Embedded income tax costs
Hank posted a request for a new thread to discuss the embedded income tax costs. He wrote “The upcoming Fairtax campaign will likely draw from the recent article on the AFFT website that I have reproduced below. I think you might want to create a new thread and either call it “embedded taxes” or “the Fairtax impact on retail prices”? There are several errors and inconsistent conclusions in the piece that need discussing, imho.”
Embedded income tax costs eliminated with FairTax
Roger Buchholtz, MI FairTax Director, recently wrote to us asking that we focus on another huge problem created by the income tax system - embedded and hidden income tax costs. He’s right; it’s the part of the income tax iceberg that lives dangerously hidden beneath the surface of our economy and our tax structure. Every consumer pays them hidden inside retail prices, wages and benefits are often depressed because of them, and American companies are at a severe price disadvantage with foreign competitors because of them. The FairTax eliminates these hidden tax costs and - among other advantages - allows retail prices to drop in their absence.
Hank, I deleted your orginal post as I did not want people replying to it in two places. I also didn’t reproduce the full text of the article in the primary post for possible copyright/fair use issues. Feel free to reprint portions for discussion.
The FairTax folks love to throw out Harvard economist Dale Jorgeson’s ten-yeat-old study on the embedded taxes.
But they never use any current quote from Dr. Jorgenson in their articles. The reason for that is that Dr. Jorgenson opposes the FairTax, has publicly stated that it won’t work, that the tax-rate will need to be too high, that the FairTax would be too regressive, and that the FairTax folks have misrepresented his studies on embedded taxes.
The next time I see another article by the FairTax folks citing Dale Jorgenson, I would love to see qt least one of them have the guts (or, at least, the honesty) to contact Dr. Jorgenson, get his opinion on the FairTax, and publish it in the article.
Naw! These are FairTax folks we’re talking about. Honesty and integrity’s not their thing. So it’ll never happen.
Hayden, Jorgenson’s opinion on the FairTax plan is somewhat irrelevant. It could just as easily be quoting the OECD or some other researcher as is done on dozens of other areas. Jorgenson stands behind his research, which is all that is being used here. It would make no sense for supporters not to use this particular research because the author doesn’t support the overall plan.
Organizations use studies from thousands of researchers to support their special interest.. do you think each researcher fully supports the goal of whatever their paper is used to support? Research is research based on some method of science and measure, support for such a plan would be completely different having that tax system align with all your personal political philosophies and goals . Your trying to make an association where none exists and turn this into a question of honesty and integrity, which it’s not.
One mistake with the article in that regard to his research though is that Jorgenson did not estimate compliance costs as suggested.
There is a whole lot more wrong about the article than just AFFT’s erroneous claim that Jorgenson included compliance costs in his 22% average producer tax cost study.
It starts with the claim in paragraph 1 that the Fairtax eliminates hidden tax costs which allows retail prices to drop. Wrong, wrong! The Fairtax eliminates tax costs which will allow producer costs to drop, but not retail prices.
The claim that taxes and compliance costs are a “big part of production costs” isn’t necessarily true. I don’t know what is considered “big”, but business taxes and compliance costs amount to 10% of sales when using 2007 actual retail sales and business tax cost data.
The article states that business tax and compliance costs are added all along the production, distribution, and retail sales line”. This claim seems to suggest that the cost savings cascade or accumulate up through the various production levels. Dollar cost savings do accumulate, but percentage cost savings do not!. It doesn’t matter if there is one or ten levels of production, the percentage cost savings remains the same. This is true because the cost savings at each level apply only to the value added at that level.
Morphh flagged one error in paragraph 4, but Jorgenson also assumed that employees gross pay would be reduced to the current after tax net pay. If we add a generous 3% of sales for compliance costs to Jorgensons 22%, only 40% of the resulting 25% in embedded costs can be attributed to business costs (10%). If AFFT believes that 22% in embedded tax costs can be removed, it is incumbent on them to also point out that everyone’s pay and pensions will be slashed significantly.
Although I have read and reread the Arduin, Laffer, and Moore study, I can’t find the 11.55% reduction in production costs claimed by AFFT. I did discover that the study report states that retail prices will rise by 24.8%, (page 31). If costs can be reduced by 11.55% as claimed, then retail prices will rise by 15%, not 24.8%. (1.00 x .8845 x 1.30 = 1.15) A little confusion there?
Finally, the claim that shifting embedded costs into the open means a more honest relationship between citizen and government isn’t really an accurate statement. Overlooked in this transparency argument is the fact that, by treating governments as consumers, 12-15% of the federal revenue raised would be hidden in higher State and Local taxes, provided that feature is not found to be unconstitutional by the courts. Not totally transparent after all?
None of these errors are necessarily earth shaking, but after ten years on Capitol Hill, it is my view that telling the truth is very important. Shading the facts may be OK for a marketing effort, but get caught in one lie on the Hill, and the game is over! Why not tell it like it is from the git-go?
Hank, I agree with most of what you said, but I think your wrong on the statement of higher State and Local taxes - we mathematically shown this argument to be incorrect in real dollars (though true in nominal dollars). This is a different issue than transparency. While we can argue that the FairTax is hidden to some degree in State and Local taxes, it’s not significantly more than what is hidden there today.
Morphh, I don’t remember discussing the State/Local government issue previously, but it seems to me that the only savings for them would be the 7.65% payroll contribution share. How does that balance against a 23% inclusive tax on their taxable spending? Doesn’t look like a wash to me? What else is hidden there today? Or are you suggesting that all government payrolls would be slashed? I don’t think so!
By the way, I forgot to thank you for posting this issue, and guarding against any copyright problems. I guess that’s why you get paid the big bucks to moderate this blog???
Hank, I put a link in the last post for the thread. Here it is again: The Cost on State and Local Government
Paid... haha
Also, here is some background for those that are new (or forgetful). We discussed embedded taxes in this 2008 thread (“No Such Thing” as an Embedded Tax?).
