The FairTax Is Fair!
Is the FairTax really unfair? "Adakin Valorem" offers a point-by-point rebuttal of Max Sawicky's criticism of the proposed tax.
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Max: The FairTax is a radical tax reform with a strong contingent of devotees …. In this campaign season, the tax is being promoted by presidential hopefuls Governor Mike Huckabee of Arkansas, Rep. Ron Paul of Texas, and Senator Mike Gravel of Alaska.
Adakin: Sir, only Huckabee and Gravel have expressed outright support for the FairTax. Congressman Paul (as well as Senator John McCain) said he would, as president, sign HR-25 if it made it through congress, but Paul advocates the outright abolition of the income tax and replaces it with nothing. Also part of that “strong contingent of devotees” are the 74 bipartisan congressional cosponsors of the bill in both the U.S. House and Senate that support HR-25/S1025, also known as the FairTax.
Max: As things stand the poor pay no federal income tax. Most families with children under median income levels owe little or no income tax. The vast bulk of individual income tax is paid by those well above the median.
Adakin: Yes and no. Even though “the vast bulk” pays no federal income tax, they all pay employment taxes, which when combined with what the employer contributes totals over 15% of a worker’s compensation. While a low-income worker sees only $92.35 from every $100 earned, an employer hiring someone at $100 per unit of work pays $107.65, with the overage being the employer’s side of FICA, for a total of $15.30 going to the Fed.
With the FairTax, a worker would get the promised $100 plus that additional $7.65. So passage of the FairTax would result in a 16.6% increase in take-home pay for those that “pay no federal income taxes.”
Max: The bottom 60 percent of households contribute a grand total of 2.4 percent of individual and corporate income tax revenues.
Adakin: Yes, but FICA taxes are spread pretty much evenly over the entire wage-earning spectrum and this is the group that would benefit most from the “prebate” function of the FairTax.
Max: What would the FairTax rate be? Some of its supporters claim it would be 23 percent. Let me familiarize you with their arithmetic. They are talking about a thirty percent rate applied to retail purchases. A $20,000 car would cost $26,000. A new $300,000 house would cost $390,000. If the product costs a dollar, the price including tax is $1.30. Thirty divided by a dollar and thirty cents is 23 percent.
Adakin: Your point regards the debate between inclusive versus exclusive taxes. The reason the FairTax people use the inclusive rate of 23% is that it replaces an inclusive tax rate. Currently, income tax is scored as an inclusive tax rate. For example, the 25% tax bracket implies that 25% of gross earnings is tax, leaving the wage earner with 75%. The FairTax people simply want to be consistent in the manner in which the two systems are portrayed. If you inclusively look at your income tax as a percentage of gross earnings, then let’s also look at the FairTax as a percentage of gross spending. Hence the $30 is 23% of the gross amount spent.
For comparison, let’s do the reverse and apply an exclusive scoring method on a typical middle-income wage earner in the 25% tax bracket and paying FICA taxes at 7.65%. The total amount of tax liability for that person is (25% + 7.65%) almost 33%. I guess that if Max is to be consistent, this person would be considered to be in the 50% tax bracket since 1/3 is half of the 2/3; she is paying almost half of her net income in taxes.
As far as a new $20,000 car costing $26,000 or a new $300,000 home costing $390,000, Max never mentions the fact that the current tax code creates hidden or “embedded” taxes within the cost of virtually everything we buy.
Several years ago, Roger Smith, the then-General Motors CEO, testified before Congress that embedded taxes comprise over 30% of the cost of a new car. Economists say that taxes and tax-related compliance costs comprise, on average, 22% of the cost of all new goods and services. Based on that figure, that new $20,000 auto should cost around $15,600 once the embedded taxes are removed from the cost of production. Now, add back the 23% FairTax and the final retail price of that new car is $20,280, or pretty much the same price it was when the Fed was removing 1/3 of your gross pay.
Think about what a new $300,000 home would cost if there were no embedded taxes factored into the cost of building it. Imagine if the builder, all of the sub-contractors, the developer, the architect, engineer, real estate broker, and appraiser no longer had to pay taxes on their profits. Or if the material suppliers selling the lumber, the concrete, the plumbing, the roofing, the wiring, and the appliances didn’t have to pay taxes on the profits that they made in their “B-to-B” dealings with the homebuilder. Once all these embedded costs are removed, that $300,000 home would suddenly cost around $234,000. Now add back the 23% FairTax and we’re back to around $304,200.
Home purchases typically require a 20% down payment. Under current tax law, that 25% tax bracket homebuyer would have to first earn almost $90,000 in order to save the $60,000 needed for a down payment. With the FairTax, the down payment requires only $60,000 of earnings. That $1440 monthly house payment would also require first earning $2160. The homeowner would then have to factor the mortgage interest deduction, saving around $250 each month. Even considering the MID the monthly payment would still require earning over $1900 so as to be able to pay that $1440. Using untaxed earnings, the FairTax would require earning only $1440.
Max: Whether it is 30 or 23, the rate on the above-mentioned worker would still exceed that of the payroll tax.
Adakin: Really? With the FairTax, that same low income worker would have 16.6% more in take-home pay. If she buys a used car, or a used home, or pays tuition, or makes any purchases not subject to the FairTax, she would be spending untaxed earnings, which would substantially lower her effective tax rate. And when the prebate factor is considered, it’s easily possible that a prudent low-income consumer could actually have a negative tax rate. Bottom line: the worker gets to choose how much he/she is taxed based on how she spends her untaxed earnings.
Max: If the tax is reimbursed for all income below the poverty line, there is still some pay rate well short of “rich” where your FairTax would be higher than your payroll tax. For a nuclear family of two parents and two kids in 2007, the poverty line is $21,027.
Adakin: Let’s look at your “poverty line” family earning $21,027. The FairTax prebate would be 23% of $21k, or $4830. Adding the prebate to their gross income plus the employer’s side of FICA (7.65%) provides that family with just over $27,400 in total spendable income. If we assume that ALL of that was spent on taxable items, this family would pay $6302 (23% of $27,400 scored inclusively). Deduct the prebate from the tax ($6302-$4830) and the net effective tax is $1472, or 7.0% of the original $21k earned, which is just under the worker’s FICA amount that is currently withheld.
