OPEN LETTER TO BOORTZ/LINDER (FairTax)

U.S. Representative John Linder
1026 Longworth House Office Building
Washington, DC 20515
Phone: 770-232-3005
Fax: 770-232-2909

I have met you before and briefly discussed your FairTax proposal years ago in downtown Norcross at a street festival. I also campaigned for you in my neighborhood when you were running against Bob Barr.

I have read your book, and I have spent quite a bit of time researching the FairTax. As a small businessman who lives in Norcross, naturally I am interested in anything that will reduce taxes and assist our economy, so the idea of a FairTax sounds good. But reading your book, the bill itself, studying the fairtax.org website, and reading the House Ways and Means Committee testimony of Dr. Jorgenson back in 1995 and 1996 as well as your most recent testimony, I am disturbed by the way the FairTax plan is being presented.

I don't think you fully understand the "embedded taxes" concept-- you are double counting this money by both giving wage earners their full 100% paycheck and still expecting their employer to be able to reduce their prices by about 23% on average.

Let's look at a wage earner-- call him George-- that grosses $1000 per week under our current system. You claim that, under FairTax, George will keep all his income (the full $1000) plus everything he buys at retail will cost about the same as George pays now. This is implausible.

Businesses will not be able to pay 100% of their paychecks to their employees, because they need these "embedded tax" savings to be able to lower their selling prices.

George currently gets $1000 a week from which his employer withholds $200 in FICA and fed taxes and $50 in state taxes, leaving George with $750 to spend. Right now, let's say loaves of bread are $1. Today, George can buy 750 loaves of bread for $1.00 each with his take-home pay.

Under the FairTax, you claim George will get his whole check, which is the same $1000 less George's $50 state taxes, for a take-home of $950. If your FairTax logic is correct, the price of the bread will quickly drop to about $0.77 (when Bob's Bakery gets rid of his "embedded taxes") and when they add the 30% FairTax at the register the final price will still be $1.00. George can now buy 950 loaves of bread with his $950 take-home.

You have increased George's purchasing power by 200 loaves of bread which is a 26.7% increase in his purchasing power. And you claim that FairTax will do this on average for every wage earner in America.

This is dishonest to make everyone think they will get a 25%+ increase in purchasing power. ("Get a 25% pay raise, and prices stay the same")

It is obviously illogical that every wage earner in America, with no change in productivity can increase purchasing power by even ten percent, let alone 25%.

The fallacy in your understanding of the "embedded taxes" is that Bob's Bakery cannot give his employees their full paycheck AND still reduce his costs by $0.23 per loaf of bread as you claim. He can do one or the other, but not both.

The baker could reduce his price by about 25%, but only if he keeps his bakery employee taxes that are currently withheld and going to the government. If he gives these "embedded taxes" to his employee, then his overall labor costs haven't gone down and he has no saving to pass along in his prices. His only big difference is he writes a check to his employee for $950 instead of two checks- one to his employee for $750 and one to the IRS for $200.

If our baker instead kept the taxes, his labor cost would now be $800, and the baker could now maybe drop his price to around $0.77 per loaf as you expect. George would still have his same $750 take-home income and he would still be able to buy 750 loaves of bread for $1 each ($0.77 cents price plus $0.23 taxes). George's purchasing power would still be 750 loaves of bread as it is now.

I think this is the honest way to look at the FairTax plan, but this is not what you are claiming.

The only other alternative is that George gets his full $950 and the price of bread drops to say $0.90 to reflect Bob's Bakery's savings on the employer portion of FICA (7.65%) for his labor costs and a few percentage savings for IRS compliance costs. When sold, the $0.90 loaves of bread will get $0.27 FairTax added for a total selling price of $1.17. Under this scenario, George has $950 take-home, which allows him to purchase 811 loaves of bread, a slight increase in purchasing power which is mainly due to the elimination of the employer portion of the FICA. (assuming Bob's Bakery kept that employers half of FICA which is really his employees money but that is another discussion)

But this second "inflationary" scenario would put retired persons, or anyone with accumulated wealth or any person on a fixed income at a relative disadvantage to wage earners because things would cost more in absolute dollars. So, this scenario won't work in practice.

Please think about what you are promising here when you say that people will get their whole pay checks and at the same time all prices will be about the same. It cannot happen-- there is no 22-25% "embedded tax" savings once you give wage earners their entire paycheck.

Dear groanup,

"Are you sure you want to throw that in there?"

Yeah, sure, why not?

"Do you have any idea how many people get screwed under the current system vs. how many benefit BECAUSE other people get screwed?"

