David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: supersize sales tax.

In the process of organizing the newly elected Congress, proponents of a plan to implement a national sales tax got a commitment to have their plan considered. The so-called fair tax would replace the income tax system and do away with the IRS. Now, this isn't a new proposal, but one that has been given new life.

To learn more about it, first we'll hear from Doug Sword, a Tax Notes reporter who's been following this issue in Congress. Later, we'll talk with Tax Notes contributing editor Robert Goulder, who shares his thoughts on some of the design elements of the tax and challenges for implementing a national sales tax.

Joining me now is Tax Notes Capitol Hill reporter Doug Sword. Doug, welcome back to the podcast.

Doug Sword: Hi, Dave. Thanks for having me.

David D. Stewart: Could you first start off with some of the history of this Fair Tax proposal in Congress?

Doug Sword: Ever since there's been an income tax, there's been those who want to replace it with a national sales tax. Now, the newest version of this effort is the FairTax Act, which has been introduced in every single Congress since 1999 and always, interestingly enough, by a Georgia Republican. Now, none of these efforts have made it out of committee though.

The bill that was introduced at the beginning of the new Congress by Representative Buddy Carter, a Georgia Republican, would eliminate income taxes, payroll taxes, and estate and gift taxes, along with the IRS. It would pay for the federal government, including Social Security and Medicare, with a 30 percent tax added onto the price of goods and services. It would pay a monthly "prebate" aimed to cover the taxes of lower-income families. And it would exempt property and services purchased for business purposes from the tax.

Now, backers have said that they've been promised a floor vote as part of a deal that elected House Speaker Kevin McCarthy, R-Calif., and that it would be a first ever on a national sales tax proposal. But that's not quite right, though it has been a long time since the House has voted on such a tax. A national sales tax proposal was shot down by the House in 1932 on a 223-153 vote.

David D. Stewart: Where are the parties today on the sales tax idea?

Doug Sword: This is a bill that appears to have no chance. Even if it were to get wide support in the Republican caucus, which it doesn't appear to have, the Democrat-controlled Senate wouldn't touch it. The bill has been trashed by no less of a conservative personage than Grover Norquist at Americans for Tax Reform, who is quoted as calling the Fair Tax a "political gift" to Democrats in a story on the news site Semafor.

And, indeed, Democrats are jumping on this like it's red meat and portraying it as a plank of the Republican platform rather than a bill with limited GOP support. It was easily the top tweet in the Democratic Twitterverse the last week. There have been press conferences where Democratic leaders, including President Biden, have criticized it. Democrats are generally portraying the bill's elimination of the income tax as a thinly veiled attempt to cut taxes on the wealthy. They also claim it would undermine both Social Security and Medicare.

This is reminiscent of last year when Democrats jumped on [Florida Republican] Senator Rick Scott's proposal to make all Americans pay at least some federal income tax and to require all legislation, including Social Security and Medicare, to be reauthorized every five years. Even though Scott's proposal was roundly dumped on by Senator Mitch McConnell, R-Ky., and other Senate Republicans, Democrats gleefully portrayed that as a mainstream GOP proposal, and now they're doing the same with the Fair Tax.

David D. Stewart: Now, earlier you talked about there being a 30 percent tax on sales. I know that proponents of this are saying that it's a 23 percent tax. Why is there not agreement on what the rate actually is?

Doug Sword: Yeah. I'm pretty sure when I used that 30 percent figure earlier that any proponents listening would pretty much be yelling at their computers. I was careful to say it's a 30 percent tax added onto the price of goods and services.

What we have here is — supporters say it's a 23 percent national sales tax, and that is the number that's in the bill. They say the correct way to compute the percentage is to divide the tax by the total amount paid for a good and service, and that includes taxes. Say you buy something for $100 and there's a $30 tax. The computation on this tax should be $30 divided by the full price paid, $130. That comes out to 23 percent. Proponents point out income tax rates are computed the same way, and that is the tax is divided by pretax, not after-tax income.

But Democrats have everyday usage on their side. Everyone else comes up with 30 percent, a $30 tax divided by a $100 price on the good or service of what was purchased.

David D. Stewart: OK. Now, you're saying that this proposal likely doesn't have much of a chance, so why is it being brought up now?

Doug Sword: Well, after the weeklong marathon of votes that eventually made Kevin McCarthy the House speaker, it came out that the Fair Tax was one of the items discussed in negotiations with the 20 so-called conservative rebels who kept denying McCarthy the speakership. Now, a hefty portion of the backers of the FairTax bill include those rebels. Conservatives say that McCarthy promised to bring the bill to a floor vote.

