Albert Einstein once said that “the hardest thing to understand in the world is income taxes”. I definitely agree with him and I think everyone’s lives would be a lot easier without income taxes. Recently I came upon something called the FairTax. It is a bill in Congress with a good amount of supporters and its goal is to establish a national consumption tax of 23% and eliminate all income taxes. I went to FairTax.org and read about the bill in detail. I must say that it is an intriguing and revolutionary bill, but is it really a fair tax?
The main point of the FairTax is that rich people spend more money so they will be taxed more. Since it is a tax on consumption instead of of income it encourages saving and investment. There is also a set level of expenditures that are not taxed. For a couple in the continental United States the limit is around $20,000. I do find this attractive because it should encourage people to spend less so that they can keep more. However, I can see how this can backfire and people will spend more than before because their paychecks will look much bigger and they will feel rich. If everyone’s social security and federal taxes were suddenly gone, many people will find their paychecks to be 20 to 30% bigger. That’s a huge increase on paper and psychologically it will induce more spending.
I am also skeptic about this tax because I still think that the rich will benefit more from the plan. There is a basic cost of living for survival no matter where you live. Suppose that amount is $30,000 a year for a couple somewhere in the United States. So they’re not taxed on the first $20,000 they spend and on the next $10000 they need to pay $3000 under the FairTax (The tax is $3000 on $10000 because $3000 is 23% of 13000). Suppose one couple in this area makes $35,000 a year and another couple makes $70,000 a year and they both spend the minimum they need to survive. The couple that makes $35,000 saves $2,000 because they spent $30,000 and paid $3,000 in taxes. The couple that makes $70,000 saves 37,000 instead, and pays the same $3,000 in taxes. The effective tax rate on the poorer couple is 8.6% while the effective tax rate on the richer couple is 4.3%. Is this fair? I think it’s debatable, but under the regular tax system the poorer couple probably could have qualified for a lot more tax cuts. Though, since these couples can’t escape the 7.65% payroll taxes on Social Security and Medicare, even the 8.6% tax rate isn’t too bad. No matter how we cut it, those who have more money will benefit more because they can live on a smaller portion of their income. The FairTax counts on the fact that richer people spend more money, but I don’t think that’s always true. If you look at Warren Buffet, from all available reports it really seems that he doesn’t spend that much on himself every year, but his investment income is enormous. If the FairTax were implemented, a gargantuan chunk of tax revenue that could have been collected from frugal billionaires like Warren would be gone. It’s great for Warren, but is it really feasible for the United States government?
Another thing I don’t consider fair about this tax system is the minimum poverty rate. They really can’t say that $20,000 is the poverty rate throughout the whole country. In expensive counties like San Mateo and San Francisco a couple usually needs more than $20,000 a year just for the necessities. The average rent for a 1 bedroom is around $1000 to $1500 in these counties. If they really wanted to be fair they would adjust the poverty rate for each region. It shouldn’t be so hard because they already have a cost of living system in place for the military where soldiers get different cost of living allowances in different parts of the country and world. The same system could be used to adjust the minimum poverty rate in each region.
This tax is also a huge boon to the bottom lines of corporations because the high corporate taxes are eliminated. The FairTax proponents argue that this is a stimulant to the economy because corporations would be able to hire more people and produce more with the income they have. Also, they argue that prices will come down because corporations will no longer have to pay their employees’ social security and medicare taxes so corporations can create cheaper products. Most of this sounds good, but I imagine it would be harder for small businesses to start because there will probably be legal barriers. Also, big corporations probably will not lower their prices just because their costs are lower. The whole point of capitalism is to make as much money as possible. If a consumer is willing to pay $100 for something, a corporation would not mark it down to $50 just because their manufacturing process suddenly became more efficient and they can produce twice as much. A smart corporation would continue to charge $100.
