The embedded cost of taxes
It is stated that retail prices are inflated due to taxes and compliance costs that become embedded into the product and passed to the consumer by producers and suppliers. We’ve tried on this blog to understand the cost associated with federal taxes embedded into the prices of goods and services; and more directly, how much of this cost can be removed with a transition to the FairTax. John Linder states the FairTax would eliminate almost all federal taxation costs from the supply chain, which could lower production costs by up to 30%. Americans For Fair Taxation has stated that the production cost of domestic goods and services could decrease by approximately 22% on average under a non-accommodation model after income taxes are removed.
The 22% figure is based on a study conducted by Dr. Dale Jorgenson, who found that producer prices would drop between 15% and 26% (depending on the type of good/service) after the switch to a consumption based tax. Jorgenson’s research included all income and payroll taxes regardless of whether they were paid by employees or employers in the estimation. It is also important to note that the Jorgenson model did not capture any reduction in the cost of compliance associated with changing from a complex income tax system to a simpler consumption tax. If businesses provided employees with their gross pay (including income tax withholding and the employee share of payroll taxes) and used the remaining to decrease costs, Arduin, Laffer & Moore Econometrics estimated production costs would decrease by a minimum of 11.55%.
So, how does this break down? Does the FairTax rate (be it higher than current legislation for revenue neutrality) have a relational tie to the taxes replaced (windfall gains to income or price offsets). Let’s discuss
I have been trying to justify my position that business costs on average are 10% of sales. Using the Kotlikoff/BHI data, my denominator is the $9.8 trillion in taxable GDP as representing sales, business income taxes paid in 2007 were $290 billion or 3% of sales, half of payroll was $435 billion or 4.5%, and the commonly accepted AFFT estimate of business compliance costs is $265 billion or 2.5%. Add them up and I have maintained that business taxes as a percent of sales averages 10% across 20 million businesses.
I have recently come to question whether or not GDP represents sales? Google retail sales and you will find that retail sales in 2008 were $4.0 trillion, less than half of the taxable GDP used in the BHI study. Wholesale sales in 2008 were $4.6 trillion, but the two still don’t match the $9.8 trillion used to determine the 23.8% Fairtax rate.
Since only retail sales will include the sales tax, you can see that the Fairtax inclusive rate would be over 55% if the $4.0 trillion retail sales figure is used as the denominator. What is going on here? What is the relationship between retail sales and GDP, if any? If members of this blog can’t enlighten me, I’ll email Larry K and see what he says, but at the moment, I think a gigantic error has been made in calculating the Fairtax rate.
Help!!!!
I’ve read that the FairTax base taxes around 80% of GDP. Federal taxes as a whole on GDP is around 18%. Probably the best place to look is the BHI study “A Comparison of the FairTax Base and Rate with Other National Tax Reform Proposals”. It would seem to me that a simple way to do this would be to subtract the prebate percentage from the FairTax rate, whatever is left over is replacement of the income tax system (it’s cost on production). This can then be broken down as a percentage to the appropriate tax replacement (meaning personal income taxes are x% of the pie, payroll taxes are x%, corporate taxes are x%).
hank....did the “retail sales” figure you found mention if it included non-taxed service transactions? i can see why those might not be included in the “retail sales” figures, as they are not commonly taxed, and (as the anti-FT crowd likes to remind us) hard to track.
i don’t know what that number might be, but i can see it being big enough to add to 4 trillion of retail sales and whatever current savings might be (if there is any) to make the 9.8 trillion GDP number.
if the “retail sales” figure *did not* include services, then their inclusion would knock down your 55% rate by a serious amount.
I agree with Justin. I found this definition of retail sales, http://www.businessdictionary.com/definition/retail-sales.html. It talks of durable/non-durable goods, i.e. doesn’t mention services. This definition of retail sales index, http://www.investorwords.com/5768/retail_sales_index.html, actually states that services are not included and therefore it represents less than half of the total consumption.
It also doesn’t make sense, imho, to add retail and wholesale. Wholesale should be input to retail. Otherwise, retailers aren’t making any profit. That’s why I’d assume that both numbers you found were product only, i.e. no services.
Does the FairTax rate have a relational tie to the taxes replaced? Absolutely. The 80% GDP number also makes sense for translating 18% or GDP into 23% of sales, i.e. 18/.8 = 22.5. Maybe the extra is for the prebate. Maybe a good debate question would be “Is the fairtax base really 80% of GDP?” If we can determine what percent the base is, figuring the rate is trivial.
