Major FairTax Article in CNN’s Money Magazine
CNN’s Money Magazine published a lengthy article today titled “Just how fair is the ‘FairTax’?” The article actually provides a surprisingly fair-minded review of the FairTax plan and the groundswell of public support behind it.
The article begins:
NEW YORK (Money magazine) - If you don’t care much for talk radio, or you don’t live in the South, the name Neal Boortz might not ring a bell.
But pay attention: Around 4 million people nationwide catch his radio show. It’s No. 1 in Boortz’s home market of Atlanta and ranks first or second in numerous smaller cities in red states.
His 180-page polemic for radical tax reform, The FairTax Book, made its debut at No. 1 on the New York Times’ bestseller list in August.
When Boortz came to Jacksonville for a book signing at a downtown hotel on a sticky, sweltering Thursday night last month, close to 1,000 people turned out for a chance to meet him — and to bask in his rage at the Internal Revenue Service.
As I was reading, I kept expecting the tone of the article to go south. But it never really does. Author Pat Regnier keeps hinting that there’s a big ol’ problem with the plan, but the meatiest criticism he comes up with is this:
In an eight-year-old study paid for by AFFT, Harvard economist Dale Jorgenson noted that because the taxes paid by everyone in the chain of production are embedded in the cost of goods, prices could decline an average of 20 percent if all those taxes were scrapped. The FairTax Book devotes an entire chapter to this idea.
What The FairTax Book fails to mention is that prices can only fall this sharply if companies cut wages. I asked Jorgenson about this, and he agreed. Say your salary is $100,000 a year today, but you take home $80,000 after taxes.
Your company is still paying that extra $20,000. In a FairTax world, it will save that money, and be able to lower its prices accordingly, only if it can reduce your salary to $80,000. In other words, your take-home pay is the same as before. Sure, you’d get to “keep 100 percent of your paycheck,” as Boortz and Linder repeatedly write, but it would be a smaller paycheck. That’s kind of a big thing to leave out.
I pressed the point with Boortz and Linder. Boortz denies that the book intentionally overpromises. The introduction, he notes, emphasizes that “this book isn’t about saving a penny in taxes.” But he concedes that the book is confusing about this, and vows to correct it in later printings. Fair enough.
Meanwhile, these guys want to replace the entire tax code, they’ve ignited a populist movement to get it done, and tens of thousands of copies of the uncorrected book make the FairTax sound like magic.
Er, I don’t know about you, but I’d happily trade our current system for one which gives me about the same amount of money in my after-tax paycheck, dramatically reduces compliance costs for individuals and businesses, doesn’t tax savings or investments at all, removes the incentive for offshore bank accounts, closes the IRS, and supercharges the economy.
I suspect a lot of other Americans would, as well. So I think this article is likely to do a lot more good than harm, overall.
After noting that a consumption tax would elminate a (conservatively estimated) $110 billion in compliance costs and would increase the average American’s real income by 9 percent in the long run, Regnier ends with this:
And although Boortz and Linder use the red-meat language of the right when pitching the FairTax, there are some elements of their plan that liberals ought to take a close look at.
It replaces the Social Security payroll tax, which tends to hit less affluent people harder. Rich big spenders could end up contributing more to the retirement system than they do today. And the other tax plans favored by Washington types raise their own fairness questions. Boston U.’s Kotlikoff, who recently argued for the sales tax in a cover story for the liberal New Republic, worries that other consumption-driven reforms will be a boon to the already wealthy.
These are serious ideas Americans should hear more about. What we don’t need is more spinning. FairTaxers promise a world where taxes are effortless, the IRS is dead and gone, and nobody has to sacrifice a thing. But we know this:
There are complications in any tax system. Somebody’s got to collect the money for the government. And there will always be losers in the tax game.
I can live with that. Kudos to Regnier and Money Magazine for what is, overall, a relatively objective and even-handed presentation of the pros and cons of the FairTax.
Go read the full article. It has some good stories and it’s an enjoyable read.
UPDATE (9-8-05) - Okay, seeing this makes me think CNN’s not being so fair-minded after all. It’s starting to look like a concerted effort to discredit the FairTax plan.
This Paragraph baffles me in the CNN Money Article.
Anyone else heard this before?
I would agree that on a $100,000 salary the Employer reduces its payroll cost becasue it does not pay the additonal 7.65% on that $100,000 salary. Did the writer misunderstand Dr. Jorgensen? The reduction for the employer is from $107,650 to $100,000. it is a reduction in payroll cost not a reduction in wages or salary to the employee.
