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Is Sales Tax Fair?

As the presidential election draws closer, the debate over taxes is getting a lot more coverage on media today. One issue on the minds of some of the candidates is about the fairness of sales and income tax. There are differing opinions on how to approach an equitable tax burden for the American public.

To get to the heart of this matter, we need to look at how the sales tax rates of different states compare, how we are gauging this idea of “fairness” and where income tax fits into this whole discussion. Finally, we are going to look at the pros and cons of some of the proposed solutions.

Tax Fairness Across America

A good argument can be made for determining sales tax fairness by gauging income versus tax expenses, including income, sales or other taxes. Are families with higher incomes paying the same, more or less taxes than those with lower incomes? In other words, are taxes truly progressive? Progressive taxes mean that as families or individuals earn more, they will pay more in taxes, while those that earn the least, will pay the least.

Recently, WalletHub did a study ranking “2015’s Most and Least Fair State Tax Systems.” This study concluded that most Americans – liberal or conservative – actually do support a progressive state and local tax rate structure – the less you earn, the less you should pay in local taxes. However, WalletHub discovered that in reality, “as income goes up, state and local tax burden goes down.” In practice, Americans pay less non-income taxes the more they earn.

That assessment comes from the Institute on Taxation and Economic Policy (ITEP), who periodically survey the fairness of tax systems in all 50 states. Their 2015 “Who Pays?” report comes to a stunning conclusion: that “virtually every state’s tax system is fundamentally unfair.” In nearly every state in the union, the lowest 20% of income earning families pay the highest in state and local taxes. That rate typically steps down for each income bracket, with the top 1% of income earners paying the least. (Note that this study is limited to non-elderly taxpayers.) Their same report in 2009 at least had a silver lining – that states were becoming aware and making changes, but this year’s report holds no such disclaimer. ITEP blames a lack of progressive income taxes on each state’s “overreliance on consumption taxes” like sales tax.

Is There a Solution?

Looking at what’s now in place, there seems to be no easy solution. The ITEP study showed that various changes made to the current tax system by various states since the 2009 report has had no overall positive effect.

Americans for Fair Taxation & FairTax

One solution would completely overhaul and rebuild our tax system has been proposed by the grassroots organization, Americans for Fair Taxation® (AFFT), founded by 3 entrepreneurs. They support passing the FairTax® bill (HR25). This solution calls for an elimination of all payroll taxes, and the passing of one national sales tax rate of up to 30%. Strictly speaking, by their own FAQ, FairTax does not repeal income tax but it eliminates the IRS, annual tax filing and all “statutory language to do with taxing income and payroll.” In fact the ultimate goal of the AFFT is to repeal the 16th Amendment, which allows the U.S. government to collect income taxes, altogether.

Is FairTax Really Fair?

Obviously, FairTax would create a major upheaval in the tax structure of the United States, and it’s the only current proposed bill that involves eliminating income tax. Does it stand a chance? More importantly, is it even viable or fair?

In “Replacing the Income Tax With a National Sales Tax,” FOX Business stocks editor Elizabeth MacDonald enumerates the pros and cons of doing just that. She criticizes the Obama Administration’s use of the IRS as “an enforcer of ad hoc policy that neurotically changes every day,” but warns that a strong argument against a national tax is that “bureaucrats simply can’t help themselves from larding more taxes on top of each other.” She says a national sales tax can also unfairly hit the poor, bringing the issue of “fairness” to a standstill.

Forbes contributor David John Marotta disagrees with the FairTax. In his article, “Is a National Sales Tax Really Fair?” he counters the definition of “progressive” income or taxes measured by income equality because they do not accurately measure what we consider wealth. The FairTax seeks to tax only money that is spent. In fact, they seem to suggest on their site that lower income earners need only to be frugal to save money with their system.

Marotta, on the other hand, argues that the FairTax system can place an unfair burden on taxpayers in certain years. His claim that “selling a house in California is the easiest way to be part of the top 1% and get hit with tremendous taxes” for those not typically in that income bracket provides a provocative argument.

Marotta also disagrees with a progressive income tax code, calling it “economically destructive” and would rather see a flat tax enacted, where all income is taxed at the exact same rate. (Most flat tax proposals put forth during the 2012 election cycle eliminated the lowest income earners, as well.) Republican presidential hopeful Rand Paul proposed his flat tax plan this summer, which eliminates some but not all tax breaks, eliminates the payroll tax and removes major deductions for state and local tax payments. Could that hurt ecommerce vendors?

Implementing a national sales tax instead of income tax, or creating a flat income tax for everyone, each has its pitfalls and would take years to implement, much more to consider the repercussions. As presidential candidates jockey for position, ideas of improving the tax system sales and income tax fairness will be a hot topic for at least another year. But even if sweeping proposals or surprise victors win, they still have to get bills past special interest groups and through Congress. There doesn’t seem be to a solution for tax fairness or simplification in the near term, but retailers should keep an eye on how the elections pan out nonetheless.