Fair Tax - Straightening Out Some Confusion

When Congressman Linder and I were busy researching and writing The FairTax Book we knew full well that it would one day become the focal point for those opposed to this tax reform idea. We tried, therefore, to make sure that our numbers and claims were correct and consistent with the research that went into the drafting of HR 25.

On review, and after reading the critiques of opponents to the FairTax plan, we have concluded that there is one element of the FairTax that could have been present with more clarity in the book; the concept of embedded taxes and keeping 100% of your paycheck. Those who have much to lose if the FairTax were to become law will focus on these areas in an attempt to undermine support, so let's put their objections and distortions to rest by addressing those matters here and now.

We explained in the book that the FairTax plan was revenue neutral. By this we meant revenue neutral for everyone ... the government, businesses and individuals. You can't put more money in the pockets of one without taking money out of the pockets of another. The harsh reality is that politicians would not support the FairTax if it meant less revenue for the federal government; business leaders would not support the FairTax if it meant a decrease in corporate earnings and profits, and the people would most certainly not support the FairTax if it meant a decrease in their income. Taking an snapshot view of our economy, an increase in income in one of these sectors would necessarily mean a decrease in another. This is why the FairTax was designed to be absolutely revenue neutral – leaving everyone pretty much where they are in terms of income or revenue. To put it more bluntly, there is no free lunch in the FairTax plan. There is no "something-for-nothing."

This brings us to the question of embedded taxes in the cost of consumer goods and services, and your paychecks.

As explained in The FairTax Book, there are taxes embedded in everything we buy. Every entity which provides a product or service in the design, production, marketing, distribution and sale of every consumer good or service will incur some tax liability as they perform their particular function. This tax liability will be incorporated into whatever these individuals or business entitles charge for their services, and will all passed through to become a part of the final cost of the product or service.

Every employee of any company involved in American commerce is also a provider of a service, and, as such, the employee incurs a tax liability as a result of his or her work. This tax liability is incorporated into what the employee charges the employer for their services, and is eventually incorporated into the final retail cost of the employer's product or service. Each employee is essentially a separate business entity providing a product, be it physical or mental labor, to the employer.

The extensive research behind HR 25, The FairTax Bill, shows that the average embedded taxes in every consumer product or service is about 22%. In some industries, such as leather goods, the embedded tax is smaller. In other industries, such as homebuilding and construction, the embedded tax is higher, but it averages out to somewhere between 22 and 23%. With the passage of The FairTax Bill, those embedded taxes disappear. These embedded taxes include the combined tax burdens of all entities involved in bringing those goods or services to market, and that includes you, the employee, and the taxes you incur as a result of your employment.

We write in The FairTax Book that the competitive pressures of the marketplace will force prices down when embedded taxes disappear from the cost of retail goods and services, and we cite 22% as the average amount of those embedded taxes. Does this 22% include the income and payroll taxes that are paid by employees? Yes, it does. So ... what does this mean to your paycheck after the FairTax becomes law?

When the FairTax is implemented, and when business and personal income and payroll taxes disappear, your employer is going to have to make a decision. He will either take some or the entire amount he had been withholding for federal income and payroll taxes and add it to your weekly check, or he will readjust your pay figures so that your entire paycheck will be equal to what you used to call "take home pay" before the FairTax. The employer may also decide to do a little of both. Either way, you can see that the amount of money you actually receive as pay – the amount you can put into your bank account – will not decrease, and may actually increase.

On a larger scale real wages will rise to the extent to which the nation's employers decide to return the embedded costs of their employee's income and payroll taxes to the employee. Likewise, the cost of the products or services produced by the employer will be reduced to the extent to which that employer retains all or a portion of those income and payroll taxes together with the other taxes on capital and labor eliminated by the FairTax. Once again, a zero-sum, revenue neutral game.

Now, let's elaborate on the "keep 100% of your paycheck" line that appears in The FairTax Book. It is certainly true that after the FairTax becomes law there will be no more withholding from your paycheck for any federal taxes. What you earn is what you get. This is not to say that your gross pay will equal what it was before the FairTax. This will depend on what your employer does when the embedded costs represented by the tax burden you have passed on to your employer disappear. One thing is certain: You will suffer no decrease in real or net earnings --- the amount of each paycheck you deposit into your bank account every other week. The "keep 100% of your paycheck" concept can more easily be applied to those who either change jobs or come into the labor force after the implementation of the FairTax. A new worker will negotiate a wage with an employer knowing that the amount negotiated will be the amount that worker receives every two weeks ... no deductions. Likewise, when you change employers you, too, will negotiate a wage that will not be subject to withholding, and you will get 100% of your wages in each paycheck.