Hank,
Re: #4 “The Fairtax eliminates tax costs which will allow producer costs to drop, but not retail prices. ”
I think you are overlooking the meaning of the word allow. If tax costs are decreased, the production cost will (not be allowed to) decrease. And if that company’s production costs decrease the company can choose to lower it’s retail price. It doesn’t mean they have to. However, the decrease in production costs allow the company to reduce retail to gain a competitive advantage over their rivals if their rivals choose not to lower theirs.
A more accurate statement might be “The Fairtax eliminates tax costs which will reduce producer costs allowing a reduction in retail prices without a reduction in profit”.
John,
I think the word “allow” is quite appropriate in the context of “allowing producer costs to drop”. Nothing says that net producer costs would drop under the Fairtax. For instance, a business with cost savings from the elimination of current taxes might also use the savings to expand the business, increase pay, or increase shareholder payments, all at an increase in cost. Net costs might remain constant. The Fairtax would allow costs to drop if the savings were applied solely to cost reduction, but that isn’t the only use of the savings. Competition may drive how the savings are applied, but I still think that “allow” is appropriate.
As for your “more accurate statement”, I don’t agree at all. The Fairtax doesn’t allow retail prices to drop. Quite the opposite, retail prices under the Fairtax have to rise even if businesses choose to totally abandon their profits, an unlikely event. There are no expert economists that believe retail prices will fall. The AFFT Director wrote that she expects employees to get their full gross pay and retail prices to rise. The Arduin, Laffer, and Moore study claims that retail prices would rise by 24.8%. The Kotlikoff/BHI study said that, assuming full monetary accommodation, retail prices could rise by the amount of the exclusive tax rate-31%. My personal opinion, based on the 2007 actual tax cost data and the 2007 retail sales figures for services, durable, and non durable goods, is that the Fairtax would cause an average 17% retail price hike. There is no way that retail prices can fall if one uses reasonable assumptions.
Hank, I’m sure John was referring to before tax prices when he said “allow retail prices to drop.”
Hank, For a family of four, your 17% retail price hike could be used to nutrialized retail spending by using your Family Consumption Allowance (FCA). Actually at 17%, it could nutrailze the spending for a family of four on their first $39,424 of taxable spending.
Steve,
You may be right about what John meant, but then it wouldn’t have been the retail price, would it? Before tax costs aren’t retail prices. This is a good example of why I have been preaching the need to be careful about how the terms “cost” and “price” are used. No big deal, but the simpler the better.
Hank,
If you remove the tax cost of a product the cost of production will drop. Period. If a company then wants to expand, give employees a raise, whatever, that is there choice, but then the production cost not changing is not due to the FairTax. That is the way I was looking at. But I don’t disagree that it is not incorrect to say producer cost will be allowed to fall.
Regarding my statement about allowing retail prices falling, I meant as Steve indicated, prices prior to adding the FairTax. I have never heard Boortz or any other FairTax supporter say after tax retail prices would drop. In fact, the first time I heard Boortz talking about the FairTax on his radio program, he went out of his way to express that the price paid for goods will most likely increase after embedded taxes (tax costs) are removed and the FairTax added. Granted at the time he was claiming a very miniscule increase. Maybe we need a new term for the price of something without the tax and one for the price including the tax. As things are now with the only sales tax being state sales tax, the advertised retail sales prices do not include the sales tax. So what is the price including sales tax called?
As I understand it in a FairTax world, the prices stamped on merchandise is supposed to be the product’s price + FairTax. I don’t know how crucial that is. While I understand it is intended to keep the price you have to pay visible (not hidden) why not just allow vendors to price the goods based on what they need to make, then add the FairTax at the register? That way statements like ratail prices being allowed to drop, won’t cause quite as much confusion.
I don’t really see statements by FairTaxers such as “allowing retail prices to fall” as being false. It’s accurate within the context of how I’ve heard it explained. Just as with any other legislation, they are trying to put a positive view on it as that makes it easier to sell. I think the FairTax has certainly been more under the microscope than what congresss has been doing lately (the stimulus package passed early this year comes to mind).
John,
The Google definition of a retail price is “the price charged to store customers”. Not terribly clear if that retail price includes State and Local taxes, if any.
I got out a number of Florida sales receipts and here are some examples of what the after tax price is called. (1) Total; (2) Final total; (3) Amount due; (4) Chit total. In almost all cases, the before tax price was called the “Sub total”.
In the Fairtax world, I still think it would be less confusing to call before tax prices “cost”, and after tax prices “price”, but whatever works is OK by me. Go back and read the first paragraph of the AFFT piece. Do you think anyone not intimately familiar with the Fairtax would read that and not conclude that retail prices are going to drop, retail meaning what the customer pays at the cash register? We seem to be edging back to the “free lunch” notion that we will get 100% of our pay and retail prices will drop? Please tell me that we all agree that just isn’t true?
I agree with you that the best place to add the sales tax is at the cash register. In Florida, everyone is comfortable with knowing that the price marked on the item will have 7% sales tax added at the cash register. I think we can also handle knowing that under the Fairtax, there will be a line that adds 30% to the shelf price, (but hopefully not including the S/L sales tax)? HR25 goes to great lengths to spell out what a sales receipt must look like, ( but never lets the merchant show the 30%), and ignores the issue of State and Local taxes. Will States “tax the tax”? Stay tuned!
Morph — Good to see you’re still alive. I had thought you had been swallowed by a giant whale or something.
Here’s my beef with the FairTax folks using Jorgenson’s research (which is similar to my beef with everything else about the FairTax proponents): they don’t accurately protray it.
They keep inserting stuff that’s just not there (just as they did with the “$13 Trillion in dollar-denominated accounts”), then the lie gets repeated over and over via talk radio and the internet until it’s assumed to be true.
Here’s the exact quote from the FairTax.org post you link to:
“Harvard economist Dale Jorgenson added up the entire FICA payroll tax cost (the employee and employer share), as well as business income taxes paid and compliance costs, and found that the production costs of domestic goods and services could decrease by approximately 22 percent on average after embedded tax costs are removed.”
What’s wrong with this quote? They left out PERSONAL INCOME TAXES paid by employees as a part of the embedded taxes. Those personal income taxes make up the bulk of the so-called embedded taxes, and the only way one can remove the embedded costs associated with such personal income taxes is for businesses to lower the wages and salaries of their employees.
