What is a government enterprise?
Mailbag question:
Sec 2(12)(A) says that some employers are taxable, meaning that the wages those employers pay are taxable under the FairTax. Sec 2(12)(A)(ii) says governments are taxable employers except for government enterprises and Sec 2(12)(B)(iii) further reinforces the exclusion of government enterprises as taxable employers.
I’ve read all the referenced parts of H.R. 25 and it seems to me that the FairTax will tax all government employee payroll at the nominal rate unless the employee works for a government enterprise.
How a government enterprise is determined then becomes a pretty big issue. The FairTax Plain Language document gives some very obvious government enterprises as examples. I’d like to know how the hard cases are to be determined under the act.
From the plain english version (written by Dan Mastromarco, one of the bill authors): “Wages paid to employees by businesses, not-for-profit organizations, and government enterprises are not subject to the FairTax. These entities collect the FairTax on the sale of taxable goods or services to the consumer. The above definitions of ‘taxable employer’ and ‘taxable service’ have the effect of taxing government consumption. Since governments generally provide services free to the public, the value of the consumption is the value of the services used to provide services to the public, i.e., the services of labor or wages paid. ”
Mastromarco describes government enterprise: “Government enterprises are governmental entities that receive payments from private persons for goods and services. They must maintain books of accounts separate from the non-enterprise governmental accounts. For example, the expenses and receipts of a county landfill enterprise must be kept separate from the expenses and receipts of the general county government. Examples are the U.S. Post Office, Amtrak, local government waste management operations, etc. These enterprises, at all levels of government, are treated the same as private businesses with respect to their purchases and sales to consumers. This means that any intermediate purchases by government enterprises are not taxed; only the final sale of goods or services to the consumer is taxed.”
So what would be some hard cases, and how would they be determined?
Hard Cases or Easy Cases?
1) A county court system (let’s say Los Angeles County) collects filing fees and imposes fines and court costs, so it collects some money from those who use the system and those who run afoul of the law. But the court system, as a whole, is not funded by the money it collects.
2) A county tax collector collects property taxes from people and businesses who reside in or own property in the county. That’s a lot of money collected — much more than the cost of operating the tax collector office. That money is used to fund most of the rest of the county government or allocated to individual cities and towns within the county to operate those local governments.
3) A state motor vehicle agency collects license and registration fees from motor vehicle users. Its operating budget may be offset by the fees it collects, but much of its operation is funded by state income or sales taxes.
4) Members of the United States Congress and their staffs, extrapolated to all elected officials, collect no money, except for their election campaigns. The election campaigns do not pay their and their staff salaries once elected.
5) The armed forces of the United States do not collect any money from people for the services they render. The Department of Defense has a budget, so I imagine it keeps separate books from, let’s say, the Department of Education.
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So, a broad question might be: Does the power to assess and collect taxes make all governments at the level of the taxing authority (Federal, state, county, or local) make the entire government entity a government enterprise?
If that were the case, then what is the purpose of defining a government as a taxable employer?
If that were not the case, then at what level are departments or agencies segregated from the “government” for the purposes of the Fair Tax? Is it just a matter of bookkeeping practices? Or is it that it must receive direct payments from private persons? Or must it be both? Or is it that a government enterprise must look and act more like a business?
Wouldn’t it be relatively easy for a government to change its accounting practices to make itself a government enterprise?
Could a government “spin off” a department or agency, make it keep its own books, and require it to collect the money directly from private persons and thus create a government enterprise from where there was none? Would it matter that a large portion of the money used to operate the enterprise came from Federal, state, and local taxes?
If a county tax collector broke down the tax bill to show $100 going to the sheriff’s department, and $100 going to the fire department, and $100 going to the person’s city, would that, in effect, make the sheriff and fire departments government enterprises?
When I pay my income or property taxes, I am not paying for any specific service. A substantial percentage of what I pay is spent on programs that are specifically NOT a service to me, but to someone who has not paid anything for the service.
I think this is a good topic, Morph.
I would suggest looking for guidance to another part of the Fair Tax bill concerning hobby activities. See Article II, Section 701. Under that section the “activity” needs to receive gross payments in excess of the sum of taxable property and services purchased and wages and taxes paid for two of the most recent three calendar years. Otherwise the “activity” is not entitled to the intermediate sales credit or the business use or export credit.
Although that section does not address the charging of tax, I would think by analogy it should provide some guidance, albeit not necessarily conclusive, as to whether a given so-called government enterprise truly is an enterprise.
