FairTax Evasion
In today’s Wisconsin State Journal, Al Ose references this three year study by the National Research Program on the tax gap.
The study found that for the tax year 2001, the difference between tax liabilities and what was actually paid was $345 billion. The IRS subsequently collected $55 billion of that amount – but they don’t say in this update what the collection costs were. Let’s say the collection costs were a conservative 18% and call the net evasion an even $300 million.
The average taxes paid on the 130 million individual returns that year was $8,265. The $300 billion of unpaid taxes work out to $2,307 per individual return. That means that 28% of the average individual tax bill went to cover evasion in the current system.
One of the popular criticisms of the FairTax is that evasion will run rampant. What would it take to reach the current levels of evasion under the FairTax?
Instead of 135 million individual tax returns that we have today, the FairTax would have about 20 million collection points. So to break even on current levels of evasion, each collection point would have to not collect $15,000 of sales taxes per year and then cook the books to hide it from the treasury. In terms of sales, that means that each and every one of the 20 million businesses required to collect tax would have to sell $50,000 of goods under the table.
And that is just to break even with the current system. To run rampant would seem to indicate substantially more evasion under the FairTax than what we have now.
Now consider that 80% of the collection points are retailers like Costco, Home Depot, Kroger and Wal-Mart. And the federal offense of tax fraud, commited consistently year in and year out, would necessarily have to involve the cooperation of their customers.
In this environment, how will evasion under the FairTax approach, much less exceed, what we currently have?
Mark,
Evasion all by itself probably won’t approach the percentages associated with the tax gap. But you can’t overlook the state experience with sales tax collections. I have read estimates of 15% or higher in uncollected revenue. Don’t sell the American ingenuity to evade the tax collector short.
I think the real problem will not be evasion, but avoidance. How many
Americans will buy used goods just to spite the federal government? I don’t know, but in my own case, rather than buying a new car every two years, I might buy an extended warranty and keep the darn thing for ten years. What does that do to sales tax revenue? Who knows, but rather than hire a bunch of computer model wizards, it might be better to listen to an economic philosopher, if there are any left in the world.
I agree with Hank. The problem with the FairTax will not be an increased amount of ILLEGAL tax evasion; instead, it will be with LEGAL tax avoidance.
You will certainly have some degree of tax evasion under the FairTax, mainly where retailers under-report sales. Think of landscapers, delis, rental houses. laundry mats, independent restaurants — cash-based and/or service oriented businesses that would be difficult, if not impossible, to audit (particularly since record-keeping ad reporting requirements are supposed to be substantially reduced or eliminated under the FairTax).
Also, I believe under the FairTax we’ll all have incentives set up our own individual LLCs to make tax-free business purchases, so you’ll have plenty of bogus “business” or “investment” purchases (think of a car that’s purchased tax-free as a business expense that is used for personal use). But, I agree that you probably won’t have as much actual tax evasion as you do today.
But tax avoidance will be the real kicker. Other than purchasing used cars and existing homes (including multi-million dollar mansions, ranches, farms and estates) the biggest avoidance will occur from overseas purchases. Think of Paris Hilton living on the French Riviera for a year, hedge fund managers with their luxury homes and yachts in the Caymans, upper-middle class folks getting elective surgury in Thailand or Brazil, or hundreds of thousands of US retirees living in Central America. They won’t be paying any US taxes at all under the FairTax, yet won’t be breaking any laws either. (By the way, that’s why Kotlikoff told me he would want expand the FairTax to include foreign purchases, but the enforcement problems with that would be enourmous).
We all hate paying taxes. When folks realize how easy it would be to legally avoid paying taxes under the FairTax system, it’s be Katie-bar-the-door at that point.
Run for the border!
First of all, Happy Tax Day everyone!
One of the “advantages” of being poor is the ability to file 1040EZ. I did mine on-line as soon as I got my W-2 in late January, so April 15 really IS just another spring day to me (although it’s colder than a normal spring day in Florida today).
Okay, on to the topic.
This is actually something I was thinking about earlier today on a somewhat unrelated topic – that is, will prices really fall and wages really rise if the FairTax is passed? I’ve taken a lot of heat on this board for saying I don’t believe either will happen by an appreciative amount, given the mindset of Wall Street (and by extension corporate America) which holds there’s no such thing as “excessive profits.”
What I was thinking about was the consequences to a business’ total sales figures of cutting prices. If a business cuts the price it charges for an item by 15%, it has to sell almost 18% more units of that item to achieve the same amount of total revenue.
There’s been a lot made of the fact that home electronics, especially things like computers, digital cameras, VCRs and DVD players have seen tremendous price drops over the years. Many attribute that to the globalization of the economy.
The reality is that when a technology is new, most people wait before adapting it. So “early adapters” pay a premium price. As more people buy the item, more units can be made and sold, and the cost per unit drops. If purchases of an item increase exponentially over time (think of the iPod for a recent example), the retail price per unit will begin to drop.
Where I was originally going to go with this was to defend my assertion that wages won’t rise by an appreciable amount, nor will prices fall by an appreciable amount, if the tax burden is removed.
The reason is simple: Even though their cost of doing business will fall by removal of the 22% in embedded taxes, companies will be reluctant to cut prices until they’re confident they can increase sales to meet revenue targets.
And unless companies CAN increase sales to keep their revenues up, wages won’t rise because most corporations base payroll on a percentage of gross revenues (my employer, for example, strictly adheres to a 15% ratio of payroll to sales).
But this thread has expanded my thinking on this topic: If more people evade the FairTax by buying used goods, sales of new goods will fall. Falling sales mean companies will face falling revenues.
Combine a 15% cut in prices with a 15% decline in sales, and the consequence’s to a company’s revenue targets would be devastating.
I await a drubbing from Morphh and Mark. One thing about posting on this board – I’m getting a thick skin!
Bill,
Paying you your gross income doesn’t cost the company anything since they’re already paying this to you, albeit some withheld by law to the government. You have a contract with your employer for gross wages. They don’t say “will you work for me for x dollars after taxes“. As described earlier by Hank, you can modify your withholding levels – it’s your money. So, the only thing that will change is that instead of withholding it to the Federal government, it will go directly to you. As I see it, it’s not the businesses money to take. This is what will increase wages in a partial accommodation model, you receiving gross pay.
I’m sure someone else can explain the business side better but I’ll give it a go. A company is making a certain profit on each product they sell. The percentage of profit on the product cost is profit margin. The allowable profit margin is determined by supply / demand and market forces. A company needs a certain profit margin on their product to make selling it worth while and sustainable. Competition (which can be outside of the market area) holds down increases in price, costs hold up decreases in price. Keep in mind that all inventory on hand when the FairTax goes into effect is credited 23%, allowing costs to drop instantly.
Let’s take a $100 widget and sell it for $120, making $20 (17% profit margin). When the costs involved with creating the $100 widget (which includes taxes) drop 10%, due to no longer having to pay taxes, the product cost of the widget is $90. If they continue to sell at $120, they are now making a profit of $30 (25% profit margin). Of course, this won’t hold. They could decrease their price to $110, and maintain the same level of profit $20 (profit margin 18%) or they may be able to drop it to $108, making $18 profit but maintaining a 17% profit margin. This will depend on the business. It is extremely unlikely they will be able to increase profit margins from 17% to 25% and pocket the addition $10 per widget, otherwise they’d be doing it today.
Let’s take gas prices, since excess profits seems to scream oil companies (which I admit I’m not that versed in.. so forgive any errors). Profit margins by big oil have held around 8% from what I understand. (Let me soap box that our government’s excise tax on gas is around 20% of the price and they don’t lift a finger. This doesn’t even include the additional tax costs above that we’re talking about. So don’t let congress smooth talk you into thinking they’re concerned about gas prices as they slap big execs around. It’s all a show. Anyway.. sorry – back to the point.) Their excess profits come from the cost going up, due to global demand. If the price of oil doubles from $1 to $2, and you make 8% profit margin, you just made an additional $.08, doubling your profit (which instantly looks like excess profits – greedy old fat cats). Gas prices tend to follow the price for a barrel of oil, so when the cost goes down, so does the price. The market in full effect. Unfortunately for us, that business sector continues to go up due to huge growth in China and India, with only periodic drops. While I’m talking about big oil, the FairTax would stomp all that corporate welfare tax breaks we’re giving.
Morph’s points are absolutely right.
