Working at a Big Four public accounting firm, we learn that auditing standards deal with the term “fraud” extensively. Intentional income tax evasion is a form of fraud. In the world of accounting and auditing, we learn that fraud exists when three items are present:
a) Incentives or pressures,
b) Rationalization or justification and
Considering we are human, there will always be ample supplies of the first two legs of the three-legged fraud stool. In the accounting world, most efforts are focused on eliminating, or at least reducing to a reasonably acceptable level, opportunities to commit fraud. The simple example being that if someone feels pressure to steal cash because of personal circumstances and can justify why they need the cash as the company underpays and “owes” them anyway, but cannot open the cash register, they inherently cannot abscond with the cash.
The FairTax actually addresses the two most important aspects of the fraud triangle. First, the current income tax system taxes Americans’ income, which in its simplest form, is the fruit of our labor and is our property. There is an inherent, underlying resentment when the fruit of our labor (i.e., income), is taxed, much of it taken from us in the form of payroll (FICA and Medicare) and federal tax withholdings, prior to ever receiving our income. Adam Smith, the famous Scottish political philosopher and economist (author of The Wealth of Nations, 1776), said that, “The property which every man has is his own labor, as it is the original foundation of all other property, so it is the most sacred and inviolable.”
This resentment plants the seeds of rationalization and justification for many small business owners and others, as it relates to income tax evasion. The thoughts borne from this are multi-faceted and include but are not limited to examples such as, “The government wastes our money anyway,” “The government taxes me too much already,” “I can’t afford to pay that much in taxes because my small business doesn’t make that much,” or “I won’t be able to buy that Lexus SUV if I pay that much to the IRS,” etc.
The opportunity leg of the fraud triangle is the most important to cut off. Opportunity is beyond a single person’s control, beyond their thoughts, emotions or perceived needs. The FairTax is the ultimate eliminator of the vast majority of the opportunity for evasion that our current income tax system embodies. The March 1, 2017 independent studies by Dr. Richard J. Cebula, Ph.D. and Fiorentina Angjellari-Dajci, Ph.D., demonstrate how U.S. tax evasion is now larger than ever, and growing at an increasing rate, with cumulative tax evasion conservatively estimated at $9 trillion cumulatively, over the 2017-2026 period. With state sales tax regimes, do we ever hear about massive sales tax evasion schemes like we do with the federal income tax?
Estimated evasion under a national consumption FairTax would be miniscule relative to our current system. Upon examining my thoughts and emotions, I admit that I do not feel the same disdain when paying sales tax for a purchase that I control, as when the fruits of my labor, income, are taxed. With humans involved, there will always be some cheating, but the opportunity for evasion is drastically reduced under the FairTax.
A key fact supporting this contention within the aforementioned study found that 6.1% of active companies make up 88% of total U.S. business receipts. Said another way, the big box stores (e.g., Wal-Mart, Best Buy and Home Depot, etc.) will collect the vast majority of the FairTax, and can any of us recall telling the Wal-Mart clerk that we didn’t want to pay the sales tax?
While I would love to hear how that plays out, the reality is that in today’s world, the overwhelming majority of sales tax collections are automated, programmed into the register at retail stores, with retailer and state infrastructure already in place to collect and remit sales tax receipts, and so it would be with the FairTax.
Jade Walle is a partner in the Assurance practice of the Denver office of a Big Four public accounting firm. He writes for FAIR Tax.