Taxing the Prebate, Once It’s Spent
From Logan Boettcher:
This might come as a shock to you (or maybe it doesn’t), but the FairTax does not exempt poverty-level expenditures from tax. In fact, it levies a 5.29% tax on all households earning their respective poverty level wages. I will use the family of four who make the poverty level of $28,000 per year as an example.
When this family spends their $28,000, the FairTax will remit $6,440 of that amount to the government and the family will obtain $21,560 in goods and services. The prebate mechanism will rebate the $6,440 back to the family to supposedly allow them to obtain the remainder of their poverty-level goods and services. But here’s the rub: the FairTax is still being computed when they spend the rebated money. So when the family goes to spend the $6,440, $1,481.20 is remitted to the government and the family obtains $4,958.80 in goods and services. This final remittance to the government is not rebated and therefore is the tax paid by this family. It figures out to be an effective tax rate 5.29%. This figure can be easily figured out by taking 23% of 23%, because 23% of the 23% prebate is not rebated, therefore it is the tax.
The new prebate would have to calculated using the tax-exclusive rate of 29.87% (.23/.77) instead of the tax-inclusive rate of 23%. But with the increased prebate going into effect, this would present a two-fold problem.
In the first scenario, since prebate spending went up X dollars, to maintain the same level of non-prebate government spending, revenue would have to increase... Revenue+X = (Prebate+X) + Spending. But for revenue to increase, the rate has to increase, and if the rate increases, the prebate would also increase. This process has no end, so it would mean that you would have to admit defeat and say that at current government spending levels, the households living at the poverty level would have a tax rate of 5.29% and the non-taxable portion would be 77% of the poverty level for that particular household, which would be $21,560 for a family of four (instead of $28,000).
The second scenario is more pleasant but less plausible because it is not revenue-neutral in the way that politicians like it. If prebate spending goes up, the equation can be modified to look like this: Revenue = (Prebate+X) + (Spending - X). Thus, you can say that you can fix the prebate problem as long as spending goes down an equal amount. We all know that this is a joke. At the very least, any tax reform that has a chance in Washington must be revenue-neutral to -positive. The FairTax rate was derived to be revenue-neutral so as to be politically possible. ...
Logan and/or Joshua
This post makes no sense. The prebate is simply a rebate paid to each head of household calculated on size of the household that is paid in advance. How the prebate is spent makes no difference, nor does how it effects a single household. The idea is simply to offset the Fair Tax spent on basic needs up to the poverty level. That’s all.
I think the point is the “rebate” is taxed when spent thus reducing it’s “real” value. You must use this “real” value when determining effective rates. Logan is correct in stating that a family at the poverty level would not have a 0% effective tax rate under the FairTax - they could not buy the poverty level “basket of goods.”
To further illustrate his example, suppose a family of 4 made exactly the poverty level of income, for example $28,000, and they also received a $6,440 prebate. This would allow them total tax inclusive expenditures of $34,440. On this spending they would pay $7,921.20 in FairTax. But they were only able to get $26,518.80 worth of goods - below the $28,000 poverty level “basket of goods.”
To determine their net tax paid, subtract out the prebate from the total tax paid ($7,921.20 - $6,440) and you get $1,481.20. To determine their effective tax rate, divide this net tax paid by their income ($1,481.20 / $28,000) and you get 5.29% - just as Logan stated.
Mr. Boettcher’s point is exactly the point I made in my Ocala Star-Banner guest column, which was posted on this blog a couple of years ago, and which I found (and traded comments with some of you on) last year.
rmforbes has a common misconception, shared by nearly all FairTax supporters, that the prebate is “simply a rebate paid to each head of household ... to offset the FairTax spent on basic needs up to the poverty level.” The misconception is common because that’s the way the prebate has been sold by those who conceived it. And it’s been sold that way because those who conceived the FairTax, according to Neal Boortz in The FairTax Book, “The folks who wrote the FairTax plan knew that burdening the poor with a 23 percent retail sales tax would doom the plan from the outset.”
My evidence that the prebate is NOT, in fact, a simple rebate to offset the FairTax spent on basic needs is in the FairTax Book itself. I direct you to the portion of the book where Boortz brings up the idea of a “FairTax Card.” (The section in all caps is added by me for emphasis, because it’s very important.)
“And it might be even easier than sending out physical checks. Consider this possibility: A FairTax Card! The government would issue such a card to every head of household who has registered with the federal government. This FairTax card would be much like your bank debit card, with a magnetic stripe identifying you and coded with your PIN.
“Once the cards are issued, it would take a simple mouse click in Washington for your FairTax Card to be credited with your monthly rebate payment. YOU THEN GO FORTH INTO THE RETAIL MARKETPLACE USING YOUR FAIRTAX CARD AS CASH UNTIL IT’S DEPLETED FOR THAT MONTH — all the while leaving the money you’ve actually earned resting comfortably in your interest-bearing and tax-free checking account.”(Pages 89-90 of the hardcover 1st edition of the FairTax Book.)
This passage clearly describes the proposed FairTax Card as a CASH CARD, not as a TAX CREDIT CARD. Here’s the difference.
You go to the store and buy $100 worth of groceries. Under the FairTax, $23 of that is sales tax. You swipe your FairTax Card.
With the FairTax Card as a CASH CARD — as Boortz describes it — $100 would be deducted from your FairTax Card, and $23 of that would be remitted back to the federal government as tax.
With the FairTax Card as a TAX CREDIT CARD — in other words, if the prebate really is intended as “a rebate paid ... to offset the FairTax spent on basic needs up to the poverty level” — then only $23 would be deducted from the FairTax Card, and you would pay $77 out of pocket for the groceries. In other words, you would be able to buy $100 worth of groceries tax-free, paying only the true cost of $77 for them.
But that’s not how Boortz describes it. Here’s his pertinent sentence again: “YOU THEN GO FORTH INTO THE RETAIL MARKETPLACE USING YOUR FAIRTAX CARD AS CASH UNTIL IT’S DEPLETED FOR THE MONTH.”
Furthermore, it’s not hard to imagine how people would use the prebate checks if they were sent out as physical checks instead of credited to a debit-style card. They’d use them the same way. As cash. In other words, for every dollar of the prebate they spend, 23 cents would go back to the government as tax.
This is what I said in my newspaper column, this is what I said in my posts on this blog last year, and this is a fact: The FairTax prebate is NOT a tax credit, it’s income. It will be spent as income, and when it’s spent, it will be taxed at the same rate as any other income. Therefore, it does NOT “offset the FairTax spent on basic needs up to the poverty level.” It’s a trojan horse, added to the FairTax proposal to make you THINK the FairTax is not regressive. But in fact, it is. And I think it was designed to be.
Of course, those people making 77% of poverty level would be tax-free, while those making less than 77% of poverty would be taxed at a negative rate.
On the statement that “this process has no end”, perhaps Mr. Boettcher should learn a little about convergent series.
In response to Mr. Boettcher’s letter, once the $28K in purchases is made spending up to the poverty level has been made. Then receiving the $6,440 back means the individual has paid no tax up to the poverty. I believe the error in Mr. Boettcher’s line of reasoning is his assumption that $28K worth of goods after the fair tax is only ~$21K worth of goods today. If you believe, and you may, that the fair tax will go on top of prices today without any embedded taxes being removed, then the new $28K of poverty will be ~$37K. However, that is a different argument and doesn’t really address the prebate system.
In response to Mr. Hirschi’s response, the “progressiveness” of any tax system has absolutely nothing to do with how that tax system operates relative to the poverty level. It is only a measure of the effective tax rate. It can be argued (and has been) that the fair tax is “regressive” relative to income, but not relative to consumption. As a side note, since the “flat tax” exempts income up to a certain amount, it too (ironically) is “progressive”.
Contrary to conventional Fairtax wisdom, the prebate isn’t a tax refund in advance. It is supplemental income which can be spent and taxed, or saved. The only reason it is thought of as a tax rebate by so many Fairtaxers is because AFFT says it is a tax rebate.
Many Fairtax advocates try to compare the prebate to an income tax rebate. But that doesn’t hold up to inspection. Most income tax rebates are simply over payments of taxes through withholding. A taxpayers gross income won’t change no matter what their rebate might be. Only those taxpayers who qualify for the EITC or the Additional Child Care credits may actually increase their gross income, and then, only if the EITC completely offsets payroll taxes. The prebate, on the other hand, increases everyone’s gross income.