For the Company its payroll cost is Salary and benefits, so $7,650 is saved alone in payroll taxes, plus compliance costs to mange and pay those numbers. Than take that and other cost savings through the supply chain and you get a range that others have also calcualtied to be 20 to 30% - Correct??
I agree with Bender. I’ve read the book twice and for the life of me couldn’t see where this Pat Regnier guy gets that employers would have to cut wages in order to lower prices by 20%. He must have misunderstood Dr. Jorgensen, there’s no other explanation. One of the great things about the Fairtax plan is that it would automatically give all Americans a pay raise when the income taxes are removed. This guy must be mistaken in his article.
On the other hand, the author apparently got Boortz to concede that the book needed to be revised to clarify this point.
Wouldn’t it be great if someone from AFFT would clear up the subject definitively?
How do we get someone to do this?
Joshua — I think if you go over to freerepublic.com, you will find that Dr. Jorgenson himself cleared this up in an email posted over there.
In order for the embedded taxes to completely disappear from prices of goods and services, then wages and salaries would need to drop by an amount equal to the amount of taxes currently paid by and on behalf of the empoyees. People’s take-home (i.e., after-tax) incomes would remain the same, but there would be no “virtual raises.”
As you know, some people (including, perhaps, Dr. Jorgenson) would argue that wages and salaries would eventually rise because of increased efficiencies in the system and thus stronger over-all economic growth resulting from the FairTax. I won’t get into that here, but there would be no “automatic” raises if embedded taxes were to disappear from the cost of goods and services under the FairTax.
It is still unclear what Jorgensen means in that post.
I have corrected people in the past who have thought employees would get a raise because they would also get the employer portion of the payroll tax, thus raising their $100,000 salary to $107,625.
The virtual raise comes from not having payroll and income taxes deducted from their $100,000 salaries. That is the raise I write about in take home pay.
Even if the employer kept both parts of the payroll tax the employee still has a virtual raise in take home pay because no federal income tax is withdrawn.
Jorgensen can’t be saying ( as is implied in the Money article) That his price drop is because the employer keeps both the payroll tax and the income tax from his employees checks. How else does the article go form a $100,000 salary to an $80,000 salary.
I think we need a better definition of the terms and make sure Jorgensen and ourselves are talking apples to apples when we use the term “take home pay”
Merrill –
We seem to be meeting up on many of these blogs! It is always a pleasure to discuss these issues with you because you are so civil in your posts. I hope I am as well.
Here’s the deal with the embedded taxes. The embedded taxes include all taxes paid all the way down the line for inputs into a finished product. That would include corporate taxes paid by the various companies that produced inputs, as well as labor. The taxes on labor would not merely include Social Security and Medicare taxes, but also the personal income taxes paid by the individual employees.
The theory is that employees are really working for their take-home (i.e., after-tax) income, not their pre-tax income. If an employee currently has a salary of $100,000, but only winds up with $80,000 after all taxes (including SS, Medicare and income) are deducted or otherwise paid, then he would theoretically accept a salary of $80,000 if no taxes are taken out. That would reduce the cost to the employer, who could then pass on that saving to the consumer. The point is, the embedded taxes currently included in the price of products include the employees’ income taxes. In order for prices to drop by the full amount of the embedded taxes, then empoyees’ wages would need to drop by the amount of taxes they currently pay (or are paid on their behalf by their empoyers.)
Now, one last wrinkle to this. Some economists claim that wages are “sticky”. That is, that employees would not accept lower salaries under the FairTax system, even if their take-home pay woud remain the same. If that’s the case, then all of the embedded taxes would not get eliminated from the retail price of goods and services, so prices would not drop (or at least they would not drop as much).
Hope this helps clarify things a bit.
If you look at the sample tax returns on the AFFT web site, the employee will take home his GROSS pay and will not be stuck with just his current after income tax pay. That to me is the answer to the original question of whether or not we all get an increase in our take home pay.
What we all seem to be forgetting is that there are some losers with the change to a consumption tax. The losers are all those who are currently not paying taxes at all - either by being paid in cash (shadow economy) or by being part of the under ground economy. We will also be taxing all tourist to the U.S. The widening of the tax base causes the ones who are now paying more than their fair share to pay less taxes overall. They are the “winners” under a consumption tax.
[...] In recent weeks, a number of people (including Brad Warbiany and Pat Regnier) have raised the question, “How much of their gross income will employees keep under the FairTax plan?” [...]
