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Fair Tax: Take 2, and….ACTION!
I (personally, not Conservative Donnybrook, as I am only a cog in the wheel) have previously endorsed the Fair Tax. Unfortunately, in attempting to keep things simple, the examples I used were inaccurate. Therefore, I shall try again, but keep in mind that this will necessarily be more complicated than the previous attempt.
Let me begin by reintroducing the players. We have Bob. Bob is the sort of guy who always wants to be first on his block to get the latest toy. And then we have Margaret. Margaret has no such compulsion and buys used goods all the time. Bob and Margaret both earn $74,000 a year in wages. They each rent a nice apartment in the same complex in Las Vegas (Clark County sales tax = 7.25%). Bob and Margaret are both healthy, stingy (they make no charitable contributions), and neither runs a business – in short, they do not have any deductions other than the standard deduction. They are both single. (We are trying to keep this as simple as possible, while still maintaining some semblance of realism.) And, just for the ease of doing the math, let us suppose they each get paid annually (one pay check per year). Let us follow them down to the car lot where they will each be purchasing a car. Of course, in order to really do this right, we have to follow them down to the car lot twice. Once prior to any changes in the tax system, and once again after the Fair Tax is adopted.
Trip One: Current Tax System
Bob and Margaret each receive their yearly paychecks. After paying income taxes, each will receive $60,518.75 to spend for the rest of the year. Each of them finds a car to purchase with a price tag of $20,000 (after haggling, dickering and negotiating – it is a redundant process), and they each decide to pay cash for it (let’s not make things too complicated by financing this purchase). Bob’s car is a brand new Chevy HHR. Margaret purchases a 6-year old Chevy Corvette.
On average, the embedded amount of taxes we pay for any good or service is 22.4%. In other words, 22.4% of the price of everything you buy goes to pay the income taxes of the person who made that item. If you purchase a loaf of bread for two dollars, 45 cents of that goes to pay for the baker’s income tax burden. The true price of the loaf of bread, if there were no income and withholding taxes would be about $1.55. This will become important when we get to the Fair Tax analysis.
As William Tabor, co-director of Virginia’s Fair Tax advocacy group stated it:
One cannot buy a loaf of bread without paying the income taxes of the baker. The price of that loaf of bread contains the cost of the flour, and the income of the baker, but it also contains the taxes the baker pays. After all, the baker does not have a money tree from which to pluck dollars to pay his taxes, he must get those funds from his customers, like any other business.
Further, the price of that loaf of bread contains the taxes of the miller, the farmer, the trucker and the grocer and those of all their employees. Those income and payroll taxes cascade through the production process and eventually make up more of the cost of that loaf of bread than the profits of any of those who worked to produce that bread.
So, back to Bob and Margaret. After state sales tax, they each pay $21,450. They each now have $39,068.75 (this is the number we will compare the costs to under the Fair Tax – how much is left after they make their purchases?). Plus, they still have to go home, fill out their tax returns, send them to the IRS, and hope they don’t get audited or they didn’t make a mistake.
Congress passes the Fair Tax and repeal the 16th amendment (woohoo!). There are now no income taxes, gift or estate taxes, corporate taxes, capital gains taxes, Social Seurity or Medicare withholdings, alternative minimum taxes, or self-employment taxes. There is only the Fair Tax and whatever form of taxation your State chooses to impose for its own purposes…Let us go buy another car.
Trip Two: Under the Fair Tax
Once again Bob and Margaret go down to the dealership and they purchase exactly the same cars. Except now, we should note that the prices have changed. No longer are there taxes embedded in the price of the cars. The HHR that Bob purchases now is listed at $20,176. (The 22.4% embedded tax has been removed and the Fair Tax replaced it). Show your math? OK. We have to first back out the 22.4% embedded tax – to do that, you would multiply the current price by .776 and, in our case, we get the result, $15,520. Now, we have to add the Fair Tax into the price of the product. To do that, we multiply the true price ($15,520) by 1.3 (or add 30% tax-exclusive). This gives us $20,176. I have to think he could probably haggle his way down to an even $20,000, but let us leave it this way.
