Replace All Federal Taxes on Income with the Fair Tax Act , HR 25 and S 122

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 Ron Wenrich on May 1, 2009 at 12:25pm

According to FairTax.org, the amount of embedded taxes on a new home range from 12 to 20%. They also attacked the problem a little differently. They used the amount of money that needed to be earned to pay for a home where income is taxed vs the Fair Tax.

It is an interesting way to present things. I think we might be getting too caught up in embedded taxes and not looking at a more interesting way to present the viewpoint. It might be better to look at how much income that has to be earned in order to purchase a new product.

For the new housing issue, FairTax.org came up with someone having to earn an additional $65k to purchase a $154k house if you use the income tax method. They used some assumptions that may be questioned, but I think if the numbers are crunched, they would still fair out better.

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Permalink Reply by Todd McLaren on May 7, 2009 at 10:38am

Pretty terrific, Matt. Without the comparisons I wouldn't have thought that after the FairTax, many things would actually cost LESS.

In fact, your hypothetical dentist visit takes into account the Medical Deduction--something most healthy people (fortunately) don't even qualify for. Perhaps adding a different "service" would be helpful as well. (I was going to suggest an accountant--but after the FairTax passes I won't need him as much!)

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Permalink Reply by Dwayne Thompson on April 30, 2009 at 10:07pm

Hey Matt, that sounds very interesting. Would you please send me what you come up with. I'd be very interested in seeing your work. Thanks.
fusionpastor

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Permalink Reply by Nancy L. Gatchel on April 30, 2009 at 9:37am

I am learning from all who are posting here, so please, keep this up. I am not in business, but I sure can learn more about how this works. I'll be able to speak more intelligently about the Fair Tax.

Matt, I'm anxious to see what you come up with.

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Permalink Reply by micheleking on May 1, 2009 at 2:30pm

wow!! This is a fabulous discussion. One thing that many taxpayers do not understand is that many businesses have to file quarterly and pay ahead (what is the word for this?). That we not only have "income" taxes, but a litany of 940's and 1120's series.

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Permalink Reply by Todd McLaren on May 7, 2009 at 10:27am

True. Paying taxes on what we don't even OWE yet. ...hey, did I mention that was a *government* idea?

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Permalink Reply by Marc Bohemier on May 3, 2009 at 8:52am

To start with all and any monies a corporation or business recieves or ever pays out in taxes or labor or any other type payment always comes from the consumer to start with. Without the consumer no business or corp would even exist. To state the a corps or business taxes are paid by them and not the consumer can bear no truth at all because there would be no monies or profits to said corp or business without a consumer. So any monies paid in taxes from a business or corp always starts from the consumer. Don't try to over think the process, because basicly it's very simple. Consumer buys product, business pays bills from (including taxes) from monies brought in from consumer.

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Permalink Reply by RC Woodworth on May 3, 2009 at 10:24am

I agree with your main assertion - that the law of supply and demand dictates everything.

However, what I don't understand from your post is the use of the word "embedded". If I understand you right, "embedded" means tax costs experienced by the seller that are built into the price of the product to the maximum extent possible.

But I think that line omits an important component of an analysis comparing our current system to the nrst. Specifically, the "embedded" taxes line measures the amount of tax included in prices on nrst priced items but does no analogous inspection of "embedded" taxes on items sold under the income tax. Hence the comparison is not valid 99% of the time - because in 99% of cases, "embedded" taxes on items sold under the income tax includes only the tax costs experienced by the seller. Since this method of calculating embedded taxes fails to include tax costs of the buyer, the comparison is faulty.

A more complete way to compare is to compare pre and post tax prices under both methods. An example:
My kid wants a baseball mitt from Wilson. The price tag says $100. Let's look at it including ALL tax costs, not just the seller's.

Under the income tax:
If the price tax says $100, I actually have to earn $126.58 [I had a 21% net effective fed tax rate in 2008]. Note this actual cost will differ by individual. So far, that's $26.58 in tax. Now for the seller's tax costs - the number I use is 9% of price represent tax costs "embedded" [9% is my number but is easily derived.] So $9 is also tax. In all, I have $35.58 in tax on this mitt. Even though I'd only hand the clerk $100, the total it would cost me would be $126.58.

Under the nrst:
If the price under the income tax says $100, the nrst price pre-tax would be $91. I'd add the nrst to that figure. So the final cost at the register would be $118.18. I'd hand the clerk $118.18. Note that this figure does NOT take my prebate into account - hence the actual cost would be less. But this example is sufficient to demonstrate that buyers' tax costs do exist - and that they are almost always omitted from any analysis.

While sellers may not exceed the price a buyer is willing to pay, the amount a buyer is willing to pay will increase. That is, real prices will fall [$126-118]. It is nominal price that will rise [$100 to $118]. The difference, again, is the tax costs of the buyer are included - as they should be.

The purchasing power of buyers increases - so the market-driven analysis you followed will benefit the nrst.

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Permalink Reply by Nancy L. Gatchel on May 3, 2009 at 1:46pm

Matt, I like your first draft. Hopefully, you can take some of the suggestions and info provided by others here and make yet a more accurate chart. I'm certainly impressed by your work. When complete, I'll copy it off and use it, if that's ok.

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Permalink Reply by Pat Conroy on May 3, 2009 at 7:16pm

RC -- that's a great way to explain the FairTax and embedded taxes. I imagine it's easier for most people to comprehend how much they have to earn to buy something for X dollars. It also pegs the seller's embedded taxes at a lower rate that is easier to defend and harder for opponents to demagogue.

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Permalink Reply by RC Woodworth on May 4, 2009 at 4:59pm

Yes Pat - in fact the 9% figure for business embeds came from an opponent. I stipulated that I would allow him to define embeds and he did as only hard costs - total business taxes - ends up about 9% of prices. Like many opponents. I don't think I'll ever win the guy over - but his error was obvious then. He like so many omitted income tax costs in the price of a good.

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Permalink Reply by Ron Wenrich on May 5, 2009 at 5:02am

I think the income tax part of the equation is a rough thing for many people to understand. The business is paying for labor rates at a given rate. Their only obligation is to pay the 7.5% of their half of Social Security.

Where the income tax comes into play is the reduction of purchasing power by the individual. In that respect, the taxes aren't embedded by the business, but by government on the consumer.

The Fair Tax will relieve business of their Social Security obligation, as well as other taxes. Business can drop their prices, but it won't reflect the removal of the income tax unless they drop the labor rate to reflect that.

My feeling is that most businesses won't be dropping the labor rate. It would pass on some of the savings by lowering the prices somewhat. But, those lower prices won't make up for the amount of the Fair Tax. That would be made up in the higher wages due to no tax withdrawals from the paycheck.

I think this is an area that really needs to be explained and understood better by both sides. Its like the 23/30% argument.