The above example assumes 100% of their income is spent on taxable purchases. If this family spends 20% of their gross income on non-taxable spending, like a used car or tuition for a child or payments on an existing home, the effective tax rate drops to just 1.0%.
Point being, with the FairTax the worker is in control over how much taxes they choose to pay.
Max: Thirty percent of the earnings of such a family in excess of $21K catches up with 15.3 percent of earnings from the first dollar at around $42K. In other words, as you escape lower class and hit the bottom rung of the middle class income ladder, you start to pay more under the FairTax than you would have under the old payroll tax.
Adakin: Of course you “start to pay more” as income increases. That’s because consumption increases proportionally as income increases. As spending increases, the percentage of benefit derived from the prebate diminishes. The FairTax is a progressive tax. Max’s statement implies an assumption that every income quintile spends all of their earnings. Lower-income people buy the necessities of life and the prebate reimburses them for the taxes they pay up to the poverty level. As income increases a consumer could choose to spend some of their increased earnings on both taxable and non-taxable items or buy investment property or simply save it. With the FairTax, whether you earn a million bucks or a thousand, if you don’t spend it you aren’t taxed. You choose when and how much you want to pay for the government that you get.
Max: Bruce Bartlett, former Reagan tax guru, points out that the bottom 80 percent of households pay less than 23 percent of their income in all federal taxes. And the bottom 90 percent pay less than 30 percent of income.
Adakin: Yes, that’s true. But their entire paycheck is taxed before they ever see it. Bartlett makes the assumption that we all spend 100% of our earnings on taxable items. The last time I purchased a new car was in 1975, I spend at least a thousand bucks a year on educational tuitions, and I’ve never bought a new home, only existing homes. None of these items would be subject to the FairTax. So the real focus should be on how you choose to spend your earnings. By the way, you can find an excellent rebuttal to Mr. Bartlett’s flawed comments by Laurence J. Kotlikoff, Professor of Economics at Boston University, here.
Max: On the high side of the income spectrum, it should be clear that those who are able to save, or spend their income in other countries, or buy stuff by mail or internet in other countries and have it shipped to them here, will pay less tax than presently. The FairTax should be great for Canada and Mexico.
Adakin: Again, Max makes the assumption that the FairTax adds 30% to the current prices of goods and services with no consideration given to the fact that the hidden costs of embedded taxes would disappear.
Max: FairTax advocates … claim the current income tax is “built into the price of the product,” so you would not be paying more out of pocket than presently. The implication is that when we switch from income tax to sales tax, the product price including tax does not change. This can only mean that income and payroll taxes on individuals and corporations are really paid by consumers. It also means your take-home pay would not increase.
Adakin: Max is assuming that the primary component of embedded taxes in a corporation or business is their employee’s payroll taxes. As an economist, he should know that the cost of employing people is contractually a fixed expense and is not an expense imposed by government fiat.
Employment taxes are a tax on each individual employee, not the employer. If you hire people, you have a contractual obligation to pay 107.65% of whatever you agreed to compensate them and that cost remains constant. The amount doesn’t change when the tax law changes. The real embedded cost reduction comes from elimination of the tax on the company’s profits and elimination of the double taxation on “after-tax” dividends paid to its shareholders.
In addition, the cost of maintaining the detailed tax records on income, expenses, capital improvements, deductions, and depreciation are all part of the hidden documentation costs imposed by the current tax law. Another consideration is the substantial “opportunity cost” that is caused by the current tax law. Most corporations and businesses pay CPAs and tax attorneys to advise them before making business or investment decisions or capital expenditures. With the FairTax, these business decisions would be based on the intrinsic benefits of the company instead of being based on the tax aspects of these decisions.
No, Max, the employees would still see their entire paycheck and the employer would see a substantial reduction in their corporate tax burden, documentation costs, and consulting expenses, leading to an increase in efficiency and profit. The lowered costs could allow the business to price their products more competitively with their overseas competitors, thus obtaining a higher market share, increasing demand for their goods and services, and creating a need for expansion, new hiring, and more jobs for Americans.
Max: One noted by Bartlett is that the government will tax its own purchases from the private sector. In other words, it will charge itself and count the proceeds as net revenue. Second, state and local governments would be liable for the FairTax on their purchases. The FairTax rates do not take into account the impact on tax burdens in the state-local sector. Third, purchase of new homes and some mortgage interest are included in the FairTax tax base. The politics of a clean FairTax base are not easy.
Adakin: When federal, state, or local governments buy goods or services, it’s assumed that the vendor is making a taxable profit on that purchase. The vendor sells their product to the government, then turns around and pays the government the taxes earned from that sale. Max is again ignoring the embedded tax component that comprises a substantial part of the production costs for each of the above items. And he assumes the government purchaser will be paying an additional cost over and above the embedded tax costs that will disappear with the FairTax.
With the FairTax, the hidden tax on the profits disappears but remains in the transaction as a sales tax where everyone can see it. The FairTax is designed to be revenue-neutral, so why does Max feel that government should unfairly benefit from these untaxed goods once those hidden taxes are removed?
Max: The FairTax calculations take no account of tax compliance. Presently the biggest rates of non-compliance in the income tax are among the self-employed, proprietors, and unincorporated businesses. Under the FairTax, these parties would have the responsibility of collecting the entirety of federal revenue, not just their own portion of the income tax. There would be a huge new incentive for tax evasion, and no IRS to walk the beat. This factor alone leads most tax economists to dismiss the FairTax as unworkable, aside from its other disadvantages.
Adakin: The IRS processes almost 200 million individual tax filings and over 30 million business filings each year. The FairTax would collect its revenue from just those 20 or 30 million retail vendors, substantially reducing the exposure to potential fraud or corruption.
Those retail businesses are already complying with their state revenue agencies that currently collect their state sales taxes. HR-25 would simply have those same state revenue agencies provide the collection and oversight of these vendors so there would be no need for duplication of services. Max says: “Under the FairTax, these parties would have the responsibility of collecting the entirety of federal revenue, not just their own portion of the income tax.” (Income tax? What income tax?) HR-25 contains a provision to compensate these retail businesses for their acting as tax collector, similar to the way that many state revenue agencies currently compensate their retail merchants for this service. There is a long history of sales tax collection, so this is not rocket science. Millions of retail merchants simply record the sales and send in the revenue each month already.
