Fair Tax Nation

Replace All Federal Taxes on Income with the Fair Tax Act , HR 25 and S 18

I have a question about an article I read regarding The Fair Tax

A friend sent me alink to a CNN Money article about The Fair Tax. There is a section at the end of the article which addresses embedded taxes. I would like some feedback on this.

Here is the section:

Part of the problem is the way Boortz and Linder are using the idea of embedded taxes. In an eight-year-old study paid for by AFFT, Harvard economist Dale Jorgenson noted that because the taxes paid by everyone in the chain of production are embedded in the cost of goods, prices could decline an average of 20 percent if all those taxes were scrapped. The FairTax Book devotes an entire chapter to this idea.

What The FairTax Book fails to mention is that prices can only fall this sharply if companies cut wages. I asked Jorgenson about this, and he agreed. Say your salary is $100,000 a year today, but you take home $80,000 after taxes.

Your company is still paying that extra $20,000. In a FairTax world, it will save that money, and be able to lower its prices accordingly, only if it can reduce your salary to $80,000. In other words, your take-home pay is the same as before. Sure, you'd get to "keep 100 percent of your paycheck," as Boortz and Linder repeatedly write, but it would be a smaller paycheck. That's kind of a big thing to leave out.

here is the link:


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It would not be a smaller paycheck. Your netpay and gross pay would be one and the same. That isn't a pay cut. The government is taking that before we see it currently. The only way their scenerio is right is if prices are not reduced and your boss decides to keep what they were giving the government. Critics twist facts but bottom line is the government is getting the same amount of money, it is revenue neutral; the tax payer base is expanded because the underground economy wpuld taxed, there are no loopholes for Charley Rangel, Gaitner etc. Competition will take care of the pricing. Let me keep my take home pay the same and reduce the prices or give me all of it and let prices stay the same, who cares?

Removing the compliance costs and record keeping will reduce the costs of products significantly. Did they forget that? I challange them to compare the 2 systems apples to apples. Anyone in their right mind picks the Fair Tax everytime unless they are benefiting from the current system.

I'm not sure what your question is. Let's start here and then I'll come back to the exact meaning of their statement. The FairTax basically MOVES taxation from the front of your income to the end of your consumption. For ease of comparison, let's ignore the standard deduction/personal exemption combo of the current system and the prebate of the FairTax and focus on the margins.

If I'm in a 15% marginal income tax bracket today...adding only the employee half of payroll taxes means I need to earn $130 for every $100 I keep to spend. So if I want to spend $100 at the grocery store, I must first earn $130 because my income is taxable and groceries are not deductible. Under the FairTax I would keep my entire $130. The base cost of the groceries would be $100 and after adding in taxes AND assuming no pretax price reduction, my total cost would be $130. All we have done is move taxation from the front of your incmoe where it isn't seen to the end of your consumption where it is.

The prebate takes the place of the standard deduction/personal exemption combo and is larger at every family size so is more beneficial. Items that are only partially deductible today to only the 1/3rd of the americans who itemize (such as home interest) become tax free to 100% of Americans.

Basically, Americans are better off even before considering any price reductions. So now to the Boortz statement and question. Will prices reduce 22%? Well if we are basing the answer on Jorgenson's study, the pretax reduction will INITIALLY be more like 10 to 12%. But that is on top of the other benefits mentioned above. Jorgenson's study DID include employee taxes so for prices to drop 22% initially based only on that study, employee gross wages would have to stay at net levels under the current system. That is very unlikely to happen since wages are negotiated orally or in writing) on a gross basis and employees would have to agree.

So back to the food example, the $100 food bill would be more likely to drop to $90 and the after FairTax price will be $117. The employee took home $130 so they have $13 left for a couple extra six packs of beer or a bottle of wine to celebrate.

Jorgenson did not include the impact of the inventory credit in his calculations because the bill wasn't actually introduced yet. That should allow businesses to lower prices even further initially but exactly what that impact will be is unknown and will vary between businesses, industries and areas of the country.

Two other considerations: 1) As industries come back to America and capital is used to increase productivity, the benefits of the FairTax in helping to increase wages and reduce prices increase. So the positive effects grow with time; 2) Most people are trying to compare the status of the current system to the FairTax. That is unfair. We are spending beyond our means and doing nothing to improve growth of the economy. We should compare the expected tax rates of the future to to cover this mess, with the FairTax that helps solve it.

As for Boortz, he addresses this issue in his second book, although I personally feel he could have made it clearer.
I totally agree, Boortz turned me a little cold to the idea in the second book when he suggested my net pay would be my new gross pay as there aren't necessarily guarantees that the prices would drop accordingly. I would be curious if there's been any estimates of what it would save corporations just dropping the corporate income taxes and payroll tax matching funds and what % drop it would show to the end price. Just the payroll tax match would be 7.65% on all payroll expenditures but I'm sure it would depend on labor intensity, etc. of the product produced.

