Mr. Rich vs Mr. Average Joe
From reader Ralph Ekwall:
Here is my argument against the so-called “fair tax.” Let me explain by using two examples. One man is Mr Average Joe and he makes $40,000 per year. The other example is Mr Rich who has an income of $10,000,000 per year.
Mr Average Joe will spend nearly all of his income and he will be taxed at the “fair tax” rate of say, 30% Hence nearly 30% of his income will be taxed.
Mr Rich has an income of $10,000,000 per year. He certainly will invest, save, put his money trust accounts or other places where it will not be taxed at all. He, at most will spend 1,000,000 per year. Only 1/10 of his money is taxed
Now look at the comparative rates of taxation. Mr Average Joe is taxed at the rate of nearly 30% Mr Rich spends only 1/10 of his income and only 1/10th of his income is taxed. His rate of taxation on his income is 3%
This certainly does not seem like a fair tax to me. Comments?
Ralph Ekwall
Takers, anyone?
UPDATE: Don’t miss quadrupole’s response (#3 in the comments below), explaining two errors in the above calculations, and noting that the actual difference between their effective tax rates is less than 1%.
Ralph’s math is off, and fixing the math makes the situation even worse.
If the FairTax is at 30%, and Joe spends 100%, he indeed is taxed at 30%. Rich makes $10M, spends $1M, of which 30% is taxed, so 300K. 3%, not 10%.
The math is unavoidable, indeed the effective tax rates are quite different. The counter-arguments:
Assumption: Most of the potential Mr. Richs are not making $10M in salary. The exceptions to these would be super high level CEOs, Sports Stars, and Actors. The rest of the Super Rich are making their money from investments.
1) For the investors: The super rich keep their investment money already in tex shelters or use tax loopholes to avoid taxes already, the effective tax rate probably isn’t a whole lot different, and for some of them it may go up (Since you hear stories of the super rich paying no taxes now)
For the actors/sports stars: Yeah, they are going to get a mostly free ride. They can’t use the tax shelter, but they can still use loopholes that the average joe can’t pay his accountant to find.
2) The untaxed money of the super rich does not go into a mattress. It is either put into a bank, and then loaned out, or invested to build business, or directly used in a business. This helps the overall economy and creates jobs. Basic trickledown econ, supply side etc, which has been proven pretty correct since the Reagan years.
3) Percent-wise, the numbers are pretty wide apart. In absolute dollars, the numbers are quite different. Joe pays 12k in taxes, Rich pays 300k.
Once you get to a rate where the government expenditures are covered, the question isn’t “Why aren’t we taking more from the rich?” the question is “By what right can we take the money?”
If average Joe spends all of his money thats his problem. If Mr. Rich only spends 1/10, thats his problem. So whats the big deal here? The tax is on what you spend, not what you make. And please don’t use the 30 percent, it just plain wrong!
Ralph isn’t considering the FairTax, but rather some arbitrary non-FairTax consumption tax. He has two errors. First, the FairTax inclusive rate is 23% (and he is using the rate inclusively here). Second, he has left out the prebate.
Imagine that both Mr Average Joe and Mr Rich have a wife and two kids. That means they both have a Family Consumption Allowance of $26400.
Presuming Mr Average Joe spends 100% of his $30k income that means he spends $3600 subject to the FairTax, for a FairTax paid of $828. This is an effective tax rate of 2.76%.
Presuming Mr Rich spends 10% of his $10 million income (or $1 million) he has $973600 subject to the FairTax, for a FairTax paid of $223928. This is an effective tax rate (over his income) of 2.24%.
The effective rates aren’t that different in this case.
[Editor’s note: the effective tax rate on Rich’s expenditures — at 22% — is much, much higher than Joe’s. Thus, Rich’s effective sales tax rate is more than eight times larger than Joe’s.]
Let us consider for a moment the question of ‘Fairness’. We have been conditioned to think of fairness in terms of taxes collected as a percentage of income. I would maintain this is the wrong measure. Why, you may ask?
Well, think about what it is about the rich that people tend to think is unfair. What most people think of as unfair with the rich is their conspicious consumption. *That* is what we are taxing with the FairTax.
Consider the following example:
The Frugals are a married couple with two kids making $150k a year.
They consume $50k a year, and take $100k a year and invest it, creating jobs and economic growth.
The Gluttons are a married couple with two kids making $150k a year, and consuming it all. They invest nothing.
Would it be fair for the Gluttons and the Frugals to pay the same amount of tax? They make the same income, they have the same sized family, but the Gluttons consumed three times as much as the Frugals. They got to ‘eat’ three times as much stuff as the Frugals. I for one wouldn’t feel right about one family getting three times as much stuff as another and paying the same tax. It would give them a much lower effective tax on what they *got*.
