The Fair Tax: Stop the Tax Cheats

The Internal Revenue Service reported [1] last week that $345 billion (not a misprint) in taxes owed for 2001 has not been collected. Not to worry, the report also indicates that IRS enforcement efforts will recover approximately $55 billion of this “tax gap.” Bully for the IRS.

Even if the IRS is successful in recovering the amounts they seek, there is simply no way that a $290 billion shortfall can be justified regardless of how it is spun. There are several reasons why taxes rightfully owed are not collected. Many taxpayers underreport income and/or claim undeserved deductions. In other words, a lot of people cheat on their taxes. Is anyone surprised?

Another factor that significantly affects tax compliance is the complexity of the tax code. According to a report [2] from the Americans For Fair Taxation [3], the federal tax code, rules and IRS rulings comprise more than 60,000 pages. While complexity undoubtedly leads to some paying more than they rightfully owe, that complexity also results in billions in unpaid taxes.

The report also indicates that individuals and businesses spent over six billion hours at an estimated cost of $265 billion dollars attempting to comply with the maze of tax rules and regulations. This is equivalent to a workforce of over 2.8 million people spending the entire year doing nothing but tax compliance.

To cover the uncollected taxes, the 130 million U. S. taxpayers are effectively subsidizing the tax cheats to the tune of over $2600 each. In other words, if the cheaters were prevented from cheating, the average taxpayer would see reduction in his or her tax bite by over 30%.

If the tax gap and compliance costs were in and of themselves not sufficient reason to scrap the tax code, the tax code also hurts the U. S. in other ways. The income and payroll taxes ostensibly paid by businesses (but are in fact simply passed along to consumers) make U. S. products less competitive on world markets. This leads to job losses in the U. S. and, as we also saw last week, record trade deficits. The complexity of the tax code also enables politicians to reward and punish via the tax code. This is probably the single worst aspect of the U. S. tax system.

The sheer lunacy of a tax system that fails to collect billions owed, enables political manipulation, hurts the economy and in general works against the taxpaying public is astounding.

There is a solution however. It is a solution that would eliminate individual compliance requirements and make April 15 just another day. This solution would greatly reduce business compliance costs and similarly reduce the size and scope of the IRS. This solution would lead to job growth and economic expansion. This solution would eliminate most of the opportunities for tax cheats and political manipulation. The solution? The Fair Tax.

The Fair Tax would eliminate all income and payroll taxes and would replace them with a national sales tax paid on the retail purchases of new goods and services. The Fair Tax protects low-income individuals and families by rebating taxes paid up to the poverty level.

The first reaction by many people to the idea of a national sales tax is that prices of goods and service would go through the roof. Under the Fair Tax, this is not the case. Consumers are already paying for the corporate income and payroll taxes embedded in the price of virtually all goods and services. It is estimated that these embedded taxes average approximately 22% of the retail price of goods and services. Make no mistake; you are paying these hidden taxes.

Under the Fair Tax individuals would incur no compliance costs and businesses would remit Fair Tax receipts similarly to the way state sales taxes are remitted today. No more armies of lawyers and accountants to figure out IRS regulations. The IRS (or some similar agency) would need to ensure compliance from just the approximately 25 million businesses instead of 155 million businesses and individuals, as is the case today.

Maybe most importantly, the Fair Tax would eliminate the patently unfair manipulations of the tax code that Congress uses to hand out favors to wealthy constituents and lobbyists. The elimination of the incentive and ability to tinker with the tax code would go much farther toward making members of Congress more “ethical” than any other type of reform.

The Fair Tax has been introduced in both the House (H. R. 25) and Senate (S. 25). The House version already has 48 cosponsors. The Americans for Fair Taxation estimate that it would require just 3000 active supporters in each congressional district to make the Fair Tax a reality. Each of the 435 districts represents approximately 300,000 taxpayers. That means that if just one percent of taxpayers became vocal supporters of the Fair Tax and took the time to write and/or call their representatives in Washington, the Fair Tax could become law.

The Fair Tax would be the most significant tax reform since the Boston Tea Party. Don’t leave this reform to others. Take a few minutes to let those in Washington know that the time for the Fair Tax is now. Think about that as you pore over your 1040 this year.

About the Writer: Jan A. Larson is currently employed in private industry in Texas. He holds a bachelor of science degree from the University of Nebraska, a master of science degree from the University of Kansas, and an MBA from Colorado State University. jan@pieofknowledge.com.

