Increased Visibility of the FairTax
From reader Andrew Martin:
Great site. I am a fair tax supporter, but I really enjoy the cordial debate that goes on here.
The main reason I support the fair tax is visibility. I think the current tax system hides the “embedded taxes”. Being market oriented, I believe that any tax change for corporate profit, payroll, income, or capital gains will have the same “not so long run” effect on the cost of a good or service, the profit made by an investor, and the wages paid to labor. Of course, in the short run, these taxes will affect that which they are directed to.
Although even if HR25 passed, the effect on investor’s profit and labor’s wages would still be hidden, at least the public could see the cost when applied to goods or services. It sort of makes sense that embedded costs are 22% and the inclusive rate is 23% (maybe the 1% represents the estate/gift tax). I read through some of the archived entries and remember Hank stating that it would be unfair for the retired to pay into social security again. Maybe they are and just don’t know it.
I was wondering how the other fair tax bloggers view this. Is the consensus more that a corporate tax affects corporations and an income tax affects labor?
For some background reading on related topics, see these posts:
- Embedded Corporate Taxes: FairTax Answers
- What Immediately Happens to Prices?
- Boortz Clarifies “Keep 100% of Your Paycheck”
Andrew,
On the subject of the visibility/transparency of the Fairtax, if that’s the primary reason you support the Fairtax plan, you need to consider at least these two points: (1) Look at the sales receipt as mandated by Sec. 510 in HR25. The actual sales tax percentage that the retailer applied to his costs at the cash register is 30%. (see Fairtax.org FAQ #47) Yet, nowhere on the receipt is that sales tax percentage shown Are you sure that”s really visibility?
(2) Do you understand that over 21% of the Fairtax consumption base consists of government consumption? So, it would seem that the cost to fund the federal government is hidden in higher government taxes that aren’t included in the 23% rate. Is that really transparent?
I won’t repeat my arguments about the unfairness of using sales tax dollars from retirees to pay their SS pension benefits. After paying in to the SS Trust Funds for 45 years, I take it very unkindly to have to resume paying under the Fairtax plan. AFFT made provisions for an inventory tax credit, but paid no attention to current retirees. Bad breach of promises made!
Andrew — Welcome aboard!
Now, quck! How much did you pay in state sales tax in 2007?
Don’t know? Don’t worry, neither does anyone else. Now, how much did you pay in income tax? Easy, just look at your last pay stub. (Yes, you might get some back or have to pay more, but you’re probably within 10%.)
Thus, I’m constantly amazed at the claim of some of the FairTax proponents that the FairTax will make it easier for folks to know how much they pay in taxes each year. I think it will be just the opposite. Unless you record each and every purchase, and the amout of tax paid, and then tabulate the total at the end of the year, you’ll have no idea how much you paid in the FairTax.
It’s a LOT more transparent to just look at you pay stub and your 1040 at the end of the year.
Now, don’t get me wrong — I HATE our current system. The really frustrating thing is that if you get to the point where your income/investments are even slightly complicated, it’s impossible to know whether you have paid too much or not enough in taxes until the fateful day that your accountant tells you.
Then, you’ll find that you have either given an interest free loan to the government or you will need to pay a penalty for underpaying your taxes. Plus, you’ll need to pay your accountant several hundred dollars for telling you this. So, believe me, I’m not happy with our current system.
I’ll let others weigh in on your question regarding corporate and income taxes.
Hayden,
The fact that you have the option — not the requirement — of calculating your taxes paid under the FairTax is a feature, not a bug.
One of the worst aspects of the current tax system is that you are required by law to generate and maintain elaborate records — and that even these records do not reflect the actual amount of taxes you have paid, because of the hidden (or “embedded”) taxes paid by other parties further up the supply chain.
With the FairTax, all you would do is multiply your total personal consumption of services and new goods last year by 23%. (Yes Hank, 23% not 30%.)
Much easier and, yes, more transparent. The fact that you and your accountant didn’t spend sixteen hours hours last May calculating that figure so it could be stored in a filing cabinet in the garage doesn’t make it any less convenient or transparent!
Sheesh.