Now back to evasion, avoidance and tax errors. In addition to reducing collection points, the Fair Tax is simple and transparent. These characteristics are shared by the Flat Tax, whose implementation in Russia, I have read, has increased tax compliance by 46%.
The other fact about the Fair Tax is that it takes two to cheat on it, a willing seller and a willing buyer. By contrast, it takes one to cheat on an income tax. A registered seller under the Fair Tax who sells off the books is jeopardizing his registration certificate. The stakes would have to be large enough to justify the legal risk. The registered seller’s taxable purchases will create an audit trail if taxed parts are used in off-the-books jobs. (An unregistered seller could not buy parts tax-free.) The registered seller also will be subject to reporting by a disadvantaged competitor, and he can never be sure whether any given customer is really a revenue agent.
Finally, an overwhelming portion of retail sales come from large or medium-sized businesses, such as Wal-Mart, who will not evade the Fair Tax.
Given the foregoing, evasion under the Fair Tax will plummet.
The avoidance problem through purchase of used goods is overstated.
~Jim Bennett
Jim,
So you say the avoidance problem is overstated. On what do you base that opinion? Are you the economic philosopher I have been looking for? How do you know how many people hate paying taxes to the government? Hate it so much they will change their lifestyle to avoid taxes?
Do you have any studies that relate increases in taxes to revised spending choices? What would be your best guess about the percentage drop in total tax revenues due to avoiding the 30% sales tax by buying used?
Hank,
I agree with Jim because I think the price differential of the FairTax between used and new goods is sometimes misunderstood. Like the income tax system, where we have discussed the embedded tax cost, used goods would contain the embedded FairTax cost. While the FairTax would not be applied to the retail sales of used goods, the inherent value of a used good includes the taxes paid when the good was sold at retail. The value is determined by the supply and demand in relation to new goods. The price differential / margins between used and new goods should stay consistent, as the cost and value of used goods are in direct relationship to the cost and value of the new goods. I believe there will be no more real incentive of cost savings to buy used goods vs new goods then there is today. Which is why I don’t argue (as far as I can recall) that someone could lower their tax burden by purchasing used goods. Directly yes, indirectly not much (a percentage of the decreased value of the item)… that’s my thought anyway.
I don’t really have an argument for emigration. Only that people tend to stay around family and that you’re subject to the tax laws of any new country. Fred posted Costa Rica, so you would be hit with their 13% sales tax, capital gains, transfer taxes, etc. May be worth it.. I could see a country adjusting it’s tax code to capture retiring U.S. citizens. I don’t discount this as a problem. Neither of these are evasion (topic point) but avoidance.
Jim –
I disagree with you that it will take two to cheat under the FairTax. That is another myth perpertrated by Boortz.
Let’s say I’m a landlord. I charge my tenant rent, including the FairTax. I decide to pocket the FairTax instead of remitting it to the government. The tenant never knows.
Let’s say I’m a restaurant or bar owner, a landscaper, a lawyer, a doctor, a small business owner, a chiropractor, a mechanic, etc., etc. I charge the customer, including the FairTax, and fail to remit it to the government. The customer never knows.
Let’s say I’m a small business owner and go into Wal-Mart to purchase a big screen TV for my home. I say it’s for my business and get it tax free. Wal-Mart never knows.
It only takes ONE to cheat under the FairTax.
In contrast, under the income tax system, there is double-reporting of most transactions. Your employer reports your salary to the government. You bank reports your interest. Your brokerage firm reports your dividends. If you’re an independent contractor, your customers file 1099′s. Because of this double-reporting, it is much harder for most people to cheat on their income taxes because it would take TWO people to cheat.
Morph — Let’s assume your are correct that the price of existing homes go up under the FairTax. Who benefits? The folks that already own homes. Who gets screwed? People who are currently too poor to own a home and are forced to rent . So, the poor get hosed twice. First, they must pay the FairTax on each of their rent payments, which will make it more difficult for them to save up to buy a home. Second, the price of homes (both new and used) will go up, putting their ability to afford a home further out of their reach.
Who else is screwed by this? Retired folks living off their savings, because now their savings are worth less since the price of everything has gone up.
Hayden,
All of your cheats under the fairtax can cheat now. The landlord collects rent and doesn’t report the income. The bar owner, etc. under reports their revenue. You could write off a big screen television now as a business owner (and I’m SURE people do).
The real price of homes should actually go down because the price distorting homeowner’s mortgage excemption will go away.
Retired folks living off their savings will be the most vulnerable under the fair tax. One factor on whether or not they do well under the fairtax does have to do with the rise in “fairtax inflation”. That’s why I still partially advocate a multi-year phase in of the fair tax. Then wages can adjust more gradually. Although I will note that many retired folks recieve pensions and social security. As shown on another thread, it is very likely that they will benefit from the fair tax. Further, the interest on a savings account (which should be substantial if their living off of it. Relatively speaking) will no longer be taxed.
Morphh,
I did not suggest that people would buy used to save money. You are correct about the “embedded costs of the Fairtax”, and I suspect that the price differential between new and used will stabilize to where it is today pretty quickly.
My question is just how many folks would buy used in order to be able to say that they paid no federal tax on the transaction. What if millions of folks did what I suggested, and kept their old car for ten years instead of two? How would that impact the revenue collected, to say nothing about the devastating impact on new car dealers?
I think one of the unintended consequences of the Fairtax may be to reuse or extend the life of used goods, which isn’t all bad from an environmental point of view, but it might suck from a revenue collection point of view? I would invest in a car repair business, because I sort of think they may be where it’s at?
Stay tuned!
Hayden,
I’m glad you brought up your landlord example, because that’s an area where I have expertise. (I am with the NJ Attorney General’s office and am assigned to a unit that collects tax debts.) Andrew is correct that the problem of unilaterally not turning over moneys paid to the tax obligor is a problem that already exists today and will be no different under the Fair Tax. I’ll expand on that by stating what happens when obligors, such as your errant landlord, make that unfortunate mistake.
The tenant under the Fair Tax has a right and an incentive to demand a receipt from the landlord. Title II, Chapter 1, Section 101. The tenant can be responsible for the tax without it. Id. Thus, where a tenant learns that a landlord is unilaterally pocketing tax, the tenant will have an incentive to turn the landlord in.
By operation of law, the money the landlord collects for tax is not his money. It belongs to the state sales tax authority, and the landlord holds it in trust until he turns it over. An individual officer, director or other responsible person of the corporate landlord can be personally liable for the obligations of the corporation.
If the landlord, following due process, is assessed for not turning the tax over, the state can seize property, garnish wages and file liens to collect the amount due. Id. Chapter 6, Section 602. In New Jersey the Division of Taxation, under the state uniform tax collection procedures act, can file a certificate of debt (“COD”) with the clerk of the Superior Court. This certificate operates as a judgment, although the tax lien applies against the taxpayer regardless of whether a COD was filed. The COD merely puts bona fide purchasers for value on notice. The NJ Division of Taxation can levy without going through a sheriff.
In New Jersey tax debts of the landlord that are past due burgeon quickly under the uniform law because the post-assessment interest rate is three points over prime.
Finally, a landlord who tries to avoid the tax debt through bankruptcy will receive a rude surprise. A trust-fund debt such as this is not dischargeable. You had better tell your landlord who wants to cheat unilaterally that it is a bad idea.
Turning now to your Wal-Mart TV case, I will concede, up to a point, that you did find an example of unilateral cheating under the Fair Tax. A small businessman could purchases a wide-screen TV from Wal-Mart ostensibly for a business, and take it home. The problem with that example is that your small businessman will have to give Wal-Mart a copy of his registration certificate in order to purchase the TV tax-free. This step creates an audit trail. Wal-Mart won’t know the difference, but the state sales tax authority will.
A more likely example of unilateral cheating is a carpenter who takes home a hammer for use around the house. Bagatelles such as those probably will escape taxation. However if the carpenter flaunts it, he will be jeopardizing his registration certificate.
Therefore, with that one de minimis exception, it really will take two to cheat under the Fair Tax, and just one to cheat under today’s income tax.
~Jim
Jim –
Thanks for the explanation of landlord tax obligations and enforcement. That was actually quite interesting. And, since I am a landlord (short term rentals) and need to collect and remit lodging tax to the state and county authorities, it will remind me to be viligent.
