This post was written in connection with a larger post, Why I am voting third party, so I’m going to take a decidedly election-centric approach here. Sorry if you stumbled upon this looking for a more generic discussion.
One of the biggest issues with the FairTax is that a tax rate of 25-40% creates significant incentives for businesses to perform untracked cash transactions or otherwise attempt to avoid paying the tax.The main benefit of a VAT is a very practical one, in that it makes enforcement easier by collecting taxes throughout a product’s development instead of completely at the end.
As an example, let’s take a $100 wooden rocking chair sold at a small furniture store for $137. Under a 37% FairTax, the store would owe $37 in taxes on the desk chair. The store might choose to have the customer pay cash and not report it, and then that $37 of taxes would be lost. Under a VAT, much of that $37 would have been paid before the company ever reached the showroom. The idea of a Value Added Tax (VAT) is to charge taxes throughout the production and sales process on the “value added” by a particular company. So, somewhere out there, a company cut down a tree, processed the wood, and sold it to a furniture production company. It cost them basically nothing to do that and they sold the wood for $40. They pay a 37% VAT on that $20 in added value. Then, the furniture company takes this $40 worth of wood, cuts cuts it into chair pieces, and packages them. It sells the chair to the furniture store for $70 and pays a 37% VAT on $30 (the difference between what it bought the materials for and what it sold them for). The furniture store then sells the chair to you and pays a 37% VAT on $67 (137-70). Even if the furniture store failed to pay its taxes, that would only be a loss of 67 * .37 = $24.75 instead of the full $37 from the FairTax.
The nice thing about a VAT is that it is somewhat self-enforcing. In the example above, the furniture store would actually be responsible for proving that all $37 of the taxes had been paid for the chair. It would do this via providing VAT receipts that were given to it alongside the actual chair itself. If it did not receive these receipts, it would be responsible for the entire amount. Because of this, it is in the store’s best interest to only purchase from suppliers that actually pay their taxes. It’s rare that there are legitimate market mechanisms to incentivize businesses to pay taxes. I’ll take them where I can get them.
As a final note, VATs also allow taxes to be captured on products that are made in the U.S. but are eventually sold as exports which would otherwise be missed by the FairTax.