Now, we (or, at least most of us) on this board umay nderstand that distinction, but the vast majority of FairTax supporters do not. They believe that the prices of goods and services will drop by 22% SOLELY ON THE ELIMINATION OF CORPORATE INCOME TAXES AND PAYROLL TAXES. They miss the main point that prices can only drop if their wages and salaries are slashed.
You (and, I’m sure, Steve) might argue that that’s just a minor point, an inadvertant mistake, who cares? Except that the FairTax folks do this all the time. Whether it’s the $13 Trillion in off-shore accounts, the studies “proving” the 23% tax rate is revenue-neutral, taxation of the “underground economy,”, the “keep 100% of your paycheck,” etc., etc., etc. They repeatedly make “inavertant” exaggerations and distortions that get repeated over and over again until someone like Hank or I ask where the evidence is to support the claim.
Then folks like Steve jump up and down and complain that we’re just nitpicking FairTax-bashers.
So, back to my earlier point. If they are going to cite Dr. Jorgenson’s work, they should at least present it honestly and, even better, state Dr. Jorgenson’s position on the FairTax. If they’re going to claim that $13 Trillion is going to come back to the US, they should provide a citation to evidence supporting that claim. If they’re going to claim the “underground economy” is going to fuel tax revenue under the Fairtax, they should show some evidence as how much, if any, additional tax revenue the so-called underground economy would yield (As you might recall from the AEI debate, the answer is zero.) Etc., etc., etc.
Or, even better, they should just quit lying.
I’m well alive, but haven’t had time to keep up with the discussions unfortunately. That’s a good catch Hayden - I hadn’t noticed they left out personal income taxes. Good point. I still don’t think Jorgenson’s opinion on the plan is overly relevant, but I do agree with you regarding the portrayal of his research. The statement in the article is deceptively inaccurate.
Hank,
“In almost all cases, the before tax price was called the “Sub total””. That’s not what the price of the item is called. That’s a subtotal of all items the cash register is totaling up for you. So I wouldn’t recommend using sub total. When I walk into a store, I want to know either how much an item I’m picking up off the shelf will take out of my wallet. Being reasonably mathematical and knowing applied sales tax rates where I live, I can compute that (to within my level of accuracy). If the Fairtax is going to add 30% on top of it, I can do that too. So we could continue to call it the retail price of the item. If the FairTax is to be included in the price tag of the item and we call that price the retail price of the item, then what do we call the price prior to adding the FairTax?
I do not believe we will keep 100% of our pre-FairTax implementation gross income and get a price reduction of goods. I have no idea what employers would do, I expect most would keep people at their current salaries so I would keep 100% of my gross income as it is now and the price paid by me (cost of goods plus FairTax) will be higher than what it is now by somewhere between 10% and 17%. Eventually the market will determine what individuals are paid and what the price of goods will be. That is what I am more concerne about as opposed to what happens during the 1st year or 1st month of the change over. And I think in real purchasing power terms, the greatest majority of people will have an increase in their purchasing power, more people will know how much they are paying to support the government and the general population will become more fiscally responsible (not necessarily a lot more, but more than they are now).
As far as the impression I have after reading the AFFT piece, I guess because I am familiar with the details, I guess it doesn’t stand out to me one way or the other. If I gave that to a person on the street who had never heard of the FairTax I can see how they may get the impression the money going from his pocket to MallMart might decrease, but I don’t think the peice was aimed at someone ignorant of the FairTax. The explanations I’ve heard and seen aimed at the general uniformed public has been layed out in more detail clarifying the impact on cost to the end purchaser.
John,
You asked what we should call the before tax price, and my answer is “cost”! When you add the sales tax, it becomes “retail price”. Seems simple enough to me.
Here is an extract from Section 509 of HR25:
” For purchase of taxable property or services for which a tax is imposed by section 101, the seller shall provide to the purchaser a receipt for each transaction that includes–
`(1) the property or services price exclusive of tax;
`(2) the amount of tax paid;
`(3) the property or service price inclusive of tax;”
From this I conclude that the before tax price is to be called “price exclusive of tax”, and the after tax price is called “price inclusive of tax”. These terms seem a bit bulky for a sales tax receipt to me, and I’d still prefer “cost” and “price” because that’s what they are, producer costs (including profit), and consumer prices.
Just out of curiosity, how did you come up with a 10%-17% range of retail price increases? I’ve explained in detail why I believe the minimum retail price increase would be 17%, so what rationale do you have for 10%?
Thanks.
Just for fun, here is a notional Florida sales tax receipt that would meet the mandate in HR25 as to just what the receipt must show.
Florida Sales Tax Receipt
Price exclusive of tax:————————$100.00
Federal tax————————————- $30.00
Price including tax————————— $130.00
Federal tax rate——————————- 23%
State tax @10%——————————–$ 10.00
Total ———————————————$140.00
Does anyone else see the probability that there will initially be long lines and some chaos at the cash register as the Fairtax is implemented? The customer question is going to be, “if the Florida sales tax at 10% is $10.00, why is the federal tax at 23% not $23.00? Pity the poor cashier in trying to explain the difference. “Well, golly, gee whiz, that is the way you calculate your income tax, isn’t it?”
Folks, I predict that the first change to HR25 made by the staff of the Revenue subcommittee, House W&M Committee, will be to display the sales tax in sales tax terms that 305 million Americans all understand. The sales tax added by the retail merchant is 30%, and that’s an inescapable fact. Just show it!
Hayden, I agree, I don’t like it when supporters exaggerate the FairTax benefits. But theses exaggerations do not make the FairTax a bad program. I just don’t like it when someone bashes the FairTax because of some peoples exaggerations. It is like saying Tiger Woods is not a great golfer because exaggerators say he can hit his wedge 400 yards.
Hank, Nothing in section 509 indicates that the Federal tax percentage must appear on sales receipt. Here is what I think the sales receipt will look like.
Price exclusive of tax:————————$100.00
Federal tax————————————- $30.00
Price including tax————————— $130.00
State tax @10%——————————–$ 10.00
Total ———————————————$140.00
Come on, Steve. Read Section 509(a)4 again. What does it say? My copy says “tax rate”?