But, with all due respect, you totally missed or ignored my points. YOU said it took two people to cheat under the FairTax. I pointed out that that is not true. It will not take TWO people to cheat, it will only take ONE. Regardless of whether its the landlord, the landscaper or the carpenter, etc., they will not need to conspire with anyone else to cheat the system. Yes, it’s possible (remotely possible, in my opinion) that some cheaters will be caught and punished, but that is the case today as well.
And, with respect to my Wal-Mart example with the big screen TV, so what if an “audit trail” is created. Are the state revenue officers going to raid the guys house to see if he has the TV in his home instead of his business? What about his car? How are they going to know how much he uses his car for personal use rather than work? And how about a vacation home that somebody buys tax-free as a vacation rental property but he stays there three months out of the year. How about restaurant meals when one is away on “business.” I could go on and on. Yes, there will be enforcement, but there will be obvious ways to cheat the system with a very small likelihood of getting caught, all of which will only take ONE person.
Which brings me to another point. Linder likes to go around saying that record-keeping will be virtually non-existant under the FairTax. “There’s no reason the government should know how much you make or how you spend your money!” Yet, you are pointing out that record-keeping will be extensive under the FairTax. Everytime you make a purchase you will need to get a receipt showing that you paid the tax and hold onto that receipt (for how long?) to prove you’re not a cheat. Businessmen will need to document all of their purchase to prove they are not for personal use. They’ll need to keep logs showing how much they used the car for business versus personal use, then calculate the proportion of tax they’ll need to pay for gas, insurance and maintenance on the car. If somebody converts a rental property to personal use, he’ll need to go back and pay taxes on the fair market value of the home, the furniture and other improvements. He’ll need to keep receipts for any purchases made overseas so he can pay the correct tax when he returns home. The point is that the record-keeping requirements will be very extensive under the FairTax, probably even more burdensome that we have today.
Finally, you (a tax collector, after all) ignored the double-reporting that occurs under our current tax code, making it impossible for most people to unilaterally cheat on their income taxes. You are fully aware that most tax cheating today occurs in those instances where there is NOT the double-reporting of income. Under the FairTax, since there won’t be any double-reporting, there is a far greater likelihood of cheating going on.
Hayden,
All your examples of one-sided cheating under the fairtax (and I agree they exist) already exist today. Plumber comes to my house today. I do not issue a 1099. I give him money and he gives me a receipt. I report nothing to a tax agency.
As far as the double reporting of income today, whether you believe it is a major source of cheating or not, it will be reduced under the fairtax to 0 because no one has to report income.
I’ll agree that some people that provide services today will have to switch their cheating from the report of income to report of sales. I’ll even agree that it will be greater under the fairtax (if you can show me that the current cheaters need to pay less than 23% of their current sales in income/payroll/etc tax.), but what things will be avoided under the fairtax that can’t be avoided today? The only one I can think of is that retailers will under report their sales, but wouldn’t those same people under report their profit?
Andfrew — I agree with you that most of the instances of cheating I described under the FairTax occur under our current income tax system. I’m also willing to agree that there will probably be LESS cheating under the FairTax than under our current income tax system.
The purpose of my examples was to respond to Jim’s assertion (which is the same one Boortz routinely makes) that it takes TWO people to cheat under the FairTax. My point was that it will only take ONE person to cheat under the FairTax.
Hayden,
In that case, I agree. One person can cheat under the fairtax.
Hayden, in response to post 10, I don’t have much time to respond at the moment so I’ll make it brief. Any accommodation under the FairTax is an expansion of the money supply and thus some level of inflation. I think we both know that inflation effects the value of all goods (not just new), although used goods most often depreciate faster then inflation, with homes being one of the exceptions. I usually assume taxation on all spending when doing analysis, so it doesn’t often matter much when we consider used goods. The burden to the poor is certainly no more if they choose to buy used. As far as housing, I’ll make some brief comments and you can fill in the gaps. Builders get inventory credit, wages increase to gross, poor can save tax free for down payments, tax is spread over 30 years with prebates each year added over thirty years, inflation decreases tax burden over 30 years and increases the prebate impact since it is index, interest rates drop 30% making homes more affordable, and purchasing power increases by at least 10% (more for less – see this discussion).
Stop the Presses!
Andrew and I agree about something!
Will wonders never cease.
Quick response to Morphh before I leave for work:
You said: “Paying you your gross income doesn’t cost the company anything since they’re already paying this to you, albeit some withheld by law to the government. You have a contract with your employer for gross wages. They don’t say “will you work for me for x dollars after taxes“. As described earlier by Hank, you can modify your withholding levels – it’s your money. So, the only thing that will change is that instead of withholding it to the Federal government, it will go directly to you. As I see it, it’s not the businesses money to take. This is what will increase wages in a partial accommodation model, you receiving gross pay.”
But that’s not what Jorgenson says. Let me repeat the quote: “A more reasonable interpretation of my 1996 testimony is that workers would keep that after-tax pay.” Boortz has also conceded this point… the “entire paycheck” you would keep is your net pay, not your gross.
In this instance, I will have to disagree with both Hayden and Andrew. A licensed business or retailer (the most likely case of cheating under the FairTax) is NOT one person, it is an entity and will be scrutinized as such. This is not simply semantics, nor is it a trivial distinction to make. Under current tax policy, employers, charitable organizations, non-profits, businesses large and small, and individuals are all monitored to ensure that their taxes are duly paid (or deferred) and all appropriate records maintained. The FairTax doesn’t eliminate Sarbanes-Oxley, GAAP, the SEC, or any of the other entities that oversee this current scrutiny. What it does eliminate is the need for any of these entities to oversee any INCOME reporting whatsoever. Without the income oversight, at least 2/3 of the individual desk jockeys and counter zombies employed by these agencies will be able to concentrate on retailers and businesses and leave regular working Joes like me the hell alone.
One final (and finer) point, then: with increased oversight where it counts, and very stiff penalties on those who don’t fully comply, how foolish and/or intellectually deficient would one have to be to routinely attempt cheating? Even with a reasonable assurance that you could get away with it once, when your increased profit is only 23 cents on a dollar, how many times would it have to occur to be truly profitable? Even for a 75K/year small business where pennies make a bigger dent in the bottom line, someone would have to get away clean on hundreds of transactions to see any real profit. That’s why I believe the cheating argument, no matter the number of people involved, is highly overinflated. And, like anything that is overinflated, it has a higher potential to rupture.
An IRS conclusion based on the referenced study: ” nonfarm sole proprietor income, which is reported on a Schedule C and is subject to little third-party reporting or withholding, has a net misreporting percentage of 57 percent, contributing about $68 billion to the tax gap.” It appears there are a lot of small businesses foolish and/or mentally deficient enough to routinely cheat. Not all need hundreds of successful transactions to make it profitable.
There’d be little risk in under-reporting FairTax – it’s unlikely any state will require that individual taxpayers document all businesses from which they purchased taxable goods. There’d be great potential reward if socking away the excess income reduced state income taxes and increased personal spending resources. Doing that could also fund a nicer retirement than reporting real earnings to Social Security. The state and federal government will have less information and fewer resources to try to reconcile taxes paid to a given business with taxes remitted by that business. To me it’s comparable to running a company with an inadequate system for reconciling payments due with payments received.
I don’t see how that increases tax code compliance or lowers the cost per tax dollar recovered through enforcement. I believe I might just be too cynical.
Bradley –
Ellen made my point much better than I could. (Thanks, Ellen.)
And, Bradley, you fell into the 23% semantics trap. Even assuming that the FairTax is leveled at a 23% “tax-inclusive” rate, the cheater would keep 30% more if he keeps the FairTax than if he turns it into the government.
Cost of good (including FairTax): $100
FairTax $ 23
Cost of good (excluding FairTax): $ 77
If he remits the FairTax to the government, he only keeps $77. If he keeps the FairTax for himself, he keeps the whole $100. The extra $23.00 is 30% of $77 (23/77 = 30%), so he keeps 30% more if he fails to remit the FairTax. I would say making an extra 30% on each and every transaction will be pretty tempting. Even if you did it just a couple of times a week (ooops, I messed up), it would be extra bucks in you pocket.
That’s another reason to quote the FairTax rate in a tax-exclusive fashion, by the way. And, of course, since I believe the real rate would be much higher than 30%, the temptation to cheat would be even greater.
