Everybody hates the IRS during tax season, except for the 85 percent of Americans who get a refund.
In fact, 47 to 51 percent of people who file income tax returns do not even pay income tax, according to the Tax Foundation in Washington, D.C. They file tax returns to get the generous Earned Income Tax Credit (EITC) and the Child Tax credit for households with children. A worker with three children and an income of $12,750 can get a refund of $8,751 from these credits, and without any payroll withholding.
In essence, the income tax has become one of America’s largest welfare programs.
Bribed with Our Own Money
The payroll withholding system was created in 1942 to make working families pay for the war against Japan and Germany. Milton and Rose Friedman’s autobiography has an excellent story about how “pay as you go” was set up to make sure workers paid the higher war taxes.
Before the war, only wealthy people had to file tax returns, because most people’s incomes were less than their personal exemptions. But Congress and the War Department needed more money, so tax collections expanded. Collecting the money in advance, with payroll withholding, was a quick solution.
Today, since most people live on narrow budget margins, with little surplus from week to week, it can be stressful to owe the IRS a balance due on April 17. To avoid that stress, your paycheck tax withholding can be a bit larger each payday, and the surplus is returned in the form of a tax refund the following February. Some people use this refund as a form of a savings account, by splurging on something they normally wouldn’t with the unexpected money.
However, what many do not realize is that the payroll withholding tables published by the IRS for employers are actually tilted to give workers a refund. So, if a family of four chose four allowances on the W-4 form, which employers use, the formula the payroll department uses will guarantee a surplus, and thus, a refund next February.
This means that the withholding system bribes taxpayers with their own money to file tax forms on time, even early, to get their money back.
The EITC and the Child Tax Credit cause a mania among the lowest income Americans, who come to H&R Block and other tax companies as soon as their W-2 forms are released – because the refunds that include those tax credits are very generous.
The FairTax “Prebate” Is Worse
You might have heard of the FairTax, as its popularity was expanded during the brief presidential campaign of Herman Cain in the Republican debates, when he proposed his “9-9-9” version. Radio talk show host Neal Boortz also wrote on the subject in books that were on the New York Times best-seller list for several months in 2005 and 2008. And there has been legislation introduced in the Senate and House of Representatives to enact such a national sales tax—and many Congressmen are co-sponsors. It is a cheap thing for a member of Congress to co-sponsor such a bill, since it is very unlikely to pass. Boortz is based in Georgia, and the legislation’s chief sponsors are from that state.
FairTax.org and popular writers like Neal Boortz have promoted the FairTax as a way to get rid of the IRS and liberate Americans from the oppressive tyranny of government tax collections. However, take a closer look and you’ll find it is almost exactly the opposite kind of scheme than it claims to be.
If enacted, the FairTax would require every American to be registered with the IRS and keep a current address and bank account information on file with the government to receive regular tax “prebates.”
The FairTax is a national retail sales tax. And a national retail sales tax is a flat tax. Sales tax rates, which most states impose, are flat rates on all transactions subject to the tax. Some states tax goods and services; other states only tax goods sold at retail and exempt wholesale and intermediate products. A value-added tax is a sales tax that does not exempt intermediate products, but allows a rebate on subsequent sales for producers, so the tax is not compounded over many stages of production.
The FairTax is supposed to be a tax only on final sales, although it is sometimes not clear when a sale is “final” and not part of a continuing series of production steps.
The problem with a flat tax, in today’s political society, is that most people believe “the rich” should pay more and “the poor” should get tax credits and exemptions, particularly if they have children.
But a flat tax is the same rate for everyone.
Another problem with a retail sales tax is that it only taxes items purchased for consumption. It does not tax savings. Higher income families have savings for retirement and college funds, while lower income families are always in debt. The sales tax would exempt savings and collect taxes even when a family borrows money to buy a new TV or repair an old car.
So if you believe a family’s “income” is the proper way to think about tax rates, a sales tax is “regressive.”
The solution proposed by advocates of the FairTax is a rebate. They call it a “prebate” because the plan would give a rebate in advance to every American family. The families would be paying the national sales tax every day, at the grocery store and the gas station, so it would be hard for them to wait until next year to get a rebate. Since the “prebate” is paid in advance, Americans will have enough money to give to a cashier for the tax when they go shopping. The “prebate” would be received as a check in the mail, or deposited to a bank account, each month – similar to how Social Security payments are made, or how food stamps are distributed on debit cards.
It’s a frightening thought that every American would depend on the automatic gift of money each month from the government.
It is surprising to me that Neal Boortz, who calls himself a “libertarian,” would promote this idea. Recall that Libertarians are opposed to taxes, and they oppose the idea that people should become dependent on the government. But, clearly, after such a system of “prebate” payments was created, the main issue among voters would be how much political candidates would promise to increase the monthly payments when running for office. If any politician suggested cutting the payments, it would be like getting caught on Twitter with lewd photos. Nobody today proposes cutting Social Security benefits, not even Ron Paul or Gary Johnson.
Sound Familiar?
George McGovern’s “Demogrant” Proposal in 1972
The idea of a “prebate” for the FairTax is very similar to an idea that presidential candidate George McGovern proposed in 1972. He suggested that every American should be given a $1,000 tax credit, which would be refunded to poor people. This idea was widely criticized, not least by Sen. Hubert Humphrey who used it against him in the California primary election. Even liberals in the Democratic Party thought it was too “left wing” for prime time.
The Earned Income Tax credit was then enacted in 1975, and it has increased continually with each new tax law. The Republican administration joined with the Democratic Congress to enact a variation of the McGovern idea, because “fairness” in the tax system is always a political football. “Fairness” is commonly defined as taxing someone else who is not “paying a fair share,” and getting a tax cut for yourself and your friends. The McGovern idea of giving tax credits is at the center of the FairTax idea of a “prebate.” The tax is not “fair” if it is really a flat tax, as most people think about these things.
But the really important question we need to ask is about taxes in general. Is it “fair” to take money from some people, who earn it or receive it by trading with others voluntarily for a profit, and give it to others?
The question is never asked.