Besides, limiting the number of “tax collectors” makes oversight far easier. For example, in Florida, a state with no income tax, less than 6% of all retail businesses collect over 90% of all sales tax revenue (i.e., Wal-Mart, Home Depot, Target, etc.), again making oversight much more efficient. In addition, it only takes one person with the current system to perpetrate fraud by filing a bogus tax form. With the FairTax, it would require the cooperation of both the customer and the vendor, substantially increasing the risk of detection.
Max: The income tax badly needs fixing, but the FairTax is an unlikely remedy. The IRS ain’t going anywhere. And we’re all going to die eventually. Some things are not going to change anytime soon.
Adakin: As noted earlier, HR-25/S-1025 currently has over six dozen congressional cosponsors in the current Congress. That’s 15% of Congress, more than any other tax reform proposal on the Hill. By comparison, the Steve Forbes/Dick Armey Flat Tax bill has just four cosponsors and has gone nowhere over the past ten years.
The FairTax would turn our nation into the world’s tax haven, allowing American goods to cost less and be far more attractive to foreign consumers since the tax component would be gone and the FairTax would not apply to exported items. This competitive edge would attract billions in foreign investment capital and would reverse the flight of American jobs going overseas. As the cost of home ownership would be reduced, our depressed housing industry could get back on its feet, putting our construction industry back in business. The same can be said for our auto and other manufacturing enterprises that would export untaxed products overseas.
The FairTax is fair because if Bill Gates, Warren Buffet, Oprah Winfrey, you, or me buy that bottle of Pepsi and a Big Mac, we will all pay the same amount of tax. No longer would someone in Washington need to know your personal business, your earnings, your marital status, whether you own or rent, or what you invest in or what you buy. Your privacy is yours again. No longer does a mortgage payment get preferential treatment over a rent payment. No longer is hard work and achievement punished as income increases. No longer would risk-taking and investment capital be penalized while failure is rewarded. Everyone pays the same sales tax and everyone gets the same prebate, yet Mad Max asks “How fair is the FairTax?”
Bottom line: the FairTax is fair because it takes the politics out of revenue generation. With the FairTax, Washington would no longer be able to use the tax code to reward their cronies and punish their enemies. The FairTax gives people the freedom to choose when and how much they want to pay for the government they desire. And that’s what really scares the people inside the Beltway.
“Adakin Valorem” is a real estate investment analyst for the Federal government. The view expressed in this column does not represent the official views of his employer.
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20 Comments
Darrell Klee:Well said, sir.
With staggering costs for social obligation looming before us, it would be good to have tax revenues on the shoulders of the economy and not the individual worker’s. Having as much privacy at the bank as in the bedroom would be nice too.
Respectfully
Mar 18, 2008 - 4:59 am GeorgiaTex:Adakin’s rebuttal presupposes that the tax rate under the FairTax would be (and remain) at the 23% “tax-inclusive” rate. That flies in the face of every independent analysis of the FairTax, each of which have concluded that the tax rate would need to be much, much higher.
It’s easy to sing the praises of a tax where the rate is set so artificially low that we would all save money. Unfortunately, it doesn’t work that way in the real world.
In order to replace our existing burdensome tax system, any new system would need to be equally burdensome and would require high tax rates. Since a consumption tax system with a “pre-bate” would shift most of the tax burden on the middle class, it would by definition raise the tax burden on the middle class.
However, at the magical 23% rate, nobody would pay higher taxes. We’d all get a free ride. Again, it just don’t work that way in the real world.
Mar 18, 2008 - 6:21 am Ken:As wonderful of an idea as it seems, no I know why it will never happen. If this system encourages people to buy used vehicles and homes, it endangers the two largest industries of our country, and pits all of their lobbyists against it.
Mar 18, 2008 - 7:34 am Clarity:GeorgiaTex,
Three important points:
1) The system is revenue neutral, the tax rate will be whatever it needs to be. However, many of the so-called “independent analysis” do not examine the FairTax, they examine sales taxes in general. This completely misses the economic efficiencies tied to eliminating corporate & payroll tax and the surge in economic growth that we know for a fact would follow. The 23% inclusive/30% exclusive is a reasonable estimate for what the initial tax rate would need to be, and if our federal government could stop themselves from growing spending, this rate could actually go DOWN in following years.
2) The FairTax does NOT shift the burden to the middle class. The middle class will have the opportunity to choose to pay much less tax than they do now, and more importantly have the opportunity to SAVE money for investment, retirement, and college education TAX FREE. The FairTax allows the middle class to BUILD WEALTH which our current system punishes.
3) We currently tax INCOME, not wealth. I know this sounds like a no brainer but please stop a second and think about this. The truly wealthy in this country do not get W-2 income, they get most of their money through capital gains and dividends, which are taxed at a much lower rate. And because they don’t get a “paycheck” as we think of it, they don’t pay a single penny into the tax revenue-starved programs of social-security and medicare. To make matters even more extreme, they don’t have to pay tax on their capital gain until they “realize” it, in other words when they sell the asset. But they don’t need to sell their appreciating asset, they can borrow money against it instead and essentially live tax free. These are the miracles that can happen when you have a small army of tax accountants working for you. So while you think our current tax system really “sticks it to the rich” it does not. The truly wealthy make out like bandits under our current system. The people who really DO get screwed are those in the upper middle class or those in the middle class who live in areas with high costs of living. They might have a little bit bigger house than the average middle class person, maybe a slightly nicer car, but they largely face the same financial challenges that everyone in the middle class does. They have to go to work all day every day to pay their bills. Yet these are the people that get stuck with the “rich” label and pay out the nose while the truly wealthy avoid most of that burden. Under the FairTax this all changes, the truly wealthy pay tax on their extravagant lifestyle regardless of what their portfolio did that year, and finally they will be paying a fair share compared to the rest of us.
It’s easy for those of us who get a regular paycheck to equate wealth with adjusted gross income as it appears on our tax returns, but they are very different things, especially for the extremely wealthy. The FairTax finally brings these Americans into the fold, along with criminal tax dodgers which the rest of us have been paying for. Meanwhile, it gives a true opportunity for the middle class to start BUILDING WEALTH, which is the key to long-term prosperity.
