Wow this sounds great, a tax that is fair.  Who could be against that?  Well the answer is this writer.  I’m betting that a lot of hard working Americans will join me after they do some research. 

My research consisted almost exclusively of studying the works of the proponents of the Fair Tax.  That’s not a typo folks.  I read the works of Neal Boortz and Congressman John Linder (R, GA-7).  I spent considerable time on Fairtax.org, the official website of the Americans For Fair Taxation.  Come to think of it that sounds pretty good at first too.

Upon further review, (the NFL reference is not an accident – read on), this proposal is a lot better example of marketing than it is of tax policy!

The birth of an idea

 

The Fair Tax is the idea of three wealthy men from Texas: Leo Linbeck, Robert McNair and Jack Trotter.

Leo Linbeck is the Chairman of Linbeck Corporation.  He also controls The Aquinas Companies with revenues of over $600,000,000.00 annually.  In 2006 Robert McNair was ranked at number 562 on the Forbes list of the richest people in the America.  I’m sure some of that wealth comes from when he sold Cogen Technologies to Enron in 1999 for 1.5 billion dollars.  Yes, that Enron, not exactly something we cheer for.  However, Mr. McNair gets his fair share of cheers on fall Sundays as Chairman& C.E.O. of the Houston Texans.  Jack Trotter’s wealth is harder to trace since his holdings are private and not subject to the disclosure of public companies.  I sincerely do not mean to imply anything wrong with that.  It is perfectly legal and ethical.  However, I feel it is safe to conclude that Mr. Trotter is considerably wealthier than anyone in my neighborhood or yours.

There is an old adage that I judge you by the company you keep.  In searching the record of these men’s political donations some interesting things jump out.  Their support of Texas candidates is commendable.  However there is considerable activity in support of out of state candidates.

Let’s explore the beneficiaries:  Representative John Linder of Georgia leads the list.  He also leads the charge for the Fair Tax.  Former Senator Larry Craig of Idaho.  Yes, that Larry Craig of airport potty fame, Representative Roy Blunt of Missouri, Senator Sam Brownback of Kansas.  A particularly interesting one is Rick Lazio.  For the vast majority of you who don’t remember him you are excused.  His opponent and the eventual winner is the famous one.  Rick Lazio stepped into the 2000 New York United States Senate race to replace Rudy Giuliani who was getting killed in the polls by Hillary Clinton.  There is one thing in common with these and many other out of state beneficiaries – they are all Republicans.

There is nothing illegal about donating money to an out of state political candidate.  I just want you to ask yourself one question.  If you were an ordinary American living in Texas would you have donated money to any of these candidates?

What is the Fair Tax?

 

The proposed Fair Tax would eliminate our current income tax system, along with Social Security and Medicare withholdings and replace them with a national sales tax.  It is a little more complicated than that and the proponents have very slickly packaged it under some different verbiage, but that is essentially the proposal.  Basically we would change from a system of taxing income to a system of taxing consumption.

It doesn’t sound all that bad at first glance.  Let’s do a little homework together.

Eliminating the IRS

 

This is the first major promise of the Fair Tax proponents.  Since we have eliminated income tax, along with all other payroll withholdings, we no longer need an IRS, the Fair Tax proponents assert.  They may literally be able to fulfill their promise to eliminate the IRS.  However, that would be in name only.  Who would collect the revenue from the new tax?  Who would enforce it?  Who will administer it along with the new prebate that is featured in their plan, (more about it later)?  We may chose to call it something else but it will still be a huge Federal Bureaucracy, the net effect is zero.

This is the first of many naive assumptions that the Fair Tax proponents make.  Again, great marketing but lousy tax policy.  The IRS is not exactly the most beloved American institution, therefore mention the idea of eliminating it and the vast majority of Americans are predisposed to start out liking your idea.

What would be subject to the tax?

 

All retail consumption except education would be subject to the Fair Tax.  Buy food and you are subject to the tax.  Pay your utility bill and you are subject to the tax.  Buy clothing and you are subject to the tax.  Go to your health care provider and you are subject to the tax.  Spend money on anything other than education and get hit with a tax bill.

Businesses to business sales for resale go untaxed under this plan.  Not a bad little feature if say you were a Texas oilman.

The prebate

 

At the beginning of each month every family would receive a payment from the government to offset the cost of the sales tax to be incurred that month based upon the size of the family up to the poverty level.

Great marketing again!  At the beginning of every month the government sends me money.  The initial reaction of most Americans is sign me up.  Prebate, you mean a rebate I get before the fact?  Sign me up again.  Wow, there really is a Santa Claus and he lives in DC not at the North Pole.

Not so fast.  Read the fine print, “Up to the point of the poverty level”.  That means if you want to feed, cloth and shelter your family well then you will be taxed for it.  This plan is a race to the bottom.  If you want to feed your children meat instead of rice and beans you will be taxed for that extravagance.

You have to admire the packaging though.  Prebate – what a great word – wish I had thought of it.

So how much is the tax anyway?

