How Will The So-Called “FairTax” Affect Prices and Wages?

The “FairTax” is a proposal designed to replace essentially all federal taxes with a national retail sales tax on all new goods and on all services. The two most well-known proponents of this new tax system are talk show host Neal Boortz and Congressman John Linder: they have written two recent books on the subject. Hereafter, I will refer to these two gentlemen as B&L for brevity.

Recently, I have begun an examination of this plan, and started by trying to objectively evaluate the primary claims of its boosters. Before I continue this examination, I have to address one of the principal assertions, one that seems to permeate the discussion of this issue. This is the issue of what will happen to the price of goods and services, and to the take-home pay of Americans if the FairTax were to be implemented.

In their first book, B&L specifically claim that, even when including the addition of the FairTax, prices will not rise. They say that the prices of goods and services have, on average, an “imbedded tax” of 22%. This is complicated, but in essence it is based on the fact that workers and businesses and suppliers in the various steps in the production process all pay some kind of federal tax, and that the consequence is that the final price of goods and services must include this tax. If all of these federal taxes were eliminated, as they would under the FairTax, then all of this imbedded tax would disappear. They further assert that, after the taxes were removed, “market forces” would drive the prices down by this amount. Then, after the 23% FairTax is added, the prices would be back to where they were before. That is, when one looks at the relationship between the prices of goods and services before and after the implementation of the FairTax, there would be little or no change.

B&L then assert that with the FairTax, there would be no deductions from a worker’s gross pay. Therefore, everyone would get 100% of his or her paycheck. At various places in their 2005 book, B&L then go on to claim that because of this, people would get “…an immediate 25 to 30 percent increase in their take home pay” (B&L 2005, p. 83). This claim is repeated at several other places in the book.

So, after the FairTax is implemented, prices remain constant, and everyone gets a 25-30% increase in their take home pay because their gross pay would no longer be decreased due to income or payroll taxes. They put these two pieces together in no uncertain terms on pages 111 and 160. Anyone reading this book can come to no conclusion other than the assertion that everyone will have 25-30% more money every month and prices will not change. This would be wonderful! If this were true, who could be in opposition to this plan?

Think for a moment about this. Compare the days just before implementation of the FairTax to those just afterward. Prices are the same, but everyone has 25-30% more money. How is this possible? From where would the money come? Well, the truth is that it is impossible. B&L and the many other supporters who repeat this claim are stating something that is simply false.

The argument in favor of this scenario is complicated. At first reading, even I thought it sounded good. The reason that it is not true is also a bit complicated, but can be understood if you think of it in this way: B&L can’t do two things with the same pool of money. They can’t take the money that would be paid in federal taxes under the current plan and both reduce prices AND give the money to their employees by giving them their gross pay as take home pay. They can do one OR the other, but not both. Either prices will remain constant and everyone’s take home pay will do likewise, or everyone will get an increase in take home pay AND the prices of goods and services will go up about the same amount. When examining take home pay and prices, they will remain constant relative to one another.

I imagine some FairTax proponents who read this will likely want to write an immediate rebuttal, simply restating what can be found in B&L’s books and all over the internet. However, before you do this, I suggest that you look at their 2008 book. On page 141, they restate this scenario (prices constant, everyone gets much more in take home pay) as “…a claim that has taken on mythical proportion in the anti-FairTax literature.” They then proceed to state that this is NOT true, and that it is likely that prices and take home pay will probably both go up by about the same amount.

In their 2005 book, B&L repeatedly made this assertion. Then in their 2008 book, they speak as if this were some claim invented by anti-FairTax people. In short, they made an incorrect assertion in their earlier book, and then tried to disavow it in the 2008 book. Yet, their myth lives on. Throughout their books, and indeed throughout the FairTax literature, there is constant reference to keeping “100% of your paycheck”. They meant for us to believe that it was 100% of our current gross pay.

This whole scenario is, I believe, one of the principal reasons why many people support the FairTax. Yet, it is untrue, so untrue in fact that B&L now disclaim ever having said it. Keep this in mind when you read or hear anything about the FairTax.