There is a tax system that everyone (except, maybe, for tax preparers and accountants) should support, and that is the Fair Tax.  Today we’ll talk about what this tax is, how it works, and what the advantages are over other taxes like income tax.

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What is the Fair Tax?

The Fair Tax is a consumption tax designed to make it easy for everyone to pay their taxes while allowing governments to collect the money needed for operations and services. By a “consumption tax,” it is meant that the tax is paid when money is spent, like a sales tax, rather than when it is earned.  The Fair Tax would replace all of the other taxes that are currently levied by the Federal Government, including the Income Tax, Payroll Taxes (Social Security and Medicare), and corporate income taxes. 

Some of the basics of the tax are as follows:

The rate: The tax would be levied on all goods and services and paid by the consumer.  It is expected that the tax rate would be about 23% if current revenue levels are to be maintained.  While this may seem like a lot, consider that income taxes for the middle class are currently about 15%, Social Security Taxes are 12.5%, and Medicare taxes are a few percent.  Add these together and the Fair Tax sounds great. Many people would be paying less.

Prebates: Each citizen would receive a “prebate” at the beginning of the year to offset the amount of taxes paid. This would be a check to provide a refund, but before you spend the money.  Because everyone would receive the same prebate, those who make less money would end up paying less in taxes each year.  Some would pay no taxes because the prebate would equal or exceed the amount they pay in tax, as is currently the case for about 50% of Americans.

Nothing taken out of paychecks: Because all other taxes would be abolished, one would receive one’s entire paycheck – no deductions – and would not need to file income taxes at the end of the year or keep track of cost bases and income sources. Your paycheck would be 10 to 30% bigger.

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Why should you support The Fair Tax

There are many advantages to this system over the current system.  A few of them are:

1) There is no need to file income taxes.  This means that there is no reason to keep all of that paperwork (or generate that paperwork), there is no need to spend hours teach year trying to figure out tax forms, and there is no need to pay a tax preparer each year just to comply with the law.  The tax would be figured out automatically when you buy things and collected by the retailer just like sales tax.

2) Those who save would pay less in taxes, motivating people to save.  Conversely, those who spend would pay more in taxes, motivating people not to spend.  Note that the prebate would prevent those with little income from paying a bigger portion of their income in taxes.  For example, if the tax rate is 20% and the prebate is $10,000 per year, no one making less than $50,000 per year would pay anything in taxes even if they spent their entire income. the tax would therefore not be regressive, at least until you make far more than a basic income.

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3)  The expenses borne by businesses for tax preparation and tax avoidance would be eliminated. Since there would be no need to keep money overseas, depreciate equipment, or play other games to reduce taxes, these costs would be eliminated, allowing businesses to lower prices and shareholders to make more.  Also note that all of those funds that are currently sitting overseas to avoid taxes would come back and be invested in our economy.

4)  All money spent would be subject to taxes, making it more difficult to cheat.  Money earned by drug sales and prostitution would be taxed when it was spent just like money earned from working at a restaurant.  Everyone would be taxed rather than just those who follow the rules.  This means that the tax rates for everyone who is currently paying their fair share would be less.

5)  Because business costs for compliance would be less, prices of things would decrease.  It is expected that this decrease would largely offset the 23% tax. Instead of paying for the store you’re buying from to comply and minimize their taxes, you’d be able to spend everything on products.

6)  There would be no need for college savings accounts, medical savings accounts, and the like.  There would be no income taxes, so there would be no reason to shelter money from taxation.  Likewise, there would be no need for IRAs.  Think of all the time that could be saved.

So, what do we need to do to get this in place?

If this sounds good, please check out the Fair Tax Website for more information.  All of the details are laid out there showing how The Fair Tax would work.

Then tell a friend or three. 

Finally, write to your members of Congress or call them and tell them that you would like to enact the Fair Tax.  If enough people speak up, we can get this passed. Then we could never need to file taxes again.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.