LOL. Depends on your perspective. Folks who are legally blind probably disagree with you.

Anyway, the point of the post is to show that some folks are going to have their financial lives badly disrupted by this new system.

Others will obtain large windfalls.

But the millions who get hurt will represent a major economic disruption in our society, and it may be large enough to cause overall economic pain for a long time to come.

As well, there are other problems with the NSRT, but that was the point of the last post - lots of comfortably-off, middle class senior citizens are going to get screwed.

sitetest

What a business needs to lower the selling price is lower costs. Since this plan would eliminate corporate income taxes and the matching of FICA taxes then business will now have money they are currently paying to the government out of their profits.

You must not have read my letter, because I address the FICA matching, that is where most of the 10% cost reduction I estimated came from. And Bob's Bakery as a small business (S corp, LLC or sole proprietorship) pays zero corporate taxes. State and federal unemployment taxes are not affected by the FairTax bull, nor are benefit withholdings. So I've addressed all your points that are valid, and I've given him a generous 2% savings in compliance costs to boot.

There is no place else to remove embedded costs. The place where Jorgenson found them was the employee wage and payroll costs, but the FairTax proponents misunderstood him and now they are promising the money to the employees in the form of a windfall pay increase to every wage earner in America.

Dear groanup,

"LOL, that's a constituency but a very narrow one."

Perhaps not as narrow as you might think. But, that wasn't the example I initially gave. I gave an example where all income is generated from pensions, Social Security, and qualified retirement accounts.

I only gave this example because you mentioned about earnings from pools of savings.

"The current system plays favorites and non-favorites a hell of a lot worse than what you are describing here. If they have that much money they'll be fine."

I don't really see it that way at all.

The rules are the rules, and they are relatively stable, and folks can conform their financial lives to take advantage of the rules, or not to. Each person may choose.

So, you're saying that someone with a planned spending budget of nearly $60,000 per year will be fine if they have to reduce that by $10,000 per year?

After planning for years under the present rules?

Well, they might not agree with you.

To me, the most unfair feature of tax laws is that they change.

But the changes we have nowadays are relatively modest.

The changes proposed with the NSRT, on the other hand, are total and complete. There is significant injustice and unfairness just in the level of change proposed.

sitetest

Tables from sitetest that I formated in HTML for him:

TABLE 1
	Raw Mat Producer	Intermed Manufacts	Final Manufact	Distribut/ Wholesale	Small Retailer (S Corp)
Input	$ -	$ 1,000.00	$ 2,500.00	$ 6,250.00	$ 7,187.50
Value Added	$ 1,000.00	$ 1,500.00	$ 3,750.00	$ 937.50	$ 2,156.25
Price	$ 1,000.00	$ 2,500.00	$ 6,250.00	$ 7,187.50	$ 9,343.75
Pre-Tax Profit Rate	7.00%	3.00%	13.00%	1.00%	10.00%
Pre-Tax Profit	$ 70.00	$ 75.00	$ 812.50	$ 71.88	$ 934.38
Effective Tax Rate	20.00%	20.00%	15.00%	20.00%	0.00%
Tax	$ 14.00	$ 15.00	$ 121.88	$ 14.38	$ -
Accumulated Tax	$ 14.00	$ 29.00	$ 150.88	$ 165.25	$ 165.25
Accumulated Tax as Percentage of Price	1.40%	1.16%	2.41%	2.30%	1.77%

TABLE 2
	Raw Mat Producer	Intermed Manufacts	Final Manufact	Large Retailer (C Corp)
Input	$ -	$ 1,000.00	$ 2,500.00	$ 6,250.00
Value Added	$ 1,000.00	$ 1,500.00	$ 3,750.00	$ 2,062.50
Price	$ 1,000.00	$ 2,500.00	$ 6,250.00	$ 8,312.50
Pre-Tax Profit Rate	7.00%	3.00%	13.00%	3.50%
Pre-Tax Profit	$ 70.00	$ 75.00	$ 812.50	$ 290.94
Effective Tax Rate	20.00%	20.00%	15.00%	15.00%
Tax	$ 14.00	$ 15.00	$ 121.88	$ 43.64
Accumulated Tax	$ 14.00	$ 29.00	$ 150.88	$ 194.52
Accumulated Tax as Percentage of Price	1.40%	1.16%	2.41%	2.34%

