a national retail tax would be simpler and fairer than the income tax, and would give Americans more money to spend resulting in significantly more economic growth.

Virtually every third-party expert to study the idea has found the opposite. A national sales tax would be complicated to administer, with massive potential for loopholes and evasion. It would cut taxes significantly on high-income households and raise them even more on low-earners. And, if anything, it would likely slow down the economy as consumers adjust their purchases to higher prices.

No vote has yet been scheduled on this bill. President Biden has said he will veto it even if it passes.

Bottom Line

House Republicans have proposed to eliminate income taxes and the IRS and replace them with a national 30% sales tax. Virtually all tax experts to study the issue agree that it would complicate the tax code and act as a massive tax cut for the wealthy.

Tips on Taxes

Photo credit: ©iStock.com/Pgiam

The post Congress to Vote on Whether to Abolish the IRS and Introduce One National Tax Rate appeared first on SmartAsset Blog.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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