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Rejecting FairTax Part Two: What You Don't Know About FairTax

In Part One, I’ll cover the dangers of taxing consumption as a major source of government revenue, both to the individual and to the economy.

Part Two will cover the little-known problems in the FairTax proposal- the “fine print” FairTax advocates won’t tell you about (or don’t know themselves); I’ll also refute some of the inconsistencies and rhetoric used by FairTax advocates.

Part Three will introduce the reader to the benefits of flat income taxation- why it’s superior to consumption tax, and the economic benefits of flattening the tax code.

Part Four will introduce the reader to the Negative Income Tax Credit- an ideal solution to the the problems of our massive welfare state, which can only be implemented in conjunction with an income tax system.

Part Two: What You Don’t Know About FairTax

In the last segment, I illustrated the problems inherent in consumption taxes generally; in this part, I’ll address the issues with Fair Tax specifically.

First: FairTax is a hidden tax. In order to avoid the offensiveness of instituting a high sales tax, a part-and-parcel component of the FairTax legislation is to make it an “inclusive” tax, one which is built into the sticker price of goods and services, as opposed to the “exclusive” sales taxes we are already familiar with, where the tax is added on when we get to the cash register.

Inclusiveness conceals the real rate of taxation. To illustrate this, I’ll use a simple example:

FairTax, as proposed, would be levied at an “inclusive” rate of 23%. This means 23% of the sale price is remitted to the government by the seller. If the seller wants to sell an item and make $1.00 from the sale, he must sell the item for $1.30, because 30 cents is 23% of $1.30.

In other words, a 23% “inclusive” rate is actually a tax rate of 30%.

This disparity between actual rate and inclusive rate grows as the tax grows: At a 33% “inclusive” rate, the actual rate would be 50% (33% of $1.50= 50 cents).

Consider this point: FairTax advocates propose FairTax as a replacement for federal income tax (up to 35%), FICA (15.3%, for both “halves”), and several other taxes. Considering this, does it seem unreasonable to believe that these taxes would be replaced by a “33%”, rather than a “23%”, tax?

In fact, the “23%” rate is only guaranteed in the FairTax legislation for two years- after which, a formula is used to calculate a new, higher rate, defined in the FairTax bill (see link at bottom) as “the general revenue rate, old-age, survivors, and disability insurance rate, and the hospital insurance rate”.

Second, unlike current sales taxes, FairTax is not just a tax on goods. FairTax, if instituted, would apply to services as well. Stated another way, this means a 30% markup your phone bill, your car insurance bill, your cable bill, your garbage removal bill, etc.; a 30% markup on your grocery, fuel, medication, and clothing purchases; a 30% markup on the purchase of a home or a car. If your washing machine or central air conditioning breaks down, the cost of parts and the bill for labor from the appliance repair service will include a 30% markup. This “30% markup”, of course, assumes a FairTax rate of 23% (see above).

FairTax advocates frequently argue that this markup wouldn’t occur, because other taxes embedded in products would be eliminated, so the price of goods would remain about the same. Hank Adler makes an excellent case to defeat this assumption, in reference to the sales tax component of Herman Cain’s 9-9-9 plan:

One need only look to the annual report of Safeway to understand the impact of 999 on grocery prices. Because the grocery business is incredibly efficient and there is significant competition, there are very, very low margins in the industry. The pretax profit in good years for Safeway is only about 2% of sales and the Federal income taxes therefore are less than 1/2% of sales. After making a reasonable guess based on other information in the Safeway annual report, the total Federal income tax plus Safeway’s portion of their employees’ payroll taxes is less than 2% of sales. Assuming that would all be passed through to the customer in the way of price reductions, the price of food must increase by about 7%.

This is, of course, in reference to the effect of a 9% tax. Consider this effect with a 30% tax!

Third: FairTax doesn’t eliminate payroll taxes. It doubles them. Another inclusion stated in the FairTax legislation (see link at bottom), is the requirement that businesses pay the 30% markup on wages and salaries if the employee’s services constitute a “taxable service”, defined as:

A taxable service is used to produce, provide, render, or sell a taxable property or service if such property or service is purchased by a person engaged in a trade or business for the purpose of employing or using such taxable property or service in the production, provision, rendering, or sale of other taxable property or services in the ordinary course of that trade or business.

This definition is extended to also include “research, experimentation, testing, and development”.