And yet, I maintain, there will be a much higher level of scrutiny on businesses and retailers under the FairTax because all of these bureaucracies that count the income beans now won’t have to. The states, being the final arbiter before the taxes are sent to the feds, will have incentive to make sure their books are correct, since they get a cut of the proceeds from tax revenue. With state and federal agency oversight, we’re right back to your double-reporting.
Hayden-
23% or 30% doesn’t matter. Generally, severe punishment is a deterrent. Will some still break laws? Undoubtedly. Will evasion + avoidance = higher lost revenue under the FairTax than currently? Highly doubtful.
Hayden actually understated the benefit of cheating. The $77 is not the profit. Say the retailer sold it for $100 with a 11.5% profit margin. Keeping the fairtax would actually be a 200% improvement on profit.
However, that doesn’t change the fact that the enormous reduction in collection points (retailers vs. income earners) will make it much easier (and efficient) to pinpoint cheating. This goes along with the fact that 85(?)% of all retail is done through Wal-Mart type businesses whose enormous bureaucracy make cheating highly improbable, like Bradley was referring to in post 21.
Andrew said: This goes along with the fact that 85(?)% of all retail is done through Wal-Mart type businesses whose enormous bureaucracy make cheating highly improbable…
They would also have to hide it from audits for lenders (or include the auditors and lenders in the scam).
And public companies would have to hide it from shareholders, annual reports, stock markets and the SEC.
There is another blog called Fairtax Absurdity, and operated by a raving opponent of the Fairtax. However, some of his rantings struck a chord and causes me to ask this question. Is there anything in HR25 that describes or limits a business activity?
Using my boat leasing business as an example, I was audited and shut down by the IRS because they unfairly deemed my business to be a hobby. I couldn’t show a profit in any two of five years, so I got nailed. HR25 doesn’t seem to contain any such limits. I could simply apply for a business registration, and then buy a boat or boats tax free, buy a truck and trailer to move the boats tax free, put an addition on my house and furnish it as an office tax free, purchase supplies- including rum, tax free, etc. etc. And if I did lease the boats out from time to time, I of course would send in the proper sales tax to the collection agency. I don’t see any business criteria in HR25 that would prevent me from doing exactly that, and the business expansion possibilities would be limitless.
So, I’m registered as a business, and I don’t have to show a profit, just send in any tax collected. Piece of cake! What’s wrong with this plan. What are the auditors going to be looking at? Does anyone care what I’m doing? Isn’t this a perfectly legal means of tax avoidance?
Bill, that was using a no accommodation model. You’re misreading Jorgensen’s assumptions for analysis as some FairTax accommodation prediction – it’s not. Jorgenson was not analyzing what the Fed Res. would do if the FairTax went into effect. He was trying to determine how much taxation is built into the system. He was laying out his assumptions for the 22% figures, which he didn’t assume “that workers would keep that after-tax pay.” It provides an understanding for the figure, as it was believed by many at the time that 22% did include workers keeping their pay. He was clarifying the figure – nothing more. This does not represent what will happen, it could… though unlikely. I said earlier, that Boortz and Linder in their latest book now believe partial accommodation, meaning that you get your gross pay and production costs will fall by a certain amount (ALM estimate is 11.55% min, Hank estimate is 10%). In any of the situations, no accommodation, full accommodation, or partial accommodation, the purchasing power should work out the same but the most likely scenario is partial accommodation in my view (and I think about everyone here on the board).
An argument is made that with fewer collection points there will be more scrutiny on every business. That’s despite the lack of detail about tax paid/collection information provided to the state. Using Hanks boat leasing enterprise as an example, if he earned $1,000 each month from leasing, collected the $300 in FairTax and reported only $300 in sales with a $90 FairTax remittance to the state, what specifically would trigger a suspicion of tax evasion? Other than his own self-reporting, what income or expense records would be reported to the state for auditing purposes?
One can argue this is small potatoes because the big box stores have more incentive to report sales accurately. That really isn’t the issue. The issue is the confidence taxpayers have in the integrity of the system. The lower the confidence level, the more the tax system is viewed as unfair. If it’s considered unfair, people feel little guilt about “gaming” it. Individuals overstated charitable contributions not because they were crooks but because “everybody does it”. They purchase from sole proprietorships knowing state sales tax isn’t being charged or remitted to the state. It’s a way to try to equalize the system for themselves. That’s my philosophy about why a tax system needs a robust mechanism in place for oversight and enforcement.
Ellen,
Oops! Now don’t have me do anything illegal. What I said was that if I leased the boat, I’d send the proper amount of tax to the tax collection agency. If I didn’t, I’d be afraid that one of my customers was an agent and was testing my accounting to see if I was following the law. Too big a risk.
All I was trying to say that it wouldn’t surprise me if the 20 million registered businesses in the US today grew to 100 million upon implementation of HR25. And, I want to know why that won’t happen? The IRC has established business criteria–where are the HR25 controls?
Some of this seems to be covered under Chapter 5, 6, & 7.
Ellen –
Where have you been hiding all these last few months? Bill, I and the rest of us independent thinkers needed you as an ally eons ago!
Now go tell Mark why a consumption tax is regressive. I’ve been through that so many times my typing fingers are starting to fall off.
And Hank, of course the number of registered businesses and rental property will sky-rocket as people will move to take advantage of tax-free purchases. Think network marketing, as the most obvious example.
And, you don’t need to make a profit in order to be a business, you just need to legitimately try to make a profit. There’s no threshhold level on the amount of profit either.
This brings up another good point, if the government is going to make you prove that you are trying to earn a profit in order to eligible for the business expense tax-exclusion, the government will require you to keep documentation of all of your income and expenses related to your business.
In addition, in order to make sure you aren’t mixing personal and business purchases, they might require you to keep a separate log of all personal expenses.
The bottom line is that the record-keeping and compliance costs will be just as bad, expensive, and intrusive under the FairTax as it is today.
Re Post No. 27
Hank,
There is a specific answer to the issue of whether a given enterprise is a business or a hobby under the Fair Tax. Article II, Chapter 7 (special rules), Section 701 requires the activity to have received gross payments for the sale of property or services in excess of the combined total of:
a. taxable goods and services purchased,
b. wages paid, and
c. taxes paid.
The activity must have received such gross payments for at least two of the most recent three years.
This section is deisgned to prevent people from using a hobby as a business and taking unfair advantage of the intermediate and export sales exemption (Section 102), the business use conversion credit (Section 202) and the intermediate sales credits (Section 203).
The provision is not unlike provisions in today’s tax code.
~Jim
Hank….just planting the seed on how easy it would be to “undo” the taxing of your Social Security benefits.
I think you could easily qualify as a business under the rules Jim provided. There’d be no third party reporting of any sales, wages, taxes etc. It’s all do it yourself.
You do bring up the excellent point that fear of getting caught is the biggest deterrent. What’s interesting about the significant amount of underreporting by sole proprietorships is that it’s difficult to prove even with the detail currently required. IRS costs to audit a sole proprietorship are higher because of that. Unless every state hires a “boots on the ground” fleet of investigators, chances for detection are even slimmer. One agent visiting to “test” accounting would prove nothing unless the state’s going to require businesses to remit tax receipts sale by sale with supporting documentation.
I could make the case that other small and medium businesses would have little trouble skimming a bit of FairTax money. How’s the state going to know what portion of the total sales were made to individuals (taxable) versus businesses (non taxable)? Some things are so obvious they hardly need to be said.
Morphh:
Read the quote again, please: “A more reasonable interpretation of my 1996 testimony is that workers would keep that after-tax pay.â€
Better yet, read the entire exchange between Dr. Jorgenson and Rob at Free Republic: http://www.freerepublic.com/focus/f-news/1470200/posts
There’s nothing in there about partial accomodation or no accomodation models: He made a direct response to a direct question in which he said, simply and unequivocally, TWICE, that it is his opinion the worker would keep his net pay, not his gross pay. Boortz has conceded this.
I believe some businesses (like Costco) would give some of the savings back to their employees in the form of higher wages. But most (think Wal-Mart) would not.
Of course, the prebate alone WILL give a $2,000-plus annual raise to working people, and that’s a good thing. But even if prices fall by 22% (which even you don’t seem to believe will happen), that doesn’t mean prices will actually fall. Best case, they’ll increase by 1%. If they fall by only 11%, prices will increase by roughly 12%. If they fall by only 5%, or if they don’t fall at all, the prebate will NOT be enough to offset the higher prices.
And even in the best-case scenario, working people will still be paying a higher percentage of what they make in taxes than they are now. Granted, they probably won’t mind because the prebate will give them more to spend. But that fact remains.
