What Distinguishes the Freedom Tax from the Fair Tax?

The Fair Tax does not really abolish the IRS.  BUT, the FreedomTax would achieve this goal for nearly everyone.  As a simple, tax-efficient income tax providing for the at-source taxation of most income, the FreedomTax would end the universal personal-return filing requirement. This reform will result in most people never again having to file a personal tax return to pay their personal tax to the IRS. The FreedomTax will result in a dramatic down-sizing of the IRS, effectively abolishing it from our lives.

By James K. Jeanblanc | December 2, 2015

The FairTax would create a new IRS-like agency at the Federal level called the Sales Tax Bureau or STB, which along with respective state level sales tax agencies would be charged with nationwide enforcement.

Both the Fair Tax and the FreedomTax are based on the premise that the present income tax system is an unconscionable mess, is unfixable, and should be junked and replaced. Both proposals would do just that.  However, . . .

1. The Fair Tax requires repeal of the 16th Amendment (authorizing the income tax) to completely achieve its goal.  BUT, the FreedomTax does not.  It works with the Constitutional structure what we now have. 

Overlooked in the Fair Tax proposal is the risk that it will cause the country to have two tax systems, both the national sales tax and a continuation of the hated income tax. In this regard, the Fair Tax proponents, in their efforts to get and keep the income tax repealed, are likely to face the reality that the income tax is a zombie, very difficult to kill and keep buried.

The Fair Tax bill has been introduced to repeal the income tax and replace it with the Fair Tax. This bill would address the understandable concern that a future Congress, on the authority of a left-unrepealed 16th Amendment, might re-enact the income tax. To avoid this and to encourage adoption of an amendment to repeal the 16th Amendment, the Fair Tax bill has a sacrificial ploy. If, within seven years after enactment of the Fair Tax, the 16th Amendment is not repealed, the Fair Tax would “sunset” (i.e., be automatically repealed).  No provision is made for a replacement tax if the Fair Tax sunsets. Presumably, no one would want the country to be left without a tax system, and the gambit seems intended to force adoption of the repeal amendment.

Everyone knows the process to amend the Constitution will be long and uncertain, all amendments requiring 2/3rds-approval by both Houses of Congress and ratification by 3/4ths of the States. After enactment of the Fair Tax into law, there likely will remain many who, in principle, are opposed to having a national sales tax, and they can be expected to organize to defeat the repeal amendment and sunset the tax. And, there will be more opposition from the many who likely will have forgotten how bad that old income tax was and who are unhappy having to pay the ultra-high 23% sales tax on all their retail transactions. Moreover, some States may have their own individual objections to the Fair Tax and refuse to ratify, perhaps even using ratification as a lever to force Congress to make changes. All of this would follow the problems beforehand during the amendment-approval process in Congress. For instance, supporters of a balanced-budget-amendment might insist upon having their amendment added to the repeal amendment.

Suppose the sunset gambit fails and the Fair Tax does sunset. What then?  There will be no tax system left in place, and Congress may seize upon the opportunity thus presented to reinstate both the income tax and the national sales tax. This two-tax package may even be attractive to a frugal Congress as an easy way to balance budget deficits, accepting the argument that it’s okay to have two tax systems if both have lower tax rates.

The FreedomTax, already an income tax, presents none of the potential issues discussed above. Moreover, it would be a true income tax to replace the current flawed income tax and it would be far more simple and efficient in design and application.

2. Even if the 16th Amendment were to be repealed, this may not end the matter. The income tax still might be able to be resurrected.

There are some who can be expected to argue that the 16th Amendment never was needed to have an income tax. They will argue that Congress always had Constitutional authority to establish an income tax and that the 1895 U.S. Supreme Court decision holding the income tax of that time to be unconstitutional was a narrow and limited ruling, not broadly applicable. And, there are some Supreme Court justices who would read international views into their interpretation of the meaning of the Constitution, and, in so doing, would point out that most all countries employ income taxation. So, to assure the objective to kill the income tax, the Fair Tax proponents should anticipate these arguments and propose a repeal amendment which goes further than now proposed, one to expressly outlaw all forms of income taxation.

3. The Fair Tax is a high-rate tax at 23%.  BUT, the FreedomTax is a low-rate tax at 10%.

Not to be forgotten is the direct relationship between a tax’s rate of taxation and the stress it puts upon compliance, its efficiency as a tax, and the distortive effects it causes.

4. Proponents of the Fair Tax contend that it’s better to tax consumption than to tax income.  BUT, proponents of the FreedomTax contend that (A) what we have is not a true income tax to make that comparison against, because what we have functions as a person tax; and (B) the better course of action is to replace this person tax system with a true income tax, simpler and more tax-efficient than a consumption tax such as the Fair Tax.

Most people haven’t come to the realization that our income tax is a person tax. Clearly, it’s not a true income tax. People, which the tax system labels “taxpayers,” are the subjects of the tax. Every year, they must file with the IRS a personal return to report all their income, to claim the tax breaks to which they qualify, and to compute their personal tax liability using the tax-bracketed rates applicable to them. This tax is assessed against and collected from them, not their income.  The vehicle making possible for the income tax to function as a person tax is the universal personal-return-reporting system.  It bears responsibility for our income tax mess and accounts for today’s disparate tax treatment of taxpayers and their income.

