The Fair Tax Act, Part LII
I’ll try to cover two short sections today:
SEC. 803. TIMING OF TAX ON FINANCIAL INTERMEDIATION SERVICES.
`The tax on financial intermediation services provided by section 801 with respect to an underlying investment account or debt shall be imposed and collected with the same frequency that statements are rendered by the financial institution in connection with the investment account or debt but not less frequently than quarterly.
This section merely states the timing of when tax is collected on debts, interest, etc. It’s pretty self-explanatory.
SEC. 804. FINANCING LEASES.
`(a) Definition- For purposes of this section, the term `financing lease’ means any lease under which the lessee has the right to acquire the property for 50 percent or less of its fair market value at the end of the lease term.
`(b) General Rule- Financing leases shall be taxed in the method set forth in this section.
`(c) Determination of Principal and Interest Components of Financing Lease- The Secretary shall promulgate rules for disaggregating the principal and interest components of a financing lease. The principal amount shall be determined to the extent possible by examination of the contemporaneous sales price or prices of property the same or similar as the leased property.
`(d) Alternative Method- In the event that contemporaneous sales prices or property the same or similar as the leased property are not available, the principal and interest components of a financing lease shall be disaggregated using the applicable interest rate (as defined in section 512) plus 4 percent.
`(e) Principal Component- The principal component of the financing lease shall be subject to tax as if a purchase in the amount of the principal component had been made on the day on which said lease was executed.
`(f) Interest Component- The financial intermediation services amount with respect to the interest component of the financing lease shall be subject to tax under this subtitle.
`(g) Coordination- If the principal component and financial intermediation services amount with respect to the interest component of a lease have been taxed pursuant to this section, then the gross lease or rental payments shall not be subject to additional tax.
For property that is business-leased and then purchased for a fraction of its price thereafter, we have these rules for taxing the final sale price of the property and the interest premiums (as discussed earlier). These types of leases are complex today under the income tax as well (my boss used to lease cars and then opt to buy after 4 years, writing a portion of the expenses off on his taxes).
James, I don’t have any idea how banks, loan companies, and other investment firms handle billings, but the Timing section is not as innocuous as you indicated. Each month, all financial service businesses will have to get the short, mid, and long term rates from Treasury, and then recalculate the tax on all debt and investment instruments. Perhaps that amounts to simply changing a computer program to reflect the new basic rates, but it sounds like a mind boggling activity to me. Also, won’t the billing cycle then have to conform to the Treasury rate announcement? Otherwise, portions of the tax would be at different rates?
Based on the data in the Kotlikoff/BHI study report, this whole implicit tax business lowers the overall Fairtax rate by less than 1/2 of one percent. I just don’t think it’s worth it!
All the timing section says is that tax will be handled with your regular bank billing statements, but no less than quarterly. So unless you have some loan that only bills you semiannually or yearly, there is no difference.
The number crunching isn’t all that complicated to actually perform, although it is a bit of an economics twister to understand all the various components of interest and why they are or are not taxed.
It should really only affect banks and how they bill folks, regular consumers should not need to perform these calculations. They’ll be informed of the tax amounts on their statements, so they shouldn’t be kept in the dark either.
I should also make note that banks routinely do these sorts of calculations as these Federal rates get published each month and are the basis of income taxation for banks today. Believe me, if any part of the FairTax bill looks like the old Internal revenue code, this part does.
Hank,
Let me describe to you why it’s worth it. Imagine for a moment that we don’t tax ‘implicit financial services’ under the FairTax. Further imagine that you are going in to purchase a new car. I, the dealer, need to get $20,000 for the car to make what I consider to be a reasonable profit. If I sell you the car for $25,974, I would get my $20,000, the government would get it’s $5974, and you would get your car. But if sell the car to you for $10,000, with $7700 going to me and $2300 going ott the government, but only on the condition that you financed through me at a rate of interest sufficiently above market to put another $12,300 in my pocket then I still get my $20k, you get your car for $3674 cheaper because we’ve just used an implicit financial service to ‘untax’ a large part of your purchase price.
Basically, if I can recharacterize what I charge you for a good or service as an ‘implicit financial service’ (ie, above market interest rate) I can untax a portion of that charge: big loophole.
The reason for taxing implied financial services is not to raise revenue, but to prevent gigantic loopholes.
James, it’s not just banks that are involved. It’s every loan company, investment firm, credit card firms, credit unions, etc. The entire financial industry will be affected.
