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.

Dear groanup,

"What I see are individuals who have an apparent agenda (I am saying apparent, not definite) in maintaining the status quo and would greatly suffer if the fair tax were implemted."

LOL. You just can't seem to accept that folks who disagree with you might have legitimate cause. They have an "agenda" for maintaining the status quo. You seem to actually believe your own propaganda, and leave no room for the concept that you could be wrong.

Frankly, groanup, this is cultish behavior.

sitetest

For folks who are still in the midst of investing years, and who are disciplined investors, volatility is their friend.

Sorry. You either have never invested in the stock market or you have a very short memory.

For folks who will actively manage their investments, even once retired, volatility is also a useful tool.

Sure. Every retired person I know loves to see his account decrease by 20% every now and then. It keeps them young at heart.

For the long haul, inflation is a serious risk for any type of fixed income asset.

Try ANY asset. If inflation robs you of purchasing power the assets themselves lose that power. Even stocks.

However, more often, rates don't provide that margin.

Please show me a time when real bond yields were negative.

As for me, these "lies" have served me well for 20 years, including through the collapse in 1987, and the recent bear market.

You say you like volatility. You say investing in stocks is the only smart choice. Yet you imply that you sailed through the recent bear market with ease. Uh huh. Forgive me for being more than just a little skeptical.

Anyway, I have a question.

Not enough information. Does he need to make another 25 million for some reason?

Dear Always Right,

As you point out, according to at least some of the NRSTers, taxing one's income is inherently immoral. Yet, taxing one's spending is not.

I don't really get the logic of that, myself.

They say it's "voluntary" what one spends, but, heck, to a large degree, it's also "voluntary" as to what one earns, no? You want more income? Work more. Improve yourself, get a better job. You want less income? Work less.

I mean, how "voluntary" is spending? I need food, I go buy it. How is that all that voluntary? I need a new sofa, I go buy it. How is that voluntary?

Well, I guess I could raise my own chickens, grow my own vegetables, and build my own furniture. That's true. Then I wouldn't need to buy all that stuff, and in that sense, my spending IS voluntary.

But heck, you don't like paying so much in income taxes? Well, then, don't earn so much! Instead of going out to work, raise your own chickens! Grow your own vegetables! Build your own furniture! Then you won't need the money to buy those things! LOL!!

Actually, at the root of it all, Always Right, I think some of these folks are puritans. In the worst sense of the word. They're afraid that someone, somewhere, is HAVING FUN!! Folks are CONSUMING!! The little devils!! * chuckle *

I guess my view as a small businessman is I LIKE it when folks consume stuff. That's what justifies keeping businesses open. That's what makes it worthwhile for the grocery and the realtor and the homebuilder and the electric supply place to stay open. And as I have clients who are all these things, that's what keeps my business going.

So, I don't see why a big hairy tax on consumption is any more moral than a big hairy tax on income.

What I'd like is for folks to stop with the distractions and work on the real problem - the fact that the government imposes these big hairy taxes at all.

sitetest

If the investment guru knew what was going up and what was going down he would just manage his own money from his yacht

I see this is considered cynicism. Perhaps it is, but I see it as one of the most accurate and profound statements made so far. For others though it has the unfortunately quality of common sense.

Once again, I think this points out a schism in attitude between Us and Them. Add to that the recurring theme of the "unfairness" of some having more than others and we probably gain insight into the true political differences at the heart of the matter.

Dear groanup,

I caught your post as I was wrapping up other work. Forgive me if I don't respond anymore today.

"You say investing in stocks is the only smart choice."

No, I never said that at all. Here's one instance of what I actually said:

"Most folks with that kind of money invest in various types of equities, some bonds, some other types of debt instruments, and real estate. Investment in equities will yield a total return, on average, of around 10% annually, for the long-haul."

I'll add to that comment so you can better understand my views: How an investor allocates his assets will depend on his individual circumstances. For some folks, a portfolio heavier on bonds will be appropriate, for others, it won't be. I even conceded that for an 85 year old fellow on death's door, perhaps even all tax-free bonds might be appropriate.

However, for most folks, including most wealthy folks, equities are, and will remain an important part of the asset allocation picture.

"Not enough information. Does he need to make another 25 million for some reason?"

No.

"Yet you imply that you sailed through the recent bear market with ease."

Nah, it was a tough road. But I certainly didn't lose anything approaching what the Dow lost, or the S&P 500, or especially what the NASDAQ lost.

Then again, I really didn't get into the whole "dotcom" thing. So, I didn't have stocks that seemingly grew to the trees prior to the bear market, either.

And interestingly, although I'm not currently invested for income, the amount of income I received in dividends rose during that period.

sitetest

...but, heck, to a large degree, it's also "voluntary" as to what one earns, no?