The FreedomTax would end this person-tax reality. It would junk the income tax and replace it with a true income tax. When compared to the Fair Tax, the FreedomTax (1) would be more tax-efficient; (2) would be simpler in application; (3) would be less distortive of the economy; (4) would result in less tax avoidance and tax evasion due to its much lower tax rate and more efficient tax design; (5) would be less prone to future changes to pick winners and losers and for back-door spending programs; and (6) would be a fairer tax because all income would bear its fair share of the tax. None of this can be legitimately said of the Fair Tax in its taxation of consumption.

On the other hand, the Fair Tax would retain the person-tax element of the present system, this in the form of its “pre-bate” family-application system. This feature, to pay out monthly family allowances, would amount to the sheltering of consumption from taxation, thus denying the Fair Tax the status of a true consumption tax. By contrast, the FreedomTax would tax all income the same and at a low 10% tax rate with no exceptions.

5. The Fair Tax is a tax system designed with a Trojan horse.  But, the FreedomTax is a tax system designed not to have a Trojan horse.

The Fair Tax embraces the fundamental concept (governing the income tax it’s to replace) that people and what is to be taxed (whether income or purchases) should be taxed differently. To this end, the Fair Tax will have its own Trojan horse; i.e., the above-mentioned “pre-bate” system where families must file annual applications to receive a monthly allowance to reduce their burden from the ultra-high sales tax. Indeed, the architects of the Fair Tax, not unlike the citizens of Ancient Troy, see the feature as an attractive left-behind from a defeated income tax and not dangerous to be brought into their tax system.

The universal personal-tax-return filing requirement is the Trojan Horse of the present income tax, enabling use of the income tax to pick winners and losers and to run back-door spending programs. How might the Fair Tax’s Trojan horse destroy its integrity as a sales tax and turn it into a person tax, just as it has done to the income tax?

The pre-bate program comes with the temptation that the annual family allowance be increased. This might be “paid-for” with an increase in the sales tax rate and, together, make the Fair Tax even more “progressive”in shifting the tax burden away from low-income families (a person-tax concept). As an allowance system, the program easily could be expanded to pay a greater allowance to cover such things as child-care expenses and even to run a cash-for-clunkers program. Approved needs and purchases would be listed in the annual application to receive a greater allowance (similar in concept how the income-tax credit is awarded for such things as the installation of energy-saving windows). And, that family allowance (proposed now for all families) might be phased-out for wealthy families (this phase-out likely to be based upon a requirement that total income henceforth would be reported in annual application). This would be full-circle, with that phase-out functioning in the fashion of a “back-door income tax.”

6. The Fair Tax does not really abolish the IRS.  BUT, the FreedomTax would achieve this goal for nearly everyone.  As a simple, tax-efficient income tax providing for the at-source taxation of most income, the FreedomTax would end the universal personal-return filing requirement. This reform will result in most people never again having to file a personal tax return to pay their personal tax to the IRS. The FreedomTax will result in a dramatic down-sizing of the IRS, effectively abolishing it from the lives of most people.

The Fair Tax amounts to a bait-and-switch proposal with the claim it would abolish the IRS. Indeed, it would abolish the IRS as an agency, BUT it would continue its intrusive and aggressive functions in a newly-created tax agency under a new name.

The Fair Tax is an ultra-high-rate tax proposal, and therefore is likely to face major compliance problems.  Its vast scope to tax all consumer-purchased goods and services at a 23% tax rate will give rise to huge compliance problems, particularly if a black market develops.  The proposed bill to enact the Fair Tax recognizes the compliance problems posed by the tax. It would establish a new IRS-like agency at the Federal level, the Sales Tax Bureau (the “STB”), which along with various State agencies would be charged with responsibility to enforce the tax.

Also, the Fair Tax bill would establish a reward system for violators, encouraged to be reported. It’s conceivable that the STB would be as interested in one’s affairs, as is the IRS.  You could be reported as a suspicious tax evader and visited by the STB. Even so, there might be spot-checking by STB agents, to check amongst one’s possessions for black-market purchases. Hence, every consumer in the brave, new world of the Fair Tax would be well-advised to retain all purchase receipts to show his tax paid and  have them matchable against all should-have-been-taxed articles.

In contrast, the FreedomTax would tax all income at a low flat rate of 10%. As already stated and not to be forgotten, the FreedomTax would tax most income at-source, freeing most Americans from ever again having to file a tax return with the IRS. For them, they would consider the IRS abolished. The FreedomTax is a simple, efficient income tax and would have greatly-reduced compliance burdens. It would reduce the Tax Code by an estimated 95%. It would save the Treasury billions in tax administration costs, including tax auditing costs. The result will be a dramatic downsizing of the IRS into a non-intrusive, ministerial agency, in stark contrast to the STB and State-enforcement agencies to be created by the Fair Tax.

James K. Jeanblanc is a CPA and Tax Counsel to the law firm Grove, Jaskiewicz & Cobert in Washington, DC. He is also Senior Fellow for Tax Policy at the Selous Foundation for Public Policy Research, author of The FreedomTax and a contributor to SFPPR News & Analysis.