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

The FairTax Fantasy

That's the title of a new book by national radio talk-show host and Law Professor Hugh Hewitt, and Assistant Professor of accounting, and tax accountant Hank Adler. They sub-head is "An Honest Look at a Very, Very Bad Idea".

I just received my copy, am currently reading it, and will try to give as fair a summary as possible of what the authors focus on, as well as comparing it to the FairTax as presented by national talk show host and author Neal Boortz, and Representative John Linder.

Full disclosure: I have been a proponent of the FairTax for years, and although there are certainly serious questions raised by Hewitt and Adler, I find their arguments on the whole less than compelling so far.

First of all, the fact that a book like this has been researched and written is actually a good thing. It not only brings FairTax questions and shortcomings to light--which is the only way they can be adequately and effectively addressed--but it gives significant additional credibility to how much headway the FairTax has gained over the years as more people learn about it.

Hewitt and Adler both agree that the tax system as we know it is a mess, and that major reforms are needed. Their premise is that the FairTax is so flawed that a huge amount of energy is being wasted by the hundreds of thousands of us on a tax system that hasn't a prayer of passing. They feel the energies should be focused elsewhere.

Part One of a summary follows:

0 members like this

Replies are closed for this discussion.

Replies to This Discussion

Permalink Reply by Todd McLaren on April 29, 2009 at 3:58pm

Chapter One.

This deals with what the authors refer to as the "Three Bobs". They use as their example a "superrich" American with an annual income of 10 million dollars. He, of course, loves the FairTax because his current income tax liability is well over 3 million a year, and that would plummet under the FairTax, which is only paid once at the retail level. He'd have to buy almost 14 million dollars worth of goods and services every year in order to provide the government with the same amount of revenue. And if he DID want a big-ticket item, he could just buy it overseas and either leave it there--like a yacht--or carry it home--like a Rolex, since the FairTax doesn't apply out of the country.

The second Bob is an outrageously wealthy foreign entertainer--say a fighter--who comes to New York, makes 100 million dollars in a bout, and leaves the country with all 100 million (minus a few thousand dollars in taxes incurred while he was staying, eating, and shopping.) Lost tax revenue to the government in second Bob's case would be well over 30 million dollars. Another one in favor of the FairTax.

Third Bob is "retired" Bob. He and his wife have saved their money for retirement but now, after the FairTax is passed, the authors claim they will have far reduced purchasing power because of the addition of this new 30% sales tax. This Bob will hate the FairTax.

Hewitt and Adler do briefly acknowledge that the FairTax "prebate" will help Third Bob cope.

One of the basic premises of the FairTax as put forth by Boortz and Linder, is that it eliminates all other federal federal taxes. With that 20-25% of federal taxes that are currently priced into everything we buy, Boortz and Linder claim that the "actual cost" of everything would soon (if not immediately) drop by that amount, so that once the FairTax is included the price at the register will be roughly the same as before. In other words, the FairTax merely replaces the already embedded federal taxes.

Hewitt and Adler don't acknowledge this. They believe there will be a huge increase at the register.

They also insist (over, and over again) that the actual percentage of the FairTax is 30% (the EXclusive rate), not 23% (the INclusive rate), because sales taxes are ALWAYS thought of as "exclusive"--that is, "added on after the price is set". From a practical point of view, the dollar amount paid at the register for any item will be identical no matter how you refer to it.

My contention in the "Three Bobs" scenario is that it's largely a "straw man" argument. Yes, the super wealthy will love the FairTax. (But I love it too, and I'm kinda poor.) Yes, they will pay less federal tax than they do now. So what? They earned the money--or their families did--and they should reap the benefits of being smart, lucky, or hard working.

Plus, how many of the 350 million of us fall into the category of "superrich"? Inventing a specific example of the rich getting richer simply smacks of class warfare.

The example of "Third Bob" is simply erroneous--unless you buy into the argument that when the inherent cost of an item drops by 20-25%, the successive price at the register wont also fall. I agree with Boortz: the free market will force the adjustment down into place.

My last point right now is that since (as described by Boortz and Linder) the FairTax significantly improves the purchasing power for everyone, especially (as a percentage) the poor, the only way to paint the FairTax as villainous is to point out that it REALLY helps the rich.

Is America so jealous of its greatest producers that it won't put into place something that helps everyone just to make certain that the most successful don't benefit? Time will tell.

Permalink Reply by Todd McLaren on April 29, 2009 at 3:59pm

Chapter Two

This chapter in The FairTax Fantasy largely describes why the authors believe it's more honest to call the FairTax a 30% sales tax rather than a 23% inclusive tax. According to the authors, it's that sales taxes are ALWAYS considered an "exclusive" tax; that is, "added on after the price".

