Myth Buster #2: It Will Be Harder to Calculate Tax Ramifications under the FairTax
A reviewer of the FairTax Book at Amazon.com stated the following:
Page 42 (last paragraph) - “Have you ever stopped to calculate just how much money you lose each year because you have to make financial and business decisions aimed at reducing your tax obligations?” FLAWED. If I have to stop and contemplate EVERY PURCHASE I make because the consumption tax of, say, 30% (23% Federal FairTax and assuming 7% state consumption (sales) tax), that will cost me much more time than considering the income tax effects of these same decisions. Example: I don’t consider the income tax obligation of purchasing a new car, but I #### sure would if I had to pay a 30% consumption tax.
This is a Myth. It is much easier to calculate tax ramifications under FairTax!
The reviewer does not consider differance between gross and take home pay. This backs up Neal’s point perfectly. If the government withholds taxes from our paycheck before we even see the money, we never miss it. Have you ever thought about how much over-time you would have to work to buy a nicer car—maybe a HUMMER? Let’s see how Joe finds out. He is trading in his car and he wants to keep his payments the same as his old car. He sees another car he likes, but payments would be $200 higher per month. The only way he could do that would be to work overtime, which he can do because his boss is always looking for volunteers to work Saturday. Joe has an hourly rate of $18.84. Over-time is paid at time and a half, or $28.26. Now for the math: $200/$28.26 per hour equals 7 hours and 5 minutes. Not bad—one Saturday per month and Joe could get that nicer car. Under FairTax, that would be true because Joe would get all of his pay and the calculation would be just that easy. Joe knows the price of the car, with and without tax. The dealer will tell him what the payments will be for both cars. Then we make one math calculation.
Now, how do we do this under the current system? We start the same. We still need $200 dollars extra per month. Overtime gross is still $28.26 per hour, but we need to look at take home pay. First, we deduct FICA at 6.2%, which shaves off $1.75 leaving us with $26.51. Then, Medicare at 1.45% takes another 41 cents. Remember to calculate 1.45% times the original gross overtime wage of $28.26, not the $26.51 from the prior calculation. Yes, Joe has to pay Medicare tax on the money that the government has already taken for FICA. We are now at $26.10 per hour.
Now, for the Income Tax calculations. First we have to figure out Joe’s tax bracket. A base wage of $18.84 per hour for 40 hours per week times 52 weeks per year is $39,187.20 per year. What tax rate do we use? Joe is a family man, so we will use the Married Schedule. We need household income now. His wife works at the same company and at the same rate. Their joint income is $39,187.20 plus $39,187.20, or $78.374.40 per year. We can lookup the income tax rate in the following table.
Schedule Y-1 — Married Filing Jointly or Qualifying Widow(er)
| If taxable income is over– | But not over– The tax is: | |
| $0 | $14,600 | 10% of the amount over $0 |
| $14,600 | $59,400 | $1,460.00 plus 15% of the amount over 14,600 |
| $59,400 | $119,950 | $8,180 plus 25% of the amount over 59,400 |
| $119,950 | $182,800 | $23,317.50 plus 28% of the amount over 119,950 |
| $182,800 | $326,450 | $40,915.50 plus 33% of the amount over 182,800 |
| $326,450 | no limit | $88,320.00 plus 35% of the amount over 326,450 |
Wait! That table is for taxable income, not gross income. Using the standard deduction, we can exclude $9,700 from taxes. With two children, Joe and his wife can claim $12,400 in exemptions. This brings their taxable income down to $56,274.40.
Using the tax table, we see that Joe is in the 15% bracket. We are close to the 22% bracket, so we will have to recalculate taxable income with the overtime pay to make sure he is still in the 15% bracket.
Where were we?— OK, we have $26.10 after Medicare and we need to take off 15% for income tax. Remember, we still take that 15% off the gross overtime rate, not the balance. So, Uncle Sam takes another $4.24. And again, Joe pays tax on tax. That leaves Joe with a balance of $21.86. Now, to get $200 more per month for that nicer car, Joe needs to work $200/21.86 per hour = 9 hours and 9 minutes. Unfortunately, a full day on Saturday once per month won’t do it. He will also have to stay late one night, if he can.
Is Joe still in the 15% bracket? Nine hours and 9 minutes of over time every month for 12 months earns Joe an additional $3,103.78 from which he can make additional car payments of $2,400. The family’s new taxable income is $59,377.18. Still in the 15% tax bracket.
