Would the Underground Economy Be a Problem?
I’m promoting Jessica’s question into a post and thread here of its own:
I don’t think we’ve really discussed the “underground economy” that Mr. Gale says would thrive. As far as I understand it, as used goods are not taxed, this could create a problem with many people selling “used” goods the way they do at flea markets and such. Any thoughts?
Comments, anyone?
43 Responses to “Would the Underground Economy Be a Problem?”
The amount of tax evasion is very hard to pin down either in the current system or under the Fair Tax. Estimates of a trillion dollar or more underground economy results in several hundred billion dollars in evaded taxes today. This is in addition to the unpaid taxes that are traceable through audits.
Where will the flea markets get the products to sell? Theft is one way. Producers could sell directly to the flea markets, but they would have to break the law by not selling to a registered retailer who has a tax exemption certificate. Pretty hard to sell services through a flea market. How much volume could a flea market generate before it became very obvious that they were evading the law?
There will undoubtedly be some evasion of the Fair Tax law whether it is through individuals or flea markets. But it takes two to play the game; the consumer and the seller. How long before the offender is reported?
As a retired auditor, I have had a lot of experience trying to determine that reported numbers were materially correct. I would much rather only have to worry about verifying total sales and the propriety of deductions reported from sales than encounter the complexity of corporate and individual tax laws. I believe that I, like any good auditor, could detect any significant cheating. For example, to verify total sales look at purchases and calculate how much sales should have been generated. To verify deductions for business to business look at the exemption certificates on file and the amount recorded against each. If necessary go to buying business and verify the amount they purchased from the business in question. Remember, willful evasion will carry significant penalties. The auditor wont catch every instance of cheating. But, two factors will keep small business from cheating; most people are honest and the consequences of getting caught makes it perilous.
Large retailers that comprise 85% of total retail sales would be foolish to engage in cheating. The evasion would have to done by one or more employees who would gain no direct benefit from the illegal transaction. Loss of business license would be a pretty steep penalty for Walmart, Sears or any large business to endure. it isn’t going to happen beyond the level of the retail theft that occurs today.
It is my estimate that evasion and avoidance of the Fair Tax law will be less than of the complex income tax laws of today.
I respectfully disagree with Marvin. I believe that although there might be less tax evasion under the FairTax, there will be far more tax avoidance.
First, since I’m not a tax lawyer, I’ll try to explain my understanding of the difference. Tax avoidance is LEGAL ways to avoid paying a tax. Tax evasion is ILLEGAL ways to avoid paying a tax.
Tax Avoidance. As all FairTaxers know, the FairTax will be a voluntary tax, which folks can choose to pay or not pay depending on their spending habits. Well, being red-blooded, tax-hating Americans, many of us will voluntarily choose to pay as little taxes as possible.
The most obvious ways to do so will be to buy a (tax free) used car rather than a (taxable) new car. Same with houses, furniture, jewelry, ect. Ebay will do very well under the FairTax.
Also, since purchases outside of the country will be free of the FairTax, many of us will choose to go on ski vacations in Canada rather than Colorado. Those of us who can afford yachts might choose to buy (and moor) our yachts in the Bahamas rather than in Miami.
All of that will be legal under the FairTax system and, in fact, must be expected.
Tax Evasion. Tax evasion will mainly result from individuals setting up businesses to make purchases. Purchases made for business purposes will be tax free. So, for example, if one has a network marketing business, one might buy a car for that business and not pay any tax. While the person is supposed to allocate the use of the car between business and personal use (and pay a proportion of the tax), it will be very difficult for the taxing authorities to really determine how much the car was used for business versus how much it was used for personal use. Although one could do the same thing today, the income from a business is a key factor in determining whether the business expense was legitimate or not. Under the FairTax, income will be irrelevant for tax purposes. Supposedly, we won’t need to keep records showing how much income we or our businesses generate, therefore one could have a network marketing business with no income and still purchase the car tax free.
So, the bottom line is, I believe there will be a substantial amount of legal tax avoidance and illegal tax evasion that the FairTax supporters haven’t really factored into the equation.
It is very clear to me that, either through modification of the bill or regulation, a business selling “used” goods would have to charge FairTax on the difference between what they paid for the used item and what they sold if for. A used car dealer would not be able to buy a junker, totally restore it, and sell it tax free. The differerence between their buy price and their sell price is actually payment for the restoration service.
If this isn’t the case, there would be all sorts of avoidance issues. Want your roof replaced? “Sell” your house to the roofing company and then “buy” it back after the roof is done. Want your furniture refinished? “Sell” it to the refinisher and “buy” it “used” after.
Hayden: There are only so many used items of any type available. Think you have heard of the law of supply and demand. When all of you tax avoiders try to buy the limited used items, you will push the price up to near new plus Fair Tax. Remember the difference is only 15% and will narrow even more over time. Eventually these limited used items will become unserviceable and someone is going to have to buy new.
Sorry; income of a business is not a determining factor to legitimize a tax exemption. Only that it was used for business purposes and not personal. When the purchase was made, the buyer declared it to be a business need to get the exemption. If it is a sham, he has committed material fraud. The amount evaded would be over $10,000 and would have been done with intent to defraud the government. The person who advised him would be guillty of conspiracy to commit fraud which you know is even worse.
How would the auditor catch this.