~Jim Bennett
Summit, NJ
Richard, I think a government enterprise would not be funded via the tax payer. A government enterprise acts like a private business, charging for its operation. Collecting revenue from the public by a government entity would not qualify it as a government enterprise, as it would just be a method of taxation or fees, something to go into the public budget. In some cases these fees (taxation), can offset the general budget assigned to the entity, but it is still providing its services for “free”. A government enterprise has to charge the FairTax to the consumer, like any business, for its product or service. This is the tradeoff - A taxable employer pays tax on the wages, but charges no FairTax on government services. A government enterprise collects the FairTax on services, but pays nothing on wages. The 5 examples that you listed are not “selling” anything, they’re just collecting fees or taxes - that is a taxable government employer, not a government enterprise. The intent is that government be on equal playing field with private business, in either situation.
so, either the (gov’t entity in question) pays taxes on its retail receipts (if it has them) or it pays taxes on its employees (if it does not)?
when you split them that way, it’s going to be hard to find an entity that doesn’t cleanly fall into one or the other.
just for grins, tho:
county road maintenance.
there’s a business that could compete for that work. it wouldn’t pay FT on its wages (private business), it wouldn’t charge FT on its sale of the roadwork to the county.
there’s a county crew that does that work, with county trucks and county asphalt, and county workers. that gov’t entity doesn’t directly sell anything to the retail market, preventing it fro being a “gov’t enterprise”
under the FT, the private business operates tax free on both sides, allowing them to undercut the county who must pay FT on the employees wages (everything else being the same; wages/materials/etc.)
i assume this is the intent, to use the tax system as the wedge to drive some specific private industry contracts out of the gov’t’s hands and back into the private sector.
but, could one argue that the county population IS, in fact, the retail consumer of the roadwork their tax dollars bought. they paid a specific price for a specific job. in that regard, it’s technically a giant retail sale, with the county taxpayers as the buyers and the county gov’t as the sellers.
once the county population becomes the retail consumer (en masse), the private business is ALSO making a retail sale, forcing it to charge/collect FT on their sale...negating the aforementioned advantage.
Justin, you stated that the private business wouldn’t charge FT on its sale of roadwork service. I don’t see why that would be the case - I think the private company would charge FairTax. The county is the final consumer.
Morphh,
But, isn’t the county a business?
but does the “county” qualify as a retail customer..is that a retail sale as defined by the FT?
If ABC construction pours me a new driveway, it’s a retail sale.
If ABC construction pours my neighborhood developer a collection of curbs and sidewalks, it’s a wholesale sale.
If ABC construction pours a new slab of main street....which is it?
if businesses are going to charge FT on sales to gov’t, i can see the “it’s going to cost muni/county/state gov’ts too much” argument holding some water.
The county is not a business, it’s a government. Government is not tax exempt on retail purchases (at any level). Local, County, State, Federal would pay the FairTax.
The purpose of taxing state, county and local governments for their employees is to put their operations on the same tax footing with private companies. To take Justin’s example, a county has a choice of either using its own people to put down a road or hiring an outside firm. If the county did not have to pay taxes on its wages and tax on its equipment and supplies, it would have an unfair competitive advantage against the private company, and privitization of services would disappear. The county under these circumstances, would choose to use its own people every time to avoid paying tax to a private contractor.
The private company does not pay tax on its employees because it charges tax to the county when it performs the work.
If the county formed a profit-making corporation that took on outside business in addition to its “captive” business, it could very well qualify as a government enterprise.
~Jim
My head is spinning!
Just to make sure I’m clear on this:
If the county pays a private firm $1 million to build a road, the county pays the FairTax to the federal government on that $1 million expenditure. So the federal government gets $300,000, and the total cost to the county is $1.3 million.
If the county uses it’s own employees to build the road and pays them $1 million, it pays the FairTax on top of their salaries to the federal goverment. So the federal government still gets $300,000, and the total cost to the country is still $1.3 million.
Is that right?
Back in the October 2006 Archives (Kotlikoff-23%), we thrashed around about a related issue which I never felt got resolved. Here is a definition from HR25 for background: “(17) WAGES AND SALARY- The terms `wage’ and `salary’ mean all compensation paid for employment service including cash compensation, employee benefits, disability insurance, or wage replacement insurance payments, unemployment compensation insurance, workers’ compensation insurance, and the fair market value of any other consideration paid by an employer to an employee in consideration for employment services rendered.”
For non government enterprises, government services (payrolls) have to be taxed to ensure a level playing field with the private sector. My question is simply does this definition mean that the tax must be applied to the burdened cost of payroll? If so, it would add a significant tax burden to state and local governments it seems to me. Burdened government costs when all those elements are included are probably well over 150%. Any thoughts?
i guess i thought i knew that, and somehow managed to talk myself out of it, anyway.
Hayden,
I think you got it right.
Hank,
To balance it out on the private side, the proxy-bying rules in Chapter 9 provide that the employer must pay cash on any taxable property or services provided as remuneration for employment. Section 901(e). For example, if an employer provides health insurance to its employees, the employer pays tax on the premium (the benefits then are not taxed).
As to the state unemployment and workers comp funds, either the state department or agency administering them pays taxes on its employees, or if the state runs these functions as enterprises, the enterprises pay tax.
