Does HR 25 Exclude Money as a Commodity?
The letter below is from reader David Wilshin. I’m editing out some of the snarky parts so that his concerns may be addressed by other readers. Depending on his choice of words, he may or may not be allowed to respond in the comments to this post.
I am new to this site and have several critisims of the Fair Tax as written in HR 25. I am therefore going to stir the pot as it were and state emphatically that I believe the FT will actually destroy the our economy if inacted. I shall be specific and would require that those who might respond be specific, factual, and intellectually honest.
HR 25 does NOT exclude money as a commodity, i.e, money is purchased millions of times daily via credit card purchases, loans of all sorts, mortgages, etc. Therefore, whenever ANY purchase is made (new or used goods) and there is any form of a deferred payment method used in that purchase, such as, credit card, zero interest or any interest loan, mortgage, collateralized or non loan, “payday,” “title,” or whatever, and the loan is not paid off in 30 days, the FT will be imposed on the amount of money not paid because each new purchase of money, by definition, is a new purchase and therefore subject to the FT. This flaw in the law will result in huge numbers of personal bankruptcies, the distruction of the home building industry, automotive manufacturing, boat, personal aircraft, mobile home, and banking industries.
Example 1: John purchases a new Ford truck priced at $20,000. The truck is financed by his credit union. He finances or purchases $17,000 in funds to pay the dealer for the truck (15% down payment).
Taxes: FT plus states sales tax (30%) = $6,000; FT on the money purchased (loan) = $3,900. Total due at point of sale - $9,900 plus tag and title. How many John’s will be able to come up with approximately $10,000 to purchase and finance a $20,000 vehicle. To my knowledge, there is no financing entity that will finance a TAX and if they did, that money purchase will also be taxed.
Example 2: William and Judy purchase a used home for $200,000. The lender requires a 10% down payment or $20,000 so that the NEW mortgage or money purchased to finance the home is $180,000.
Taxes: (1) FT is $0 for the home because the home is used. (2) State sales tax = $0. (3) FT (23%) on the money purchase or mortgage = $41,400. The new buyers will therefore have to come up with approximately $61,000 plus closing costs in order to take possession of their home.
Example 3: New home purchase — Pre- FT cost is $369,000. Post FT cost is $300,000.
Robert and Jan purchase a new home for $300,000. The lender requires a 10% down payment or $30,000. They purchase a mortgage of $270,000 from the lender to finance their new home.
Taxes: FT on the new home is $69,000 (23%). State sales tax = $0.
FT on the money purchase or mortgage = $62,100 (23% of $270,000).
How many Robert and Jan’s will there be who can come up with approximately $161,000 plus closing costs to purchase this mid-range new home?? Again, I know of no lender who will finance this TAX.Example 4: Patricia goes to Sears and spends $250 on goods and charges the purchases on her VISA in January. She pays only $50.00 on that charge or bill in February.
Taxes: (1) FT on the goods - included in the sale. (2) State sales tax =
7% of approximately $200 or $14.00. FT on the money purchase of $200 (unpaid VISA balance) = $46.00.
David — As much as I dislike the FairTax, I’m afraid you are only partly right.
Money is no “purchased” in the transactions you desctibe, but it is borrowed. The interest charged for borrowing that money is considered a “service,” and therefore taxable. But not all of the interest is taxable, only the portion above a certain baseline (which I think is the 10-year treasury rate.) And it would not be payable all at once at the time of sale, but would be paid each month as the payments are made.
I don’t have a financial calculator handy, but let’s look at your example of purchasing a $300,000 used home and borrowing $270,000. Let’s say the bank charges you 8% and the 10-yr treasury rate is 5%. For each payment you make, you would be charged a tax on that 3% spread.
So, if your monthly payment is $1000, and $900 of that payment is interest, the “spread” would be $900 x 3/8 = $337.5. At a 30% tax rate, the tax on each payment would be $337.5 x .3 = $101.25. The tax payments would decrease over time because you will eventually pay less interest on your payments (as you pay more principle.) But over 30 years, the tax on the “tax-free” home would probably add up to around $18,000.
Now, the really unfair thing about this is that folks that can afford to pay for their home with all cash, will not need to pay any tax (since they won’t be borrowing any money.) On the other hand, people with bad credit (who tend to be poorer), will pay much higher interest costs, and thus much higher taxes.
Same with car payments and credit card payments. The higher your interest rate, the higher your tax burden.
I don’t see anything less complicated about the FT than the current system.
John H
[Ed: The current tax code is more than 60,000 pages long. The FairTax is 132 pages. The IRS estimates Americans spend 6.6 billion hours per year filling out tax forms—including 1.6 billion hours on the 1040 form alone. In 2002 Americans spent roughly $194 billion dollars on tax compliance. That amounts to 20 cents of compliance cost for every dollar collected by the tax system. Please confine yourself to making constructive remarks or find somewhere else to post! Thanks. –Joshua]
I find myself agreeing with Hayden on both points: one, that David’s entire premise is incorrect, and two, that the taxation of interest by a percentage of the interest above some base rate is contrary to good public policy.
Since one way of looking at taxation of interest is that the tax boosts one’s apparent interest rate by a certain amount, I’d prefer to have that boost capped in some fashion.
The plus side, however, is that down payments would be accumulated through pre-tax dollars, which should make it easier to save up money for a reasonable down payment.