The most likely scenario is you taking home your gross pay. Your employee agreed to hire you for "X"/hr. That won't be changed without your agreement. The question of how much and if aftertax prices rise depend partially at least on whether the Fed accomodates and will also be affected by competitive factors in each industry/business/region. Accounting for employer based payroll taxes and compliance costs, a 10% pretax reduction is reasonable. My main point above though is that even if prices don't drop, most Americans are better off.

In addition, consider how much of an average family's initial cash flow will not be taxed. Most families already have a house payment, 2 car payments, contribute to a 401-k, maybe make charitable contributions, etc. For example assume a $50,000 annual income for a family of four with a $600 house payment ($7,200/year), $400 a month in total car payments ($4,800/year), contributing 5% to their 401k ($2,500/year) and 5% to their church ($2,500/year). The house payment and car payments are not taxed because they existed prior to passage of the FairTax and the tax is considered embedded in the price they paid. Their contributions to the 401k and church are not taxed either. That's a total of $17,000 dollars off the top of their $50,000 not taxed, leaving them with a maximum to be considered taxed consumption of $33,000. The prebate for 2009 gives them the money to cover $28,000 which only leaves a maximum of $5,000 that could be subject to taxes. Since that is all they have, we would use the inclusive tax rate and the maximum they could pay in taxes is $1,150. Even that number is high because as written, the FairTax does not tax state and local income/sales taxes paid either and it is likely they are paying both.

That is the maximum and assumes NO pretax price reduction. Under the current system, JUST the employee's share of the payroll tax ($50,000 X 7.65%) is $3,825. That is before calculating their income tax and not including the employer's share of payroll taxes (if they are self-employed, they pay both).

Of course, we aren't even including the benefits of a growing economy and increased capital investment; new jobs to compete for labor, higher productivity, lower interest rates, etc.
This has been one of the hardest parts of the package to wrap my brain around. Bill has done a pretty good job of explaining it.

The only way to have prices fall is for labor to take a reduction in their pay. Their current take home pay would be their new salary. Although their income tax is withheld by their employer, it isn't paid by the employer. The employer only pays their half of Social Security and possibly some corporate tax.

I do subcontracting work, and most of all my expenses is for labor. So, the only savings would be for my self employment tax and Medicare. My bookkeeping costs are fairly low.

But, Boortz made it sound like you are going to keep all your current paycheck and prices are going to fall by an average of 22%. Then you get the prebate, and you're really coming out ahead.

Prices are likely to drop, but the 22% is based on a study that 1) included employee taxes that probably accounted for 10 to 12 percent of that embedded cost and 2) did not include the inventory tax credit that businesses get to take.

You will be able to pay your laborers their full gross pay and still reduce your costs because your suppliers of everything from nails to insurance all have embedded costs (the same as you do) and will be able to reduce their costs to you. And as you pointed out, you will have reduced personal costs as well in employer payroll tax savings, any business income taxes and compliance costs.

Any inventory you have on hand when the bill passes will be eligible for a 23% tax credit to apply against taxes owned, allowing you to initially reduce your costs still more. As capital and jobs come back to the US, the demand for services will increase, helping you even more in the long run. Even if you don't have a large inventory, many of the products you buy such as vehicles could very well reduce their costs more as they clear their existing inventories. As the economy grows and more companies compete, price competition keeps them low.

The bottom line I want to make clear is you do come out clearly ahead even if pretax prices don't drop at all. A pretax drop in prices is the gravy, not the meat. I usually only refer to a pretax drop in prices in passing and everyone still loves the FairTax.
Well said Bill. Here is what I posted on another site that may add to the discussion:

There are two halves to the FICA payroll tax--one half is paid by the employer and one half is paid by the employee (the self-employed pay both). There seems little question that the employer's half--that which is paid above your agreed upon salary--will stay with the employer. The debated question is what happens to the employee's share--7.65% of your salary up to $102,000 a year.

Most believe this should stay with employees, with the consequent effect that post FairTax wages go up more and retail prices will not drop as much. Others believe this belongs to the employer and will allow greater reductions in retail price levels. I believe that this is part of your salary and should go to the wage earner. That does mean that retail prices will not drop as steeply under market pressures.

In truth, economists say that "embedded" tax costs (which are greater than just FICA taxes, by the way) have two effects--depressing wages and benefits or higher retail prices (or a combination of the two). Boortz is right in the second book that there is no "free lunch". Paycheck go way up with elimination of income tax withholding and one or both halves of FICA taxes. It is hard for me to see how the employer's share should go to employees or how the employee's share should go to employers.