Thanks for reading.
Mar 18, 2008 - 7:47 am Webutante:A very important piece on how the Fair Tax works in theory. It’s the kind of article I have to read and re-read in order to grasp it, but well worth the time and effort. Thanks for this rebuttal; please do more of this in the future.
Mar 18, 2008 - 8:08 am Wolf Pangloss:GeorgiaTex, one of the necessary steps on the way to lowering the tax burden is to remove hidden taxes and bring them all out in the open. The Fair Tax does this. The current tax system does not.
Mar 18, 2008 - 8:26 am JJ Wampler:First off, thank you Mr. Valorem. When I read Mr. Sawicky’s criticism the other day, I too wanted to send a long rebutal. But alas, as someone that is currently part of the middle class, i don’t have that kind of time, currently.
And I say that a bit in jest, but more to point out to GeorgiaTex the middle class consumers already PAY a large portion of the tax burden because they are indeed consumers that spend a majority of what they make due to the embedded taxes.
The FairTax removes sooo many of the taxes put in place that try to glean money off the dreaded rich, that they inadvertently keeps the middle class in the middle class.
Once we step into Class Warfare it’s often easy to rally the mob against the “evil” rich, but what is often missing in these rallies against capitalism and it’s workings, is the cold hard facts about just how much taxes we ALL really pay, and what constitutes “rich” in America.
What matters more than money and taxes is Jobs, and our current tax code is taking away jobs and investing in our country. Now I know FAR more middle and lower class people that would be more concerned about having a job or more options for a better job than they would about taxes when they don’t have a job.
But in short, the deeper I dig when researching and understanding our current Tax Code the WORSE the smell. Now I’d be glad to have a debate and have gotten into MANY debates on the merits of a FairTax like system, and what I generally find people don’t know ENOUGH about the FairTax, but are dead set on Defending our Current Tax System, which they know even LESS about.
Please Go READ or listen to the FairTax books! And then do us a bigger favor, and get others too!
Mar 18, 2008 - 8:48 am Max Sawicky:O.K. Mr. Adakin Valorem. If that is your real name.
In the same order as your post:
1. The Ron Paul detail was dealt with in the comments.
2. Your quote of me refers specifically to “Federal income tax,” which you failed to refute. I did not neglect the payroll tax. There was no “yes and no.”
When you say that under the FairTax the worker gets his entire gross pay (current take-home plus the 15.3% for payroll tax), you are making an assertion about tax incidence — about what would happen with no payroll tax. You provide no support for this assertion.
3. You assert, again without support, that the bottom 60 percent would benefit most from the FairTax.
4. “The reason the FairTax people use the inclusive rate of 23% is that it replaces an inclusive tax rate.” I’m not a mind-reader, so I can’t swear that I know what they are thinking. The FairTax is a sales tax, not an income tax. Everybody understands a sales tax as a percentage applied to the price of a product. In this sense, the FairTax rate is 30, not 23. The only reason to peddle the latter number is minimize the apparent level of the tax.
5. “Max never mentions the fact that the current tax code creates hidden or “embedded” taxes within the cost of virtually everything we buy.” Actually I address this issue in my piece, as you acknowledge later. Our friend Adakin says that current taxes are “embedded” in the product price. The implication is that with no income/payroll tax, the product price goes down. But then the seller cannot deliver this dividend to the worker in the form of his former gross wage, as promised by Adakin previously in his piece. He is double-counting FairTax revenue, first in higher take-home pay, second in a lower product price. It could be split in this way, but the full amount (15.3% of pre-FairTax wages) can’t be used twice.
“Economists say that taxes and tax-related compliance costs comprise, on average, 22% of the cost of all new goods and services.” “Economists” say no such thing. A few of them, perhaps. If you want to believe Roger Smith, go ahead. He’s not exactly a disinterested party in this debate.
6. 23 is still more than 16.6. Mileage will vary, some will come out ahead, some behind. Few wealthy people will come out behind.
7. The poverty example does not speak to my point, which was that workers above the poverty line but well short of rich could pay more under the FairTax.
8. “If you don’t spend . . . you aren’t taxed.” Sounds like a plan!
9. Adakin says an existing home would not be subject to FairTax. Well if I buy a new home that IS subject to tax and want to sell it, I will want to recover my tax amount as well as the base price. So an existing home could carry the tax along with it. Who would buy a house and then sell it at a loss, unless forced to?
10. Re: FairTax bounty to the rich, Adakin reiterates his embedded point, irrelevant in this context.
11. Adakin says labor costs are “a fixed expense.” Assuming this is true (it isn’t), then the employer MUST add the FairTax to the pre-FairTax product price. Just as with any sales tax.
12. “The real embedded cost reduction comes from elimination of the tax on the company’s profits and elimination of the double taxation on “after-tax” dividends paid to its shareholders.” Here is a new point I haven’t seen before. Somehow or other, the elimination of the corporate income tax ($370 billion in 2007) is going to replace $2,568 billion in total Federal receipts.
13. Gov “benefit” has nothing to do with it. You’re double-counting again.
14. Fewer taxpayers yes, much more incentive to cheat for each one. And those currently cheating the Feds are probably cheating the state too. State governments presently rely on the IRS to provide information on taxpayers. Without it the state governments would be burdened with doing more, which is part of the plan of the FairTax — to raise the costs of collecting taxes.
15. FairTax and exports. The FairTax treatment would be the same as other countries now. Under the VAT, our exports would be taxed at the other country’s border, the same as their domestic products. So no tax advantage to U.S. exports.
16. “The FairTax is fair because if Bill Gates, Warren Buffet, Oprah Winfrey, you, or me buy that bottle of Pepsi and a Big Mac, we will all pay the same amount of tax.” Raise your hand, anybody who thinks any of these people will pay more tax than they do now under FairTax.
And if they pay less, who pays more?
Thanks to Adakin for the exchange, and may all his mortgage-backed securities return his labor with profit.
Mar 18, 2008 - 10:25 am GeorgiaTex:Clarity — Thanks for your civil reply. Here’s my quick responses:
1. Look at William Gale’s analysis of the FairTax in the May 15, 2005 ed. of Tax Notes, published three months before The FairTax Book came out. It is an analysis of the FairTax as written. Both the FairTax Book and the recent book ignore it. (When forced to acknowledge the Gale study, Boortz simply lies and says it is not the FairTax.)
