How to Ease Transition Costs?
One of my biggest worries about the implementation of the FairTax is the immediate transition after it passes. Boortz, in the book, glosses over this one, seeming to think it will be a smooth process. I don’t think that will be the case at all.
We have an enormous, unmanageable tax code. It’s got so many loopholes and pitfalls built into it that an average person just can’t comply. What is important, however, is just how much of our current market and pricing system is built around all those loopholes and pitfalls. The immediate visceral reaction to the President’s Tax Reform Panel illustrates my point. We all want a fairer, simpler income tax. But any time you try to close a loophole, you get a huge cry from the beneficiaries of that loophole. The Tax Panel wants to make some major changes which will affect millions of taxpayers, and which might be positive changes, when considered on their own merits. But the immediate transition will be ugly.
Moving to the FairTax could potentially be even more ugly. We’re looking at a fundamental change to the way taxes are collected, and as such, the market will respond by re-pricing goods and services based on the new situation. We’ve seen entrenched opposition in the comments of this blog from those who are renters or landlords. The idea to buy rental property as an investment is predicated on a knowledge that certain things won’t change. People fear change. Uncertainty is the bane of the investment market. And when you’re talking about big-ticket items with low liquidity (like houses and rental property), it is a serious matter. And the FairTax involves fundamental changes to markets, and those changes will have effects.
We all believe the FairTax is a fundamental improvement over the current system. But it is also a fundamental change to an enormous tax code that an enormous economy revolves around. Any change to a tax code benefits some people and hurts others. If we allow the transition to occur so quickly that the market doesn’t have time to absorb it, we’re going to have problems.
This is much more difficult with the FairTax than if we were simply tweaking the income tax. We cannot accept incremental change. We can’t have a FairTax and an income tax at the same time, or we’ll be stuck with both. So there is no way to phase in the FairTax while phasing out the income tax. It’s an all-or-nothing proposition. So we need to ensure that the plan itself has a built-in soft landing.
I think the best way to engineer a soft landing is by tweaking the prebate. I would propose that when the plan takes effect, we set the value of the prebate at double what it will eventually be. Over the span of 24 months, the prebate will diminish, back to the amount that is scheduled to be in relation to the poverty line. I think this will help greatly to ensure that the market can adjust while the effects of embedded taxes and the FairTax are felt.
Right now, we’ve got a three-step plan. Step 1: Enact the FairTax. Step 3: Bask in the wonders of a fair and simple tax system. But the biggest questions we’ll have to answer is what happens in step 2, when the world is tossed upside down by a complete overhaul of the tax code. If we don’t come up with an answer to those questions, we’ll never get to step 1.
If you double the prebate, it will never go down. Never.
That’s the biggest worry. I’d consider it to be a smaller worry than having both the FairTax and an income tax at the same time, but a big worry nonetheless.
I’m certainly open to suggestions on ways to smooth that transition. If doubling the prebate isn’t it, that’s fine.
Anyone have other ideas?
Tom Wright addressed the issue of transition on a recent radio show in Indianapolis. He noted that the revenue-neutrality of the fair tax bill would keep profiteering and inflationary pressures in check. Also, Alan Greenspan requested a six-month delay between passage and enactment of the bill. This would give analysts a chance to gauge the reaction of the economy. Finally, under the bill, existing inventory purchased or manufactured before the bill is enacted will be sold at the pre-fair tax prices. Only inventory and goods purchased after enactment would be sold at the new rates. This would create a smooth transition at the lower rate. The passage of the bill will result in an immediate 12% drop in prices.
Keep in mind, many people and groups will have a knee jerk response of ” whoa is me, I am losing a tax deduction” or some other benefit in the current income tax code(mortgage deduction).
But that concern is based only on taking advantage of the income tax system. We are changing the paradigm and everyone has to think and plan differently.
I am not convinced that all short term concerns or even short term losses or adjustments need to be provided for to business or consumers.
When you look at the tremendous medium to long term beneftis to business, manufacturing and to average American Families, any short term bump is an easy pill to swallow.
Even without an immediate and full price drop, the average American Family will be taking home enough extra take home pay to cover any increase in prices. Add in the Prebate as proposed and they will actually have extra spendable income even before prices drop. They will have a take home paycheck 20 to 30% higher plus a prebate check sent on day one of the first month of enactment.
I think the aggregate pricing of goods and services won’t change too much. It’s the relative change that is troublesome, mainly at the margins.
