I keep getting letters and seeing articles about whether the FairTax is really 23% or maybe 30%.
The FairTax advocates like to say 23% (inclusive) for one simple reason – comparing it one on one with the current income tax (also inclusive). All of our taxes now are taken out of our gross paycheck, before anything else – right off the top. It is a certain percentage, based on your gross income. It is not added on top of your gross. Get it? (Of course, your income tax is arrived at after many individual deductions, but that is another story)
The FairTax naysayers like to say 30% for one simple reason – to kill the whole idea of the FairTax by making it sound worse than the FairTax advocates call it. The 30% is an “exclusive” tax, which does not compare at all with the present income tax.
Now let’s complicate things a bit. Let’s make a fair comparison with the present income tax. That’s where it gets confusing, people’s eyes cross and their minds go blank.
It is easy to take 23% of someone’s gross income (well, easy for the government), but let me show you how that would have to come about if, say, you were selling your house. Your Realtor comes and says your house is worth $100,000. Well, you look the Realtor in the eye and say “Fine, add your commission to the top of that and I will list with you”. So the Realtor gets out his trusty calculator, puts the $100,000 into it and divides that by 94% and comes up with $106,382.98, rounds it up to $106,400 and gets the listing. When the Realtor finds a buyer for $106,400, he shows you the amount you will gross after his commission: $100,016. That makes you happy and you sign the papers to sell. The Realtor is happy because he gets his 6% commission. The buyer is happy because he gets the house he wants. The lender is happy because it appraises up to price.
What we have just done is make the price of this home “inclusive” of the Realtor’s commission, whereas the homeowner had told the Realtor to make it “exclusive” (add the commission on top of my price). You see, the Realtor has to talk full price; therefore, the price of the home had to “include” his commission.
When the merchant sells his goods, he has an amount he has to gross. Let’s say he needs to gross $1.00. In order to do this, he has to add the amount of the tax to his gross profit, just like the Realtor had to add his commission amount. He gets out his trusty calculator, puts in $1.00 and divides it by 77% (1.00-.23=.77) which adds a 23% sales tax to his $1.00. Well, low and behold, that comes to $1.30 so naturally the naysayers call it a 30% tax. Well, if that were true, the merchant would have to charge $1.43 for his product in order to gross his $1.00 amount. Do the math. $1.30 - 23% = $1.00.
The merchant has to sell his goods and services at one price, a price that “includes” the sales tax. If you think it is worth it, you buy it; if you don’t, you won’t buy it. You make that judgment based on the total price, not the price the merchant wants, only to be hit with a 23% sales tax at the cash register. Your receipt automatically breaks out the tax amount so you will see exactly how much you spent in taxes. You don’t have to keep that receipt because you don’t need it to keep as a deduction when you file your taxes in April. Why? Because you won’t be filing (or paying!) taxes in April, ever again; therefore, you don’t need any deductions (including your home mortgage deduction)
The merchant has to keep that receipt, because he has to file a report along with the tax money he sends to the government every month. He gets paid for doing this, by the way, just like your tax account used to (only not nearly so much!)
These examples probably did not clear up the muddy waters for you. I think the only reason it made sense to me immediately is because I was a Realtor and many times have been told to add my commission to the top of the price I quoted to a seller. This is another example of embedded taxes, which is done all along the merchandising line, driving prices ever upward.
There are approximately 22% embedded taxes in every thing you buy. With the advent of the FairTax, this practice will stop, because goods and services are taxed only once: at the point of sale. How will it stop? Good old American competition. So if the prices go down by 22% and the FairTax is included in the price of goods and services (23%), it looks to me like you will be paying out 1% difference between the two, which isn’t going to change prices much at all, either up or down.
But you will be keeping 100% of your paycheck! No more payroll taxes and no more income taxes. Plus you will be getting a monthly prebate to help you stomach all of this .
This is terribly long today and the closer Christmas is, the busier I get. I am going to let you digest this for a week and comment on it. Also, go back and read my other blog on the 23%vs30% sales tax and maybe it will sink in. It’s a hard thing to grasp. I welcome your comments. Maybe someone else can explain it better than I. I have to relate it to something I know – real estate – and I thought these examples might be helpful to you also.
I noticed a number of interesting comments on my last blog - makes for good reading this week.
Subscribe to:
Post Comments (Atom)
18 comments:
Bobbie,
It seems that I have been wasting my time and energy talking about pricing issues on your blog. Either you don't believe me, haven't read my stuff, or you just prefer to "drink the Houston Kool-Aide. I'm disappointed and frustrated. With your permission, I'm going to try one last time to explain.