Joshua
Side note to Joshua,
Hank and et al certainly agree with you that in the context of your statement, 23% is correct. But the tax percentage the retailer adds to his costs plus profit is 30%.
Please tell me, how does one determine their annual consumption of new goods and all services? Are we to become a nation of citizens, each with dozens of shoe boxes filled with receipts, MC/Visa credit card statements, bank statements, etc. etc.? I’m not that anal, but I would like to know how much I paid in federal sales taxes. Might be easier to note all non taxed spending and subtract from gross?
What’s a “sheesh”?
Hank,
“Please tell me, how does one determine their annual consumption of new goods and all services?”
If I wanted to have the figure, I would look at my bank statements and end-of-year credit card summary. Within an hour or so, I would have a figure that is far more accurate than that on any hypothetical pay stub.
I agree with you, it’s probably easiest to subtract non-taxed spending from the gross.
So... One hour with my bank and credit card statements — versus sixteen hours between me and my accountant. Is there any real comparison?
Double sheesh!
Joshua
PS. You write: “Are we to become a nation of citizens, each with dozens of shoe boxes filled with receipts, MC/Visa credit card statements, bank statements, etc. etc.?” Er, that sounds like a perfect description of our current situation, where tax deductions must be backed up by physical evidence. Under the FairTax, as a private citizen you don’t have to keep or tally any of this stuff unless you want to. And it radically simplifies things for businesses as well. Taken on its own merits, wouldn’t you agree this represents a major improvement?
Wow. Thanks for all the responses.
Hank,
On point 1, if I had my way, when discussing the fair tax it would always be with the tax inclusive rate (or we’d change to discussing the replacement taxes as exclusive, but I know you guys have hashed that out pretty well). However, when printing the percentage on the receipt, I would prefer to use the higher exclusive number. I would want the size of the tax to look as high as possible (while maintaining accuracy).
On point 2, you guys did an excellent job of debating the virtue of a government taxing itself. I believe they do currently “tax” themselves, no matter how you view the system. If, as I propose, the market allocates all taxes as a cost to investor, labor, and consumer, the government is currently taxing itself when it buys any product or service. If, on the other hand, taxes are only paid by those entities at which there directed, they currently pay payroll and income tax. Although, I’ll concede it makes much more sense under the current system, so that government employees aren’t exempt from social engineering, e.g. having kids, buying a house, etc.
On point 3, if my view of the market allocating tax cost is accurate, I believe you are paying for social security today. You’re paying for your own, Ross Perot, and soon for Bill Gates.
Hayden,
7.75%. My 10 year old nephew knows that. Every time he goes to buy something for 99 cents and has to shell out $1.07 he reminds me how he “hates taxes.” Now how much “embedded tax” is in that chair you’re sitting in? Don’t know. That’s alright.
As far as income tax paid, yes I could look that number up, for last year. This year I don’t know. It’ll probably be roughly the same, except that I have another dependant, and I don’t exactly know how the AMT fix is going to affect me.
But my original point on transparency isn’t to see if I can do the math on my gross income and tax burden (which I have to do or face fines/jail time), it’s on how markets spread tax costs.
I think 97% (2006?) of all income taxes paid were paid by the top 50% of income tax filers. Does that mean that bottom 50% only have 3% of the burden, or is that just the number that’s assigned to them on a piece of paper? Are the bottom really burdened by some of the 97% (along with payroll, corporate, and capital gains tax), but it’s just too difficult to show on paper? I don’t feel I’m being too articulate here. Am I making any sense?
Thanks again,
Andrew
OK, even the blog owner should win a debate once in a while!! You make a good case. You win!! Now, what do you really believe is going to happen to prices?
Hank,
Good question. I’m not really a numbers guy, but here’s my personal take on what would happen to prices.
My gut sense is that prices would eventually stabilize at around 5% to 15% higher, on average, than what we currently have. And that these price increases would be more than offset by savings in other areas — e.g., no income tax, no compliance costs, and the ability to keep 100% of my earnings from real estate or investing.
Plus, my real purchasing power would be affected by very significant levels of economic growth. I mean, just picture what happens when every business-to-business transaction in the country — and every dollar saved or invested by private individuals as well as corporations — is suddenly 100% tax-free.
