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.

Several things wildly incorrect in this latest post of yours.

First, it's not MY spreadsheet, but one I like because it clearly shows the embedded tax effects and it is clear and should not be misunderstood by most (yourself excluded, apparently).

"Companies don't sell their profit"??? Actually I don't recall saying they did. That's also irrelevant to this discussion which is about embedded taxes. These taxes are derived by using the tax rate in the example (called "tax rate") and multiplying it by the amount shown as "profit margin" (if that term causes you to not understand the clear meaning of the example, call it "smudgepot" or any other term you'd like). Same with the term "tax rate" for that matter.

Obviously something is warping your mind since you seem to misunderstand how taxes are calculated - by dividing the amount due in taxes by the amount subject to taxes - both of which show up in the example as written. It nowhere says that taxes are derived a percentage of revenues for the very simple reason that they are not.

Give it up pal. The example I posted clearly shows the mechanism and it has nothing to do with revenues per se. It has to do with the amount of taxes and those are not calculated and reported to the IRS as a percent of revenues.

You're not allowed to redefine the example I posted just to try to warp it into something meaninglses as would be your percent of revenues example, so you may as well stop trying. Go check with the IRS if a business pays taxes as a percent of their revenues - lots of luck!!

It's obvious you don't understand the example as you try to present it as some sort of addition of numbers to arrive at a selling price. That's not the way it works at all. Think of it this way the input on L1 ($1.00) has a target profit margin of $0.33. To reach that level at the marginal rate of the business (34.4%) will involve a tax payment of an additional $0.11 and would cause a sell price of $1.44. The tax amount, though, would be the projected $0.33 times 0.344 = $0.11. That is the amount embedded into the $1.44 price. We're unconcerned about the tax as a percent of revenue ... that doesn't enter in at all. You seem to take this as some sort of accounting compilation of calculating a sell price. That's not what it shows - and that is obvious to most people from the example.

Sorry, but you don't get to redefine the example to be something it's not. It shows the cascading effect quite nicely - and the tax paid is not calculated from the selling price listed (nor is the profit) as you believe. The "amount subject to tax" is exactly as I explained it rather than your misunderstanding and the "tax rate" also is as I explained it rather than as your misunderstanding and attempts to redefine it. The tax rate times the amount subject to tax is the $0.11 as shown.

Perhaps you don't understand the example but I'm satisfied with it as showing what I said it did and understandably so. You don't get to redefine it to suit your purposes just as you don't pay income taxes based on a percent of revenue. That's a meaningless concept in trying to show embedded taxes (or even in paying taxes).

Dear pigdog,

I'm gonna give it one more try, pigdog.

Corporate income taxes are calculated on an inclusive basis. One does not calculate a percentage of the after-tax profit, and then add that to the selling price. I wish it were so. ;-)

No, one multiplies the ENTIRE PROFIT before taxes to come up with the tax liability.

Let's look at the problems with the table you posted. Just one level:

$1.00 - Input
$0.33 - Profit margin of 33%
$0.11 - Tax rate of 34.4%
$1.44 - Selling price

Accumulated tax costs $0.11
Tax costs as % of selling price 7.86%

Okay. The selling price is $1.44.

How much is the net pre-tax margin on the sale? 44 cents.

The input was a dollar, and no other costs are identified. As well, 33 cents is identified as "profit margin," and 11 cents is identified as "tax."

But unless you're positing that there are 11 cents in other costs (unidentified), the only way to read your table is that 33 cents is the profit the business keeps, and 11 cents is the profit the business sent off to the IRS as corporate income tax.

Thus, the profit, before calculating the tax bill, is 44 cents.

Now, when you calculate your corporate income tax, here's how you do it:

Income tax = Net Pre-tax Profit X Tax Rate

So, we come up with the formula of:

11 cents = 44 cents X TR (where TR is the tax rate)

Solve this equation, and the answer is that the actual tax rate on which you've computed was 25%, not 34.4%.

If you wanted a 34.4% rate (and assuming the after-tax profit will still be 33 cents), it would look like this:

$1.00 - Input
$0.33 - Profit margin of 33%
$0.17 - Tax rate of 34.4%
$1.50 - Selling price

Here, there is 50 cents of pre-tax profit (selling price minus input [which is identified as the total costs of the product]).

34.4% of 50 cents is actually 17.2 cents, but, hey, I rounded.

So, with this equation:

Income tax = Net Pre-tax Profit X Tax Rate

We come up with the formula of:

17 cents = 50 cents X TR (where TR is the tax rate)

and TR = 34%.

To repeat, taxes are calculated by multiplying the tax rate on the ENTIRE PRE-TAX NET PROFIT.

"We're unconcerned about the tax as a percent of revenue ... that doesn't enter in at all."

Actually, pigdog, you appear to miss the relevance.

I haven't said that one figures out the amount of taxes owed by applying a percentage to revenues. Of course not. As I've explained to you repeatedly, one calculates taxes as a percentage of pre-tax profits.

However, if we're asking the question, "How much can the price of the product go down if the company no longer pays any corporate income tax?" then the tax AS A PERCENTAGE OF THE SALE PRICE, as you, yourself have shown, is relevant.

And to see what that effect is on a corporate level, one calculates how much the tax is as a percentage of the revenues of the corporation.

Let's try a simple example:

John owns a company that makes one sale this year.

The selling price is $1,000,000.

The profit is $100,000.

The tax rate is 35%.

The tax owed is 35% X $100,000 = $35,000.

John's company, after subtracting the tax out from the $100,000 profit, made $65,000 after taxes.

Now, if John's company paid no income tax (tax on profits), how much could John have sold the item for, and still made $65,000?

Well, that would be $1,000,000 - $35,000 (the amount of tax paid) = $965,000.

The customer saved $35,000.

So, how much did the price of the item come down?

3.5%. Which is the amount of tax paid divided by the original sale price. Which is the amount of tax paid by the entire company divided by the revenues of the entire company.

That's why we go to the trouble of figuring out what the level of taxation is as a percentage of revenue. To calculate possible savings if the tax isn't going to be paid.

I'm not getting the amount of the tax by applying a tax rate to the revenue, but rather, I'm getting the tax-as-percentage of revenue to identify potential savings.

With a company in your example, get rid of the tax, lose 11% of the price. Applied to all the sales of the company, 11% of total revenue wound up being the amount of profit paid in taxes. Get rid of the taxes, lose 11% of the prices across the board for the whole company. Cool!

Now show me 20 Fortune 500 companies where if you get rid of the federal corporate income taxes paid, you can lower the price by 11%.

I won't wait up.

sitetest

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