2. If taxes are eliminated on the poor and slashed on the wealthy and high-income families, the tax burden of the middle class must increase. (Boortz will claim the money will come from illegal aliens and the underground economy, but if you actually run the numbers you will see the money is just not there.)
3. I certainly agree there is a difference between high income and wealth, and I also agree the upper middle-class and high income earners get screwed under our current tax code. But to think that the FairTax is going to tax wealth is simply wrong. In the first place, the FairTax eliminates the estate tax, which is the only tax we currently have on wealth. Second, the truly wealthy do not spend their principal on what would be taxable goods and services, at most they spend their interest, dividends and capital gains. So the vast bulk of their wealth will never be taxed under the FairTax, but will simply grow untaxed in perpetuity.
Mar 18, 2008 - 12:43 pm Clarity:Max:
You sound like you’re deliberately attempting to poke holes in the plan instead of considering any benefits of it, which is unfortunate. The plan doesn’t need to be perfect so long as it is a vast improvement from what we have now, which it is.
To address some of your points:
2. Federal income tax is only one piece of taxes we pay to the federal government. It’s pointless to only discuss this subject in regards to the income tax as the FairTax replaces much more than that.
3. The bottom 60% will benefit for the following reasons. a) The prebate makes up a much larger percentage of their income than the top 40%, b) many of the goods people in the bottom 60% purchase are used/second hand such as vehicles and homes, and as such would be tax free. c) People in this segment desperately need opportunities to save money and build wealth; the FairTax promotes this by giving them their entire paycheck and allowing them to choose how to save/spend it. The reason the “rich are getting richer and the poor are getting poorer” is not income, it’s assets. The truly wealthy are able to accumulate wealth through assets, whereas the lower income brackets never have a choice to save pre-tax money because the government takes it out of every paycheck before they ever see it.
4. People who get bent out of shape about the 23/30% thing are the ones that seem to be trying to play devil’s advocate and being deliberately obstructive. The bottom line is that we’re talking about replacing the income tax system, so it’s perfectly reasonable to calculate it in the same way that your effective income tax rate is calculated. The bottom line is that $.23 cents out of every dollar you spend on new retail goods and services. It makes you feel better to call that 30%, knock yourself out, but the number is the same either way.
5. Lower product price is not just a result of the elimination of payroll tax, it is also a result of the elimination of corporate tax, compliance costs, and economic inefficiencies related to complying with the tax code. There is no double counting here.
6. Wrong. The truly wealthy have a myriad of legal ways they can avoid paying tax currently. Under the FairTax, most of those legal loopholes will be eliminated. While there will still be people who try to cheat the system, the reality is the vast majority of Americans are not interested in violating tax law.
7. They could pay a lot less as well, that’s where choice comes into play. You do believe in choice, don’t you?
8. You mock this line, but it’s an important point. We currently live in a country that has a negative savings rate. We have a borrow and spend culture. Our tax code is of no help because it essentially punishes working harder in order to save money. Under the FairTax, savings is encouraged because it is not taxed. People can get a second job to pay off their debt or save for their kids’ college and they are not penalized by being stuck in a higher tax bracket. Think about it!
9. There are two issues here, cost and price. The cost of new homes has an above-average amount of labor costs in them that will be reduced should the FairTax be passed. The price of resale homes will be dictated by the market, not by how much of the retail price was tax.
12. We’ve seen real world of examples (such as Ireland) where dramatically reducing corporate tax results in substantial economic growth. In an economy as powerful of that of the United States, that growth would be explosive and reach across all sectors of our economy especially because the FairTax would eliminate corporate tax altogether.
14. It’s much tougher to cheat under the FairTax than under the income tax. With the income tax you have the inherent conflict of interest of people doing their own taxes. Meanwhile, the FairTax would reduce the number of sources of tax returns by 80% since it would collect from retail businesses and not individuals. This means it would also take two parties (the seller and buyer) conspiring to avoid taxation. Will there be cheating? Of course, some will always cheat, but it’s much harder to do under the FairTax. Also the majority of FairTax revenue will be collected from a relatively small number of large retailers who have no interest in violating federal tax law. In addition, a big part of our problem now is not illegal tax dodgers, it’s the people who are dodging taxes using perfectly legal loopholes. Most of those loopholes get closed with the FairTax.
15. You are completely neglecting the fact that our exported products currently are at a disadvantage because of the huge corporate tax, tax compliance costs, and payroll tax costs that are embedded in the price of the goods before they go overseas. They are then taxed AGAIN by the importing country. By removing the embedded taxes, it would put American goods on EQUAL FOOTING with domestic goods in foreign markets. This would be a huge boon for our export industries, and would bring manufacturing jobs back to America.
16. I’m one of the people who would raise their hand. Warren Buffet has already come out and admitted he pays less in tax than his secretary. Why? Because he gets most of his money through investments, not traditional income sources. And guess what, if Buffet has a bad year, he might not pay much in the way of tax at all. Does that sound fair to you? I’d rather Buffet’s consumption be taxed, because I know that not only will be a more stable source of revenue, but it will continue to be stable regardless of what the rest of the economy does. The FairTax insures the truly wealthy among us pay their fair share, regardless of what accounting shenanigans they can pull off under our current system.
Mar 18, 2008 - 1:07 pm Clarity:GeorgiaTex-
I’m somewhat familiar with Gale’s analysis, he and economics Prof. Kotlikoff of Boston University have gone back and forth on this. Gale’s approach to the FairTax is dismissive and contains some erroneous calculations. Prof. Kotlikoff has been more rigorous in his approach to the FairTax and I suggest reading some of his publications on the matter.
2. There are several things you are missing. For one, taxes would not be slashed on the truly wealthy, because as it is currently, they can avoid federal income tax to a substantial degree through various accounting gymnastics. Between wealthy tax dodgers, tax cheats and the underground economy, the tax base would be broadened considerably. So the tax burden would not need to increase on the middle class because the tax base is broadened. Additionally, because the middle class would suddenly receive the entirety of their income, they would have the freedom to choose when and how much tax they are going to pay. That is a HUGE opportunity for the middle class to try to build wealth instead of just continuing on the paycheck-to-paycheck treadmill they are on now.
