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

On Implementation of Fair Tax - Taxed Twice on Savings?

OK, so I have money that has already been taxed in savings or wherever. Say $1,000. On implementation of the Fair Tax, I now need to spend 23% more for a product using money that I've already paid taxes on. I've read both books and can't figure out how this is addressed. Effectively, I would be paying taxes on my saved money again.

The day before the Fair Tax is implemented, a product costs $1.00. The day the Fair Tax is implemented, I now have to pay $1.23. Which is fine, if there is no longer an Income Tax on my paycheck.

Wouldn't a Pre-bate on all my current cash / assets need to be made in order NOT to lose 23% purchasing power on money I've already paid taxes on?

Am I missing something?

Thanks!

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Permalink Reply by Ron Beyer on September 22, 2010 at 12:06am

I agree with Mr Wolf's point that saved money that has already been taxed will be taxed again under the Fair Tax, and that this is unfair. Someone who instead chose to put their money in a traditional IRA will have a great advantage, since they avoided the initial (income) tax. Of course this is unfair! As Mr. Wolf pointed out in a previous message, this is a show stopper. (So I wonder how he can support the Fair Tax as it is.) I am semi-retired and am living off a large savings that has already been taxed, so this is a very important issue for me. Of course, young people that have little or no savings also have a great advantage (clearly unfair).

The question is, how can this unfairness be fixed? One way is to divide all money and investments (including your home) into two categories - already taxed or not. Money earned after the Fair Tax is implemented, and money in a Roth IRA, has not been taxed (category 2). Other money and investments (including your home) have already been taxed (category 1). Only money in category 2 will be subject to the Fair Tax. (I'm sure this can be implemented, but how to implement it is another topic.) The only problem with this solution is that most people with category 1 savings will use that money to buy things in order to avoid the Fair Tax, thus greatly reducing total tax revenue. To compensate for this, the Fair Tax rate would have to be much higher than 23%. In other words, if the Fair Tax rate were actually based on fair assumptions (avoiding double taxation), the rate would be much higher than 23%. It is ONLY by implementing unfair double taxation that the authors of the Fair Tax were able to achieve a rate of 23%.

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Permalink Reply by Ron Beyer on September 22, 2010 at 10:18am

Hank, Yes I meant to put traditional IRA (not Roth) in the "not already taxed" category. You are saying that even though the Fair Tax would be unfair to me, I should grit my teeth and make a big sacrifice by essentially donating a large portion of my hard-earned savings to people who have not saved as much. I am not that generous, and should not be required to be. At least you admit the "Fair Tax" is not fair, which implies the name should be changed. You say you don't believe there is a practical way to solve the double taxation problem. I believe there is a way, although it would require some work. I think the double taxation problem needs to be solved before the "Fair Tax" is acceptable.

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Permalink Reply by Steve Keller on September 22, 2010 at 11:23am

There is no way to completely solve this problem. One idea that could help is to offer a higher prebate based on the age someone starts receiving S.S. benefits. For example at age 62 you could receive an additional $100 per month; if you wait until 65 to begin receiving benefits you would receive $150. This is by no means perfect; the problem is that it would benefit both those who have saved and those who did not save. This might seem unfair to the savers.

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Permalink Reply by Terry Warns on September 22, 2010 at 12:44pm

Hank,

I look at it differently. Yes taxable savings may be taxed twice. I think the real problem is tax deferred savings is being only taxed once(FairTax). If that was reconciled somehow, then would the arguments be different?

Based on your belief that taxable savings is double taxed, then you must agree that deferred savings is single taxed.

Therefore those with deferred savings is given a big tax break with the FairTax. Some of the deferred savings has FICA already paid on it (401K/IRA). Some deferred savings has no FICA and no income tax paid on it(Capital Gains).

Couple that with your belief that prices will rise 18%, then the tax becomes even less progressive. The poor is uneffective because of the prebate. The rich is uneffective because the rich spends less than 100% of their income. The middle class will get hit harder because they spend most of their money but they get more take home and the prebate to offset the increase. Seniors, those with taxable savings will get hit extremely hard, because there is no rise in SS unlike those working gets additional income to pay for the 18% increase.

Do I understand your position?

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Permalink Reply by Terry Warns on September 22, 2010 at 8:44pm

Hank,

First of all, in their current $53K of purchases there is at least 5K in embedded taxes (9% of 53K). So I would compare $7K to $5k. In addition, I agree there might be some price inflation which would be reflected in the SS received by the seniors, so the end result is not nearly as bad as you put it.

In my review of the FAIRTAX criticisms, the major one is we need to make it more progressive and we need to lower the tax rate. They go hand in hand. The more we do this, the less impact seniors will see.

I like taxing deferred accounts 10% upon withdrawal. It is easy to understand and easy to justify and it will make it more progressive and lower the tax rate. Great Idea.

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Permalink Reply by Ron Beyer on September 24, 2010 at 9:52am

I did some more studying before reading the above messages of Terry and Hank, and came to the same conclusion that there is no problem with double taxation, but instead traditional IRAs and 401K's should be taxed. My reasoning is that take-home pay after FairTax is started should be about the same as take-home pay prior to FairTax, and that the same monthly take-home pay will buy the same amount of goods before and after FairTax starts, so there is no problem with double taxation.

The money in traditional IRAs and 401K's was tax deferred, so income tax must be paid on this money regardless of FairTax. However, I am not sure that 10% is enough. It should be roughly the tax they would have paid had they not deferred the tax. But to avoid a lot of protesting, maybe 15% would be fair, or maybe even 23%.

On the other hand, I don't see why FairTax would be better than a flat income tax (maybe at 23%) plus a prebate. Maybe someone can explain this.