Hank is correct on it including the rate. I figured it would look something like this. I also assumed the state would apply their tax on the subtotal, so they don’t have to change their tax rate.
Florida Sales Tax Receipt
Good #1 —————————————— $104.00
Good #2 —————————————— $26.00
Price including tax ————————— $130.00
Federal tax @ 23% ————— $30.00
Net cost of goods:—————— $100.00
10% State tax ——————————— $13.00
Total ————————————————$143.00
Morphh, I was just following the order and terminology laid out in HR25. I like your presentation better. No telling how many variations 20 million businesses will come up with!
I think my main thought is that the goods listed will include the tax cost. This is what Linder states is how it is to be implemented. So each good has the tax cost built in and is then displayed as inclusive to the total. Good #1’s production cost is $80, and Good #2 is $20 - but the item price includes the tax, so the listed retail is $104 and $26. Also note that I taxed the tax at the state level to make adjustments in purchasing power changes, so the state would not have to increase their tax rate.
Of course, it would be simpler if the state used the FairTax method making the State rate @ 9% of total, and increasing the good retail price to $114 and $29.
Looking something like this:
Florida Sales Tax Receipt
Good #1 —————————————— $114.00
Good #2 —————————————— $29.00
Price including tax ————————— $143.00
Federal tax @ 23% ————— $30.00
State tax @ 9% ——————— $13.00
Net cost of goods:—————— $100.00
Total ————————————————$143.00
Hank, sorry my mistake! Since the price tag of an item will include the tax, I would imagine the sales slip will look more like Morphh’s version.
Morphh/Steve,
Regarding that sales receipt, I liked Morphh’s first version, but it seems to have changed four times in the last two hours, and it isn’t getting any better. Worse if anything, imho. And it looks like a couple of misprints are adding to my confusion?
Guys, there isn’t one word in HR25 that requires a retail merchant to put a tax inclusive price sticker on the goods on the shelf. And, with all due respect, Jphn Linder has never run a retail business, just a dental business. I’d really like to hear from a retail merchant as to whether or not he might prefer to let the cash register computer handle the tax at checkout. I’ve never run a business, but I just can’t see a retail merchant going around and adding an exclusive tax of .2987012 to the cost sticker of every item on the shelf? How would you handle sale items?
As for taxing the tax, one of the goals of HR25 was to eliminate cascading or multiple taxation at the federal level. Why is it OK for State and Local Governments to tax the tax? And, I don’t think taxing the tax would begin to pay the S/L federal tax bill, although I can’t seem to get my mind around it. Need a math major to figure that one out. In any event, taxing the tax may keep the rate constant (I don’t think so), but it is still a tax increase on State and Local residents. The troops will see through that scheme in a heartbeat.
All in all, I don’t care much for the tax the tax scheme, and I’m not convinced Linder’s implementation plan to place tax inclusive price stickers on stuff on the shelf makes any sense. Stay tuned!
Hank,
I’m not sure why, but I just don’t like calling it cost. That’s what it is from the producer’s point of view. I have no problem with it being a price, but should be distinguished from other prices. We have wholesale prices and retail prices. How about government price? That was meant as a bit of a joke.
Here one common definition of price:
the sum or amount of money or its equivalent for which anything is bought, sold, or offered for sale.
And interestingly enough, cost is a synonym of price. Hmmmm
Here is a common definition of cost:
the price paid to acquire, produce, accomplish, or maintain anything.
Also, we ask what the price of something is...or we may ask what something costs. So I guess I’m talking myself out of objecting to pre tax prices being refered to as cost.
I suppose it doesn’t make much difference as I’m sure society will evolve into calling it something.
Hank,
As far as my 10 to 17%. I the honest answer is I don’t know. I have read many posts on this site and others discussing the issue. I think you make a reasonable case for 17%. I do remember that when reading your rationale, I did not agree with all your assumptions, however, that was some time ago and I don’t recall what those were. I also remember reading some arguments for why 10% may be possible.
We are talking about an awful lot of goods and services so to expect that they will all drop by some fixed amount is unrealistic. Just as today all goods do not have the same tax costs (as a percentage of their retail price) we can not expect them all to drop by a given amount. If I recall in Boortz first book (I know it probably makes you cringe when I mention his name, huh?), he had a table listing embedded tax costs of a variety of products. The percentages were all over the place.
Hank, I owned a retail furniture store for 10 years from 1972 until 1982 and I for sure my price tags whould have included the tax. It is an inclusive tax so it should be included in the sticker price. Besides it will be much easier to figure the tax to be submitted. All you need to do is take your gross sales times 23%.
John, Let me try to refresh your memory a bit as to why I believe 17% is a valid number. You have to start by agreeing with me that businesses can’t reduce costs by any more than they spent on taxes and compliance costs. That is, all of us are going to get 100% of our pay or pension. Employee payroll reductions aren’t going to be used to lower business costs. So the next question ought to be, how much do businesses spend on taxes and compliance costs?
Using the 2007 data contained in the BHI/Kotlikoff study you just read, Corporate income taxes paid in 2007 were $291 billion, the business share of payroll contributions was $435 billion and the Boortz estimate for compliance costs in 2007 was $265 billion. I also found that retail sales in 2007 totaled $9.5 trillion when I added up the retail value of services, durable goods, and non durable goods, Dividing the actual taxes and compliance costs paid in 2007 by the retail sales value results in useful percentages of 3% of sales for income taxes paid, 4.5% of sales for payroll contributions, and 2.5% of sales for compliance costs. Add them up and the average cost savings as a percent of sales comes to 10%, Remove 10% from business costs and add the 30% sales tax and retail prices have to rise by 17%. (1.00 x .9 x 1.30 = 1.17) Simple math. If businesses can’t reduce their costs by more than they paid, the outcome seems clear.
You are correct that when Jorgenson did his embedded cost study back in 1998, he looked at 35 different industry segments and the embedded costs ranged from 15% to 30% depending on the type of business. But, if you add up the estimates for each of the 35 industry segments displayed in the Boortz book, and divide by 35, the average across all industries was that infamous 22%. By adding a generous 3% in compliance costs which Jorgenson didn’t address, I believe that compliance costs are actually 25%, of which 60% are employee income tax and payroll contributions, again based on the 2007 actual figures.