The House Freedom Caucus chair, Scott Perry, R-Pa., who is a cosponsor of the bill, pointed out that another thing conservatives were pushing for was to make bills go through the regular committee process. So this bill wouldn't be coming directly to the floor; it would have to go through a committee first.

David D. Stewart: Do we expect a vote to actually happen?

Doug Sword: Well, as I said, House Republicans are returning to what is called regular order, which is a term used for the process we all learned about in the little booklet "How a Bill Becomes a Law." In regular order, a bill goes to a committee of jurisdiction where it is vetted and voted on.

In this case, that committee would be House Ways and Means. The bill would first have to get through Ways and Means, and that's going to be a problem for the sales tax backers. In the last Congress, Buddy Carter's FairTax bill attracted 30 cosponsors, zero from Ways and Means Republicans. This year's version of the bill attracted none of the returning 15 Republicans as cosponsors. However, 10 Republicans were added to the committee to reflect the party's House majority, and one of those is a cosponsor of the FairTax bill. Still, 24 Ways and Means Republicans are not cosponsors.

At a recent event, Representative Kevin Hern, R. Okla., a returning Republican on Ways and Means, wasn't giving the bill much of a chance in the committee. Hern is also chair of the Republican Study Committee, and he's one of the conservatives the GOP rebels voted for during their weeklong tussle with McCarthy. Hern said mothballing the IRS wouldn't save any money and that the sales tax would probably wind up just getting layered on top of the income tax, even though one provision in the FairTax bill is that the Fair Tax would sunset unless the 16th  Amendment is repealed.

Hern apparently hasn't been chatting with the new committee member who backs the Fair Tax. Not surprising, since Greg Steube, a Florida Republican who has cosponsored the Fair Tax, had an accident at his Sarasota property recently, and he is at home recovering from injuries. At the event that Hern was at, he was quoted as saying, "I haven't found a Ways and Means member yet that's for it."

David D. Stewart: Now, I'm sure if there are any surprises, you'll come back and let us know, but until then, Doug, thank you very much for being here.

Doug Sword: Oh, my pleasure, Dave.

David D. Stewart: Joining me now to give us his take on the FairTax Act is Tax Notes contributing editor Robert Goulder. Bob, welcome back to the podcast.

Robert Goulder: Thank you, Dave.

David D. Stewart: Could you tell us a bit about the history of this proposal and how it's been designed?

Robert Goulder: Yeah, sure. It's not new. It's been around a long time. Some version of the Fair Tax has been introduced in every session of Congress going back to the late '90s. For many years, the main proponent or congressional sponsor was a congressman from Georgia named John Linder. He's moved on, and now other people are introducing it. But there's always this sort of sliver of support for it in the Republican conference that doesn't really go to mainstream conservatism. So it's kind of a niche concept.

David D. Stewart: What problem is this proposal trying to solve?

Robert Goulder: Well, that's a bit of a loaded question. I mean, I would answer it by saying this. The Fair Tax is trying to solve the problem that we currently have a tax system where the federal government is funded by these revenue tools based on a person's ability to pay. That's viewed as a problem. They want to wean us off of the income tax because income taxes are based on the ability to pay, and consumption taxes aren't.

So when you abolish federal income tax for individuals, for corporations, you get rid of payroll taxes, you get rid of withholding taxes, you get rid of all of that and the IRS that enforces it, and you're left with a consumption tax. You're replacing a progressive tax with a regressive tax. That's the problem that it really solves.

You look at the income tax. You have progressive tax rates. The more you make, the more you pay. They don't like that. In fact, if you get the book, there's an explainer basically. It's called The FairTax Book, coauthored by a talk show host, Neal Boortz, and Congressman Linder, who I mentioned before. The preface opens up with material from Karl Marx and the Communist Manifesto and this whole idea that a redistributive tax system is Marxist. So if you spoke to a proponent of the Fair Tax, they would say it's guarding against socialism.

David D. Stewart: OK. If your goal is to get away from progressive taxation, what about the other proposal out there, the flat tax?

Robert Goulder: Well, flat tax doesn't go far enough for these people. You could have an income tax where everyone pays the same rate, whether it's 18 percent or 23 percent; take your pick. You'd still be taxing labor [and] all of your taxable income.