Remember that "revenue neutral" really means that the amount of taxes collected today under the income tax and payroll tax system will be matched by taxes collected under the FairTax. It is a dollar for dollar replacement. Revenues now derived through "embedded" taxes will also be matched by revenues under the FairTax. The big shift is bringing these taxes into the open without either payroll withholding or embedding of costs. And, I think we should all remember the other positive effects that Bill rightly details and the elimination of the unbelievable $300 billion or so a year Americans pay in tax preparation costs just to obey the law (those are embedded costs, too ).

The new revenues that come into the tax base are from illegal immigrants, closed loopholes, taxation of existing wealth, when spent, and taxing the profits, when spent, from the underground economy.

The FairTax calculator at Fairtax.org can bring into fine focus what your tax burden is under the FairTax and compares it to current income tax burdens. Most are very pleased with the results.

There seems to be tendency by some critics (not here) to seize upon a detail that might have been misunderstood as "proof" that the overall benefits of the FairTax don't stack up to scrutiny. I would ask them to always compare the destructive effects of taxation of labor and investment, the daily selling off of loopholes by Congress, the undermining of investment and upward mobility and the sheer complexity of the current system when weighing the advantages and disadvantages of the FairTax as a whole.

I believe, of all the advantages, the fact that we make taxes highly visible under the FairTax is the most compelling. If we as a people do not begin seeing government spending as something besides "free money" we are lost. We are now borrowing against the future earnings of our children and grandchildren. Only a highly visible consumption tax can make "stakeholders" of every consumer who will then make it politically possible to see restrained spending. Right now our votes are being bought with spending that depends on borrowing huge sums against future earnings. Voters find it attractive as do candidates and incumbents. That must change because our path of ever deepening debt is unsustainable.
The question of exactly how eliminating income, payroll, and business taxes will result in lower prices is somewhat complex. And, unfortunately, exactly what happens once the FairTax is passed is “unknowable” until it actually happens.

However, one thing we can be sure of is that the FairTax will result in lower pre-tax prices for goods.

The price of goods and services is made up of five basic components; the price of raw materials, the cost of labor, business taxes, business overhead, and profits. The cost of labor may be further divided into monies and benefits given to the employee (wages, income and FICA taxes, and benefits paid for by the employer), and the employer portion of the FICA taxes.

For average businesses, raw materials average about 20% of the costs, overhead and business taxes are roughly equal to 20%, profit averages about 10%, with labor making up the remaining 50% of the costs.

Let’s consider how each of these components are likely to shift once the FairTax is passed.

With a profit of only 10%, business taxes amount to about 3% of total business costs (10% times 30%).

Business overhead will be reduced since the company will no longer need to maintain the same accounting and payroll staff as needed under the current tax system. Instead of having large staffs to calculate various deductions, withholding and payroll taxes, a smaller staff that simply writes and distributes checks will be enough. In addition, the large accounting departments to study the effects of the tax code on the business will become unnecessary, and further cost savings can be realized which, averaged over many business sectors, amounts to about 5%. Business overhead savings can also be used to reduce the prices of goods or services.

The labor cost calculations are interesting, but since they make up about 50% of the total business costs, they are vital. Labor costs usually consist of about 70% direct costs and 30% benefits. This equates to 35% of business costs are direct labor costs. Of this 35%, 7.5% is the employer portion of FICA taxes, or 2.6% of business costs are associated with employer FICA taxes which, under the FairTax, can be kept by the business and used to reduce the price of goods or services.

To this point, we’ve identified a 10.6% reduction in business costs that can be used to reduce the price of good or services. In addition, we also have reductions in the price of raw materials and the benefits portion of labor costs that will be at roughly the same ratio. This amounts to about 3% for raw materials and 1% for labor benefits. Added together, a nearly 15% reduction in business costs can be used to reduce the price of goods or services while still giving the employee the full portion of their income and payroll taxes.

Under this scenario, the employee sees an increase in their paycheck equal to the combination of their income taxes, 15% or so, and their payroll taxes, about 7.5%, for a total of 23.5%. Of course, this may vary between individual employees, but the analysis is still valid overall.

In the final analysis, the business is able to reduce the price of their products by about 15%, onto which a 23% sales tax is added, for a total price of goods or services equal to 107% of the pre-FairTax price. The employee, on the other hand, has a paycheck that is 123.5% of his pre-FairTax paycheck, for a net gain in purchasing power of 16.5%, not including the pre-bate.

No matter how you look at it, the FairTax works!!!!!


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