Why 60%?. Look at chart #3 in the BHI report. Individuals paid $1563B in taxes, while businesses paid $990B when the compliance costs of $265B are all assigned to businesses. Dividing both by the $2553 billion total results in a 60%/40% split. No mystery there. 40% of 25% is 10% and that is the business share average cost which can be eliminated by the Fairtax.
It is by this reasoning that I maintain that retail prices are going to rise. It may be of interest to note that the webinair scheduled for the 19th has as a subject the AFFT claim that retail prices will remain about the same. I emailed the moderator and asked if his definition of retail prices included taxes and he confirmed that retail prices did indeed include the tax element. When I tried to explain why average retail prices had to rise unless he assumed reductions in employee payroll/pensions, his response was that he would explain why retail prices wouldn’t rise during his presentation on the 19th. Clearly I don’t agree with him unless he comes up with some logical rationale which has escaped me. I intend to participate in the one hour session and will report the results.
Hank, I don’t think it would require a retail merchant to put a tax inclusive price sticker on the goods on the shelf, only that it is listed inclusively on the receipt.
Again, it is not a tax increase on State and Local residents. Please read this thread. If you don’t understand it than please discuss it, but don’t keep repeating this blindly.
Morphh,
I didn’t agree with your analysis back then, as indicated by my post#5, and I don’t agree now. We may be talking past each other about nominal and real tax increases? Maybe you could take another try at explaining just where the money to pay the federal tax burden on S/L spending is going to come from–in plain English? Kotlikoff also said that taxes would have to increase, spending decrease, or even tax the tax to balance the books. If that is what we differ about, I agree that raising taxes is only one option. But the money has to come from somewhere, doesn’t it?
Hank,
Okay, we are back to picking nits.
291/9500 = 0.0306 or 3.06% Not 3%
435/9500 = 0.04579 or 4.579% Not 4.5%
265/9500 = 0.02789 or 2.79% Not 2.5%
Which add up to 10.43%, not 10%. Not a huge difference. But when you then compute the price increase instead of 1*.9*1.3 it should be 1*0.8957*1.30 which comes out to 1.164. That isn’t far off from 1.17, however using normal rounding techniques one would never round 1.164 to 1.17, it would be rounded down to 1.16.
As I said before, you make good case for what you believe the price increase will be. But your began your case on the assumption everyone will keep 100% of their current gross. While I think that is most likely on day one, as soon as the next guy gets hired, it muddies the water on analysis. He no longer has a current gross for the company to be forced into sticking to. If unemployment is high (as it is now), many people may be willing to work for a lot less and therefore prices can come down even further. Also, there is no guarantee that employers will continue paying at current gross salaries. Some industries may choose to renegotiate salaries or just pay people their previous net (and risk lawsuits or some other retailiation). If they do, they can drop their prices even further. I can imagine a struggling company gathering employees around and tell them it’s either we do cut salaries so we can undercut our competition or we are all going to be looking for work. That happens in our current tax environment. It’s the nature of a competitive market.
We all know if HR25 ever makes it to the house floor, they will tweak the crap out of it. Who knows, they may lower the rate on S/L government spending or eliminate it completely. If they do, they will need to increase the Federal rate to maintain revenue neutrality. I personally believe S/L government spending should not be taxed. We will end up paying for it anyway and it will just make the FairTax less transparent. One important features needed in any tax system is transparency. We need to know just how much of our hard earned dollar ends up in government’s hands. The more transparent it is the greater the incentive to pressure our representatives to reduce spending. To increase this transparency, I would even go along with the sales slip showing a 30% exclusive rate.
Steve,
This is getting scary! I’m agreeing with you more and more, it seems.
How about talking me through the idea that looking at a sales receipt will alert us to the cost of government? Once a year, when I file my income tax forms, I learn exactly what my effective income tax rate is, and I also know how much I paid in FICA. Looking at a Fairtax sales receipt tells me nothing useful as near as I can tell. Is it your belief that simply seeing the tax rate, I will begin to object to higher government spending? Take your best shot! I’d really like to know what it is that is so transparent, even if we don’t hide part of the tax in increased State and Local taxes as you suggested.
I don’t think transparency is necessarily about the receipt or some acknowledgment of total dollars paid, thought that would be nice. I’d fully support removing withholding, having one lump sum payment, and shifting tax day to the day before elections.
I think the transparency is with having a single tax and a single rate, not multiple taxes hidden all over the place and class warfare battles that disguise the burden from a large portion of tax payers. “Corporations need to pay their fair share” is a perfect example of such deception.
Hank,
Sales receipts are a constant reminder of the cost of government. It is transparent because you know the exact amount of tax you pay on every dollar you spend. Your income tax return is a once a year reminder of your direct tax burden, but you have no idea of the tax cost that has been passed on to you in the goods and services you buy throughout the year. Under our current system you may be concerned about government spending, but the only day you really get upset is the day you file your return.
You ask if it is my belief that simply seeing the tax rate will cause objections to government spending. Since it is an everyday reminder, I say it most certainly will. It is like listening to the constant drip of a leaky faucet, with each drip you become more and more agitated. Eventually you will call a plumber; if he can’t fix the leak, you fire him and call a new plumber. If you only hear the dripping for a few minutes out of each year, you are less likely to have it repaired.
Hank,
It’s unfortunate, but many people view getting a check from the IRS at tax time (because they over withheld) as not having to pay taxes. They also don’t even realize how much they paid in FICA. let alone have any idea that some percentage of what they buy has built into its cost the taxes paid along the way of it being produced (whether it be corporate income tax or the employer share of SS/Medicare). So short of requiring every one to pay their taxes in one lump sum, I think seeing the rate paid on the reciept is a simple and effective way to educate more people on the cost of their government. Sadly, some people will still not have a clue.