3. The FairTax doesn’t tax wealth, but it comes much closer to it than income tax. Estate tax is a joke because it can usually be avoided anyway. Once again, you’re talking about the wealthy, who have all the tools at their disposal necessary to avoid paying taxes legally. You will never stop the truly wealthy from being wealthy, and we shouldn’t try to. And what you’re forgetting is that while many wealthy people are able to live off their interest and dividends in good times, when the market is slow and their portfolio shrinks, they DO spend some of their principle capital. Meanwhile as it is now, they get a tax holiday for a year because their stocks didn’t grow. Yet they still were able to cruise down to starbucks in their new Bentley that gets 12 miles to the gallon and buy their $10 latte (with extra foam please). Does that sound fair to you? Consumption is a far more fair and stable source of revenue to fund our federal government. Yes if someone wants to be a miser and live it poverty while having a fat bank account they can avoid paying tax, but that’s not a very realistic scenario, and even if it were, when they die and pass on that money to their children, I guarantee it will be spent at some point along the line. And when it is, it will be taxed.
Mar 18, 2008 - 1:29 pm GeorgiaTex:Clarity –
You are the type of person I enjoy discussing the FairTax with because you make an effort to think things through. Obviously we are not going to change each others minds, but at least we can have a pleasant discussion.
1. Kotlikoff’s (actually, Beacon Hill’s) analysis was not more rigorous than Gale’s, he just used different numbers and assumptions. You need to read that study VERY closely because they do all sorts of sneaky things. For one thing, they assumed that the deficit would be $476 billion (or three times what it currently is) in order to get the rate down to 31.25% (tax exclusive.) Second, they did not account for any tax avoidance, that is, the legal actions people would take to avoid paying the FairTax. Buying used homes instead of new homes, for example. When you factor in these to facts alone, you get a tax rate of 45% in order to pay the obligations of government. (Admittedly, the government spends too much money, but the FairTax does not address that.)
2. I’m afraid you overestimate how easy it is for the wealthy to avoid paying income taxes (and, particularly, estate taxes). And you underestimate how easy it will be for the wealthy to avoid paying the FairTax. For example, Paris Hilton can simply go live on the French Rivera for a year tax free. If the rich try so hard to avoid our income tax, don’t you think they will do the same thing under the FairTax. They’ll make tax-free purchases for “business” or “investment” expenses. Vacation overseas. Buy yachts and villas in the Bahamas. There is simply no way to force them to spend all of the their money on taxable goods and services in the U.S. (Even Kotlikoff recognizes that, by the way, because I’ve discussed this with him.)
Also, the middle class keep 100% of the paychecks ONLY if prices rise by the full tax-exclusive rate of the FairTax. So their purchasing power does not increase at all, and their savings are worth considerably less. Read the Beacon Hill/Kotlikoff study and you will see. (Even Boortz and Linder admit this in their latest book, though in a completely muddled way so it is not obvious what they are saying.) Dale Jorgenson took them to the woodshed for misrepresenting his studies on the “embedded taxes” in their first book.
3. Again, I’m afraid it is an urban myth that one can simply avoid paying the estate tax. (Why do you think so many of them campaign so hard for its elimination.) At under $10 million or so in assets, you can take certain steps to minimize it’s impact, but above that level you have to pay the estate tax unless you give your money away. Many wealthy folks do leave their money in charitable foundations administered by their children, but those foundations are carefully regulated. The children can’t spend the money on themselves.
If you believe that Bill Gates and Warren Buffet are going to pay MORE in taxes under the FairTax than under our current system, you are not thinking through your analysis.
Suppose, for example, that Warren Buffet spends $10 million a year on TAXABLE goods and services (which for him would be a lot), his total tax under the FairTax would be $2.3 million per year, which is only a tiny, tiny fraction of what he currently pays.
There’s really no way to seriously argue that the FairTax increases the tax burden on the wealthy. Kotlikoff tries to make the argument that OVER GENERATIONS all wealth is eventually spent, so it will eventually be taxed. It’s a pretty weak argument, if you ask me. And as Keynes famously said,”In the long run, we’re all dead.” Relying on future generations of wealthy folks to pay taxes on their wealth is a pretty weak basis for increasing the current tax burden on the middle class.
Yes, I know you believe that the FairTax is a VOLUNTARY tax and that middle class folks can save on taxes buy simply consuming less and buying used, but you miss the point that EVERYONE will do the same thing, which will not only totally disrupt the economy (home builders, car manufacturers, etc.) but will result in a further loss of tax revenue, which will require the FairTax rate to be increased even farther.
Look, I’m all for tax reform, but the FairTax ain’t it. (Read “100 MIllion Unnecessary Returns” by William Graetz if you want to see a well-thought-out tax plan that incorporates a consumption tax.)
Oh, one final thing, Ireland has a corporate tax AND an income tax AND a consumption tax. So, saying that they simply reduced corporate taxes is not really accurate.
Mar 18, 2008 - 2:51 pm John D:None of the opponents of the Fairtax address the real problem that most of them have with it.
The secret is, that there are huge amounts of money to be made and influence that can be bought by manipulating the current tax code.
That is what lobbyists work to bring about. That is what our Representatives in Washington DC spend most of their time doing, and they are not going down without a fight.
How do you expect lobbyists to earn their money if they can’t convince a Congressman or Senator to put through a tax loophole to benefit their client, or conversely impose taxes and regulation that disadvantage their competition.
You don’t get a fat expense account if you can’t do that, and that is what remaking the tax code would do.
That is without even considering the “financial advisers” and estate planners that would loose their place on the gravy train because they couldn’t figure out new ways to keep from paying income and estate taxes.
You’re talking about large, well financed, and well connected opposition here. They include or can hire all kinds of well respected “experts” that will come up with all kinds of excuses why it won’t work, and don’t expect any help from any of the pundits in print or media either. They’re part of the game.
The Fairtax will never come to pass no matter what the advantages. There’s just too many people who are invested in the current system to allow it.
Mar 18, 2008 - 3:30 pm Clarity:Georgia-
Likewise. I never think I can convince someone, especially on the internet. That’s something they have to do themselves. I just try to present the facts as best I can.
