Evasion Potential with the FairTax vs the VAT Tax
In response to Brad Warbiany’s article “Evasion Potential of the FairTax,” Dale Franks at QandO wrote “Fair Tax Supporters: Whistling Past the Graveyard,” in which he asserts that tax evasion would be significantly harder under the VAT tax, compared to the FairTax.
In the comments to that article, Kirk Ellis posted the following, and it stands well enough on its own to warrant reproducing here:
Dale made some good arguments about possible evasion, but he also made them in a vacuum.
He fails to mention that evasion of the VATs in Europe are also rampant. He fails to mention that 85% of retail sales are made from major corporations—not small businesses—and Wal-Mart and Target are NOT going to risk their business with evasion. He ignores the evasion rates under the income and payroll taxes. He pretends it only takes two people to evade the FairTax but ignores the fact that it takes only a single person to evade the Income and Payroll taxes.
You cannot evaluate a tax system in a vacuum. You can only compare it to another tax system.
So let’s suppose a very dishonest small-business community—half of all small businesses operate under the radar and don’t collect or remit the FairTax. So we lose 23% of 7.5% of all purchases. We’ve lost 1.78% of all purchases. Roughly $150 Billion. That’s horrible ! Until you notice that the IRS regularly reports $350B of taxes owed unpaid every year—not including illegal activity. Estimates of illegal activity are over $1T, meaning at least another $250B in tax revenue lost. So we are really talking about $150B lost under the FairTax vs. $600B lost under the Income and Payroll Tax system.
A VAT requires extensive paperwork and payments and credits and the economic latency that delays of those payments create. That is a drag on the efficiency of any economy. Reporting at each layer of the supply chain under the FairTax would be substantially less, but still include a minimum level of info—essentially, what you sold B2B and what the certificate# of the purchaser was. For a Retailer to collude with a Consumer and evade the tax means the supplier to the Retailer still shows a B2B sale that is not reflected the the Retailer’s sales and is not in his inventory. Software will find these suspicious Retailers quite easily and target them for sting operations where an agent tries to tempt the Retailer into giving them a tax-free deal. And remember, even if we don’t catch any of them at all, we’ve lost only 1/4 of what slips through the Income and Payroll Taxes.
Compare this evasion to the Income and Payroll taxes. How many people in a small-business does it take to evade those ? Just the owner. That’s all.
At least with the FairTax the consumer has to be in on the evasion as well. Offer a reward—say 10% of taxes and penalty for the year—for being the first person to report a suspected Retailer and Retailers won’t be willing to risk operating off the books. Remember, there is that previous layer of suppliers that probably ARE keeping records. Claiming pilferage or breakage might work, but anything significantly higher than the statistical norms for an industry are going to flag you for a painful and time-consuming audit. An audit is not always about collecting owed taxes. Sometimes it is just about nuisance-factor and discouraging certain behaviour. For a small-business owner, their own personal time is probably what generates their profit. Having an auditor suck up that time every month because your numbers are outside statistical norms is not going to be worthwhile.
Remember, the States receive 25 basis points of the revenue collected. For California, that would be almost twice what they are spending on enforcement of Sales Taxes, Tobacco Taxes, Alcohol Taxes, and Fuel Taxes—combined. With that kind of funding, I would worry more about overzealous State Auditors than evasion.
As far as buying items under a business certificate and back-dooring them to friends goes, again you will hit statistical minefields triggering audits. How many TV’s can an office with twenty workers reasonably purchase ? How many PCs ? Remember that there are now laws requiring these to be disposed of properly. You can’t say they were scrapped if you don’t show proof from the recycling center. Still this is the most likely evasion. The question is what volume could it possibly be ? And it is something that probably already is being expensed by dishonest businesses and slipping through the Income Tax. So it isn’t a net loss compared to the Income Tax.
I wouldn’t mind different classes of certificates that limited what items could be purchased tax-free. That is not spelled out in the FairTax bill, but it would depend on how the State chose to implement the FairTax. The State has a stake in the revenue, so intelligent design to reduce auditing needs would be expected.
For the full context for this discussion, read Brad’s original article promoting the FairTax and Dale’s reply promoting the VAT tax.