Andrew/ Justin,
Thanks! You were right–the retail sales data did not include services. Same data source shows that retail services were $5.1 trillion in 2007, so when added to the $4.0 trillion in retail sales, we are getting close to the $9.2 adjusted personal consumption number used in the BHI study. My mistake, but the retail sales data wasn’t real clear about including services or not.
According to the same BHI 2006 study, the gross Fairtax consumption base is indeed 81% of the 2007 GDP. No mystery there.
Although I’m still not sure why, it seems that Chamber of Commerce retail sales data for durable and non durable goods plus services sales are roughly equivalent to the 81% of GDP used by Kotlikoff/BHI from their 2006 base/rate study. Both result in a Fairtax consumption base of $9.2 trillion. Dividing business income taxes, business share of payroll taxes, and business compliance costs by $9.2 trillion results in a cost of sales of 10% that could be removed under the Fairtax. 10% is optimistic in that there will be demands on the cost savings other than price reductions, such as business expansion, increased shareholder payments, debt retirement, increased profits, and increased payroll. The 10% is pessimistic in that I divided the total payroll tax receipts in half, half for business and half for employees. To the extent that businesses pay both halves of the payroll tax, the 10% may be off somewhat. I have found no way to estimate the number of owner operated businesses that might pay all of the 15.3% payroll tax.
As for the ALM study mentioned in the original post, I have read the study several times and do not agree that it makes a case for business cost reductions of 11.55%. Unfortunately, we can’t reproduce the specific passage in the report, but reading page 19-20, it basically talks about investor benefits from eliminating taxes on dividends and capital gains. The report states that under the Fairtax, investor returns would go from $89.65 per $100 to $100 per 100, an 11.55% increase in after tax returns. In no way does this statement seem to be talking about embedded cost reductions. To say that ALM believes that costs would be reduced by 11.55% seems to be somewhat of a stretch!
I continue to believe that business costs could be reduced by 10%, and retail prices would rise by 17% if the exclusive rate was 30%, higher if the revenue neutral exclusive rate is higher, which seems to be the case.
as a fairtax supporter, i don’t have any problems with retail prices going up 17%, since my spendable income will go up about 29.5% at the same time.
right now i only get to spend about $77.35 for each $100 i make, thanks to a ~ 15% income tax and a 7.65% payroll tax.
$77.35 + 29.5% = $100.16
as long as the 30% is revenue neutral, i personally come out ahead. and, even if the rate has to be higher, it would still take a bit to wipe out the increase in spendable income wage earners will see as a result of removing the taxes on working.
(and, this is totally (and intentionally) disregarding the new money i’ll have to spend thanks to the prebate)
Justin,
This may appear to be nit picking, but I have frequently pointed out that you shouldn’t add a tax bracket (15%) to a tax percentage (7.65%) and get anything useful. You should add together effective tax rates to see what your tax burden really is.
In your case, if you happen to be at the high end of the 15% bracket ($32550 gross), your effective tax rate is 13.5%. Added to the 7.65% payroll tax gets a total effective tax rate of around 21%. Which means you can spend 79% of your gross pay or $25,614. Call that your purchasing power under current tax law.
Under the Fairtax, your income would be $32550 plus the $2392 prebate for a total of $34942. Assuming you spend it all on taxable consumption, you would pay $8,036 in sales taxes, leaving $26,906 as your purchasing power?
Slightly better than under current law, but now comes the price increase question. If prices rise by 17%, it seems to me you will have significantly less purchasing power under the Fairtax. What am I missing?
in order to make sure that i don’t owe taxes at the end of the year, i withhold at the maximum rate possible (i have a couple of jobs, and that always gets you hosed at tax time). for the last decade, just about every dollar i’ve gotten back in a federal tax return, i’ve owed to the state tax return (that’s my punishment for living in oklahoma and not having kids).
every 15 days, my paycheck sees about 15% of my gross pay go to IC withholding. i have no idea what my effective tax rate, or my marginal rate or anything else is....when i divide my IC withholding by my gross....i’m withholding about 15%.
if i get paid a gross of $100, $15 of it goes to federal income tax, and $7.65 goes to payroll taxes. (ignoring state taxes for simplicity’s sake)
that leaves me with $77.35 to spend.
under the fairtax, i’ll have $100 to spend...that’s $22.65 more than i had before. 22.65/77.35=29.28% that’s a 29.3% increase in spendable income.
if retail prices go up 17%, and my spendable income goes up 29.3%...i’m coming out ahead by over 12%...i’ve gotten a 12% raise in purchasing power.
i agree the numbers might be different for other people, but middle-of-the-road me makes a good barometer. that 12% buffer allows me to still come out ahead whether the rate has to be bumped up for revenue neutrality, or another’s effective rate is lower due to their actual tax burdens.
you asked what are you missing? here’s my best guess:
you are considering the sales taxes ($8036) as a separate entity from the purchasing power (26906)
that causes two problems..