They do acknowledge that a 23% inclusive tax and a 30% exclusive tax is the same; they do not acknowledge that there will be any price change when the 20-25% federal taxes already included in the price of all goods is removed.

In other words, Hewitt and Adler give an example of a $1.00 item increasing in price after the FairTax to $1.30; Boortz and Linder would say that after the federal taxes are removed from the $1.00 item, the actual cost will be about $.77. Include the 23% FairTax, and the price at the register will be... $1.00.

Hewitt and Adler also claim that some economists believe that the 30% number is far too low, and that the actual FairTax rate will need to be about 50%.

They go on to mention the "prebate", how it's only available to legal citizens, and about how devastating it will be for the 12 to 15 million illegal aliens in the country, for them to wake up one morning and find the prices of everything they're already struggling to buy 30% more expensive.

They also briefly mention projected problems they see in an inevitable international trade war, since American goods would be so much less expensive overseas; how investment property would be far cheaper than a home you would buy to live in; and what chaos it would throw the states into, since they depend on the current income tax system to raise their own revenues.

My reaction: Again, Hewitt and Adler insist on referring to the higher 30% figure than the 23% figure. Proponents of both have their agendas: If you're for the FairTax, the 23% figure is more palatable. If you're against the FairTax, the 30% figure looks more scary.

I think Boortz and Linder have the better argument for the following reasons: 1) the embedded federal taxes the FairTax replaces are already factored into the price.

Here's an example, And for purposes of explanation that will become clear I'll change the numbers slightly from 23% and 30%, to 25% and 33% (identical inclusive and exclusive rates):

You go the register to buy a widget--assume we're in a state with no additional sales taxes--and the clerk rings up one dollar. You put four quarters on the counter. The clerk says, "y'know, one of those quarters goes to pay embedded federal taxes."

"No kidding?", you answer, "That's 25% of the price! Well, the FairTax gets rid of those taxes, so let's slide that quarter over here for a sec. These three quarters now represent the widget's actual cost."

"Right," says the clerk, "but now you have to pay the FairTax, so let's slide it back over to cover it."

Boortz and Linder would argue that the FairTax is 25% of the purchase price--after all, it's a quarter!. Hewitt and Adler would claim that the quarter of tax represents a 33% increase over the three coins that the widget "costs".

You and I? We don't give a rat's patootie. We pay the buck and leave with our widget.

Permalink Reply by Todd McLaren on April 29, 2009 at 6:16pm

The second reason I think the FairTax proponents have the better argument is that the income tax that the FairTax is designed to replace is figured on an "inclusive" basis. Are you in the 15% tax bracket? You're actually paying 17.6% under the Hewitt/Adler description. 28% bracket? Actually, "exclusively" it's nearly 40%! How about President Obama's proposed 39.6% tier. On an "exclusive" basis, you're paying over 65.5% tax. Swell.

Yes, the FairTax is technically a "sales tax", which is traditionally referred to on an "exclusive" basis; but I believe it makes more sense to compare apples to apples.

In their other examples, I don't believe illegal aliens would be any worse off than they are now. Prices under the FairTax should remain about the same. Things WILL be better for legal residents, since they'll receive their "prebate" every month to cover the tax on items up to the poverty level.

International trade may be a factor, but that's well above my pay grade. And Boortz and Linder, and Hewitt and Adler are all making projections, after all; but the marketplace works best when finding it's own level.

The one example they give that I do see as problematic is that new homes bought for investment purposes will be far less expensive than those bought to live in. I would expect to see "partnerships" develop wherein two people buy property for investment, and rent to each other.

This could be a real issue, but is probably way too complex to pull off on a consistent basis. For their own personal protection, there would need to be very thorough contracts put in place to cover such a partnership so that each party feels secure in the ownership of "his" house. And what happens when one of them wants to move? All of this would raise red flags among the attorneys who'd have to draw up said contracts. How would they feel about being part of an illegal tax conspiracy?

There would probably have to be laws put in place to prevent an investor from selling that property for a substantial period. Say three to five years. Something to address though.

The summary continues when I can.

Permalink Reply by Art Villa - Global Perspective on May 1, 2009 at 5:00pm

Thank you for this summary Todd.

Keep in mind that regardless of tax bracket that you still have to add Payroll Taxes to get to an apples-to-apples comparison since funding of Social Security and Medicare are covered by the FairTax. Individually, we pay 7.65% for FICA and Medicare. Truthfully, we pay 15.3% when we consider employer-matching FICA and Medicare. Sure, the employer pays half of it but it could easily have been labeled 15% employee-only tax on a higher wage but that would come across as too scary. With politicians, it is all about painting the scenario that is easiest to swallow.

I invite you to see a few scenarios at my blog post on FairTaxNation at http://www.fairtaxnation.com/profiles/blogs/lost-my-respect-for-hugh.

