Fair Tax Nation

Replace All Federal Taxes on Income with the Fair Tax Act , HR 25

FT and Embedded Taxes (Econ Question)

FairTax proponents argue that all embedded taxes are ultimately passed on to consumers by corporations, but it would seem to me that, at least based on economic theory, that they’re only passed on to the extent that the consumers are willing to tolerate the overall price of the product (supply and demand).

In other words, if the embedded taxes, plus the company’s profit margin are too much, consumers may potentially stop buying a product. To combat this, many companies end up lowering their profit margins to ensure that they’re able to sell their products.

In essence, if tax rates increase the price of a product will only increase to the extent that consumers are willing to tolerate the price? This seems to mean in theory, that not all embedded taxes are automatically passed on to the end consumer.

Thoughts?

Thanks!

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Permalink Reply by Jim Tomasik on April 24, 2009 at 12:06pm
This arguement might make sense for an item such as a named brand shoe that has a high profit margin but as far as truely competitive marketing, it makes no sense at all. Most companies sell at minimal profit margins in an effort to stay competitive. They cannot afford to absorb the embeded tax when competing with overseas products as they are not burdened with the U.S. taxes.

I have worked in a very competitve industry for nearly 30 years and can attest that what you are saying is not the case.

I hope you will visit FairTax.org and study these issues. That site will provide answers to most of your questions.
Permalink Reply by KC on April 24, 2009 at 12:20pm
Thanks for the response Jim. I have visited the main FairTax site, and these are questions that still remain unanswered, so hearing responses of FairTax fans is very helpful.

I agree 100% with undifferentiated items... If you're selling potatoes, profit would seem to get squeezed the most from the start (under the current system), whereas differentiated (who don't necessarily have a 100% acceptable alternatives) items might build in a higher level of profit.

For example, I would imagine that Apple has more room to inflate their profit margin because people want the brand name (even though there are competitors). This leads to two possibilities if embedded taxes are increased... either the Apple can increase them equally (because consumers) will still want the product) or they will eat some of them (to keep market share and keep their customers from venturing out and trying a new brand).

In my business experience, it's usually a combo of both...

Thanks again... Any follow up thoughts are greatly welcome!

-Ken
Permalink Reply by KC on April 24, 2009 at 12:21pm
BTW, I'm not opposed to the FairTax... just trying to fully understand... :)
Permalink Reply by Jim Tomasik on April 24, 2009 at 3:48pm
no problem at all!
Permalink Reply by Ron Wenrich on April 24, 2009 at 4:37pm
In your example, if embedded taxes aren't passed onto the customer, they are taken out of the profits. So, either the customer pays for the taxes, or the shareholders.
Permalink Reply by Randy Stone on April 24, 2009 at 4:58pm
I have 2 retail stores and I can attest to the fact ALL business taxes are passed on! I agree that prices are pressured by consumer needs and competition. But in order to STAY in business, you must keep prices at a point you do not lose money. Business trends are up and down like the stock market and there are times that costs of raw materials may cause you to end up with less profit. I will say this though, You will always find ways to control your expenses so that there is a profit, even a minimal one so that you can do business next year. Please be assured that the expenses of a business will be included in the price of the end product.
Permalink Reply by John K Eck SR on April 24, 2009 at 5:53pm
While the "embedded" tax might increase a point or two under the FairTax, with the elimination of all federal withholding, taxpayers will have much more spendable income (20-30%) and that does not include the "prebate" which further increase spendable incomes.
Permalink Reply by Sean Fagan on April 24, 2009 at 6:12pm
I have a couple of thoughts...

After the Fair Tax is enacted, the consumer will be expecting to pay about the same prices for goods and services they were paying before the Fair Tax. I believe the consumer and market forces will interact to drive the price level to where it should be.

For example, like Randy Stone, my wife and I are small business owners. We were not very knowledgeable when we first started the business and never figured the cost of taxes into our prices. Yet, even though we are in a "niche" market with little local competition, we will still lower our prices if for no other reason than we don't want to appear greedy to our customers. We know consumers have the choice to simply walk away.

Will our profits suffer as a result? Not at all, the break we'll get on our taxes will easily cover it.
Permalink Reply by Randy Stone on April 25, 2009 at 8:15am
I agree with Sean, that after the Fair Tax, the savings on the taxes imbedded will be enough to expect overall prices to remain about level. I also think that the matching payroll expenses will be given to the employees. Therefore they (employees) will bring home even more money to make the Fair Tax more rewardable to them. If that means prices will be slightly higher, it can be expalined by the fact pay raises were given. Which would be a normal inflationary thing.

On the pricing of the product, you price to make a profit. If expenses run to high, then the decision to raise the price or to cut expenses will arise. At the end of year P&L review, all expenses measure up to all income. Any business will strive to be in the black.

Low profit margins must bring higher volume of consumers in. But these are normal issues that exist both before and after the Fair Tax. I personally see a very slight increase in todays prices that it will not be noticed so much after the Fair Tax. The fixed and low income folks will be far better off. The choices to spend the new found money or not will keep prices down.
Permalink Reply by Pat Conroy on April 25, 2009 at 11:37am
For a business to remain in business over a long period of time, it must either generate a net profit or be subsidized. There is little difference between me paying the employer's portion of FICA (direct embedded tax) or paying office rent (which includes embedded tax from the owner of the building). Both are expenses that must be "covered" by the price of the software and services my company sells in order for me to make a profit.

Some years I don't make a profit. Fortunately, most years I do and those are the years when I can build up my working capital, invest in new equipment, hire new employees, and provide bonuses to the employees who contributed to generating the net profit. Unfortunately, the amount I can invest and reserve for working capital is reduced by up to 35% because that is the amount of the "tribute" I have to pay to the IRS for the privilege of operating my company responsibily and earning a profit.

The Feds are my unwanted partners -- sort of like a Mafia "protection" racket. They are only partners when I am making money. They are not there to share in the losses. That's for me and for employees who may be laid off because there isn't enough working capital.
Permalink Reply by Jeffrey Savage on April 29, 2009 at 2:56pm
Yes, this could be the case. But those taxes take away from the bottom line, thus the shareholders end up paying them. And if the taxes end up where they can't embed them and still make a profit, thats when companies leave the US.
Permalink Reply by chiefcook on April 30, 2009 at 8:25am
I looked at the embedded tax costs a little differently. If you want to purchase $100 worth of product, how much tax do you pay under the current income tax code vs the Fair Tax. I used two examples. The first is a self-employed person in the average 28% tax bracket. The second is an employee at the 15% tax bracket. These two persons would fall into the average for each type of worker household.

I further worded the example to use strictly food purchases as many states do not charge sales tax on food. The chart is called "Can we afford a party?" I am attaching the flle. Feel free to use it, The second file is set up to printout four (4) to a page so we can hand them out at events. People are shocked what they have to earn in order to spend $100. (It does not matter how much you earn.)

I hope it will help you.
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