Bill,
I’ve read Jorgenson’s work and have also studied and written on his “Efficent taxation of Income”, which I like and support. You’re taking a little snippet from an e-mail and misunderstanding the meaning. He stated what the basis of his testimony was. The point of the statement is that many thought you could reduce prices by 22% and keep gross wages. He was clarifying (answering a question regarding) the base of his analysis (which is a no accommodation model, where you can’t have both).
And for the third time, Boortz has not conceded this. In his latest book he states he believes people will get their gross pay. He “was” suggesting in earlier work a no accommodation model but now believes otherwise.
Could someone else, any of the critics here, please back me up… Hank, Hayden… Please lets put this to rest. I’m tired of discussing it.
I don’t believe production costs will fall by an average of 22% if people get gross pay, but do if they get net pay. Walmart… you mean the place with the lowest prices (with a 2% profit margin).. would windfall a 15% profit margin?! Would Walmart have any workforce left if the fed expanded the money supply to allow gross wages and didn’t.. it would be a massive class action lawsuit for violation of contract. You dismiss the basic forces of capitalism as altruism.
Morph –
If you are asking ME to back you up, you must be getting desparate.
Actually, one of your questions to Kotlikoff, et. all might be how they believe prices will be affected if workers get their current gross pay under the FairTax. From their studies, they seem to be conceding that prices would rise by the full tax-exclusive rate.
I can’t remember which study it was, but Kotlikoff even said that would be a GOOD thing, because it would make savings immediately be worth 30% less than they currently are, which would therefore be an implicit tax on wealth since the wealthy own most of the saving in this country.
Not desperate.. I just believe you to be an honest person. While it often seems like we’re on teams or something were we have to disagree with each other on everything, I know that’s not the reality. I guess I should reply more often when I think you’ve made good points. Point is, I believe that if you agree, then you have no problem stating it, even though we tend to be at odds here and there. I don’t agree with you on many things, but I’ll concede good points and confirm statements you make that I agree with. I also thought it might mean more to Bill coming from someone that is also against the plan.
Regarding Kotlikoff, it seems most studies go one way or the other – no accommodation or full accommodation. I suspect the math is easier to do or something. I have heard Larry make the wealth point with full accommodation, particularly the reduction in the real nominal value of U.S. government debt.
So many things to address. The economic response of FairTax, tax evasion, economic growth! I love how you guys stick to topic! Cool!
I don’t think anyone can predict accurately what will happen to the economy under the FairTax proposal. Will prices go up or down? Yes! Will wages go up or down? Yes!
Initially, I think people will get their full wages and prices will go up. The market will determine how much. Then businesses will lay off expensive people and hire cheap people and wages will go down. Then prices will go down.
Purchasing power will likely stay the same initially. Wages will buy about the same amount of stuff. So what! The market will adjust. Then, businesses will ramp up because they will not have to spend money on accounting and tax avoidance (not evasion, but avoiding taxes through management). They will become more efficient and productive. Then businesses may bring jobs and manufacturing back home from overseas because it is more efficient to build things here. The tax code has become business (and citizen) friendly. Then, and this is the big one, foreign businesses will come here, and invest here, and even incorporate here, because this will be the most friendly tax environment in the world.
Companies can build stuff here and ship it overseas and PAY NO TAXES!
Tax evasion? Studies (see the FairTax site) have shown that an easy, fairly administered tax is tolerated by citizens and is a disincentive for evasion. FairTax is easy and fair. Evasion goes up exponentially when taxes are a burden or are perceived as unfair. (People want to stick it to the Gov. when thay feel abused!) The vast majority (80% plus?) of the retail sales in the U.S. occurs in “big box stores” like Walmart. Most evasion will occur with person to person sales. Most of those sales are used stuff. Small businesses will comply because it’s easy and relatively cheap. (I am a small businessman.) The new tax code is easy. Businesses will comply.
Don’t forget. The IRS deals with about 100,000,000 returns per year. (Forgive me if my numbers are inexact. Check it out.) Retail sales tax firms number about 1/3 of that. This is not difficult, merely hard. It’s easier than the IRS has it now by an order of magnitude. Most of the states are set up for sales taxes now. If they say they have a 15% tax evasion problem, is that volume of taxes or number of taxees (sorry)? If it is taxees, I bet you will find the taxes lost are much smaller.
FairTax will result in economic growth. The growth will be explosive. Evasion is not a big problem. FairTax is fair, easy and controllable by the citizens of our nation. Government is not.
Casey Elliott
1. Why would an individual (not a business owner) after suddenly becoming free from all income taxation, record keeping, etc. and getting a prebate, want to turn around and give all that freedom away by registering as a business and living in the gut wrenching fear of audits, record keeping, etc that we have now? And if they did, I say they are too stupid to get away with it anyway!
2. As far as business’ go, It seems the real advantage of the fairtax is to be able to make decisions based on business rather than tax implications. Also, won’t the playing field be leveled to a great extent with foreign companies who are not taxed by their governments.
3. Who can argue that getting rid of lobbying and special deals for those who can buy influence from politicians is a bad thing?
4. Isn’t it true that the super rich don’t pay income tax under our current system due to all of the loopholes that allow them to basically launder their money through offshore banks, trusts, etc. and at worst collect it as capitol gains taxed at just 15%?
5. Why is it bad if we use goods more thoroughly instead of buying new and throwing away, and at some point aren’t used goods also new and purchased as such?
6. Wouldn’t the fairtax system encourage saving compared to consumption and isn’t that good?
7. Does anyone think we can continue as a consumption based economy?
8. Isn’t it easier to conceive of a complete replacement of the existing system rather than to use bandaids, baling wire and duct tape on the current one? After all that is what a wise person does when something has no usefullness left in it.
I’d appreciate responses to any or all points, thanks.
Frank –
OK. I’ll bite.
1. Why would an individual (not a business owner) after suddenly becoming free from all income taxation, record keeping, etc. and getting a prebate, want to turn around and give all that freedom away by registering as a business and living in the gut wrenching fear of audits, record keeping, etc that we have now? And if they did, I say they are too stupid to get away with it anyway!
FOR MOST INDIVIDUALS, THE RECORD KEEPING FOR INCOME TAXES IS NEXT TO NILL. YOU GET A W-2 FROM YOUR EMPLOYER AND THAT’S THAT. RECORD KEEPING DOESN’T REALLY START BECOMING BURDENSOME UNTIL/UNLESS YOU OWN A SMALL BUSINESS OR RENTAL PROPERTY, THEN THE RECORD KEEPING COMES IN BECAUSE YOU WANT AS MANY TAX DEDUCTIONS AS POSSIBLE.
WELL, GUESS WHAT. UNDER THE FAIRTAX, RECORD-KEEPING WILL BE MORE BURDENSOME. FOR MOST PEOPLE (WHO DON’T OWN BUSINESSES) THEY WILL BE REQUIRED TO KEEP THE RECEIPTS ON ALL OF THEIR PURCHASES (FOR HOW LONG?) IN ORDER TO PROVE THAT THEY PAID THE FAIRTAX ON THE PURCHASE. WITHOUT THE RECEIPT, THEY COULD BE LIABLE TO PAY THE GOVERNMENT DIRECTLY.
THEN, IF YOU OWN A BUSINESS OR HAVE RENTAL PROPERTY, YOU WILL NATRUALLY WANT TO MAKE SURE ALL OF YOUR PURCHASES FOR THE BUSINESS AND RENTAL PROPERTY ARE TAX-FREE, WHICH WILL REQUIRE YOU TO KEEP EXTENSIVE RECORDS TO DOCUMENT EXACTLY WHAT PURCHASES WERE FOR BUSINES AND INVESTMENT PURPOSES, AND WHICH WERE TAXABLE PURCHASES FOR YOUR PERSONAL CONSUMPTION. IN SOME CASES, YOU WILL NEED TO ALLOCATE BETWEEN TAXABLE AND NON-TAXABLE PURCHASES (EX. GASOLINE FOR A CAR THAT IS PARTLY USED FOR BUSINESS.)
SO, I AGREE THAT THE FAIRTAX WILL BE MUCH EASIER FOR LARGER BUSINESSES, BUT I THINK THE FAIRTAX WILL BE JUST AS BURDENSOME AS OUR CURRENT SYSTEM FOR INDIVIDUALS AND MOM & POP BUSINESSES.