No matter what anyone wants to call it, the prebate is in fact a cash grant entitlement and is being proposed at a time when entitlements are squeezing out discretionary spending in the federal budget, including Defense discretionary. Not everyone seems to understand that entitlements, once passed into law, are basically put on auto pilot. Discretionary spending must be debated and voted on each year by Congress. Entitlements are not even discussed by Congress annually unless a change to the enabling law is needed.
The prebate will cost from $500 -$600 billion annually and is protected from inflation, just the same way that SS pensions have an annual cost of living adjustment. There is an economic train wreck approaching, and adding a huge entitlement such as the prebate will certainly hasten the disaster.
For these reasons, I think a targeted prebate, much like EITC, would have made much more sense. If we are really concerned about the regressive nature of a national sales tax on the poor, it turns out that a targeted prebate would do the job at a cost of around $59 billion annually.
This is just utter nonsense and bad economics. There are plenty of legit things to criticise the FairTax about without making crap up. This is borderline dishonest. Bartlett made this argument - redefining effective rates and tax burden methodologies. Read Memo to Bruce Bartlett: Just Do the Math By David G. Tuerck “It seems counterproductive to provide numerical illustrations that could encourage readers to think only in the nonsensical way Bartlett suggests. By trying to reinvent the calculation of the effective rate, Bartlett steers the reader into a mistake of his own making”. And you criticise them for the 23/30% thing.. talk about twisting numbers to bias the view. I’m mad I even spent the time to post to this thread.
Sorry we made you mad, morphh, but facts are facts.
(WARNING: This post is long, and the math SEEMS complex. But if you take it step by step, it’s really pretty simple.)
FairTaxers keep trying to say the FairTax has nothing to do with income because it’s a consumption tax. But ALL taxes on individuals — be they sales taxes, property taxes or income taxes — are paid with the money those individuals have in their wallets and bank accounts. And where does that money come from?
For most, the money comes from one’s job. For retirees, it comes from Social Security payments, a pension or interest on savings or investments. For big shots, it may come from capital gains on investments or stock dividends. For the poor, some of it comes from government benefits. But it’s all INCOME.
Try to follow the logic here. All taxes are paid with the money we have. All the money we have comes to us, in some form, as INCOME. Therefore, all taxes are paid with INCOME. And because of that, tax burden is ALWAYS — I repeat, ALWAYS — expressed as a percentage of INCOME.
AFFT seeks to change the math — and make the FairTax look progressive — by calculating one’s tax burden based entirely upon one’s spending, and using the prebate to offset the taxes paid on spending up to the poverty level. Spend just to the poverty level, AFFT maintains, and your tax burden is 0. Spend above the poverty level, and your tax burden increases as your spending increases. Spend BELOW the poverty level, and you actually have a negative tax burden! Presto-chango! Progressive tax!
But tax burden is NOT expressed as a percentage of spending. It is always — ALWAYS — calculated as a percentage of income, because ALL TAXES — EVEN SALES TAXES — ARE PAID WITH INCOME!
And the prebate, my friends, is not — as AFFT wants you to believe — a credit on taxes paid. It is, as Hank points out, a direct cash payment from the government. And a cash payment from the government is INCOME!
The best way to make you see this is with a real world example. I’ll try to keep it simple.
AFFT says if you spend just up to the poverty level, your effective tax rate will be zero. I’m going to prove to you this is not true. I’m not going to “twist” numbers. All my numbers will be very straightforward, and I’ll walk you through the math. And I’m going to use the example of the FairTax Card just as Neal Boortz describes it.
You are a single person. You bring home $2,000 in a typical, two-paycheck month from your job. (That’s $2,000 in FairTax Land, with nothing withheld — your “entire” paycheck).
It’s the beginning of the month. You’ve just gotten your first $1,000 paycheck, and your FairTax Card has just been credited with your $199 prebate.
You go to the grocery store and buy $100 worth of groceries (that’s $100 worth with all those nasty embedded taxes taken out and the FairTax already added in). You get up to the cash register and swipe your FairTax Card. The register subtracts $100 from your card.
TOTAL SPENT: $100
FAIRTAX ON PURCHASE: $23 (100 x .23 = 23)
AMOUNT LEFT ON CARD: $99
You go to the gas station. You fill the 8-gallon tank in your Smart ForTwo with premium unleaded at $4.00 a gallon (that’s $4 a gallon after all those nasty embedded taxes — presumably including gas taxes — have been taken out, and the FairTax already added in). You pay at the pump with your FairTax Card, and the pump computer subtracts $32 (8 gallons x $4.00/gallon) from your card.
TOTAL SPENT: $32
FAIRTAX ON PURCHASE: $7.36 (32 x .23 = 7.36)
AMOUNT LEFT ON CARD: $67
That night, you take your girl to the movies. Movie tickets, $18. Popcorn, nachos and drinks, $20. Not having to pay all those nasty embedded taxes, and having the FairTax already added in, Priceless.
TOTAL SPENT: $28
FAIRTAX ON PURCHASE: $6.44 (28 x .23 = 6.44)
AMOUNT LEFT ON CARD: $39
Finally, you stop at a bar on the way home and buy your girl some drinks (you’re driving, so you just drink soda). The tab comes to $40 (that’s $40 with all those nasty embedded taxes taken out and the FairTax already added in). You give your FairTax Card to the bartender, and he swipes it through the register. It deducts the last $39 from your card, and the bartender informs you that you owe him $1. You whip out your wallet, pull out your debit card, and give it him. He rings it up, frowning. He knows he’s not going to get a tip from you (hey, you’re frugal, and after all, the bartender gets to keep his whole paycheck now). The $1 is deducted from your checking account.
TOTAL SPENT: $40
FAIRTAX PAID: $9.20 (40 x .23 = 9.20)
AMOUNT LEFT ON CARD: $0
By the time you go to bed, you’ve made $200 in taxable purchases, only $1 of which came out of your checking account. The rest was deducted from your FairTax Card. But, as you may have noticed, your prebate card hasn’t paid $199 in taxes. It’s only paid $46 in taxes (23 + 7.36 + 6.44 + 9.20 = 46). The rest of your monthly prebate was spent on the cost of the goods themselves (this is how Boortz describes it, and how most people would use it). And your prebate card is now exhausted for the month.
Now, so far, you’re doing pretty good. You’ve purchased $200 in taxable goods, paid $46 in FairTax, and only spent $1 out of your first $1,000 paycheck for the month.
The month goes along, and you get your second $1,000 paycheck. Finally, it’s the end of the month. Time to tally up and see how much you’ve got left to roll into your savings account.
Now, you’ve been frugal (no tip for that lazy bartender), and you’ve spent exactly the povety level in taxable purchases for the entire month (including the groceries, gas, movies and drinks you put on your FairTax card). That means your total spending for the month was $866. The FairTax on that was $199, which is exactly the amount of the prebate put on your FairTax Card at the beginning of the month.
You had $199 on your FairTax Card. You paid $199 in taxes. Your tax rate is zero, right? That’s what AFFT says.
Not so fast, bunky. Let’s go back to your bank account.
You got $2,000 in paychecks this month. You spent $866. You should have $1,134 left (2,000 - 866 = 1,134).
But wait. Remember at the first of the month when you got your first $1,000 paycheck? You went out and spent $200 that day, but at the end of the day, you still had $999 in the bank. You only spent $1 of your paycheck.
Through the rest of the month, you got another $1,000 paycheck and spent another $666, all on the debit card for your bank account. So only $667 of your spending for the month came out of the $2,000 in paychecks you earned. That leaves you with $1,333 in the bank, not the $1,134 you were expecting (2,000 - 667 = 1,333).
Are you following this? You earned $2,000. You spent $866. You have $1,333 left in the bank. That doesn’t add up (2,000 - 866 DOES NOT = 1,333).
But it DOES add up when you add the $199 prebate to your income (2,199 - 866 = 1,333).
So was your tax rate zero, as AFFT claims? No. Because you spent your $199 prebate AS CASH. It ADDED $199 to your INCOME. It DID NOT SUBTRACT $199 from the tax you paid.
So what was your tax burden? Remember, tax burden is ALWAYS expressed as a percentage of income. To get your tax burden, divide the amount you paid in taxes by your income.
Your total income for the month (earned income + prebate) was $2,199. You paid $199 in FairTax. Your tax burden for the month was 9 percent. (199 ÷ 2,199 = 0.09)
“But wait!” I can hear a lot of you shouting at your computers right now. “My income was $2,000, not $2,199. My prebate paid my $199 in FairTax!”