1. I reject the notion that people considering the purchase of used goods as necessarily increasing the tax rate to 45%, that doesn’t jive with how the free market works. While new goods and services will have the FairTax applied to them, there will be reduced cost on the backend, minimizing the price increase, so I don’t anticipate a spike in demand for used goods, and even if there were that would quickly balance with the cost of new goods and we’d get back to a reasonable equilibrium of new-versus-used pricing.
2. I think you underestimate the capabilities of tax accountants & attorneys under our current system. We can go back and forth on hypotheticals of what the ultra-wealthy will do under one system versus another. But the reality is the vast majority of very wealthy Americans have the vast majority of their consumption domestically, and there’s no indication that would change.
I’m not sure what you’re trying to say by claiming people will only get their full paychecks if prices rise by 23% - the legislation is clear, there will be no payroll deduction from their paycheck at all. Spending power is enhanced, not reduced. AFT has a nifty interactive FairTax calculator on their site these days, I suggest you check it out to see how you would fare under the FairTax.
3. I don’t claim to know every detail of the tax situations surrounding Bill Gates or Warren Buffet. But I do know Buffet only pays what he does because he chooses not to avoid any taxes, which he cuold easily do. It’s also somewhat flawed to use the two wealthiest individuals in the nation as any type of guideline. But that’s really not the point, and it makes no sense to design a tax system based upon the tiny handful of people in their category.
What I do know is that someone who is independently wealthy can have an extremely low income tax obligation in years where their investments don’t do well. It’s a perfect demonstration of how income does not equate to wealth and why income tax is a fundamentally flawed and unfair method of taxation. On the other side of the coin you can have young professionals coming out of graduate school with a ton of debt to pay off, only to get hammered on taxes from day one as if they are debt free. We shouldn’t be making it harder for people to pay off their debts, we should be making it easier! The same goes for the entrepreneur, who after years of debt accumulation finally has a breakout year, only to have half his profits taken by the federal government before he can pay his own debts first. I see that as fundamentally wrong.
And I reject your notion that “everyone will buy used” - that’s just nonsense. Used goods are cheaper currently and we remain an extremely wasteful society. The people who are going to buy used are those who most need to financially, and that will remain the case.
As for Ireland, that is a bit of a tangent, but they did most certainly aggressively lower their corporate tax rates and they themselves credit that with substantial improvements in their economic growth rates.
Mar 18, 2008 - 3:45 pm James Hines:The “FAIR TAX” …WHY BOTHER?!
K.I.S.S.: Just Repeal the 16th Amendment!
If we’re going to bother with effort required to pass the - as yet UNTESTED “Fair Tax” (a tax that is absolutely NOT desireable UNLESS the 16th Amendment is entirely repealed): why not simply return to the TRIED AND TESTED mode of taxation recommended as the least obnoxious form of taxation by the authors of our Constitution? A form of taxation which provided the vast majority of all revenue collected by the federal government for the first 70 years of its existence …a form of taxation that would be ENTIRELY available to Congress - WITHOUT passing much more than a single simple bill establishing the uniform rate(s) - once the 16th Amendment was repealed?
I speak of the UNIFORM EXCISE TAX.
Why would this be better than the so-called “Fair Tax”?
First (and again) it has been tried and tested …and it works BRILLIANTLY!
It only places a tax on IMPORTS …NOT on the goods WE hope to export.
This means that it is, for the most part, a VOLUNTARY TAX: if you don’t want to pay the tax - simply refuse to buy imports.
There are no forms for the average citizen to fill out. In fact, there are no forms for the RETAILERS to fill out. The taxes are collected at the port of entry. That is FAR more simple than the Fair Tax.
EVEN IF we were to allow for a uniform rate of (for example) 23% (the rate recommended by Boortz and Linder in their FAIR TAX BOOK) that rate would ONLY apply to IMPORTS.
To be sure: foreign markets may well tax our exports when they arrive on THEIR shores as “imports”: but many already DO that. Our income tax invariably serves as a hidden or built in tax on the price of our exports BEFORE they ever leave our shores. We cannot prevent other nations from taxing our products when they arrive on their shores: but we can and we SHOULD reduce the cost of the products we export as much as possible (by eliminating taxes that increase the cost of producing them here) so as to render them as competitive as possible on the world market.
A UNIFORM rate means that the same excise tax is levied on any given product REGARDLESS of which port by which it happens to arrive in the United States. This also serves to discourage our representatives and senators from selling their votes to the ambassadors or corporations of this or that country.
The Uniform Excise Tax is also self-regulating to a large degree. Before the American Revolution, history had already shown that there is a glass ceiling to how high a government can effectively raise the rate before such increases prove self-defeating. At some point, people will actually stop buying imports for the explicit purpose of avoiding the expense of the tarriff on them. This forces Congress to REDUCE the rates simply to get the public to start purchasing imports and, hence, paying the tarriff to produce government revenue again.
This can also help to keep even imported goods more affordable for even the poorer citizens.
To the extent that such a tax might render some exports prohibitively expensive …this would, at the same time, reveal an opportunity for resurrecting the domestic manufactures of the product concerned. That means MORE JOBS in the USA!
Some will call this “protectionism.” In truth, what we have NOW is protectionism: OUR INCOME TAX HAS SERVED TO PROTECT THE ABILITY OF FOREIGN PRODUCERS TO MARKET THEIR GOODS AND SERVICES IN THE UNITED STATES TO THE DETRIMENT OF THE VERY DOMESTIC MANUFACTURERS AND BUSINESSES THAT PAY TAXES IN THE UNITED STATES! So long as our government is going to practice “protectionism” it would be nice if the policies of our government actually protected our own citizens, manufacturers and economy rather than those of China and a host of other nations.
In any event: the Uniform Excise Tax also serves as an ideal compromise between “liberals” and “conservatives” as we define ourselves today.
As the costs of paying the excise are built in to the wholesale and, consequently, the retail price of the goods; the higher price of these goods suggests that the majority of those purchasing them and, consequently, paying the tax will be the “wealthier” citizens. Hence, the burden of taxes will be borne disproportionately by the wealthier citizens than the poorer ones. For these reasons, the more “liberal” citizens among us should be satisfied that the Uniform Excise Tax is, in a large degree, “progressive.”