You guys really don't get it do you? Ever heard of the American dream? Nah, too corny. As for me and my retro adherance to capitalism and freedom, allow me to first accumulate wealth. Then I'll decide what to do with it.

Working is voluntary? How so? That would mean eating drinking and staying warm is voluntary also. Guess I'll never figure you guys out.

But I certainly didn't lose anything approaching what the Dow lost, or the S&P 500, or especially what the NASDAQ lost.

Well done. That would mean you probably were heavily into value stocks and fairly heavily weighted in bonds and real estate. So your portfolio was moderately risky. Fine. What's wrong with little or no risk? Nothing. In fact there is nothing wrong with a lot of risk. The ony problem I have is someone taking unnecessary risk. I trade futures and I don't take unnecessary risks.

I disagree with a substantial portion of what Neal Boortz explains in this piece. THERE IS A FREE LUNCH IN THE FAIR TAX ACT! The free lunch comes from ridding our tax system of the tremendous inefficiency of the income tax. That inefficiency costs about 90% of the $300+ Billion per year expended by Americans for compliance with the tax system as it now exists. THE FREE LUNCH WILL AMOUNT TO THE ECONOMIC EQUIVALENT OF $250 BILLION/YEAR IN TAX CUTS - THE LARGEST AND MOST BENEFICIAL TAX CUT IN HISTORY - SIMPLY BY THROWING OUT THE STUPIDITY OF EXTREME WASTE OF MANPOWER REQUIRED TO COMPLY WITH THE PRESENT TAX SYSTEM. That will enable a net gain in the economic growth rate not less than 1-2% per year, which will be sufficient to pay the costs of Social Security reform and more.

All the quibbling over exactly what happens to the repealed income and payroll taxes (whether they go back on the paycheck - which I think they will do in 90% of cases) or are recaptured by the employer through negotiated salary reductions does not amount to a hill of beans. Let's keep our attention on the big picture, which is MORE than enough to justify entirely adoption of the Fair Tax Act of 2005 as real tax reform.

I think that is absolutely correct and when you add in "As you point out, according to at least some of the NRSTers, taxing one's income is inherently immoral. Yet, taxing one's spending is not."(site test to always right) you find even MORE confirmation of it!

Failure to comprehend THAT issue says all that need be said as far as I am concerned!

Umm, it is not the fair taxers who use the 'fairness' rhetoric? The whole way the fair tax is spun and marketed is right out of liberal focus grouping sprinkled with a bunch of overpromises.

Eating, drinking and staying warm is where you pay sales tax and is less voluntary than earning income.

Well then both you and he are throwing out one of the main features of the fair tax. Food water and warmth are the only three things humans must have to survive. Those can normally be paid for completely tax free under the FT. But they aren't free from any cost at all. One must make some income to acquire them. That isn't voluntary. Making income now costs tax money or at least SS/medicare.

The point is, for a large portion of our population they spend every penny they earn and they don't consider any of their spending as discresionary. Almost all of it goes for food, clothing, car, housing, and rent, with a modest amount left over for cable TV, utlities, phones, etc. Most of this spending really falls into the 'involuntary' category unless you think it is reasonable for people to live like the unabomber. From that extreme viewpoint, I guess some of those bills could be considered voluntary. I don't think 99% of people consider those types of expenditures voluntary.

Food water and warmth are the only three things humans must have to survive. Those can normally be paid for completely tax free under the FT.

Also, for the truly needy, the ones they claim concern about, there are still the government "safety net" programs which provide all that. With those things provided, the prebate then becomes spending money. Spending money expose itself the the NRST, broadening the tax base.

Your whole way of addressing the subject, groanup, is little more than propaganda.

Your post #340 is not worthy of comment because it is nothing more than an" accuse the opposition" argument. The fair taxers have a wealth of information, links, economists, rebuttals on and on. Yet you call it propaganda and you expect to be taken seriously. Well I for one hereby point out your hypocrisy and hope everyone else notices it too.

The fair taxers have a wealth of information, links, economists, rebuttals on and on. Yet you call it propaganda and you expect to be taken seriously.

The 'wealth' of information is all one-sided spin. That is not a source of objective information.. It has been carefully crafted to present the fair tax in the best light possible. In many cases it leaves out important details. Propaganda is a more accurate discription than a 'wealth of information'.

The 'wealth' of information is all one-sided spin

As you have pointed out over and over. OTOH, you and your anti's (Notice I didn't say Status Quo Lovers, wouldn't want to start an insult war) have very little in the way of ideas or positive input. I'm really beginning to see what some of the other Fair taxers have been trying to tell me: you guys don't want to add anything you just want to disrupt.

Whatever happened to YN's VAT? Was that thoroughly discredited or is it still on the table?

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