No it didn’t. You spent it as cash, remember? Your prebate card only paid $46 in FairTax. You paid the other $153 in FairTax out of pocket.
Now, you COULD reduce your tax burden to zero. When you went to the grocery store, the gas station, the movie theater and the bar, you COULD have paid $77 of the grocery cost, $24.64 of the gas charge, $21.56 at the movie theater and $30.80 of the bar tab out of pocket. Then only $46 would have been subtracted from your FairTax Card. And if you had done that all month — used your own money to pay the actual cost of the goods you bought and used your FairTax Card JUST to pay the tax — then your tax burden would be zero.
And you would have $199 LESS in your bank account and wallet at the end of the month.
Either way, $199 goes bye-bye.
You can plug any numbers you want into this scenario. If you want to spend your prebate as cash, add it to your income. But then you don’t get to subtract it from your tax burden.
The formulae under this scenario are as follows:
ei + p = ti (”ei” = earned income, “p” = prebate, “ti” = total income)
ts x .23 = ft (”ts” = taxable spending, “ft” = FairTax paid)
ft ÷ ti = tb (”tb” = tax burden)
If you want to use your prebate to cover all your taxes up to the poverty level, you can’t add it to your income. The formulae under this scenario are as follows:
ts x .23 - p = ft
ft ÷ ei = tb
Using the prebate ONLY to offset your FairTax reduces your tax burden. But it also reduces your total income, and therefore your purchasing power. And for those struggling to make ends meet, and living paycheck to paycheck, that’s a problem.
And no matter how you do it, the basic fact remains: The poor spend a higher percentage of their income than the middle class, and the middle class spend a higher percentage of their income than the rich. Therefore, a sales tax — even one with a prebate — is regressive.
I didn’t read your entire post as I don’t have enough time to go through it and do a proper rebuttal at the moment but you are completely incorrect that tax burden is always based on income (what is normally considered “wages”). There are many metrics economists use for assessing economic well-being. While most often measured using single year income, economic well-being can also be measured by multi-year income, lifetime income, expenditure, or wealth (variations often depend on the tax base). Models such as the Suits index, Gini coefficient, Theil index, Atkinson index, and Robin Hood index are sometimes used to factor progressivity through measures of inequality of income distribution or inequality of wealth distribution.
Every informed economist will tell you that income is poorly correlated with expenditure and that annual income is not an especially accurate measure of one’s ability to pay. Households at the high end of consumption often finance their purchases out of savings, not income. A household’s consumption tends to fluctuate less from year to year than its income does, and in some respects offers a better measure of a family’s sustainable standard of living. Many economists feel that averaged over periods longer than one year, which smooths out fluctuations in annual income, expenditure comes closer to reflecting “permanent” income and is the more appropriate measurement. Economists have also used lifetime income when measuring the progressivity of a consumption tax.
As far as the “effective rate” suggested here. I think Tuerck does a decent job describing the false nonsensical math of it. Standard economics defines an effective rate to be tax minus government offsets. The prebate is a government payment meant to offset a tax burden - it is in the tax code for that purpose. You’re trying to redefine the terminology and standard methodologies; however, similar models exist (such as Friedman’s negative income tax) that have like tax offsets. The offset applies to expenditure during the next month. How can an offset apply if it is part of the expenditure when determining the effective rate? - it can’t. If the rebate is considered income (instead of tax offsets) then we’re back to a proportional tax of 23%. You can twist the math to try and represent 0% marginal to the poverty level and then apply to the prebate as income, but this is not anything commonly done. It is a new mathematical formula - just for us - created with the purpose of making the effective rate appear higher.
I’ll try to get back to this tomorrow if I have a chance.
In response to post 8,
As far as I can tell from perusing, the math seems to be accurate. However, the reasoning behind the math is completely illogical.
The most egregious example is this paragraph:
“Now, you COULD reduce your tax burden to zero. When you went to the grocery store, the gas station, the movie theater and the bar, you COULD have paid $77 of the grocery cost, $24.64 of the gas charge, $21.56 at the movie theater and $30.80 of the bar tab out of pocket. Then only $46 would have been subtracted from your FairTax Card. And if you had done that all month — used your own money to pay the actual cost of the goods you bought and used your FairTax Card JUST to pay the tax — then your tax burden would be zero.”
Maybe I am misunderstanding, but is the suggestion that where one decides to pay for a purchase, i.e. from the FAIR Tax card or from their own bank account, has anything to do with the effective tax rate? Is so, this is completely wrong.
I am not claiming to be a huge proponent of the “prebate”, but pre-refunding the monthly tax on spending up to the poverty level is no more income than the tax I don’t pay on my income tax personal exemption. If instead of receiving a prebate, all of your purchases for the month were tracked and you didn’t pay the fairtax until your spending had reached the poverty level (adjusted for no tax) would you consider the money in left in your account that would have paid for the tax as new income. I wouldn’t. (Of course, all of this only applies to spending at or above the poverty level. Everyone else is getting income equal to the prebate minus the fair tax paid.
Logan,
so what? The 5.29% is FAR better than the 15% the working poor have to pay now for FICA. Never mind how much better off the working poor will be with prices dropping at least the 5.29% and the economy growing at a rate higher than anything we’ve ever seen.
Hank,
the prebate costs less than half of current refund schemes. If you target the prebate then you have to collect information on income and such. People can and do lie for benefits. Should our government be in the business of prying into our personal lives or encouraging it’s citizens to lie?
Bill,
all wealth is created by businesses so all income comes from businesses. Tell me why we should burden businesses with anything other than creating wealth?
You appear to have bought the “evil rich” BS of the left. If someone doesn’t spend all their income, what do they do with it? They invest.
All investing in America helps our economy. The FairTax will eliminate federal taxes on investments and leave darn few if any reasons to invest anywhere else.
Investments in businesses increases capital which is directly related to increased productivity which is directly related to increased wages and lower prices. The working poor will benefit tremendously with the FairTax. Please get off the “evil rich” BS.
dculling,
You wrote: “the prebate costs less than half of current refund schemes”. I don’t know what data you are looking at, but according to the IRS, in 2006 the total refunds amounted to $280 billion, less than half of the proposed Fairtax prebate The 2006 refunded amounts included not only $52 billion for the refundable EITC and Child Tax credits, but also included overpayments by citizens who don’t seem to mind giving the feds an interest free loan, favorable(?) audit results, and interest on some types of refunds.
As for collecting income information in order to target the prebate, you may have forgotten that income information will still flow to the SSA even under the Fairtax. I admit I haven’t thought too much about targeting the prebate, but it doesn’t seem to be any more difficult than targeting the EITC??
I think the problem with the lead post from Logan is that it takes a static view of the prebate. Sure, the prebate, as Fred Johnson points out at Post No. 2, is partially taxed when spent, thus reducing its value slightly in Year One. However the amount of the prebate is not set by the Fair Tax Act but by the Department of Health and Human Services. We don’t make it up. Thus, if the prebate for Year One is inadequate to cover poverty-level spending, HHS certainly will take that into account when it sets the poverty level for Year Two. The problem self-corrects.
~Jim Bennett
Summit, NJ
Jim,
The prebate isn’t “partially taxed when spent”, it’s all taxed, which reduces it’s real value by 23% it seems to me. And there is absolutely no relationship between the tax on the prebate and the poverty level as set by HHS. HHS will determine each years poverty level, and the prebate will be increased accordingly. But the tax on the prebate will still be unaccounted for. There is nothing “self correcting” about this issue!
Jim,
This is one of the issues. It seems the AFFT assumes that the poverty level would be adjusted up to accommodate the FairTax, but if this is true then the prebate would be much larger than claimed and all the FairTax rate estimates we’ve seen are too low.
morphh - You’re putting words in my mouth when you describe “income” as “what is normally considered ‘wages.’” Wages are part of income, but they are not the only component.
The Bureau of Labor Statistics defines “income” as “wages and salaries; self-employment income; Social Security and private and government retirement income; interest, dividends, and rental and other property income; unemployment and workers’ compensation and veterans’ benefits; public assistance, Supplemental Security Income and Food Stamps; rent or meals or both as pay; and regular contributions for support, such as alimony and child support payments.”
It’s certainly true that economists use “many metrics” for assessing economic well-being. I’m not an economist by trade, so I use the metric the vast majority of Americans use: “When payday rolls around, what’s left from the last paycheck?” If I still have money in the bank when my next paycheck hits, I’m doing okay. If I had to dip into savings, roll loose change to make a bank deposit, or max out my VISA card (again) to make it from paycheck to paycheck, things aren’t going so well.
