As a first-semester student in Presidio School of Management’s MBA in Sustainable Management program, I’ve been learning quite a bit about what sustainability really means, and what it will take for business and our economy to become sustainable. One topic that gets discussed quite a bit is how to encourage people and business to use natural resources more efficiently, while encouraging them to use more of the one resource that isn’t in short supply: human labor. Inevitably, the discussion turns to tax policy, specifically, how the US income tax system makes labor more expensive while discouraging savings and encouraging consumption. One professor suggested that a possible solution is to stop taxing labor and begin to tax things that we want less of, like carbon emissions.
This really caught my attention, because I have been a long-time advocate of the FairTax legislation, which would replace the Federal income tax and payroll taxes, and many other federal taxes with a consumption tax. It occurred to me that enacting the FairTax would, in addition to a myriad of other benefits, solve one piece of the puzzle, namely untaxing labor and making labor more attractive in the marketplace. I also realized that there are a number of other benefits of the FairTax which apply to sustainability, such as encouraging savings and discouraging consumption, encouraging purchases of used items (re-use), encouraging investment in education, and creating a safety net for the poor. In the remainder of this article, I will explain how the FairTax can be a positive tool in the effort to make the U.S. more sustainable.
I would like to start by stating a couple of things straight away: I am currently a volunteer community coordinator for American for Fair Taxation, the organization whose mission it is to get the FairTax bill passed, and, as such, I would not consider myself a disinterested observer by any means. I am very passionate about changing our tax system.
Secondly, I do not believe that the FairTax is some “magic bullet” that can solve all sustainability problems. I firmly believe that enacting the FairTax is the first step in moving towards a tax system that works positively for people and the environment. It will mostly affect labor and consumption. I believe that the next step would be to start implementing taxes on natural capital, so-called “eco-taxes“, so that the price of finished goods more accurately reflects their real cost to society and the environment. If eco-taxes were done right, the FairTax rate could be gradually reduced as these new systems are implemented, and the final price of goods could stay the same, and would accurately reflect their “true” price.
I also want to mention that the FairTax does not try to address waste in government spending. (It only removes the waste from income tax collection) It is designed to be “revenue-neutral”, so that it exactly replaces the current levels of government spending. What this means is that under the new system, all government expenditures would be fully funded, including Social Security and Medicare. While these are important issues that need to be addressed, the writers of the legislation felt that they would overly complicate things, and make it impossible to otherwise implement the needed tax reforms.
The FairTax legislation is a nonpartisan effort to create a simple, fair and transparent tax system which does not favor any particular ideology. Here is a particularly good explanation of the FairTax from Wikipedia.org:
The FairTax (H.R.25/S.1025) is a proposal in the United States Congress for changing tax laws to replace the Internal Revenue Service (IRS) and all federal income taxes (including AMT), payroll taxes (including Social Security and Medicare taxes), corporate taxes, capital gains taxes, gift taxes, and estate taxes with a national retail sales tax, to be levied once at the point of purchase on all new goods and services. The proposal also calls for a monthly tax rebate to households of citizens and legal resident aliens, to “untax” purchases up to the poverty level. The sales tax rate, as defined in the legislation, is 23% of the total register price (23¬¢ of every $1 – calculated the same way as income taxes), which is comparable to a 30% traditional state sales tax (30¬¢ on top of every $1). Because the U.S. tax system has a hidden effect on prices, it is expected that moving to the FairTax would decrease production costs from the removal of business taxes and compliance costs, which is predicted to offset a portion of the FairTax effect on prices.
Due to the rebate, the effective tax rate is progressive on consumption and could result in a tax burden of zero or less…the plan’s supporters argue that it would increase purchasing power, and decrease tax burdens by broadening the tax base and effectively taxing wealth. Many mainstream economists and tax experts believe consumption taxes, such as the FairTax, would have a positive impact on savings and investment (not taxed), ease of tax compliance, increased economic growth, incentives for international business to locate in the U.S., and increased U.S. international competitiveness (border tax adjustment in global trade).
The FairTax bill was first introduced into Congress in 1999, and has been re-introduced in each successive congress, substantially unaltered. The FairTax has been the most successful tax reform legislation to date, garnering 56 co-sponsors in the 108th Congress, 61 in the 109th, and 64 in the 110th Congress (2007). By comparison, the Freedom Flat Tax bill, has only 4 cosponsors in the 110th Congress. Very recently, several 2008 presidential candidates have expressed support for the FairTax.