Working backwards, my bottom line position is that prices will rise by a minimum of 17%, real prices may be about the same, and the 17% price increase financial impact on governments will require higher state and local taxes.
First though, I don't care how you describe the sales tax rate, as long as you say either 23% of every dollar spent or a 30% sales tax. But, please don't call it a 23% sales tax. That is seriously misleading for the American public. Read FAQ47 and you will find that the tax is 30% at the cash register. HR25 is a piece of sales tax legislation and is no place to be discussing income tax calculations. 20 million retailers have absolutely no use for the 23% rate when they try to come up with the final sales price. They need to add 30% to their costs plus profit to arrive at a selling price, all other things being equal. And just for fun, please try to compare the 23% Fair Tax rate to any income tax rate. Can't be done! Only by figuring out your effective tax rates for both cases can you determine which tax system costs you less in taxes.
OK, moving on, you seem to be aware of Dr Jorgenson's study that concluded that there were, on average, 22% in embedded costs of the income tax system in producer prices. What you don't seem to grasp is that two thirds of those embedded costs are employee income tax and payroll tax withholding. So, in order to drop costs 22%, everyone would have to agree to give all those dollars currently withheld from your paycheck to your employer in the hopes that the money would be used to lower prices. But that won't happen, if for no other reason than existing contracts. I don't recommend you tell all the unions that their members gross pay will be cut and current withholding given to the business owners. At any rate, you seem to believe that you will take home 100% of your paycheck which I take to mean your gross pay. So the unions are happy.
How much can businesses reduce their costs due to the elimination of business income taxes, business share of the payroll tax, and business income tax compliance costs. The one third of Jorgensons 22% embedded costs is around 7.5% excluding compliance costs, and compliance costs can be estimated at a generous 2.5% of costs. So, costs will be reduced 10%, and when the 30% Fairtax is tacked on, prices rise by a minimum of 17%. (1.00 x .9 x 1.3 = 1.17)
As discussed in an earlier post, citizens may not be too concerned about the price increase because they are taking home their entire paycheck and are getting the prebate to boot. So, prices are up, but income is also up, so "real prices" may be about the same. Your standard of living may be relatively unchanged.
But what about governments? HR25 treats all governments as consumers, so governments will have to pay higher prices for all new goods and all services. The only cost savings for governments is the elimination of employer share of the payroll tax. Governments don't pay income taxes, so their "Paycheck" can't go up. Real prices for governments are going to have to go up. How will governments pay for the increased costs? Simple! Governments will have to raise all taxes by around 30% to pay the national sales tax. I'm emailing Betty a copy of my study that details my conclusions about the serious impact on governments. Perhaps she can share it with you?
I really hope this helps, but let me say it again. You can't keep all your paycheck and have prices remain about the same. That's the "free lunch" myth that even AFFT now agrees isn't going to happen.
Excellent post, dutchman3, but I think your minimum price increase might actually be too low. Under the FairTax, employer purchased health insurance would be taxed at the FairTax rate. Considering the current tax advantage for employer purchased insurance, this would have to be seen as a very significant new cost of employment for businesses.
Fred,
Excellent point. It turns out that even though the purchase of health insurance by a business for the employees would appear to ba a business to business transaction, and therefore not taxed, HR25 says that businesses must pay the tax on such insurance purchases/premiums in order to eliminate any tax avoidance potential.
So, not only do businesses lose their current tax deduction, the cost of the insurance premiums will go up at least 17%, or whatever. My guess is that passage of the Fairtax legislation will hasten the end of employer provided health coverage. There better be an agreed upon national alternative at that time, which I don't see emerging at the moment? Hillerycare, anyone?
OK,someone please just answer this question plain and simple. Lets say the Fairtax is passed. On day one I go to the store to buy a shirt that cost $40 (disregarding any state sales tax-Im just concerned with the fairtax) the day before the start of the Fairtax. The store, the manufacturere the shippers, etc, etc. were all making their money from the $40 price. So On day 1 of the Fairtax what would I be charged for that $40 shirt-would it be $49.20 or would it be $52.00. This seems like a simple question to answer.
Rick
Rick,
Unfortunately, there is nothing simple about your question. AFFT has never done a price impact study,and no one really knows what is going to happen to prices.
However, after doing my own price analysis, here is what I believe is most likely to happen.
First, the $40 dollar shirt yesterday will still cost $40 on day one of the Fairtax implementation. There is a tax credit for existing inventory, so no tax will be charged for the shirt. (The inventory credits must be used by the end of the first year).