Translation: Since virtually every employee (other than a personal employee such as a maid or chauffeur) meets this definition, every employer will be required to pay a 30% tax on wages and salaries.

If this doesn’t make you, the reader, jump away from FairTax right now, I don’t know what will.

Fourth, this 30% markup on everything extends to purchases by state and local governments. Yes, you read that correctly: State and local governments will have to pay taxes to the federal government. This means two things to you: 1) Your state and local taxes will go up; 2) State and local governments will be in continuous debt to the federal government.

This brings us to the Fifth point: The claim made by FairTax advocates that FairTax would eliminate the Internal Revenue Service. This is false.  As you can see in the FairTax bill (see link at bottom), the IRS would merely be renamed as two new agencies: The “Excise Tax Bureau” and the “Sales Tax Bureau” of the Department of Treasury. Some personnel would be transferred to the Social Security Administration to administer the prebate program (see “Eighth”, below).

However, the responsibility of collecting the tax would be transferred to state tax departments. In other words, not only would state and local government be constantly indebted to the federal government, but would also be required to perform work for the federal government.

This bizarre arrangement has another implication: It paves the way for further federal intrusion into state affairs. Instead of Congress debating over ways to fund new mandates on the states, Congress will simply be able to place mandates on the states in exchange for a tax credit. Cash-strapped states (i.e. every state, currently) will accept these opportunities to lower their tax burden to the federal government.

Stated differently: You can kiss the Tenth Amendment goodbye.

Sixth: On the subject of Constitutional amendments, we encounter another problem with FairTax: The Sixteenth Amendment, which authorized the federal income tax. Adding a constitutional amendment is extremely difficult; it’s even more difficult to repeal one. In the case of FairTax, in order to be constitutional, both would have to happen: The Sixteenth Amendment would have to be repealed, in order to prevent Congress from taxing both incomes and sales (and you and I both know Congress would do that if given a chance), and to authorize a federal sales tax. FairTax advocates believe the Constitution already permits a national sales tax. I disagree. The Constitution authorizes taxes which are limited in scope- excise taxes, which are currently applied to a specific category of goods- but does not authorize a universal tax on the sale of all goods and services. We already have enough problems with Congress assuming powers not expressly granted in the Constitution, without handing them another one.

Seventh: On the subject of federal power grabs, let’s consider an implication of any (and every) sales tax. Governments use sales taxes to manipulate purchasing habits by exempting certain products from taxation. The states are limited in their ability to do this, however, since a price difference of 5-8% generally isn’t enough incentive to change the buyer’s mind about a purchase. The federal government’s ability to manipulate purchasing habits is also currently limited to income tax credits, which can be claimed at the end of the year to partially offset the cost of a major purchase such as a hybrid car or a new home, months after the purchase is made. The ability to immediately alter the shelf price of items by 30% or more would give the federal government an unprecedented ability to centrally plan and manipulate the economy.

Eighth and last is the “Prebate”. As shown in Part One, consumption taxes are highly regressive. In an attempt to offset this regressiveness, the FairTax proposal includes a “prebate”, a check issued to every household in the United States, every month, to offset the amount of sales tax paid up to the poverty line.

This, of course, presents two significant issues:

1) Any argument that FairTax would reduce federal bureaucracy is patently absurd, given that this proposal means the federal government would now have to issue more than a billion ‘prebate’ checks every year;

2) The next time our government experiences a budget crisis (as we’re experiencing now), there will no doubt be an effort to “means-test” the prebate- just as there are now proposals to means-test Social Security and Medicare. A “means-tested” prebate would amount to yet another welfare grant. Instead of working to reduce the cost and scope of the welfare system, this would only add to it.

In sum: In addition to all the problems with consumption taxes generally, FairTax would give us a stealth tax, embedded in the cost of goods and services, which uses ‘fuzzy math’ to conceal the true rate of taxation; FairTax would present insurmountable Constitutional issues; it would give the federal government unprecedent power to manipulate both the economy and state governments; and would pave the way for a costly new welfare benefit.

Folks, don’t be hoodwinked by slick FairTax salesmen. Don’t make the mistake of assuming (as many FairTaxers do) that anyone opposed to FairTax is a “closet liberal”, or “opposed to change”. And don’t blindly accept any change just for change’s sake.

You can read the full text of the FairTax bill presented to Congress (the most recent version) here.

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  1. You can certainly see your expertise within the work you write. The world hopes for even more passionate writers such as you who aren’t afraid to say how they believe. At all times go after your heart.