Anyway, this is an issue to watch for in the 2008 elections. FairTax.org has a list of presidential candidates who have stated in public whether or not they support the proposal. Personally, I am wary of this proposal and I agree with what Giuliani and McCain said. This is a new system that will take a lot of effort to implement and get used to. It also needs to be fleshed out further and looked at more carefully by more people. I doubt that it will be passed in the near future because there is just too much logistics involved. I am glad that people want to change America’s crazily convoluted tax system, but I am afraid that there is really no system that can be simple and equitable to everyone. I think the FairTax is definitely an interesting idea, but it probably won’t get enough support to be passed into law in the state it is in now. Additionally, all 50 state governments will have to agree to it and implement it, and that may be more difficult than just getting it passed in the Congress.
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9 comments ↓
To be fair (pun intended), Warren Buffet regularly complains that he pays a lower effective tax rate than his receptionist under the current tax system. (For three reasons – unrealized capital gains aren’t taxed at all, realized cap gains are taxed at a lower rate than “ordinary income” and FICA taxes are capped at the first $97,500.00 of income.)
So, in comparison to the current system that particular aspect of the Fair Tax is a wash.
You made some good points in your analysis of the proposed “fair tax”.
While I am not sold on it yet myself, I do believe that a national sales tax has advantages over the current income tax system.
By taxing individuals at the level of consumption, the “underground economy”, which makes up a large part of the current “tax gap”, would finally be forced to pay taxes. I am talking about those with cash businesses who either substantially under-report their income or do not report any income at all. When they buy a car they would have to pay the federal sales tax just like any salaried employee.
The Wandering Tax Pro
I like Newton’s quote better: “I can calculate the movement of the stars, but not the madness of men.” (after losing money in the South Sea Bubble)
I would challenge your unfairness example. In order for the $70k couple to be taxed at a lower rate you have to assume they never actually spend the money. Unless the plan is to fuel the funeral pyre with dollar bills, the higher earning couple will eventually spend the extra $35,000 on something, and pay the $6500 in taxes then.
Another point is that the Fair Tax won’t have any net impact on the underground economy at all. The handyman I pay in cash to do some work on my house is no more likely to report the sale and send in a sales tax than he is to report the income and pay income tax. That he pays sales tax when he spends what I paid him later is neither here nor there – there is no tax paid on our transaction under either tax plan.
I think this article is pretty darn good. The author complains about two primary items, one: the Fair Tax is not hard enough on rich people and two: the Fair Tax is not hard enough on corporations. Guess what, the current system favors the rich and the corporations as they have accountants to structure their dealings. When is the last time someone who earned less than $20,000 had the time or energy to minimize their income tax? The only fair option is to junk the income tax completely (and replace it with nothing) as Presidential candidate Ron Paul wishes.
http://whoisronpaul.name/
Point by point:
Yes, paychecks will be bigger, and people may spend more… so for those foolish people, the change will be a wash. For more prudent people, it will be a gain. I highly doubt you’d see a net negative based on this aspect.
Using your example for a couple that makes $35,000/yr and spends $30,000/yr, under the current tax system I highly doubt such a couple is walking away with any more than $2000 at the end of the year without some good (expensive) tax help.
Any criticism that uses Warren Buffett as an example is highly suspect. He’s an outlier in every sense of the word.
For the poverty rate, that’s a valid criticism, though it seems a pretty trivial problem to tackle, as you’ve noted.
For corporations, sure, people are willing to pay $100 for something today, but those same people probably won’t be willing to spend $130 on it tomorrow. Corporations will have to lower their prices to keep the total cost of the item within the same range that it’s currently in. Though, honestly, how corporations will react is pretty much mostly conjecture at this point, there is a decent argument to be made in either direction, but capitalism works both ways: if one company keeps the price high to take in extra profit and another lowers their price to maintain profit and capture market share, which do you think consumers will choose?
50 state governments do not have to buy into it, as federal tax is wholly distinct from state & local tax. They’ll have to option to model their taxes after the federal system, but it’s not required for it to work and to benefit people.
And, all of this ignores the expense (in both money and time) that people and corporations incur to comply with the current tax system. That’s a savings beyond the basic tax rate, and it will have a significant impact.
