Thursday, January 10, 2008

What is the Fair Tax? And how will it help me build wealth?

Its difficult to not be cynical, since there has been discussion about scrapping the IRS for as long as I can remember. Yet, the IRS continues to grow into a gigantic government bureaucracy. It's ridiculous. What’s even more distressing is that there is very little talk amongst presidential candidates to overhaul the system.

One idea that does catch my eye is the national retail sales tax or fair tax that Mike Huckabee is advocating.

I found a quick guide at CNN and have included the meat of the article in this post. It asks some common questions about how the "Fair Tax" is supposed to work and some of the problems it might run into.

As for Personal Finance, the best part of the Fair Tax is that it will not penalize us for investing. No more taxes on dividend income, capital gains, or interest from savings. Everything that you save will have tax free growth and remain tax free right up to the day you spend it. This would make a huge difference for someone in my situation where my federal taxes exceed my living expenses!

How would the "Fair Tax" change the tax code?
It would scrap it almost entirely. You wouldn't pay income tax, Social Security and Medicare payroll taxes, the alternative minimum tax, a capital gains tax or estate tax. No more complex tax returns to fill out, either.

Instead, everyone would pay a flat sales tax on almost everything they buy: Food, clothes, new cars, diapers, even health care and financial services.

How high would the sales tax be?
Under the proposal, you'd pay a 30% mark-up over the pre-tax price.

A 30% tax on food and medicine would be hard on the poor, wouldn't it?
Not exactly, the sales tax plan would partly offset this effect by sending every household in America, a check to cover the taxes on their spending up to the poverty level.

Factor in that cash from the government, and each family's net tax burden goes down, so that the Fair Tax looks more progressive.

For example, a family of three earning $30,000 a year and spending all their income would give 7% of their pay to the government; one earning and spending $125,000 would pay a net rate of about 19%.

What's the point of doing this, anyway?
Shifting to a sales tax gives people more incentive to save and invest, which supporters believe would be a big spur to economic growth.

But the cover of The FairTax Book sums up the real grassroots appeal: It shows the letters "IRS" inside a red circle, with a big red line slashed across.

Could this happen?
The Fair Tax may have fans among talk radio listeners, but it hasn't been taken very seriously in Washington so far. That may be because the sales tax would take away many special tax breaks and loopholes beloved by lobbyists.

And with all taxes rolled into one high rate, the temptation to cheat could be very high as well. Too much evasion would require the government to raise the tax.

So while there might not technically be an IRS anymore, you can bet there'd still be plenty of government employees out there enforcing the tax laws.

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