Like I said, your perspective on whether the $1,260 laptop is a good deal depends on who you are.

Precisely a good point, and whether or not you use marginal rates like you have in stating that number and as I have in mine to make comparison of what I must earn on the margin in terms equal to those you set.

For I notice you have not discounted at all for the FCA that $100K or $50K or retiree receives as a sales tax rebate plus the advantage of Social Security indexing in the total cost to any of them under the FairTax legislation.

Shall we deal in intellectual honesty, or do you intend to continue your games? So far it looks that you are more interested in playing spin numbers rather than clarity or honesty

Great. Let's take into account the FCA (and any SS indexing for the retiree.) But please note that MY calculations above are based on EFFECTIVE tax rates not marginal rates. We'll apply the FCA (and any other adjustments) in like fashion: "effective" impacts, not marginal impacts.

First, let's start with you ... after all, you think you got a bargain on the laptop.

You intimate that you are self employed. You claim you paid 15.3% Payroll tax and 7.7% Income Tax. Since you probably took advantage of a raft of business deductions, your AGI for the year was probably about $75K.

Being the good FairTax supporter that you are, and being so well aware of the competitive price pressures, you give the "Employer" half of your Payroll tax savings and all your Income Tax savings (since it IS business profit tax) back as price reductions in your business -- remember, the central tenant of FairTax price reduction is that businesses pass ALL their payroll tax and profit tax savings on as price reductions.

That leaves you with a FairTax take-home of about $63.5K. Of course that also means the $1300 you earned to buy the $1000 laptop under the Income Tax system turns into just $1100 under the FairTax. BUT, since you're single, you get a annual prebate of about $2200. That raises your "effective income" to about $66K or, said another way, the prebate provides an "effective discount" on purchases of about 3.3% (2.2K/66K)

The After-Tax FairTax price of the laptop rose 26% to $1260. Applying the "effective discount" of the prebate to that price nets a FairTax "effective price" for the laptop of $1218.

Since you only earned an equivalent $1100 to buy it you need to dig into your savings (or forgo other consumption purchases) to make up the $118: a nearly 10% loss in purchasing power!

You Lose.

Next we'll look at the retiree.

You intimate that you are self employed. You claim you paid 15.3% Payroll tax and 7.7% Income Tax.

Strange, somehow, a marginal 15.3 plus 7.7% does not add up to 30% isn't it. Once again we watch your masterful use of the Strawman to construct your argument.

Since you probably took advantage of a raft of business deductions, your AGI for the year was probably about $75K.

First error, business expense is never income, it deducts from gross revenue because it comes out of operating capital that is merely being returned to the business put of revenues. One does not consider the principal of a loan for example, to be income as it is returned to the lender.

Neither is operating capital being returned to the business from its gross revenues considered income. That is the reason business "expense" is deducted. It is not in any way income nor does the tax code consider it to be such.

Income is what a business has left after its business expenses, not what it receives as it gross revenue.

But you know that, so why have you chose to characterise it otherwise. Obviously to build your pitiful attempt at once again argue from a fallacy.

You have once again shown your total lack of intellectual integrity. On this one you did not even get out of the first gate of the chute.

You Lose, once again by trying to spin numbers to fit your agenda, rather than engage in an honest assessmen and debate.

Good day to you, you can continue this conversation with yourself from here on out. It is obvious you have an inherent block to ever engaging in any but spin and propaganda.

Now, let's take a look at the Retiree.

He is 68 years old and unemployed. He lives off of about $13K of Social Security and $12K of pension. He pays $0 in income and payroll tax. His Income for the year was $25K.

His FairTax take-home starts at $25K, but may rise due to SS indexing (stay tuned.) Of course that means the $1000 he took in to buy the $1000 laptop under the Income Tax system initially remains at $1000 under the FairTax. BUT, since he's also single, he gets a annual prebate of about $2200. That raises his "effective income" to about $27.2K or, said another way, the prebate provides an "effective discount" on purchases of about 8.1% (2.2K/27.2K)

The After-Tax FairTax price of the laptop rose 26% to $1260. Applying the "effective discount" of the prebate to that price nets a FairTax "effective price" for the laptop of $1158.

Since he only has an equivalent $1000 to buy it he needs to dig into his savings (or forgo other consumption purchases) to make up the $158: a nearly 13% loss in purchasing power!