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Now, all of that said, I’m not an economist, and I don’t have all of the answers. I support the Fair Tax because I think it’s a net win. I wouldn’t make the claim that it’s perfect because I just don’t have the kind of basis to make that claim. I like it on a personal level because it gives me control that I don’t have otherwise. There needs to be changes made to the tax system, and this is the most viable proposal I’ve ever heard. The status quo is not sufficient.
Yes, the point of capitalism is to make more money. But no company sets prices in a vacuum. Prices cannot stay artificially high when costs come down. Someone else will come in and undercut you.
Also, I can’t see how FairTax would lead to more regulations for Small Business start ups. If anything it will greatly simplify the accounting for those businesses, which is a huge hump to get over when you expand a business from a couple people to more employees.
Sales tax is regressive. Point. (Regressive tax means that people with larger incomes pay a smaller proportion of their income as tax and vice versa). Lower income people save relatively little, while the upper classes spend a smaller proportion of their income and save more. Therefore, a smaller proportion of the well-to-do people’s income will be taxed. Because of this, the national sales tax will necessarily shift some tax burden onto lower income people. In fact, the sales tax is even more regressive than a flat income tax (tax is flat, when everyone’s income tax rate is the same. In this country, the federal income tax system is meant to be progressive, meaning those who earn have a higher tax rate). This whole national sales tax initiative is a plot by the same people who argue that rich people should be taxed less and that the government as a whole should tax less and spend less. Reducing income taxes or making them less progressive is not feasible for various reasons. So, they’re pushing for this entirely new, supposedly “fair” kind of tax.
Of course, what’s fair and what’s not is debatable. The arguments against the national sales tax are the same as those against a regressive income tax. On the other hand, some say that since people derive utility from their wealth only when they spend it on something, only consumption should be taxed.
The main point of the Fair tax isn’t rich vs poor- income isn’t an issue. The main point is that it eliminates income taxes! It unshackles us from the slavery we’re in. People will feel richer because they will be richer- and more free. If we choose to spend more it could cause prices to rise but only until they have risen as much as our incomes. That’s when spending will level off. That’s how free markets correct themselves.
Under the Fair tax, all households are granted an anual consumption allowance based on the Poverty Guidelines as published by the Department of Health and Human Services (http://aspe.hhs.gov/poverty/07poverty.shtml). According to the 2008 Fair Tax Prebate Schedual (http://www.fairtax.org/site/PageServer?pagename=about_faq_answers), the annual consumption allowance for a couple is $20,800. So the annual prebate they would be getting now if the Fair Tax had passed in 2007 is $4,784- $399/month. Notice that this is exactly 23% of the annual consumption allowance. Also notice it has absolutely nothing to do with income. All it does is refund the tax on every dollar they spend upto the spending allowance. If they earn $30,000 a year, per your senario, they would only pay tax on $9,200. But the Fair tax is 23%, not 30%, because it is included in the price tag, not added on at the register. So they would only pay 23% on the remain $9,200 ($2,116) assuming they spend it. If they save anything they would pay less.
According to the 2007 Income Tax schedual (http://www.irs.gov/formspubs/article/0,,id=164272,00.html), a couple earning $30K and filing jointly had to pay 10% on their first $15,650 ($1,650) plus 15% on the remaining $14,350 ($2,152.50) which totals $3,802.50. Now I didn’t do the math but, I’m pretty sure they would have saved some money under the Fair tax.
Also keep in mind that more than half of the total income tax burden on the middle class is collected at the register rather than garnished from our wages. That’s because business never really pay taxes, we do. Taxes on businesses raise prices by about 22% and that effects everyone including the poor and elderly. The Fair tax does replace those hidden taxes with it’s own tax but, the prebate refunds 100% if it to the poor and the elderly so they stand to see a 22% drop in their cost of living. At the same time, corporations would save fortunes on income taxes. That’s a GOOD thing for everyone! It would untax the whole economy, create more jobs and allow American products to compete in the global economy. Foreign companies would bring trillions of investment dollars here to build new plants and create even more jobs. It all adds up to one thing- more power to the America people.
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