How Much of Embedded Taxes Is Payroll?
From reader Ed Dennis:
I need an explanation of the % of embedded taxes that are not wage related.
I have heard proponents of the Fair Tax say that you will get to keep everything you make. There will be no income, Fica, Medicaid or any other tax taken from a paycheck.
QUESTION: If an employers payroll cost are not reduced how can the employers charge for goods and/or services be rolled back.
I hear quotes that embedded taxes amount to more than 20% of the retail cost of almost every product we consume. How much of the embedded taxes are payroll taxes and how much of the embedded taxes are other taxes and related cost.
Thanks for your help.
10 Responses to “How Much of Embedded Taxes Is Payroll?”
If you did not include employee income tax and payroll withholding, Arduin, Laffer & Moore Econometrics estimated production costs would decrease by a minimum of 11.55%. This reduction would be from the removal of the corporate taxes (15-39% income) and the employer share of payroll taxes (7.5% of wages). Further, production cost may also be decreased by the reduction in compliance cost - estimated at around 500 billion - and the potential offset/gain from FairTax compliance payments (.25% of tax collected) estimated at around 5 billion to business.
Morphh-
Don’t forget that production cost also includes material supplies that also have the same embedded costs.
Here we go again. For what I hope is the last time,
let me state that the percentage cost savings does not cascade or accumulate up through the various levels of the production of goods. It doesn’t matter if there is one or ten levels of production, the percentage cost savings is the same. That may not be intuitively obvious, but it’s a fact!
Assuming that workers and pensioners keep their gross pay, the best you can hope for is a 10% (me) or 11.5% (A.L.M. Econometrics) reduction in producer costs, including compliance costs. This means that retail prices will rise by 14% to 17% on average. There has never been an official price impact study done to the best of my knowledge, but if anyone wants a copy of my version of a price study, just email: vanlinda@comcast.net
Just a correction/clarification on Hank’s statement. A.L.M Econometrics did not state that was the best you could hope for. They said it was the least (a minimum reduction of 11.5%).
Hank,
You are right, percentage cost savings do not cascade or accumulate through supply lines. But a major component of cost of sales is component and material supplies that go into the creation of the final product (and not mentioned by Morphh in his post). I can see your rather pessimistic view of the impact retail prices, if you do not believe that these costs will not go down because of the reductions in their production cost for domestic companies. Wait a minute, domestic companies able to be more competative, what a concept.
It’s been a while since I read Hank’s study, bu I don’t believe that prices would drop even 10 percent.
Besides needing employees to accept lower wages, you would also need landlords to agree to reduce the rent they charge. You would need banks to lower interest rates. You would need suppliers to accept lower profit margins, bondholders to accept lower interest, and shareholders to accept smaller dividends.
And, of course, the FairTax will not have any impact on the pre-tax price of imported raw materials, inputs, supplies or finished goods.
So, the bottom line is, nobody is going to lower their prices until they are certain that the overall price level will drop. Since nobody lowers their prices, by definition, then all afer-tax prices will automatically rise by the tax-exclusive rate for the FairTax.
Thus, when everyone sees that prices have risen, they are certainly not going to accept lower wages, rents, profits, etc. I believe that is why the Beacon Hill studies assume that prices will simply rise by the tax-exlusive rate.
Hayden,
You may be right in the short run, but it will not take very long before competition will adjust prices downward. There may be many who take your wait and see approach but the longer they wait the more market-share they will let go to the competition. Again, the big winner will be the small domestic business that can seize the opportunity and reacts quickly to build their market-share. Plus, domestic businesses will enjoy a level field against imports that now have an unfair advantage without imposing tariffs or breaking trade agreements.
Hayden said “So, the bottom line is, nobody is going to lower their prices until they are certain that the overall price level will drop.” I can’t disagree with this more. Somebody (because of greed) will drop their prices to “steal” market share. That person, while wanting to maximize their profit, is willing to make the same margin they were willing to make before the FairTax. Once this person lowers their prices, others will either lower their prices, or go out of business (because no one will be willing to pay the higher prices). If you need an example, look at gas prices. When they rise, everyone says it’s because of greed. No one (outside of free market supporters) has an answer why they lower.
What Hayden said about imports is absolutely correct. Whatever expense is born outside of the US will not be affected by our tax policy (directly). Prices at Walmart will certainly go up. The amount will depend on the average mark up (the lower the markup, the higher the price will go up). This is why US manufacturers (both labor and investor) will benefit from the fair tax.
The 10-12% is basically a minimum. Assuming all gross wages are kept. It could be a little less because some this cost reduction will go to labor and some will go to investor (as occurs naturally in the market). The other 12-10% (22%-) will depend on how restrictive the labor markets are and how easy entry to the product market is. Heavily unionized labor will make wages more immobile. Something like fast food should adjust to the new market wages quickly (I am assuming because of easy entry to the market and high employee turnover). That’s why I am not against having the fair tax implemented over a series of years (3-5). It will allow wages to adjust more gradually as businesses will be able plan (say by giving smaller raises over the adjustment period).
Since FICA is less than 8% of payroll, and payroll is usually 1/3-1/2 of the expense of most businesses, and since the business owner pays half of the FICA, the FICA cost to the business owner, while substantial, is hardly 22%.
Most business would save less than 1.8 percent of their total revenue, by not paying FICA. Therefore, they could only cut their prices by that much, due to that particular savings.
Whoever came up with a business saving 22 percent, I would like to see the books on that business, and see the math.
The “savings” on income tax is almost as dubious. This first of all treats the owner’s income tax as a business expense. Its clearly not. Its a personal expense of the business owner.
Even so, the income tax paid by the business owner, is also no where near 22% of the gross business receipts. I’ve never in my life seen a business owner pay 22% of his gross receipts in income tax.
To pay 22% of your gross receipts in income tax, you would have to have almost unheard of profits. You might well pay 22% of your PROFIT in taxes. But not 22% of your gross receipts. There is a world of difference, as any business owner can tell you.
And that might be part of the confusion.
As for compliance cost — its clear here too, that the Fairtax would increase compliance cost, at least for a while.
Douglas,
The 22% includes employee payroll, employee income, and corporate tax. I may also be leaving out some others. That’s why we often on this site about how much of the 22% embedded taxes can be removed. I believe it’s mostly based on labor willing to receive less than today’s gross (although some still be believe corporations will just take bigger profits, i.e. no market forces).