Some of you reading this amplification of the principle's of the FairTax may have come to a rather interesting and accurate conclusion. The reality is that in America we're already operating our federal government off a consumption tax. A convoluted and impossible to understand consumption tax, but consumption tax nonetheless. We say this because ultimately all taxes paid by businesses or individuals eventually make their way through our economic system until they are embedded in the cost of some consumer item or service. In other words, taxes, like that other stuff you've heard about, roll down hill. At the bottom of that hill we find the retail sale and you, the ultimate consumer.

As we said in the book, and as we repeat here, the FairTax is not a "something for nothing" scheme. It was designed to be and, in fact, is revenue neutral. Having said that; the non-government economists who studied the FairTax play are nearly unanimous in their agreement that the implementation of the FairTax will lead to unprecedented economic growth in the United States. We will see economic growth in our economy of such magnitude that it will, sooner rather than later, lift all boats ---- including yours.

Well how long are you going to evaluate them?

For the life of the product.

How will you dispose of them?

It depends on the product.

What are you going to be reviewing? give some examples please.

Cars, TVs, refrigerators, computers, etc. You know...stuff.

And if they are for business use not personal use, you wouln't be caught using them for personal use would you?

All my use of the products is business use. It's all using the product for continuing, long-term, real-world review purposes.

As far as making a profit, now businessed are subject to a test to determine if they are a hobby or business, some people try the same thing now, and may or may not get away with it.

Under the current system, I can only deduct as much as my revenues. If I have $100 in revenues, I can only deduct and save taxes on that $100. Under the FairTax, I can deduct all of my expenses regardless of my revenues.

Yours is not a new idea.....I doubt you could prove to a reasonable man that yours was a legitimate business unless after a period of time you made a profit.

And the IRS spends a lot of time trying to catch those people, but the IRS is history with the FairTax. Par-tay!!

Are you going to be competing with consumer Reports? C/Net etc? Clearly this is one area that will be subject to review just like it is now...

I'm not "competing" with them in the sense I would have the same revenues, but their sites are doing what I would be doing, just on a larger scale.

How many people/corporations write off questionable items now?

What's questionable. I have a business and I have expenses. I don't pay taxes on the expenses. Is someone going to ask me to file some sort of profit/loss statement to get the business exemption? Sorry, I don't keep those records since the income tax went kaput.

How much money will you save compared to your time and effort and risk?

What risk? And the time would only be a few hours a month. That's worth saving ~23% on my purchases.

If the scofflaws purchase something new in the legitimate economy, it will be taxed in either system.

Because we are talking about different kinds of taxes here it is easy to confuse the issue, at least for me. The income tax is only affected by sales in that sales improve the economy and create new jobs. The economy is affected by many things other than the tax code and makes the whole tax collection or increase iffy. A sales tax, conversely, taxes purchases of taxable items immediately. I see little correlation or similarity of the effect.

If the scofflaws purchase something new in the underground economy, it won't be taxed under either system.

This is what I meant in the post you are replying to when I said you are technically correct but that is short term and limited. As soon as the ill gotten gains cross over into the legitimate economy, as they eventually must, they will be taxed by the NRST. I see no way for the income tax to touch them except long term and indirectly through job creation.

Underground economy transactions by definition can't be taxed.

A correct but meaningless statement.

Hoping someone will show me where I am wrong...

I just don't see it. Americans want the newest, shiniest, coolest gadgets they can get. They also want a huge selection. They also want convenience. Sure a black market will exist, it does now, but what if you need a new driver for your golf bag while you're on vacation in Hilton Head? What if your window AC unit goes out in August? What if you need a new blender right now because you're having a party tonight? What if you forgot to do all your Christmas shopping until the last minute? ON and ON.

Do you really think a black market can accomodate American tastes and demands. Maybe a little but not a lot.

