It's Called the Fair Tax, Not the Perfect Tax

Recently on his radio program, Hugh Hewitt raised two objections to the National Retail Sales Tax (i.e. the Fair Tax.) That it would eliminate the charitable giving tax deduction and would eliminate the tax deduction on home mortgage interest.

Taking the first objection, as the Fair Tax only taxes retail sales, there would be no tax on charitable contributions. In neither case are you being taxed on the money you give to charity. And for the 70% of us who don’t itemize our taxes, the Fair Tax would actually be an improvement.

What about Home Mortgage Interest? This is a thornier topic. Under current law, only those who actually itemize get a deduction on Home Mortgage Interest, everyone else is taxed on this income. Again, only 30% are actually taking this deduction.

Under the Fair Tax, the Principal Payments on your mortgage are not taxed. In addition, what we must understand about mortgage interest rates is that, like all other goods and services in the economy, tax is embedded into the Interest rate because banks must pay taxes on the interest income they receive. Without banks having to pay taxes on their interest income, interest rates will drop by 1/4th. Yes, some mortgage interest payments may be taxed as financial mediation service. However, in consideration of a lower interest rate, that payments will be made with 100% of a person’s paycheck, I think taxpayers come out with a pretty good deal.

However, this leads me to a larger point about the way Fair Tax opponents attack the proposal. The argument against the Fair Tax is not that, when all options are weighed, we are better off with the current tax code than with the Fair Tax, but that certain features of the Fair Tax will not benefit people engaged in certain behaviors, or that the plan’s delivery system is flawed. One such objection is the idea of giving every household in the United States a prebate equivalent to the taxes on spending up to the poverty level to ensure that no one is taxed for the basic necessities of life.

Some folks on the right decry the prebate as welfare. I wonder what they would call the Earned Income Tax Credit? Do they prefer a system in which illegal aliens are able to live in the country, take government services, and pay no taxes for it because they and their employers dodge the income tax?

The genius of our leviathan tax code is not its efficiency, or the way it encourages growth while collecting necessary revenue, but how it grants favors to certain groups and individuals in order to curry political favor. Fear that somehow these government bobbles might be taken away causes otherwise sensible people to rally around a cumbersome system that is a dead weight on our economy,

The tax code has become a motherly creature, rewarding us for doing what mother thinks is good (giving to charity, taking out student loans, paying mortgages, going to college) while punishing us for doing what she thinks is bad (investing in stocks and earning dividends, selling stocks and earning a Capital Gains, saving money and earning interest.) The tax code is a cavalcade of special interest breaks meant to control economic behavior according to the dictates of those who pay enough money to lobby Washington.

Lost in this is the ultimate purpose of taxes: To raise revenue in the way that is least harmful to the overall health and growth of the economy. If we are using the tax code as a way to make people buy homes, to social engineer, or benefit some industry over another, we’ve ultimately misused the tax code.

The fundamental question that must be asked is not, is the Fair Tax perfect or if there’s anyone out there who might have to pay more under the Fair Tax than they do under the current code. The question that must be asked: Is the Fair Tax a better system for raising revenue while maintaining a strong economy?

Consider the current flaws of the Income Tax Code:

• Compliance costs of $350 billion per year.
• An untaxed underground economy of illegal aliens, drug dealers, prostitutes, and organized crime.
• Hidden taxes that hide true cost of government from the average American.
• Hidden taxes also weaken U.S. products overseas. American companies imbed the cost of taxes into the price of every product sold. Foreign companies do not.
• Our tax code encourages companies to move their business offshore. Trillions of dollars is put in the Cayman Islands and other tax havens to avoid the U.S. Income Tax.
• The corruption of our government in Washington, DC, which has been besieged by lobbyists who have turned the Internal Revenue code into their personal playground.
• The invasion of privacy by government, as well as the threat of identity theft from hundreds of millions of pieces of paper (W2s, 1098s, 1099s, etc.) floating around in the mail with the name, address, and social security number of taxpayers.

It’s time for opponents of the Fair Tax to explain how to fix the problems with our current tax code without fundamental change rather than trying to¬ find some group of people that may not do as well under a Fair Tax. Consider this, the government pays out $64 billion in Home Mortgage Deductions. Without taking anything else on my list into consideration, is $64 billion in Mortgage Deductions worth $350 billion in tax compliance costs? If not, then this piecemeal selective attack on the Fair Tax is irrelevant. And it’s time to have a serious debate.