Behind Huckabee's radical 'Fair Tax'

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NEW YORK (Money) -- With Mike Huckabee's big win in the Iowa Republican caucus Thursday, more people are asking, "So what's this guy actually stand for?"

Answer: For the most part, he's a pretty conventional conservative Republican.

But on economics, he has one big, out-of-left-field-or maybe make that out-of-right-field-idea. It's called the "Fair Tax," which is spin-ease for a national retail sales tax.

The sales tax idea isn't Huckabee's invention. It was developed by a group called Americans for Fair Taxation, and it has already been written into a bill sponsored by Georgia congressman John Linder.

Conservative talk radio host Neal Boortz has helped turn it into a grassroots cause, and his FairTax Book, which he co-wrote with Linder, briefly held the No. 1 spot on the New York Times non-fiction best seller list.

Here's a quick guide to how the "Fair Tax" is supposed to work, and to some of the problems it might run into if a President Huckabee ever tried to get it passed.

How would the "Fair Tax" change the tax code?

It would scrap it almost entirely. You wouldn't pay income tax, Social Security and Medicare payroll taxes, the alternative minimum tax, a capital gains tax or estate tax. No more complex tax returns to fill out, either.

Instead, everyone would pay a flat sales tax on almost everything they buy: Food, clothes, new cars, diapers, even health care and financial services.

How high would the sales tax be?

Under the proposal, you'd pay a 30% mark-up over the pre-tax price.

Hang on... I read another story about this and it said the Fair Tax would be 23%

Well, it depends on how you want to do the math.

Say you buy a $1 pack of gum, and then pay 30% in tax, for a total price of $1.30. The extra 30 cents you paid is 23% of $1.30.

Sales tax supporters frequently cite the number as percentage of your spending. They say this makes it easier to compare the sales tax to the income tax.

Critics, including conservative commentator Bruce Bartlett, have argued that people generally think of sales taxes in terms of mark-ups - that's how state sales taxes are expressed - and that FairTaxers are just trying to come up with the lowest possible number to make their idea easier to sell.

A 30% tax on food and medicine would be hard on the poor, wouldn't it?

If that's all there was to the plan, yes. On its own, a national sales tax would be extremely regressive - that is, it would tax everyone who spent everything they earned (and that's a lot of us) at 23% of their income, while those who made enough money to set some aside would, in effect, pay a lower overall rate.

But the sales tax plan would partly offset this effect by sending every household in America, from the family of a poor single mother to Warren Buffett, a check to cover the taxes on their spending up to the poverty level.

Factor in that cash from the government, and each family's net tax burden goes down, so that the Fair Tax looks more progressive.

For example, a family of three earning $30,000 a year and spending all their income would give 5% of their pay to the government (see correction at end of story); one earning and spending $125,000 would pay a net rate of about 19%.

So the "Fair Tax" really is pretty fair then?

"Fair" is a value judgment, but a lot of people won't think this admittedly lurid scenario sounds fair at all: Let's say a hedge fund manager has a good year and earns $1 billion. If he can somehow manage to scrape by spending, say, $100 million, the other $900 million is tax free. He'll have paid about 2% of his income in taxes that year.

If those who can afford to save a large chunk of their income pay less, the burden of taxes in any given year likely shifts to lower earners.

Advocates of a sales tax point out that the hedge fund manager will still have to pay taxes on that $900 million when he (or his heirs) actually spend it. They argue the tax looks much more equitable if you consider tax burdens over a lifetime.

What's the point of doing this, anyway?

Shifting to a sales tax gives people more incentive to save and invest, which supporters believe would be a big spur to economic growth.

But the cover of The FairTax Book sums up the real grassroots appeal: It shows the letters "IRS" inside a red circle, with a big red line slashed across.

Could this happen?

The Fair Tax may have fans among talk radio listeners, but it hasn't been taken very seriously in Washington so far.

That may be because the sales tax would take away many special tax breaks and loopholes beloved by lobbyists. It would also limit the ability of legislators to target tax breaks to help favored groups - including many in the middle class.

And besides the inevitable debate over fairness, many tax experts, including a panel appointed by President Bush to consider tax reform options, question whether it could really work.

Would legislators really be willing to tax baby food, or will they try to carve out exceptions? With each exception, the rate on everything else would have to be higher.

And with all taxes rolled into one high rate, the temptation to cheat could be very high as well. Too much evasion would require the government to raise the tax.

So while that might not technically be an IRS anymore, you can bet there'd still be plenty of government employees out there enforcing the tax laws.

Correction: An earlier version of this story understated the impact of government offsets to the consumption tax. After receiving a government check, a family of three earning $30,000 a year and spending all their income would effectively be taxed at 5%, not 7%.