The buyer brags to people at the bar how he got a new car without paying any tax. Others stuck with paying the tax, report the fraud. Or, the auditor is reviewing the tax exempt autos sold by a dealer. He notices a new Cadillac was bought by a small internet sales company. Curious, he follows up with the buyer. Remember this transaction evaded over $10,000 of taxes.
Not everyone will be caught. But, the penalties will be severe for those that are. How many want to risk getting caught? There will be some evasion but it wont be material in amount.
So, the individual is going to avoid a 15% tax on a couple of thousand dollars ($300) by going skiing in Canada rather than in Colorado. How much more is that going to cost him?
So, a few very rich people that can afford to have a yacht and bear the expense of mooring it in the Bahamas can avoid the tax. Now anytime they want to use their toy they have to go to the Bahamas. How much will that cost? Besides what is the purpose of having a fancy boat if you can’t show it off to those you want to impress? The amounts involved are probably insignificant to the buyer and they are certainly immaterial to the $2.2 trillion of total taxes collected.
Small amounts can and will be evaded and avoided. Large amounts will be uncovered and punished making it a dangerous and expensive game to play.
I say amounts will be insignificant. You say they will break the system. Unfortunately, neither of us can prove our assertions.
Don’t forget that the cost of products and services should remain about the same as they are now. Now with the extra money in the consumers pocket, most would not see the benefit of trying to get around the system. The hassle of getting around the system would not be worth the time or trouble. There are inconveniences involved to include time, risk, travel,... that would make it simply easier to just follow the rules.
I’m fairly new to this movement and will do all I can to support it’s success, it’s the fairest most common sense approach to the replacement of the current system. But I do believe this issue will most definately be a problem that will have to be addressed. As I watched the promotional video for the first time this evening this was one of the “Red Flags” that popped up as I watched it. As this movement gains momentum the detractors will be looking for weak spots to attack and I definately see this as one.
I’d also like to find out if the question has been asked concerning Home Mortgage values? If interest Rates, costs of goods and services, and in turn, the price of New and Used Homes Drop, what will be the answer to those who will complain that they will loose their life long investment in the Value of thier Home. If a purchaser of a new home now for $300,000 as an investment for the future, thinking home prices will rise, then this plan is passed in the next few years driving home prices down, what would help this person see why this tax plan would benefit them?
Would the Underground Economy Be a Problem?
The underground economy is everything from Wendy Waitress not reporting all of her tips to Mr. Cash Money, the drug dealer.
Let’s play a little game. Let’s take a look into the life Mr. Cash Money.
Mr. Cash Money sells “medicinal items” for cash on the street and takes a “commission” from working ladies. He even provides a “protection service”!
Do we think Mr. Cash Money files a tax return every year? Don’t hold your breath.
Poof, now we are FairTax land.
Mr. Cash Money needs a new suit. Nothing used for this guy! Bam, FairTax paid.
Mr. Cash Money needs some groceries, Bam, FairTax paid.
Mr. Cash Money needs to pay his rent, Bam, FairTax paid.
Mr. Cash Money needs to………..you get the picture, Bam, FairTax paid.
Do you think Mr. Cash Money will expose himself to the Gov’t by applying for the prebate?
Again, Don’t hold your breath.
Now let’s look at Wendy Waitress. She has been good and filed her taxes, just did not report all of her tips. A bad tax plan made a technical criminal out of a good person. She has worked hard but was never able to get ahead.
Poof, now we are FairTax land.
Wendy applies for and gets the prebate. She now takes all her tips and put them into savings which are no longer taxed. She is frugal and buys used items where possible which is not taxed. She takes a night course which is not taxed. She gets a better job which is not taxed. Now she is able to buy that new car, dress shoes or whatever she has always wanted, and yes, it is taxed. But so what, thanks to the FairTax Wendy has been able to get over that hump of sustenance to success.
So in the grand scheme of things…….. No, the Underground Economy would not be a problem.
Hayden: There is no doubt that with FairTax there will be huge amounts of both avoidance and evasion - in the billions for sure.
But what is the amount of avoidance and evasion now? Regardless of the system, when you are trying to gather trillions of dollars, you are going to have a cost benefit decision on collection methods to minimize that loss.
Going back to the fundamental design goals, as long as the FairTax is revenue neutral and the lost collections are the same or less, then it is hard to argue that there is a downside on this point. At the end of the day, you are going to raise what you need to raise and the law abiding tax payers are going to foot the entire bill - same as it is now.
So while concern over the effect in this regard can and should be raised, it seems that we have to compare it to the same effect on the current system to make a meaningful judgment. Given the convoluted process that is in place, is there any way to really know what amount is uncollected now on avoidance and evasion? In the existing system, there are entire industries built around interpreting, arguing and representing clients on where avoidance stops and evasion begins. So even the difference between the two is not readily discernable now much less how much of each is going on.
For the manufacturers and retailers of new goods, avoiding tax is currently an important part of being competitive. Evading tax in the current system and getting caught is decidedly not a sustainable practice but, done with the right finesse, is quite possibly cost effective in many situations, even with otherwise respectable companies. So with the current system, there is a alot of incentive to spend money on avoidance and, in some cases, controlled evasion.