Wow. That’s just huge. I mean ... HUGE. I would love so see that in my lifetime.
But like I said, I’m not a detailed numbers guy, so my sense of it is really based on watching dozens (if not hundreds) of conversations transpire among people who are much deeper in the weeds than I am.
I can see why the picture would look somewhat less rosy for a retiree than for a young entrepreneur like myself. But I am also pretty sure there are lots of retirees who would love to live in that new economy. To say nothing of their children and grandchildren, and the effects it would have on their future.
Joshua
Joshua,
Speaking of compliance costs, I am way overdue in thanking Fred Johnson for directing me to a paper presented at the June 2007 IRS Research Conference on the subject of compliance costs. Some IBM and IRS guys got together and followed up on some small business surveys that were reported on at the 2005 conference.
What is most interesting is that the study results show that compliance costs can be over 25% of sales revenue when a business has total receipts of $20-$50,000, falls to 1.9% at revenues of $500,000 to $1,000,000 and drops to .5% for sales revenue over $1,000,000. The costs are both time and dollars spent on everything tax related including tax planning. Although the study concentrated on small businesses, I suspect that a .5% or lower compliance costs would hold for big boxes with billion dollar sales.
A couple of conclusions. First, business compliance costs are a small percentage of total compliance costs, with the bulk of the costs being born by individuals. Business compliance costs can be estimated at around $51 billion annually. Second, anyone that thinks that business compliance costs will provide a significant cost reduction is probably mistaken. With regard to business embedded costs of the income tax system, I no longer believe that those embedded costs would be any where near to my previously estimate of 2.6%. And, after adjusting business compliance costs to around .5%, total embedded costs of the income tax system would be 8% and after tax prices would rise by almost 20%, assuming employees keep their gross pay.
Food for thought for which I am most grateful to Fred.
Oh, wow!
Joshua has come down from his lofty perch a blogmeister and is getting down in the mud with the grunts! Things must be slow in the web design world!
Careful, now. When you lie with the pigs you get mud up your nose.
Or something like that. Never was too good on analogies.
Hayden,
Now, how much did you pay in income tax? Easy, just look at your last pay stub.
Only a third of IRS revenue is from individual tax returns (ie, “your last pay stub”).
Yet, individuals ultimately pay for all IRS revenue - the remaining 2/3 through the cost of goods and services consumed.
As such, I don’t believe that currently there is any reasonable way to determine one’s actual federal tax burden. For the same reason, I don’t believe there is any way to determine the true regressive/progressive nature of our current tax code.
Unless you record each and every purchase, and the amout of tax paid, and then tabulate the total at the end of the year, you’ll have no idea how much you paid in the FairTax.
What does the “end of the year” matter for a person paying via the FairTax? When is the beginning of the tax year? When is the end? There are no tax years. There are only tax moments - when you make a purchase.
If, for some odd reason, you did want to calculate your annual burden (maybe for old time’s sake), you may have to employ a shoebox, but at least you could figure it to the penny. Personally, however, I would recommend Quicken, both of which would spit it out instantly as opposed to a shoebox.
With the FairTax, individuals are faced directly with their entire federal burden at the point of sale. That doesn’t take any record keeping. Just look at the receipt and you can see the burden.
The FairTax is infinitely more determinable and intuitive than the current system.
Mark, I just looked at my pay stub and it shows my Social Security and Medicare taxes. And I think most people realize that their employer matched that amount on their behalf. I even get a neat little yearly statement from the SSA showing how much FICA I’ve been taxed over my lifetime and it also shows my employers’ matching.
Doing a quick run of the numbers, 78% of the 2007 receipts where directly attributable to individuals (PIT, FICA, estate and gift taxes) and the precise amounts of these are easily determinable by those individuals. The corporate income tax was only 14% of receipts. The other ~8% percent were taxes that wouldn’t be affected by the FairTax.
Kotlikoff shows that 82% of the FairTax base is “private consumption” (i.e., individuals spending money), the rest is government consumption spending. Obviously individuals would eventually pay what governments are taxed, but there would be no way for an individual to know the exact amount they’ve paid.