On a side note, I was unable to determine, by reading HR 25, whether the tax due on loan interest payments is due in equal installments over the course of the loan, or is rated in the same proportion as the interest due over time.
It’s important to understand a few things about the application of the FairTax to interest.
First, it’s intended to prevent the shifting of purchase prices into financing. Without it, I could sell you a truck at half price, duck half the FairTax, and make my money through exorbitant interest rates. It’s not about taxing interest, it’s about preventing avoidance of the FairTax through restructuring transactions.
Second, your interest rate is made up of basically three pieces:
1) The fair market interest rate
2) The risk premium
3) Financial intermediation services (ie, excess interest you are charged above the fair market rate plus risk premium).
The FairTax explicitly does not tax 1 and 2. It only taxes 3.
The net result is that in most circumstances, you won’t be paying much FairTax on your interest, and if you are, you might want to consider that you are being ripped off by your lender (ie being charged much more than the fair market rate on the money plus risk premium).
To put things in perspective, the spread between mortgage rates and 10 year treasuries is about 1.5%, some of that is risk premium, but assuming *no* risk premium in there, you’d be looking at a FairTax rate on your loan of 23%*1.5% = 0.345%, or about $931 over the lifetime of a $270,000 loan (worst case scenario). To further put that in perspective it’s about $2.5 per month on average over the life of the loan.
Quad,
I don’t want to do a rerun of our interesting exchange from last April on this subject, but I still may not agree with your calculations.
First of all, isn’t the the tax rate 30%, not the 23% in your example? Just like any retailer, banks would use the exclusive rate to determine price.
Next, here is a quote from HR25
“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.”
I took that to mean that the implicit tax would be calculated and charged each month, or quarter, and is not just a one time charge spread out over the life of the loan? In your example, I would suggest that the implicit cost could be: .015 x .3 x $270000/12 =$101.25 per month. Or is it :.015 x .3 x $270,000/360 = $3.37? Big difference, and I’m obviously confused.
Page 5 of the Kotlikoff/BHI report from September 2006 shows how they calculated implicit taxes. They estimated that the taxable implicit services for just home mortgages and personal credit would be $128B and $155B respectively, and that amount was added to the Fairtax consumption base. That would seem to be an annual calculation?
Not included in their report were the implicit taxes on investments. Here, the “spread” is probably going to be less than for debt instruments. If your investment returns aren’t earning close to the going Treasury rate, why not look elsewhere to minimize your implicit taxes on investments?
quadrapole, The AFT states “The FairTax is not imposed on the risk premium because lenders get a credit equal to the FairTax rate times their bad debts.” But this doesn’t make sense to me. They claim that by giving lenders a credit for their bad debts they aren’t taxing the risk premium but clearly what is going on is that they risk premium is taxed but it is “untaxed” if a loan is defaulted on. So, unless a loan is defaulted on the risk premium is tax. From the consumer’s perspective, the FairTax is charged on the risk premium of every loan they are paying on.
Second, I think your math is bad. Wouldn’t it be 29.87% x 1.5% = 0.448%? And you can just multiply that result by the initial principal to get the total FairTax paid. If this was a typical 30-year loan, the FairTax paid over the life of the loan would be more like $23,000.
Wow! The Fred/Hank “truth detector” squad is out in force! Good to have some allies who can actually do math!
So, the bottom line is, the FairTax does tax the risk premium of those who actually pay their debts. And if your struck with a high interest rate — tough!
Fred, you are correct about the calculations (I should not calculate while sleepy).
Look at it this way. Lending is a *very* competitive field, and *most* of the time the market has a pretty good handle on the risk premium (current subprime insanity aside). I would imagine that competition would drive most lenders to discount the rate being offered by the amount of FairTax that would be paid on the risk premium (or a portion of the risk premium) in order to grab market share... this would be particularly true for debts that carry high risk premiums (like credit cards) but are also very competitive (like credit cards).
Hank
We do not need to rerun the discussion from last April
There’s the question of representation and perception (ie, comparing an inclusive income tax rate with an exclusive FairTax rate, I don’t care which we use, inclusive or exclusive, but we’ve got to use the same for both for an apples to apples comparison).
This was a matter of just simply screwing up the calculation (in more ways than one) because I was sleepy. Mea Culpa.
The right way to look at this calculation is (to expand a bit on what Fred said, because he appears to be essentially correct) is to look at the FairTax as adding to your interest rate. Putting aside the risk premium issue for the moment (for much the same reason I usually put aside the embedded tax issue: it’s complicated, subtle, legitimately variable in effect, and some folks just believe the rich evil business folks will pocket it), Fred is correct to note that 30%*1.5% = 0.45%. So the FairTax basically adds abut 45 basis points to mortgage rates.
Using a handy mortgage calculator online, and considering a $270k mortgage at 6.5% vs 6.95% we get mortgage payments of $1,706.58 and $1,787.26
respectively. So that would raise your mortgage payment by (1788.26-1706.58)/1706.58 = 4.7%.
Also consider you have a prebate, which when added over the life of a 30 year mortgage, is quite a lot of money. Considering that a roof over your head is normally considered a necessity, the rebate will easily cover the tax on this service. Also, it is suggested that interest rates will fall under the FairTax by 1/3rd. You also have to consider you’re paying everything will untaxed dollars and weight the fact that you can not deduct payroll taxes under the current system. Sorry this is not really complete or detailed.. I have family over for the weekend and can’t spend the time to go through this.. but I wanted to add a quick comment anyway.