I tend to agree with all your thoughtful responses. And, it seems to me that you all have made an excellent case for getting rid of the inclusive tax description and showing the exclusive tax rate on the sales receipt. Big difference in that even the uniformed can add. Based on the Kotlikoff/BHI rate study, the exclusive rate was 31.4% and adding the adjusted Florida sales tax rate of around 8%, we are perilously close to 40%. And, it the Diamond study is correct, the exclusive rate would be 39% and adding in State/Local, the total on the receipt could approach 50%. At that point, don’t you think we would have a major tax revolt? Howe about a 10th Amendment Commission with a goal of reducing the size and coat of the federal government by 10% initially, with subsequent reductions planned?
Scrap the idiotic inclusive tax rate and tell the truth!!! Or is this a case of “how high is too high?”
I have no problem with a goal of reducing government by 10% or why stop there, how about 25% or 1/3? Oh, I see you also mentioned 10% inititially with subsequent reductions. I’m all for it.
Using the inclusive tax rate is not a lie. It is the truth. Had AFFT not gone out of their way (which I believe they have) to explain the difference between inclusive and exclusive, then I would think something deceptive was going on. I don’t know how much more clear they need to be. Prior to hearing about the FairTax, I never thought about tax rates being inclusive or exclusive. But once explained, they make sense and are confusing as long as you know what is being applied. If I say I’m going to tax you at 10%, but don’t tell you it’s inclusive....that’s a different game. Granted using the inclusive rate certainly makes the pill easier to swallow, but the actual dollar value is the same. If the FairTax (a good idea in my opinion) was promoted using the exclusive rate and went nowhere is that really a good thing?
I am not fond of deceptive advertising or misrepresentation. However, there is a fine line between good marketing and misrepresentation. Don’t tell me you think that many opponents of the FairTax or any other legislation don’t misrepresent their case whether intentionally or not. Or what about other legislation that occurs, sometimes just the name of the bill is misleading. Unfortunately, it’s part of the game.
I guess I’d have to agree with Jorgenson on this and not AFFT. The embedded taxes aren’t just what the business pays (their income tax and share of payroll), it is the entire tax burden (plus employees payroll and income). Although Hank often disagrees, people work for their net pay. To think of it another way, they demand their gross pay, but once you eliminate their income/payroll taxes, they’ll only demand their net. Why? Because you are eliminating a large cost (taxes) from their lives.
Will people continue to get their gross? Maybe in nominal dollars, but it can’t be stated enough that “real” prices and salary will shift until the natural equilibrium is reached, or in other words, real prices/wages will stay the same, on average. Again, I say on average because the current tax system favors certain activities (employer provided health insurance, mortgage interest, first time home buying, etc.), so the inequities produced by those breaks will be corrected. But if the cost of government (revenue neutrality) remains the same, the average cost in the purchase of goods will remain the same (they’ll just shift from being taxed at time of production to time of consumption).
Transparency comes from the fact that people really work for their net and the taxes they pay are really priced into the products they buy. Now they’ll just see it (and our exports will have removed and imports will put it back in).
As far as taxing the tax goes, it is about as useful an argument as inclusive vs exclusive. Once people understand how it is calculated, it makes no difference. If you tax the tax at 10%, you really have a tax rate of 12.3% (23%*10% + 10%). You’re government takes 35.3% of everything you consume.
Andrew,
You wrote: “Although Hank often disagrees, people work for their net pay. To think of it another way, they demand their gross pay, but once you eliminate their income/payroll taxes, they’ll only demand their net. Why? Because you are eliminating a large cost (taxes) from their lives.”
We will never agree with your view of pay and what we work for, but not only does the Fairtax eliminate taxes as you wrote, but it causes prices to rise by 17%. I’m still going to demand my gross pay, and so should everyone else. Giving up a large share of my gross pay without a fight, in the forlorn hope that businesses will lower their retail prices borders on stupidity, imho.
Of course people are going to want to keep their gross pay. That does not mean it will happen. If you are faced with either accepting less than your gross or not having a job, what will you accept? As a matter of principle, you might choose to find another job. The employer will fill your position and pay that person what the market will bare. You will look for another job (possibly) and you will be paid what the market will bare. You will be getting your gross in your new paycheck, but it may or may not be anywhere near the gross you were working for at your previous employer.
I think the issue is really only important during the transistion period from our current system to the FairTax. If you look past the short term I think the long term (two years or more) view more important and such inequities will be corrected. If I had a little more trust in the government I would be more inclined to insist on a 5 year transistion. I think something has been mentioned in this forum before. In theory it sounds good and reasonable. I’m not sure if it may somehow be abused (by employers, employees or the government). My biggest fear of a 5 year switch over is that midway through, Congress freezes it so we are being taxed on consumption and income both.
I can’t imagine an employer lowering an employee’s gross pay as a result of the FairTax. The FairTax creates a condition whereby gross pay has a better chance of going up rather than down. It just depends on whether the employer wishes to keep or pass on his portion of payroll taxes.
Please no 5-year transition period. I guarantee we would end up with both consumption and income taxes.
John,
Last things, first. Until and unless the 16th Amendment is repealed, the federal government can employ both an income tax and a sales tax at any time. And, the nations Governors, through the National Governors Association, are opposed to any type of national sales tax. Repealing the 16th would be very difficult in the event of fifty vetos. It seems to me that HR25 could incorporate a five year transition plan protected from change by a clause requiring a super majority to approve any changes.
As for keeping our gross pay/pensions, I have often written that it won’t happen for fairness and contractual reasons. Here’s what I meant:
(1) Contracts. Everyone works with a contract, whether a hand shake or a multipage contract. And all contracts deal with gross pay, not net. If all business owners tried to lower that gross, only “legalman” would benefit. Do you really think that all government workers/retirees, all unions, and all management employees are just going to roll over and say “Reduce my gross to my current net, it’s OK, and please use the money to lower your retail prices”? Nonsense! What they all will be saying is “The next voice you hear will be my lawyer’s”! Contracts are important, and a deal is a deal!
And how about minimum wage workers? Business owners can’t lower their pay unless the current law is changed. Any attempt to reduce contractually obligated gross pay would result in chaos in the labor market, imho.
