Fair Tax Act Of 2023 Has Rate That Varies
I have been having silly arguments with Fair Tax enthusiasts. The Fair Tax Act of 2023 would be a tremendous simplification of federal taxation. It does not, however, reduce 70,000 pages to 131 and it does not entirely eliminate the Internal Revenue Code. Also it does not abolish the IRS.
It renames parts of it and has $10 billion or so, currently spent by the IRS to be spent by numerous state revenue agencies instead. Over my forty year career I have not found state employees to be easier to deal with than federal employees, so I don’t see what we would be gaining there.
And while much simpler than the current system, there is still some complexity. That is what I would like to tell you about, because some of that complexity is worrisome. All section references are to the Internal Revenue Code of 2023 as specified by the Fair Tax Act of 2023.
The Variable Rate
Discussions of the sales tax proposed in the Fair Tax Act of 2023 focus on the tax inclusive 23% rate. Using a tax inclusive rate makes it apples to apples with an income tax. If you make a hundred bucks and pay 23% you have $77 to spend. On the other hand every sales tax I know of is on the price without the tax. As an add on rate like other sales taxes the inclusive 23% rate is 29.87% and change, Those darn imprecise commentators call that 30%, but you and I aren’t going to put up with that.
Regardless of that silly argument and much more significantly the 23% inclusive rate will automatically vary based on the statute. That is because it is really the sum of three rates that produce three separate streams of revenue. One for general revenue, one for Social Security and one for Medicare (Sec 101(b)(3)) . In 2025 there is a percentage breakdown consistent with the 14.91% established for general revenue (Sec 101(b)(4)).
After 2025 the Social Security Administration determines the Social Security and Medicare rates (Sec 904(d)).
The old-age, survivors and disability insurance rate shall be that sales tax rate which is necessary to raise the same amount of revenue that would have been raised by imposing a 12.4 percent tax on the Social Security wage base (including self-employment income) as determined in accordance with chapter 21 of the Internal Revenue Code most recently in effect prior to the enactment of this Act. The rate shall be determined using actuarially sound methodology and announced at least 6 months prior to the beginning of the calendar year for which it applies.
I hate to be snarky, but you will note that we just smuggled some pages from the old code into the new, but it is fewer than fifty so not that big a deal. There is similar language for Medicare (“the hospital insurance rate”) aiming for 2.9% of the Medicare wage base.
Most business people I know discount the effect that paying social security taxes has on their future benefits causing many to scheme to lower their social security taxes. A common technique is to organize as an S corporation and take a significant part, if not all, of the income as distributions. Now wages and self-employment income will be reported to the Social Security Administration solely for the purpose of computing benefits. Well if that is all that is at stake, the more the merrier. And the better off people who were scheming to reduce Medicare tax can just relax about it.
I predict that the combination of those factors will have the Social Security Administration raising the sales tax rate. And note that unless Congress changes the law, Congress will have no say in the matter. What I find interesting is that this provision was in the Fair Tax Act of 1999 and with all the promotion of the 23% rate over the years nobody seems to pay much attention to the fact that the statute calls for automatic increases or, to be fair, decreases at the discretion of the Social Security Administration and its actuaries.
The earliest iteration of the Fair Tax concept, the National Sales Tax Act of 1997 did not repeal Social Security and Medicare taxes and had a rate of 15%.
Section 202 The Business Use Conversion Credit
There have been a few Code Sections that over the years have entered into common vocabulary – 401(k), 501(c)(3) maybe 1031 and 179 if you move in certain circles. The latter two are sometimes used as verbs. If the Fair Tax passes Section 202 will probably be like that. Sellers are required to state the tax on your bills. You will grimace when that $770 laptop comes in at $1,000, think for a second and decide why it is that you can 202 that sucker. There are people I have encountered over the years who will 202 just about everything they buy.
Registered seller will deduct the business use conversion credit from the amount they remit when they send in the sales tax every month. Person who are not registered sellers will have a form that they can use to apply for a refund. The 202 credit is for taxes you paid on taxable property and services which commenced to be used during such month 95% or more for business purposes. “Business purposes” means for resale, to produce, provide, render, or sell taxable property or services or in furtherance of other bona fide business purposes (Sec 102(b)(.
Now “taxable property or service” is any property or service except for used property or intangible property. Used property is property on which tax was paid without anybody claiming a credit or that was held for nonbusiness purposes on December 31, 2024. It would seem that producing intangible property or dealing in used property are trades or businesses so people in those businesses would be claiming 202 credit for anything they paid tax on to use in their business. So they would be getting refunds every month since what they are selling is not taxable.