1) they are not separate. you cannot purchase without buying the tax. you are suggesting that the 17% increase in prices happens BEFORE the taxation (well, you are now...in the previous posts, you didn’t seem to). I am suggesting that the 17% increase in prices happens AS A RESULT OF the taxation.
2) nowhere near 100% of my spendable income is spent on taxable retail goods. you are wanting to inflate 100% of my purchases, when in fact, only about 1/3 to 1/2 of my income is spent on taxable retail purchases. this skews your numbers considerably. my mortgate and car loan payments won’t go up 17%, they’ll (possibly) go up a couple of percent for the services portion of the bill. my shop rent likely won’t go up at all. in just four monthly bills, i’ve negated your 17% increase on $2000 of the $3000 a month or so i gross.
increasing $3000 in spending by 17% would be tragic, to be sure.....but increasing $1000 in spending by 17% while increasing my spendable income by almost 30% is much more bearable.
Justin, You have suggested that your take home pay will go up substantially (you say about 30%) and prices may only go up 17%. This is similar to a major claim made by Boortz and Linder. Although they have backed off of this claim somewhat, they initially said in their first book that everybody’s take home would go up by 25-30% and prices would remain constant. I’m not sure why anyone can seriously believe this. Think about it: compare the day before the FT takes effect to the day after. If everyone takes home 25% more pay but prices don’t go up, you are really suggesting that somehow, 25% more money instantly comes into existence. Boortz and Linder have sort of backed off of this claim, even going so far as suggesting that it’s really a claim made by overzealous supporters (part of the responses in their latest book). Actually, I can provide numerous quotes from their first book that say exactly this. So, how can you believe that the FiarTax will “magically” create a huge amount of moiney inistantaneously?
actually, i have said that some people will fight for their current gross paycheck, and that i’m not a fan of that model because i believe it will cause massive inflation and devalue most savings accounts.
They haven’t backed off the claim, they’ve just recognized that some people don’t understand the difference between nominal and real dollars. that has caused them to restate their claim more completely. (the shopping cart example is real dollars, not nominal dollars)
their original position was that “prices would stay the same,” and that is accurate; ‘real’ prices WILL stay the same. nobody is suddenly going to spend $5 for something that cost $3 yesterday unless their spendable income went up by a similar amount. (and honestly....probably not even then).
their original position also assumed that people would not demand a raise based on nothing more than a change in tax policy. just as Bob isn’t going to spend $5 for the item that cost $3 yesterday, Bob should not expect to take home $500 for the job he took $300 home from yesterday. they assumed that every tax dollar involved in the production of a good (corporate, income, and both sides of the payroll taxes) would come out of the retail price (about 22%)...then replaced by the 30% FT.
in the long run, (in their view) you still have as much as you always had to spend (old-net=new-paycheck), and prices go up ~ 1.4%.
so, because people incorrectly assumed that they meant nominal dollars, and that “keeping you whole paycheck” equaled “getting an increase in spendable income (old-gross=new-paycheck) they argued that it couldn’t happen...and yes, they were correct.
the critics assumed facts not in evidence, created a situation supported by those fallacies, and then complained that there was a problem.
this led to two things.
1) a discussion about how paychecks would really be affected in the real world. the common consensus now is that everyone will continue to get paid their gross pay, and since the payroll and income withholding are no longer taken out, that money becomes spendable income. depending on your w2, you could see anywhere from 7.65% to 40% new spendable dollars in your paycheck. (recall, i’m not a fan of this plan...but i’m kinda hollering into the wind on this one)
2) a discussion about how prices would really be affected in the real world. the common consensus now is that businesses will roll their side of the payroll taxes and their corporate taxes into their prices (or, more accurately, out of their prices). someone figured out how much of that 22% total was employee side (~12%), and the rest was business side (~10%).
so, a pre-FT $100 dollar item loses 10% business tax and becomes a $90 item. the 30% FT is added, and the $90 item becomes a $117 retail priced item.
on the average....people will see that 12% employee side of the 22% in their paychecks, and they will see that 10% business side of the 22% (plus the FT) on the store shelves.
but...there’s one last piece of this that inflated my numbers above.
that 12% is of your gross pay, and if you’ll notice, i was very careful to indicate an increase in your spendable income.