The Corvette, however, is listed at $19,440 since there is no Fair Tax imposed on used products – only on the purchase of new goods. The trade-in value for the Corvette probably remains the same (about $17,500) and I’m assuming the dealership currently adds $2,500 in profit to the trade-in. That profit will include the embedded taxes previously discussed (it could be a bit less since there is only one step in the cascade now, but you will see that even if there is no change in price for the Corvette, Margaret still wins – and the dealership will too), so to make the same amount of profit, the dealership will have to add $1,940 to the trade-in cost.
Each of them has just received their yearly paycheck, but now those checks are each for $74,000 since nothing has been taken out of it – there are no income taxes or payroll withholdings. They earn $74,000, they keep $74,000!¹ The sales tax in Clark County remains the same – 7.25%. The total purchase price then for each of them will be $21,638.76 for the HHR and $20,849.40 for the Vette. This leaves Bob $52,361.24 and Margaret $53,150.60.
fn 1: It is also quite likely that their annual pay will have been increased since their employers no longer have to pay their share of the withholding tax. Bob and Margaret will probably show up at the dealership with fatter wallets. Either that, or they will have more co-workers as employment expands.
Bob puts $5,000 into a (traditional) IRA and writes an $8,292.49 check to Clark County Right to Life and Margaret puts $5,000 into a (traditional) IRA and writes a $9,081.85 check to the Clark County Humane Society (she loves little doggies). And, each of them are EXACTLY where they would have been if the prior system were still in place. Seems to me that Bob, Margaret, Clark County RTL and Clark County Humane Society made out better under the Fair Tax. But the story doesn’t end there…
When Bob and Margaret drive their new cars home, they DO NOT have to fill out a tax return, they DO NOT have to send it to the IRS, they DO NOT have to worry about making a mistake and getting audited, fined, or imprisoned. They DO however, find in their mailboxes, a check for $10,210 (or the annual prebate for each tax payer). Maybe they’ll go on vacation…
UPDATE: Oh yes, I almost forgot to mention. Mike Huckabee is the only candidate who has endorsed the Fair Tax. Oh yeah, and that other fellow from Texas: “I’ll vote for the FairTax if it comes up because I have made a promise that I will do anything to get rid of the income tax and the IRS, and repeal the 16th amendment and that FairTax certainly moves it in that direction.” See? There are things I like about the good doctor.
January 26th, 2008 at 5:16 pm
Ah, the Fairtax. What a pleasant dream.
January 26th, 2008 at 5:57 pm
Thanks for stopping in, Dr. Paul. We all wish you luck.
January 26th, 2008 at 6:39 pm
Thank you. But Karl, I have flightier dreams than the Fairtax.
January 28th, 2008 at 3:06 pm
There seem to be two conflicting assumptions in your example:
Assumption 1: employers will keep all of what was previously income tax withholding and payroll taxes after FairTax. Therefore, the “embedded tax” in products is eliminated.
Assumption 2: employees keep what was previously taxed under the income and payroll taxes. Therefore, Bob and Margaret take home $74,000 each year.
How does the FairTax fairy dust allow both of these assumptions to be true?
January 29th, 2008 at 7:59 am
These are two separate things. Employers withhold from an employees paycheck the employee’s portion of the tax. PLUS, the employer must also pay a portion of the tax. Eliminating that tax benefits both the employer – he gets to keep what he earns – AND the employer – he no longer has to pay the employer portion of the tax or collect the employee portion for the government.
Also there are direct taxes on businesses. This is not hocus pocus; there are levels upon levels of taxation, all of which is applied to the cost of goods that we buy. Take a look at the taxes that would be eliminated by the Fair Tax and you begin to get an idea.
One added benefit is that because the employer no longer pays the employer portion of the payroll tax, it is possible that wages will increase for Bob and Maragaret OR that their employers will be able to hire more employees. Either way, wage growth or employment growth is a boon to the economy.
January 29th, 2008 at 4:27 pm
That’s not what the quote you put up implies:
But you’re saying that personal income taxes have nothing to do with the calculation that yields the 22% “embedded tax”– just the employers’ half of the payroll tax, plus the corporate income tax and whatever else. Right?
Even Boortz admits that the 22% calculation includes all income and payroll taxes paid to employees:
January 29th, 2008 at 4:39 pm
Here’s a related question: The FairTax is supposed to be designed to be revenue-neutral. If Bob and Margaret reap such a windfall from FairTax, then who will be paying more taxes to make up for it?