On the other hand: given that such a system is largely voluntary - and certainly far more voluntary (in the means of its enforcement) than our present income tax: the wealthier among us also need not complain. After all: all that is necessary to avoid paying the tax altogether is to refrain from purchasing imports.
The Uniform Excise Tax also avoids that most egregious aspect of the Fair Tax. In order to support the Fair Tax, we must effectively agree that it is reasonable for the federal government to continue to collect and spend 23% of the gross domestic product produced in the USA on an annual basis. Basically, what the proponents of the Fair Tax offer to citizens is a compromise with the Federal Government in which we are offered a much simpler means forfeiting roughly the same amount of money we are presently forced to part with each year IF we will agree that the status quo of around 23% of the GDP is a reasonable amount of money for the government to take from us on an ongoing basis.
Well, it is NOT reasonable for the Federal Government to take that much or to spend that much and we would be FOOLS to concede that it is reasonable to accept such a practice.
In conclusion, though, allow me to re-emphasize the FIRST point of this diatribe of mine: given that even the most fervent advocates of the Fair Tax agree that it would NOT be a good idea to adopt such a form of taxation UNLESS the 16th amendment were to be repealed in the first place: and given that the Fair Tax could not be implemented even then unless another bill were passed to authorize such a system of taxation: why not simply advocate the repeal of the 16th amendment …after which Congress would find that the Constitution itself already grants them all the power they need to levy a uniform excise tax on all goods IMPORTED to the United States.
In Liberty!,
James Hines
Mar 18, 2008 - 10:15 pm Smokey:What is to stop the government from saying, “We need just a little more money, so that 23% will be 23.2% next year…”
You can see where that would end up: a 60% “Fair Tax” after a few decades.
Unless there’s a Constitutional amendment capping the government’s vigorish, the whole proposal would soon be as bad — or worse — than what we have right now.
For another view of the tax issue:
http://www.forbes.com/forbes/2005/1017/042.html
Mar 19, 2008 - 6:18 pm henry gomez:There would be a gigantic black market for goods. Even now, when making a big ticket purchase at a mom and pop you can often get the “cash discount” which means it’s an off the books sale on which you won’t have to pay state sales tax. Imagine a national tax at the level they are talking about.
Mar 19, 2008 - 6:34 pm Christian:James,
You indicate fear that “Unless we repeal the 16th amendment, we will have both a sales tax and an income tax” when the FairTax is passed. Well, in all honesty, nothing is preventing that from happening now! Instituting a sales tax on top of the current income tax is perfectly allowable under current law. We don’t have it because Congress realizes the people wouldn’t stand for it.
Because the FairTax legislation in it’s very first section deletes most all the current tax code from the law books, after the FairTax passed the only way you could have an income tax again would be for Congress to vote for it to be reinstalled in the law books. Again, the same forces preventing them from adding a sales tax now would be in place preventing them from adding an income tax after the FairTax.
Is removing the 16th amendment a great idea? Absolutely! But it isn’t a deal breaker. And frankly, once people enjoy living under the FairTax, the movement to repeal the 16th would only grow.
Smokey,
Nothing stops Congress now from raising our taxes ad nauseum so your example isn’t a reason to dismiss the FairTax. To the contrary, when congress must raise taxes on EVERYONE in the open instead of just hiding a random new tax in the books that “only affects the richest 1%” will people start holding their elected officials a little more accountable.
Henry,
Mar 25, 2008 - 12:30 am George Dance:That “cash discount” becomes a little more tricky when the monitoring agency is now only focused on businesses instead of each individual taxpayer in this country. Furthermore, in order for that “mom and pop” store to buy their goods tax free in order to sell to the final retail customer, what they’re actually doing is claiming a credit versus the tax they owe every month. When their credits start exceeding their liabilities, that’s a big giant red flag right there.
And, um, how much fraud to you think we have under our current system? Let’s just say it dwarves what fairtax fraud will be…and yes, I admit people will find a way to avoid the fairtax as well. It’s the American way.
Stephen Gordon over at Third Party Watch reports that Bob Barr, in the running for the Libertarian Party nomination, is proposing a version of the Fair Tax. If Barr wins the nomination, which is likely, then the LP will be campaigning for a Fair Tax this year.
Apr 7, 2008 - 7:50 pm Mark:Talking about whether Fairtax would be 23 or 30% is like two mental patients, deciding whether the Halle Bopper commet will come get them on a Tuesday or Wednesday.
Fairtax is a farce — literally, a farce. It wouldn’t be near 30% — it would be more like 70-100%, and collapse. The only question is - how high would it get, before the whole system crashed — 70 or 100%
First of all, Fair depends on the absurdity of the FEDERAL government PAYING ITSELF 800 billion or more each year. Utter nonsense, complete and utter nonsense.
Don’t believe me that Fairtax depends on the government paying itself a large portion OF ITS OWN TAXES?? Read the book. Page 148, “The federal government itself will become a MAJOR taxpayer.”
No, the federal government CAN NOT pay itself 800 cents, much less 800 billion dollars. Why? Because of LOGIC. When the government writes itself a check for those taxes, it has to PAY the check. You can’t possibly count it as income.
As amazing as it is - these fools are depending on the federal government PAYING itself.
And thats just the START of the absurdity. This would be THE HIGHEST SALES TAX ON EARTH.
Not only would this be the highest sales tax on earth — it would apply to things NO ONE ELSE even taxes. These morons are going to tax cancer surgery — chemotherapy, nursing home patients. If you spend 500,000 to keep your child alive, these morons will hit you with a 200,000 tax.
If you want to buy a new house — if you saved your money for years, and now want to buy the home of your dreams for 400,000, these morons would TAX you 150,000 in SALES taxes. You might only make 40,000 a year — so what. They don’t care. You will be taxed 150,000 on that new house.
Heaven forbid you buy a new house the same year you have high medical costs — you could easily have 300,000 dollars going to SALES taxes — even though you only made 30,000.
Its insane — its a farce — its bullcrap. Its literally a farce.
I hope they pass it. I want to see this farce in action.
Sadly — Fairtax “leaders” know its a farce, and they aren’t trying to pass it. They are trying to fool stupid people — gullible people. And that they are doing.
Please pass this tax - PLEASE. I would love it.
Apr 10, 2008 - 5:56 pm