On Taxing Government Expenditures - Part II
Hank van Geison sends this new thread-starter on the topic of “On Taxing Government Expenditures.”
By way of review on this thread’s subject, here is what I think we are more or less agreed on if the Fairtax replaces the income tax.
(1) employees will receive their gross pay, (less state/local taxes,etc.)
(2) pre tax business costs will fall by 10%, including a generous estimate of business compliance costs.
(3) After tax prices will rise by 17%, or higher depending upon how the business cost savings are utilized.
(4) The Fairtax exclusive rate is 30%,
In order to determine the costs to governments of the Fairtax, the following assumptions are suggested, and are lifted from the Kotlikoff/BHI base and rate study, September 2006:
(1) Government taxable consumption for 2007 is $1.093 trillion for state and local governments and $916 billion for the federal government.
(2) Wages (payroll) comprises 32% of federal consumption and 41% of state/local consumption.
(3) Non-wage purchases are therefore 68% and 59% respectively.
In addition, using the HR25 definitions, HR25, Section 703, taxes the burdened cost of salaries and wages. It is assumed that the burdened cost of government salaries/wages is 150% of the basic payroll cost.
The increased cost for non-wage purchases is ($1093 x .59 x .17) =$109.6B for state/local, and ($916 x .68 x .17) = $105.8B for federal, assuming the 17% price increase.
The increased cost of burdened wages is ( $1093B x .41 x 1.5 x .3 -(1093 x .41 x .0765) = $167.4B for state/local, and ($916 x .32 x 1.5 x .3 - (916 x .32 x .0765) = $109.5B for federal.
Total increased costs are $277B for state/local governments, and $215.3B for federal. Note: The payroll estimates include a 7.65% FICA tax offset, which is the only cost reduction available to governments.
State and local cost increases due to the federal sales tax will require a 25% increase in state/local taxes, or a similar reduction in state/local services.
The increased federal costs are not paid for, but should require an increase in the Fairtax rate to cover the added federal tax costs.
This simple analysis does not take into account any dynamic changes in the national economy, but is just a static look at what would have happened in 2007 with no changes to any other economic factors.
Comments, please.
Hank, #2 is an inclusive figure and #3 is an exclusive one... correct? In the second to last paragraph.. “but should require an increase in the FairTax rate to cover the added federal tax costs.” I think this should say “tax” instead of “FairTax” unless your talking about them adopting the FairTax for income. Is this analysis meaning to determine an average state expenditure increase, and thus determine approximately how much a state / local government would need to raise tax rates?
On a side note, perhaps a new topic, what evidence do we have that the FairTax would be implemented exclusively? Linder and Boortz are saying it will be implemented inclusively. All other U.S. federal taxes are inclusive. European national sales taxes (VAT) are inclusive. Why would any federal legislator want to give the perception (real or not) of a higher rate? Just seems we instantly make this assumption that it is presented as inclusive but will be implemented exclusively.
Morphh, Section 510 of the bill states “For each purchase of taxable property or services for which a tax is imposed by section 101, the seller shall charge the tax imposed by section 101 separately from the purchase.”
If the FairTax wasn’t exclusive, state and local sales taxes would be applied to the FairTax.
Also, not all federal taxes are inclusive. Gift taxes are exclusive as is the employer portion of payroll taxes.
Morphh,
Glad to get a comment or two. In rereading the original post, I didn’t do a good job of explaining the purpose. You figured it out, I’m trying to get general agreement about the amount the federal sales tax will add to state and local spending (if any), which will then allow an understanding of how large an increase in state and local taxes would be needed, or, the magnitude of any decrease in state and local services, the two choices that seem to be available?
Yes, the percent in #1 is inclusive and in #2 exclusive. It seems to me that is how a retailer will figure out his after tax prices. First, he will determine what cost reductions he might be able or willing to make, and that number is an inclusive percent. If current costs are 100, and he reduces costs 10%, the new cost is obviously 90. Now, he adds the exclusive Fairtax rate of 30% and gets his new price of 117. I wouldn’t know how else a retailer could do the calculations?
As for the next to last paragraph, we are talking about the federal government here, and it is the Fairtax rate that needs to be raised to account for the increase in Federal costs. Everyone tends to let this one slide, but until I see an explanation of how a government can tax itself into prosperity, I will continue to believe that something isn’t right about the rate. This shifting money from one pocket to the other doesn’t wash with me. Someone has to pay the added costs! And I suspect it is us?