12% of every 100$ earned is $12. so if (pre-FT) the average person is paying $12 tax on every $100 they earn, they only have $88 left to spend. but if the FT gives them that $12 back....that wasn’t a 12% raise in spendable income...it’s a 13.63% raise. (12/88=13.63).
so...again, on the average....the worker sees a 13.63% raise in spendable income, and retail prices go up 17%.
some workers will see a bigger than 13.63% raise in spendable income, other workers will see a smaller than 10.63% raise in spendable income.
again....this is average concerns of individual transactions. you and your employer will have to decide how much of that 22% should go in your pocket, and how much should be reinvested into the company. likewise, you and your local retailer will have to decide how many of those reinvested dollars will go into price reductions, and how many will go into improvements, or R&D, or whatever.
wal-mart will probably fight to pay their employees their current net, and push every one of those saved dollars into their prices to get them as low as possible.
other retailers won’t...and they risk losing market share to wal-mart.
in the above diatribe, the sentence “depending on your w2, you could see anywhere from 7.65% to 40% new spendable dollars in your paycheck. ” should have read “depending on your w2, you could see anywhere from 8.28% to over 40% new spendable dollars in your paycheck.”
sorry for in accuracy...i wish we could edit posts.
Ken,
Re #10, I don’t think the issue is about creating money as you suggested. The money is (sort of) already there, it’s just that the employer will no longer be sending off your money to the government, but instead will leave your money with you. All workers have some sort of contractual guarantee for a gross pay. If deductions are no longer necessary, what gives the employer the right to keep your money? For instance, if I pay alimony through a payroll deduction and the alimony ends, surely you don’t believe that my employer will keep my alimony amount?
The issue of prices has been handled very badly, imho, and a price study by competent, unbiased experts is really needed.
Justin, Re #9, I never suggested that the price increase would happen prior to adding the tax. My 17% retail price increase is based on a 10% reduction in business costs and a 30% sales tax. (1.00 x .9 x 1.3 = 1.17)
I agree with you that it is too conservative to assume that all spending will be taxed. It’s an individual thing, and can’t be generalized very successfully. However, you might want to rethink your claim that your mortgage and car payment would be unaffected by the Fairtax. Read HR25, Sec. 801-806 which describes both explicit and implicit taxes on financial services. Everyone understands explicit bank service charges, but the implicit part is confusing to some. Here is an example of how it works: (you might want to input your own numbers?)
Assume you have a $150,000 mortgage at 7% for 20 years. As of today, the long term Treasury rate is set at 2.5%. The monthly implicit tax would be based on the amount that the mortgage loan rate exceeds the Treasury long term rate times 23% divided by 12 In this example it is $150,000 x .045 x .23 / 12 = $129. Your monthly mortgage payment of approximately $1163 will go up by $129, a significant increase. Your car loan increase as well as any credit card debt can be estimated in the same way.
I might add that any interest bearing investment would also be taxed, but the tax calculation is based on the amount that the Treasury rate exceeds the investment rate of return.
Hank,
“All workers have some sort of contractual guarantee for a gross pay.” This statement is a bit nebulous. Your guaranteed gross pay that would encompass “all workers” is only true for work performed. Even an explicit contract has definable end. Your employer has the right, at any time, to alter how much they pay you, as long as, (as you have stated) they have no contractual obligation. In many (dare I say most) jobs, the employer could cut your pay in half, next week. They don’t need a payroll deduction, alimony, or any other kind of excuse. According to wikipedia, in 2007, 12.1% of workers were union.
I’m not sure where you get the idea that employer doesn’t have just as much right to not pay an employee as an employee has not to perform work. It is based on a voluntary interaction between someone needing labor and someone else willing to provide it.
Your mortgage example is good, but fails to mention the cost savings that the mortgage company will have under the fairtax. It is entirely possible that the $1163 mortgage payment will go down (I’m talking about the person who gets the loan in the future). In fact, considering the tax breaks our government gives that totally inflate the price of housing, it is likely that mortgage payments will go down (since the price of housing should). Should we argue about the effect of repatriated dollars on interest rates?
Andrew,
What repatriated dollars are you referring to?