So, since the FairTax would generate 92% of receipts and 82% of that would be directly attributable to individuals, only 75% (92% x 82%) of receipts under the FairTax would be directly attributable to individuals — compared to 78% for the current system. So which one make the federal tax burden more visible to individuals?
And this analysis doesn’t even take into account the prebate. It seems to me that if you are trying to make people aware of the federal tax burden, sending every legal family in the US a monthly check that has nothing to do with the amount of taxes they’ve paid is a strange way to go about it.
Sorry, Mark, but either you are wrong or the Kotlikoff/BHI report is wrong. On page 9, the report shows that for 2007, Individual income taxes raised $1101B, Corporate taxes $290B, and SS $871B. Splitting the SS results in two thirds of the federal revenue coming from individuals and one third from Corporations. I think you have your numbers reversed?
Fred, Hank, I stand corrected - I was using numbers off the top of my head thinking $3T spending / $1T individual returns. But the individual should include employment taxes and the spending should not be spending, but revenue which is 2.5 or so.
Mark –
I do agree with one of your main points (and that many people like about the FairTax) in that under the FairTax one would know instantaneously what the taxes are in an item or service one wishes to purchase and decide at that point whether one wishes to pay that amount of taxes or not.
I won’t repeat all my criticisms of the FairTax, but I do agree that is a very appealing aspect of the FairTax vis-a-vis our current system.
Now, please excuse me while I go wash my mouth out with soap.
Hayden,
I’m coming to Atlanta to be sure you do wash out your mouth with soap. There is absolutely nothing in HR25 that mandates that merchants display the after tax price on an item on the shelf. Only when you have bought the item and looked at the receipt can you tell how much tax you paid. I really think the majority of retailers will simply display the costs and add a note that a tax will be added. Otherwise, merchants will have to add a 29.87012% tax for every shelf item, recalculate it for every Xmas sale, etc. etc. I think it will take a lot less time and cost to let the cash register do the higher math. And by the way, when is the last time you saw a price on an item at a big box store? Frequently the bar code is all you get, until checkout.
Have I missed something in HR25 that makes me incorrect??
I don’t want to put words into anyone’s mouth, but just for my own desire to know, based on this thread would it be fair to say the following:
Hank, Hayden, Fred, Mark, Josh, and Bruce Bartlett (to jump ahead a thread) all believe that our individual tax burden is accurately measured by our individual income/payroll taxes. The employer is responsible for corporate tax and employer payroll contribution. So the corporate tax, employer payroll tax, and capital gains tax make up the 22% “embedded taxes”.
I’m the only one (here) that believes the tax burden can not be accurately calculated this way (although doing so is great for class warfare).
I guess it all comes back to a discussion I keep having with a friend. Do you work for your gross pay or for your net pay? Maybe some economist out there can give me the academic answer.
Thanks,
Andrew
Andrew,
As the senior partner in the august group you listed, I usually understand the question. But, I don’t really understand how you might propose to calculate the tax burden, and I don’t see what income tax and payroll tax withholding has to do with class warfare. I do know that you may be confused about the makeup of the 22% embedded costs of the income tax system.
The 22% embedded costs of the income tax system, according to Jorgenson who did the study for AFFT back in 1997, consists of approximately two thirds employee tax withholding, and one third employer income tax and the employer 7.65% share of payroll tax. Employer embedded costs also include a small percentage for compliance costs which Jorgenson didn’t include in his study.
I don’t know about the rest of us, but I “work” (I’m retired) for my gross pay (pensions) and budget around my net after taxes. Is there another way?
Hank,
I guess the other way to look at it is that labor is a market of its own. If wages stay constant, but a new tax is added to labor, the supply of labor will go down. Assuming labor demand is constant, a labor shortage will occur. This will drive up the wages paid to labor until equilibrium of supply and demand are reached. Since wages are just another cost of product production, this labor tax has just been “embedded” into the price of the product.
Note: After the tax is imposed, labor takes home less money, the employer pays out more in wages, and the cost of the product is more.
The class warfare aspect comes from saying we’ll lower labor taxes and raise corporate/capital gains taxes. My assertion is that they end of doing the same thing.