So there's an incentive to make sure people are able to buy the things they need and corporations make a profit and the government is funded

That means that in order to get their pork money it is to the politicians' benefit to make government actions beneficial to business as opposed to the strangulation by regulation and taxes that we see now.

However, we will still have to fight the left because killing the economy is a goal of theirs. Just as in Russia and China, we will have to see which wins out with the Communist (Democrats), their greed or their ideology.

You missed section 701, yes you may be required to file a statement to get the exemption. you can have hour hobby, but no exemption...Even without IRS businesses will have to keep records, and you will have to prove your exemption:

`(a) Hobby Activities- Neither the exemption afforded by section 102 for intermediate sales nor the credits available pursuant to section 202 or 203 shall be available for any taxable property or service purchased for use in an activity if that activity is not engaged in for-profit. `(b) Status Deemed- If the activity has received gross payments for the sale of taxable property or services that exceed the sum of-- `(1) taxable property and services purchased; `(2) wages and salary paid; and `(3) taxes (of any type) paid, in 2 or more of the most recent 3 calendar years during which it operated when the business activity shall be conclusively deemed to be engaged in for profit.

...post-tax money I already have in savings.

A legitimate gripe. Remember, MOST savings are inside qualified plans such as IRA's and 401(k)'s. Those would instantly become tax free. A whopper of a boon for retirees.

As for after tax money, the ony part of consumption we're dealing with is the amount over and above "necessities", or, that amount over and above the pre-bate. Yes, you will intitially pay more for your goods and services, my guess is about 10-15%. But the stifling effect on retail sales will force sellers to reduce prices to clear inventory. The initial economic effect has been estimated at +10% or more to the GDP. Such an economic boon will certainly raise asset values and, when sold, those assets would enjoy tax free gains. Also, the interest on bonds and CD's and the dividends on stocks would not be taxable.

So there ARE benenfits to the taxable accounts. Will it be enough? I dunno. I do know that the overall benefit to all Americans is huge and that the winners' category is large and beneficial and the losers' category is small and may not be destructive to the losers themselves.

Bottom line - the very rich make out very well with this.

Not that I'm complaining, as I wouldn't object to being in that category sooner or later, myself.

Wonderful. IMO, confident people and well adjusted people feel that way. I think many more people desire to maintain a system that allows them to become rich than there are who are jealous and resentful of the rich.

As far as the tax, I think the rich have so many legal ways to avoid taxes today that the "tax the rich" mantras or empty political rhetoric. However, one of the main benefits of being rich is being able to spend. The rich buy expensive stuff, they buy more of it, and they buy more often than the rest of us. The rich will pay much more tax than the rest of us but they will do it by choice. That means their fair share of the SS and medicare burden is the same for them as for the rest of us, never ending.

Invested money has to go to work to make investing it a wise and profitable thing. That has to eventually come out the other end as taxable purchases and activity.

Dear Mind-numbed Robot,

Some rich folks don't pay much in taxes at all because they got rich from building up their own business into something world-class, and their primary wealth is in their business. Think "Bill Gates." He only incurs any significant tax when he decides to sell a chunk of stock so that he can buy something.

However, even there, although he's spent a fair amount of money on regular "stuff," most of the money he's cashed in from Microsoft, he's used to invest in other businesses. Without a capital gains tax, Mr. Gates would pay nearly no taxes at all, compared to his wealth.

On the other hand, many very rich folks didn't get rich the same way as Mr. Gates. Many very rich folks have diversified portfolios, from which they receive dividend and interest income, and capital gains. These are taxed.

Although rich folks spend more than poor folks, or even middle class folks, the very rich who have diversified, income-producing portfolios, spend a lot less of their income than middle class or poor folks. More money, much smaller percentage of income.

Thus, where income is now generally subject to tax, and thus, these folks pay whether they buy a new Lexus or 1,000 shares of IBM, under the NRST, these folks will pay much less in taxes than they are paying now. Much, much less.

As well, a significant portion of their retail purchases ("used" estates, like Donald Trump's Mar-a-Lago, "used" art, "used" antiques, etc.) will be untaxed, as well.

Now, it's true, when the multi-multi-millionaire buys the $40 million estate in the Hamptons, or wherever, he's likely to add $5 million in "touching up." And on that, he'll be taxed, about $1.5 million.