I would maintain that what is ‘fair’ is for the Frugals to pay the same amount of tax as any other family of four that got $50k worth of stuff, and the Gluttons, who got three times as much stuff, to pay more.
Ah, you might say, but how is it fair for the Frugals to pay the same amount of tax as the Smiths who only *made* $50,000 and consumed it all. The Frugals still have $100k in investments. To this I would reply: we will get them in the end
You see there are really only two things the Frugals can do with that $100k they invested: they can reinvest it, thus generating more and more economic growth, or they can consume it later. For long enough values of later they will eventually consume that $100k. This is what everyone instinctually realizes, and resents. But when that $100k is eventually consumed it *is* FairTaxed. In effect it’s taxation has only been defered for as long as the Frugals keep it invested.
This is the central fallacy people run into when they look at effective tax rates in terms of income, rather than consumption. You can talk about what income is made in a given year, but not all income made in a given year is consumed at that time, but eventually, it is consumed. If you don’t believe me, look around at how *few* family fortunes survive to the fourth generation. All you do when you tax *income* instead of *consumption* is a reduction in *investment*, and thus economic growth.
[...] Quadrupole left an excellent comment on our discussion of Mr. Rich vs Mr. Average Joe. [...]
I saw that example nearly verbatim on fairtaxfraud.com. They had the math that proved that the poor spent literally everything they earned on consumption. That means every part of their income was taxed - or a 100 percent tax rate. Middle class saves 20 percent for tax-free investment and spends 80 percent of all earnings on necessities (consumption subject to Fair Tax) so their tax rate is 80 percent. The rich man spent less than 5 percent on food/rent/clothes/healthcare so only 5 percent was taxed and 95 percent wen into tax-free investing. Therefore the rich mans tax rate was 5%.
John,
You seem to
a) Be confusing taxable income with effective tax rate
b) Again be completely ignoring the actual FairTax proposal by not taking the Family Consumption Allowance into account.
Ah... I just went to look at the fairtaxfraud site... they seem to want to calculate the tax rate as the amount of tax paid plus the amount of consumed. They also are presuming a family size of 1, and are labeling all consumption as necessities. A few basic problems:
1) They are either highly deceptive or have no comprehension of how effective tax rate is defined (ie, dollars in tax paid divided by either income or consumption).
2) They are either highly deceptive or have no comprehension of how the FairTax prebate works (as they peg all family size at 1 without mentioning it).
3) They are either highly deceptive or have no comprehension of how the poverty line is defined or what is usually considered necessary expenditures. A family of 1 spending $30k a year is living at more than three times the poverty line.
I’m all for addressing legitimate complaints, but these guys are either really confused or actively seeking to deceive people.
I sent an email to the admin of that site. He said he would make som updates to better exalain his position.
No offense...just curious...what does the poverty line have to do with this?
No offense taken.
When you are talking about necessities, you need someway to quantify them. For example, clearly everyone needs food, but not all spending on food is necessary. It’s very unfair to treat Mr Rich’s filet minot as being as necessary as Mr Poor’s rice and beans. Likewise with other essentials like housing, clothing, etc. This is one of the reasons why the FairTax uses a prebate instead of exempting certain good.
The generally accepted way of quantifying necessities is the poverty line (which varies by household size). This year the poverty line for a household is $9800 for the first member of the household plus $3400 for each additional person. The family consumption allowance for the FairTax is generally set at the poverty line (varying by household size). There is also an anti-marriage penalty clause that raises the Family Consumption Allowance (FCA)for a married couple so that both spouses count as $9800 in FCA. So married family of four would have the first $9800 + $9800 + $3400 +$3400 = $26400 of their spending effectively tax excempt (through the prebate). Can a family of four spend more than that on housing, food, clothing, etc. Absolutely. But the FCA is meant to subsidize the bare necessities, not the lifestyle choices that people make above and beyond them.
Is it a perfect system? No. It is however the best system I’ve seen to date for trying to make sure that people don’t pay consumption taxes on their necessities of life. It also compares quite favorably to things like the current standard deduction and exemptions (which are meant to server a similar purpose).
Le me know when the admin of fairtaxfraud updates his site. I am very interested in seeing high quality dialog on the FairTax, whether for or against.
I certainly do not agree with the fairtaxfraud site’s use of numbers, throwing around terms like 100% tax bracket and such. It leads readers to believe that all of their income will be taxed (when it won’t be, even in the most extreme examples of hand-to-mouth poverty).