BUT WAIT! the SSA has noticed that the real purchasing power of its transfer payments (benefits) may have declined. Though Pre-tax prices have, on average, declined the FULL 20% advertised by FairTax supporters (imagine that!), After-Tax prices rose by 4%. Of course, considering that the prebate offsets some portion of the increase, the SSA calculates that our Retiree's benefits of $13K combine with his prebate of $2.2K to provide an effective income increase of 16%. Since that MORE than offsets the After-tax Price increase in the CPI, SS benefits are not increased (good thing too, because if they HAD increased, the Treasury wouldn't have had enough revenue to fund the increase!)

So, after considering both the FCA AND any potential SSA adjustments to benefits, the retiree is STILL looking at a nearly 13% loss in purchasing power!

Looks like the Retiree's losses are even bigger!

Shall I go on???

First error, business expense is never income...

C'mon, don't be so dim. It is PRECISELY because business expense is not income that businesses attempt to categorize as much of their spending as possible as expense. As a SELF EMPLOYED BUSINESSMAN, you probably took deductions for home office use, business use of automobile, meals, and a host of other things. Had you not done that, you would have had to classify those expenses as income to you and paid income tax on them.

Since you didn't specify your income, I took the Tax Stats bracket for a 9% average effective income tax rate of $50K to $75K and figured that your actual income was on the high side of the bracket and your actual tax paid was on the low side of the bracket, because I presume you to be a cunning businessman. If you'd rather be just an average taxpayer, then let's lower your income to about $40K, where 7.7% effective tax puts you and redo the numbers:

Original Gross = $40K
FairTax Gross = $33.9K
FairTax Income equivalent to $1300 original income = $1100
Prebate = $2200
Effective Laptop price = 94.5% of $1260 = $1191
Net Deficit = $91.
Net loss in purchasing power = 7.6%

There. Feel better now?

Yep. I've maintained that from the start, however, for this particular example, no increase was needed. I generously allowed pre-tax prices to drop 20% just to show that even then any product with high value imported components - like a laptop - still rises out of reach of the larger take home pay plus the prebate.

Realistically, after-prices would rise more than I allowed in the example, entitlement indexing would kick in, and the tax revenues would be insufficient to pay the increase.

The tax revenues are insufficient even without an entitlement increase since the shell game of taxing federal spending doesn't actually raise any tax revenue on that spending, and taxing state/local spending doesn't raise the required tax revenue without a state/local tax increase ... two fatal flaw in the tax rate calculation deriving from an improperly formulated tax base.

If the laptop was for business use, wouldn't you be able to deduct the cost?

If indeed it were for business use, it would be deductible under the income tax.

Of course by the same token, if its for business use, it is exempt from the retail sales tax as well.

Businesses will gain under the FairTax retail sales tax system by the amount saved in paying no tax and a reduction in price in the business use supplies an products they purchase.

In the adhoc example concocted by Dimples, the Business would save over what they would pay under the income tax system in the purchase of the laptop for business use, as well as the income and payroll taxes they are no longer on the hook for (not to mention any savings in tax system related overhead associated with the current system.

In the example, $1260 (tax included) for the laptop in question would be $969.23 to the business for the hypothetical $1,000 laptop under the income tax system.

If indeed it were for business use, it would be deductible under the income tax. Of course by the same token, if its for business use, it is exempt from the retail sales tax as well.

Actually, under the current system, if you had a home business, you could deduct the portion of the computer used for business. If you used it 40% of the time for business, 40% of the cost would be deductible. Under the FairTax, you could only get the business use conversion credit" if the computer was used for business 95% of the time or more per month. And you would have to file for this credit monthly.

The current system's deductions for a home office apply to the cost of the home, utilities, etc. It looks like these deduction would be lost under the FairTax and the home business owner would have to pay the Fairtax on the full amount of these costs even though a portion was for business use.

Of course, this all assumes that, under the FairTax, a person buying a computer for mixed use wouldn't buy it using a business-use certificate. I'm sure, even though they would save money and hassle by not paying the FairTax, everyone will comply with the law and pay the tax and then file for their credits.

So does that mean ancient_geezer's laptop, the one he claims would be $969.23 under the FairTax would really would cost the Home Business Owner $1260 under the FairTax since the laptop was used 10% of the time for non-business, personal use???

Does that mean that the same laptop purchased under the Income Tax system would cost the Home Business Owner who's effective income tax rate was 7.7% only $930.70 (1000 - (90% * 1000 * 7.7%)) since, on average, the purchase saved him $69.30 of income tax ????

