Under the FairTax, we would basically all pay a “national sales tax” on goods and services, but we would not pay a tax on our income, and more importantly, our savings/investments (as well as tuition payments). In his Slate article, Steven Landsburg likens this to having no limit on how much you can put in your IRA (in a traditional IRA, you invest pretax income, then pay taxes on your investments later when you withdraw this money). Professor Landsburg also informs us that many economists support unlimited IRAs “on highly technical grounds”. This may be true, but I’m a little skeptical of Steven’s comparison.

First, in an IRA you pay a penalty if you withdraw your money too soon (before you are 60). Second, you eventually have to withdraw your money, and when you do you pay an income tax. Under the FairTax, neither assumption holds, so I don’t think it’s reasonable to simply cite support for unlimited IRAs to convince readers that the tax is a good idea. What’s more, the Slate article doesn’t actually cite anyone, so I can’t even check if these assumptions matter. Instead, I’ll just list several of my own concerns with the FairTax. As far as I can tell, these concerns do not apply to unlimited IRAs.

1. The most obvious concern with the FairTax is that a tax on consumption, or national sales tax, is regressive. In other words, we’d all pay a flat rate, but since less wealthy people spend most of their total income, they end up paying a larger fraction of their income in taxes. To fix this problem, the government could provide a tax rebate to low income households. The FairTax, however, would give a rebate to all households based on their number of children.

Any form of monthly rebate is a logistical challenge, but having a rebate that is not based on income basically simultaneously ensures that the rebate is small. For example, an individual making $60,000 a year will get a rebate of at most a few hundred dollars a month. As a result, their tax rate will necessarily be very close to that of a person earning $2,000,000 dollars a year. In other words, even if the FlatTax is technically “progressive”, tax rates flatten out very quickly. Meanwhile our income gap is rising, as the top 1% of house household incomes accounted for over 21% of all reported income in 2005.

2. Supporters of the FairTax often claim that, eventually, people spend what they make, so it’s not as if rich people avoid paying tax on most of their income. This just isn’t true. If you find yourself earning several million dollars a year, you will likely invest most of that money. These investments would generate a substantial amount of interest, and under the FairTax, are not taxed.

In four or five years, you will have a very large sum of money. It will be earning enough interest for you to live on, and you will have never paid taxes on any of it money. If you live modestly (spending say, a few hundred thousand dollars a year), your investment will continue to grow tax free. Since the FairTax does away with the Estate Tax, you’ll be able to pass your mass of cash on to your children, and no one will have every paid taxes on any of it. In short, the FairTax is great if you’ve just won the lottery or received a ginormous holiday bonus, but it’s not nearly as hot if you’re building up your nest egg by saving %10 percent of your income each year.

3. The most appealing aspect of the FairTax is probably its apparent simplicity. Rather than dealing with a bunch of deductions and tax loop holes, we simply all pay taxes whenever we spend money, then we get rebates. Still, providing every household in America with a monthly rebate, seems like a real challenge. Furthermore, a simple rebate scheme, one that doesn’t depend on income or spending, isn’t particularly fair (see point 1 above). A more elaborate rebate scheme, however, could end up being quite complicated as well as susceptible to fraud.

Furthermore, under a FairTax, all purchases aren’t actually taxed, since you need to avoid taxing the same good twice. If you own a clothing store, for example, you can buy clothes tax free, if you then sell them in your store. Also, used goods are also not taxed. I’m not clear that it’s always so easy determine what should be taxed, however. If you buy fabric, pay taxes on it, and then use that fabric to make a suit, what tax should be paid on the suit? Also, what about if I fix up my car myself before selling it? According to Wikipedia, the concern here is that the FairTax is retail sales tax rather than a value added tax.

Another issue with the FairTax is the potential for a large underground economy. For example, goods that were never properly accounted for could be sold directly for cash. Similarly, a retailer might artificially mark down prices, but accept cash from customers on the side. There are lots of ways that one could imagine selling goods in a tax free fashion, but there are also lots of ways one can avoid paying taxes now. This isn’t necessarily a short-coming of the FairTax, but it is a reason to be skeptical of it’s simplicity. Perhaps FairTax supporters should just focus on simplifying existing tax code instead.