Common sense tells me that the forces of simplicity and transparency will only work in favor of the FairTax in this regard. There is virtually no interpretation with the propsed system so there is no avenue for avoidance or evasion if you are a company that depends on a good reputation. If a company wanted to be a total outlaw, evasion to some extent would be possible. But it wouldn’t be long lived and couldn’t reach a very high volume so, logically, in aggregate it couldn’t amount to a significant part of the economy.
Take Walmart, for example. How much avoidance is going on there now and how much would there be with FairTax? From their $35 billion in retail sales comes personal income tax, corporate tax and sales tax, among others. Of those three taxes, which ones are being actively avoided and which aren’t? In relative terms, the sales tax is pretty hard to avoid.
Regarding the idea that “...the FairTax will be a voluntary tax, which folks can choose to pay or not pay depending on their spending habits...”, it should be pointed out that income tax is every bit as voluntary depending on how much one chooses to earn.
Fred: Regarding the selling of a used item to the supplier of a new installed component that then sells whole assembly back as used - It seems to me that a well written sentence or two of clarification in the legislation could shut that down pretty quick. But it is a good point, except for the house example. It seems like the legal costs of the transfers in that situation would approach if not exceed the tax on a new roof.
Mark –
First, let me state upfront that I emphatically agree that our current Tax Code is a mess for many of the reasons that FairTaxers espouse. So, I am definitely in favor of tax reform. And, yes, there is much tax evasion and tax avoidance under our current system.
The key point I was trying to make is that under every analysis of the FairTax rate there is the implicit assumption that people will sheepishly continue buying taxable goods and services at the same rate as they currently due and that they won’t take steps to legally avoid paying taxes or illegally evade paying taxes.
I am merely pointing out that there will be a ton of ways — some perfectly legal, others clearly illegal — to avoid paying taxes under the FairTax system, which tax-hating Americans will surely take advantage of. This tax avoidance will require higher tax rates to make up for the lost tax revenue.
Higher tax rates will (a) result in even more tax avoidance, and (b) require the Prebate to be higher, each of which will push the required tax rates even higher.
I believe that it is wholly misleading if not intentionally dishonest for the FairTax proponents to pretend this will not be a problem and does not need to be factored into the tax rate. (I am not accusing anyone on this blog of intentional deception; I am referring to those who are behind the bill and are actively advocating for it for their own purposes.) By ignoring the tax avoidance issue, the FairTax proponents are deliberatly creating a distorted impression in people’s minds as to how high the FairTax will need to be and what the effect of the FairTax will be.
If they would simply acknowledge from time to time that the FairTax rate might, in fact, need to be 50-60% (as most independent studies have concluded) and that many people would, in fact, change their consumption habits or otherwise devise ways to get out of paying the tax, then at least we could have a serious national debate on the issue.
Until then we’ll just have people on one side screaming, “It’ll work! It’ll work! It’ll work!” and people on the other side screaming, ” No, it wont! No, it won’t! No, it won’t.” Since the FairTax proponents have money, organization, and talk-show hosts on their side, I’m sure they will win the shouting match in the short term, though I don’t think that the goal of understanding the pros and cons of the FairTax will be advanced much at all.
Todd - It has often been said that the price of products will remain approximately the same. This is based on the statement that the 22% taxes embedded in current products will be offset by the 23% Fair Tax. It isn’t quite that simple. The 22% is based on all income taxes personal and corporate as well as all payroll taxes. While these taxes will go away under the Fair Tax, business costs will only be reduced by the employer share of payroll taxes (7.65%) and the income tax on businesses. It is assumed that, at least initially, wages wont be reduced to the net wage after today’s withholding. Without that reduced cost of wages, prices will only fall by about 10%. The worker will still get the full benefit. Only it will be split between lower prices and more money in his pocket. After tax prices will probably rise by 15-18%.
Dennis - Why do you expect home prices to fall under the Fair Tax? In fact after the fair tax is added, new home prices will probably rise 15%. Only a slowing economy or an anomaly in the market will cause prices to fall. For example in Arizona, home prices were rising rapidly because of the demand from the growing population. Speculators started buying the new homes and flipping them without ever moving in. That looked like a good way to make easy money and other speculators tried it. Eventually demand slowed and the speculators tried to get out. This dumped more homes on the market and prices have fallen in some areas.
I believe that the Fair Tax caused increase in the cost of new homes will result in used home prices rising by 15%. The perceived value difference between new and used will be maintained. The tax can be avoided by buying used. But this will soon result in more buyers for used homes than there are sellers. The price will rise accordingly. Only if the population stops increasing and people stop wanting homes, will prices fall. Of course a failing economy could leave people without the money to buy homes which would put downward pressure on prices.
Lower interest rates and being able to save for a downpayment before taxes are taken out will make it easier for the home buyer to afford a house. People buy big ticket items like houses based on affordability of the payments. The Fair Tax will help not hurt the home building industry.
Hayden - How about solving this “he said-she said” dilema by outlining ways the Fair Tax could be evaded or avoided. Then others can explain how it would be stopped. It is easy to make this sound like a big problem without being specific and with no quantifying how much it will cost the tax collector. Remember, that 85% of all retail sales go through large businesses. What percent of the Fair Tax will come from services vs products?
Marvin –
We seem to have come full circle. See my post No. 2 above.