As a commentor to a previous post of mine pointed out, if you’re a landlord of rental property, and you’re highly leveraged, the FairTax will immediately add some cost to rents. We keep telling renters that their rents won’t go up or will only do so slightly, but those landlords may be in a situation where they can’t drop rents or they won’t make their monthly mortgage payments.
Simply put, when you add a large direct tax on rents which was largely taxed extremely indirectly in the past, it shakes the market. And the market relies on the situations staying relatively stable. When you shake up the market, it needs to find a new equilibrium. And that’s not transition costs as far as what the government has to take into account, that’s a transition cost of real dollars to real lives.
It’s a serious issue. I’m not 100% sure it’s fully addressed in the plan, but I’m not sure how to work out those kinks. If we enact the FairTax and there are a couple of wild swings in the market, it can destabilize the entire economy. That’s something I’d like to avoid!
Ah crap, I was just at the end of a pretty lengthy response and hit a wrong key accidently and there went my post!! Hit the back button and it was gone too!! :(.... Oh well, I’m cursed with that always happening, lol.
Landlords will not have to collect the FairTax on any units that are built prior to the passage of the FairTax, only those units that are built afterwards. Even on new units built after the FairTax builders are going to have 0% income taxes, and their supplies will have 0% in embedded taxes into the costs, and the builders will not have to pay the FairTax since they’re buying for business purpose. They will be selling the homes for a much cheaper cost to the landlords.
The landlords will also now be paying 0% income taxes and $0 in compliance costs, which you’d imagine this cost would be a pretty big burden due to the nature of the business. There wouldn’t be an issue with the landlord lowering the cost of rent to offset the FairTax cost the tenant would have to pay, who is also now paying 0% in income taxes, $0 in compliance, and getting a monthly prebate.
Previously there was a discussion on the IL Yahoo FairTax group where a landlord had basically confirmed that he/she would lower the cost of rent due to the reasons above. I think everybody is much looking forward to passage of the FairTax.
Keep in mind we’ve also had over 15,000 transitions to the IRC since 1986. This is one transition we will ALL be looking forward to!
Tom Leser
Melbourne, FL (formerly Lafayette, IN)
IN Asst. SD/FL-15 DD
www.fairtaxindiana.net
Every year there are changes made to the existing tax system that have adverse effects on our pocketbooks for years to come, and no one says anything about them. Now we have a chance to drastically change the way taxes are collected that will improve our everyday lives and the economy and people want to bulk about it. All because there will be a few bumps that won’t last for any great period of time.
Change scares people, this is a fact of human nature. But we all grow with it and even prosper at times. This is one of those times!!!!
ok, let me get this straight:(correct me if i’m wrong)
1) if you buy business supplies aka B to B(machines, materials, ect...) under the Fairtax there is no tax paid
2) if you provide a service to a business tax is collected
3) renters being the end user of a product(rental property) pay tax on rent
ok, if all these points above are correct the landlords would pay no fairtax on new units(business material), repairs, and if they have a full time maitainance staff they would pay no tax on labor unless they use outside contractors, and the government would be thanking them for the monthly addition to the federal budget.
If i owned rental property i’d have no problem lowering the rent 10 percent and then start to upgrade units as they are vacated then increase rent after the transition period is over. $1000 rent 900+207tax=1107 that way the tax burden is shared and with the increased income tenents don’t complain.
As for the innitial transition i think all old inventory prices should be reduced exactly 23% then a credit in that amount should be added to the final income tax return then everything is taxed from that point on or a credit on their fairtax accounts so the tax on old inventory seems prepaid and they recieve exactly the same price that it would have been sold before the fairtax and consumers pay the same as they would before the fairtax and from that point the prices should quickly drop to their actual pretax prices.
This idea could be applied to rental property where inventory is all outstanding leases that way the rent stays the same and the landlord is not required to pay that portion of the fairtax because it will be concidered prepaid under the old system $1000 rent gets reduced to 813+187tax renter still pays $1000 and landlord gets $187 credit for each month left on the lease. then new prices take effect when lease is renewed.
Re #6:
That’s not the way I understand it! As far as I am aware, rents will be taxed on units built before the FairTax, just as rents will be taxed on units built after the FairTax.
If rents on existing units were not taxed, demand would soar raising rents, to levels comparable to new units) for them while only the rop end of the rental market could afford to rent new units.