I have heard of the 'Fair Tax' as a proposed system of federal taxation in the US.
I am not 100% sure what it is, other than a Sales tax.
What are the challenges presented with said system?
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The fair tax is a proposal to replace the US income tax with a sales tax.
Pros of Fair Tax:
It's a large change to the way the United States currently does things. The "Fair Tax Act of 2011" is H.R.25 in the US House and S.13 in the Senate. The full text of the bill is available at the links provided.
There are some fairly large consequences of implementing a fair tax. For example, 401ks and Roth IRAs serve no benefit over non-retirement investments. Mortgages would no longer have a tax advantage. Luxury items would get far more expensive.
You asked about the challenges. The transition itself is the biggest one. For people to get used to the tax at the register vs at their paycheck. For a great number of people to find new work. I don't know the numbers, but anyone involved with personal income taxes would be out of work. Sales tax is already part of the process in most states, bumping it to a federal tax wont add too much in overhead. I make no moral judgment, but consider, most prostitutes and drug dealers are avoiding income tax, but they still are buying the same goods in stores you and I are. This proposed tax reduces the collection noncompliance, and brings more people into "the system". Another factor some may not like is the ability to affect behavior by picking and choosing what to promote, via deductions, such as home buying or charity.
In a nutshell - Value Added Tax. America, as usual, discovers what others have known and used for years.
The idea of not taxing income that's tied to it is ridiculous. If you're only taxing spending but not income, people will just take spending elsewhere (Canada, Mexico, further away), and the economy will go down the drain.
That's similar to the way people avoid paying sales tax now, except that it will be in orders of magnitude. Why should a corporation by office supplies in the US, if it has a branch in China?
Edit Also, Fair Tax doesn't take into account moving money overseas. I've mentioned living elsewhere down below, and that also got me thinking of how I personally would certainly gain from that ridiculous thing called "Fair Tax". Basically, that's exactly how the "rich folks", those who push for it, will gain from it. Being able to move money out of the US basically makes it a perfect tax shelter. You don't pay taxes on the income (that you have in the US), and you don't pay taxes on the spendings (that you have elsewhere, because in that country income is taxable so you only pay VAT or sales taxes). This means that all the wealthy people, while investing and gaining money from the American economy (stocks, property, etc), will actually not be spending it in the US. Thus, no taxes paid to the US, dollars flowing out. Perfect. Actually, I should be all for this stupid idea. Very fair to me, no need to pay any taxes at all, because food will probably be exempt anyway.
Its a new way of computing sales tax. Wikipedia has a nice article on this http://en.wikipedia.org/wiki/FairTax