The National Consumption Tax Proposal Explained

A national consumption tax represents a shift in how the federal government collects revenue, moving from a system based on income to one based on spending. This approach taxes households on the value of the goods and services they purchase, rather than on what they earn through wages, salaries, and investments. The most prominent legislative example of this concept in the United States is a proposal known as the FairTax. First introduced in Congress in 1999, this proposal seeks to replace the existing structure of federal taxation with a single, national retail sales tax.

Core Mechanics of the Proposal

The proposed consumption tax would be applied once to the final retail purchase of all new goods and services used for personal consumption. The system distinguishes between new and used property. For instance, the purchase of a brand-new car from a dealership would include the national tax, but the subsequent sale of that same car between two private individuals would not be a taxable event.

The tax base is designed to be broad, encompassing services in addition to goods. This includes payments for services like legal consultations, home repairs, and haircuts, which are often treated differently under state-level sales tax systems. The inclusion of services is an element in creating a comprehensive tax base that captures a wide spectrum of economic activity.

Business-to-business transactions are exempt from the tax. This means a manufacturer buying raw materials or a retailer purchasing wholesale inventory would not pay the consumption tax on those inputs. The tax is only triggered when a registered business sells a finished product or service to a household or individual for their personal use.

This structure is designed to avoid “tax pyramiding,” where a tax on an input gets embedded in the cost of a product, only to be taxed again at the final sale. This can increase the consumer’s price by more than the official tax rate. Businesses would be required to be registered to purchase goods and services tax-free for business purposes, certifying that the items are not for personal consumption.

Proposed Tax Rate and Rebate System

The plan is structured to have a 23% tax-inclusive rate, which is different from how traditional state sales taxes are presented. This means that for every dollar spent, 23 cents represents the federal tax. For example, on a $100 item, the tax would be $30, making the total cost to the consumer $130. The $30 tax payment is 23% of the total $130 transaction. This is mathematically equivalent to a 30% tax-exclusive rate, which is the rate applied directly to the pre-tax price of the good.

The proposal includes a mechanism to shield lower-income households from the tax on essential spending, known as the “family consumption allowance” or “prebate.” This untaxes spending up to the annual federal poverty level, based on family size. The prebate would be an advance, monthly payment sent to all qualified households, such as a family of four receiving a check for the tax they would pay on necessities.

By providing the rebate in advance, it ensures that families have the funds to cover the tax on necessities throughout the month. The amount is determined by the Department of Health and Human Services’ poverty guidelines, which are updated annually and vary by household size. To receive the payment, households would need to be lawfully present in the U.S. and register with the agency administering the tax.

The FairTax Act specifies how the revenue would be divided in its first year: 64.83% to the general fund, 27.43% to the Social Security trust funds, and 7.74% to the Medicare trust fund. After the initial year, the rate would be adjusted based on federal spending levels, with separate components calculated to ensure the solvency of the Social Security and Medicare programs.

Taxes Replaced by the Proposal

The national consumption tax is designed as a substitute for the current federal tax system, involving the repeal of several major taxes. The most significant is the federal personal income tax, paid by individuals on their wages, salaries, and other income. This would eliminate the need for individuals to file the annual Form 1040.

The proposal would also eliminate federal corporate income taxes, which are levied on the profits of corporations. In addition, the plan repeals federal payroll taxes (FICA) that are deducted from paychecks to fund Social Security and Medicare. These programs would instead be funded directly from consumption tax revenues.

Other federal taxes slated for elimination include capital gains taxes, applied to profit from the sale of assets like stocks and real estate. The federal estate tax, a tax on property transferred after a person’s death, would also be repealed. The federal gift tax, which applies to property transferred between living people, would be abolished.

The proposal’s implementation is legally tied to the repeal of the 16th Amendment to the U.S. Constitution, which grants Congress the power to levy an income tax. The FairTax Act includes a provision that would terminate the national sales tax if the 16th Amendment is not repealed within seven years. This change would also lead to the elimination of the Internal Revenue Service (IRS), as its primary functions would no longer exist.

Impact on Filing and Compliance

For individuals, the proposal eliminates nearly all current interactions with the federal tax system. There would be no requirement to file an annual federal tax return, such as the Form 1040. Households would no longer need to track their income, charitable donations, or other deductible expenses for federal tax purposes. Paychecks would also change, as employers would no longer withhold federal income or payroll taxes.

The only administrative requirement for most individuals would be to maintain a valid registration to receive the monthly prebate payment. This would likely involve a simple process to verify identity, family size, and lawful residency. This moves the primary burden of tax compliance from the individual onto the retail business sector.

For businesses, the tasks of corporate income tax filing and payroll tax administration would be eliminated. Businesses would no longer need to calculate and remit employee withholdings for federal income tax, Social Security, or Medicare. This would remove a substantial administrative function.

Instead, the primary compliance duty for retail businesses would be to collect the national consumption tax at the point of sale and remit it to the government. This process would be similar to how businesses currently manage state and local sales taxes. The proposal allows businesses to retain 0.25% of the tax collected as compensation for the cost of collection. States would be given the option to administer the tax collection, for which they would also receive an administrative fee.