TABLE 3
	Raw Mat Producer	Intermed Manufacts	Boeing Aircraft	Airline
Input	$ -	$ 10,000,000	$ 25,000,000	$ 62,500,000
Value Added	$ 10,000,000	$ 15,000,000	$ 37,500,000	$ 62,500,000
Price	$ 10,000,000	$ 25,000,000	$ 62,500,000	$ 125,000,000
Pre-Tax Profit Rate	8.00%	4.00%	8.00%	0.00%
Pre-Tax Profit	$ 800,000	$ 1,000,000	$ 5,000,000	$ -
Effective Tax Rate	20.00%	20.00%	20.00%	0.00%
Tax	$ 160,000	$ 200,000	$ 1,000,000	$ -
Accumulated Tax	$ 160,000	$ 360,000	$ 1,360,000	$ 1,360,000
Accumulated Tax as Percentage of Price	1.60%	1.44%	2.18%	1.09%

The place where Jorgenson found them was the employee wage and payroll costs

Correction: One place where Jorgenson found them was the employee income and payroll taxes, I'll let him explain:

March 27. 1996 (104-46) at http://www.gpoaccess.gov/wmhearings/104.html

"Since producers would no longer pay taxes on profits or other forms of income from capital and workers would no longer pay income taxes on wages, prices received by producers, shown in the fifth chart, would fall by an average of twenty percent."

(the referenced fifth chart is the same basic chart that Boortz used in his book, Fig 5.1)

Sounds pretty clear that he expected the workers to give the money they saved by not having to pay taxes on wages back to the "producer" (their employer) to enable them to lower prices. Jorgenson was under no delusion that the wage earners would get to keep 100% of their current paychecks. He knew they would get to keep 100% of their new smaller paychecks (reduced by about the amount they now pay in income and FICA taxes).

Those look a tad bit more realistic, it is good to see companies add value and have reasonable profit margins. Kinda changes the numbers for a more realistic business scenario. Like we have been saying there is some cascading of taxes on profits, but it is a small number, no where close to 20-25%.

So a ten percent total cost savings on average *instead of 20-25%* looks about right for FairTaxWorld where the employees and owners get to keep their income and payroll tax savings. The bulk of that is the FICA matching portion, plus a small amount of "cascaded" income taxes, plus a small compliance cost savings.

After planning for years under the present rules?

So we keep the goliath because a narrow constituency might be inconvenienced. What about people trying to do estate planning? They have a one year window to die in 2011 or else they must spend a lot of money on life insurance, trusts, etc. We're worried about planning now?

The average retirement savings for baby boomers is about 18,000. You're worried about someone who might have 55,000 instead of 60,000 to spend in retirement, assuming every thing they buy is brand new, when there are benefits of the fair tax that would make the playing field level for tens of millions of people.

What would you do? What is your plan? Do we keep the system we have? Do we use a flat tax?

I don't really see it that way at all.

Do you honestly believe that? The current system is relatively fair? If you believe that you are not one to be debated but rather suspected.

Of course, you don't wish to "debate the macreconomic effects" until FairTaxers acknowledge your supremacy in estimating tax costs.

Actually I just want the FairTaxers to acknowledge that their plan as it is being sold is based on a mistaken premise. I have no idea when the premise was introduced that people can keep their whole paycheck and prices will still be able to stay the same, but however that got started is where the wheels started to come off.

In my business it is called over-selling. It leads to unsatisfied customers, returns and loss of future trust/business.

Dear RobFromGa,

I don't think you can assume that we can take the employer's side of FICA and Medicare and lower prices with it.

The problem is that there are lots of middle class professional folks, with really good benefits, moderate incomes, who just don't pay a high percentage of their total gross compensation in federal income taxes.

They don't even pay 15%, really, of their total gross compensation in payroll taxes.

That's because a lot of their compensation is hidden in things like company-paid health insurance (which in my state, is very expensive).

If you don't give them back both sides of FICA and Medicare, many of these folks will be upside down.

I look for little or no price drop.

As I think about it, large publicly-held corporations will come under dramatically huge pressure by shareholders to give the saved corporate income taxes back to the shareholders, not to use that money to lower prices.

The reason why is otherwise, share values will take a hit relative to the inflated price levels after the NSRT takes effect.

Here's why. Let's say the P/E of ABC Big Public Company is 10. And earnings are $1 per share. So, the share price is $10.

Okay. Under the old regime, I sell the share. I bought it for $5 (I did really, really good ;-)). I pay 75 cents in tax (15% of the capital gain). I now have $9.25. I go and buy $9.25 worth of stuff.

Under the new regime, if my share is still worth $10, I sell it, I get to keep the whole ten bucks, but now, it only buys $7.70 worth of stuff. I'm screwed.

