You Decide
April 8, 2008 · Filed under: Media Citings
KQED in San Francisco, is producing a series of “devil’s advocate activities” called You Decide. Each activity is a question that you respond to with a yes or no answer. Depending on how you answer, it argues the opposite position. You get 5 answers and 5 opposing arguments. After the fifth answer, you get to place your final vote.
The current question is Should the federal income tax system be reformed? Pitches for the FairTax, flat tax and VAT are included if you are steadfastly answering no.
Its a fun idea - check it out. This activity is part of a larger project related to election issues funded by the Corporation for Public Broadcasting.
14 Responses to “You Decide”
Good catch, Mark. Took a look at the previous question as well. Not exactly objective, as it seemed to make one side of the argument deliberately weaker in terms of sources and statistics, but what can you expect from CPB? There’s a section in which you can post replies to the topic at hand, and on the tax reform issue there is an overwhelming concensus that we need some kind of reform. Someone affiliated with KQED has asked which specific reform posters support, and why. Perhaps an opportunity to plug in tons of pro-FairTax posts?
OK, guys. Reality time.
We’ve all just done our income taxes. I’d like folks to estimate how much they would save (or need to pay extra) under the FairTax.
I calculate that I would save 90% under the FairTax. My wife and I save a good chunk of our income. Most of our spending is on tax-free item (house payments, vacation home, foreign travel, business and investment expenses), so we only spend about 25% of our pre-tax income on what would be taxable goods and services under the FairTax (and most of that is health insurance and unreimbursed medical costs.
25% x 23% = 6%. So, my effective tax rate under the FairTax is 6% of my income, MINUS the prebate. So my real effective tax rate is even lower than that.
That’s the reason I got suspicious of the FairTax calculations in the first place. However, I would be interested to see how other folks on this board would fare under the FairTax (at the 23% tax-inclusive rate). Would your taxes be higher or lower?
And, if you believe they would be higher, please show how they could be higher under the FairTax vis-a-vis what you are currently paying in Social Security, Medicare and federal income taxes..
I would call savings tax deferred, not tax free. So remove it from what you would consider taxable income for this year. When you spend it, that would be the year to factor it as taxed or non-taxed income.
Hayden,
My taxes under the Fairtax would be higher. With a gross income of $94,800 plus the prebate of $5874 for a total of $100,600, I would have had $30,000 in untaxed spending (savings plus S/L taxes)., and would have paid $16238 in sales taxes, offset by the $5874 prebate for a net sales tax of $10364.
My income tax was $9853, which is only $510 lower, but that buys a lot of beer?!
One thing I can’t seem to get across to many of you is that as a retiree, I don’t pay any payroll taxes. And that makes a big difference! Retirees are generally being treated like chopped liver in that the Fairtax Calculator doesn’t work for us, Kotlikoff’s studies don’t have a retired group, etc. etc.
You really ought to remember that we do vote-in droves - having little else to do? I would encourage all of you to forget about double taxing our savings, and forcing us to resume paying for our government pensions. (Just a small plug for Fairtax Lite!)
Hank, just to clarify, did you factor the adjustment to social security and the change in purchasing power? If you could provide further details, how much of your income is from SS? Either of these two factors would easily put you in a better position. Such would increase your SS cola by price increases (making this income essentially tax free), and decreases in production cost would provide your total gross income plus rebate with a 10% increase in purchasing power.
Morphh,
For clarification, I believe the question was how much tax would I pay under the Fairtax and current law in 2007. My answer stands. If you want to get into effective tax rates and purchasing power, that’s a whole different ball game, and one where I suspect we may have some serious disagreements about definitions, etc.
Hayden, what was the question again?
Well, I think if you got an increase in social security to cover taxes, it would effect how much you pay... correct? In addition, it would also seem that if your saying I’ll pay xx more, your creating a comparison and it seems off to me when the value has changed. If you held the quantity of goods the same under consumption (instead of the $$), you might pay less. If just unvalued dollars is point of this exercise, then the numbers are meaningless bashing and not anything worth discussing.
OK, Morph — How much would you defer in taxes under the FairTax?
Hayden, into a savings account I have very little (a few thousand for emergency funding). I have some pulled out for 401k. The rest I use to pay down loans - credit, car, home, land. Oddly, I’m not the accountant / tax person in my family - my wife is. She has her degree in finance.
Hank, I was just remembering (hopefully correctly) that you’re retired military (an officer correct? - my thanks for your service). I believe the COLA formula (possibly the exact same system) used by the government for military retirees is the same one for Social Security. I expect that it will be the likely case that you will not only get an increase in SS benefits (that is if your under FERS) to cover the FairTax, but your retirement benefits as well. Similarly, CSRS would use the COLA if you fall under that plan. If this is the case, this, along with the increase in purchasing power and the prebate, might make you the person on this board to gain the most out of the FairTax.