But previously, the entire $45 million would be purchased with income that had been through the tax system, and generated a lot more than $1.5 million, or about 3% of the income used.

I've checked with my CPA. Although the very rich (at least $1 million or more in annual investment income) do things to minimize their income and cap gains taxes, they nonetheless currently pay a substantial portion of their income and cap gains, in federal taxes. Lots more than 3%.

The bottom line is that the very rich pay the disproportionate share of income and capital gains taxes in the US, and they pay a similar percentage to middle class folks.

However, with the NRST, since most of their income will be channeled into re-investment, and a large part of the rest into "used" stuff, they're effective tax rate will fall well into single digits.

Cool by me, as a side effect. That's where I plan to be in 10 years, anyway.

But someone's gonna have to pay the taxes the rich aren't then paying.

It's a zero sum game.

sitetest

That's great Nightie ... and as several of us have pointed out to you whenever you bring up his hare-brained notion ... by all means DO SO!! there are several of us who'd be happy to bring you cigarettes, cigars, soap (sorry, razor blades not allowed - nor files) providing you pay for them of course and the prison doesn't prevent it.

That's be really a cool way to ding yourself - but then, hey, no one ever said you were too smart (well actually one guy named Looey did, but we know how that goes, eh?)

So you just have your "business" and keep losing money - hopefully not too much or you might have been better off to pay the tax in the first place and not subject yourself and your family to such hassle, expense, and embarrassment. But, hey, big guy, it's your life - waste it however you please. Just keep us all advised as to how much the fines are and how long the prison term is.

That's a really fine idea Nightie - gopherit!!

You'd be well advised to read the bill and re-think whatever you think the "black market" might be lest you end up in the same cell as Nightie.

In fact, think about how much evasion goes on right now. It is far, far more than would be going on under the FairTax. All of the illegal economy (drug dealers, illegal aliens, etc) contribute little or nothing to tax revenues where under the FairTax they would end up boosting tax "contributions" by hundreds of billions of dollars on the things they buy at retail (and not the illegal transactions themselves).

The IRS says that from 20-25% of tax revenue is never collected due to "non-compliance" which does not include tax avoidance, tax evasion, or illegal income. Most of that non-compliance goes away with the FairTax along with a good bit of avoidance and evasion in various forms. We're talking about hundreds of billions of tax revenue presently not paid. Yet many people never stop to think about it. There is no conceivabkle "black market" you could devise that would even approach duplication what we now have sub-rosa.

My use of them would not be for "personal" use, but would be me evaluating the products (in real world situations, of course) so I can review them on my site.

Yahhhn, just give the state tax auditors you story, I'm sure they will agree with your assessment.

OTOH, once you have evaluated the product I'm sure you will have no problem selling the item. With the Google ad money plus return from selling the demonstator item, heck ,you might even manage to make that necessary profit that keeps your tax free purchasing status alive and give you some sales and tax collections to remit boot.

Who is going to tell me these expenses are legitimate business expenses?

State sales tax administators on audit review of the disposition of items purchased under business certification may have abit to say, depending on what you actually do with said products.

"Underground economy transactions by definition can't be taxed."

Well, at least THAT'S valid - so why bother to keep stating the obvious? The argument never was about the FairTax (or even the income tax for that matter) taxing illegal income, but was about which system obtained more in tax revenue from the illegal economy when that income was spent for taxable things.

Your pretense that those in the illegal economy presently somehow pay lots of income taxes when they buy things is quite incorrect. Thay pay only a very small tax contribution presently under the income tax when they buy something at retail. We once estimated that on a $100 purchase presently, the tax contribution would be something like (from memory) $3.75 whereas under the FairTax a $100 purchase would contribute $23.00.

That's a huge difference in favor of the FairTax.

Look at it this way:

If you take your money out of savings and spend it right now you will be paying what amounts to another tax - a "hidden tax" in the form of prices that are articially raised by the effect of having income taxes embedded in them.

With the FairTax you have the benefits of controlling your consumption and not all things are taxes - used things for example are not taxed. You can't control this typically with some types of withdrawals presently since they will be taxed when withdrawn. In addition, investments are not taxed under the Fairtax so you have a better opportunity to climb up a few rungs on the economic ladder.

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