The evidence I have that favors implementing the Fairtax in exclusive terms is more common sense than anything else. First, HR25 is a piece of sales tax legislation and 300 million Americans understand sales taxes in exclusive terms. Next, the rationale for inclusive rates does not stand up under inspection That rationale–wanting to be able to compare the Fairtax to the income tax—falls apart when you ask the follow on question: “What do you compare the 23% Fairtax rate to?” There is no way to make a useful comparison without calculating effective tax rates for both. (I’m just speculating, but when I explained the Fairtax to my 45 year old son, his first reaction was “Great, I’m in the 28% income tax bracket, and 23% sounds a whole lot better”. Is that the hoped for reaction? I certainly hope not!
Now, how about the retailers? The 20 million retail businesses have absolutely no use for an inclusive tax rate. As mentioned earlier, when the retailer adds the tax, that tax would be 29.87012%. Why not simply call it 30% and ease the complexity?
I don’t agree that our federal legislators would try to cover up or obfuscate the real sales tax rate as understood by everyone. Every state and locality uses basically an exclusive rate, so why not the Federal government. Think about that sales tax receipt that is supposed to provide so much transparency. Even though the merchant used 29.87012% to figure the price, that percent never appears on the receipt. And just where will the state and local exclusive tax appear on that receipt? Try to explain that mess to your customers.
Morphh, there is no longer a need for the convoluted legislative language that reads”23% of the gross payments for the taxable property or services”. You can’t determine the gross payment without using the exclusive tax rate, so what is the inclusive thing all about? I’m left with the simple explanation that 23% sounds better than 30%. And that’s OK with me if only Fairtaxers would say “23% of every dollar spent”. That is also a true statement, but when you say “a 23% sales tax”, the mystery begins, IMHO.
The real rate is 30% and I would give you odds that the first thing the W&M Revenue subcommittee staff will change is the rate definition. Inclusive has no place in a piece of sales tax legislation.
You can’t determine the gross payment without using the exclusive tax rate, so what is the inclusive thing all about?
Actually, Hank, you can - but it’s far from practical! You just need to realize that the FairTax rate is applied to the tax. So basically it taxes itself.
So for a $100 tax exclusive purchase:
$100 x 23% = $23
$23 x 23% = $5.29
$5.29 x 23% = $1.22
$1.22 x 23% = $0.28
$0.28 x 23% = $0.06
$0.06 x 23% = $0.01
$23 + $5.29 + $1.22 + $0.28 + $0.06 + $0.01 = $29.86
[Or you could just multiply $100 by 29.87%]
Fred,
Now that really is “out of the box” thinking. You must be a math major? I’d like to suggest you put that one back in the box. As you said, no practical value. However, I am learning not to make such positive statements–never say never??
Great to see the input and thought process on the subject. I’m still not clear if anyone thinks taxing the states and locals is either a good idea, or is a politically practical venture.
For me, I view it as a fantasy because it will never happen, as explained in Part I. So, shall we add 3% (the amount proposed by kublikhan in Part I, post # 13) to the much-touted 23% inclusive FairTax sales/consumption tax rate? I’ll let you more knowledgeable participants determine the exclusive rate, or present your own figures as to the perceived worth of applying the tax to states and locals.
At any rate, 3% sounds about right, so we’re up to at least a 26% rate, are we not?
If you all will indulge me a bit further - Let me bring up the subject of “households employing domestic servants”, its connection to government being the only other entity defined in the bill as a “taxable employer”.
I understand the reasoning for including this in the bill because the “servants” certainly will not collect taxes and remit them for their services, but does anyone really believe that those employing them will remit taxes to the government? These are two-person arrangements with very little, or no record keeping. I propose that compliance will be virtually non-existent - About as much chance as the drug dealer on the corner reporting his sales!
How would the government enforce compliance? Do we propose that the federal revenue agency will send undercover agents out into our communities posing as maids, butlers, gardeners, handymen and pool boys in order to identify and punish these scofflaws? I believe that attempted enforcement of this provision would cost the government much more than it could ever collect.
If this provision is another fantasy, as I believe the taxing of state and locals is, does anyone know what value has been assigned to this provision?
Regards,
John
Fred, if we continue reading section 501 bullet 4 reads “the tax rate (the amount of tax paid (per paragraph (2)) divided by the property or service price inclusive of tax (per paragraph (3));” We’re talking about how the receipt should read. List the item cots, the total, the tax cost with the percentage listed based on the total. It will be listed on the receipt as an inclusive tax per the legislation. Also having the state tax applied on top of the FairTax is one of the solutions offered by BHI to address the additional revenue needed to pay the FairTax. Another would be to conform to the base and add a few % points. I don’t want to get bogged down into which way is right or wrong. Hank, I see it as correct for your son to compare the marginal rate of income tax (though have him add in payroll taxes too) to the marginal rate of the FairTax (inclusive). Although effective rates are a much better reference. That is the purpose of presenting it inclusively - right or wrong as it may be. Sorry, didn’t mean to get us off topic.... back to the real post.