2. As far as business’ go, It seems the real advantage of the fairtax is to be able to make decisions based on business rather than tax implications. Also, won’t the playing field be leveled to a great extent with foreign companies who are not taxed by their governments.
GENERALLY SPEAKING, I AGREE WITH YOU THAT THE FAIRTAX WOULD ELIMINATE MOST OF THE TAX-DRIVEN DECISIONS OF BUSINESSES. AND I THINK THAT WOULD BE A GOOD THING.
I’M NOT SO SURE I AGREE WITH THE “LEVELING THE PLAYING FIELD” ARGUMENT. WHAT MAKES YOU THINK FOREIGN COMPANIES ARE NOT TAXED BY THEIR OWN COUNTRIES? OF COURSE THEY ARE.
BUT LET’S TAKE THIS A LITTLE FURTHER. ASSUME THE FAIRTAX PASSES, AND THE U.S. GOVERNMENT SUDDENLY TAXES ALL FOREIGN GOODS THAT ARE SOLD IN THE UNITED STATES. DON’T YOU THINK THAT FOREIGN GOVERNMENTS ARE GOING TO RETALIATE AND IMPOSE A TAX ON ALL U.S. GOODS THAT ARE IMPORTED TO THEIR COUNTRIES? OF COURSE THEY WILL! TO THINK THAT WE ARE GOING TO GAIN THIS GREAT COMPETITIVE ADVANTAGE OVER GOODS PRODUCED IN OTHER COUNTRIES IS NONSENSE. IT IGNORES THE WAY THE WORLD REALLY WORKS.
3. Who can argue that getting rid of lobbying and special deals for those who can buy influence from politicians is a bad thing?
THAT WOULD BE A GOOD THING. HOWEVER, I’M NOT SURE HOW MUCH LOBBYING IS REALLY DONE FOR TAX PURPOSES RATHER THAN COMPANIES TRYING TO GET GOVERNMENT CONTRACTS OR PASS OTHER NON-TAX LEGISLATION (E.G., PRESCRIPTION DRUG ACT, BANKRUPTCY BILL, ETC.). THERE WILL STILL BE PLENTY OF LOBBYING GOING ON EVEN IF THE FAIRTAX IS PASSED.
4. Isn’t it true that the super rich don’t pay income tax under our current system due to all of the loopholes that allow them to basically launder their money through offshore banks, trusts, etc. and at worst collect it as capitol gains taxed at just 15%?
NO. IT’S NOT TRUE THAT THE SUPER-RICH DON’T PAY INCOME TAX UNDER OUR CURRENT SYSTEM. IF THAT WERE TRUE, WHY WOULD THE RIGHT-WING RADIO BLOWHARDS BE COMPLAINING SO HARD ABOUT HOW MUCH IN TAXES THE RICH NEED TO PAY TODAY. AND, YES, THE CAPITAL GAINS RATE IS 15%, BUT THE ESTATE TAX RATE IS 45%. (BOTH OF THESE WOULD BE ELIMINATED UNDER THE FAIRTAX.)
TELL ME, IF YOU WERE GOING TO INHERIT A BILLION DOLLARS, WHICH WOULD YOU RATHER PAY. AN ESTATE TAX RATE ON YOUR INHERITANCE OF 45%, OR A CONSUMPTION TAX ON YOUR SPENDING OF 23%? I THOUGHT SO.
5. Why is it bad if we use goods more thoroughly instead of buying new and throwing away, and at some point aren’t used goods also new and purchased as such?
NOT SAYING THAT IS A BAD THING. BUT IF THE FAIRTAX ONLY TAXES THE PURCHASE OF NEW GOODS AND SERVICES, THEN THE GOVERNMENT WILL COLLECT LESS REVENUE THAN EXPECTED WHEN FOLKS BUY MORE USED GOODS. THIS WILL REQUIRE THE GOVERNMENT TO RAISE THE FAIRTAX RATE EVEN HIGHER.
6. Wouldn’t the fairtax system encourage saving compared to consumption and isn’t that good?
YES, BUT SAME PROBLEM AS ABOVE.
7. Does anyone think we can continue as a consumption based economy?
I DON’T UNDERSTAND YOUR QUESTION. IF WE DON’T CONTINUE AS A CONSUMPTION-BASED ECONOMY, HOW COULD A TAX ON CONSUMPTION POSSIBLY WORK?
8. Isn’t it easier to conceive of a complete replacement of the existing system rather than to use bandaids, baling wire and duct tape on the current one? After all that is what a wise person does when something has no usefullness left in it.
I DON’T THINK WE NEED BANDAIDS. I THINK WE NEED A COMPLETE SIMPLIFICATION OF OUR CURRENT TAX SYSTEM TO GET RID OF ALL LOOPHOLES AND DEDUCTIONS.
Moderator Note: Hayden’s intention with the uppercase letters was to identify his reply in the discussion and not as a form of shouting.
Maybe the real tax-avoiders under FairTax will be everyone outside the US as exports will not be taxed
To take an example a US company exports 10 trucks for $1,000,000 to Japan. The Japanese have to pay in US currency for the trucks and get it by selling a thousand Japanese made televisions at $1 000 each. Both sides are happy.
Under a Fair Tax, the taxes embedded in the US made truck are reduced and the truck can now be sold for $77, 000 each, presuming the worker gets the same net pay. The Japanese have avoided paying tax as they need only export 770 television sets at the same price, and they have 230 sets they can now exchange, for example, for French wine. The US appears to be worse off and to have priced incorrectly in not including the costs of government services in the price of the truck.
The Japanese television sets of course will be fair-taxed in the US. They will now cost 30% more and the Government gets their cut. However, the US worker now has to pay 30% more for his TV and his pay packet has not increased. Under this scenario, the winner is Japan at the expense of the American worker.
The cheaper trucks will be in strong demand so US exports will rise, but the US will have to sell 13 trucks to get a thousand televisions. You could make more trucks by working longer hours but it sounds like a country getting poorer, not richer.
One solution might be for the US to start making televisions, but that sounds like giving up on overseas trade because under Fairtax, you can’t make it pay. At any rate, the US can’t make enough bananas, coffee, oil and a thousand other essential items. Are you really prepared to take a 23% drop in the imports you get from the outside world by not making foreigners pay for the government share of the US economy?
I just can’t see what happens to the uncollected tax. Who gets the benefit – the Japanese, the employee, or the exporter? Maybe I have missed something but untaxed exports sounds like a great deal for everyone but the US.
There is another important point to consider relating to the “fair tax”. As it is now with the income tax the IRS has tyrannical powers not seen since the King of England ruled America. Look at Wesly Snipes being imprisoned for something he didn’t do. That is correct 3 years for doing nothing. That alone should be incentive for the “fair tax”. 3 years in prison for not doing what the IRS told him to do. FILE. There is no filing with the fair tax therefore no prison time for not doing anything.
Dear Foreigner,
Don’t forget that Japan already abates its VAT on exports to the US.
~Jim
Ok great. I’m a newbie researching this Fair tax and so far I’m impressed ! Please answer this question.
What prevents someone who has a new good to lease or rent it out then it would be considered used?
Then be able to sell it without any taxes.
If I was a new home builder. I would rent it out for 3 months to my buddie to Store his motorcyle out then it would be considered USED. It would be exempt and I would sell my house way under the compititions price for the same good.
You can do this with all other goods.
Ross,
Has the good, real or personal, already paid the tax? A “new” good or service, for the purposes of the Fair Tax definitions, is a good or a service that either has paid the tax, or it existed at the dawn of the Fair Tax and was held privately – making the home, car or TV set you already own today meet the definition of “used.” Renting a new good or parcel of real property out does not make it “used” for Fair Tax purposes. It’s paying the tax on it that makes it used. Does that help?
~Jim
As much as I dislike the FairTax, I believe Jim is correct on this one.
If we were living under the FairTax system today, and a builder were to build a brand new house, rent it out for a few months, and then put it up for sale, the buyer would still need to pay the FairTax on the then fair market value of the house (which, absent collusion, will presumably be the price he pays for it.) The idea being that everything gets taxed once (and only once) when it is eventually sold.
But that brings up another point which may or may not have been answered previously on this board. What if a car is leased for, say, 20 years? At the end of the 20 years, the car has no material value, so taxing a sale at that point doesn’t really do anything.
Would the use of that car essentially go untaxed under the FairTax? I don’t know, but I’m sure others on this board do.
