Taxes and Prices
Here is a brief essay sent by reader Ralph Layman, partly in response to our thread “No Such Thing” as an Embedded Tax?...
Jobs and Taxes
Nearly 50 years ago, I was hired to teach pre-algebra in Sparta, Wisconsin out of a ten-year-old text, which employed dozens of obvious everyday situations to illustrate the uses of algebra. Most of the text dealt with things like carpeting, fencing and seeding, but one chapter was on business and economics. Unfortunately, many of our present day politicians, economists, and bureaucrats are completely oblivious to a concept the textbook writer thought 60 years ago would be obvious to ninth graders not quite ready for algebra.
Businesses usually buy something, do something to it, and sell it at a higher price. What was paid for the item(s) in the first place was labeled (C) for Cost. The expenses involved in processing the items including labor, taxes, rent, utilities, packaging, advertising etc were called (O) Overhead. (S) Sales is the number of dollars that would be realized by reselling the improved items. Profit (P) is equal to what is left after both C and O have been paid for, or
P = S - (O+C)
Pretty obvious isn’t it? If the Cost of the goods and the amount to change it (Overhead) is more than the S the selling price, then P is a negative number and the business is, or soon will be, no more.
Consider the effect on Overhead, when it must include not only the workers take home wages, but about 15% of the workers wages in Social Security, and the costs of medical insurance, retirement plans, not to mention the withholding of personal income tax that the worker never even sees. If there is still a positive (P) after all of this, the government taxes it twice, once on the corporation and again on the individual investor.
Can anyone still wonder why American jobs are going overseas? Taxing the Overhead only in businesses that operate in the USA is absolute stupidity in a global economy. Prices of American goods include this hidden taxation whether they are sold here or abroad. and usually, because of these hidden taxes, we cannot compete.
Our federal government receives only about 4% of its income on the sale of foreign goods sold here while collecting more than 90% on the purchase of American goods through taxes hidden in our prices. Go to the store and just try to find something made here. Notice too, that the expense of labor-intensive federal, state and local governments is similarly increased by social security and other taxes on labor.
Fortunately there is a bill in congress co-sponsored by about 10% of the members of the House that could remedy this situation. It is progressive in that it has a zero taxation rate up to the poverty level and taxes many things now escaping taxation because of the 50,000 pages of loopholes in the IRS tax code. The bill is called the Fair Tax and would do away with the IRS. If we impose the same tax on both things we produce here and imported items, there is a level playing field consistent with the concept of Free Trade.
Ever wonder why the entertainment, sports, and software industries are able to pay super high salaries and earn fabulous profits? It is simply because they are not labor intensive and most all of their expenses are tax deductible. Our so called Progressive Income Tax really isn’t very progressive any more.
If you care about jobs in America, support the Fair Tax and let’s fund needed social programs like health care and social security with taxes on consumption instead of on production.
How prices and foreign competition are affected by the FairTax
by Ashford Schwall
A simplified example
We are off to the shoe store to buy a new pair of all purpose hunting /hiking /work boots. The store has many styles and the one we like is made by AmeriBoot model Brown 3 and sells for $100.00. Next to it is a “knock-off” version from ChinaBoot model BRIII at $77.00
Our desire and sense of duty says “buy American made!”…but our wallet says “save money, by the China-Boot”.
Now let’s put in some numbers here. ChinaBoot sells 10,000 pairs a year of BRIII and AmeriBoot sells 2,000 pairs of Brown 3. AmeriBoot has enough brand loyalty to overcome the higher price.
Under our current tax system, the income tax, American products have somewhere between 20 to 30 % of their product price as embedded corporate taxes and compliance costs. Foreign products do not. 23% is the working average (see:Taxing Sales under the FairTax – What Rate Works? footnote below)
Now we leave Income Tax land and step into FairTax land.
Remember, under the FairTax plan H.R. 25, we remove all income taxes and compliance costs (23% inclusive) from the production side and add it back to the consumption side of the equation (30% exclusive)
The income tax equation is income- taxes-compliance dollars = spending
The Fair Tax equation is income = spending + taxes+ compliance dollars, so here we are taxed as we spend and keep the compliance costs
AmeriBoot can now remove 23% from its price structure ($100-23) and are now able to bring its product to retail at $77.00 ChinaBoot never had that 23% in their price so they can’t do anything. So now AmeriBoot is the same price as ChinaBoot. ($77.00 + the 30% exclusive tax), both are now $100.00
What do you think Americans will do now?
You guessed it, switch to AmeriBoot. In fact let’s say AmeriBoot takes half of ChinaBoot’s market share.
Sales now: AmeriBoot 7000 vs. China boot 5000. AmeriBoot has so much new business, it has to expand the factory (capital outlay) and /or add another shift ( labor outlay).
Great for everyone but ChinaBoot !
Wait, wait, wait, No way, some say! Those fat-cat American corporate executives won’t drop the price. They will just keep the same price and take the savings in profits and higher bonuses. Believe it not, that is what many of the FairTax nay-sayers cry. They don’t understand the invisible hand of market forces.