As a result, I look at the FairTax not from a theoretical standpoint, but from a “real world” standpoint: What will it mean to me and other people at my end of the economic ladder (that is, a majority of Americans)?
Hence the “real world” example I offered. This is not economic theory. This is how it would work in the real world.
You ask how an offset can apply if it is part of the expenditure when determining the effective rate. But that’s precisely why I maintain that the “prebate” is NOT a tax credit, as it is so often described. It’s NOT a true offset. Most people who get the prebate will NOT use it just to pay the FairTax portion of the cost of taxable goods. They’ll use it for the full amount of the purchase. So for every dollar of the prebate spent, 23 cents will go back to the government in the form of taxes.
Andrew - Yes, it sounds illogical, but it really isn’t. Where you’re misunderstanding is by confusing TAX RATE with TAX BURDEN. The tax rate is constant at 23 percent. But the tax burden changes based upon how much you spend. And in the case of the FairTax prebate, your burden CAN (and will) change based upon how you spend it.
If you use your prebate JUST to pay the FairTax on your purchases, than the prebate will, as FairTax supporters contend, pay every penny of the FairTax on your purchases up to the poverty level. But if you use the prebate to pay the entire cost of taxable goods or services (which is how most people will use it), it will only cover 23 percent of the tax on spending up to the poverty level. The other 77 percent will come out of your pocket.
You write: “If instead of receiving a prebate, all of your purchases for the month were tracked and you didn’t pay the fairtax until your spending had reached the poverty level (adjusted for no tax) would you consider the money in left in your account that would have paid for the tax as new income. I wouldn’t.” Neither would I, and that’s my point. If the FairTax Card Neal Boortz proposes were used to track your purchases and deduct the FairTax from them until your allowance for the month was reached, it would be a true offset, and you really wouldn’t pay one penny in taxes up to the poverty level. But unless it’s set up that way instead of the way Boortz describes it, the prebate has to count as spendable income (in the same way the BLS counts government assistance, Supplemental Security Income and Food Stamps.
dculling - No, I haven’t “bought the ‘evil rich’ BS from the left.” I get it for free every day.
By that I mean I see the effect of the “Greed is Good” mentality on my life and the lives of those around me on a daily basis.
For the record, I don’t think all (or even most) rich people are “evil” or that corporations are bad. I support capitalism and admire entrepreneurship. But I don’t buy into the “What’s Good for Wal-Mart is Good for America” credo. I don’t believe elevating the interests of stockholders over those of customers and employees is good for America. I think the success of companies like COSTCO, where the CEO earns only $135,000 a year and all employees receive a living wage, is proof that good corporate citizenship is also good business.
You write: “All wealth is created by businesses so all income comes from businesses. Tell me why we should burden businesses with anything other than creating wealth?”
Here’s why: Businesses, like everyone else, benefit from the existence of government. Government enforces contracts. Government provides security in the form of police to protect against criminal acts against the business, firemen and other first responders to protect the business from natural and man-made disasters, and a military to protect the business from acts of terrorism or overt acts of war. And perhaps most importantly, government provides critical infrastructure - roads, bridges, ports - without which American businesses could not even operate on a regional scale, much less a national or global one. And because business benefits from the existence of government, business should have a responsibility to share in the cost of government.
Regarding post 12: the post from Logan does address a non-static prebate and makes the point that if the prebate amount increases, those dollars must come from the non-prebate funds collected. If the tax itself is revenue neutral as advertised, there will be no surplus funds to provide an increased prebate to every household in a subsequent year. The problem will self-correct only via an increase in the actual tax rate. A compensating reduction in non-prebate government spending would require legislative action and could not be considered self-correcting.
That’s my understanding of one problem presented in the original post.
Ellen
I guess I do understand how some would have the need to complicate the Prebate into something that they are familiar with, like our current tax system. But, the whole idea with the Fair Tax is to simplify the entire process. So, try to follow the logic. A calculation is made to determine the amount an average household would pay in Fair Tax at the poverty level. That number is divided by twelve and paid at the beginning of each month. It does not matter how the prebate is spent or that tax is applied to the purchase, it’s irrelevant.
What is relevant is that poverty level spending is multiplied by the inclusive FairTax rate to determine the prebate. If the calculation were determining what an average household would pay at poverty level spending, the spending would be multiplied by the exclusive rate. The confusion apparently goes back to the desire to present the 23% inclusive rate rather than the 30% exclusive rate for comparison to existing income tax inclusive rates. The prebate calculation provides the tax dollars needed to cover about 77% of current poverty level spending. In the example provided, the prebate covers “tax free” spending of $21,560 for a household in the $28,000 poverty level spending category. That’s relevant to some, irrelevant to others.
Bill,
I did not limit your definition to wages - I said it is normally considered wages. However, after posting, I thought it better if it were removed but I could not edit. Sorry for the confusion.
What you are describing is a perception - not an effective rate, which has standard economic methods for factoring. Don’t twist economic terms to meet new definitions, particularly when they’re inconsistent with the methods used to measure the present system. Don’t make it out to be better then it is or worse then it is. A tax offset is something in the tax code with the specific intent to offset taxes paid (the prebate is a tax offset). While you could consider it a welfare check or some other form of subsidy, this is not how it is computed when economic models determine what the tax burden or effective tax rate are (see Philip B. Coulter: Measuring Inequality, 1989, which describes about 50 different inequality measures).
I have to back step a little bit as I quickly read through the lead post and ended up reading Bill and Hanks posts and then skimming through the rest. There are actually two arguments going here so let me clarify. I’m not sure that I disagree with the lead post (Logan and Fred). While I’ve never seen the effective rate presented that way in studies, it does seem to follow standard economic models. I do disagree with Bill and Hank’s argument (if I’m reading it correctly) that the rebate should not be factored as a reduction in tax liability and only as income (at least when discussing effective rates), which is all taxed at 23%. Two different sets of math..
Hank, in regard to #12 reply. dculling was likely referring to the income tax deductions, tax preferences, credits, etc. under the current system, that was estimated at $945 billion by the Joint Committee on Taxation.
If the argument is with how the amount of the Prebate is calculated and it needs to account for the added Fair Tax is just not right. The calculation already assumes that 100% of all earnings up to the poverty level of the base household are spent on basic needs to reach a dollar amount. In reality no household spends everything on NEW basic needs. If they do their income would be way below the poverty level and even that is not realistic because some of their basic needs will be used and not taxed.
Morphh,
You are basing your whole argument on the Wiki definition of “effective tax rates” Which reads: “the effective tax rate is the amount paid when all other government tax offsets or payments are applied, divided by the tax base (income or spending)”.
I took the time to review dozens of other source definitions in the first ten pages of Google references for effective tax rate, and they all define “effective tax rates” as “the actual income tax paid divided by net taxable income before taxes, expressed as a percentage”. Nothing about offsets or spending considerations.
Without pointing fingers, it seems to me that someone with an agenda might have tinkered with the Wiki definition, particularly when that someone added spending considerations as part of the definition. I find it odd that that is the only definition I could find that talked about spending, government tax offsets, or “other (government) payments”? As for that last, does that mean that those of us receiving government payments in the form of military pensions, or all SS pensioners should deduct those payments when calculating effective tax rates? I don’t think so!!
Morphh, the prebate is only a tax refund because you (and AFFT) say it is. In fact, it is a cash grant entitlement which will be taxed and spent, or saved depending on individual circumstances. It doesn’t matter if people think of it as a tax refund, an alimony refund, rental assistance, gasoline tax refund, or whatever, it is still going to be scored by OMB as an entitlement. And we don’t need any more entitlements in the federal budget! I’m glad to read that you agree with the initial post (and Fred) because they make a valid point. A point that has been glossed over or ignored by Fairtaxers since day one.
Hank, it is part of the tax code as a tax refund for the purpose of offsetting tax liability. SS pensions or military pensions are not part of the tax code and are not intended to offset tax liability. As far as effective tax rates, I could find plenty of sources that define it more broadly. Google works by page count, and of course, most U.S. sources define it that way since they are mainly measuring income taxes. Read the Tuerck paper.
We can debate economic theory until the sun explodes. If economics were an exact science, all economists would agree and the optimum fiscal policy would be easy to establish.
I read stuff like “Every informed economist will tell you that income is poorly correlated with expenditure and that annual income is not an especially accurate measure of one’s ability to pay.” (morphh, post 9), and I scratch my head. That may make sense to an economist, but to someone like me living from paycheck to paycheck, it’s total nonsense.