Or does it cost the Home Business Owner only $775.00 (1000 - (90% * 1000 * 25%)) since his marginal tax bracket was 25% and the purchase actually reduced his income taxes by $225 ???

What would happen to the Home Business Owner's prices if this same situation applied to his formerly partially deductible home office, car, and utilities (How do you determine how much of your water, gas and electricity are 95% business use anyway ???)

Did you say you had to figure this out EVERY MONTH ??? (good thing the FairTax reduces business compliance costs so much!)

My, my ... the head spins ...

Of course, this all assumes that, under the FairTax, a person buying a computer for mixed use wouldn't buy it using a business-use certificate.

Actully the law provides the credit for those cases, such as travel where use of the certificate is not convenient.

The general case is filing a copy of the certificate with suppliers and businesses

For mixed use, anything that is purchased for personal use and converted to mixed or wholly to business use does have the advantage that a credit can be applied against NRST remittences.

I'm sure, even though they would save money and hassle by not paying the FairTax, everyone will comply with the law and pay the tax and then file for their credits.

Why would you assume that?

Many enterprises do not fully abide with such a law today. Why would you expect better compliance under any other tax system? After all the same folks evading taxes now are not about to change the ways just because the point of collection is changed. To think that would be foolish.

Fraudulent deduction of business assets applied to personal use is a substantial MO used to evade the income and payroll tax system today. There is no reason to believe that such would be significantly lower under a sales tax, other than the increased scrutiny that focus on fewer tax filers by tax system adminstators allows for. Decreasing the total number of tax reporters/filers by 90% would allow greater focus of resources to go after evasion, but I don't see as that will have substantial impact on hard core evaders the current system has enabled and in fact actually encourage with its sporadic enforcement in any short time frame.

Of course, this all assumes that, under the FairTax, a person buying a computer for mixed use wouldn't buy it using a business-use certificate.
Actully the law provides the credit for those cases, such as travel where use of the certificate is not convenient.

The law does not provide for a credit unless the item is used more than 95% for business use, as in the mixed use computer we were discussing. You changed the example to something that usually doesn't have mixed use (travel) to try and bolster your weak argument.

For mixed use, anything that is purchased for personal use and converted to mixed or wholly to business use does have the advantage that a credit can be applied against NRST remittences.

Only if it is used 95% for business use!

Why would you assume that? Many enterprises do not fully abide with such a law today. Why would you expect better compliance under any other tax system?

Well, under the current system, I can only deduct as much as my home business makes. If it doesn't make any money, I get no deductions. Under the FairTax, I get the item tax-free whether my home business ever makes a penny or not.

Fraudulent deduction of business assets applied to personal use is a substantial MO used to evade the income and payroll tax system today. There is no reason to believe that such would be significantly lower under a sales tax, other than the increased scrutiny that focus on fewer tax filers by tax system adminstators allows for. Decreasing the total number of tax reporters/filers by 90% would allow greater focus of resources to go after evasion, but I don't see as that will have substantial impact on hard core evaders the current system has enabled and in fact actually encourage with its sporadic enforcement in any short time frame.

Again, under the current system, with my home business I can only deduct up to the level of revenue I make. Under the FairTax, I save the full amount of tax on my "business" purchases regardless of whether the business has a penny in revenue. There will be a lot of "paper" businesses starting up under the FairTax that wouldn't have any opportunity to cheat the current system.

For mixed use, anything that is purchased for personal use and converted to mixed or wholly to business use does have the advantage that a credit can be applied against NRST remittences.

Only if it is used 95% for business use!

Did I say otherwise? I'm certainly not disagreeing.

Looks to me to be a good rule to assure that an asset is actually for a substantial use in business before allowing a credit on it. You figure it ought to be otherwise?

Seems to me the laxity of the current system in allowing higher levels of personal usage of business assets just begs for people to abuse and violate deductibility.

Well, under the current system, I can only deduct as much as my home business makes. If it doesn't make any money, I get no deductions. Under the FairTax, I get the item tax-free whether my home business ever makes a penny or not.

Strange, that isn't how I read the bill. If it isn't an engaged in for profit activity, as measured by the rules in the legislation, looks to me tax exemption and credits are not allowed.

`SEC. 701. HOBBY ACTIVITIES.

`(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.

Again, under the current system, with my home business I can only deduct up to the level of revenue I make. Under the FairTax, I save the full amount of tax on my "business" purchases regardless of whether the business has a penny in revenue.

