Neither the flat tax nor the FairTax plans are radically new ideas. The U.S. implemented a flat income tax for a short time after the Civil War. Many states and countries use a flat tax today, but the specific plan for the FairTax is relatively new and dates back to the mid-1990s. Did you know that the U.S. federal government relied on sales tax before the income tax was fully enforced with the passing of the 16th Amendment in 1913? To understand how radically different the two ideas are, let's delve into how each would work.
Supporters of a flat tax believe that the only fair income tax would apply an equal percentage to all taxpayers. Specifically, many supporters advocate a rate of 17 percent. In other words, if one person earned $50,000 a year and another earned $300,000 a year, both would pay 17 percent of their income to the federal government. Although flat tax plans do away with most of the exemptions, loopholes and deductions that result in much of the complexity of the current system, many versions include an exemption for families [source: Mitchell]. Advocates say that, with a flat tax, most people could figure their annual taxes on a simple postcard.
The most notable element of the FairTax is that it would completely abolish Federal income and corporate taxes as well as the Internal Revenue Service. Instead, it would institute a national sales tax that would pull in enough to cover all government programs -- taking revenue from what is spent rather than what is earned [source: FairTax.org]. To make sure that the poor don't suffer the brunt of these sales taxes, the government would send a monthly check called a prebate to families that would cover taxes on necessary expenses. The idea is that "no American pays tax on necessities" [source: AFT]. The check amount would be up to the poverty level; a family doesn't need to fall below the poverty line to receive one.
The two plans have a lot in common: They both eliminate many forms of taxes and claim to be fairer than the current system. Proponents of both the flat tax and the FairTax say that their plan will improve everyone's situation because it will promote economic growth by eliminating the capital gains tax and double taxation that currently discourages productive activity like saving, investing and job creation [source: Mitchell].
Critics point to many potential transition problems with these tax plans. For the flat tax, people expecting a tax advantage won't get it. For instance, homeowners can no longer expect a tax deduction for the interest on their mortgage [source: Weisman]. For the FairTax, some argue that immediately before we switch over, consumers will buy items on credit without the tax and then pay for the credit for years to come with untaxed income.
In response to these accusations, the Tax Foundation group -- which aligns itself with neither plan -- argues that any problems with transition to the new system are worth the benefits each would produce [source: Hodge].
Neither plan has yet gained enough support in Congress to overhaul the existing system. Time will tell if Americans will see one of these, or perhaps some other plan, take over the unpopular tax code.
Related HowStuffWorks Articles
More Great Links
- FairTax.org. "Thumbnail sketch of the FairTax." FairTax.org. [Sept. 12, 2008] http://www.fairtax.org/PDF/FairTaxThumbnailSketch.pdf
- Hodge, Scott A. "Tax Reform: Flat Tax or FairTax?" The Tax Foundation. Aug. 20, 2007. http://www.taxfoundation.org/publications/show/22562.html
- IRS. "New IRS Study Provides Preliminary Tax Gap Estimate." Internal Revenue Service. [Sept. 12, 2008] http://www.irs.gov/newsroom/article/0,,id=137247,00.html
- Mitchell, Daniel J. Ph.D. "A Brief Guide to the Flat Tax." The Heritage Foundation. July 7, 2005. [Sept. 12, 2008] http://www.heritage.org/Research/Taxes/upload/80562_1.pdf