For someone in my situation — indeed, for most working people — income is precisely correlated with expenditure, and is not just an accurate measure of one’s ability to pay, it’s the ONLY measure.
Morphh accuses me of “twisting math.” I’m puzzled that simple addition, subtraction, multiplication and division can be considered “twisted.” I used real world examples showing someone receiving a paycheck and a prebate check, then “going forth into the retail marketplace” and spending the money. Then I broke out how much of that was tax, and I calculated — using the most basic math known to man — how much of the money my hypothetical person had coming in went to pay tax, and expressed that as a percentage. And I promptly got accused of twisting the math.
I’m not the one trying to overcomplicate the simple. You get $2,000 in wages in a month. A check comes from the government for $199 and you put in the bank. You buy $866 worth of stuff. You pay $199 in tax. You had $2,199 coming in, $866 going out and $199 of what went out was tax. The tax going out was 9 percent of what came in. What’s twisted about that?
People living below, at, or slightly above the poverty line tend to spend close to (in some cases more than) 100 percent of their income. People in the middle class tend to spend slightly less than 100 percent of their income. People in the upper class tend to spend much less than 100 percent of their income.
Again, we’re talking simple math. If you spend 100 percent of your income on taxable goods under the FairTax, your tax burden as a percentage of your income is 23 percent. If you spend 75 percent of your income on taxable goods, your tax burden is 17.25 percent. If you spend 50 percent of your income on taxable goods, your tax burden is 11.5 percent.
You can muddy the water with talk about keeping your entire paycheck, costs coming down, expressing the tax rate as an inclusive number and how the prebate pays all your taxes up to the poverty level, but you won’t really change anything.
Everyone’s income may be higher if the FairTax works as advertised. Everyone’s costs may be lower. The prebate would help a little. The numbers may change slightly. But the basic equation will remain the same. The poor will still spend a higher percentage of their income than the middle class and the middle class will still spend a higher percentage of their income than the rich. That means the tax burden on the poor will be higher than that on the middle class, and the tax burden on the middle class will be higher than that on the rich. That’s the textbook definition of a regressive tax.
It really is that simple.
Hank, with the definitions you found they usually state “actual tax paid”. What defines the actual tax paid? Taxes paid minus tax offsets (refunds, rebates, credits). That which is defined in the tax code to reduce your tax liability.
Morphh,
As you wrote earlier, there are two issues being discussed here. (1) Is the prebate income?; and (2) How are effective tax rates calculated?.
There can be little argument that the prebate isn’t income. Just look in your checking account each month.
As for the definition of effective tax rates, I believe that given the opportunity, you might have made it clear that you are the author of the current Wiki definition, which you are using to defend your definition of effective tax rates. Sort of like being the pitcher and catcher at the same time, isn’t it? Frankly, I think you were very premature in revising the Wiki definition to reflect Fairtax considerations. Imagine the confusion you have created for the 299 million folks that don’t understand the Fairtax when trying to define effective tax rates, they see a bunch of stuff about offsets, spending, actual taxes, etc. Until the Fairtax becomes law, I think the simple definition of tax paid divided by income works just fine.
As for Dr. Tuerck’s attack on Bartlett, his definition of effective tax rates is certainly different. If I read the Tuerck rebuttal correctly, he would calculate effective tax rates by dividing tax paid by taxable income. All that does is make the income tax effective tax rates higher, and portrays the income tax in the worst possible way. Makes no sense to me! I still prefer tax paid divided by income. Simple and clear.
Hank, I am not the author of the wiki definition, although I did contribute and merge data in the article. I merged the effective tax rate, marginal tax rate, and average tax rate article into one article, so perhaps it appeared that created the definition. The definition was there before I edited the article and partly based on the Australian Commonwealth Government Treasury website “... the effective rate is the average rate of taxation for every dollar of income or consumption. It is the total tax obligation, including all relevant taxes and credits, divided by total income or consumption.” It goes on to state “the effective tax rate reflects the tax payable as a proportion of total (rather than taxable) income or consumption. In this case, the effective tax rate can differ from the statutory rate where taxable income differs from actual income — for example, because of tax offsets.” Apology forthcoming I hope for the false charge.
I agree that the prebate is income in that it appears in your checking account, but so is an income tax refund. The question is if the prebate is a return of income paid on taxes or “new” income? You’re arguing that it is “new” income and that the prebate is not a tax offset. Do you add your tax credits and refunds to your current income? No, this is a return of income paid - a restoration of purchasing power. Tuerck’s definition is the common income tax effective rate calculation. “Tax paid” is taxes minus refunds, credits, etc. - the actual taxes paid after all tax code offsets apply - divided by taxable income.
Morphh, why would you divide actual taxes paid by taxable income? Shouldn’t you use comprehensive cash income? Using your method, any deduction that reduces taxable income wouldn’t necessarily change a person’s effective rate even though they are making the same comprehensive income and paying less taxes.
I think there is some confusion. Tuerck uses Gross income, not taxable income and I’m not sure where I stated taxable income. I think Hank stated taxable income and I did not correct him. The quote also uses a reference to taxable income when talking about alternate methods of calculation. I was only pointing out the reference to tax offsets. Usually the calculation uses total or gross income, not taxable income since taxable income can include such offsets.. to your point I believe.
Oh, I see where I said that (last sentence).. typo - should be total income. Good catch Fred.
Bill, of course, the less you make the higher the percentage you pay in taxes. That’s the way it is now and if you take into account hidden taxes, real tax burden is increasing for everyone everyday under the current mess. But everyones individual/household tax burden will be reduced with the Fair Tax. You fail to take into account that millions of taxpayers will added to the rolls. I live in San Diego and we have a large tourist industry that attracts about five million foreign visitors annually. Not to mention the illegal boarder crossers and underground industries that are not current taxpayers. These very large groups, which now are not contributing anything to the tax base already consume or inflate the need for government services significantly. With the Fair Tax they will become taxpayers and reduce the burden on the rest of us. Ask the man that is struggling to make ends meet if he would rather pay less money in taxes or a lower percentage, less money will win every time. It’s really that simple.
Morphh,
I’ll give you a half apology, because I can’t tell just where or when the revision to include offsets in the definition was made. But, no matter where the idea came from, you are solely the author of the revision which included consumption or spending in the definition. (August 16th, 2007.) It is the inclusion of consumption in the definition that causes me to say that you were premature, and will lead to confusion if the nation does not adopt a consumption tax.
Meanwhile, I must confess that within my own household, there are conflicting views as to what is income in the effective tax rate equation. I maintain it’s the amount on your tax return that is called gross income. My wife, who is a volunteer tax preparer for AARP says it should be the adjusted gross income. And others seem to think it’s taxable income. Who knows or cares? Except the new Fairtax calculator is designed so as to change my effective tax rate depending on my choice of pre tax cost reductions. Now tell me, what do prices have to do with my effective tax rate? Price reductions or increases should impact only purchasing power, but not effective tax rates. But, even after numerous emails to AFFT, the calculator remains unchanged, and completely fraudulent IMHO.
Hank, The wikipedia article should represent a global viewpoint and not present a single view as being the correct one. To this end, it is necessary to have a broad definition, as shown above with Australia, that includes spending as a base for computing effective rates. So what the U.S. does or doesn’t do with a consumption tax is irrelevant. There is nothing premature about it. I edit hundreds of tax articles and most of have nothing to do with the FairTax. The source where it was pulled (June 7, 2006) included “the effective rate of tax represents the average tax when all other government tax offsets or payments are included” - Australian Commonwealth Government Treasury. This lines up with the way we compute effective rates as well (unless you’re Bartlett attacking the FairTax).
I’m a little confused by your second paragraph as the price of goods should have no effect on the effective tax rate. I would agree and while I haven’t used the AFFT calculator, this seems illogical. This comment seems to deviate from the your original debate though and seems a bit confusing. Under the calculation of assuming the rebate as additional income, there would be no effective rate, or more clearly, it would be the same as the statutory rate (not even the marginal rate since we have two brackets 0% and 23%). So there would never be a change in the effective rate from 23%. This is what appears to be your argument. That the prebate is not a tax offset but additional income. If that is your argument, then there is no effective rate - only a 23% tax with a government subsidy to increase income. This is not how effective tax rates are calculated in any country. Since the rebate is included in the tax legislation for the specific purpose of reducing the tax liability of the taxpayer, then it is to be included in the calculation as a reduction of tax paid, not additional income. If you earn $10,000 and spend $10,000 (paying $2,000 in taxes), when the government issues a tax rebate, it is to restore your purchasing power to $10,000, not increase it to $12,000.