Under FairTax, we had to know the extra price of the nicer car, and the overtime wage. We made one simple calculation to find out that Joe had to work about 7 hours of overtime per month for the better new car.
Under our current system, we still had to know the extra price of the car and our overtime wage. We also had to look up the FICA and Medicare rates. We had to estimate the income for the year as well as that of the spouse. We had to know how many children Joe had and look up the exclusions and standard deductions. We had to look up the tax rate in a table, twice. We found out that Joe had to work over 9 hours per month for the better new car. This took about 14 calculations. Fourteen calculations versus one. Which way is easier?
Hey, Joe’s wife likes this idea. She also is trading in her car. And, for $200 more per month, she can upgrade to that mini-van with thet left side sliding door—and it only takes about 9 hours of overtime per month. Not bad. Wait. Joe’s overtime put them right against the next tax bracket. Jane will have to do her calculations with a 22% tax rate. We find out that she will have to work 10 hours of overtime per month. One more hour per month than Joe for the same reward—is that fair! It also took another 14 calculations to figure this out.
Under FairTax, seven hours of overtime each would allow Joe and Jane to both get better cars. One calculation gave us one number that worked for both of them.
Under the current system, it took almost 30 calculations to find out that Joe would have to work 9 hours overtime and Jane would have to work 10 hours of overtime to get their better cars.
When making business decisions, the same thing happens. Once the cost and potential profit of a project are estimated, it takes another 14 to 30 calculations to fully examine the tax ramifications. Sometimes the tax ramifications make us backtrack and redo calculations, costing us more time and money—compliance costs.
Most retailers will post the price of the product with the federal sales tax included. If not, simply multiply the posted price by 1.3 and you have the correct total price. If your state has sales tax, you will still have to make that calculation, but you have to do now anyway.
Reviewing tax ramifications will be easier under the FairTax. Boortz is correct. It is the reviewer that is flawed.
Also look at Myth Buster #1: Dividends are considered a deduction to corporations.
If you are interested in seeing a complete version of this calculation, including child credits, phaseouts, earned income tax credit, etc... go look
at my FairTaxBlog over at Blogspot.
I did do a very simple calculation using only the std. deduction and exemption. If Joe and Jane started an IRA, they could reduce their taxes and keep Jane’s income in the 15% bracket–but I assumed that other issues such as an IRA remained the same–or they had a 401 at work. There are many many more calculations in addition to the 14 that it took me. I tried to keep it simple. The many many tables on the above Blogspot link certainly help prove that this myth is wrong.
FairTax is the way to go. Simple, Transparent, Fair.
Bill
Please note, I wasn’t faulting your computation. Sometimes one clear example is better than tables of detailed examples. Your example is clearly comprehensible to people. My tables demonstrate that you aren’t cherry picking an example that demonstrates your point. Both serve valuable purposes.
Quadrupole , I did not think you were. Your link does point out many other considerations that a person would have to review on a real tax return.
Everyone should know that I did take as many shortcuts as I could — but still needed to make over a dozen calculations. As Quadrupole points out, there are many many more issues to consider in a real tax return. Hey people, this is the problem—there are tons of issues that have to be considered.
The subject myth is that we will have to calculate and make hard decisions on each and every FairTax purchase. That is not the case because everything is equal under FairTax. Tax is always applied to new consumer purchases and always at the same rate. Under fair tax, if you decide to spend money, your only tax consideration is to buy new or used. If you buy new, you will pay tax. That is it.
The Amazon reviewer begins to think only after he gets his take home pay and seems to have no idea how the current tax system works. He is paying his own income tax before he gets his pay check and then pays another 22% income tax for the business where he makes his purchases. He just does not get it. He is ignoring the entire IRS tax code.
This is the main point that I wanted to get across in the original article–but with all the math, it is hard to stay on track.
Bill
Even in my calculations, I simplified. For low income earners, my calculations produce the lowest possible current tax liability. Low income earners cannot really effect their tax burden through optional behavior. Higher income earners have a HUGE swath of optional tas behavioirs, far more than I can reasonably account for. Just trying to decide how to represent the fact that someone making $100k a year could be paying anywhere from $0 to $50k+ in mortgage interest and thus taking a deduction from $0 to $50k+ is virtually undoable. That’s before you even start to get into other optional tax behaviors like 401(k), IRA contributions, etc.
This is an auxillary point I want to get across. Under the current system, two people, both making the same income, both with the same family size/arrangement, can pay radically different rates of tax. How is that fair?
I’m just a lay person and all of this is still confusing to me. From what I have heard, the Fair Tax Method is the way to go...