On the other hand, if the company has an additional 25 cents per share of profit (assuming that it was paying 20% of its pre-tax net profit in taxes), my share now has earnings per share of $1.25. Apply my P/E of 10, and voila, I've got $12.50. That's got $9.625 of purchasing power compared to the old price levels. I'm doin' okay. Heck, I actually PICKED UP 4% of purchasing power!

No, I think that saved corporate income taxes will go back to shareholders, not to consumers.

Especially since the top management of these companies often own a lot of shares. No way do they want to see their shares instantly devalued.

sitetest

Here is what Chairman Greenspan said when he met with Congressman Linder in Feb 04 "Oh, you don't have to sell me, I've studied your plan and I don't think any serious economist will disagree with you.

Greenspan might have just been looking at the bill, not listening to the promises of the FairTax groupies.

The bill itself doesn't promise that employees will get to keep their whole paychecks. How could it? Salaries and wages are a private matter between an employer and his employees. The government cannot dictate that salaries will stay the same, except for min wage earners.

It is the cheerleaders of the plan that are misrepresenting it. I would imagine that Boortz is likely partially to blame, he probably misunderstood it early on, repeated the error a few times, and no one ever corrected him.

Either way, for this to move through the legislative process, these questions need to be addressed and straightened out.

I don't think you can assume that we can take the employer's side of FICA and Medicare and lower prices with it.

I agree with you, but I was trying to give the FairTaxers every benefit of the doubt in coming up with an estimate, and I didn't want to get bogged down in this argument. Linder/Boortz did not represent that the wage earner would keep the employers half of FICA/Medicare (even though he makes a statement that this is really the employee's and it is a standard quote of Boortz to ridicule callers who think that the employer pays half).

So I made all my numbers generous to avoid arguments, not that it mattered much with hard core bunch. I figured that ten percent price drop was still so pitiful when compared with a retail tax of 30% that it would make the point.

Ten percent is a maximum cost savings in my estimation, without the employer half of payroll it would be more like 2-3% cost savings.

Not at all, Nightie. The example in #88 illustraates cascading very well, indeed. As a tax cost from one level is passed to the next, that next level's numbers have within them the tax from the previous level and that is operated on by the multiplicative effect of the calculations.

If one level's "numbers have within them the tax from the previous level," that's an additive process, not multiplicative. In your example, Level 2 has $0.12 tax cost on $0.47 profit. For this to be a cascading effect, the $0.12 would have to higher because of the previous level than it would be without. It wouldn't. In your example, a business making $0.47 profit would pay $0.12 profit whether it was on the first level or the fiftieth.

To have a cascading effect, the tax on one level must be taxing the tax from another. That is most definitely not happening in your example. Each level's profits are being taxed and as the profits accumulate, so do the taxes. (Duh.)

The following is an example of a cascading turnover (sales) tax:

Level
1

2

3

4

5

6

7

8

Inputs
$ 1.00

$ 1.66

$ 2.76

$ 4.59

$ 7.64

$ 12.70

$ 21.11

$ 35.10

Profit
$ 0.33

$ 0.55

$ 0.91

$ 1.52

$ 2.52

$ 4.19

$ 6.97

$ 11.58

Total
$ 1.33

$ 2.21

$ 3.68

$ 6.11

$ 10.16

$ 16.89

$ 28.08

$ 46.69

Nominal 25% Sales Tax
$ 0.33

$ 0.55

$ 0.92

$ 1.53

$ 2.54

$ 4.22

$ 7.02

$ 11.67

Cumulative Tax
$ 0.33

$ 0.89

$ 1.80

$ 3.33

$ 5.87

$ 10.09

$ 17.12

$ 28.79

Effective Tax Rate
25%

40%

49%

55%

58%

60%

61%

62%

Ratio: Effective/Nominal
1.0

1.6

2.0

2.2

2.3

2.4

2.4

2.5

Notice how the effective rate quickly exceeds the nominal rate? This is the cascading effect. "As a rule of thumb, it is estimated that the effective rate of a cascade tax to the retail stage is approximately two and a half times the nominal rate."¹ In your example, the effective rate could never be greater than the nominal rate because even if every level was 100% pure profit (which it almost is in your example), the effective rate would still only be the nominal rate, 25%.

The table above is illustrating a cascading tax. Your's is not. The income tax is not a cascading tax.

Tait, Alan A. Value Added Tax: International Practice and Problems. Washington, D.C.: International Monetary Fund, 1988.

Dear groanup,

Narrow constituency?