Does the calculated 22% average imbedded tax existing in today’s products and services INCLUDE income taxes paid by employees OR NOT? If it is included then that is a HUGE,HUGE problem. The fair tax is being promoted as though the price ,excluding the tax, of goods and services will fall once the income (and others) taxes are removed to a point where their retail sale price including the new fair sales tax will only be a SLIGHT increase.
“… consumers of all incomes will be paying at least 20 percent less… they’ll have to pay the new national sales tax-but when u factor in the lower prices caused by the disappearance of the embedded taxes, you’ll see that the total price paid for consumer goods will remain very nearly the same.”
The Fair Tax Book by Neal Boortz, pg.84
Neal’s book CLEARLY states that another positive effect is that people will get all of their pay without the deductions we now face as a result of those taxes.
“Whatever they earn, they get on payday. For most of those we categorize as poor, this would mean an immediate 25 to 30 percent increase in their take-home pay.”
The Fair Tax Book by Neal Boortz, pg. 83
Nowhere in his book does he suggest that these two positive effects are an ‘either\or’ situation. If the *28.2 average percent (exclusive) drop in current prices does not happen to be able to absorb a 29.9 average percent (exclusive) increase in prices after the fair tax is added UNLESS the employers reduce wages then both of these advantages cannot be realized together. This NEEDS TO BE CLEARED UP IMEDIATELY IF WE EXPECT TO WIN OVER VOTERS! Personally I cannot see how the imbedded taxes could be as low as 22 percent (inclusive) if they did include taxes paid by employees but either way we need clarification from the panel that came up with the 22 percent figure.
*Looking at the 22 percent imbedded tax from an exclusive point of view similar to those who say the fair sales tax is a 30 percent tax would be that the prices will fall 28.2 percent as a result of a loss of the imbedded taxes.
Ok, i responded before i checked the last link. This may scare many people away especially those fealing deceived, but the Fair Tax is still far better than what we have now. I’ll post in the “keep 100 percent of your paycheck” explained blog as to why i think that.
could someone answer this question for me? if the wages are reduced so that the take home pay is the same, then where will the
money come from to pay the sales tax? the sales tax would be substantial, say 25% plus or minus... lowering the wages paid by the employer would be the same as paying the income tax PLUS paying the sales tax. that can’t be the answer.
There is little reason to think that employees’ wages will fall in most cases. The FairTax legislation does nothing to alter any previous legal agreements, contracts or minimum wage, etc. This means that in these cases, those wages won’t go down, period, without significant legal work, negotiations with unions, etc.
In addition, most businesses know that reducing wages (even to provide the same take-home pay) would probably chase many workers off. Hiring a lot of new employees is costly in terms of training, lost productivity, etc so there is little incentive for a company to do this.
Businesses also no longer have to pay personal income taxes (sole proprieterships) or corporate income taxes, or employer-side share of payroll taxes (Medicare/SSA). This means that even if they do not change employee’s pay they will have significant tax savings.
Now does this mean that prices cannot drop by the full 22-23% mentioned in Jorgensen’s study? Probably so. Prices will likely end up a net 10-15% higher than today, at least in the beginning. After a couple of years, further savings in efficiency in costs may drop prices lower than that. But with your whole paycheck and the prebate, this should still result in a lower effective rate of taxation (by far) for most citizens.
This has been hammered out in many forums here and elsewhere. It is a legitimate concern, but please remember that the government (nor HR 25) does not dictate what your gross wages are. You have an agreement with your employer what your gross wages are. It is harder to reduce wages for an employee than it is for an employee to quit or be fired. Most employment agreements state that an employee or employer can terminate their agreement at any time without notice, but generally no one enters into agreements wherein the wages or salary are/is not guaranteed.
Hi,
I am a middle school teacher, and in class we are having a debate on fair tax vs. flat tax. Have any pointers? I enjoyed this site, but believe that you should have a list of pros and cons for both a fair tax and a flat tax. Thanks!
Leslie –
Since I don’t support either the FairTax or the Flat Tax, I’m probably not the right person to respond to your request, but I’ll try.
FairTax.org has a summary of the FairTax and it’s (purported benefits.) It might also have a comparison with the Flat Tax somewhere, though you will need to look around on the site.
I don’t know much about the Flat Tax, but I think there are several versions floating around that might have subtle but important differences. I don’t know how much time you have for this, but the intellectual basis for the Flat Tax is laid out in a book from many years ago called The Flat Tax. It is supposed to be very good. A more recent book on the subject was written by Steve Forbes.