Hank,
I was sort of joking (it sounded much better in my head). I know you guys love to debate the ($14T?) money that is currently held offshore because of tax considerations. If that money (however much it is) is brought back and kept in US banks, that will drive down interest rates. It just illustrates another huge difference between proponents and opponents. Proponents believe this number will be huge (although I haven’t thought about it enough to warrant an opinion). Opponents believe this number will be insignificant (or at least much smaller than proponents estimate). I think the fairtax is still superior to our current income tax system regardless.
Andrew,
I’m not sure if all the funds held in offshore accounts will make it back onshore when the Fair Tax is finally enacted because some of that money is being hidden from spouses, business partners, etc.... not just the government. But, what does come back will certainly have a huge impact because it will have a dynamic effect on the economy. As funds circulate they create even more economic activity, this is the idea behind economic stimulus. I really doubt that the money will just sit in bank savings accounts anyway. Plus the effect of removing all taxation on income will attract foriegn investments and help the real estate market as multi-nationals move operations to the US. This could ultimately have an even bigger impact on the economy.
I have developed a couple of major reservations with the Fair Tax that would absolutely need to be changed before I could support it once more. And it’s all your fault Hank. You called me out for being a tax protestor nutcase when I pointed out the communist connection to the 16th amendment and our current income tax system, so I decided to get educated about how it all came about. I found out some very interesting facts and the real reason why the Fair Tax is supported by many on the far right that don’t normally use logic very well. I have found out that Hank was right the current income tax system is constitutional as written, as it was when it was re-instated in the early 1890’s. The 16th amendment did not change this fact, what the amendment did was close a loophole that was openned by the Supreme Court in the 1895 Pollock v Farmers Loan & Trust decision. That decision found several sections of the Act were unconstitutional because they laid a direct tax on earnings from personal property. In essence, it removed the earnings from capital gains from the income tax and it stayed out until 1913 when the 16th amendment was ratified. The investor class has been trying to untax capital gains since and the Fair Tax has that aim embedded within it. The 16th amendment has nothing to do with personal or corporate income tax at all. There is no real reason to repeal the 16th amendment at all, it will not make any difference. If you really want to end the income tax, just expose the IRC’s unsound construction. Just learn who’s earnings are taxable under the IRC and who’s not. I think you’ll be surprised.
RM,
I guess I always assumed that the amendment repealing the 16th amendment would have more meat than just stating, “The 16th amendment is repealed.” I figured it would outlaw personal and corporate income taxes, payroll taxes, and estate/gift taxes specifically. It depends on who is writing the repealing amendment I guess.
But why bother if it’s not actually what makes income taxes constitutional, wouldn’t it make more sense to attack the true souce instead. It’s a waste of time and energy.
RM,
The 16th amendment does actually make income taxes, all of them, explicitly constitutional. Without it, their constitutionality is ambiguous (and rides on the determination that they be considered indirect taxes in order to skip the constitutional apportionment requirement). I seriously doubt they would have been held up as constitutional in 1789 or anytime during our founders’ time of power. But today, like many things constitutional, I wager the court wouldn’t give much thought to just making them constitutional (including an override of what was deemed unconstitutional by Pollock).
But if an amendment was written that repealed the 16th and specifically prohibited all forms of income taxation, you would be specifically addressing what makes income taxes constitutional (if not the 16th, then the constitution itself).
Not so, the 16th amendment has nothing to do with income from wages earned by individuals or profits earned by businesses. The 16th amendment closed a loophole that was being exploted by the investor class from the late 1800’s to early 1900’s. You are right that the language of the amendment implies that all income is taxable no matter the source. But a law (or amendment) has to be explicit to what is actually covers. The 16th amendment explicitly covers “Taxable Income” only. The IRC defines various activities as taxable income. These activities are decribed very specifically but none of them apply to earnings dirived from private sector profits. The IRC is where the income tax is most vunerable and needs to be exposed. By exposing how the IRC remains constitutional eventhough it seems to be in conflict with the Article 1 Section 9 prohibitions, we can make it completely null and void. Why go through all the hassle of another constitutional amendment when it would be just as effective to expose the fact that the Income Tax as currently written does not apply to most Americans.
RM,
Here is the text, from wikipedia, “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.” I have no idea what you mean by “The 16th amendment explicitly covers “Taxable Income” only.” It’s very wording is simply defining all income as taxable. It further nullifies any ambiguity about income taxes being direct or indirect, by stating that, constitutionally speaking, it doesn’t matter, incomes can be taxed without regard to the representative proportionality requirement of direct taxation.