So let’s play devil’s advocate and pretend that is true.
AmeriBoot decides it will keep the removed 23% cost and apply it to profits. They are sure that brand loyalty will keep their sales constant. So now we add the 30% FairTax exclusive rate to AmeriBoots’s $100 price and to ChinaBoot’s $77 price and now we have $130 vs. $100.
Still a $30 spread and both prices are higher. Consumers are now faced with higher prices and the ChinaBoot is still cheaper.
AmeriBoot is wrong. Since both prices are now higher, AmeriBoot ends up losing half its market share to ChinaBoot. Sales now: AmeriBoot 1,000 pairs, ChinaBoot 11,000.
AmeriBoot is now faced with lower sales and has to shut down a machine or layoff workers. Not good.
There is hope. This scenario can only last for a while until market forces step in.
This is a dynamic economy. Remember that 23% comes off of all industries, including banks. There are now banks willing to loan money at lower costs now.
A handful of folks come together with a business plan and a loan. Perhaps even ex-employees of AmeriBoot. They start a company called TexasBoot and come up with their own version Brown3 called Rocky8. They can bring their product to market at $77 and promote the American made label.
That makes 3 brands on the shelf with an end retail price and tax of, AB at $130, CB at $100 and TB at $100
TexasBoot sales soar. They take half of the market share from each AmeriBoot and ChinaBoot.
Sales now TexasBoot 6000, ChinaBoot 5500 and AmeriBoot now at 500.
TexasBoot, being new, was able to invest in newer and more efficient machinery than AmeriBoot ever had. They even hire away some of AmeriBoot’s workers. The new plant and equipment is so efficient that they can now bring their boot to market for $60.00!
Wow, now we have a no brainer!
TexasBoot at $60 x 1.30 = $78.00
ChinaBoot at $77 x1.30 = $100.00
AmeriBoot at $100.00 x 1.30 = $130.00
What do you think will happen to market share now? Your guess is as good as mine but I guarantee you it won’t be good for ChinaBoot and AmeriBoot.
The above is an example with just two original competitors. Think how quickly prices will change with multiple competitors.
Neil Boortz’s website links to a study by economists with the Beacon Hill Institute which states that it “seems likely” that the Federal Reserve “fully accommodates the introduction of the FairTax and permits consumer prices to rise by roughly 30%.” (page 26, paragraph eight).
Can somebody please explain the apparent discrepancy between the applicable statement in this study and the arguments made above?
I actually asked that question to the BHI guys on January 3rd but haven’t heard back yet.
Monthly wages for a Chinese shoe worker are around 600-700 yuan, about $100 to $120 US a month, A tax cut of 22% in the US would make no appreciable difference in competitiveness. US workers will not be making mass market shoes regardless of tax cuts.
There are very few US costs embedded into Chinese shoes - they are unpacked from a shipping container and dumped onto shelves of low markup high volume stores. Their price would increase with a sales tax, but there would be no American made shoes for a budget customer to switch to. And no amount of wishful thinking or made up numbers will make any difference,
Ashford: I am new to the Fair tax issue and came to this site while searching for understanding of how FT would affect consumer prices. Your example is a wonderful illustration, easy to understand and full of positive implications for the movement.
I would hope the powers that be would promote your brief essay because I think it would go a long way to helping many people get past the fear of higher prices.
Thanks so much for taking the time to write your post.
Ashford,
Now look what you’ve done. Your little essay has newbies such as Jeffrey all excited, but you have made a couple of big mistakes in your shoe story. Promoting your story would not be a good idea if you want to retain your credibility.
First, the embedded costs of the income tax system include employee income tax and payroll tax withholding. In fact, two thirds of the embedded costs can be attributed to the employees, so businesses can’t possibly reduce their costs by 23% as you claim, unless workers gross pay is cut to the current net after withholding. And, that isn’t about to happen! The best you can hope for is a 10% reduction in costs, and a 17% retail price increase under the Fairtax.
So, let’s step back into Fairtax land. The Ameriboot cost will be reduced 10%, and the new retail price will be $117. The Chinaboot which costs $77 will be reduced in cost by 10% and the retail price will be $90. Still looks bad for Ameriboot, doesn’t it?
Oh but, you say, how can Chinaboot’s costs go down? Easy! It isn’t Chinaboots’s costs that go down, it’s Wal-Mart’s costs that are reduced 10%, and that cost savings can be applied to any product on their shelf, no matter where it is manufactured. Remember, it doesn’t matter how many levels of production there may be, the percentage cost savings remains the same whether there is one level or ten.
You tell a good story, but the fact is that the Chinaboot product will retain it’s cost advantage no matter whether we are under current tax law or the Fairtax. Blame it on the unions, or whatever, but cheap foreign labor will continue to be a problem for US manufacturers.
#5 Thanks so much for your compliments.
#4 You are certainly correct that all the really cheap shoes will be imported.