The current income tax systems taxes 100% of your income (or at least tries to) in ANY bracket, even the poor (I sure saw a lot of withholding working at AMC when I was 18!). Your complete income is totaled up including virtually every form of wage, investment, profit or gain you can come up with, and the government takes a percentage of it. Standard exemptions remove taxation for basic necessities of life, using a similar principle to the FairTax. For example, a single person can typically be exempted from taxation on the first $6400 of his income. The FCA actually grants a greater exemption of spending ($9800 to start and 3400 per person thereafter) than does a regular exemption ($3200 apiece in 2005).
Also, once should keep in mind that SOME necessities may not need to be taxed, particularly for the thrifty. Clothes in particular, can be bought at thrift stores like Goodwill (my parents did that when I was young) as can many other goods, and since they are used, would not be taxed at all.
In effect, the FairTax should at worst, not further hurt the poor. At its best, it could in many situations greatly assist them by enabling to have more money up front, and more options to reduce their tax burden to virtually nothing.
Grumbling about percentage rates of taxation for people who invest is also silly. A businessman who is investing money or saving money will be indirectly assisting the economy anyway. Invested money is great because it more money in the market assists millions of 401K investors who are trying to retire on their own steam. It also builds up businesses by providing capital, which can be used to hire workers and make more products available. Saved money in banks is great too, because the more money is available for banks to lend, the lower interest rates get, assisting everyone who is financing anything from a car to a house. We should be REWARDING those who invest heavily. They are helping themselves and MANY others by doing so.
Great discussion and most of my comments are covered somewhere.
The Frugal income is increased by $6000 to $10,000 per year by the prebate and the taxes that are no longer deducted from the pay check.
In effect he is paying tax on only the amount above the necessity level of his family size. He can buy most things used so would only pay tax on food and medicine and that has been refunded to him in advance.
The rich guy can’t take it with him. Somewhere, someday, his heirs will spend it. In the meantime we benefit from his savings adding to the economy.
Good discussion. Thank you.
Here is another example of how the rich would be paying their FairTax share. I visited Beverly Hills, CA last year and checked out Shaquille O’Neils house. It was a work still in progress, but it is valued at 32 million. Shaq will pay $7,360,000 in taxes.
Another point to consider is that most of the ‘really rich’ keep their money off-shore hidden from the IRS. They use debit cards to pay for things.
There is an estimated $11,000,000,000,000 (trillion!) green backs off shore that would be repatriated under the FairTax. This, plus all of the rest of the $$ we invest would have a dramatic effect on the stock market and reduce interest rates by about 1/3.
Also,
If there was no tax system and this debate was about a new and wonderful tax system system that would have 60,000 pages of tax code, cost 250 billion a year to comply with, a bureaucracy enabled to give each citizen a financial rectal exam each year, one that asurred political corruption, one designed to protect the ‘rich’ from paying taxes, one that put evreything “made in the USA” at a significant cost disadvantage — would you embrace it? Or write it off as lunacy.
It is interesting that humans don’t like change to the point of self inflicted misery.
It’s OK to question the FairTax. I certainly had questions. But the more I investigated the more that these questions have become clearly answered.
The FairTax IS a radical change. We need to be cautious. But a half trillion dollars a year is a lot of “unintended consequences” that the originators of the 16th Amendment could not have possibly anticipated.
In truth the FairTax represents the greatest transfer of power from the government to “we the people”, since the Revolutionary War.
I have just started examining the Fair Tax and I can’t find the answer to this question, so I apologize if it has been addressed already. Why should we institute a beauracracy in order to administer the rebate for the FCA when we could just exempt families with a certain income from the NRST for food bought at grocery stores and rent? I would in general be opposed to any other exemptions. Thanks in advance!
One of the biggest problems with today’s tax system is exactly what you mention: exemptions. Granting exemptions or other tax breaks for this or that inevitably leads to a series of tax complications that are unnecessary and are often manipulated by politicians to buy votes for office. This exact problem was addressed by the FairTax plan by attemping to tax all consumption (goods & services) WITHOUT EXCEPTION, BUT ONLY ONCE.
Such a notion simply hasn’t been tried, because it seems unfair to tax lower-income individuals beyond their ability to pay.
However, there are many other problems with implementing what you suggest.
It means that two classes of businesses have to report taxes differently from everyone else: grocers and landlords.
It also means that people from a certain income level have to be treated differently from everyone else: those below the poverty line.
This also means that those just above the poverty line might get overlooked, and get taxed heavily just as they begin to make ends meet.
The prebate mechanism provides a base level of exemption that becomes less significant the more you make, but more significant the larger your household becomes.
In addition, the prebate is going to be administered by an existing government agency, not a new one.
According to the bill, the Social Security Administration will be in charge of sending FCA payments to families. The SSA already sends many millions of checks every month as it is, and has the expertise and infrastructure necessary to implement the FCA with little problem. With the advent of electronic deposit, this is not nearly the bureaucratic nightmare that it is being made out to be.
http://www.fairtaxvolunteer.org/pdf/FairTax_Act_Summary.pdf
Look on the bottom of page 14 for the full details.