  2. You really make it appear so easy with your presentation however I in finding this topic to be really one thing that I believe I might never understand. It kind of feels too complicated and extremely vast for me. I am having a look ahead to your subsequent post, I’ll attempt to get the hold of it!

  3. Jim Bennett says:

    Kauffman’s criticisms ring hollow and present nothing that we FairTax-ers haven’t heard before. The first argument about expressing the tax in tax-inclusive terms is purely semantic. It is akin to contending that I am not really 5 feet 8 and a half inches tall, I’m really 175 cm tall. The taxes that the FairTax replaces, by the way, are also expressed in tax-inclusive terms.

    Even if the rate is not just 30% but let’s say 35%, the argument misses the core issue. You’re paying that much already. You just don’t see it today. Between tax costs that are built into the cost of goods and services and taxes taken out of your pay, we know what the REAL hidden taxes are. The FairTax makes federal taxes glaringly overt. And purchasing power actually rises -even though the FairTax is a consumption tax.

    The FairTax makes no secret about taxing governments, which are end consumers of goods and services just like individuals. State and local government consummption is 9.7% of total consumption. Taxing government consumption is necessary. Without it there would be a flight from privatization towards the public sector. The FairTax, as in indirect tax, may tax state and local consumption constitutionally. See Helvering v. Gerhardt, 304 U.S. 405 (1938), Massachusetts v. United States, 435 U.S. 444 (1978). When state and local governments lose the ability to transfer part of their burden to the federal government through the state and local tax deduction, the become more responsible.

    And while we are on the subject of constitutionality, there is no immediate need to repeal the Sixteenth Amendment before passing the FairTax. Congress and the state legislatures will do that all on their own. The FairTax sunsets if congress and the legislatures fail to act within seven years.

    The FairTax also makes no secret of having a broad base, including services. Any other arrangement would invite cherry-picking by lobbyists. By taxing all goods and services at retail at the same rate, the FairTax shows niether fear nor favor and maintains a lower marginal rate than income taxes. The regressivity issue is addressed through the Family Consumption Allowance, popularly known as the “pre-bate.”

    Administration of the pre-bate is simple. By one account, 70% of American households already receive a benefit from the federal government. By growing the address list only 43%, the entire country is covered, and the need for cross-checks between the IRS and the Social Security Administration is eliminated.

    Mr. Kauffman will have to do far better than this piece if he thinks he can break the sale.

    ~Jim Bennett
    Summit, NJ

  4. Al says:

    The FairTax amount will be visible. It will be printed on every receipt for a consumer purchase. The rate used is 30%. The 23% rate is used to compare it to an income, or inclusive, tax. Any research will show that our tax system adds to the costs of goods and services. Art Laffer recently showed an added cost of $431 billion or 30%. The FairTax will eliminate these embedded costs and reduce prices.

    The FairTax is not 9-9-9.

    Payroll taxes are eliminated. Businesses will pay zero taxes. Please read the legislation.

    If governments were not charged the FairTax they would be able to outbid all contractors for ALL projects. Just think about what that would mean.

    The FairTax would not eliminate the IRS. It would still be needed to collect tax returns from each state. But only the states.

    Congress’ control over your spending habits with tax breaks etc. has reached its zenith because of our current tax system.

    The prebate is expected to be issued electronically to most households. Each month roughly 115,000,000 prebates would be issued.

    The ability to defeat the ignorance shared by the writer can be defeated with a little research. Read the bill at http://Thomas.loc.gov. Search for bill number hr25 or s13.

  5. WillofLa says:

    Now, I’m going to try to disassymble this arguement. Firstly, I agree that the people who came up with the 23% were wrong in how much money they would need to do all that the government would need to do. And the other thing is the tax is not based on how much a person would want to make on something they sell. The tax is just on the price of the product, not on the price plus the profit margin, which in this case is the example of $1.30. That premise is all wrong. The Fair Tax should be only on the price. If the company wants to make a certain amount then they, as they do now, is added onto the price of the product, not some added amount that he wants to make later on when the sale is going on. If the seller wants to make a $1.30 on his product, then he needs to add that when he quotes the price. If the price is $5.00 + $1.30 then the tax will be on $6.30, not the $1.30 profit part.