Yet I really think we should start getting money to fund our government when those shoes are sold here.
I usually buy New Balance shoes. They are not too expensive and are made here. They would be more competitive if the chinese shoes were taxed and that they didn’t have to raise money for Social Security etc to employ workeers.
Heres is a quote from their web site:
To ensure the best fitting, best performing shoes and apparel, we focus on improving our technology and production methods. A big part of that is maintaining five manufacturing facilities here in the United States where we continue to produce shoes and apparel that meet the standards we’ve employed for 100 years. We have also remained commited to a core set of values that include integrity, teamwork and total customer satisfaction.
#6, you have to remember that any discount at the Wal-mart level will also be applied to AmeriBoot as well as Chinaboot, still making the two boots closer in price. The FT will not make them even, but it will narrow the gap.
We are the most productive people in the world.
http://www.nytimes.com/2007/09/04/business/worldbusiness/04output.html?partner=rssnyt&emc=rss
When we remove the shackles of the tyranny of income taxes, no other country will come even close.
When America becomes the tax free haven of the world there will be plenty of money available for companies to borrow at low rates so they can upgrade with productivity improvements like automation and robotics.
There is the possibility then that TexasBoot will be able to lower prices further and begin selling to the Chinese. Come on, the Chinese don’t want toxic boots, toys or whatever and they know how we feel about that.
I did read somewhere that America sells more Buicks in China now than we buy for ourselves. For some reason they love Buicks.
I wish fairtax were true. If you accept the premise that its voluntary, that companies will lower their prices 22%, that the military can pay 1/4 of a trillion dollars in sales tax, that its revenue neutral, and that the math adds up, its great.
Its just a shame — none of those are true.
Its not voluntary for cancer patients — they must spend 100,000 to 2 million to stay alive. Thats 23K - 230K in sales taxes to them.
Its not voluntary for nursing home patients — they must spend 9,000 to 20,000 a month on their care. Thats 2100 - 4600 tax every month.
Its not voluntary for the parents of a brain damaged child, who need 400,000 a year care for that child.
You can say “oh, we wont tax those people” I know you wont. Huge politcal pressure will force Congress to correctly exempt not just the hard cases, ubt all of health care from the high sales tax. Two trillion dollars therefore will go untaxed, and the treasury will have 460 billion shortfall.
Your rate just went up to 34% to be revenue neutral.
The military and government cant pay 250 billion in sales taxes. Sorry. Sure, you can make them write a check. But that check wont be any net increase to the treasury. And thats the whole point of applying the tax - to get the revenue in. This charade of taxing yourself to pay yourself, just doesnt bring any spendable money in.
Your tax rate just went up to 43% to be revenue neutral.
You cant tax new housing — at least, you cant get the 110 billion the Fairtax expects to get. Since many people will simply avoid buying new houses, or buy less expensive homes, to avoid the high tax, this market segment will not contribute as expected to the treasury.
Your tax rate just went up to 46% to be revenue neutral.
You wont be able to tax rent either. Few people even understand, Fairtax taxes rent. Thats a 190 billion dollar market segment. Fair tax was based on getting 42 billlion from that into the treasury. Renters will scream bloody murder, and Congressmen will give rent an exemption to, or lose the next election - and those congressmen will give rent an exemption.
Your tax rate just went up to 48% to be revenue neutral.
Im sorry to say it, cause I wish FT would work. But it cant. Furthermore, many people promoting this concept know it cant work.
You’re accepting the premise that prices won’t drop. As I’ve shown in other threads the basis of that opposition is in question.
Health care has some of the highest embedded costs and highest compliance costs so have the potential to drop the most.
There are other reasons to tax government consumption. One of them is to minimize the potential for corruption. We have enough of that now in government don’t we?
New housing also has some of the highest embedded costs, but of course you’ve bought the idea that prices won’t drop, right?
Property owners that own rental property tend to be in the highest tax bracket of 52% (exclusive), but you probably believe the “evil greedy rich” propaganda and can’t see how much rent can fall due to competitive free market pressure.
I wonder how you “know” what other people are thinking?
If pessimism and misinformation runs this country now we are doomed anyway.
Seems that rant also doesn’t consider the rebate to untax up to poverty level spending and I’m not sure how it considers medical insurance. I’m not going to waste my time on this rant.
Actually, many landlords actually enjoy a current tax SAVING since they can write off “depreciatiuon” on their appreciating rental property. (Yes, this tax break is “recaptured” at sale, but it’s at least a substantial deferral of tax.)
Also, I have followed various large property tax cuts over the years (California, Massachusetts, Michigan) and have seen NO evidence that any tax cuts anywhere, at any time, has ever resulted in a decline in rents.
Oh, another thing. Landlords will have to register their rental properties with the (state) tax collector, which opens the door to increased regulation of rental properties, such as annual government inspections.
So my landlord will collect the tax from me and pass it along. What about the homeowner with spare bedrooms who rents out a room or two? Is he gonna register? If he doesn’t register, how you gonna collect?