The difference with the Fair Tax is that it exempts your personal savings. Really, any national-level, broad-based consumption tax is fundamentally different than an income tax because you're not taxing what people save. Think of it this way: Think of a mathematical formula. Your income equals your consumption plus your savings. The difference with the consumption tax is you're exempting the savings.

David D. Stewart: OK, well, there's another aspect of this that I'm curious about, and you mentioned it in your earlier answer that they want to abolish the IRS. Now, since this is a tax, how do they collect it?

Robert Goulder: Great question. They've thought about that. They have an answer for it. I'm not sure it's a good answer. But what they would do is they would have the United States Treasury Department enter into contracts with state governments so that state governments would administer this national sales tax. I think 45 of the states currently have a state-level retail sales tax. So for those states, it wouldn't be a game changer because they're already enforcing a sales tax system. They would just need to add this to it. So they're still collecting tax from people who are selling things, goods, or services.

Now, the states probably don't want to do that. What's in it for the state governments? There's a mathematical formula whereby they get to keep a portion of the receipts that they collect. The proportion is currently 0.25 percent. So a quarter of 1 percent of all of the receipts a state — take our state, the state of Virginia, everything that they collect; they'd get to keep a share of it and then hand the rest over to the feds, the Treasury Department. So in theory, you could do that without the IRS.

David D. Stewart: OK. In this age of the states fighting with the federal government over various issues, is there anything to stop a state, say Texas, that's concerned about redirecting money toward a border wall, or California that's worried about more environmental spending, from just redirecting the money instead of turning it over to Treasury?

Robert Goulder: Well, that's something that would have to be settled in the contract. I mean, the Fair Tax talks about a contract between the federal government and the state governments where the states help administer the tax. And when you think of a contract, you think that it's a negotiation. Right? How can you have a contract without the negotiation?

One thought that comes to my mind is what if the state walks away? Say you've got a state that just doesn't like this. What if Massachusetts says, "No, we're not going to do this. You can't make us sign a contract." If it's a contract by compulsion, then it really isn't much of a negotiation.

But to your question, what if the states keep more of the money than they should? Say they keep more than 0.25 percent. They've got their hands on it, so there would be a temptation for them to say, "Well, we'll get you back later."

David D. Stewart: All right, so I see that there's definitely some questions to be answered there. Another question that I have is that you're talking about a consumption tax, but based as a sales tax, which is close to a value added tax. So why not just go all the way and do a value added tax like is implemented in many other countries?

Robert Goulder: Well, I'd love it if they did that. I have a reputation around the office of being a fan of the VAT or GSTs (goods and services taxes) that you see in other countries. They're very common. Worldwide, there's around 160-170 countries out there that have a VAT. They're efficient. They work well. They raise a lot of money. They're not perfect. They do have some leakage issues. There's a border rebate because they're destination-based.

I think the real reason why the American conservative mindset doesn't like a VAT is that it just has a bad connotation. It gets a bad rap. For better or worse, there have been people for decades now who have been criticizing the VAT as a cash machine for big government.

It has a huge revenue-raising capacity, and that's actually viewed as a bad thing. The fact that VAT is efficient at raising tax receipts works against it. They look at these European governments, and they see, "Oh my goodness, the public sector is a huge share measured by GDP. Why would you want that?" They think that the VAT feeds big government. So it's got a bad association.

But on the merits, there's a lot more to be said for the VAT than there is for a retail sales tax. Just very simply, when you have a retail sales tax, you're not exempting business inputs, so you get cascading. You end up getting a tax on a tax on a tax, rather than a tax on economic activity.

David D. Stewart: Could you go into the differences between VAT and how a sales tax works?

Robert Goulder: Absolutely, my pleasure. With a basic sales tax, it only applies at the retail level. If you think of something like the shoes that you're wearing right now, there's a sophisticated stream of commerce that goes into all of those pieces being put together, and those are all contracts between suppliers, manufacturers, [and] wholesalers. Eventually, through that whole series of transactions, it ends up on a store shelf, or in this day and age, a website if you buy it online.

A retail sales tax is only imposed on that last stage in the chain of commerce, when it goes from the retailer to the final consumer of the pair of shoes. That's true for everything throughout the whole economy, like a car. You'd only impose a retail sales tax when you go to a car dealership and you buy the car.

A VAT is incremental. It is imposed at every single stage of production. Anywhere where value is added, there's a proportional tax on that value added measured by the difference in the sales price, the price that you pay versus a price that you charge out to the next person in the chain.

