The Fair Tax Smack

To say the reaction to my last piece on the Fair Tax has stirred conversation would be an understatement. I’ve been called every name in the book except for the worst possible insult. No one has yet to accuse me of being a Yankees fan.

In all seriousness, much of this has come from my fellow conservatives, and has been directed at myself and other supporters of the Fair Tax. It’s amazing the amount of bile and vitriol in conservative circles. There’s a reasonable disagreement over whether we should have a Fair Tax, a Flat Tax, or tinker around with the current code. I don’t think anyone advocating these positions, least of all, grassroots pundits, are intentionally misrepresenting anything. If, within our own ideological camps, we can’t even reasonably disagree, then we are in for serious trouble as a nation.

There are a few areas of confusion that do need to be cleared up. The first is in regards to the rate of a National Retail Sales Tax. It’s a 23% tax inclusive rate. That means 23% of the shelf price of a product goes to the tax. However, this is not the way states calculate tax. State sales taxes are a tax exclusive rate that is added up at the register on top of the shelf price of the product.

The fair tax takes a pre-tax cost of a coat at $77, adds in a $23 tax that brings the shelf price to $100, and says that the coat has a 23% tax inclusive rate because the tax makes up 23% of the shelf price of the coat.

Under the state sales tax/exclusive tax rate model, using the same numbers, the shelf price of the coat is $77 and the additional $23 in tax added at the register is 29.87% of that. Your total bill is still $100, only you may find yourself over budget if you forgot about the tax or miscalculated it.

Fair Tax opponents insist the tax inclusive rate is used to make the Fair Tax seem smaller, thus jumping to motives and mind-reading in a political debate. There’s actually a far less sinister motive.

The tax exclusive rate doesn’t actually tell us a whole lot when it comes to the cost of the tax. Try asking this question of someone, “If you’ve spent $10,000 including tax and the tax is 30%, how much tax have you paid?” I’ll wager that in most cases, the person will either shrug their shoulders or incorrectly identify the amount as $3,000 (the correct answer is $2300.) Figuring out 23% gives people a far better idea of the overall cost. I suppose we could universally agree to state the Fair Tax as “29.87% which equates to 23% of what you spend”, but barring that, the 29.87% is as likely, if not more so, to confuse the issue than the 23% rate.

Second is the issue of embedded taxes. In my previous column, I reported that embedded taxes were 22% of the price of goods and services. While this was accurate, there was an issue with the computation of those taxes. The professor who calculated the rate included taxes employees had to pay on their own income.

What this meant is to achieve a 22% cut in prices as a result of a Fair Tax, employers would have to cut Employee wages to their current after-tax amount. In many cases, this isn’t possible due to minimum wage laws and written labor contracts, nor is it feasible that most companies will be able to pull this off. Those who try would find a rush of employees heading for the door. The only exception here would be the self-employed (Contractors, Lawyers, Doctors, etc.) who have to pay their own employer portion of the payroll taxes and whose income taxes are directly paid by their clients.

Therefore, without employee taxes, the best estimate I can find is an embedded rate of 10-12%. I’d lean towards the 12% figure due to self-employed people reducing some pre-tax prices further to remain competitive.

Under this scenario, most people will still come out ahead. Not only will everyone have 100% of their earnings without income or payroll taxes taken out, but every American household will be issued a prebate at the start of the month that will cover the cost of paying the tax up to the poverty level. In addition, savings, retirement, tuition, the purchase of used goods, loan payments, and charitable contributions will not be subject to tax. As it is now, only the 30% of Americans who itemize can claim the mortgage and charitable deductions.

Still, its undeniable that there will be some losers under the Fair Tax. If we’re looking for a plan without losers, then we might as well lay aside the issue of tax reform. Trying to say, “Everybody’s a winner,” particularly in the short term, is great politics, but it’s unrealistic policy. Every plan will have winners and losers. For example, under the Flat Tax, my wife would lose her student loan interest deduction. Itemizing Americans lose tons of deductions under the Flat Tax as well. Under the Fair Tax, I lose the savers tax credit, which in addition to my tax deduction for retirement savings, gives me a partial tax credit for each dollar I save for retirement.

That said, ultimately, we’re all losing under the current tax system. Our complex income tax code is helping to drive jobs and investment offshore. The tax code is a $400 billion drag on our economy in compliance costs alone, drives our trade deficit, punishes investment and achievement, and helps foster a culture of corruption in Washington.

A reasoned debate needs to be had over how we fix these problems, not just a selfish argument over who benefits and who doesn’t.