January 30th, 2008 at 7:39 pm
Okay. Once again, I screwed this up. Willmoore is correct, please see Mr. Boortz’s explanations as really knows what he’s talking about.
I still wholeheartedly endorse the Fair Tax. Simply eliminating the hopelessly confusing tax code and the IRS should be enough to recommend it.
January 31st, 2008 at 11:38 am
I must still argue with you on the abolition of the IRS. The consumption tax would not be able to eliminate the Service. You have prebates (as you call them) that would have to be paid out. You have exemptions, credits and you have reporting by the businesses. the IRS would not go away, the burden would be reduced by the ordinary tax payer (as far as reporting goes) but not by those selling products or services. I seriously doubt the government would simply trust them to send in the correct amount of tax dollars.
Therefore, you may like the consumption tax, but it will not eliminate the Service. And you know better.
February 6th, 2008 at 2:39 pm
Fairtax is math nonsense. It pretends to tax the federal government to pay the federalg goverment. Thats like me paying myself 10,000 a day to cut my own grass. I can write the check – and deposit it in that same account. But at the end of the month, I dont have 300,000.
Plus other absurdities, like taxing cancer surgery, chemo, nursing home patients. All medical cost would be taxed — can you say irate folks calling congress?
Plus – taxes RENT. Won’t renters be surprise.
Fair tax is not a little nonsense — its a lot of nonsense. It would be hated by 50-80 million people if enacted,and they see what it really does.
February 12th, 2008 at 2:28 pm
Actually, Fairtax does have some great points — if it worked.No IRS! Nothing withheld from paycheck, and a prebate to pay our taxes on necessities!
But what if Fairtax didn’t work? What if, for example, half of the money it says it can collect, turns out to be uncollectable? WOuld then the fairtax have to be 46%?
And if so — would the fairtax have to be 46% or more to make up for it?
Do you know that fairtax taxes the federal government, to pay for the federal government?
Neal Boortz wrote “The federal government itself will become a major taxpayer” (Page 148 in his Fair Tax Book,)
Tax the federal government to pay for the federal government. ??
Isn’t that a bit like me, pretending I can pay myself 10,000 to cut my own grass? I can write the check, I can even deposit the check. And I can do this every day. But at the end of the month, I don’t have 300,000 dollars.
Fair tax advoates want to claim the government “will become a major taxpayer” — but it can’t possibly be so. And the REASON fair tax has to pretend to tax the federal government —they need to show, on paper, that they can collect 2.3 trillion in taxes.
So Fair tax would have to be higher than 23% to remain revenue neutral, just for this one fallacy.
Are there any other fallacies?
Fairtax can only work IF it gets people to pay 460 billion in taxes — on their health care costs. People who get heart bypass surgery, cancer surgery — people who are in nursing home. Famlies fighting leukemia and other expensive illnesses will get incredily hard by the “fairtax”.
One family, who has a child with leukemia — could get a 40,000 SALES tax.
One nursing home patient, who gets by on her social securty — would get a sales tax of 25,000 a year — plus more tax for any other medical costs.
One cancer patient, with surgery, chemo, and radiation, could have 50,000 in “sales taxes”.
So you will have the absurdity of a person who is actually taxed MORE sales tax than they have income.
Therefore, one way or another — these patients will get exemptions, either defacto exemptions — by not paying it. Or dejure exemptions – by getting an official exemption.
EIther way, the Fairtax can’t possibly collect 460 billion-dollars from these folks.
Most likely, the outcry from even attempting to tax an 80 year old stroke victim in a nursing home, would result in Congress exempting all health care cost from the “fair” tax.
Fair tax has to get 150 billion in taxes — from people as a tax on their rent.
Fair tax has to get 150 billion by taxing people who buy new cars — and pretend that new car sales won’t drop because of the high taxes.
Fair tax has to pretend it can collet 200 billion by taxing people who buy new houses — and pretend the huge tax on new homes wont diminish sales.
Group after group will scream bloody murder — and get exemptions.
So with all these inevitable exemptions — Fairtax rate would have to be 60-80%.
February 12th, 2008 at 3:53 pm
Not only healthcare, but home purchases would not be affordable! Can you imagine a 23% tax on a $500,000 home? That is $115,00 in tax!
The national sales tax is bunk.