I’m not sure why you state that the IRC is vulnerable. The IRC is dependent upon the whims of congress. It’s only limit is the constitution. If we can make income taxes unconstitutional, congress will be powerless to change it (although that’s the theory. They currently do a great job of ignoring the constitution.)
Andrew/RM,
To further clarify the income tax law, here is the exact wording from Section ll of the Act of October 3, 1913, entitled “An act to reduce tariff duties and to provide revenue for the Government and for other purposes”
A. Subdivision 1. That there shall be levied, assessed, collected and paid annually upon the entire net income arising or accruing from all sources in the preceding calendar year-to every citizen of the United States, whether residing at home or abroad, and to every person residing in the United States, though not a citizen thereof, a tax of 1% per annum upon such income, except as hereinafter provided; and a like tax shall be assessed, levied, collected, and paid annually upon the entire net income from all property owned and of every business, trade, or profession, carried on in the United States by persons residing elsewhere.
B. That, subject only to such exemptions and deductions as are hereinafter allowed, the net income of a taxable person shall include gains, profits, and income derived from—salaries, wages, or compensation for personal service of whatever kind and in whatever form paid;– or from professions, vocations, business, trade, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in real or personal property;–also from interest, rent, dividends, securities, or the transaction of any lawful business carried on for gain or profit;–or gains or profits and income derived from any source whatever, including the income from but not the value of property acquired by gift, bequest, devise, or descent:
The law goes on to list the deductions allowed, etc. etc.
Despite the lawyerly language, it seems clear to me that the law requires us to pay an income tax. Period!
Hank,
I can’t speak for RM, but I wasn’t suggesting that the law doesn’t properly require us to pay an income tax. I was suggesting, however, that a properly worded amendment could make any law null and void (by being unconstitutional). It would still be desirable, imho, if such an amendment were ratified.
Hank & Andrew,
Yes I was in error, in my previous statement I cited Taxable Income when I should have said Taxable Person. In the IRC, which is a codified version of all the applicable laws and regulations concerning our current Income Tax System, there is no definition of income. However, the IRC is very specific on whom the taxes apply and it does not apply to most Americans. In 1920 only 3% of the households filed Income Taxes because they were not required to do so, the law did not apply to private sector earnings. It still does not apply to private sector earnings because the IRC’s definition of employee, employer, citizen, and United States are narrowly defined to include only to specifc public persons. It does also apply to officers in the Army and officers of United States corporations. The only mention of private persons is those diriving profit from a lease of United States government property or receiving profit through contract with the federal government. After WWII, the Victory Tax was initiated and payroll withholding began but the income tax laws did not change. The Victory Tax was voluntary to individuals receiving private sector earnings but was concidered patriotic to do so, those filing returns grew to 38% of American households. The basic laws have never changed but over the years we have been conditioned (and reinforced by those to whom the law does apply) to believe that all income is taxable but that would be a capitation tax and in direct conflict with Article 1 Section 9 of the Constitution. The law as currently written is constitutional because it is very narrow in scope and does not apply to most Americans. The IRS regulations do require everyone to file a return but most filers earning not become taxable income until they sign the form delaring them so.
RMForbes, here is the official IRS response to your claims. I’m no expert, but you might want to think twice about espousing such flawed opinions? The slammer awaits!
“Contention: The only “employees” subject to federal income tax are employees of the federal government.
Some argue that the federal government can tax only employees of the federal government; therefore, employees in the private sector are immune from federal income tax liability. This argument is based on a misinterpretation of section 3401, which imposes responsibilities to withhold tax from “wages.” That section establishes the general rule that “wages” include all remuneration for services performed by an employee for his employer. Section 3401(c) goes on to state that the term “employee” includes “an officer, employee, or elected official of the United States, a State, or any political subdivision thereof . . . .”
The Law: Section 3401(c) defines “employee” and states that the term “includes an officer, employee or elected official of the United States . . . .” This language does not address how other employees’ wages are subject to withholding or taxation. Section 7701(c) states that the use of the word “includes” “shall not be deemed to exclude other things otherwise within the meaning of the term defined.” Thus, the word “includes” as used in the definition of “employee” is a term of enlargement, not of limitation. It clearly makes federal employees and officials a part of the definition of “employee,” which generally includes private citizens. The Internal Revenue Service issued Revenue Ruling 2006-18, 2006-15 I.R.B. 743, warning taxpayers of the consequences of making this frivolous argument.