As you probably know, an (in my view) over-simplified book about the FairTax was written by Neal Boortz. I consider it terribly misleading and wouldn’t suggest that you put a whole lot of stock in it, but at least it’s easy to read.
Good luck.
Well when we talk about the flat tax, we need to be very specific because there are multiple sorts of flat taxes.
The basic idea behind any flat tax is to have an income-based tax that taxes everyone at the same rate. This is often mixed with some sorts of exemptions or deductions to restore a sense of progressiveness for certain groups of people by reducing tax burdens in one way or another. There have been several variations on this idea.
The basic pros of a Flat Tax are greater simplicity in the tax code (at least at the outset) and some economic gains from streamlining the process. However, the simplicity of said system would likely be erased once politicians begin granting more tax deductions and exemptions to placate special interests.
The Fair Tax, on the other hand, is a very specific version of a National Retail Sales Tax. The Fair Tax is a flat sales tax on consumption rather than on income, and includes a rebate system to create progressiveness, similar to some Flat Tax ideas. The unique thing about the Fair Tax is that it attempts to completely exempt business from taxation in order to provide the most transparent and economically beneficial system of taxation. The Fair Tax would be even simpler than virtually any Flat Tax proposal, and more economically beneficial.
Flat Taxers believe that it would be easier to implement a flat tax because it is simply a reorganization of the income tax system. The Fair Tax however, has garnered more support as a proposal, even though it is a much bigger change, repealing several taxes and disbanding a Federal agency as it goes.
Fair Taxers are often fond of pointing out that the income tax isn’t particularly good law in the first place, and that the IRS is an agency apparently run amok with injustice. Also the lobbyists tend to use the tax code as their favorite way to bring money back to their interests from the government. Because the Fair Tax untaxes business completely, there should be virtually no need for lobbyists to attempt to get the tax code changed for their benefit. They may try to get money from the government in other ways, but at least the tax code should be more resistant to change.
There are a lots more details on this to explore, and not everyone will agree with the points I have made here. I would point you to the web at large to research the issue. Wikipedia has good articles on both systems, and there are advocate sites everywhere. Let us know how your debate goes!
Leslie,
Try this site for more information: http://www.fairtaxfraud.com/othervoices.asp
Leslie —
As previously noted, I don’t like either the FairTax or the Flat Tax, but this might be the sort of simple comparison you are looking for. (Note: This was posted on a pro-FairTax site, so you might be safe in assuming there might be some bias in the comparison.)
http://www.fairtax.net/flat-tax.htm
I have a question. Say all of my after tax savings are in the bank and I mainly live off of the savings. If the Fair Tax went into effect tomorrow, would my savings be worth only 77% in purchasing power tomorrow?
George, well, not exactly. I’ll give you my analysis and I’m sure that others will correct any misinformation I may provide. As they say, “the first liar doesn’t stand a chance?!”
Purchasing power is a function of prices, and in another thread on this blog, there is a good rationale supporting a position that after tax prices will initially rise by 18%. (1.00 x .91 x 1.30 = 1.18) What this equation shows is that businesses can reduce their pretax prices by 9% by eliminating the income tax costs, and after adding the 30% Fairtax, the final price at the cash register will be up 18%. So, if that was the end of the story, your savings would only purchase 82% as much tomorrow.
But other factors have to be considered. First, you will be getting a prebate which will provide you with more purchasing power. Next, you may not spend all of your savings on taxable goods, so your savings will go farther. Non-taxed spending might include mortgage payments, gifts, installment payments, and state/local property and sales taxes. You do need to be careful about how your nest egg is invested. If your savings is paying less interest than the appropriate Treasury rate, there will be an implicit tax on the difference. This could reduce your purchasing power.
Everyone’s situation is different, but here’s an example you might use to get a handle on your specific case. Take a retired married couple trying to live on $40,000 annually. Assume they spend 80% of their income on taxable goods and services. If after tax prices do rise by 18%, they will lose $5760 in purchasing power. But they will get about a $4500 prebate, so their net loss in purchasing power is only $1260. Unfortunately, their (assumed) $400,000 nest egg is invested at only 3% at their local bank, and the current Treasury short term rate is 4%. They will be taxed at 1% x $400,000 x .23(inclusive Fairtax) = $920 annually or $76 per month. That will also reduce their purchasing power.
Sort of makes one wonder why this couple would support the Fairtax, doesn’t it? Perhaps someone else can provide a rosier economic picture?
