Monday, November 29, 2010

Whatever's Fair

The FairTax is innovative, reasonable and frequently misrepresented. Indeed, it is a consumption tax that is collected at the point of final sale on new products…used items are exempt because the underlying premise is that something should not be taxed more than once. As it has been proposed, the FairTax replaces nearly all existing federal taxes (income, AMT, corporate, Social Security, Medicare, gift, estate) on a revenue-neutral basis. As designed the FairTax would NOT replace certain excise taxes such as the gasoline tax, the communication (telephone, internet) tax and selective limited resource extraction taxes. The greatest weakness of the FairTax proposal, in my view, is that it does not address massive government spending, although I understand the reasoning for this posture---to minimize opposition and simplify the argument. My preference is that we eliminate the excise (hidden) taxes as well, and offset their revenues with spending cuts. If this scenario can be achieved, then no one pays ANY federal tax until they consummate a purchasing transaction for a product or service.

The analysts have concluded that as originally constructed, a FairTax of 23% on every new product or service would offset the monies generated by the non-excise sector of the federal tax code. Their examination has yielded that each domestic commercial transaction carries with it an “embedded” tax of roughly 22%. That means that throughout the cycle of the product or service from raw material to finished product/delivered service, the various federal taxes that are levied at each stage of the process comprise approximately 22% of the final cost to the consumer (taxpayer). At first glance one might assume that the FairTax would be more costly for the taxpayer (23% vs. 22% embedded). Okay, it’s math time.

For the sake of clarity and as a fiscally responsible commentator, I will assume for this model that the actual impact of the “embeds” is a mere 18%. If the price of an item is $ 1.00 (one dollar), then the REAL cost without taxes would be eighty-two cents ($.82)(1.00-.18=.82). When we add the FairTax to the cost of the product or service, we note that amount to be $1.0086 or $1.01. So, if the embedded amount is only 18% versus the 22%, then the final transaction COULD be a penny higher than it is under the present structure…….BUT remember, you are not paying withholding taxes for income, FICA or Medicare. Let’s assume that you have 19 exemptions and pay NO income tax. Your FICA rate of 7.65% means that even IF the cost of goods and services were to rise by one per cent, you will continue to net 6.65% of your gross income for saving, additional purchases…whatever you desire. I truly believe that this is a very conservative estimate. In my view, your net yield will be much larger which in turn would generate more economic activity.

The previous discussion has overlooked an important “embedded” benefit. Just as the individual wage earner/taxpayer will not be required to pay the FICA tax, neither will the employer. This outcome could lead to lower prices, more capital investment or higher profits and wages. Any of these results would provide a benefit for the economy.

So, the easy question is how does this FairTax concept really help the taxpayer? And the easy answer is …more freedom. Your overall tax liability will, in a large measure, be determined by you. Need a car? Well, purchase a Kia and pay a relatively low tax, buy a Lexus and pay a higher sum,…..or buy a late-model used Cadillac and pay NO tax. The choice is yours. You choose. Acquire your clothes from high-end thrift shops and pay no tax. Have a garage/lawn sale and be legal, for once, by collecting no tax.

Tomorrow we’ll examine how to offset the lower incomes of the poor, and examine the mechanism for implementing the FairTax as a REPLACEMENT not an ADDITION to the current tax nightmare. Please check out .

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