(2) Fairness. Reducing gross pay by the amount of withholding would create an unfair situation. No problem with FICA, everyone pays the same 7.65% up to the cap. But income tax withholding is different for everyone. Employers have no idea just what income taxes are paid by each employee. The only information available is the W-4 on file. But, some employees over withhold and some under withhold. Employees making the same gross pay may have very different amounts withheld each pay period. So, would it be fair to simply reduce gross pay by the withheld amount. Not at all!!
And imagine the chaos should HR25 look like it might become law as workers rush to submit revised W-4’s in an attempt to protect as much of their gross pay as possible. Wouldn’t surprise me if everyone under withheld by the 10% which is perfectly legal.
As the AFFT Director of Research once wrote, “the most likely scenario is that everyone would receive their gross pay and retail prices will rise.”
I agree!!
Hank,
Maybe this is why we talk past each other. Pay won’t be set based on a business saying “Well, now I’ll give my employees just what they currently get after withholding is taken out”. A businessman can say that, but that doesn’t set pay. Pay is set by what the employer/employees do collectively. If paying net (based on withholding) is too low for a particular business, those employees will leave. If it is too high, that business will be at a competitive disadvantage and either adjust or cease to exist.
The market is fluid. You have as much a chance of removing water from the left side of a glass only as you do of saying “from now on, everyone just recieves their gross including withholding and payroll”. The market forces just don’t work that way.
I agree with John that this is only a transitional issue. The only difference between our opinions is that I’m willing to take the dual tax system risk (which I do consider large) in order to mitigate the market adjustment inflation factor (which I also consider large) by having a 5 year phase in. This would negate the union factor (although it is only 7% of the private market and the public market will still be paying income taxes anyway) and allow employers to adjust pay gradually.
I’m not sure where Hank gets his information on labor contracts, but the vast majority don’t go much beyond a two-week notice.
I got my contract information by Googleing “employment contracts” and reading a number of US and foreign examples. And I never found a single example that stated in writing that the employer has a right to reduce the agreed upon gross pay. Of course, the employer can fire anyone with proper notice.
The fundamental question remains just who should provide the solution to the Fairtax impact on prices? The employee by accepting a lower gross and hopefully unchanged retail prices, or the employer by paying the contract gross pay and raising retail prices as necessary. That is a business decision, imho, and the books shouldn’t be balanced on the backs of the employee! There are too many other business uses for those employee gross pay cuts, and retail prices may or not remain about the same even if the employee suffers a gross pay cut.
Hank and Steve,
I agree that the most likely scenario is that everyone will receive their gross. And I am not advocating anything else. I am saying however, that is it possible a segment of the popluation will have their pay reduced. And Hank, I agree we work under somewhat of a contractual agreement. Some have that contract in writing (whether by law in the case of minimum wage or some other formal contract). There are many who do not have such a contract. I am one of those. There is nothing stopping the company I work from reducing my salary other than the market price of replacing me. I agree if a lot of employers attempted to reduce salaries down to the net amount, there would be chaos. But that does not mean it won’t happen to some or they hold the employee’s pay stagnant for a few years until it is essentially the same as what their net would have been under the old system after the same period of time (if it’s possible to tell what that would have been).
The point I was attempting to make is that it’s a transitional issue anyway. After a few years it won’t matter.
Hank,
You say the books shouldn’t be balanced on the backs of the employees.
It’s always balanced on the backs of the employees. Maybe company A’s are not balanced on the back of company A’s employees, but if they raise prices....someone pays it, if the cut profit someone looses. It’s not the company that pays. Or if they do, they go out of business.
Hank/John,
Once equilibrium is reached, individuals purchasing power (be they employer/employee, owner/laborer) will be the same all else. Of course, fairtax proponents believe everyone’s purchasing power will increase (on average). Proponents believe it will decrease (or at least shift in an unacceptable way).
Employees will be able to buy the same things when they recieve there net today. Nothing will be done on their backs.
Andrew,
I agree with you. What I meant by my response to Hank about it always is on the employee’s backs is that anything that happens to a corporation (whether it’s taxes or something else) impacts the employees either directly through increase or decrease in wages or indirectly by the fact that it might not be the company they work for that effects them (prices of what they buy goes up/down or investments going up/down). So instead of using employee, it might be more accurate to say it’s always balanced on the backs of the taxpayers. If corporate taxes are increased, then it’s not the company that is hurt (unless we are comparing a US based company with a company outside the US that are competing for the same market), it’s the employees through reduced wages, customers through increased prices or share holders through reduced profits.
I was responding to Hank’s position against the employees baring the brunt of the changes. My point is that whether we are talking FairTax, VAT, Flat Tax, current tax (whatever it’s called) the employees and citizens bare the brunt of it. And I think the FairTax is the best hope for minimizing the effects. It’s not perfect, some may be worse off in the short run, but in the long run everyone will be better off.
One more time, here is what I have been trying to get across–unsuccessfully it seems.
Two simplistic scenarios: (ignoring the effect of the inventory tax credit)
(1) Employees gross pay cut to current net upon Fairtax implementation and retail prices drift down over the next few months or even years. Prices are sticky downward so it may be some time before equilibrium is reached. During that time, the economic burden is on the consumer, not the business owner.
(2) Employees get their full gross pay and retail prices increase as needed by business owners in order to pay the federal sales tax, and stay in business, yet meet the competition’s prices. Here, the burden is on the business owner to make the tough decisions, while the consumer has the dollars in hand to handle whatever happens to market place prices.
I obviously prefer #2.
I can’t speak for anyone else, but I’d prefer #2 as well.
I’m not sure why Hank would prefer #2. If you are retired and hold much of your wealth in the bank, you stand to lose 15% of your wealth due to Hank’s calculated 17% inflation. Devaluing of the currency is never fair. “Retail prices increase” means they increase in nominal dollars.
Here is a scenario: Day 1: Everything is 30% more. Many people stop buying things because of the expense. Day 2: Businesses realize they have a surplus of goods and lower prices to dump their excess inventories. People start buying things again. Day 3: Businesses realize their costs are too high to support a worthwhile profit. They lower their labor costs. People continue buying products because they are the same price as before and they take home just as much money as they previously did. Day 4: Everyone makes their previous net. Prices with the fairtax are now the same as prices that used to have the embedded taxes.