Thanks for the response. I read more after I posted my question and now with your explanation, I see why a complete exemption would not work as those just above the cutoff would be penalized much more in comparison. I apologize in advance for my lack of knowledge, but I do have some more questions. My concern is that a low income family would be able to spend all of their income on not just necessities, but also luxury items and not have to pay a tax on that. This does not seem fair to me and it would not encourage discipline in spending. It is arguable that this is not the government’s responsibility, but why not?
I appreciate that the Fair Tax proposal is a huge step in the right direction, but it still bothers me that we still feel a need to redistribute wealth to the extent that the FCA does. The more wealthy someone is does not increase, beyond a certain point, the amount of food that they can consume. The more wealthy someone is does affect the types of foods that they consume and where they consume them. If we were to completely exempt basic foods like those covered under WIC, I think that would be fair. The question of rent comes to mind as well, due to the hardship it would impose on landlords to collect the taxes, so why not eliminate this as well? Thanks again for enlightening me!
Jason,
I may be wrong on this, but I beleive that the only way for the FairTax to properly work in the long run is if we exempt nothing, and I mean nothing! As soon as we start to differentiate between certain types of spending we will get into the same quagmire that we are in today with the “brilliant” social architects in Washington buying votes because they promise to exempt some group’s pet desire. I can see each and every argument for exemption and I tell you that in my humble opinion, if there is one flaw inherent in the FairTax, it is that there will be continuing pressure on Congress to give up on keeping it fair by buying votes with tax exemptions. If somehow the system would work in a manner that only allowed congress to raise and lower the rate without being able to give in to the temptation to sell out to special interest that would be great.
Jason,
One thing to consider is if the tax system should be used for social engineering. The FairTax says No. The FairTax does not get into the debate of if government social engineering is correct or not. What it does say is that such should not be part of the tax code. If you want to give the poor a break on food or medicine, then do it outside of the tax system in programs such as Medicaid. If you want to give an industry a subsidy or provide some welfare to the poor, then do so, if you can gather the support, in a social program, but do not complicate and create special interests in the tax code.
I wish fairtax would work. If you accept the premise that its voluntary, that companies will lower their prices 22%, that the military can pay 1/4 of a trillion dollars in sales tax, that its revenue neutral, its great.
Its just a shame — none of those are true.
Voluntary? Not for cancer patients — they must spend 100,000 to 2 million to stay alive. That’s 23K - 230K in sales taxes to them.
Its not voluntary for nursing home patients — they must spend 9,000 to 20,000 a month on their care. That’s 2100 - 4600 tax every month.
Its not voluntary for the parents of a brain damaged child, who need 400,000 a year care for that child.
You can say “oh, we wont tax those people” I know you wont.
Huge political pressure will force Congress to correctly exempt not just the hard cases, but of all of health care from the high sales tax. Two trillion dollars therefore will go untaxed, and the treasury will have 460 billion shortfall.
Fairtax rate just went up to 34% to be revenue neutral to accommodate the 460 billion dollar shortfall from not taxing health care.
The military and government cant pay 280 billion in sales taxes. Sorry. Sure, you can make them write a check. But that check for 280 billion wont be any net increase to the treasury, cause the treasury has to issue the check too. The result - a “wash” But not the wash Boortz an others claim. Its a “wash” as far as receipts. There wont be any addition the the Treasury.
And thats the whole point of applying the tax - to get the revenue in.
Fairtax rate just went up to 42% to be revenue neutral, to make up for loss of 280 billion.
You cant tax new housing — at least, you cant get the 110 billion the Fairtax expects to get for the treasury by taxing new homes. Since many people will simply avoid buying new houses, or buy less expensive homes, to avoid the high tax, this market segment will not contribute as expected to the treasury. Its impossible to tell how many people will avoid buying new homes, but since even small changes in interest rates effect housing sales, its very reasonable to assume a huge sales tax will change behavior.
Fairtax rate just went up to 46% to be revenue neutral to make up for the 110 billion shortfall from not being able to tax new homes as planned.
You wont be able to tax rent either. Few people even understand, Fairtax taxes rent. That’s a 190 billion dollar market segment. Fair tax was based on getting 42 billion from that into the treasury. Renters will scream bloody murder, and congress will exempt them to, or be voted out of office,and the next congress will grant the exemption.
Your tax rate just went up to 48% to accommodate loss of that 42 billion..
I’m sorry to say it, cause I wish FT would work. But it cant.
Furthermore, many people promoting this concept know it cant work.
My sincerest hope is, the Fairtax passes. The leaders of this movement will have a lot of explaining to do.
Mark,
See my response to what is apparently the same post in the other thread.