The original post makes an argument using the rebate as a tax offset, and then goes to discuss how the prebate was not correctly calculated due to the taxation of the prebate itself - concluding the prebate is insufficient to fully restore the original purchasing power. Your argument is completely different, which seems to suggest that there is no restore of purchasing power - it is an increase of purchasing power with no offset to taxation. Now, I agree that you could perceive it this way. I’m not going to suggest that you are incorrect in how you may view this - that’s your opinion. But we can not take this definition as the method of computing an effective tax rate - it goes against common calculations. What is the point in a definition of effective tax rate that does not include any offsets? Again, I don’t have a problem with the argument itself, I just have an issue with the term used (which deviates from every standard definition).
Logan, I’m not sure I agree with your assessment that the figure would have no end. I would expect it to decrease each time as the base is much larger then the cost of the rebate. The additional revenue needed may increase the rate (lets say 23.1%), which increases prebate, which increases the rate (23.11%), repeat (23.111%), repeat (23.1111%). At some point you just say 23.12% and are done with it.
Morphh,
Sorry about the confusion. My comments about the AFFT Fairtax calculator had nothing to do with our discussion about how to define effective tax rates. It just happens that the calculator changes my effective tax rate when I use the option page to adjust my preference for before tax cost reductions. (The default is 10%, but you can choose from zero to 30% in pretax price reductions). And as you say, it is entirely illogical to change effective tax rates based on price changes.
I guess I was looking for a little support to get AFFT to fix the darn calculator. They haven’t done anything in response to my complaints. And meanwhile, lots of folks are using the thing and are reporting to be very happy with the results which incorrectly penalize the income tax option. In your spare time you might try the calculator. I don’t think you’ll like it!
So - should Section 301 be rewritten as...
`SEC. 301. FAMILY CONSUMPTION ALLOWANCE.
`Each qualified family shall be eligible to receive a sales tax rebate each month. The sales tax rebate shall be the sum of section 301(a) and 301(b).
`(a) An amount equal to the product of–
`(1) the rate of tax imposed by section 101, and
`(2) the monthly poverty level.
`(b) An amount equal to the product of–
`(1) the rate of tax imposed by section 101, and
`(2) the amount calculated by section 301(a).
I ask because Linder and Boortz said several times (in their latest book) that they were open to changes that followed the principles of the plan. Perhaps such a change could be suggested - submitted to AFFT.
Sec. 301 should be rewritten so it’s like Title III, Sec 303. That section adjusts Social Security benefits to account for the FairTax but if the Consumer Price Index doesn’t include the FairTax it requires the exclusive rate to be use. If the CPI does include the FairTax, the inclusive rate is used. The same should be done for the prebate and the poverty level.
Responding to rmforbes in Post 32 - sorry it took so long. I worked Friday and Saturday, was ill all day Sunday, and had jury duty today. Not much time to catch up on things.
Including “hidden taxes” - presumably Jorgenson’s famous “22 percent added to the cost of everything you buy” — as part of one’s tax burden is like adding the impact of higher fuel prices on the cost of everything you buy to what you pay at the pump to calculate your gas budget. It’s an exercise in futility.
One can quantify one’s personal tax burden — for me, it’s what I pay in income tax, Social Security and Medicare payroll taxes, Florida’s 7 percent sales tax and my share of the local property tax on the house my family owns. But it’s impossible to precisely quantify the burden of “embedded taxes” on a given individual because it’s impossible to know how much federal tax cost is embedded in the individual items one buys.
To take an example from the FairTax Book, Neal Boortz says Mercedes carries a built-in tax advantage over Cadillac because the German government refunds the VAT on export Mercedes-Benzes. But if you compare the prices of Mercedes-Benzes to Cadillacs, you’ll find that a bottom-end Mercedes costs slightly less than a bottom-end Cadillac, while a top-end Cadillac costs considerably less than a top-end Mercedes. Clearly, the effect of the tax component has a negligible impact on the actual cost of these two vehicles.
The income tax itself is progressive — that is, those who make less pay a lower percentage of their income than those who make more. You can add Jorgenson’s 22 percent embedded tax average to the income tax to make it SEEM regressive, but I don’t think that’s valid. Again, it may work for some economists, but it makes no sense in the real world.
I’ll concede the point that the FairTax will add new taxpayers by taxing tourists, but the same thing could be accomplished through a national bed tax on hotel rooms. As for the underground economy, what’s to prevent those people from offshoring their purchases just like they’ve offshored their income?
Finally, I’ll agree that most working people (myself included) would choose paying less in real dollars than less in a percentage. But after looking at the FairTax, I’m convinced that it will not only cost me a higher percentage of my income than the income tax, it will cost me more in real dollars as well.
So if the poverty level figures issued by the Department of Health and Human Services include the FairTax, then the inclusive rate should be used (as currently written) but if the poverty figures do not include the FairTax, then the prebate should use an exclusive rate calculation. Correct?
I have read a number of responses in this blog before giving up on analyzing each of them individually. There are some confusing areas and some one-sided presentations. The analysis, I believe, can be made more simple yet comprehensive.
Let’s start, if we may, by agreeing to compare the real purchasing power of those people in the poverty levels, under both the present system and then under the Fair Tax system. Do those people lose, or instead gain, in the value of goods and services (G&S) which they can buy under the Fair Tax plan?
First, define some variables. Let:
M=the dollars used to purchase G&S (Good & Services). This is the amount of money that actually changes hands when you buy goods and services.
ET=the dollar value of embedded taxes in the G&S. The embedded tax percent is 22.
FT=the dollar value of fair tax in the G&S purchased. The fair tax percent is 23.
V=the real value of G&S. It can be seen that this value is the dollar amount spent on the G&S minus the dollar amount of any taxes (the taxes do not add value to the products) in that purchasing price. That is,
V=M-ET-FT
P=the poverty level which we are looking at for our analysis. I will use P=$28,000 as has been used previously. In the present system, then, M=$28,000, as the family at that poverty level has that amount with which to work.
Second, calculate the value V of G&S which can be purchased under the present system of taxation.
M=28,000
Embedded Taxes are 22% of the purchase price:
ET=0.22(28000)=6,160
There is no FT in the present system, so FT=0
V=M-ET-FT=28,000-6,160-0=21,840. That is, the actual value of G&S which this family can buy is $21,840.
Third, calculate the value V of G&S which can be purchased under the Fair Tax system of taxation.
Now, there are two extremes which we need to consider under the proposed Fair Tax system. What actually happens will be between these two extremes.
1. The purchase price of G&S decreases by 22% since there are no embedded taxes.
2. The purchase price of goods and services remains the same. This can happen if none of the anticipated savings otherwise passed on to the end consumer are actually passed on. Contributing to this scenario, for example, would be if workers demanded that the employers’ tax contribution on wages were instead taken by the workers to increase their take-home pay even more.
Analysis of these two extremes:
1. The purchase price of G&S decreases by 22% since there are no embedded taxes.
The Prebate is 23%, and the poverty level we are considering is 28,000. Prebate=0.23(28000)=6,440.
Thus, the total amount of money (M) this family has to spend is 28,000+6440=34,440.
The amount of fair tax in this spendable money is 23%.
So, FT=0.23 (34,440)=7,921
The value of G&S that the family can purchase is given by
V=M-ET-FT=34,440-7921=$26,519
NB: This family can buy $4,679 more in real G&S under the Fair Tax system than they could under the present system, which is an increase of 21.4% in buying power.
2. The purchase price of goods and services remains the same.
The amount of money available to spend is still 34,440; that is, M=34,440.
We need to consider both the fair tax and the embedded taxes in this 34,440.
The fair tax amount is 23%, so FT=0.23 (34,440)=7,921. The amount of money (M) “remaining” to purchase the products is 34,440-7,921=26,519. However, out of this 26,519, 22% goes to the embedded taxes. ET=0.22 (26,519)=5,834. Now, what is the value V of G&S that this family can actually purchase?
V=M-ET-FT=34,440-7,921-5,834=$20,685.
NB: In this case, the family at the poverty level of 28,000 can only purchase a value of goods and services that is $1,155 less than under the present system, which is a decrease in real purchasing power of 5.3% [1,155/21,840 *100]. This correlates with Logan’s calculated 5.29% at the beginning of these response.