David D. Stewart: All right. What's the advantage of doing it that way?

Robert Goulder: The advantage of doing it that way is you get to deduct the VAT that you paid. If you're a middleman, maybe you're a wholesaler, you're buying from the manufacturer, and you're selling onto the retailer. You pay a VAT when you get it, and then you charge a VAT to the next guy, and you get to deduct the VAT that you paid.

All of your input VAT is a dollar-for-dollar credit. So you only pay on the differential between what you bought it for and what you sell it on for because that price differential is an economic proxy for the value that's been added.

David D. Stewart: OK. Let's turn back to another issue that you brought up in one of your earlier answers, and that's about the question of regressivity. Does this tax, as it's planned, create higher burdens on lower-income potential taxpayers?

Robert Goulder: Oh, sure. I think that's sort of the point indirectly. Everybody knows that a consumption tax is regressive. All consumption taxes are like that. All income taxes are progressive to the degree you have graduated rates where the rate goes up as you earn more income. There's really no doubt.

Now, there is something that I will give them some credit for. With a broad-based consumption tax, how do you at least try to mitigate the regressivity of the tax? Well, what countries with VAT do, which is kind of silly, is that they have multiple rates. There'll be a discounted rate for so-called necessities: vitamins, unprepared food from the grocery store, children's clothes, diapers, or school books. All those things will get a discounted rate.

Then you have a basic rate. Even if you want to go further, you could have almost a luxury rate. If you're going to something that isn't really necessary, say opera tickets or a visit to the tanning salon, they get a higher rate with the idea being that you need to help poor folks by charging them a lower rate on necessities where they really don't even have a choice to buy the good. They have to go out and get that stuff.

What I don't like about a consumption tax with multiple rates is that you inevitably get enforcement and compliance headaches because nobody knows what rate to charge. There's the example of Jaffa Cakes. Is it a cake or a biscuit or a cookie? Because there's a different rate for each category of goods.

Well, my goodness. I mean, common sense is just screaming to say, "Please give us a federal consumption tax with a singular rate." And the Fair Tax does that. There's just one rate. The introductory rate of the tax would be 23 percent. [It would] change over time, but would start out at 23 percent.

So then the question comes up, how do you try to compensate for the regressivity of the tax if you're only going to have a single rate? They come up with this idea of a prebate. Maybe this is a controversial idea. I don't know. Maybe when people know more about it, they won't be as fond of the tax because it sounds a little bit like we're creating a new entitlement program.

But the vision is that the Fair Tax would have a prebate where the Treasury Department would send every household in the country a check, a transfer payment, if you will. It might be done weekly. It might be done monthly. It probably makes more sense to do it quarterly just because you have fewer transactions that could potentially go wrong.

But they'd send people money. And it would be the same for every household, irrespective of your personal wealth, your income level, or your zip code. It would be the same for everyone. You'd get this money. The concept is that [the] money would compensate you for the necessities that your household would need to acquire over the relevant time period.

Now, there's no guarantee that people would actually spend it on necessities. They could squander it away in a hundred different ways, but at least you're giving people the money to cover their necessities. This prebate makes up for the fact that it is a regressive tax. I will give them that. They don't completely take poor folks and throw them under the bus. They do have this concept of a prebate.

The problem is liberal progressives like the prebate so much that it's starting to become unpopular in conservative circles. It sounds very much like another form of welfare. It sounds very much like an entitlement program because you, as a U.S. taxpayer, citizen, resident, would be receiving this money from the government.

Now, I don't like the idea of the Treasury Department sending out all these checks every week or every quarter or every month. They're talking about using debit cards. Somehow, and you can see how there's a whole bureaucracy that would rise out of this, every household would register with Treasury and get a debit card, and it would have to have some sort of an identification number on it.

I don't know if you want to base it on your Social Security number. Or maybe you take this whole chore of distributing prebates and maybe you assign it to the Social Security Administration because the IRS can't do it because you've just eliminated the IRS. But it does sound like an entitlement program.

David D. Stewart: Another major issue that we've been hearing about for the last, at least, year has been inflation. This tax would be a 23 or 30 percent, depending on who's counting, tax on top of the price of goods. Would this exacerbate the inflation problem?

Robert Goulder: Depends on who you ask, Dave. But that's a big, big issue. When you introduce a retail sales tax, aren't you making everything that you buy more expensive? They would say no. If you read the primer book, The Fair Tax Book that was written about this, they spend a lot of time going over this concept.