I am sure you are painfully aware of the many problems with the IRS and the income and payroll tax system in general, so I will not bore you with a lengthy discussion of those. This article give a good overview of the costs of compliance inherent in the current system and this article talks about the origins of the income tax.
The greatest benefits of moving away from an income and payroll tax based system lie in the effects on wage earners. Under the current system, employees have income and payroll taxes (social security and medicare) deducted from their paychecks, before they get a chance to decide what to do with that money. In addition, employers pay a share of payroll taxes which is equal to the amount that employees pay. Since this costs is borne fully by the employer, this
essentially a tax on labor. The effects of a labor tax are decreased employment, decreased pay and increased prices on goods. It should also be noted that payroll taxes disproportionately affect low- and middle- income workers, because the tax is only applied to the first $90,000 of wages. By eliminating the income and payroll taxes, real wages will increase, employment will increase as the cost of labor goes down, and consequently, the price of goods will decrease as well.
My personally favorite benefit of the FairTax is having more control over how much tax I pay and how much I can save. By eliminating the income and payroll taxes, and enacting a sales tax, I now have taken back control of my money from the government, who currently considers it “their” money first. Now, I don’t have to worry about 401(k)s, medical savings plans, etc., because everything is now pre-tax!! Now, if I want to save my money to buy a house, I can save as much as I want, and not have to pay any tax on it, at least until I buy the house (if it’s used, I won’t have to pay any tax…more on that later). If I simply want to pay less taxes, I can endeavor to purchase less. So, you can see how keeping the income tax in place is discouraging people to save, which, in turn, encourages them to consume more, and we all know that consuming more is a bad thing.
Encouraging people to reuse products instead of purchasing new products is a great way to reduce waste and also resource consumption and emissions, because reuse removes the demand for a new product and also keeps a previous product from being disposed of. By only taxing new goods, and only taxing them once at the initial point of purchase, the FairTax will create a new incentive for consumers to purchase used goods, including houses which are not new construction.
When many people think about a sales tax, they assume that the sales tax will not be progressive, and will negatively affect the poor, since poor people spend a much higher percentage of their income on necessities. This is not so under the FairTax plan, because each legal taxpayer in the U.S. will receive a monthly check, called the “prebate”, for the amount of tax they would pay on purchases up to the poverty level of spending. This would protect all families from paying sales tax on the necessities of life. Thus, a couple with two children receives a prebate of $6,297 per year, allowing them to consume $27,380 free of tax and reducing the effective tax rate on a family spending $54,760 to 11.5 percent. In contrast, all families today, even the poor, pay 15.3 percent in payroll taxes. The FairTax is the only tax reform plan that entirely eliminates taxes for the poor because it is the only tax reform plan that repeals the high and regressive payroll tax. In addition, taxpayers who earn well below the poverty level wage will see their effective tax rate drop, up to the point where they actually have a negative tax rate. This is commonly known as creating a “floor” for the worst off in our society, such as homeless persons, by providing them with a basic level of income.
The FairTax considers education to be an investment, and, as such, is not taxed. This makes it much easier for people to afford to pay for college, and, with the previously mentioned incentive to save, helps them to save for college as well. In creating a sustainable world, we want to begin to use people more instead of natural resources, and I can think of no better way to do this than by having more people go to college.
On a final note, elimination of the IRS and the income tax, and implementing a consumption tax will have one very direct environmental impact: a massive reduction in the use of paper. Reportedly, the IRS sends out 8 billion pages of forms and instructions each year. Laid end to end, they would stretch 28 times around the earth. Nearly 300,000 trees are cut down yearly to produce the paper for all the IRS forms and instructions. A consumption tax, administered by the states, has a much smaller bureaucracy and a greatly reduced need for paper consumption.
There are so many benefits to a consumption tax over an income tax, and so many detriments to the IRS and our current tax system that I could go on indefinitely, which, I’m sure would bore the pants off of you! You may also find that a lot of my points may bring up more questions than they answer. I will gladly answer any and all questions which you may have.
I find that the income tax challenge seems as insurmountable as the sustainability challenge. I would like to put forth that they are actually the same struggle, the struggle for a fair and equitable world, with an economy that takes into account the real costs of production to the world when it prices its goods.
Steve Puma is currently pursuing an MBA in Sustainable Management from Presidio School of Management while also working as an IT consultant in San Francisco. Steve’s interests include green building, New Urbanism, renewable energy and thinking about the big picture.
He is also a big supporter of the FairTax Act of 2007, which abolishes the IRS and replaces it with a national retail sales tax.