———————-
*For those who may be unsure of the calculations immediately above, consider this:
The value of G&S, as far as the fair tax is concerned, is 77% of the money available to spend. In the paragraph above, the money (M) is 34,440 and the value of that money–the value of the G&S which it buys– is 26,519 [0.77 (34,440)=26,519].
The value of G&S as far as embedded taxes are concerned is 78% of the money you have available to spend.
The total value of goods and services which you can purchase if there are embedded taxes and a fair tax is given by V=(0.77) (0.78)M. Again, using M=34,440 gives
V=(0.77) (0.78) 34,44=$20,685.
————————–
As illustrated above, the poverty level would have to be increased 5.6%, or $1,568, for a family at the present $28,000 poverty level to be able to purchase the same real value of G&S [0.056*28,000=1568]
The 23% Prebate would then be based on $29,568, and would equal $6,800 [(0.23) 29,568=6,800].
The total amount of money (M) available would then be 29,568+6,800=36,369
The value of G&S is then found by V=M-ET-FT=36,369(0.77)(0.78)=$21,843, which is the same as the present-day situation.
*Before any Fair Tax supporters become angry with me for pointing out this last scenario, and before any opponents shout with glee that they were right all along, let me point out this important fact:
If the embedded tax of 22% remains in the price of the products as in this last scenario, then there are a number of groups of individuals who are getting this 22%–workers through increased take-home pay, shareholders who get higher dividends when their company does better, small-business owners, etc. If these individuals spend this extra 22%, the government will take in 5.06% more in taxes on this extra spending [23% of 22% is 0.23*0.22=0.0506=5.06%].
Therefore, neither the government nor those families in poverty will be hurt financially by increasing the poverty level cutoffs and using the Fair Tax system. In the first scenario, recall, those poverty families did much better! In both senarios, the overall economy does better.*
If I have made any errors in this argument, please let me know. However, do not introduced new issues, such as arguing how much of the embedded tax will be passed on to the end consumer, as they is not germane to this particular argument. Thank you.
Mark,
Here are a few observations I might make:
(1) Under current tax law, the family of four you are using for your example actually gets about a $1000 net refund from the federal government after accounting for payroll taxes. This refund is due to the application of the refundable EITC and the refundable Additional Child Care credits. Therefore, their purchasing power is $29,000, and the embedded costs of the income tax have no bearing on that purchasing power. Prices under the current system are what they are and it’s not appropriate to make that 22% adjustment. The embedded costs should be treated under the Fairtax calculations.
(2) Under the Fairtax, I agree that it is almost impossible to do any group analysis. Each family situation is different. I would suggest, however, that you set aside a percentage of gross income, including the prebate, as non taxable spending. In the case of a $34,000 gross, it might be appropriate to set aside 15% as non taxable spending? Failing to do this unnecessarily penalizes the Fairtax.
(3) Although you don’t seem to want to discuss the possible price impact of the Fairtax, there is some agreement on this blog that the most likely result will be a 12% decrease in cost by removing business embedded costs, and a 14% increase in retail prices. This bears directly on purchasing power and might be useful for your analysis. For example, with gross income of $34,000 including the prebate, and setting aside 15% as non taxed spending, taxable spending would be $29,000 and the 14% price increase reduces purchasing power to $24854. Adding back the non taxed spending results in a total purchasing power not very different from that under current law. It’s pretty much a wash for this family.
Mark, the problem I see with your calculation - and one of the points I tried to make in my last post - is that the 22 percent embedded tax is not a constant. Even Neal Boortz admits this in The FairTax Book by presenting a chart which shows the amount of embedded tax across various sectors of the economy. And even within those individual sectors, the numbers shown are averages.
If we lived in a world of perfect economic theory where the retail cost of goods and services was directly related to the cost of producing those goods and services, then your calculations would be valid. But we don’t. And they aren’t.
You argue that even if the cost of goods doesn’t come down, that 22 percent (average) reduction will find its way into the economy in other ways, including “workers through increased take-home pay, shareholders who get higher dividends when their company does better, small business owners, etc.”
What would, in fact, happen to that 22 percent (average) of corporate money now going to corporate income taxes once those taxes are eliminated? No one knows. But one can guess based upon another indicator - the impact of lower labor costs.
It’s no secret that hundreds of thousands - if not millions - of American manufacturing jobs have been sent offshore to low-wage countries like China and Mexico. The savings resulting from paying a Chinese worker a tiny fraction of what his or her American counterpart used to make has given a huge boost to corporate profits, which are at an all-time high.
So where has the money gone? Higher wages for workers? Nope. Lower prices for consumers? To some degree, but not much - I can buy a pair of Dickies pants made in the U.S. for $23, while an imported pair of Dockers costs $55. Small business owners? They’re being run out of business by the corporate giants who have muscled into their markets.
No. Most of the higher profit has gone to shareholders, and to top-level management in the form of higher salaries, stock options and perks.
Had those skyrocketing profits gone to higher wages across the board or even, to a larger extent, lower prices, there might have been a real benefit to the economy gained from offshoring all those manufacturing jobs. But instead, the money has been hoarded at the top between the big shareholders and the corporate big-wigs. The result? The richest one-tenth of 1 percent now hold more than 90 percent of the wealth in our country, while incomes at the bottom remain flat or are losing ground to higher prices for things like food and gas. That’s why our economy is in the tank even though, on the surface, the indicators look good.
Based upon that experience, I believe the same thing will happen to the savings realized through the elimination of corporate taxes. Wages on the low end will remain the same (or fall). Prices will remain the same (or rise). And even more wealth will be concentrated at the top. Have you listened to the financial news lately? That formula isn’t doing our economy any good now. What makes you think things will get better when corporate profits are even higher, the richest one-tenth of 1 percent are even richer, and the rest of us have a 23 percent sales tax tacked onto the cost of every good and service we buy?
Error Alert! I wrote “the top one-tenth of 1 percent now hold more 90 percent of the wealth in this country.” Chalk it up to faulty memory and the fact that I got up earlier this morning than normal. I WAY overstated the percentage.
The most recent numbers I’ve located on wealth distribution were posted on the Internet by a computer statistician from South Carolina named Mark Whittington. He ran a computer model based on statistics he compiled from Census reports and other sources, and came up with these numbers, which he posted at opednews.com on Feb. 24:
The Top 1% holds 34.52% of the wealth
The Top 5% holds 64.45% of the wealth
The Top 10% holds 74.49% of the wealth
The Top 20% holds 83.81% of the wealth
Conversely:
The Bottom 60% holds only 5% of the wealth
The Bottom 40% holds only 1% of the wealth
Okay, not 90 percent concetrated in the hands of the top one-tenth of 1 percent, but still a pretty stark picture of income inequality.
The bottom line is this: The richest one-tenth of 1 percent of people in this country have seen their incomes skyrocket since the Reagan era, while those below them have seen modest gains, or none at all.
Why does it matter? After all, if you believe in equalizing income distribution, you’re a utopian socialist. The problem is, when wealth is concentrated among a small group of people instead of being spread throughout the economy, the economy as a whole suffers. That’s what’s happening now. And call me crazy, but I don’t believe allowing the super-rich to accumulate even more wealth will make things better.
The 90 percent number was overstated. I apologize. But my point remains unchanged.
Bill,
I would love to see a similar breakdown of the amount that various income groups contribute to the economy — in the form of driving product innovation, introducing valuable new services, and creating jobs for other people.
...Although, come to think of it, it may be pretty similar to the breakdown that you showed above.
In any case, trotting out the “hey, the rich guys own everything” argument demonstrates pretty much nothing, in my book, until you’ve also considered how much more these people contribute to the economy than the guy who flips burgers at McDonald’s or collects trash for a living.
The only question I have for the wealthy people I know is “How can I do a better job of accomplishing what you’ve accomplished?” And I wish more people were asking that question, and looking at how to be more productive themselves, rather than throwing around out-of-context figures that make wealthy people appear to be robber barons.
Joshua
Joshua - I’m not questioning the contributions some... and note I said some... wealthy people make to society in the form of innovation, providing new services and creating jobs. I certainly admire people like Bill Gates, Steve Jobs and Papa Johns Pizza Founder John Schnatter; all of whom started with nothing but a better idea and turned that idea into a thriving business and a personal fortune. There are many more I could name, and I think America needs more people like them.
But for every one of those self-made millionaires, there are 10, 20 or 30 people like John Trani, who wrecked Stanley Tools; or Robert Nardelli, who oversaw the wholesale devaluation of Home Depot’s stock and then bailed out of the company with a $210 million golden parachute; or Ken Lay, who built the Enron empire on a foundation of lies and amassed a huge personal fortune, then left his employees holding the bag with no jobs and no pensions.