Marvin,
You suggest that the FairTax would increase the cost of new homes, and it would. But the way most people think about buying a house makes that slightly deceptive. Most people when they go to buy a $200k house, think they are spending $200k on the house, and so when you tell them that a new house will be subject to the FairTax think they will pay FairTax on the $200k. The truth is, that $200k you think of as the price of your house is actually the price of the land plus the house. All land is definitionally used. So if you buy a $100k lot and pay $100k to a builder to build you a home, only the $100k you pay to the builder is subject to the FairTax.
Quarupole –
If that’s true, that land would not be taxed when purchased with a new house (which, I agree, is probably correct), then that is another error in the calculation of the 23% rate.
The FairTax calculations include the price of new homes in the tax base. They do not subtract the land value from the tax base. Thus, the purported tax base is artificially increased by land values.
Now, this is admittedly a small portion of the purported tax base (the projected new home purchases for 2007 total 345 billion), but its one more example of where they over-state the tax base. (Incidentally, I notice that real estate broker commissions are also included in the tax base — 121 billion. That means that the FairTax will be added on to broker’s commissions (as well as to mortgage payments). All of which will further drive up the cost of new homes under the FairTax. No wonder realtors aren’t too fond of the idea.
Hayden,
All the revenue neutrality figures I’ve seen for the FairTax have subtracted the implicit rent from the NIPA tables and added in the value of new housing construction. That housing construction number does not include the value of the land, just the housing construction.
As to taxing brokers commissions, of course. Your broker is providing you a service. Just like any other service, that service is taxed. The brokers commission is what you are paying them for that service.
As to mortgage payments, they are not FairTaxed. ( I am presuming you were refering to mortgage payments themselves, not the possibility of having to borrow to pay the FairTax on new construction, nor rolling in the FairTaxing of implicit financial services).
I don’t think the brokers will be crying when the dust settles. If you are a prosperous broker making $100k a year you are looking at 15% self employment tax off the top. Given that you are into the 33% tax bracket at that point, would you rather pay 48% of your commission under the current system, or 23% under the FairTax?
Even looking at it statically (ie, no assumption of embedded taxes going away on things the broker purchases), if that broker charges you the same $1 in commission under both systems, under the current system he gets to go spend $0.52 of it, for which he gets $0.52 of value. Under the FairTax he gets to go spend $0.77 of it, for which he gets $0.59 of value.
Quadrupole - Interesting thought on the price of land not being taxable because it is used and will be owned by someone on the date the Fair Tax becomes effective. In Arizona, that could be the state as they are still holding huge amounts of undeveloped land. I have not seen this addressed anywhere before. None of the economist articles that I have read mention this. I haven’t seen this in reading the Fair Tax bill. Is it just not mentioned anywhere in HR 25?
If land is excluded, would it reduce the taxable value of a new house by 25%? How would that amount be determined; appraisal value? A used house is purchased and torn down to build a new house; what is the taxable amount on the new house? What about improvements done to the land such as sewer, water, streets, utilties, etc that are included in the price of the lot you bought. If these were added before Fair Tax day, they would be tax exempt. If added after, they would be subject to the tax. As quoted above total new home sales in the tax base is $345 billion. 1/4 of that would be $85 billion. Fair Tax about $25 billion.
But would this be like transition inventory and only be exempt if sold within two years after Fair Tax enactment? Interesting issues that need to be clarified. Not a deal breaker but would increase the Fair Tax rate by 1/4 of 1 % if land is exempt.
Marvin,
As I noted above, the estimates of the tax rate have *never* included the value of land changing hands. They have always just been about the value of residential *construction*, so the Fairtax rate need not change.
As to how the land/house split is worked out, that would depend. In many, many instances people purchase lots for new construction and then hire a builder. It’s pretty easy in this case, because the consumer pays the builder for the construction service in a really straight forward manner.
The teardown case is interesting, but also straight forward. You have a house (with the land), you go to tear it down and build a new house. The construction of the new house is a sale to you of new goods and services, and so the whole construction cost is taxed. In effect buying a used house, tearing it down, and building a new house is the same in tax consequence as buying a lot and building a new house.
The interesting cases are things like spec houses. Say a builder buys a lot and builds a house with the intention of selling it. He’s in business as a builder, and thus does not pay FairTax on his building costs. Then he sells you the house (with the land) for a single price. At *that* point the FairTax would have to be applied to the house. I presume this would be resolved by appraisal.
Another interesting case, which is the same in practice as the spec house, is the conversion of new rental constrution to individual residence. Say I build a house as part of a real estate rental business. I pay no FairTax on my construction costs, because it is a business expense related to the business of renting the house. I rent the house out for 5 years. I collect FairTax on the rent I receive for the house. At the end of 5 years, I sell it to a nice couple. Since the house has never been FairTaxed, it is at that point of sale. It’s the same as the spec case in practice, because it would have to be resolved by appraisal. It’s interesting because there is such a large time delta between when it is built and when it is sold at retail.
LOL... it just occured to me that there is one case were one might make an argument to FairTax land: creating new land by landfill into bodies of water. This is less common these days, but used to be done all the time in NJ.
My concern isn’t as much the blackmarket type transactions as it is the possibility of an explosion of businesses like Play It Again Sports, Kid’s Clothes Re-Salers, etc. These are For Profit companies and some of them already have national store chains with taxes the way they are. It would seem to me that it would become a Very lucrative type business model with a built in 23% advantage over “New” items.