In June 2006, a federal district court in California permanently barred Christopher M. Hansen (using the business names of the “Family Guardian” and the “Sovereignty Education and Defense Ministry) from promoting a fraudulent tax scheme based on the frivolous theory, among others, that only federal workers are subject to the Internal Revenue Code. See http://www.usdoj.gov/opa/pr/2006/June/06_enrd_345.html; see also 2006 TNT 107-98 (Jun. 2, 2006).
In March 2007, a federal court in Michigan issued a temporary restraining order barring Donald A. Gray from preparing federal income tax returns for others. The court found that the Portage, Michigan, man had been preparing income tax returns for customers based on the frivolous theory that wages are not income for federal tax purposes unless the wage earner works for the government. See http://www.usdoj.gov/tax/txdv07024.htm.
In May 2007, a federal court in Michigan permanently barred Peter and Doreen Hendrickson from filing tax returns and forms on which they falsely report their income as zero. The injunction order also requires the couple to repay more than $20,000 in federal income, Social Security, and Medicare taxes that they had obtained by filing false tax returns with the IRS. The order notes that the couple based their improper conduct on a book Peter Hendrickson wrote called “Cracking the Code.” The book states that federal tax withholding and income taxes on wages are applicable only for a limited class of people, primarily government employees. See http://www.usdoj.gov/tax/txdv07320.htm.
A law cannot imply meaning it must be stated explicitly. By the way the IRS lost the case against the Hendricksons.
May I also point out the flaw in the IRS argument. They argue that the income tax is not a capitation tax because it is limited in scope to persons that derive priviledge from the United States government (meaning of excise tax). But the definitions that actually limit the scope imply a broader context. If, as you say, the income tax applies to all income earners in America then it would be a capitation tax in direct conflict with Article 1 Section 9 of the Constitution. The 16th amendment did not repeal Article 1 Section 9. The Supreme Court has repeatedly upheld the 16th amendment because it created no new forms of taxation and therefore the 16th amendment only applies to taxes that were already constitutional. This looks like a house of cards to me. Expose the frivolous truth and it will all collapse.
RMForbes,
The only thing frivolous are arguments such as the one you espouse. Again, here is the IRS rebuttal.
” Contention: The Sixteenth Amendment does not authorize a direct non-apportioned federal income tax on United States citizens.
Some assert that the Sixteenth Amendment does not authorize a direct non‑apportioned income tax and thus, U.S. citizens and residents are not subject to federal income tax laws.
The Law: The constitutionality of the Sixteenth Amendment has invariably been upheld when challenged. And numerous courts have both implicitly and explicitly recognized that the Sixteenth Amendment authorizes a non‑apportioned direct income tax on United States citizens and that the federal tax laws as applied are valid. In United States v. Collins, 920 F.2d 619, 629 (10th Cir. 1990), cert. denied, 500 U.S. 920 (1991), the court cited to Brushaber v. Union Pac. R.R., 240 U.S. 1, 12-19 (1916), and noted that the U.S. Supreme Court has recognized that the “sixteenth amendment authorizes a direct nonapportioned tax upon United States citizens throughout the nation.”
Relevant Case Law:
In re Becraft, 885 F.2d 547 (9th Cir. 1989) – the court affirmed a failure to file conviction, rejecting the taxpayer’s frivolous position that the Sixteenth Amendment does not authorize a direct non-apportioned income tax.
United States v. Collins, 920 F.2d 619, 629 (10th Cir. 1990) – the court found defendant’s argument that the Sixteenth Amendment does not authorize a direct, non-apportioned tax on United States citizens similarly to be “devoid of any arguable basis in law.”
Lovell v. United States, 755 F.2d 517, 518 (7th Cir. 1984) – the court rejected the argument that the Constitution prohibits imposition of a direct tax without apportionment, and upheld the district court’s frivolous return penalty assessment and the award of attorneys’ fees to the government “because [the taxpayers’] legal position was patently frivolous.” The appeals court imposed additional sanctions for pursuing “frivolous arguments in bad faith.”
Broughton v. United States, 632 F.2d 706 (8th Cir. 1980) – the court rejected a refund suit, stating that the Sixteenth Amendment authorizes imposition of an income tax without apportionment among the states.
Stearman v. Commissioner, T.C. Memo. 2005-39, 89 T.C.M. (CCH) 823 (2005), aff’d, 436 F.3d 533 (5th Cir. 2006) – the court imposed sanctions totaling $25,000 against the taxpayer for advancing arguments characteristic of tax-protester rhetoric that has been universally rejected by the courts, including arguments regarding the Sixteenth Amendment. In affirming the Tax Court’s holding, the Fifth Circuit granted the government’s request for further sanctions of $6,000 against the taxpayer for maintaining frivolous arguments on appeal, and the Fifth Circuit imposed an additional $6,000 sanctions on its own, for total additional sanctions of $12,000.