They're saying that not only is the Fair Tax revenue neutral, which I personally doubt — I don't think it's going to raise as much money as it would lose by repealing all those other taxes — but beyond that, they think it's going to have price stability. There's an assumption of price stability that is conceptually different than the presumption of revenue neutrality.

How do you get price stability? All right, let's say there's a raincoat you want at this store, and it costs 100 bucks. Now, common sense might make you think, "OK, take a $100 jacket, multiply it [by] .23 to add on a 23 percent retail sales tax, [and] it's going to cost $123. Whereas without the tax, right now, it costs $100."

They claim that there are all of these embedded costs that are basically sucked in and absorbed into the current price of that jacket, and that by repealing the income tax and the payroll taxes and all these other taxes that get repealed as a result of the Fair Tax, you have an opportunity here through the invisible hand of the marketplace, through competitive pressures, the pricing will adjust. That jacket won't cost $100 once you factor out all of those embedded costs.

The price will be somewhere close to $81 or $82, everything else being equal, all right? Assuming a perfectly static universe, the embedded costs would disappear. And then once you have a jacket that only costs $82, then when you factor in the retail sales tax, it takes you right back, approximately, to the $100 price level that you started with, hence price stability.

David D. Stewart: The last thing I want to ask you about is the changeover from one tax system to a completely different one. We have over 100 years of experience with an income tax, and that meant that everyone has arranged their affairs in the way that they do to minimize the way that they pay, to how much they pay taxes, or they've gotten to a point in their life where they've transitioned from work to retirement. What effect would changing the entire game have on these arrangements going forward?

Robert Goulder: Oh, it would be absolutely massive. This would be social change. This would be a transformative social change. The cultural change would probably be greater than the fiscal change. I mean, just think about it. No income tax and no IRS means no tax returns. No tax returns means no return preparation industry. So the likes of TurboTax and all of their competitors would go the way of the dinosaurs. They would become obsolete overnight.

What about all the CPAs and enrolled agents across the country who help people do their income taxes? Their economic prospects going forward would look very bleak. What about all of the tax planning out there? You know how tax planning work. A lot of tax planning is based around this idea of taking ordinary income and disguising it as a capital return.

Well, that's all out the window. That's obsolete. That's irrelevant. It no longer matters. A lot of tax planning is about trying to have a taxable income item recognized later rather than sooner. Timing differentials [and] deferral no longer matters.

So how do people save for their retirement today? They have IRAs. They have Roths. They have 401(k)s. They have other ways, flexible spending accounts and so forth. All of this stuff that's based on a deferred tax benefit just becomes useless. Your 401(k) is basically just a bank account under this tax. Likewise, for your IRAs. Roths are particularly interesting because there, it's not deferral. It's like the opposite of deferral. Let's just say that people with Roths might have a gotcha moment.

David D. Stewart: They've already paid income tax on it, and now they will be subject to sales tax on future purchases.

Robert Goulder: Yeah.

David D. Stewart: Does the group planning for this have any sort of transition for this, or is it just something that where a person with a 401(k) will be a winner and a person with a Roth IRA will be a loser?

Robert Goulder: Hearts will be broken, Dave.

David D. Stewart: OK. Well, Bob, this has been fascinating. I thank you for coming here and helping me understand this issue more.

Robert Goulder: My pleasure. Thanks for having me on the podcast.

David D. Stewart: And now, Coming Attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief Paige Jones. Paige, what will you have for us?

Paige Jones: Thanks, Dave. In Tax Notes Federal, Marty Sullivan argues that this year's inevitable congressional clash over federal finances could be the most contentious we've seen yet. Allison Christians and Stephen Shay explain why the pillar 2 undertaxed profits rule would be consistent with U.S. tax treaties.

In Tax Notes State, Tom Yamachika traces the history of Hawaii's transient accommodations tax. John Dorocak creates an image of what a socialist tax could look like in the United States.

In Tax Notes International, Philippe Penelle explains why transfer pricing guidance needs an update. Three Cyril Amarchand Mangaldas lawyers explain the taxation of cross-border transactions between Indian residents and non-residents.

In Featured Analysis, Marie Sapirie takes a closer look at the critical minerals and battery components white paper.

And finally, on the Opinions page, Ryan Finley questions why Brazil needed five years to update its transfer pricing guidelines to align with the OECD's.

David D. Stewart: That's it for this week. You can follow me online @TaxStew, that's S-T-E-W. And be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.