    But it’s the 23% that I disagree with to begin with, and the way that the people who came up with this amount left the door open to further raises in the near future. That is wrong. If they are going to come up with higher and higher taxes based on the fact that there’s not any longer a “income tax”, it would have to be assumed that there still would be a Social Security Admin. who’s duty it would be to pay out Social Security retirement payments, which under the full bill would not exist because people would be responsible for putting back money for their own retirement, and not have to depend on the government. But there would necessarily need to be some kind of Disability payments, and Veteran’s Disability payments because you can’t just cut off these people who became injured in some way and were no long able to work. What would you do with them just throw them out into the street? Have them rely on family members or the church? And I don’t know about Disability for State workers or City or County workers who became disabled at no fault of their own or had a accident. I don’t know what to do for them but that is not the subject anyway. That would have to be figured out later on based on how much of this huge money that would be pouring into the government anyway.

    But as far as all the other taxes that don’t apply to some things and do to others, it’s that way anyway. Individuals won’t have to pay “corporate taxes”. And small businesses don’t pay other kinds of taxes that the airlines have to pay. So all that would be more or less like it already is anyway. That’s a given. But as far as the individual is concerned since that’s what everyone is concerned about is how much are we going to pay in taxes if we had the Fair Tax in place. I’m saying that what this article is saying is how it would be if the Fair Tax is how it is set up now. And Mr. Kauffman is incorrect about the Constitution not having a tax like what most people think about what it says we would be paying if we had a purely Constitutional tax. The Constitution clearly says that the only tax that would be put on the people, and yes, it does not include all the other fees, costs, administrative fees, etc. that the government collects everyday from businesses that the people don’t have to worry about. That Constitution says that the only tax that is to be levied on the people for a tax on things they buy for businesses is “excise tax” . It doesn’t say how much it is supposed to be, unfortunately. If it did we’d be in better shape than we are now. At least we’d have something to base our taxes on and not the theft we are putting up with now.

    But this “excise tax” is “not” what the people who came up with the Fair Tax says it is. And the reason why is the creator’s of the Fair Tax did not want the Democrats, liberals, or whoever to explode and start accusing them of trying to come up with a bill that was going back to Constitutional taxation, or no income tax, just an excise tax on things people buy. And that’s what I believe the Fair Tax should have been, not this other thing that got everybodies hopes up that we wouldn’t have to pay income tax anymore. And the “inclusive” tax is not the way to go with this tax. It should be added onto the price of the product you are buying, not added into the price of the product. If it’s like that, then, yeah, it would be that way that this writter is saying is would be. But I’m saying that the creator’s of the Fair Tax should not be adding it to the after profit amount, it should be added like all taxes are added after the price of the thing you are buying is rung up, not just one ring up and that’s what you pay.

    I’m saying that this part of the Fair Tax is not as fair if it’s added to the price as something fixed, but only for the first two years then we start paying out of the nose. I’m saying that Mr. Kauffman is wrong if he is figuring the tax based on the price of the product which already has the profit added to it, when it should be figured on the actual price of the product which is what I’m saying the Fair Tax is figured on. If Mr. Kauffman is saying that 23% is actually 30% then where is he figuring it, from a dollar, or a dollar thirty? If he’s figuring it from a dollar then the tax is 23%, but if he’s figuring it from a dollar thirty then 23% of a dollar thirty is $.30, not 30%. It would be 30% if the tax was based on the price of $1.00, but it’s not, it’s based on the price of $1.30, which is still 23% at $.30 cents.

    See, he’s wrong.

    • Gracemarie Collins says:

      Dear WillofLa,
      It appears from your reply that you have some misunderstandings about the Fair Tax.
      First paragraph 1.the 23%, inclusive rate (just like income tax is inclusive) is revenue neutral. The government is funded the same as under the exsiting income tax. The amount they spend is a fight for another day! 2. Right now corporations embedd all their costs of taxes and compliance in their price plus what they want to make in profit. So right now when we buy something we are paying their taxes and the sales tax added on at the register that the applicable state wants us to pay as a consumer. Under the Fair Tax corporations will not have to pay income tax, capital gains, or spend money on compliance. The cost of goods will go down by about the same amount that will be added on by the Fair Tax.

      Paragraph 2 The Fair Tax funds everything that the income tax funds now. Actually Social Security and Medicare will be better funded because under the Fair Tax everyone pays taxes therfore everyone pays into Social Security and Medicare. Wages will still be reported to Social Security and Medicare for every individual who gets a paycheck.

      I would urge you to read all the rebuttals to Mr Kaufman’s article as well as got the Fair Tax.org site and see for yourself.