I never really liked dealing with the purchasing power thing. It is the correct way to do it but it’s often confusing. However, as you have done, people will do a comparison of burden and exclude corporate taxes (income & payroll) but then not make any adjustment at all on the FairTax side (which turns out to be about 30% of the tax collection). That’s not insignificant.
Morphh,
Thank you for your kind words about military service. Best decision I ever made, but timing is everything, I guess. Not sure I’d re-up today? Tough call!
Turns out SS and military pensions do get the same COLA adjustment. But, what did I miss re your comment about adjusting my pensions for the Fairtax? I expect both the prebate and my pensions will be adjusted for inflation (COLA), but what did you mean when you said that my pensions would be adjusted for the Fairtax? Are you saying that there is an adjustment over and above the COLA? Never heard that before. Please explain.
Since you raised the purchasing power subject again, here is my method for determining PP under both tax systems:
Income tax: Income - taxes = PP. In my case for 2007, that would be $94800 - $9854 = $84946 PP. ( My effective tax rate was 10.4%.)
Fairtax: Income + Prebate x .83 = PP. Mine would be $94800 + $5874 x .83 = $83559 PP. (The .83 represents the estimated retail price increase of 17%.) The effective tax rate was 16238/100600 = 16.1%
And it doesn’t matter if I actually spend it all or not, purchasing power remains the same, or about $1400 less than under current law. What significant tax adjustment are you talking about that I missed? Purchasing power under current law is what it is, and it includes embedded costs. That’s why prices are what they are. What would you have me do to the PP calculation under the Fairtax? I’ve already removed business taxes and added the sales tax. What is missing?
Hank,
It is my understanding that SS benefits are adjusted to the change in after tax prices. So if prices increase by 17%, then you should multiply your SS and/or Government retirement income by 1.17. I believe you are correct that the prebate is also indexed to price changes, so this should also be multiplied by 1.17.
In regard to purchasing power, 17% (your .83) should be recalculated as an inclusive value (17% = 14.5% inclusive or .855). My calculation for PP = income + prebate * .855. This is the same thing as (income + prebate * 1.11) * .77 = PP, which I’ll describe below leaves you $1,100 more than the current system. 1.11 represents a 10% reduction in production cost, which is 11% exclusive. 1.11 * .77 = .855, which is 14.5% inclusive (17% exclusive).
This is going to be a long post but I think it should be laid out, since it is a confusing issue.
Part I - Puchasing Power
I’ll use the $100 widget example again.
$94,800 - $9,854 = $84,946 under the income tax gets you 849 widgets.
FairTax goes into effect - gross wages, and production cost reduce by 10%
Widgets cost $90 * 30% = $117
$94,800 + $5874 prebate = $100,674 under the FairTax gets you 860 widgets.
You get 11 more widgets under the FairTax, which is equal to $1,100 under the current system. We’ll come back to this number as this is the increase in purchasing power over the current system.
To buy the same 849 widgets under the FairTax would cost $99,333 after taxes, paying $21,505 of it in FairTax after adjustment.
Adjustment: ($99,333 * 23%) = $22,846. ($100,674 - $99,333) = 1,341. $22,846 - 1,341 = $21,505.)
Now you might be thinking.. holly ****, that’s almost double the amount in taxes $9,854 vs. $21,505.
If we look at the base:
$94,800 - $9,854 = $84,946 for the current system
$99,333 - $21,505 = $77,828 for the FairTax
Again, we have less $$ under the FairTax by $7,118. Ignoring the widget count, it’s not looking good in the dollar comparison and this often seems to be the place where the critics stop.
So how can we have more widgets here (860 under the FairTax) than the current system (849) if we’re paying more taxes? We’ve clearly seen an increase in the standard of living, yet we’re paying more! Confused yet?
The reason is... we’re not showing the increase in dollars from the purchasing power changes. Under the FairTax, $77,828 can buy more goods than $84,946 can in the current system, due to the 10% reduction in production cost.
$84,946 can buy 849 widgets at $100 each.
$77,828 can buy 864 widgets at $90 each.
So in the terms todays dollars purchasing 849 widgets, $76,410 ($90 * 849) under the FairTax is equal to $84,946, because it purchases the same amount of widgets. To factor this in a comparison, we can multiply $76,410 by 11% (which represents a 10% decrease in production cost), making $76,410 equal to $84,815 ($76,410 * 1.11) in today’s dollars.