Now, lets assume that the shirt was manufactured after the Fairtax went into effect. Assuming everyone gets their gross pay, business embedded costs of the income tax system will be reduced by an estimated 10%. The 10% includes business income tax cost savings, payroll tax cost savings, and business income tax compliance costs. If costs to manufacture the shirt are down 10%, and all the cost savings are used to lower prices, then the retail price will be ($40 x .9 x 1.30 = $46.80.) The cost of the shirt is down 10% and after adding the 30% sales tax, the retail price is up 17%.
But don't despair. Your are now taking home your full gross pay, and getting a prebate to boot. "Real" prices won't change very much if at all. Prices are up, but your income is also up. Your standard of living will remain about the same, and the $46.80 shirt will still be affordable!
Works for me!
The short answer is nobody knows and not even price impact studies would help. That's because what happens to prices after the FairTax was passed would largely be determined by what the Fed did with the money supply. Most economists, including the AFT's own Kotlikoff, expect the Fed to increase the money supply so that there is no change in pretax consumer prices.
Also, dutchman, your description of the tax credit is a little off. On stock held a the moment the FairTax went into effect the FairTax would be charged on the sale but the retailer wouldn't have to remit the tax.
Fred,
I think I disagree with your view on the inventory tax credit. While I admit that the "Plain English Summary" of HR25 provided by AFFT is somewhat confusing, look on page 120 of the Boortz/Linder paperback copy. It clearly says "For example, if you have a million dollars in inventory on December 31, the first million dollars in sales in the next year will not be taxed".
Now, this wording leaves open the situation where the first million in sales does not match the items in inventory. But, if the Fairtax is charged on everything sold to the public, won't the retailer get a windfall at the expense of the consumer. If customers have to pay the tax, but the business doesn't have to send it in, how is that fair? How is that consistent with taxing things once, and only once?
This is not a minor issue, because Boortz writes that the inventory credit will cost the federal government$350 billion, which by your interpretation, would still come out of taxpayers pockets and into businesses? Something isn't right here!
Any other views?
Fred,
A postscript, after discussing this issue with someone smarter than the Dutchman, (my wife?).
I have always assumed that retailers would somehow mark/identify their existing inventory as of December 31, and it would remain on the shelves with the original price, not the new Fairtax price, (if there is a difference?). At $40 in the example used, that price for the shirt includes the embedded costs of the income tax. If the merchant now increases the price to $46.80 as I predicted, it seems to me that the merchant will get a huge windfall.
Now, I realize that there really isn't any way for the public to know they are being had, other than shopper vigilance. Frankly, if the merchant wants to rip off the public by raising prices unnecessarily, there is little or no protection.
The more I think about it, the less I like the inventory tax credit. Too much opportunity for abuse.
It doesn't matter how much fair tax haters try to muddy the water, the facts remain the same.
The rate is quoted at 23% because it is an inclusive tax. It is NOT an exclusive tax, so why quote it at an exclusive rate?
The other fact is that prices WILL drop by 22% on average. You have expert economists from Harvard, MIT and others confirming this--so whatever Joe Schmoe says on a blogger forum about prices actually INCREASING is null and invalid. There is no factual evidence to support it.
And to answer Anonymous' question:
If you go to buy a shirt and the price says $40, you won't pay $49.20 or $52.00, you'll pay $40.
The Fair Tax does not work like a standard sales tax does--which is exactly why it's quoted as 23% and not 30%. But it IS a sales tax--because it's a tax on sales.
Saying, "you can't call it a sales tax because it doesn't work like other sales taxes we've had" is ignorant. It's a "sales tax" because it's a tax on sales. There is no rule for how a sales tax works and there is also no rule that states you must copy the current function of sales taxes to call it a sales tax.
If it's a TAX on SALES, it's a sales tax, regardless of how it functions.
With all due respect to the previous poster, that is the most blindingly ignorant post I have ever had the misfortune to read on Bobbie's blog.
There is not one economist at MIT, Harvard or anywhere else that claims that "prices will drop 22% on average". The only study available was done in 1997 by Dr Dale Jorgenson under contract to AFFT, and he concluded that producer costs/prices would drop an average of 22%. But his study included employee payroll and income tax withholding amounts as part of the costs. In fact, a big part. Two thirds of the 22%embedded costs can be attributed to employee withholding, and, unless you think that everyone will accept a large pay cut from their current gross to their current net, then the best you can hope for is a 10% cost reduction which means prices at the cash register will rise a minimum of 17%. Nothing magic, just simple math.
Your circular argument that the 23% sales tax is quoted that way because it is a sales tax makes no sense. Sales taxes are generally quoted as exclusive taxes, and there is no reason to try to cover up the fact that the tax is 30%. Just read FAQ 47 and you will learn that even AFFT agrees that the tax rate at the cash register is 30%.
