FairTax - Income Taxes vs. Sales Taxes

We saw in the previous section that a simple analysis cannot help us determine what will happen to consumer spending. However from that analysis we can see that a change to a national sales tax is likely to have the following effects:

• Production is likely to rise as marginal income tax rates fall to zero which induces people to work extra hours.
  
  
• Take home income will rise as people are not being taxed on income.
  
  
• Spending within the United States may or may not rise.
  
  
• Saving and spending abroad will increase, which will cause:
  
  
  • A weakening of the U.S. dollar as Americans who want to buy foreign goods will need to exchange their U.S. dollars for foreign currency. We should expect to see the U.S. dollar become less valuable relative to other currencies, particularly the Canadian dollar. See A Beginner's Guide to Exchange Rates and the Foreign Exchange Market for more details.
    
    
  • The price of investment goods such as bonds will rise as people wish to save more, so interest rates will fall. The link between interest rates and the demand for investments can be seen in my article The Dividend Tax Cut and Interest Rates
    
    
• The after tax price of consumer goods will go up due to the sales tax. However the pre-tax price of consumer goods is likely to fall since increased productivity will cause an increase in the supply of goods. We have seen that we cannot be sure whether or not there will be an increase or decrease in demand for consumer goods purchased within the United States. The price of these consumer goods will increase but not by the full amount caused by the tax increase.
  
  
• The price of goods outside of the United States (particularly in Canada) will increase because of this increased demand. Cities such as Windsor, Ontario should expect to see even more American visitors than they do already.
  
  

Not all consumers will be effected equally by these changes. We'll next look at who will lose and who will win under a national sales tax.

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