FairTax Implications for Service Providers, Contractors, and Imported Components
Below are questions submitted by an anonymous reader. I’m adding numbers to the questions so they can be answered more readily.
In light of the upcoming elections, I am trying to decide whether or not I should support the Fair Tax initiative.
1. I wonder if you would clarify the following (quoted from “What Would be the Impact of the Fair Tax on Seniors”, on the FairTax.org site):
“The FairTax taxes only new goods and services...”
I don’t understand the use of the term ’services’. Specifically, I fail to see the effective difference between a tax on a service and an income tax. For example, if one were to provide piano lessons, then the amounts received would (obviously) represent personal income. Any tax liability on that amount would in effect be a tax on income, regardless of how you frame it.
2. That brings to light another concern. Suppose I am a general contractor with 1099 subcontractors providing services. Would all of these subcontractors have to start filing tax forms and writing checks to the government for sales tax on the amounts that I pay them each week/month/etc?
On top of that, would I need to start filing forms and writing sales tax checks every month, and would the amount I pay be offset by the sales tax paid on subordinate amounts paid by my subcontractors?
It seems to me that’s no better than the current system in terms of workload. In fact, it appears to be significantly more work. Additionally, assuming that is the case, would individuals collecting sales tax on services they provide be subjected to audits, similar to the current system?
3. Another question:
quote: “The FairTax reduces manufacturers’, services’, and retailers’ costs, allowing them to lower costs to seniors.”
I will grant you the cost reduction to retailers, but it doesn’t take a genius to realize that the vast majority of goods purchased in the US are manufactured or sourced overseas. I don’t see that changing for the better anytime soon. As such, the Fair Tax would have zero effect on the cost to manufacture these items, and only serve to boost inflation.
That would include everything from food and clothing to computers and to some extent, automobiles. Even in cases where final assembly is domestic, virtually all of the components are manufactured elsewhere, which would mitigate cost reduction. It sounds good on paper, but in the real world, wouldn’t it be an entirely different story?
It may sound as if I am trying to tear down the credibility of this initiative, but that’s not the case at all. I am sincerely hopeful that I am mistaken in my assessment, and your answers will allow me to support Fair Tax. There are a lot of benefits. I am extremely anxious to hear your response.
Dear Anon,
1. Services make up around half of our economy, and the tax on services is not paid by the provider, but by the person receiving the service. In your example, the piano teacher will add a 30% tax to his/her costs plus profit to arrive at a price for the lesson, and then send the tax amount off to the State collection agency. The teacher will receive a 1/4 of 1% fee for collecting the tax. Hopefully pretax costs will decline under the Fairtax, and there won’t be an overall 30% increase in price. (Although I’m hard pressed to know exactly what costs might decline for the piano teacher??)
2. There are no taxes on business to business (BTB) transactions. As for the last part of your question #2, yes, anyone collecting taxes could be subject to an audit, and the penalties for fraud are severe.
3. I agree that foreign manufactured goods arriving at the port will still cost the same. So, when the importer and final retail seller figure out their prices, foreign goods should have higher prices, and isn’t that good? Well, it’s good for domestic manufacturers, but not so good for consumers. Some of those cheap Chinese goods on the shelves at Wal-Mart might disappear?
I also get the feeling that you believe that cost savings accumulate or cascade up through the various levels of production? While it’s true that dollar savings accumulate, the percentage of costs doesn’t. It doesn’t matter if there are ten levels of production or one, the percentage cost reduction is the same. For a more detailed discussion of “Cascading Embedded Costs”, check out the discussion in the archives from last July, item #6. (Probably best to read the last comment first?)
Thanks for taking time to comment. You cleared up some misconceptions.
I loved the fair tax at first. I really was hoping it wasn’t this bad. Now that I looked things over closely and discovered that that it would indeed impose a tax on services and on interest from debt, I don’t think I can support it.
Regarding the statement “the tax on services is not paid by the provider, but by the person receiving the service”, I contend that the tax has always been paid by the person receiving the service. The only difference (assuming you actually achieve offsetting cost reduction), is that the tax would be listed as a separate line item, labeled “sales tax”, whereas now it’s an embedded cost.
Personally, I can’t imagine how we would ever realize offsetting cost reductions sufficient to mitigate the sales tax in the case of service providers. I think that by and large this will be inflationary in the real world. This has other ramifications as well. In the case of independent software developers, the cost to produce domestically would balloon, which would kill whatever chance the US has to compete globally, and make it more compelling to take or keep these dealings entirely offshore.
Additionally, there are millions of self-employed individuals in service industries that would still be subject to collection, compliance, payment, reporting, and of all things - an audit. Everyone from the maid to the kid that cuts the grass. Call it what you want - in these cases, it’s based on income, so I call it an income tax. They would all have to file forms and send payments more frequently as well. I don’t see where it’s much better than the current system in these cases.