It should be noted that this process could take longer (maybe 5 days).
To the Hardcore-(Hayden, Morphh, John, Steve, Andrew, Fred, et al),
This thread petered out some time ago, but I thought it was a good effort at a civil discussion about what lies ahead. Of late, I have been locked in contact with David Tuerck at BHI, and others who are concerned about some more Fairtax dertails.
(1) Although AFFT continues to predict that GDP will rise by 10% in year 1 of Fairtax implementation, economic experts such as Larry K tell me that taxes are not included in GDP calculations. If that is true, it seems to me that GDP will fall by 10% in year 1, not rise, assuming a 10% reduction in producer costs?
(2) In a related question, will the 23% of the retail price that is the federal sales tax be financed by the banks? For example, a $300K house today might be built for $270K under the Fairtax and the retail price would be $351K. Would the home buyer have to come up with the $81K in taxes plus whatever down payment might be standard? Or would the bank include the tax in their valuation and finance it?
(3) Economists are fond of the price equation that basically says that prices can not rise without monetary accommodation. That is, unless the money supply expands, prices can’t rise. But in the unique case of the Fairtax, consumers are going to be given a huge increase in spendable income due to getting 100% of their gross pay, and the FCA (prebate). This amounts to over $2 trillion annually and should support any retail price increases, imho. Does the Fed have to take any action regarding the money supply? If so, what?
Any comments would be appreciated.
It is said, death and taxes are certain.
Well, why not use one against the other.
When we all know that death is certain, while also taxes, it may be advisable to invest in taxes, to defeat death.
While we pay taxes, do business, all and sundry, there is not certainty (atleast as much death and taxes) that it will last (how the mighty have fallen), to give consistent returns to our children.
Every investment is subject to a certain decree of risk. Investments may get dried up, due to contingencies, eroding the capital.
What else can be the safest investment? which company/investment house, can guarantee consistent returns? Which company has assets to last? which entity would not run away with our money?
DIRECT TAXES:
I understand that it can the tax department (read company). While the capital / principal investment would always be the property of the government (after payment of tax – no risk of depletion), a consistent . . . . say may be 1% p.a. (considering standard interest rates across the globe – subject to correction) for the next 100 years . . . . from the date of payment . . . or from the year of the assessment of tax . . . . may be the best initiative for us to, MOST honestly and to our maximum ability to pay taxes, and ask the government to honour every tax paying citizen (not just the elite few) by returning what they have contributed, in the form of yearly return, free of taxes and protected from attachments (like the PPFs, etc..). So when everything around us falls, the past deeds of proper payment of taxes, would ensure / give the guarantee of lifetime (100 years includes after death too) for consistent returns. An ordinary citizen / consumer, normally ends up paying the maximum tax, which if properly computed, may show that it is more than is lifetime savings. . . . then why not encash it . . . . . evolve it . . . . to counter benefit . . . and ensure prompt payment . . . prompt assessment . . .etc . . .etc.
I PROPOSE A PAYMENT OF 1% p.a. return as interest on gross tax paid by every citizen . . . . for the next 100 years by the tax dept. (to the assessee and his family) . . .which would ensure while everything (read investment / business) has collapsed around him . . . his honest in payment of taxes would help him sustain. . . .
Indirect taxes:
We do not realize, that while tax authorities with all the mighty power of raid, search and seizure (may be successfully or may be unsuccessfully) may have collected “X” amount of tax…. Well . . . . . it is sorry state of affairs, . . . . but for the population of our country . . . they may be out numbered . . . . may be more often than not . . . many may escape . . . .
It is not the duty of every citizen to help the tax men. . . . does not the tax dept. give incentive to people helping unearth tax evasions . . . rumoredly a 10 or 20% of the collection . . . but still there is unrest with the people and the depts..
It may be beneficial / transparent / simple . . . .and most advisable to engage the services of 100 crore Indians, to help and assist the taxmen. . . . . by giving a 1% p.a. of their contribution . . . . . Yes, it is the ordinary citizen of the country who purchases . . . food grains . . . consumer articles, groceries, vehicles, . . . . and contribute to the national exchequer in the form of central excise, import duty, sales tax ( central and state), VAT, service tax, levies, etc. . . . .See annexure – I for the rate . . . A price of 1/= product is built with not less than 10 – 50 % of taxes, more often than not . . . . .
Who pays . . . it is not the entrepreneur . . . . but the citizen (end consumer as everything is passed on to him/her). . . .and he does not insist for a bill / receipt. Why . . . he considers it of no use . . . . unfortunately . . . . . but if a incentive of 1% p.a. of his contribution is calculated . . . . . . and he required to lodge the bill for claiming his contribution . . . .by producing a receipt . . . there would be a self check mechanism. . . . . by not less than 100 crore citizens . . . . keeping a vigilant check on the economy .. . . .
I PROPOSE A PAYMENT OF 1% p.a. return as interest on gross of all tax under various heads . . . paid by every citizen on purchase or use of goods and services . . . . for the next 100 years by the tax dept. (to the assessee and his family) . . .which would ensure that while everything (read investment / business) has collapsed around him . . . his honest in payment of taxes would help him sustain. . . . and also ensure there is no evasion . . . at any point . . . it will be like 100 crore taxmen . . . . working 24 X 7. . . . at a salary / incentive of 1% p.a. of what they contribute. . . . . .
Ofcourse, it may look tedious (time, money and concept) on working out the above plan . . . . but after having spent 50 years on other methods . . . . 5 years may be spent on trying to build a network of 100 crore . . . taxmen . . . . also to create awareness . . . cut out corruption . . . . etc. . . . . etc. . . . . etc. . . . . etc. . . . . etc. . . . . etc.
. . . . . . any ideas . . . . . improvements . . . .additions . . . . deletions . . . .
Annexure – I
Vivek Jain
vivekbrjain@gmail.com
while you all may be busy calculating if you have paid more taxes, or have more savings, note, you might have actually spent the most, (thereby contributed towards taxes), friends . . . . .: I need you to fill out annexure – I