I borrowed this piece from AFFT, don't tell!
Question:
Why do some people say the rate is 30 percent instead of 23 percent?
Answer:
When you talk about the FairTax as an inclusive tax, the tax rate is 23 percent. Our current income tax system is expressed as an inclusive rate, and therefore, the best most direct comparison of the current system rate to the FairTax rate is as an inclusive tax.
When you discuss the FairTax as an exclusive tax, the rate is 30 percent. The actual tax that you pay, however, is the exact same amount regardless of whether the tax rate is expressed in inclusive or exclusive terms.
Let me give you an example. Under the FairTax, if you pay $100 for a good, you are paying $77 for the good itself, and $23 in taxes on that good. If you take the $23 as a percentage of the $100 you paid, you have a 23 percent tax. If the take the $23 as a percentage of the $77, you have a 29.9 percent tax.
The important thing to remember is that either way you still pay the exact same $23 in taxes. Opponents of the FairTax prefer to speak about the 30 percent tax exclusive rate because it sounds higher, and unfortunately they fail to mention in their explanation that using either rate, the amount you pay in taxes is the same $23.From, betty.
To Dutchman3,
You are beginning to sound like a 'one man band' who needs to get off that stage and come play with the rest of us! (That is meant in a kind way.)
Please give me a 'very short synopsis' at how the FairTax will 'help you.' Do not mention anything negative and completely leave out anything concerned with the current tax system.
No cheating! Please only respond to my request. Thank U. From, betty
Betty,
I almost feel like Fred Thompson, who refused to raise his hand in response to a inane question. However, you deserve an answer, so here goes:
Passage of the Fairtax will benefit me by (1) Allowing me to receive all my pension income;
(2) Sending me a prebate of $4500 annually; and (3) I won't have to spend approximately one hour per year filing an income tax return.
This Fairtax is a heck of a deal, isn't it? Of course, under your ground rules I can't mention any of the drawbacks, but I think you are already aware of most of them?
Cheers!
Lemme give it a shot:
The FairTax won't benefit me.
Anon,
Now that is a classic example of "the art of concise writing". Congrats! Wish I had followed Fred Thompsons lead after all!
Thanks guys. At least you are both being honest, I think. Aren't you sweet. Boop!
This is Rick,and I am the one who submitted the question about the $40 shirt. It appears the answer is $52 ( not including the either 10% or 22% decrease in cost). I am completely in favor of the Fair Tax. I am a recently retired ironworker from NYC. I believe in the begining (assuming we got the Fairtax) it would actually cost me some money.
However, when I look at the long run and the benifits to us as citizens, I would definetly sacrifice some money just to get rid of the lobbyists and the blatant corruption associated with them.
I believe the economy will zoom. Companies will move back to the US, and others would be looking to move in. The trade deficit would start to reverse, the dollar would regain stregnth etc, etc. As this takes place, the value of my personal income will increase again-plus some.
What I find more important, concerning this issue, is the fact that just the threat (I dont mean threat as a negative to those in favor of the FT) of the possibity of the Fiar Tax gaining momentum has many of the good old boys shook up.
I believe in the late 60's we worked six weeks a year to pay taxes. Now for those working it's about 17-18 weeks a year.It doesn't matter who was in power, republicans or democrats, our taxes kept going up. If the fed tax went down, most of the different states taxes went up.
There really is no accountability for the government. WE WORK for the government. They no longer work for us.
Congressmaen and senators who are in office for 5 years get lifetime full pensions and dont even pay into social security.
I wonder what percent of them move on to Golden Parachute jobs for the Military industry, the drug companies or the oil companies. These companies rule the nest (lobbyists).
I realize that this post has no real economics behind it, so please dont call me a moron. This is my opinion. This is why we (should) vote. I have read the fairtax book over twice and am convinced it can be a great way to turn our future, and our grandkids and theirs, around.
Yes, there are some things that should be ironed out ( the above inventory problem for one). But, all in all, The Fairtax will cause many very good changes.
Even if the FT is not passed, I certainly take my hats of to the people behind it. It is becoming a very strong grassroots movement and waking up many people to the importance of voting. And I mean actually voting-not just going to the voting booth and pulling a few levers with no idea of what they are voting for!!
Just an opinion of mine!!
rick
Anonymous Rick, thanks for your comments. You have made some very good points. I just put a new FairTax Calculator on my blog in the links section. You might want to check it out. Also, if you have not signed the FairTax petition, there is a link to that also. It is very important to get as many signatures as possible on this petition in order to convince our polititians that we mean business. You can also sign up as a FairTax volunteer and help out in lots of ways. Thanks for reading my blog.
Post a Comment