Regarding the statement “There are no taxes on business to business (BTB) transactions”, can someone clarify? If I am a self-employed independent service provider, and all of my clients are businesses (and in fact the final consumer of my service), would the services I provide be tax exempt? For example, if I rent web hosting, and only do business with other businesses, would I need to charge sales tax? Conversely, if my business purchases its office supplies from another business, would this be tax exempt? Can’t be.
Then there’s the matter that someone else brought up - sales tax on interest. A very good point was made in that those with means are rewarded, and those without are punished. I am not the kind of person that believes in extending government assistance to people that are financially irresponsible, but I do think that if we start to charge tax on interest and late fees, we’ll be on the fast lane to economic disaster.
To summarize, I would consider supporting Fair Tax if and when it’s rewritten with a higher base rate in exchange for elimination of the sales tax on services.
Comments are welcome!
Thanks and Happy New Year to all.
Anon,
I don’t know how to make it any clearer. BTB transactions are not taxed, period! Provide services to a business- no tax. Purchase office supplies–no tax. Purchase stuff for the business and then take it home—go directly to jail!
By not taxing business to business transactions, business costs will go down due to the elimination of income /payroll tax costs. The government will get it’s share when a retail business finally sells their product to any consumer, –including the government?!
Hank,
Thank you for clarification of the B2B matter. That somewhat resolves another concern in I had in that any self-employed individuals that provide services to anything other than a retail consumer wouldn’t need to be concerned with tax collection matters. Only those providing services directly to consumers would be affected. That’s fairly significant.
Well, a major issue that remains a concern in my mind would be the sales tax imposed on credit card and mortgage interest. Considering the amount of high-interest debt many Americans seem to carry, that factor alone could very easily wipe out any benefit gained by elimination of federal income tax, especially if the debtor was in a lower income bracket to begin with (which would likely be the case). Even if one didn’t have any credit card debt, the moment one purchased a new home, the tax on the purchase and the loan interest would be huge. For that matter, assuming the home is used and sales-tax exempt, interest on the mortgage would still be be taxable. As such, many would consider this to unfairly tax those that could least afford it. It’s kind of difficult to argue that wouldn’t be the case. Oh, and by the way, if you can’t afford to buy a home, your RENT would certainly be taxable, correct? Again, people in lower and middle income brackets bear the burden. Of course, if you are fortunate enough to own your home free and clear, as I do, or you can purchase outright, then you avoid all of this expense.
Anyone here think that’s a good idea?
Thoughts?
I think its a good thing to tax debt. 70% of Americans live paycheck to paycheck and have an average car payment of $432. The average American spends $1.03 per $1.00 they make so that shows that our current system is not working. Why would you tax someone for working hard and making good decision by not going into debt and living with in there means while people that drive cars they can’t afford and live in houses they should not be in gets a tax break that’s what our current system does. People that make bad decisions with there money get all the breaks while people that don’t go into debt and work hard to gain assets pays for it. The fair tax would make them think about what is best for them. Then if they still want to finance a car for 60 months that’s there choice. That’s true freedom. I would love to see the average debt load per family (now just over $9,000 per family just in credit card debt) go down and I think the Fair Tax would do that. In the long run you can’t say that will not put american familys in a better postion if they cut there debt load.
I beg to differ on the BtoB issue: as the Fair Tax is written, materials which get made into products which are then sold by a business would not be taxed. Anything in which the business is acting as a consumer would, indeed, be taxed. So most provision of services (legal, web-site, etc.) to a business would be taxed. (The only case I see as an exception is where the services are able to be incorporated into a product.)
I can see a lot of fun and games with the lawyers, however. If services which get incorporated into a product are not taxable (computer software), what is the difference between that and other services which get incorporated into a product with longer lead times? Why would R&D not fall under this as well?
(And how services being charged tax on does not equal an earned income tax is beyond me.)
Hey, Grumpy,
Where in HR25 do you read that business purchases for stuff other than what goes directly into their retail product is taxed? I don’t believe that’s true. If you have a business registration ticket, everything you buy is not taxed, including all new goods and all services! Just don’t try to buy stuff with your tax exemption and then take it home for personal use. You may have to use your “get out of jail free” card.
If a business took on a new salesman, they might supply them with a brand new car. laptop and cell phone - all up say $33 000 and, as a business they would not have to pay the $10 000 sales tax. As the miles clock up, they sell these goods and the next buyer for the car and gear may be intending to use them for non-business reasons.
How do you catch this revenue? Does the government get nothing as the goods are sold second hand, does the $10 000 needs to be paid by the seller to the government or is there some other arrangement?
So, if someone has a home business and is a renter, is the tax prorated on the basis of business use?
For example, if my business use is 20% of the home, is tax collected on only 80 percent of the rent?