Yes ! I feel if there is a loop hole that people exploit it will be ratted out and fixed. After all of the reading and debating the FAIR TAX has won my heart and support. Count me in. Im going to talk to my local one newspaper about it and see if I can get an article puplished about it. MORE American high paying jobs to stay and come back to the USA. Thanks !!!!
Re post 46
Please read: “A “new” good or service, for the purposes of the Fair Tax definitions, is a good or a service that [either] has NOT paid the tax, … .
Hayden,
I think leases are taxed at the beginning of the term for the full market value. Will post a citation later.
~Jim
Marvin Ammentorp posted this response on the same question in comment 27 of this post from May of 2007:
I want to be sure I understand this car leasing scenario so let’s say I’m going to lease a new $30,000 car. The leasing company doesn’t pay FairTax as a business and it has two options when I sign the lease: 1)collect the $9000 in tax from me at signing and base the lease on the tax-exclusive cost of the car or 2)pay the tax itself and collect it from me in monthly payments based on the tax-inclusive price of the car. Under option 2 if I decide to terminate the lease early, I assume whatever remained in FairTax would be added to termination charges. Then the company could lease the car again or sell it without trying to collect un-repaid tax from a second customer. Am I correct? (Comparable options for buying and mortgaging a new home that would have two elements: equity and tax?)
There are now demo cars – used by car dealership owners or salesmen. Unless the tax is paid by the dealership, as an employee benefit, or the employee as if it were a purchase, demos would be a thing of the past. Am I right? If a dealership included a warranty on used cars no longer covered by the original warranty, would the cost of that new warranty need to be included in the sales price and taxed?
One final clarification, any new goods or services donated by a business to a charity for fundraising events would be taxed by the charity when sold unless the business paid the tax as part of the contribution. The charity, I assume, would be responsible for obtaining the documentation to prove the tax status of all items prior to selling them. Am I correct?
Ellen,
Go to Chapter 8, Financial Intermediation Services. Section 804 addresses the effective sales price in the case of goods are leased for long terms under a financing lease, and the lessee has the right to purchase at the end of the lease for 50% o rless of its fair market value. This language is partially responsive to your inquiry. The language of Section 804 is as follows:
Section 804: Financing Leases
‘‘(a) DEFINITION.—For purposes of this section, the term ‘financing lease’ means any lease under which the lessee has the right to acquire the property for 50 percent or less of its fair market value at the end of the lease term.
‘‘(b) GENERAL RULE.—Financing leases shall be taxed in the method set forth in this section.
‘‘(c) DETERMINATION OF PRINCIPAL AND INTEREST COMPONENTS OF FINANCING LEASE.—The Secretary shall promulgate rules for disaggregating the principal and interest components of a financing lease. The principal amount shall be determined to the extent possible by examination of the contemporaneous sales price or prices of property the same or similar as the leased property.
‘‘(d) ALTERNATIVE METHOD.—In the event that contemporaneous sales prices or property the same or similar as the leased property are not available, the principal and interest components of a financing lease shall be disaggregated using the applicable interest rate (as defined in section 512) plus 4 percent.
‘‘(e) PRINCIPAL COMPONENT.—The principal component of the financing lease shall be subject to tax as if a purchase in the amount of the principal component had been made on the day on which said lease was executed.
‘‘(f) INTEREST COMPONENT.—The financial intermediation services amount with respect to the interest component of the financing lease shall be subject to tax under this subtitle.
‘‘(g) COORDINATION.—If the principal component and financial intermediation services amount with respect to the interest component of a lease have been taxed pursuant to this section, then the gross lease or rental payments shall not be subject to additional tax.
Ellen,
On the demo car -
If you’re talking about a demo car’s being made available to the dealer or employee for personal use, it could be considered “proxy buying” by the business under Section 901. Under that section, if the business provides taxable property or services to a person as remuneration for employment, and such property or services were not previously taxed, such property would be taxable.
If the dealer sells or leases the demo car to one of his employees at a discount of over 20% off fair market value, however that may be determined, there is tax on the excess discount over 20%.
~Jim
On the Charity -
You are correct. Under Section 706 the organization receives a qualification certificate, and its purchases for charitable purposes are not taxed. Donations to the charity by a business also are not taxed. If, however, the charity provides taxable services for a charge, i.e., a church receives bibles donated by a publishing company and sells them to raise money, the sale is taxed.
Actually, Jim, charities would pay the FairTax on their purchases unless they were for resale or export.
Jim, thanks. I had read that section of the bill and was trying to decide how leasing companies would incorporate the tax into monthly payments and the actual terms of the lease. It doesn’t sound as though they’d have to pay the tax upfront. Instead they could collect and remit the tax amount (based on initial principal cost) within the lease period or at early termination. In my $9000 tax example, with a 36 month lease I’d pay $250 per month to cover the tax. If I terminated the lease after 2 years, my termination fees would include $3000 in tax. Is that a reasonably accurate interpretation as you read the language?
One thing that’s a bit confusing from a revenue perspective is that the base used to calculate the tax rate appears to include the assumption the tax is paid in full at purchase. With high cost items that are financed, it seems only a portion of the total tax might be remitted each year. In the case of new homes, a consumption base of $400b ( as an example) generates $92b in tax for the year. Isn’t it probable that base would generate $3b instead if the total tax wasn’t due at purchase and 30 year mortgages were the standard financing tool? Perhaps someone could clear up what seems to be a logical disconnect – no doubt on my part.
As to 56:
Fred, I don’t understand where do you get that. Under 706 purchases by a charity for its charitable purposes are tax-exempt.
As to 57
Ellen, limiting my comments to the sale of the home, an outright purchase of a new home where the buyer borrows money would be taxable up front. The financing is an internal matter between purchaser and bank (where financial intermediation services, Chapter 8, would come into play. The builder of a new home gets a business use conversion credit when he buys the land, Section 202. On the remainder of the costs the builder has lower costs and lower real mortgage interest rates as a direct result of the Fair Tax.
Installment sales are theoretically possible today. Legal costs would be substantially higher because an attorney would have to hold a deed in escrow during the pendency of the installment sale. I suppose the Secretary would try to disaggregate the transaction to it come out roughly equivalent to an outright purchase. Interesting question.
~Jim
No, Section 706 states that non-for-profits are eligible for the exemptions in Section 102. Those exemptions are purchases “for resale, to produce, provide, render, or sell taxable property or services, or in furtherance of other bona fide business purposes.”
As Kotlikoff stated “The FairTax taxes nonprofits’ sales of goods and services to individuals and their purchases of goods and services that are not sold on to individuals, including capital goods.” Using Kotlikoff’s numbers, nonprofits would have paid ~$36 billion in FairTax last year.
We went through this here last year.
Re 59:
Fred, You are correct that Section 706 refers to Section 102, which exempts taxable property or service purchased for— … (A) a business purpose in a trade or business. If we read the two together in pari materia, the business of a charitable organization is its charitable purposes. Otherwise the reference in the charitable section to Section 102 would be meaningless. A principle of statutory construction is that the language was intended by the legislator, and we give effect to it.
~Jim
Jim, nonprofits only get the exemption “for resale, to produce, provide, render, or sell taxable property or services, or in furtherance of other bona fide business purposes.†Charities are not businesses. Purchasing things to give away is not a “business purpose.” The rate calculation paid for and approved by the AFT (Kotlikoff/BHI) included ~$121 billion in expenditures by nonprofits in the FairTax base. Are you claiming this was in error? If so, then so is the rate in their conclusion.
Re 61:
Fred: I don’t agree with that interpretation for the reasons I set forth in Post No. 50. Your point about Kotlikoff, however, is interesting. Perhaps Kotlikoff should not have included consumption by non-profits for their charitable purposes in his tax base.
~Jim
Or perhaps you’re wrong and nonprofits are taxed on their purchases that aren’t for resale. This is the only way the FairTax can fulfill it’s stated purpose, “To tax all consumption of goods and services in the United States once, without exception, but only once.” You seem to want to make consumption provided by a nonprofit an exception.
According to AFFT, taxable property and services purchased by a qualified non-profit or religious organization ‘for business purposes’ would not be taxable. Charitable operations operate under a sales tax exemption certificate as they do today with most states. No purchase made by an exempt charity is taxed.
Then, Morphh, you have to either accept that the AFFT is wrong in this document (which I believe they are) or that Kotlikoff was wrong and his rate calculation is too low. Which is it?
