Because of the increased concern about a tax reform that doesn't really address the problems of tax evasion under the income/payroll tax system, we wanted to run again this excellent article from Professor Cebula.
My name is Dr. Richard J. Cebula. I was a Professor of Economics at Emory University for 17 years and at Georgia Tech for seven years. Currently, I am the Walker/Wells Fargo Endowed Professor of Finance at Jacksonville University. I have authored 15 books and over 550 articles in peer-reviewed scholarly journals.
Since the mid-1990’s, I have researched the extent of income tax evasion and the factors that influence income taxation in the aggregate in the U.S. My papers on this topic have appeared in such mainstream journals as the American Journal of Economics and Sociology, the Southern Economic Journal, Public Finance/Finances Publiques, Crime, Law and Social Change, the Review of Economic Analysis, and the Atlantic Economic Journal.
These various studies strongly suggest that the evasion of income taxes yields to the evaders both direct benefits, i.e., reduced tax payments, and secondary benefits, i.e., an expression of disapproval of government policies or politicians per se, especially the President. For example, the evader’s primary benefits of tax evasion are increased when tax rates are increased or simply are “high”, while secondary benefits increase when the Presidential approval rating is low or declining, when/if the U.S. is involved in an unpopular war, when the federal budget deficit is high or increasing, when unpopular legislation is enacted (e.g., The Affordable Care Act), when the unemployment rate is high or improving only because people have dropped out of the labor force and/or employment is characterized by persons with jobs who prefer to have full-time rather than their current part-time jobs, or when inflation is regarded as excessive. On the other hand, income tax evasion is only very modestly lower when IRS audit rates are higher and/or IRS penalties on unpaid taxes are higher.
Income tax evasion is the result of the following presumably conscious acts: failure to report taxable income (“being under the IRS radar”); underreporting taxable income; and exaggerating the magnitude of tax deductions and exemptions. It is important to acknowledge that no one with certainty knows the actual size of the “underground economy,” i.e., the actual aggregate amount of income tax evasion. The most common sophisticated methodology for estimating the extent of federal income tax evasion has computed aggregate income tax evasion to be on average in the range of 19-20% of aggregate adjusted gross income; however, there has been a gradual rise in this figure, beginning in 1999 (the year following the Clinton impeachment by the House), with a somewhat sharper increase beginning in 2005. Persons who are self-employed or whose wages are paid in cash, persons who are independent contractors, persons who itemize their deductions, persons whose business is conducted at all with cash (including individuals providing services such as maid service, lawn care, handyman, and so forth) find it especially easy to evade taxation.
Given this background, under the current income tax system and given prevailing circumstances, it would be logical to expect objectively that the magnitude of aggregate income tax evasion is destined to keep growing. This would be attributable, among other things, to very high federal budget deficits, government policies that have been ineffective in stimulating economic growth (e.g., President Obama’s 2009 “stimulus package”), two consecutive Presidents with a low job approval ratings, an unpopular healthcare reform policy, failure to address illegal immigration, the implementation of the Affordable care Act, failure to enact a simple and equitable income tax system and, instead, to make that system more complex, the continuation of unpopular wars and ineffectual handling of the Iraq withdrawal and avoidable rise of ISIS, and so forth.
Tax Evasion Under The FAIRtax
Under the FAIRtax, a system that is consumption based, consumers pay their taxes at the time of purchase. The only way to legally and practically avoid paying the tax is to not buy new goods and services, but that is hard to imagine and perhaps to a large degree hard to do. Most of the purchases of new goods and services involve frequently purchased items such as food, new clothing, gasoline for the family car, electricity for the home, cable TV, internet services, movie tickets, and the like. Typically, when such items are purchased, there is no practical way to avoid paying the tax liability. It is reflected on the invoice and must be paid either with cash, check, credit card, or debit card.
As is done today with state sales taxes, other types of transactions, such as new automobiles, new trucks, and so forth, will also carry a line item at the time of purchase or lease that must be paid in full, FAIRtax included. The list goes on, and the simple fact is that evading the FAIRtax will be very difficult because of the way in which it would be billed and because of the “paper trail” and electronic records that would be generated at materially all places of businesses across the nation. Furthermore, it is likely that most transactions, especially modest ones, involve such small sums that the effort to evade the tax is not only difficult but also simply not worth the effort, especially in view of the fact that everyone would have much more disposable income due to the elimination of the federal income tax and the payroll tax.
Arguably, the net incentive to make an effort to avoid this tax, given how difficult that avoidance would be, make this tax largely insular from the tax evasion problem associated with the income tax.
Given the “prebate” component of the FAIRtax that protects the very poor from taxation, the magnitude and dependability of the federal budget receipts under the FAIRtax are very promising and in view of the impracticality of evading the tax, adoption of the FAIRtax holds out the prospect (if Congress and the President hold their spending sprees in check) of a balanced budget. If the predicted economic growth happens, the growth in FAIRtax receipts will likely result in a surplus and it will be possible to reduce the FAIRtax rate.
It is for these reasons that I believe the FAIRtax is a superior tax system for the United States.