Like I’ve said, I’m fairly new to this concept, but I’m absolutely behind it 100% and we MUST get away from a system that taxes Income - because that’s in essence slavery. But if there are holes in the plan people will try to manipulate the system causing changes, etc. and then we head right back down the slippery slope.
Why would you find the explosion of business selling used items to be a problem?
One of the core principles (in fact listed in the bill as the principle of interpretation) is that the FairTax taxes all new goods and services exactly *once*. Used items are items that have already been taxed, either when new (if sold new after the FairTax comes into effect) or through embedded taxes (if sold before the FairTax comes into effect).
I actually see the encouragement of the efficient reuse of used items as a benefit of the FairTax.
The concept of people buying mostly used items to avoid the Fair Tax is just not realistic. People buy new over used now for the percieved value that new is better than used. Most people buy a new car long before the old one is worn out when they can afford it. People will be able to afford the new because they will have just as much money as they do today.
Used items will be in short supply, if everyone wants the old. The price of used will rise until the difference is narrowed to the point where people will choose new. I think people need to examine why people don’t save more money today by keeping the old.
Thanks for the explanation of what should be fairly obvious to me, I’m trying to get my mind into the mode of thinking how things would work when this becomes a reality. It seems to me that for lower income individuals this would be a true benefit to them and should possibly be used as a selling point for them to buy into this system. No matter how much prices on used goods would rise due to demand they should always be 23% cheaper (if purchasers are smart) than buying new, so those who would receive a Pre-bate and use it wisely buying used goods, in my estimation would see a tremendous benefit under this system.
Dennis - There is a difference in price between new and used today. That difference is established by the market place. This perceived difference in value will be maintained but not necessarily at 23%. Certainly not at 23% plus the difference between new and used today. More people bidding for the used items will cause the price to rise because there is a limited supply of used.
The price of used items will increase based on demand. In effect, this means that some of the Fair Tax is shifted to the buyer of the used item. It wont be as easy to escape the Fair Tax as some think it will.
Let me try to reinforce some excellent comments made by Marvin. It appears that we need to discuss what I would call the “embedded costs of the Fairtax”! Yep, similar to the embedded costs of the income tax (22% on average according to Jorgenson’s study), there is going to be a 31% cost (according to the Kotlikoff/BHI study), embedded in the price of goods and services under the Fairtax. What that means is that if you buy a “used” good, (Fairtax previously paid), the price you pay will include a portion of the original sales tax. No, none of the used sales price money will be sent off to Washington as tax revenue, but you will be helping the original owner offset the national sales taxes he paid. The cost/value relationship existing today between new and used goods will not change one cent under the Fairtax. That relationship is strictly market driven. So, go ahead and buy used goods if you wish, but you won’t be saving any more money than you save today under the income tax.
While we’re at it, I’d like to mention (again) that the opportunities for tax avoidance by buying “used”under the Fairtax are fairly limited. Over half of the US economy consists of services and there are no “used” services. There are no “used” housing rentals, no “used” groceries or restaurant meals, no “used” gasolene for your car, etc. etc. Take a good look at your family budget and see just what you might spend on used goods. And then remember, by buying used, you will still be helping pay for the original sales tax (the embedded Fairtax) and you won’t be saving any additional money over what you might save today. If you want to purchase your underwear at Goodwill in order to claim that you paid no direct tax to the Federal government, be my guest, but it makes no added economic sense to do so!
Hank, you lost me on the “embedded Fairtax”. If the tax was already paid when it was originally purchased and there’s no tax on the sale at “Goodwill” then the tax is gone and no longer in the item, especially on a donated item, to a place that puts it up for re-sale.
I’m not trying to be some advocate for Tax Avoidance, I’m trying to see the possibilities that this could help those trying to get ahead. I was in the position a few years ago where I had to make it on a VERY limited budget, and although never had to purchase “my underwear at Goodwill”, it was helpful (with 5 children) to have access to the option of massively discounted items when necessary, for things that we might need.
I live in Charleston, SC and have a brother In-Law who owns a VERY successful business in Ohio and does very well financially. He went into a store looking for a pair of swimming shorts, being the penny pincher that he is, when he saw the $60.00 price tag he left without purchasing. On a whim his wife suggested stopping at a Goodwill they saw on the way back to their Condo. At that Goodwill they found the EXACT same pair of BRAND NEW (the tag still on) , $60.00 shorts for sale for $3.00. These shorts were probably purchased (Fair Tax paid and Gone), but never worn and then donated to Good Will. This was not an isolated incident, my family was able to do the same thing with clothing for our daughters when we were struggling. Granted, Goodwill may raise their prices some due to demand, but not to a level where it’s still not a tremendous bargain. That’s were I see it helping someone who is Lower Income and get’s a Pre-bate. Having been there before, I know I could budget my non-discretionary money well enough to be able to purchase items that are bargain priced and don’t have the 23% tax (not to avoid taxes, but to save money). I thought this was the whole idea behind making lower income people basically Tax Exempt? And if people are ignorant enough to purchase Used items at less than 23% differance of a New item, then we are really in a Common Sense depression in this country.
I’m past the point of thinking that this will be some huge industry of selling used items that will put a drag on the amount of taxes collected, but I’m hoping that the Lower Income (Democrat Voting) people will see way’s that this plan may benefit and not hurt them.