Thanks again for your post here!

Art Villa

Permalink Reply by Ron Wenrich on April 29, 2009 at 7:19pm

The third Bob will also be able to roll his 401K or SEP or IRA without any withholding. That will give them more income, not less. There will be no tax when they sell any of their stocks off or any of their other holdings.

The first Bob may make $10 million, but his effective tax rate is a lot lower, since he has all the money to buy lawyers and accountants to hide his money in overseas banks where it is used to improve other countries' economies.

I think the second Bob would also be able to figure out how to evade taxes here and in his home country.

Permalink Reply by Joe McCune on May 1, 2009 at 9:27pm

Bob 1, annual income of $10 million a year, a conservative guess he will spend say $2 million this year and pays $460,000 in FairTax. He got quite a savings this year, but the other $8 million, unless he stuffs his mattress, or buries it in his back yard, which does him absolutely no good what so ever, goes back into the economy, creating capital and jobs. What about next year when he decides that he needs to upgrade his lifestyle and has a $20 million dollar house built for himself. Taxes he pays this year are going to be $4.6 million. Ok, he still comes out ahead but that will sure narrow the gap.
Bob 2, prize fighter from abroad comes to NYC and gets paid $100 million for a fight. The promoters who put up that $100 million have had to collect and remit to the government, taxes on that money, through ppv or box office receipts. Say they collected $200 million, they will have to remit to the government $46 million. Thats more than the fighter would have had to pay in current income taxes.
Bob 3, retired, he may or may not get hurt by the FairTax. Unless retired Bob invested in a Roth IRA or paid taxes on his interest and dividends along the way, he is going to be paying taxes on his investments when he takes money from them. He would more than likely be much better off. So, if he has children and/or grand children, he will gladly make the sacrifice for their sake.
When the FairTax is enacted, there will be some losers in the short term, but the long term benefits will far outweigh any short term losses.

Permalink Reply by cary henderson on May 5, 2009 at 10:57am

> To presume that a foreign national who competes in an event in the U.S. as with second Bob will receive compensation here is almost definitely wrong. Why would he allow his contract to expose him to the U.S. tax code to begin with. He is after all a citizen of another country. His contract will be written with every loophole and deduction allowed by the current code and he will pay tax based on a very small portion of the prize.

Under the FairTax 23% of the ticket sales will be taxed, in addition to anything he buys here. Comments?

Permalink Reply by Todd McLaren on May 5, 2009 at 11:22am

I'm not sure if he CAN avoid paying income tax if he makes legal income in this country. According to Hank Adler, co-author (who is a tax attorney) Bob #2 would have the huge bite withheld prior to the payout, much as lottery winners do here no matter where they live.

Any "financial planning" would likely have to be done prior to the contract, i.e. "I want to make $50 million for this. Make sure the purse is big enough so that any taxes taken out leave me with 50 mil."

Permalink Reply by Pat Conroy on April 29, 2009 at 5:16pm

Hewitt and Adler couldn't construct a logical syllogism if I spotted them the major premise and the conclusion.

1. The yacht and the Rolex purchased overseas will have embedded taxes in them. Richie Rich will be paying 23% (30%?) more for them when he buys them in Italy or Switzerland.

2. So rich guy saves a million or two (I doubt it -- if he is paying $3MM+ income tax on $10MM income, he needs to get another accountant -- and not Adler). But if he ends up paying a million or two less in income taxes, what will he do with the savings? Will it never be spent? Maybe he will invest it and create more jobs. Maybe he will give it away like Bill Gates. Regardless, unless he uses his cash to fuel his fireplace or pad his mattress, it will be spent. Otherwise, why earn it?

3. Illegal aliens will pay more? So what? THEY ARE HERE ILLEGALLY! Either make them legal or quit complaining how they will be hurt.

4. As for Bob the foreigner, The pay-per-view is taxable. If the promoters have enough money left over to pay someone $100 million, that means they probably collected $200 million and the tax on $200 million would be $46 million -- more than Bob the foreigner would pay in income tax.

5. For retired Bob, refer to the FairTax.org website to see how retirees are affected.

6. What Hewitt and Adler leave out are Bobs 4 through 100. I'm Bob #4. I own my own business. I would be happy to debate Hewitt and Adler about the pros and cons of the FairTax and the current system.

Permalink Reply by Todd McLaren on April 29, 2009 at 6:34pm

Pat:

Regarding your above answer #1, I don't beleive that's true after the FairTax is passed: those embedded taxes disappear; that's one of the big selling points of the FairTax.

The real question I think is how are other countries going to react when all of these American goods show up that are less expensive than the local counterparts. Boortz and Linder expect that it will mean a boon to American business. Hewitt and Adler suspect huge tarrifs and a massive trade war.