Quadrupole, I’m getting old and slowing down, but your justification for keeping the implicit taxation has a faint odor about it. If your scheme to screw the government out of tax revenue is correct, then why not simply give the car away and finance the whole thing? Send nothing to the government. Something is wrong with your plan, but I can’t express my doubts completely just now. Tell me, how long would a car dealer last with the auditors if thay sold a $25,000 car for $10,000 or even $0? It seems to me that the tax is due on the total value of the car, no matter whether a portion of the sales price was financed or not.
What am I missing? (aside from your creative imagination)
Hank, yes all lending institutions will have to do this. I am aware.
However, I have to say again: pretty much all of these people have income taxes calculated on a monthly basis from these rates TODAY. I am pretty sure they have processes in place to get the information and automate their taxes today, and could easily automate their billing systems to accommodate this in the future.
So I just don’t think it’s a big deal for them.
Yes Hank, you are missing something
In any large transaction (like buying a car) where financing is involved the vendor (car dealer) can make their money from one of two sources:
1) The actual sales price of the item (the car)
2) The financing of that item (ie, the car loan)
If you tax the sale of the item (the car) but not the implicit financial service of the financing (the above market interest rate on the loan) you will naturally cause the vendor to move more of the cost into the untaxed regime: the financing. It’s just that simple
To avoid this sort of *trivial* tax avoidance, the FairTax applies to implied financial services (ie, above market interest rates).
If anything this feature of the FairTax shows *how MUCH* thought has gone into closing loopholes.
Quad–O.K., I’ve had time to research the bill and do a little calculating on the math involved with your scheme. Lets use your $25,000 car example. We agree that if the inclusive price is $25,000, then the sales tax going to the government is $5750, and the pretax value of the car is $19250.
Now, how much tax revenue will be sent off to Washington under the provisions of sections 801-806? I assumed that the mid-term basic rate was 4% and the dealer financed 100% of the car value at 8% for 60 months. Each month, the implicit tax sent off to the government would be $14.75. (19250 x .04 x .23/12 =14.75). Over the life of the “loan”, the government tax revenue would be $885 versus $5750. Doesn’t pass the laugh test. Something is wrong with your plan, because the loophole really doesn’t look like it has been closed?
In rereading the bill, the Fairtax taxes the fair market value of a product, and the implicit tax is an additional tax on a service. The two aren’t mutually exclusive, but are additive. I still believe that a car dealer would have a tough time convincing an auditor that he sold cars at half the wholesale cost? The slammer awaits those who try to defraud the government.
I’m still missing something- what is it?
I think quadrupole’s point was that if sales costs were taxed and interest was not, then car dealers might instead begin to lower prices on cars but increase the interest rates they charge to finance, thus avoiding some of the taxes and maintaining roughy the same profit margin with less shrinkage from taxes.
I don’t know if I agree with this assessment, but I would have to admit its plausibility. I haven’t seen any research into a similar kind of avoidance scheme in a state sales tax for example.
One other point…
It is a common (and legitimate) business model today to sell an item at a loss and make your profit in the financing or extended warranties.
James, it’s getting clearer, but I still think that there will be a sales tax on the “fair market value”, plus an implicit tax on any financing with rates that exceed the basic interest rate. My point is that the dealer can’t sell the car much below the fair market value without running afoul of the tax auditors. And dealers certainly can’t sell below the wholesale price, can they? I don’t think it matters whether the car is financed or not. The sales tax would be the same.
This does raise another question about the implicit tax. Currently, some car dealers are selling cars with no interest financing. How does that impact federal government revenue?
Since wordpress seems to be eating my posts… I’ll try breaking this up…
Hank,
You are very close to following my point. Let’s take your $25k tax inclusive price and 100% financing at a 4% midterm rate at 60 months as a starting point. Let’s further assume that the dealer need to get $19250.
Senario 1: The dealer sells you the car at $25k with 100% financing at a 4% rate for 60 months. The dealer gets his $19250, the government gets it’s $5750. There is no FairTax on the loan as it’s at the midterm rate.
Continueing the above comment (wordpress still seems to be eating my posts)
Senario 2: The dealer sells you the car at $19480 with 100% financing at a 10% interest rate for 60 months.
So up front the dealer gets $15k, and the government gets $4480.
Over the life of the loan (I am not going to do the amatorization here correctly, because it distracts from the point, but will instead follow your example) that’s an extra $19480*0.06*5=$5844 in interest.
Of that interest, $1344 goes to the government, and the dealer makes an extra $4500.
So in senario two, in the final analysis, the dealer gets $15000+$4500= $19500, and the government gets $4480+$1344=$5824.
So in summary:
Senario 1: Dealer: $19250 Government: $5750
Searnio 2: Dealer: $19500 Government: $5824
given all of the compounded rounding in my example, these senarios produce about the same net effect.
Does this make sense to you Hank? (I am not always very good at explaining these things
).