It’s going to be hard enough to explain to Low Income People the current embedded tax theory, and the New tax on Food and Services that they currently don’t pay. It’s going to be much easier for detractors to cut the plan down if we don’t find simple explanations for how the plan will either benefit .....or at least not hurt....the lower income people in the country. And what’s the percentage, something like 52% of the country currently don’t pay taxes? We have to get some of those to support the plan if we’re going to change anything.
Dennis, thanks for your thoughtful comments. It seems that this is one of the very few websites where folks can disagree without being disagreeable.
I understand you to believe that once the Fairtax is paid, it’s never a factor again. I disagree and here’s why. Let’s use a new car as an example under current tax law. Let’s also agree that a new car loses 20% of it’s value for the first year the day it get’s driven off the lot by the new owner. So, when it’s time to resell, the owner expects a 20% loss, and the used car buyer is satisfied with the used car price–everyone is happy.
Now, under the Fairtax, not only is that new car going to cost 18% more (after tax), but you suggest that when the car get’s resold as used, the 31% sales tax will not be considered when setting the used car price. Doesn’t that mean that instead of losing 20% on a new car resale, you expect the owner to suffer a 50% loss in year one? Again, referring to the sales receipt as outlined in HR25, you think the used car price will be figured off of line one on the receipt (the pretax cost), while I expect the used price to be calculated from line three (the after tax price).
Turns out it probably isn’t possible to say who is right or wrong at this point. But if you are right, here are some possibly adverse consequenses. (1) Many buyers of new cars who understand they are going to lose 20% today for the privilege of driving a new car may balk at the idea of losing 50% for the same privilege. (2) There will be a rush to buy used cars, and keep them longer. Used car prices will soar. (Auto repair shops should do very well! ) (3) The Fairtax rate would no longer be revenue neutral if the sale of new goods lags as expected.
I stand by my “embedded cost of the Fairtax” concept. It’s too large a number to be ignored.
What Hank is saying seems consistent with one of the points that Kotlikoff makes about the FairTax. That is, upon the enactment of the FairTax there will be an immediate devaluation in the value of accumulate savings. In other words, when the price of goods and services increase, the value of your savings immediately decrease.
Kotlikoff has stated that he believes the decrease will equal the tax-exclusive rate of the FairTax (i.e., in his view, 30%). So if you have retired with a $1 million nest-egg, that nest egg won’t buy what it used to since everything will have increased in price by 30%. (Obviously, those of us on this blog disagree on the amount that prices will rise. Hank say 20%, others less. I say it will be much higher. But the concept is the same, the value of accumulated savings will immediately drop.)
Kotlikoff seems to think that would be a good thing because it would be an implicit tax on the wealthy (though I think the wealthy would have plenty of ways to protect their wealth), but it’s certainly not something you hear the FairTax proponents discussing very often.
Hayden - This point needs to be thought through carefully. I don’t think you can make a blanket statement that says savings will be devalued if prices rise. Those who are paying taxes will have that money in pocket. That cash along with the price reductions that will occur and the prebate will exactly offset the Fair Tax. Not necessarily equally for everyone but on average for all individuals. How is this a real price increase? Nominal prices are higher but you have more money in your pocket. This is just collecting the same amount of tax at the end of the equation instead of in the middle. A-B-C=D is the same as A-C-B=D.
IRA’s and other deferred savings will be worth more because there will be no incme tax to pay. Real estate will be worth more because of the price rise you noted. In the end this doesn’t fit the discription of inflation. It is a one time adjustment to the numbers. Stocks will be worth more as the economy grows.
Cash on hand may have a reduced value. Fixed pensions may have a reduced value. Wont Social security increase by the automatic COLA built into the formula?
One of the problems with understanding the Fair Tax is that most of us take one small piece of information and assume that it covers the total picture. When in fact, it relates only to the bit examined and doesn’t consider the other side of the equation. Sort of like sitting on a jury and only hearing one side of the case. Most of us would have to rule on the arguments that were presented.
The Fair Tax will have a huge impact; mostly positive but may negatively impact some individuals. The overall impact will be strongly favorable in my opinion.
Hank,
We probably will disagree on this point, but I don’t see how it’s possible to incorporate a Visible Sales Tax into the value of an item. I think most people’s view on the value of an item is it’s Listed Price when purchased. When I buy a wrench at Home Depot for $15.00 (Listed Price) the value to me is $15.00 I don’t consider the 6.5% Visible Sales tax as part of the value of the tool. If after I use the tool for some time I want to sell, I would base my selling price on the $15.00 value of the tool minus wear & tear. After thinking this through out loud, I may change my thinking when the total cost of the tool is $18.75 vs. $15.97, but I think it would still be a paradigm shift for alot of people to go from using the Sticker/Shelf price as the valuation base, to using the last line of a reciept.
I also have to say that I Whole Heartedly agree with Marvin that although there may be some adjustment period to the new system and maybe some disadvantage to a few in areas where there weren’t before, this is by far a better solution than the current enslavement that we serve under. To place a Tax on someone’s basic human right to be compensated for their labor is just abhorrent and a complete disgrace to those who’ve given their lives for the Freedom’s that this country was founded on.
The KEY for those that are adversely affected by this plan and don’t have a Socialistic or Communistic view of how things should work, will be that once this plan is implemented they work together with the rest of us who believe the government shouldn’t be spending so much and get them to trim back the expenses, therefore reducing any hardship that might be caused by the change in system.