2) As I said, I have no problem with rich people keeping the money they make. But the opponents are going to use arguments like "the rich get richer" to shoot the FairTax down. Of course he'll end up trying to make as much as he can with his money. Which means investments, more jobs, and a stronger economy.

3) Not really broken up about illegals either, but Hewitt and Adler are playing the sympathy card here... as FairTax opponents will.

4) The pay-per-view IS taxable. To the VIEWER. Remember, the tax is paid by the final retail end user. But you're right: the collected tax would likely approach or surpass what the fighter would pay in income tax.

5) For "retired Bob", he would be hurt if what Hewitt and Adler claim: that retail prices do not reflect the removal of all embedded federal taxes. He would be helped if what Boortz and Linder claim: that the price of goods would settle out to be about the same.

I believe the latter is more likely, but no one knows for sure.

Thoughtful and legitimate questions that point out possible flaws and drawbacks are helpful and necessary in this quest to pass the FairTax, for two reasons: 1) we want to make the FairTax as flawless as possible, and 2) opponents are going to throw all of this stuff up at us and people should be prepared with how to answer them.

Permalink Reply by Todd McLaren on April 30, 2009 at 1:49pm

Chapter Three of The FairTax Fantasy reiterates Hewitt and Adler's claim that the tax rate must be described as the exclusive 30% rate rather than the inclusive 23% because that's how all sales taxes are described. They dismiss Boortz's claim that, because the FairTax replaces the income tax and the income tax rate is inclusive, the FairTax should be described that way as well.

Again, both sides agree that both the 23% inclusive and 30% exclusive rates are identical.

Hewitt and Adler also claim that the rate won't be high enough to cover the nation's required revenue, and that the switch from an income tax to the FairTax will be confusing and uncomfortable.

Permalink Reply by Todd McLaren on April 30, 2009 at 1:50pm

Chapter Four is titled "Truth About Its Consequences". The authors claim that the very powerful senior citizens' lobby will prevent the FairTax from passing because it would be very detrimental to those living on fixed incomes. Again, they cite the 30% increase in prices they expect.

They say--correctly I think--that the effect of the elimination of the income tax on people of all income levels will not be either universally positive or negative. But they claim that the middle class will almost all lose money.

Here is where they introduce the fact that under the FairTax a home bought for investment purposes will be far less expensive than one bought to live in.

I believe Hewitt and Adler have a very valid point here, since the FairTax is only paid once, by the final user at the retail level. And remember, this only applies to new items. Used items are not subject to the FairTax.

So how do the proponents of the FairTax forsee a scenario like this settling out: Investor A buys a home for investment purposes, rents it to Tenant B for two months, then sells it to Tenant B for a big discount on what Tenant B would have to pay for a new home? Would there need to be a minimum amount of time an investor would have to own the property before he were to sell? Would it be a time period, like one year or five years? Or would it be tied to a monetary amount, like long enough for the FairTax on the rents to equal what the FairTax would be on a new home? Is this scenario already covered in HR 25?

Conversely, would "new" simply mean "the first time a home was acquired by an end user", no matter how old the property actually was? The FairTax would then be paid on the purchase price; thus preventing any home built after the FairTax goes into effect from escaping being subject to the tax, unless it's never lived in by an owner.

As Chapter Four continues, the authors list many of the social benefits now supported by tax deductions that would no longer be encouraged by tax benefits. The mortgage interest deduction, IRA's, charity deductions, adoption credits, medical deductions, and foreign tax credits are among thse listed that would no longer exist under the FairTax.

In addition, Hewitt and Adler list several ways in which high net worth individuals would escape taxation on their existing assets and would be able to leave larger estates to their heirs, thus creating an even larger gap between ordinary Americans and the "economic aristocracy".

The authors point out that many items that are traditionally non-taxable will now be subject to the FairTax, and that business that depends on things like foreign tourism will be adversely affected by, what the authors claim will be, far higher prices.

My take: Aside from the real estate issue, which I've addressed, Hewitt and Adler's points largely rely on their opinions--backed up, they say, by the economists they choose to cite--that are completely at odds with the economic studies Boortz and Linder choose to cite.

FairTax proponents argue that once embedded federal taxes are removed from the cost of items and replaced by the FairTax, the prices at the register will be about what they are now. Hewitt and Adler argue that there will be no price reductions, and that the addition of a 30% sales tax will mean massive price increases only slightly offset by the elimination of all withholding, and the monthly "prebate".

The elimination of the current tax deductions bothers me not in the least. What, pray tell, are you going to deduct your expenses FROM? Withholding will be eliminated under the FairTax. And no one gives to charity, or adopts a child just for the tax consequences. Does it make financial sense to give $1000 to a charity so the government will give you back $330? Or pay the $330 in tax and keep the $660? As they say, "do the math".