And what of those people at the bottom end... the 60% who hold only 5% of the wealth and the 40% who hold only 1%... please don’t tell me you really believe 60% of the American population contributes only 5% to our economy. What would the CEO of McDonald’s have if it weren’t for the guy flipping burgers? And do you want to live in a neighborhood where nobody collects the trash?
I’m trying very hard not to get preachy. But if you want the context of those income inequality figures I noted in my last post, here’s the context: Our economy is in trouble... deep, serious trouble... precisely because of that extremely skewed distribution of wealth. That 60% of the population you believe only contributes 5% to the economy is actually the majority of the American people, the ones who buy gas and groceries, shop at Wal-Mart, eat at McDonald’s and work hard for their slice of the American dream. If they have no money to spend, their homes get foreclosed on, they stop spending on anything but necessities (and skimp on those), and the economy grinds to a halt. You know... the stuff that’s happening now.
Rest assured, I am not a socialist, and I don’t want something for nothing. But I do believe everyone who is willing to work deserves a living wage. And more importantly, I believe that if every American who worked RECEIVED a living wage, our economy wouldn’t be in the toilet.
My apologies to the rest of you on this thread. I started out addressing the question of what happens to the 22 percent embedded taxes, made a mistake on income distribution, corrected it with precise figures, and then wound up on my soap box. I’ll try to get off of it now.
Joshua said:
The only question I have for the wealthy people I know is “How can I do a better job of accomplishing what you’ve accomplished?”
That’s easy, Josua! Do a better job of choosing your parents.
Actually, in my opinion, one of the keys to our economic success in this country is that we’ve had a relatively high estate tax (which the FairTax would eliminate). By taxing (or, as you libertarians would say, confiscating) a large portion of inherited wealth, the government essentially forces each new generation of Americans to create their own wealth. I think this has fostered innovation, competition, etc. and benefitted the country.
Obviously, this is an inperfect system, and wealth still tends to concentrate in the hands of a few. About 70% of the Fortune 500 are themselves the children of millionaires. And children of wealthy parents receive many real and intangible benefits besides just the money they inherit (social networks, ability to get prestigous internships, career contacts, financing for college and starting out in life). But imagine how concentrated wealth would have been if there were no estate tax!
Countries that don’t have an estate tax eventually stagnate. The most obvious examples of this are third world countries. The rich essentially own everything, including the government and indusitries. They have no incentive to create new products or industries; they would much rather simply protect the status quo. They routinely avoid taxing themselves, so there are few if any programs designed to enhance society, such a free education through high school, an abundance of colleges and universities, etc. And, of course, health care for the masses is either absent or abysmal; the rich can afford private doctor and hospitals.
The end result is not only a completely unfair society, but an unstable one as well. As the rich spend more and more of their resources protecting what they have and literally walling themselves off from the rest of society (complete with private guards and attack dogs), and much of the rest of society ends up tuning to crime or even revolution.
I realize I’ve gone off on a tangent here, but I tend to agree with Bill. The concentration of wealth in this country really is obscene. Most wealthy people I know have legitimately worked hard for their money. But the money paid to corporate CEOs, movie stars, pro athletes bears little relation to their actual talent, and is due primarily to the socieity we’ve created where “superstars” are paid tens of millions, while mere “stars” are paid in the hundreds of thousands and the “good” are paid in the tens of thousands. And to a large extent, the “good” and “adequate” are being replaced by outsourced jobs.
And those that are outsourced, of course, lose their incomes as well as their health insurance so the top 1% can increase their share of the nation’s wealth from 34% to 36%. Something is definitely wrong with this system.
Bill, Bill, Bill,
How can you say in one breath that you can see where the Fair Tax will add more taxpayers to the roll and in the next say you will end up paying more. It’s simple math if you spread the same tax burden over more individuals everyone pays less!!! The only losers will be people that are currently gaming the current system for profit or power. The reason the federal governement has been allowed to grow out of control is because we can not see the much of the taxes that we are currently paying. They are enbedded in the price we pay for any product or service we now purchase. Let’s make the tax we pay transparent so that we can control the government, they are after all working for us right?
Hayden and Bill,
The free enterprise system has created more economic mobility than any other political system in the history of mankind, so these complaints about the “skewed distribution of wealth” and the “rich getting richer” are exactly backwards: The United States leads the world in the poor getting richer through their own effort.
Hayden, where do you get off on forcing parents (with the blunt instrument of government coercion) into spending money only in ways you approve of — i.e., not giving it to their children as a gift? Isn’t that just a tad arrogant?
If you don’t want to give money to your children, then don’t. But when I finish making my money, and am deciding where to spend it or to whom I should give it, shouldn’t you damn well mind your own business?
Regarding your “choose better parents” argument — it’s not the children I want to learn from; it’s the parents.
Fundamentally speaking, there are two ways to get money in this world: deal with people by means of consent and persuasion, or by means of coercion and theft.
What you are advocating is a dressed-up form of theft, of taking money from people who would not give it to you willingly; and I want no part of it, thank you very much. I think your wishes to confiscate wealth from those who create it, even under the guise of “supporting the poor,” are deplorable.
If you want to give money to the poor, then give money to the poor. And if you want to convince other people to do the same, then you should come around hat in hand and ask them to do so.
But when you instead reach for a gun — or a legislator — to do your “charity” for you, then you’ll get no sympathy or support from me.
Joshua
Hello.
I just came across this blog and am impressed by the quality and civility of the posts I’ve seen.
I’m a novice [be patient] trying to gain some insight on tax policy issues and have a elementary question of two on some of the posts that I hope can be addressed without to much effort. Thanks in advance for any help and hope I won’t drag down the intellectual level of the site to far....
First question is on post #43, for Bill I guess:
The statement in post #43, “It’s no secret that hundreds of thousands - if not millions - of American manufacturing jobs have been sent offshore to low-wage countries like China and Mexico.” is certainly true, but only low wages are mentioned as the cause.
Isn’t there a more favorable tax environment offshore for manufacturing , and also for the products brought back to the USA, that is partially to blame for this outflow of jobs? If you agree, do you have a feel for what the relative impact of each factor [wages vs. taxes] is on the motivation to move offshore? And what might be done to improve the current situation?
With regard to Mark’s post (#41) it may be appropriate to consider the taxes on “M”. If the family in question earned $28,000 legitimately (let’s assume they did), at minimum they would pay 6.2% to Social Security and 1.45% to Medicare which comes to $2,142. Is it appropriate to assume zero $ federal withholdings at poverty level? I just went to turbotax online (free for under $30k/year filers) and entered the absolute basics with $28k for a family of four & came up with $1,100 in federal tax. With this, the actual disposable income for the family would be $24,758 under the current tax system whereas under the FairTax the disposable income would be the full $28,000.
Now, here’s a kicker… if the family of four did not earn its $28,000 legitimately… they pay less than their fair share under the current system which means the rest of us pick up their share.
One thing is certain, the FairTax is infinitely simpler. This in and of itself is a great reason to move to it.
Peace,
YK
Eliminate the IRS. No more tax planning for maximizing investing for my future. Making daily choices on consumption now vs saving for later. Now I can see, without much of the nit picking, that the new view on selling my labor could be a simpler understanding of disposable income and funding the actions (desired and not so desired) of my government. Really grasp the concept of no longer paying for the new sofa long after the government has stripped your earnings of withheld taxes, but actually seeing your contribution to the government coffers as you redecorate the living room. The relationship you have with the government becomes more real and personal. This may very well encourage many more “good citizens” to take an active part in establishing constitutional accountability, on the part of elected officials. The Prebate issue is not a sticking point when it is considered as a general off set rather than an accurate replacement for “subpoverty” tax expenditures.
This makes no sense at all, the prebate is not spending money. Spending money comes from your job. Say a family of 4 makes the poverty level income and spends at just the poverty level on basic necessities, $28,000. That means they will pay a total of $6440 in taxes that month. The prebate of 6440 simply replaces that. It is not designed to give them an extra 6440 in spending power.
Jason, if I make $0 and then get my prebate, what’s my spending power?
Jason,
Spending money comes not only from your job, but also from the federal cash grant entitlement you choose to call the prebate. Just look in your checkbook each month and you will find your paycheck and the prebate, all spendable.
Assuming you meant $6440 per year, (not per month), then your poverty level family will indeed have an extra $6440 in spending power each year. And that additional spending will also be taxed at the Fairtax rate if spent on taxable new goods and all services.