Dennis, you are correct in that, in my case, I wouldn’t include the Florida 6% sales tax as part of the “price” I paid for an item. However, forgetting for the moment your $15 Home Depot wrench, let’s talk about my new car that costs the dealer $20,000 (line 1), and which has a 30% tax of $6,000 (Line 2), for a total price (line 3) of $26,000. Assuming that the current premium for new versus one year old used cars is roughly 20% (pick your own number), do you really expect me to take a $10,000 bath (rather than $4,000)on the resale? That’s a 50% loss. I don’t think so! But, only time and the market place will sort this one out. But if you are right and there is no paradigm shift, then I’ll drive that car for ten years rather than buying a new one each year. And if that’s typical of John Q. Public, there goes the Fairtax 23% inclusive rate–it wouldn’t be revenue neutral anymore.
As for the remainder of your comments, I don’t think I’m a Socialist or Communist–just a frustrated Republican who has been paying income taxes for 55 years. The founders of our great country had no objection to a direct tax on labor- they just wanted the tab to be apportioned state by state according to a periodic census. And the 16th Amendment simply removed that restriction.
You may demagogue the IRS/IRC if you wish, but as a senior retiree, my effective federal tax rate is around 10%. As Dr. Walter Williams once wrote “if 10% is good enough for the Baptist church, then 10% ought to be good enough for the US Congress”! I agree!
But you are entirely correct that the real problem facing the country is how to reduce the size and cost of government. There is a train wreck coming, probably in my lifetime, and the focus ought to be on downsizing. In my opinion, it doesn’t make a bit of difference how revenue is extracted, just how and how much is spent.
Dennis –
I am sure we all agree that government spending is a huge problem. Unfortunately, given the make-up of government spending, the only real solutions to spending would be to either cut back on our military spending or kick our friend Hank off the Social Security/Medicare gravy train. Either one of these solutions appear to be politically impossible, or they would have been done long ago.
Im’ afraid I disagree with your assertion that it is “abhorrent” to “place a Tax on someone’s basic human right to be compensated for their labor.” I’m not exactly crazy about the income tax, but wouldn’t it be even more abhorrent to force a person to pay a tax on top of the cost of his or her cancer treatment? Health insurance? Heating oil? Food? All of which would be taxed under the FairTax. The whole concept of taxing consumption strikes me as being Marie Antoinette-ish. (Yes, the FairTax would have a pre-bate to supposedly ease the burden on the poor, but our current income tax system has exemptions, credits and deductions for the same reason.)
Even if the government gets its spending under control, tax revenue will need to come from somewhere, and somebody is always going to complain about how the tax is determined. Personally, I think the fairest tax would be to have an annual tax on wealth rather than taxing income or consumption, but for a number of reasons that won’t happen. The estate tax is, of course, a tax on accumulated wealth and look at the efforts to get rid of it. So, at least for the forseeable future, we will be forced to rely primarily on the taxation of either income or consumption to fund the government, and, of the two choinces, I continue to believe it is much fairer to levy taxes based on income.
Hank,
I respect your knowledge and wisdom, being of younger generation, I will respectfully listen to anything that you would have to say and take it into consideration. It seems we agree on a major problem in the country today, the size of the government. But, there’s no way I will ever believe that the founding fathers gave thier lives to unfettering themselves from an oppressive government, just to turn around and imagine a system that was even more oppressive. Your Tax rate may only be 10%, but there are many who aren’t that lucky, and most of those who pay much more than that are acheivers, driven to success and betterment for themselves, the country, and the people around them (I’m not saying that your aren’t or weren’t). The current system penalizes their Labor ...under penalty of imprisonment...which is in effect Slavery. We are heading for a definite train wreck and it WILL happen in my life, and will affect myself, my wife, and my 5 children for the rest of thiers.
Under the current system we have NO control and could be taxed at 100% if “they” chose to, again under penalty of imprisonment. This would be absolute undeniable Slavery. The only difference between the current and what could be ...is the percentage of Slavery. How is it right, under the current system for me to work 70 or 80 hours a week to earn a good living, to then have to turn around and under threat from the government (who’s supposed to be working for me) have to give my Compensation for LABOR to them to re-distribute as they see fit. At least with the Fair Tax, I have the choice to pay the tax where and when I see fit, and EVERYONE pays the same amount, with the exception of those living in poverty. There will still be re-distribution of funds but at least we take back some control and dispense with alot of the Tax lobbying that gives some an unfair advantage over others.
Once we have put some of the control back into the hands of the people, we will have much more power to reign in the governments wild spending habits, much of which is spent on those same Tax Break lobbying hacks that are now employed in Washington.
[...] In the discussion for the post “Would the Underground Economy Be a Problem?” FairTax critic Hayden Kepner concluded his comments with: So, at least for the forseeable future, we will be forced to rely primarily on the taxation of either income or consumption to fund the government, and, of the two choinces, I continue to believe it is much fairer to levy taxes based on income. [...]
Hayden,
If savings are immediately devalued under the FairTax, they are also bolstered by the ability to earn TAX-FREE interest.
Dale,
If you still believe that investment interest as well as interest on debt is not taxed under HR25, you weren’t paying attention when James put Section 801-806 up for discussion. There will be an implicit tax on the interest differential, when compared to the appropriate Treasury base rate, on both investment and debt instruments. It seems that the interest differential is viewed as a service and taxed accordingly. My assessment is that this implicit tax will hit hardest at credit card debt, but who knows? Time will tell.