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Permalink Reply by cary henderson on September 24, 2010 at 10:40am

> You are obviously new to the FairTax. The whole idea behind the Fairtax is to do away with taxation on income. I know this goes against all that most people in this country have known all their lives, but we used to have freedoms here. The income tax is the first tool the politicians used to begin taking away those freedoms. All the bad distortions in our economy have occured as a result of the income tax, and the loopholes politicians have put into it. Read the FairTax books to get an understanding of the issues. By the way, the income tax monster we have now was a flat income tax.

Permalink Reply by Ron Beyer on September 24, 2010 at 11:19am

I did some thinking to figure out how much withdrawals from tax-deferred savings accounts (traditional IRA and 401K) should be taxed under FairTax. (Hank suggested 10%.)

I like the following rule: A person who has all his savings in a traditional IRA should be able to buy the same amount of goods in a given year as he would have without FairTax, accounting for the FairTax prebate, and assuming retail prices (including the new tax) will be about the same under FairTax as before.

Thus, it is just a matter of using the current (2010) IRS tax table. We can assume the prebate takes care of the standard deduction (although the prebate is more generous since it uses 23% as the rate instead of the minimum IRS tax rate of 10%). So simply using the IRS tax table on IRA/401K withdrawals should be fair enough. For example, a single person who withdraws and spends only $10,000 would be taxed $1000 (10%), but would get a FairTax prebate of $2491. Since retail prices will be about the same as before, he will be able to buy more goods than without FairTax.

On the other hand, a person who withdraws $100K from his IRA/401K would be taxed according to the IRS tax table (25% for the amount above $68K).

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Permalink Reply by Ron Beyer on September 24, 2010 at 5:21pm

Hank, I'm not assuming the same gross pay. I'm assuming the same after-tax take-home pay, so wages will be reduced by about 23% on average to keep take-home pay the same. This is consistent with retail prices (including consumption tax) remaning the same, as in Jorgenson's research. This makes sense to me, since it results in the same take-home pay and the same ability to buy goods (on average). So there is no free lunch, just a consistent ability to buy goods.

To make this work, there should be a rule that when FairTax starts, everyone's salary must be reduced so that take-home pay remains about the same on average. To achieve this, salaries can be reduced based on the IRS tax table, or perhaps by a fixed rate such as 23%. (The prebate ensures that low-income people will not have a reduced ability to buy goods.)

On the other hand, if pre-tax wages remain the same (which I don't think is the best solution), so that take-home pay goes up, then I have another solution to avoid the double taxation problem, which is to give tax credits based on the amount of after-tax savings a person has.

Are you assuming that pre-tax wages will remain the same?

Permalink Reply by Terry Warns on September 24, 2010 at 9:41pm

Ron,

It would be simple for the investment company to withhold a flat amount for each and every withdrawal. By trying to implement a graduated rate, it now requires much more paperwork.

Also if it was a flat 10%, then some people will bite the bullet and withdraw everything while others will withdraw only small amount and continue to let the money grow. For instance if I had a $1M IRA, i could withdraw everything and pay $100K, or I could withdraw 4% - $40K and get $36K. It would take 25 years to reach the $100K.

The real question and I think there are other opportunities is what to do with this extra taxes raised outside the FairTax. I think it should go towards the deficit.

If that was part of the FAIRTAX proposal, deficit reduction, we have another great economic argument for the FAIRTAX

Permalink Reply by Ron Beyer on September 27, 2010 at 12:29pm

Hank, If we all get 100% of our gross pay (tax free), then as you mentioned there would be a large increase in retail prices (you said 18%), thus reducing the value of existing savings accounts. That is why for fairness, people with after-tax savings should be compensated, perhaps by giving them tax credits based on their after-tax savings. (Tax deferred accounts can be left alone since they already have an advantage.) However, giving all those tax credits might greatly reduce the tax revenue, so it might not be feasible. Also, getting to keep 100% of our gross pay would increase high salaries much more than low salaries, i.e., it will make rich people richer. Also, I wonder how the huge increase in prices will affect exports.

My conclusion is that FairTax can only work if we try to keep take-home pay (and retail prices) about the same as before ON AVERAGE and accounting for the prebate. Thus, minimum-wage earners would NOT have a reduction in salary. This is the only way to avoid sudden inflation and other instabilities. Nobody should complain if they get the same take-home pay as before. As for retail prices being uncertain, they are more likely to be stable if take-home pay is the same. Your suggestion to take 100% of gross pay is more likely to cause great inflation and instability.

Pay reduction need not use W-4s. For example, one solution is to reduce everyone's pay by a fixed percentage (between 15% and 23%). If the prebate is counted as income, then people below the poverty level will not have any reduction.

One of my concerns with FairTax is still that after-tax and deferred-tax savings accounts need to be handled differently, for fairness. Simply taxing IRA/401K accounts by 10% helps, but not enough imho. Also, if we suddenly get paid 100% of our gross salary, then instead of taxing deferred accounts, after-tax accounts should be given tax credits (due to the reduced real value of those accounts)

Permalink Reply by Terry Warns on September 22, 2010 at 11:34am

I look at the business sale differently.

Under the current system, taxes effect every business sale and is reflected in the price. So yes you would sell your business for $1M and pay $333K in taxes the day before the Fairtax. But you would sell your business for $666,666 the day after the fairtax. You would not get $1M the day after the Fairtax.

In both cases you end up with $666,6666 to spend. Now before the Fairtax, every purchase has imbedded taxes, after the Fairtax, you still have the taxes but are more transparent.

As far as the $1m being taxed twice, you do not understand what is happening now.

When you spend $1M now, approximately $800K goes to the goods and services and $200K goes to taxes.
When you spend $1M after the Fairtax, approximately $800K goes to the goods and $200K goes to taxes. You just see it differently