The business use conversion credit is based on the fair market value of the property when it is converted limited by the amount of tax actually paid when the property was acquired. To qualify for the full credit the property has to be used at least 95% for business. Section 705 gets into what happens with property or services that has business use below the 95% threshold. The credit is spread out over thirty years for real property, 7 years for most tangible personal property and 5 years for vehicles with periods for other types to be determined by regulation
The credit is figured each month based on mileage for vehicles, floor space for buildings and time used for other tangible property, You account for the credit on a calendar year basis and then claim it in any month following that year Sec 705(b). You are supposed to be doing this sort of tracking for income tax compliance and a lot more, so this does not mean there is not major simplification going on. Still it is not quite as simple as the Fair Tax enthusiasts project.
Specially Treated Industries
I think the exclusion of used property from taxation may open up a wide area of potential abuse. Unless I am misreading the statute the business of dealing in used property is still a business that can get 202 credits. Used property is property on which the tax was paid and no credit under sections 202, 203 or 205 was claimed or property that was held other than for a business purpose on December 31, 2024. How much can you fix up and refurbish used property and still have it be used ?
Section 702 has special provisions for “Gaming Activities”. It is not about family game night. It is about gambling. The term “chance” is defined in (Sec 702(b)) and includes lottery tickets, chips, wagers and anything else like that you can think of. Chances are not a taxable property or service (Sec 702(c)). Instead there is a special tax on “Gaming Services” (Sec 702(e)). The tax is 23% of the proceeds less the payoffs and gambling specific taxes. You can see the logic. The tax is on what the marks collectively lose.
Financial intermediation services rate a chapter – Chapter 8. It is only seven pages, but I still have not figured it out.
A general theme of the Fair Tax Act of 2023 is to make things more taxpayer friendly. Some of the friendly provision will be catnip to fraudsters. In Section 1 Principles of Interpretation besides the presumption of innocence in criminal matters there is a presumption of lawful behavior in civil matters.
Section 505 has something which is a little lawyerly for me.
In all disputes concerning taxes imposed by this subtitle, the person engaged in a dispute with the sales tax administering authority or the Secretary, as the case may be, shall have the burden of production of documents and records but the sales tax administering authority or the Secretary shall have the burden of persuasion.
One of the concepts that has been burned into my consciousness from reading opinions is that IRS determinations start with a presumption of correctness. I couldn’t find the source of it. Lew Taishoff helped me out indicating that it was judge made law.
The deficiency determination asserted by the Commissioner in the notice of deficiency is presumed to be correct and the taxpayer has the burden of proving it to be wrong. Welch v. Helvering, 290 U.S. 111 (1933). The presumption of correctness is a procedural device that places the burden of producing evidence to rebut the presumption on the taxpayer. United States v. Janis, 428 U.S. 433, 441 (1976); Barnes v. Commissioner, 408 F.2d 65, 68 (7th Cir. 1969). Justification for the presumption of correctness lies in the Government’s strong need to accomplish swift collection of revenues and in the need to encourage taxpayer record keeping. Carson v. United States, 560 F.2d 693, 696 (5th Cir. 1977).
He confirmed that putting the “burden of persuasion” on the sales tax authorities would reverse that long held rule.
About That Page Count
When Fair Tax enthusiast claim they have take the tax law from 70,000 pages to 131, I don’t think they worry about where the 70,000 came from. As best I can determine it was the page count of one of the services like CCH at some point. That is many more pages than the Code even if there is a large print version. I don’t have a version of the Code that is printed without a lot of reference material, but a pdf I just downloaded from an official source has about 7,000 pages including a lot of reference material, The part of the Code repealed by the Fair Tax Act of 2023 was over 4,000 pages (including reference material) so they did do a good job of shrinking it.
The body of tax authority is another matter. It is much larger than 70,000 page. Including case law it must run into the millions. And the Fair Tax Act of 2023 will not make it any smaller. Section 1(c)(3) indicates that a secondary aid to statutory construction is 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 pretty well smuggles back in all the 70,000 plus pages.
Take a look at the the 1913 legislation that initiated the income tax – An Act to reduce tariff duties and to provide revenue for the Government, and for other purposes – The income tax portion starting on page 166 runs about fifteen pages (granted the print is pretty small).
The sales tax in the Fair Tax Act of 2023 incudes special treatment for used property, intangible property, gambling and financial intermediation. Do you think it will pass or stay unamended without other industries making the case that they are also special? Will Congress be able to resist carving out a host of exceptions and rebates? The other thing that will add to complexity is the need to deal with shenanigans.
There is a good case to be made for shifting to a consumption tax. Karl Smith makes it in a Washington Post column Republican Tax Proposals Aren’t as Bonkers as They Sound.
Economists have long known that flat consumption taxes are less damaging to economic growth than the current system. More recent research suggests that this advantage grows exponentially as tax rates rise. The reason the Fair Tax Act isn’t a realistic way of implementing a flat consumption tax is that, like any sales tax, it places the entire burden of tax collection on retailers. This can work as long as tax rates are low, but once they start to climb into the double digits, selling goods and services “off the books” at a discount becomes so profitable that honest retailers could find themselves run of business.
My point is that even the proposal on the table is not nearly as simple as the Fair Tax enthusiasts make it out to be. And it will only get more complicated if it moves forward.