Hank
Do you have data to quantify the total amount of Fair tax from various types of loans and investments? What is the government base rate? Is it the FED discount rate or the rate paid on 10 year government bonds? If the base rate is low, there would be less tax on savings; If it is higher there would be less tax on debt.
It seems this suggests the tax would be 30% of the interest rate paid times the balance of the loan/investment divided by 12 to get monthly amount. On a $200,000 mortgage at 6% with a base government rate of 4%, the monthly tax would be $100. But, some economists claim that interest rates will fall by 25%. That would drop the 6% rate to 4.5%. Would the rate difference be only 1/2 of 1 percent. That would eliminate most of the tax. On a credit card charging 18% interest, each $1,000 balance would yield a tax of (1,000 X .14 X .30 divided by 12) $3.50. Is that going to disuade people from running a credit card balance?
We need to have a better understanding of this area before we can make an assessment of what it means in the real world.
Marvin,
The only real data I can find is in the Kotlikoff/BHI study from last September. Their consumption base includes a $128 billion implicit tax from mortgages and a $154 billion implicit tax from individual credit card debt. There is no sign of implicit taxes on investments in the base, although the legislation requires one.
There are three base rates: short term-3years or less; mid-term- 3 to 9 years; and long term- more than 9 years.
I think the tax is calculated using the inclusive 23% rate, not 30%.
I certainly agree that this area is not well explained or understood. What it means in the real world, to me, is that AFFT and other advocates have glossed over the impact of this section and published faulty statements that “investments won’t be taxed under the Fairtax”. Disappointing!
“It seems that the interest differential is viewed as a service and taxed accordingly.”
Yes. It is taxed because it is an implied fee. But interest above the fed rate would be untaxed.
On an interest-bearing debt, the interest above the fed rate would be taxed.
“On an interest-bearing debt, the interest above the fed rate would be taxed.”
I was refering to the interest income of a savings account, not interest expense of a debt. Taxing interest expense is a good thing to me because it discourages debt.
Should A New COLA be published every 4 years for every voting district in America? If we have these figures, then the FairTax or
major tax reform will become an interest to America.
The Reasoning I believe is as follows:
Voters making less than $40,000 yearly which I believe all Americans can live with, would like to pay a 10% FairTax. This means after saving 20%, they would be able to afford living with $32,000 a year.
How much more would the prebate need to be so that those making more than $80,000 a year would be able to pay closer to the full 23% or 30% tax rate in order to support negative income earnings given
to most Americans needing twice the level of poverty to raise a family?
Before you answer, please give all new to economics a refresher course.
How much does the federal, state and local government need to maintain its level of spending so its citizens will be able to enjoy their community?
We thank the rich for their patonage to help the homeless and destitude. No American wishes anything bad to happen to our nation and jobs created by tax emempt low interest loans is a good solution.
FairTaxing simplifies but it is not perfected enough to win back our freedom to become healthier and wiser for those making less than $35,000 a year today.
I do not want to borrow money to survive. I will retire in 20 years. I would like to have a home paid in full for myself and my best friend.
The FairTax is what our big government needs yearly. It would be
collecting this tax from all living above the poverty line.
If our tax dollar continues to erode, no tax system is fair. We have to
make consumption durable and rewarding to those working at jobs that are less than double the cost of living.
What will our economy collect in taxes then and how much will
I need to live a good life during retirement assuming that housing or
rent would be 40% of my cost of living.
Let’s project a FairTax rate for 2027 allowing for inflation at a rate that
would be .25%.
I am not an economist, but I believe that if we can limit government
spending over the next 20 years while paying off the deficit, the
FairTax would work for those who have paid into the system for
the past 50 years.
Show me my future FairTax rate assuming that I am part of the voting public that makes less than $50,000 a year today and would like to assume that our paycheck will grow .50% annually doing the same job year after year. (Note: I work the perfect job and I have been able to keep it for 17 years. I have the ability to work doing skills picked up to make $50,000 to $100,000 a year but transitioning careers costs no less than $20,000 of which I do not have this money to make this move happen.
I would rather exempt myself from paying any income tax today working for myself lose my skilled job to those flooding our borders learning my job for half the price.
Show America that the average worker will be able to save money over the next 20 years to afford a house paid for with a 20% down payment while paying no more than 40% of their take home pay for
rent and I will want to rent to own any available 1400 sq ft home anywhere for a fair 45% of my gross monthly pay.
Show those wealthy investors in companys who hire 50,000 workers or more that paying these workers overtime a Fair paycheck will boost our economy with the FairTax because more families will be able to
afford better housing, education and jobs for our wealthier families needing good medical and services.
Sorry for the desertation. You do not need to post all of this but
please feel free to post anything you believe might help America wake up and get rid of income taxation.
I do not want to be audited for not paying income taxes. I would like to pay a fair and flat 10% tax too. But for now, I just need to pay off high interest credit card debt on loans that I created for the purpose of career changing into selling real estate last year. (Bad move on my part, right?)
James Russell
JGR Real Estate, LLC
I think it is possible that the AFFT is underestimating the impact of the underground economy. The size of it has been estimated at between $1 trillion and $3 trillion. I saw a cite which said we could have surpluses if we could tax the underground economy.