LOL. Even the folks WITHOUT the three quarters of a mil lost nearly 8% of their purchasing power.

You're talking about millions of senior citizens. LOL. "narrow constituency."

"They have a one year window to die in 2011 or else they must spend a lot of money on life insurance, trusts, etc. We're worried about planning now?"

I don't like that either. That's why I'm fighting to make the President's tax reductions permanent.

"...when there are benefits of the fair tax that would make the playing field level for tens of millions of people."

Frankly, I don't see it as "leveling the playing field."

In my view, the people who are rewarded the most by the NSRT are folks with few children, are renters, are folks who don't take advantage of things like qualified defined contribution plans, are folks with minimal savings, are folks with minimal equities and other financial assets, who haven't bothered to try to get jobs with good health insurance.

And the very rich.

In my view, it punishes most middle class folks who've had kids, who've purchased their own homes, are folks who make sure they max their retirement accounts and get every penny form their employers in matching funds, who will take less pay to get better health insurance, who have taken care to accumulate some savings, some other financial assets, etc.

"What would you do? What is your plan? Do we keep the system we have? Do we use a flat tax?"

Well, to me, changing taxation systems when the federal govt controls 20% of GDP is like rearranging the chairs on the deck of the Titanic. Kind of a waste of energy. In this case, possibly a very disruptive waste of energy.

You gotta knock back how much of the economy runs through the govt's fingers.

I'd start with gradual Social Security privatization, moving over the course of several decades (can't do it faster) to complete privatization.

Of course, to do that would force Congress to cut the budget in other areas, in that they couldn't paper over how Social Security surpluses are currently being frittered away.

But once we did that, we'd take something like 6% - 7% of GDP away from the government and put it directly in the hands of individuals. Good start.

Even better, the money that individuals and companies now spend on qualified defined contribution retirement accounts would become redundant, at least for folks satisfied with a comfortable retirement.

Talk about saving "embedded costs."

"Do you honestly believe that? The current system is relatively fair? If you believe that you are not one to be debated but rather suspected."

Well, it depends on what you compare it to. To the possible havoc and chaos of a complete turning upside down of 100% of our federal tax laws might cause?

Yeah.

sitetest

Last time I looked around, there already are plenty in that business already. Are we, for some reason that you see as a national priority, supposed to be concerned?

I believe so. So far, they are preying on a relatively small portion of the population. If a "Fair Tax" was enacted, that population would increase by at least an order of magnitude.

Can you then fathom the liberal media claiming that "the disenfranchised" are being taken advantage of and we should give them even more compensation? I can.

You don't have to concern yourself with the major economic problems which are exacerbated by our current awful tax system, nor a workable approach to addressing them, you just want to talk about how you disagree with the imbedded tax estimates.

You are right- I am not debating the relative merits or other tax plans, or the problems with the current system. I am merely pointing out a serious fallacy in the proposal for a FairTax. I personally find it more useful to try to concentrate on one thing at a time, rather than to get all wrapped up in some other argument, even if that other argument is one worth having at some point. Some of us concern ourselves with solutions and getting something done about a tax system which is a national embarrassment.

Well, I appreciate that you are looking at the overall picture, I really do, and tax policy is in need of action. But this FairTax proposal is an embarrassment too, I am actually shocked that they are this incompetent to let such a glaring mistake stand on the record.

The fact that I do not plan to propose the correct alternative plan, does not mean that I am not allowed to comment on the plan that has been presented, does it?

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Level	1	2	3	4	5	6	7	8
Inputs	$ 1.00	$ 1.66	$ 2.76	$ 4.59	$ 7.64	$ 12.70	$ 21.11	$ 35.10
Profit	$ 0.33	$ 0.55	$ 0.91	$ 1.52	$ 2.52	$ 4.19	$ 6.97	$ 11.58
Total	$ 1.33	$ 2.21	$ 3.68	$ 6.11	$ 10.16	$ 16.89	$ 28.08	$ 46.69
Nominal 25% Sales Tax	$ 0.33	$ 0.55	$ 0.92	$ 1.53	$ 2.54	$ 4.22	$ 7.02	$ 11.67
Cumulative Tax	$ 0.33	$ 0.89	$ 1.80	$ 3.33	$ 5.87	$ 10.09	$ 17.12	$ 28.79
Effective Tax Rate	25%	40%	49%	55%	58%	60%	61%	62%
Ratio: Effective/Nominal	1.0	1.6	2.0	2.2	2.3	2.4	2.4	2.5

TABLE 1

TABLE 2

TABLE 3