Paper businesses don't meet the requirements of Section 701, If an activity has gross sales less than than total of property & services purchased, wages and taxes paid. They do not get credits nor are there purchases tax exempt.

There will be a lot of "paper" businesses starting up under the FairTax that wouldn't have any opportunity to cheat the current system.

As if there weren't already a lot of "paper" businesses designed only for their ability to create tax deductions for their owners under the income tax system.

Tax writeoffs are not exactly unknown in the current system, LOL.

Looks to me to be a good rule to assure that an asset is actually for a substantial use in business before allowing a credit on it. You figure it ought to be otherwise?

Yes, I do. I've done plenty of freelance work in my time and I can't think of one item I've had to buy that I used 95% or more solely for those business activities. And I certainly didn't buy a house to use solely for a home business. What about the self-employeed that have to drive in their car a lot. Are they suppose to get a separate car for their business?

Seems to me the laxity of the current system in allowing higher levels of personal usage of business assets just begs for people to abuse and violate deductibility.

So a few people abuse the system and we must squash other home business people? This is more of your BS. The current system is more favorable to home businesses and you're trying to spin it.

Strange, that isn't how I read the bill. If it isn't an engaged in for profit activity, as measured by the rules in the legislation, looks to me tax exemption and credits are not allowed.

So, what - under the FairTax a home business is a hobby until it turns a profit? LOL! You're kidding, right? According to your interpretation, any business of any size is a hobby unless they turn a profit in 2 of the last 3 years. It looks like GM better turn a profit this next year or they will be considered a hobby and have to pay the Fairtax on their purchases!

Paper businesses don't meet the requirements of Section 701, If an activity has gross sales less than than total of property & services purchased, wages and taxes paid. They do not get credits nor are there purchases tax exempt.

Neither does virtually every start up business. Looks like they will be paying the FairTax until they have 2 out of 3 years of profit!

The FairTax: The End of Small Business (and Unprofitable Ones of Any Size) in America.

As if there weren't already a lot of "paper" businesses designed only for their ability to create tax deductions for their owners under the income tax system. Tax writeoffs are not exactly unknown in the current system, LOL.

You may have missed the part they you can only deduct as much as your business has made from you taxable income. A paper business with no revenue means no deduction.

I've done plenty of freelance work in my time and I can't think of one item I've had to buy that I used 95% or more solely for those business activities.

Using it less just means less of an tax advantage you are supposedly losing.

Interesting that the IRS doesn't allow the employee a deduction from his wages for the use of the family car in gettng to and from work or hobby. Even where that is the only use of said vehicle.

Sorry, I just can't work up a whole lot of sympathy for you wanting to grab a credit or a deduction under, for something that is actually a personal asset. A privilege that has shown itself to be rife with abuse under the current tax system.

Simple fact is, IF you figure 95% is too high, I'm sure you will get agreement with many others as well as Congress Critters to change the bill to reflect your concerns.

Of course, I'm sure you can expect everyone else to want to support you in higher tax rates on personal consumption to finance your desire to get a credit on YOUR FAMILY's car and subsidize your hobby.

What about the self-employeed that have to drive in their car a lot. Are they suppose to get a separate car for their business?

That's one choice. Of course the other is go ahead and continue use it for less than 95% business and not take the credit which is for business use assets only.

It looks like GM better turn a profit this next year or they will be considered a hobby and have to pay the Fairtax on their purchases!

If they indeed have gross sales revenues less than their expenses in each of those years for three years in a row, they just as well be a hobby.

However, the test is for those where there is some question as to the status of their activity as a business. You know like the "paper" business you were complaining could get away with evading the NRST by declaring everything purchased for business use.

If your "business" can show gross revenues in excess of wages, purchases and taxes paid, It is conclusively proven to be a for-profit business under the FairTax legislation and will receive the appropriate exemptions and credits that are due such a business.

OTOH it does appear GM could easily qualify as a charity for the aid of indigent unions and financial institutions and thereby receive tax exemption for purchase of supplies to make products they apparently sell to promote their contribution drives.

You may have missed the part they you can only deduct as much as your business has made from you taxable income.

Except when a paper company is bought out by businesses for loss carry overs used to reduce taxible income in their bottomlines. An interesting topic all in itself.

A paper business with no revenue means no deduction.

nd paper business with no revenue under the NRST means no credits, and no tax exempt purchasing.

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