Thanks to some positive feedback on my recent piece, I have decided to dig deeper into the Fair Tax Act of 2023. The Reader’s Digest version of the act is that it eliminates federal corporate and individual income tax, payroll taxes that fund Social Security and Medicare, estate tax and gift tax.
In their place there will be a federal sales tax on most goods and services consumed in the United States. For the fiscal year ending September 30, 2023 the taxes proposed to be replaced by the sales tax are projected in the budget to yield $4.314 trillion in revenue. I took a pretty deep dive into the act in this piece and as noted have had some positive feedback.
In this piece I will cover some odd and ends that I have thought of and respond to some commentary.
The Effective Date
The Fair Tax Act has an effective date of January 1, 2023, but the provisions set a rate for the year 2025 and have December 31, 2024 as the transition date for assets. This puzzled me, but I just went forward on the assumption that January 1, 2025 was the real effective date. Turns out I am not alone in being troubled by this. I heard from Kerry Bowers. Mr. Bowers ran for the Republican nomination for President in 2016 and the Fair Tax was an important part of his platform.
As it turns out the Fair Tax Act has been regularly submitted since the Fair Tax Act of 1999. I have not gone through the versions word by word, but there does not appear to be much difference between them other that dates. The Fair Tax Act of 2017 has an effective date of January 1. 2019 and all the earlier ones had an effective date two years out as opposed to the more recent ones that have an effective date that would be retroactive, but inconsistent dates thereafter. I have not had any luck contacting Mr. Bowers, so I will leave it at that.
Other History – Stolen Name?
The first introduction of the concept appears to be the National Retail Sales Tax Act of 1996. That act had a sales tax structured like the one in the Fair Tax Act of 2023 but it had a lower rate- a 15% inclusive rate compared to the 23% inclusive rate of the Fair Tax. It did not eliminate the Social Security and Medicare tax. In 1985 Senator Bill Bradley introduced the Fair Tax Act of 1985. That had nothing at all to do with a sales tax. The available summary indicated it involved drastic rate cuts and base broadening. It appears it was a step in the journey to the Tax Reform Act of 1986.
The Rate Debate
On Twitter I have engaged in a fairly pointless debate about the rate. The rate in the bill is 23% for 2025 but it is on the gross amount spent. When people talk about sales tax, the rate is usually, if not always, stated on the pretax price of the item. The 23% tax inclusive rate works out to a 29.87% add on rate, which in most discussions is rounded to 30%. People who use the 23% rate in discussion have a good argument. It makes it apples to apples with income tax rates. If you make a hundred bucks and pay a 23% income tax, you have $77 to spend. On the other hand referring to it simply as a sales tax of 23% when every other sales tax is on the net is probably misleading.
I have not found anything definitive on whether the 23% rate will produce the $4.314 trillion coming from the taxes that it is supposed to replace. There is optimism among the advocates that taking the strain of the income and payroll taxes off the economy will have a positive effect.
For what it is worth, it appears that the Social Security and Medicare provisions of the Act will automatically adjust the 23% rate so that it will yield what the payroll taxes would have brought in. In the legislation the general revenue rate is fixed at 14.91% but the Social Security and Medicare rates vary from year to year after 2025.
Social Security And Medicare
The new tax funds Social Security and Medicare by breaking the receipts into three buckets, For 2025 it will be 64.83% to general revenue 27.43% to Social Security and 7.74% to Medicare. After 2025 there will be explicit rates going to Social Security and Medicare based on what would have been collected had the 12.4% and 3.9% rates on wages and self employment income been if effect. As I read it, it appears that this will automatically adjust the overall sales tax rate.
There will still be reporting of wages and self-employment income for the purpose of determining benefits. I could see some serious shenanigans going on here. People making less than the social security maximum won’t want tax free fringe benefits anymore. S corporation owners will definitely want to raise their salaries if they think about it.
I am struggling to make sense of the definition of self-employment income Section 903(c) which is gross income received for taxable property or services minus gross payments made for taxable property or services and wages. Regardless, I suspect the number of people reporting making more that $160,000 per year will skyrocket in states without income tax.
Administration Cost
In Fiscal Year 2022 the IRS got $12.6 billion. The act does not actually totally abolish the IRS. It kind of renames it. There has to be some sort of federal administration of the sales tax, which is going to cost something. And then there are the parts of the Internal Revenue Code that were not repealed. It costs something to collect them. The heavy lifting on the tax collection is supposed to be done by the states if they want to. Assume for the sake of argument that they all do. The federal government will have to pay them $10.785 billion if they bring in the $4.314 trillion that the repealed taxes are supposed to yield. A like amount is supposed to be paid as a credit to the businesses for collecting the tax. If you count the latter the cost to the federal government of collecting the Fair Tax will be much higher than is currently spent on the IRS.
Who Needs To Register ?
When I look at how the various sections fit together or maybe don’t I get a little confused. Under Section 102 no tax is imposed on taxable property or services used for business or investment purposes. It is not clear to me what someone like me who purely provides business to business services is supposed to do. Am I supposed to register and charge my customers who will then get a credit? Or can I just get some sort of assurance from them that my services are used in their business. What is further confusing is that the definition of self-employment income starts with gross income from taxable services. Does that count business to business services? Implicitly it seems like to should.
How Many Pages?
You have to give the Fair Tax Act of 2023 credit for substantially shrinking the Internal Revenue Code, but some commentators get a little carried away with it.
The 70,000 page meme has been bugging me for some time. It appears to be based on the page count of the 25 volume CCH Standard Federal Tax Reporter at some point in the not so distant past. That is way more than the Code although way less than the entire body of tax authority.
The problem is it is hard to say how many pages the Code actually is, since nobody sensible uses physical books for this sort of thing anymore. And any physical books I can find have a lot of notes embedded. What I did find was the site of Office of the Law Revision Counsel United States Code. I downloaded Title 26. It came to 6,979 pages. It is inflated by a lot of statutory reference material. Nonetheless it is less than 10% of 70,000 pages.
The Fair Tax Act of 2023 with less than 130 pages (when you kick out the enacting language) does not replace all of it, but it replaces a lot. It kicks out three of the ten subtitles, but those three subtitles along with their cross-referencing material and an 87 page historic table at the beginning take up 4,711 pages. Cutting 4,711 pages to 130 is very impressive even if the 4,711 is a bit inflated.
Unfortunately the vast body of tax authority which is much larger than the 70,000 pages is not really getting any smaller when you consider some of the language in the act. We have in the new Internal Revenue Code of 2023 the following:
In Section 1(c)(2) concerning secondary aids to statutory construction – …”the meaning and construction of concepts and terms used in the Internal Revenue Code of 1986 as in effect before the effective date of this subtitle”
That clause smuggles in all the existing case law which is a heck of a lot more than 70,000 pages. The Code governing the sales tax will get more complicated as people find ways to game it. Mixed use and used property seem to offer a lot of opportunity for shenanigans. Further we have the example of the Tax Reform Act of 1986 which was a major simplification. It was followed by new layers of complexity. What will prevent this happening to the sales tax ?
Overall
I almost wish that the Fair Tax Act of 2023 would pass just to see how it would actually work, which is the only way we will ever know. The transition period would definitely be quite exciting.