So for a proper comparison between the tax systems, we need to show the dollar value of the additional widgets gained as an increase in purchasing power. Therefore, when using a partial accommodation model in which production cost decrease by 10% and prices increase by 17%, we need to multiply the total income by 1.11 (substitute your preferred values as needed). To show the purchasing power, we should have (Income + Prebate * 1.11) * .77 = PP. In Hank’s example, (100,674 * 1.11) * .77 = $86,046, which is $1,100 more than the current system. The $1,100 increase in purchasing power buys an additional 11 widgets in the current system, which is the difference between 849 and 860. For simplification, this is essentially the same thing as multiplying $100,674 by the inclusive value of the price increase. 17% exclusive would be about 14.5% inclusive, which is factored $100,674 * .855 = $86,076.
If we considered index adjustments, the $5874 prebate would be $6872 and some portion of Hank’s $94,800 would be multiplied by 1.17 as well. Take all that and then multiply it by 1.11. So I would think it might look like this: (gross non-index income + gross indexed income + indexed prebate) * 1.11 * .77 = PP in todays dollars.
Note that in post #4, Hank stated that $30,000 was untaxed spending but in my purchasing power example above, I considered it all as taxable under the FairTax. If recalculated in the equation, his purchasing power would be further increased under the FairTax. $100,674 total including prebate: ($30,000 * 1.11) + (70,674 * .855) = $93,426 in comparable purchasing power, an increase of $8,462 in todays dollars.
Part II - Effective tax rate
I think the standard of living and purchasing power are the real measures of tax burden in a comparison, and a proper effective tax rate calculation should reflect the relative increase or decrease. Let’s consider the effective tax rate using the examples in the last post.
If we did nothing to factor purchasing power, our effective tax rate would also be effected. Example: $94,800 * .23 = $21,804 - $5874 = $15,930 or 16.8%. Another way to factor it (discussed on this board) would be 100,674 * .23 = $23,155 leaving $77,828 or $16,972 in tax on $94,800, for a rate of 17.9%. In post #10, Hank correctly factors his effective tax rate under the current system (with $84,964 in purchasing power) as 10.4%. As shown in the last post, the FairTax increases purchasing power by $1,100 to $86,076. How can we have a higher effective tax rate comparatively if you increase your standard of living and purchasing power? What’s missing here?
While correct to say a 17% tax rate - is this a proper comparison based on the relative burden? 17% under the FairTax includes the removed corporate taxes (income and payroll), but the 10% does not. We have the same issue as in the last post where there is no factoring for the increase in purchasing power. Going from an effective tax rate of 10% to 17% implies that the burden is significantly higher, yet we see that it is not - it’s actually less. Using the same base of income reference of $94,800, the $86,076 purchasing power adjustment shows a comparable effective tax rate of 9.2%. 10.4% to 9.2% better compares the relationship based on the increased standard of living and purchasing power.
To factor the changes in purchasing power on the effective tax rate, we multiply the amount spent by the tax inclusive value of price increases (14.5%). Using the math above (that resulted in the 17.9% rate), we make the purchasing power adjustment: $100,674 * .145 = $14,597. $14,597 - $100,674 = $86,076 for a comparable effective rate on $94,800 of 9.2%.
Morphh,
Put Mrs. Morphh on the line, please. I want to know if you are spending too much time in the minutia of taxes, and you aren’t spending enough time mowing the lawn or playing with the kids?
Seriously, before I try to understand your examples, we need to go back to Section 303, Social Security Indexation. This is once again written in such a way as to defy understanding, but after staring at it for a while, it seems to say that if the CPI doesn’t include the sales tax (which it doesn’t at the moment), then the CPI index should be multiplied by 1.2987% to adjust for the sales tax.
Here is an example of how I think it would work. For 2007, the CPI index rose by 3.5%. When adjusting for the sales tax, the new CPI index would be 4.5%. This would mean that our Social Security pensions would be increased by $1350, rather than $1050 without the adjustment, a $300 difference.
I fail to see why you think that my SS pension would be essentially tax free? Under the Fairtax, if I spent the whole $30,000 on new goods and services, the sales tax would be $6900. Hardly offset by the $300 adjustment?
Do you have a different reading on Section 303?
Hank,
I’m definitely spending too much time in the minutia of taxes. It’s an addiction that I’m trying to break.
From the plain english summary of the bill:
If production costs decrease by 10%, CPI would decrease if it doesn’t include the FairTax. Therefore, an adjustment needs to be made. If CPI was 100 before the FairTax, and 90 after the FairTax. CPI would be adjusted 90 * 1.299 = 116.91. COLA = (116.91 / 100) - 1 = 16.91% increase. Your $30,000 in benefits should become $35,100. You’re increase in purchasing power covers the other portion of the FairTax. $35,100 * 1.11 = $38,961 purchasing power in todays dollars.