Hank, were do you get that Federal costs are not paid for? I agree that this was true in the early studies (referred to as “the mistake”) but the most recent rate studies by Gale and BHI account for the additional spending required for the federal government to pay taxes to itself. I agree that increased state spending is not part of the rate, this is left the the states (I feel like I’m breaking some FairTaxer code by admitting such).
BHI states that any loss to the states is a gain to the people, so the state just needs to maintain real spending. So it wouldn’t be a increase per say but maintaining the same tax burden for state / local services.. so the people would not receive a windfall gain (there, I earn my FairTax card back.. haha). 
John - I agree with some of your points. I prefer a VAT to a sales tax for some of the reasons you stated. There are several things to note with regard to evasion.. I expect it has been discussed here at length. Economic figures show that 47% of all retail sales are made by just 688 businesses (”Big-Box” retailers). 87% of retail sales are made by 193,000 businesses, which is 3.7% of U.S. businesses. So even if we let all those other businesses and domestic servants “off the hook” and focused enforcement on only that 3.7%, we’d still have a much better evasion rate then today (by almost half). When you add in the other factors like reducing the number of tax collection points by 80% (from 145 million to 25 million), reduce the filing complexity to a simplified state sales tax form, the administrative fee for retailers and state, the reward system for turning in tax cheats, etc. - I’m not too worried about it.
Man.. three different discussions going on in that one thread.. too much to think about.
Morphh,
Well, focus on my part of the puzzle for a moment. I can’t see where or how Gale or Kotlikoff accounted for the over $200 billion in net added taxes paid by the federal government? If Kotlikoff had accounted for those costs, the Fairtax rate would have been around 25.9%, not 23.8%. So, why do you believe that the federal government can tax itself, and we, the taxpayers won’t have to pick up the tab? Inquiring minds want to know!
Morphh, I don’t think we’re talking about how the receipt should read - we are talking about shelf/advertised prices. The portion you quote is details about the receipt (BTW, try to imagine the confusing mess receipts would be with the FairTax requirements and state sales taxes listed). Reread the portion I quoted, “For each purchase of taxable property or services for which a tax is imposed by section 101, the seller shall charge the tax imposed by section 101 separately from the purchase.” It clearly states the tax is separate from “the purchase.”
Also, I think BHI suggesting that, to make up for the extra revenue required to pay the FairTax, states could apply their sales taxes to the FairTax (as if that’s not a tax increase) is a non-starter. I don’t think would (or should) happen.
Morph –
Maybe you can understand BHI-speak better than I, but I’m not so sure that the BHI study really addressed the government spending “Mistake” that Gale referred to.
In Gale’s 2005 analysis, he essentially concluded that the taxation of federal government spending did not add any net revue to the government, so he left federal spending out of his equations in determining the required FairTax rate.
In the BHI 2006 analysis, however, BHI seemed to say that they were adopting Gale’s methodology, but then they added the taxation of federal spending in calculating the required rate (which, naturally, brought the rate lower than Gale’s study.) At least that’s what it seemed to me.
Now, I admit that I cannot follow BHI’s analysis, either because I’m too dense or the study was intentionally obtuse, or some combination of the two, so maybe I’m way off base. But it seemed to me that Gale excluded federal government spending and BHI included it.
Please feel free to correct me if I’m wrong or explain my misunderstanding. Believe me, at one time I was pretty good with numbers, but I just can’t follow the BHI stuff.
Hayden, I’ve actually been looking same thing. It’s clear they included federal spending in the base which means to keep real spending level (which they claim they do) they must increase the revenue required. I can’t find where they do this.
Like you, I find the study very hard to follow.
Fred, I know we are talking about the retail shelf prices, which is why I brought up the point that the section you were quoting is discussing the receipt that presents it inclusively. It also requires as you stated that it be listed separate from the price. This says nothing at all on how the retailer is to price it on the shelf. I don’t think the bill addresses this as of now. I’m not trying to make an argument that they would present it this way on the shelf. I was just saying that we don’t know for sure how it will be presented. It could go either way and from what Linder is saying, it is to be included in the price as the retailer sells it, presented on the receipt as a separate item from the tax quoted inclusively. So you have the bill sponsor saying one thing, and we’re assuming another. It’s a good assumption - I don’t argue that but there are reasons as I stated above that it could go the other way.
“The seller shall charge the tax imposed by section 101 separately from the purchase” seem pretty clear to me, but further clarification from the authors (Burton and Mastromarco, I believe) would be helpful. My understanding is that Linder had nothing to do with the development of the legislation so he’s just reading it and interpreting it just like we are.