What case against the Hendricksons did the IRS lose?
Let’s be perfectly clear, I am not advancing any tax-protester rhetoric. I am just citing inconsistancies in the IRC. The current income tax is constitutional and upheld because it is a excise tax on income. An excise tax is a priviledge tax and therefore applies to only those accepting the priviledge. The IRS has lost at least 3 cases in the last two months because of this fact. Of course they are screaming bloody murder but they are still losing the cases in court. They don’t want this to get out and start to snowball. I’m not personally trying to single handedly bring down the IRC but I was baffled why the Fair Tax required to repeal the 16th amendment. This made as much sense to me as the far right supporting this very progressive idea until I realized that capital gain taxes was the real target. I’d bet if the Fair Tax was amended to keep the capital gains tax so the consumption tax was much lower the far right wignuts would drop the Fair Tax like a hot potato, even if the income tax were invalidated.
RMForbes — Actually, I think the real target is the estate tax. If the FairTax were revised to provide for an estate tax, it would certainly make it more progressive, but the far right would drop it in a minute.
(That’s why it cracks me up that Linder will call the FairTax a “tax on wealth.” If he really wanted to tax wealth, he wouldn’t be so keen on eliminating the estate tax.)
Okay we can add it too, the lower we can get the consumption tax rate the better for it is for everyone. The estate tax is not nearly as large of a revenue source as the capital gains tax though. When the Supreme Court ruled on Pollock in 1895 the revenues to the treasury dropped by more than 50% because it lost revenue from capital gains until 1913 and the 16th amendment was ratified.
Fred-
The IRS was able to get an injunction against the Hendricksons’ but when challenged the injunction was set aside. Did the IRS lose the case? Maybe or maybe not it’s how you inturpret it. The IRS was able to get an injuction in federal court which sets a court date for defendant to respond, when they were able to present their side the injunction was nullified (as were scores of other injunctions filed by the IRS). Hiring a lawyer and defending themselves against the injunction cost them significant amounts of money, so they really didn’t win. But, they didn’t have to pay the judgment so the IRS didn’t win either.
Let’s be clear, the IRS has never lost a case against Hendrickson on the merits of his (and now your) argument about the tax code. And, from what I can gather, he’s about to lose another one.
Honestly, IMO this isn’t the place to discuss these tax scams and frauds.
Fred.
Agreed this is not the place to discuss the income tax laws, we should start a new string. But examining the tax codes interesting use of the language is not necessarily a fraud or a scam. Having injunctions set aside is a loss in my book.
With all the appointees of the Obama administration with tax problems just goes to show that the Income Tax laws are outdated, cannot be understood by regular people, and even those that have higher than average educations cannot understand or follow all the Income Tax laws.
The Income Tax laws are biased against those who live in big cities and along both coasts where you HAVE to earn a lot more just to live. Those people that live in these expensive areas pay a higher percentage of Income Tax just because they HAVE to earn more. Business owners, right now, make costly mistakes by having to buy equipment before the year ends, even if they don’t need the equipment, just for the tax deduction and when they can’t really afford the expenditure. The Fair Tax is so simple.
Unfortunately, there are a few flaws in your argument here... First of all, it is the choice of these individuals to live in areas that have a higher cost of living and therefore command a higher salary. This is not the fault of the federal government, nor should the government make any accommodations in the tax code for lifestyle choices. People living in these high cost of living/salary areas could choose to move to another locale with a lower cost of living/salary and reduce their tax burden. This is a simple matter of market forces.
The FairTax will also do nothing to change this scenario. For example, if a gallon of milk costs $4 in Texas and $5 in New York, the person purchasing milk in New York will end up paying more in taxes via the FairTax just as they pay more in taxes currently. I am in favor of the FairTax, but this is not going to change the fact that people in high cost of living locations are still going to be paying more in taxes than those living in lower cost of living areas.
I will agree completely with your final point regarding deductions in our current system. The FairTax will completely eliminate this problem and that is a good thing. Personally, I think that the FairTax offers numerous other benefits/advantages which make it a superior system to what we currently have in place. The FairTax is not without it’s shortcomings, but I think that as a whole it would be a great thing for our country and economy.