Hank - a good analysis. There is one thing that doesn’t seem to be considered. You value the savings at 100% at today’s prices. Would those savings be free of all taxes? If the $40,000 is from interest on the total nest egg, current income taxes would reduce the amount you have to start with. If everything above the minimum tax level comes from reducing savings, then your analysis seems correct.
I find that trying to calculate how much product and services a person would be able to acquire under the Fair Tax and under the income tax provides a more accurate picture.
In general if a person gets all of his money free of taxes through gift, theft, illegal activities, tax free bonds or from a chest buried in the back yard, he will pay more taxes on spending beyond the poverty level than he spends today. How many people fall into that category?
Hank - I am confused about the 1% penalty on the $400,000. First, why would anyone accept bank rates of 3% on large amounts when rock solid T-bills pay 4%? Second why is there an implicit short term tax on the amount of interest received. The implicit tax that I understand is when loan rates exceed T Bill rates. The lender will pay a 23% tax on the difference as “financial services” segment of the loan payments.
Contrary to what many seem to believe, both debt and investment instruments are subject to the implicit tax provisions of Section 801-806 in HR25. If the rate you are getting on an investment is lower than the going Treasury rate, the difference is taxed. If a debt instrument is charging more than the going Treasury rate, the difference is taxed.
My major concern over this section is in regards to credit cards such as Visa or Mastercard. Most charge 12-18% or more depending on credit history, and that is a lot higher than the going Treasury rate. So, if you have a card that tends to stay maxed out at say $10,000, you are going to pay a heap of implicit taxes each month. Is that fair??
As to why anyone would park their nest egg in a local bank savings account at less return than a Treasury bill, I agree that makes little economic sense. Maybe some folks just don’t trust the government, or prefer to keep their money in the bank down the street? Who knows? The example was provided mostly as an indication of how to calculate the tax.
I haven’t studied HR 25 closely enough to understand this section. Most provisions in tax laws have a logical reason. In HR 25, services are taxed. Lenders provide a service. To determine what the amount of service is, they use a base interest rate (a Fed funds rate). The excess is a charge to the customer for the service. That makes good sense. I can’t fathom a circumstance where a lender would charge a customer less than the no risk Government bonds. But, if he did why should there be a service fee. If the rate charged is the same no tax, but if the rate is less a tax. Makes no sense.
HR 25 says income from investments is not taxed. Why does it matter what rate of interest is received? To slap on a 23 % service tax for amounts higher or lower than a benchmark is absurd.
Suppose a person has a 30 year mortgage with early payment penalties at 6 percent; refinancing is not feasible. But under the Fair Tax, interest rates drop by 25% as predicted. The base government bonds rate drops from 4% to 3%. Your example suggests the homeowner will be stuck paying the 23% on half of the interest on his mortgage. Is that really true? If so, I can’t believe those rules will survive discussion in congress.
Marvin, in your para 1, you accurately describe the implicit tax on debt instruments and your rationale is right on. It’s basically a charge on a service. However, please note that if the lender charges equal or less than the basic interest rate, there is no tax. To do otherwise would indeed make no sense.
As for investment instruments, I don’t think HR25 says that investments won’t be taxed. AFFT and other advocates frequently make that claim, but that just isn’t accurate. Do you have a reference in the bill? And just to clarify, if the interest rate paid on an investment is more than the basic rate, there would be no implicit tax.
As for home mortgages, my understanding is that if the mortgage is a fixed rate instrument, the Treasury rate at the date of issuance remains the rate for the life of the loan. It doesn’t matter what happens to the Treasury long term rate, the implicit tax, if any, won’t change.
However, for variable rate loans, the tax will be calculated based on the difference between the variable interest rate for the loan, and the Treasury rate published each month. Depending on what the variable rate is tied to, it also shouldn’t matter. Won’t the tax, if any, basically remain pretty constant as the rates move up or down?
On balance, if the Kotlikoff/BHI study data is correct, the implicit tax provisions in HR25 impact the Fairtax rate by less than one half of one percent. As I have written elsewhere, I don’t think the massive paperwork is worth the effort and I would hope this provision gets eliminated during Congressional debate.
IF YOU MAKE $100 AND ARE TAXED $20 THEN YOUR EMPLOYER MUST MATCH THAT TAX SO EMPLOYER DISH’S OUT $120 DOLLARS. 100 TO EMPLOYEE AND 20 TO IRS. SO FAIR TAX WOULD SAVE YOU AND EMPLOYER $20. SO HOW DOES HE FIGURE THAT EMPLOYER WILL NOT SAVE $?