~Jim
Hayden,
I thought if the county pays a private firm $1 million to build a road, the private firm sends $230,000 to the taxing authority, just like if I pay them to build a private road. If the county builds a road for $770,000, they pay the taxing authority for whatever portion of that is wages/compensation and the rest is submitted by the entity that sold them the supplies or provided them the services. This should total $230,000.
I am not sure that is how it actually works, but it seems kind illogical if the county skipped paying taxes, so they could pay them later.
Jim,
Thanks, but I don’t think I did a very good job explaining my question. Let me try again and see what you think?
HR25 defines wages and salary as including all the burdened amounts for all sorts of benefits. Burdened salary calculations typically amount to 150% or higher of the base wage or salary. HR25 also says that governments must pay a sales tax on salaries and wages as representing services provided. My question is does this mean that the tax would have to be applied to the burdened amount or just the payroll amount. Makes a big difference on the impact of the Fairtax on governments at all levels.
Thanks!
Hank,
Could you please elaborate on what you mean by burdened amount? Thanks.
~Jim
Jim,
My understanding of the term “burdened” wages or salaries is it means all compensation paid for employment service including cash compensation, employee benefits, disability insurance, or wage replacement insurance payments, unemployment compensation insurance, workers’ compensation insurance, and the fair market value of any other consideration paid by an employer to an employee in consideration for employment services rendered.
This happens to be the definition of “wages and salaries” provided in HR25. Taken literally, it seems to me that the sales tax on government wages and salaries should be applied to the burdened amount, but I wouldn’t know how to go about calculating such a burdened amount? Perhaps a business expert could shed some light here? How would one prorate monthly a pension benefit? How do you figure out the individual share of all those insurance payments? Sounds like a huge bookkeeping chore to me, and I’d like to know if HR25 needs some clarification here?
Hank,
I agree. Title II, Subtitle A, Section 2(17) taxes not only direct payments for salary but also payments such as workers comp and insurance that would not otherwise arise, but for the job. This provision gives the states an incentive to either privatize their services or adopt their own versions of the Fair Tax - thereby eliminating separate payments from salary for workers comp, disability, and state income tax.
I think computing the present actuarial value of a contribution to a defined-benefit pension is not difficult at all. The alternative is to let employees keep their money and contribute it to their own retirement savings. If contributions to retirement for government employees go untaxed, a loophole would arise.
~Jim
Jim,
I’m going to take your response to mean that State and Local governments will be taxed on the burdened payroll amount, and that it shouldn’t be too difficult to compute on a monthly basis.
Therefore, let me remind you all about the probable financial impact of the Fairtax on State/Local governments.
Using the 2006 Kotlikoff/BHI study date, and correcting the rate to 26.5%/36% per the Rice study (corrects the BHI failure to add revenue to offset the federal government taxing itself), there is $1.1 trillion in S/L taxable consumption, split 59% for stuff, and 41% for payroll.
For the stuff, I assume that prices will rise by 22.4% (1.00 x .9 x 1.36 = 1.224) after producer cost savings of 10% (employee gross pay remains the same). So, the impact on S/L governments for the purchase of stuff would be: $1.1T x .59 x .224 = $145 B.
For payroll, assuming a burdened cost of 150% of basic payroll, and a savings of $34.5 billion by eliminating the current 7.65% payroll tax, the added payroll costs would be: $1.1T x .41 x 1.5% x .36 - $34.5 = $209B.
The total added cost to S/L governments would be $354B, an increase of 32.2% over current law. This could be paid for by reducing S/L services, taxing the tax, or most likely, raising all S/L taxes by 32.2%. That isn’t an insignificant amount!
This also means that there is 15.2% of the required federal revenue hidden in higher S/L taxes. Not very transparent, imho!
I can’t resist adding that those of you who support the Fairtax based on computer models that show a rosy future for all Americans might rethink your position. Allen Greenspan set back economic computer modeling at least 100 years in his recent House testimony, when he admitted, that with hundreds of the finest PHD economists at the Fed, he was unable to predict the last economic meltdown. So much for LK and his ESP model. You may take comfort from his Fairtax predictions, but I don’t!
Hank,
If I’m not mistaken, under today’s income tax the rules are very similar. Witholdings for state unemployment and disability insurance as well as witholdings for Social Security, Medicare and FUTA (I think that is your definition of “burdened” payroll, but I’ve never heard the term from anyone else) are not deductible from the federal income tax. In effect there is a tax on the tax. Without these taxes either the employee could receive more, or the employer, including state and local employer, could pay less.
The health care and life insurances are a loophole I have written about before.
We already know that state and local government costs will rise under the Fair Tax, but they will be on the same tax footing as for-profit private business. The two offsets will be employer contributions to Social Security and Medicare and, I believe, lower real borrowing costs - which should be huge. I admit that I do not have research to back the second item up, but I think intuitively that an effect of increased savings and investment will be lower real borrowing costs.
~Jim