When it comes to consumption taxes, the United States has always taken a different approach than the rest of the world. There is a proposal, however, that is currently sitting in the U.S. House that would upend the U.S. tax system and more closely align it with the rest of the world. While this bill is extremely unlikely to become law, it’s worth taking a moment to examine how tax compliance would radically change if the bill is enacted and the United States adopts a national sales tax.
How is the United States “different”?
The United States sales tax system took shape in the 1920s and 30s. Depending on where you look, either West Virginia, Kentucky or Mississippi was the first state to adopt such a levy. Regardless, every state in the union, aside from New Hampshire, Oregon, Montana, Alaska and Delaware, imposes a statewide sales tax. Even the District of Columbia and the Commonwealth of Puerto Rico have joined the chorus. When you add in separate local taxes applied at the county, city and district level there are more than 12,400 taxing jurisdictions in the country. In most of the rest of the world, consumption taxes are applied at the national level, with the national Value Added Tax (VAT) being essentially the same no matter where you may be within a country. While many VAT countries also impose corporate and personal income taxes, VAT revenue is an important component of national budgets. In early 2023, the Tax Foundation reported that within the OECD countries, consumption taxes represented 32% of all tax revenue. In the U.S., by contrast, sales tax represented only 16.6% of all tax revenue.
What is the FAIRtax?
For the last 20+ years, legislation has been introduced imposing a national sales tax and the 118th Congress is no exception. Specifically, Rep. Earl “Buddy” Carter (R-GA) introduced HR 25 – The FAIRtax Act of 2023. The bill currently has 25 co-sponsors and is sitting in the House Ways and Means Committee. To date, no equivalent bill has been introduced in the U.S. Senate. This bill has been garnering extra attention as Rep. Kevin McCarthy (R-CA), in his effort to become House Speaker, reportedly promised that the proposal would receive a floor vote.
The bill represents a radical change to taxation in the United States. It would:
- Abolish all federal taxes including the personal and corporate income tax, estate tax and payroll tax.
- De-fund the Internal Revenue Service after 2027.
- Apply a new national (destination-based) tax on sales of goods and services at the effective rate of 30% starting in 2025.
- While the language of the bill specifies a 23% rate, the effective rate is really 30%.
- The tax base would be very wide – including most goods and services.
- Goods and services “purchased for a business purpose in a trade or business” would not be taxed.
- State and local sales tax would not be abolished, meaning that some sales may be taxed at total rates exceeding 37%.
- Lawful U.S. residents would receive a monthly “pre-bate” equal to the income poverty level multiplied by the tax rate. It’s a little bit like the standard deduction that exists for income tax today.
- Sellers collecting this tax receive vendor compensation equal to $200 or one-quarter of 1% of the tax remitted.
How it would work
Since the IRS is abolished, the tax would be administered by state governments along with their own individual state and local sales tax. As it relates to remittance, the statute is somewhat confusing. According to the FAIRtax website, states would simply add an additional line on existing sales tax returns. This means if a seller is not currently obligated to register for state and local sales tax for a particular state, they would need to register to remit the FAIRtax. It also leaves up for interpretation the language in the statute that allows the Secretary of the Treasury to create a form to enable remittance, as well as the language that seems to impose a weekly prepayment for certain “large sellers.”
The states would be required to remit the funds to the U.S. Treasury within five days or receipt: maintaining an “administration fee” of one-quarter of 1% for themselves. The Treasury may opt to administer the tax if a particular state fails to meet its obligations and states are free to enter arrangements where they may administer each other taxes for a fee.
Audits would be conducted by state governments, but states are prohibited to conduct audits “at facilities” other than those within their state boundaries. Instead, the states shall “cooperate with other administering states.”
While the bill is not entirely clear, it seems that the “business use” exemption is effectuated though a credit equal to the aggregate amount of tax paid on taxable property and services purchased and used in business. While the FAIRtax proponents are quick to say that their proposal is not a national VAT, this provision feels very similar to an “input tax credit,” which broadly seeks to exclude business inputs from tax.
What it would mean
The question of whether the FAIRtax could adequately fund our national government is beyond the scope of this article. However, it’s worth noting that while the FAIRtax effective rate of 30% is higher than anywhere else in the world (the highest VAT rate is 27% in Hungary) most countries with national consumption taxes nonetheless continue to impose personal and corporate income tax.
Should Congress enact the FAIRtax it would apply alongside existing state and local sales tax which, over the years, have become an ever-increasing source of state revenue. While some states have expanded their sales taxes in recent years to cover digital equivalents to tangible property and other services, others have reduced their base by excluding food, diapers, feminine products and other necessities. Since states would need to administer both taxes simultaneously, and since adjusting the application of the FAIRtax is beyond their authority, it seems probable, if not likely, that many states would move to expand their state and local tax base to match the extremely expansive FAIRtax.
While the proponents of the FAIRTax would tell you differently, when taxes are applied at a very high rate, legitimate avoidance and illegitimate evasion schemes become more prevalent. To combat evasion, many countries around the globe have established electronic invoicing requirements where transactional data is sent to the government in real (or near-real time). Governments are then able to utilize this data to validate the accuracy of any subsequent VAT filings. While creating an e-invoicing requirement as a means of supporting sales tax compliance was always a substantial challenge because of disparate state and local rules here in the U.S., an e-invoicing system intended to support FAIRtax compliance is a possibility.
Stated plainly, this bill has no chance of passing in the current Congress. Even with 25 co-sponsors, there is no guarantee it would pass in a House floor vote. The U.S. Senate remains controlled by Democrats who view the FAIRtax as a thinly veiled attempt to cut taxes on the wealthy. Further, President Biden is also on record as being vehemently opposed, with every intention of vetoing any such federal sales tax bill that reached his desk. Nonetheless, sellers need to remain vigilant. Political and economic forces can conspire to create new and complex tax requirements including novel exemptions, sales tax holidays and point-of-sale fees. A proactive approach to compliance that embraces the role of tax technology is the only way to be ready for what might come next.
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