At the risk of belaboring the point, it’s not about what I want non-profit consumption to be, or about what AFFT wants it to be, but how to properly interpret the language of the bill. If non-profit consumption for non-profit purposes is taxed, then the incorporation by reference in Section 706 to Section 102 would be rendered meaningless.
I agree that, if my interpretation is correct, Kotlikoff may have to revise his calculation.
~Jim
According to the plain English version of HR25:”Taxable property and services purchased by a qualified not-for-profit organization “for business purposes†are not taxable. So, in other words, purchases for business purposes are not taxable and sales to consumers are taxable. However, the organization must present its qualification certificate to the seller when making a purchase in order for the sale to be tax exempt.”
Maybe a question could help clarify: is “for business purposes” defined the same for not-for-profits and for-profit businesses? If so, a charity would be taxed on the same purchases as a for-profit business.
Jim,
I think you know where I’m headed with my leasing questions/examples and it all comes down to when tax would be collected for lease with option to buy items:
HR 25 states the principal component of the financing lease shall be subject to tax AS IF a purchase in the amount of the principal component had been made on the day the lease was executed. Use of the clarifying term “as if” leads me to conclude the full tax wouldn’t be collected on the day the lease was executed. If, as predicted, interest rates drop and investment returns increase, it could be financially beneficial to minimize large upfront tax payments.
I think it’s probable financial institutions would create and market new “leases” or installment contracts for homes and other expensive purchases. The contracts could adhere to the letter of the tax law while enabling consumers to avoid costly upfront tax payments. An argument could be made that such contracts would adhere to the spirit of the law as well – whether we finance or lease, we haven’t really bought an item until we’ve paid the full agreed upon purchase price. Until then, we’ve bought only the amount of the principal cost we’ve repaid to the lender or leasing company.
I’m interested to know if others interpret the “as if” language differently. If not, is there some reason lenders would be prohibited from creating new products to compete with leasing companies.
It’s not meaningless. If a nonprofit organization sells something, it’s taxed when sold (consumed) but not when the inputs for that good are purchased (the exemptions in Section 102 would apply). If a nonprofit gives something away, there is no transaction to tax, so the inputs are taxed when purchased. This is the only what to assure that “all consumption of goods and services in the United States [are taxed] once, without exception, but only once.”
If the FairTax doesn’t work this way then there is a loophole big enough to drive a truck through. (A truck I purchased FairTax-free through my nonprofit organization, BTW. Thank God there’s no IRS to investigate me!)
Ellen,
On Non-Profits:
I think interpreting “business” purposes to apply analogously to non-profits is the only interpretation that makes sense. See my previous posts.
On Financing Leases:
I’m a little out of my element here. It would seem from a common-sense view that disaggregating the principal and interest components would entail looking at the cost over time of leasing/buying a widget and distinguishing that from buying it outright for cash now. The former would require more dollars ultimately because it is being paid for over time, and the lessee/purchaser has the use of the money.
It would seem that the Secretary would make the lessor/seller give the lessee/purchaser a statement similar to the Truth-In-Lending statement today, showing how much would ultimately be paid out, how much would be principal and how much would be interest. I think the principal amount would pay tax, and the interest payment amount would be tax free (actually an anomaly under the Fair Tax). The component of interest payments representing financial mediation services would be taxed.
I doubt there would be any inflation adjustment. Do you think discounting back to present value would figure in?
What to you and everyone else think?
~Jim
PS to Post 70:
Under 804(e) the principal amount would be payable on the date of purchase.
Post 69:
Fred,
If non-profit gives something away other than as part of its charitable purposes, it encounters the proxy-buying rules making that item subject to tax. Section 901(e). If it operates a soup kitchen and gives away meals to the poor, that’s not proxy buying. If it “gives” something to its minister or one of his cronies as disguised compensation, that’s proxy buying and subject to tax.
~Jim
Jim, Section 901(e) applies to “registered persons,” (I assume registered under Section 502) providing “taxable property or services to a person either as a gift, prize, reward, or as remuneration for employment.” Nonprofit organization aren’t “registered” under Section 502 (or any other section) so 901(e) doesn’t seem to apply to them.
Fred:
“Registered Person” is not a defined term in the bill, so we have to look to instances where the bill calls for registration. “Registered Seller” is a defined term and includes the term “person.”
“Person” is defined as ‘‘any natural person, and unless the context clearly does not allow it, any corporation, partnership, limited liability company, trust, estate, government, agency, administration, organization, association, or other legal entity (foreign or domestic.)”
Registration is not only pursuant to Section 502 but also, for example, for purposes of the prebate.
Registration also applies to a non-profit organization, which must register to receive a “qualification certificate.” Therefore, non-profits clearly are included in the term “registered person” for the purposes of the proxy-buying rules under Section 901.
~Jim
So now a not-for-profit organization who have applied and been provided a “qualification certificate” is a “registered person”? (Even though they don’t have to “register.”) You stretching the language of the bill way past the point of breaking, IMO.
[Can't someone in the loop try to get an answer from David Burton or Dan Mastromarco on the not-for-profit issue? I don't trust that the people at the AFFT understand how this portion of the bill is intended to work.]
Jim
For some reason, I find this leasing issue interesting. Probably because paying out huge tax dollars in one lump sum seems contrary to the value of compounding savings AND I’m actually looking for an understanding of how it would work. So, do you think a lender could create a long-term “home lease with option to buy” that had 3 elements: principal on which interest would be paid; tax escrow on which interest would not be paid and the interest itself? If I needed to finance $160,000 over 30 years, interest rates are low and investment earnings are high and tax-free, could there be a product that would allow me to keep and invest my “lump sum” $48,000 tax and pay equal portions ($133.333) of it monthly using an escrow type vehicle within a lease arrangement?
I think the answer to that depends on whether taxes on leased items are calculated on the full purchase price (principal) but collected and remitted by the leasing company in installments over the length of the lease. Does 804(g) help clarify if that’s the case?
Yup! If a non-profit wants a qualification certificate, it most certainly would have to register – with the state tax authority.
BTW, for my info, who are David Burton and Dan Mastromarco?
~Jim
I believe David Burton and Dan Mastromarco (Argus Group) wrote the Fair Tax Act for Congressman Linder.
Burton and Mastromarco are the one who actually wrote the FairTax bill. My understanding is that if there is a question about the language, the AFT asks them or they just interpret the language just like you or I would. Frankly, I don’t trust them to interpret the language.
This case is a good example of why. Their (and your) interpretation goes against what to me is the clear meaning of the language. It also goes against the even clearer stated purpose of the bill – to tax all consumption of goods and services in the U.S.
If it were the way they and you claim, why wouldn’t Section 706 say specifically what you claim – that nonprofits don’t pay the tax on any of their purchases? Why is there even a designation of nonprofits in the bill? How are they any different from businesses?
Ellen,
I’ll need some time to study your inquiry. However my one immediate reaction is that houses are not sold today on the installment plan because of the tax code. It wouldn’t make sense for the purchasers today to forego the benefits of the mortgage interest deduction and the property tax deduction.
Many people today do lease cars and buy them on the installment plan because income tax considerations play no role for these kinds of transactions.
With the Fair Tax, people might start to look at alternative arrangements for housing such as leasing homes with the option to buy. There would be no negative tax consequences any longer for plans structured this way, and people’s behavior would become driven strictly by what they think makes business sense for them.
This would become one more example of tax considerations dropping out of people’s economic decisions once we have the Fair Tax.
~Jim
Ellen:
PS: Just thought of something else. Rent is taxable under the Fair Tax. If the transaction starts to look too much like rent instead of an installment sale or a lease with an option to purchase, the tax authority and the Sales Tax Bureau would characterize the transaction that way and tax it accordingly. If the buyer pays tax on the disaggregatged principal up front instead, it would become disingenuous for the sales tax authority to try to characterize the transaction as rent and tax it that way%.
~Jim
Jim….regarding # 81. I agree the transaction couldn’t look too much like rent; however, the wording of the bill would seem to distinguish between renting with no intent to purchase and leasing with option to purchase. You’re right in # 80 about considering the tax benefits of a mortage under the current code. In fact, people were encouraged to get the largest mortgage they could afford for two reasons: the tax deduction and keeping as much discretionary money as possible for other uses. Obviously reason number 1 goes away under the FairTax but reason number 2 still applies.