 

The Fair Tax proponents are suggesting a 23% inclusive consumption tax.  That may sound like uncomfortable language but language is very important to a con man so I have to quote them accurately.  We will explore the verbiage later.

This tax is designed to be revenue neutral.  In other words the federal government would derive the same amount of revenue but through a sales tax instead of the payroll deductions.  Well that doesn’t sound bad you say – I’m paying the same amount in tax just via a different method.

Not so fast – the Fair Tax is designed to be revenue neutral to the government but not necessarily to any individual taxpayer.  In fact, it is only from the viewpoint of the federal government that the Fair Tax lives up to its name.  The IRS, oh excuse me the agency that is really the IRS but is no longer called the IRS because we eliminated the IRS, gets the same amount of money.  The taxpayer may pay more or less depending on whether he decides to voluntarily pay more taxes by consuming.  That’s right, the Fair Tax proponents say one of the great features of their plan is that taxes now become voluntary.  They are correct.  If you chose not to feed your family, heat your home in the winter, use electrical appliances, put fuel in your car etc. then you don’t have to pay taxes.  These people also have a solution for air pollution – stop breathing.

23=30

 

What is a consumption tax?  It is a sales tax.  How do Americans envision a sales tax?  You go into a store and take an item with a $100.00 price tag on it to the counter.  The sales clerk rings you up and since there is a 7% sales tax in this municipality you pay the clerk $107.00 and go about your day, simple enough.

OK, therefore since the Fair Tax people tell me that they are charging a rate of 23% that $100.00 purchase would be $123.00.  Wrong.  They are saying that the $100.00 already includes $23.00 in taxes.  $23.00 in taxes on a $100.00 purchase is a sales tax rate of 29.87012%, (23 divided by 77), or for us mere mortals 30%.

Neal Boortz goes on and on with his inclusive versus exclusive charade but the bottom line is this is a sales tax and Americans envision a sales tax as something they pay on top of the selling price of the good.  Difficult to follow – you bet!  Just remember you get $77.00 worth of pre-tax value for your $100.00 purchase under the Fair Tax.  Hey, which shell did the pea end up under anyway?

For those of you familiar with retailing this is similar to the relationship between gross profit percentage and markup.  A 33% gross profit percentage is equal to a 50% markup.  If you are a supplier trying to convince a retailer that they should carry your product you tell them that they can get a 50% markup, not a 33% gross profit.

If by some miracle the Fair Tax ever became the law of the land, I seriously doubt that the tax would be in the shelf price of the item.  Retailers are not going to include the federal sales tax in the shelf price and add on the state and local sales taxes at the checkout just to accommodate the Fair Tax proponents.

What happens to my paycheck under the Fair Tax?

 

Fair Tax proponents correctly point out that under their proposal your employer has the opportunity to pay you your gross paycheck.  Since they no longer have to deduct for Income Tax, Social Security and Medicare withholdings, employers may pay those sums to you.  In fact, they could even give you a pay raise to reflect the employer payroll taxes they will no longer have to pay.  Will they?  In all honesty if the Fair Tax ever came to pass I think employers might actually pay you the gross paycheck.  As to the employer contributions that would no longer exist – don’t hold your breath, unless of course you are trying to avoid the air pollution problem.

Wow, what a great deal I get to keep all the money I earned plus maybe even get a raise!

What happens to consumer prices under the Fair Tax?

 

Fair Tax proponents say they stay essentially the same.  The 23% tax is offset by the 22% savings employers experience by not having to pay the amount they pay their employees that is deducted to cover Income Tax, Social Security and Medicare withholdings and the employer payroll taxes that will no longer exist.

Wow, I just got a big raise in take home pay and prices stayed the same at the stores.  This Fair Tax plan is too good to be true.

Wait a minute, this Fair Tax plan is literally too good to be true.  Didn’t it just spend the same dollar twice?  Exactly, your employer can’t give you a raise in take home pay and lower the cost at the same time.  The Fair Tax proponents actually admit this but then go on to use the same dollar twice in example after example by discussing wages separate from prices as I just illustrated in this and the previous section.

It has to be one or the other and that doesn’t even allow for greed on the behalf of the employer.

Dirty words

 

The fair tax people bad-mouth our current progressive income tax system every chance they get.  They really don’t care about accuracy as long as they can make it sound bad. Neal Boortz has continually linked the progressive income tax system to The Communist Manifesto.

The history of progressive taxes predates the American Revolution by decades.  In terms of American history the War of 1812 brought about the first progressive tax, it however was never instituted since the Treaty of Ghent in 1815 ended the war that made it necessary.

Karl Marx was born in 1818.  Now Mr. Boortz and I may have an honest disagreement about when life begins, but suggesting that Karl Marx influenced American tax policy six years before he was born is going too far.

You may ask why I am spending so much time on Neal Boortz.  Fair question, he is the Fair Tax people’s chief mouthpiece.  His credibility is an issue.  His verbal slight-of-hand is masterful.

Taxes that go away under the Fair Tax

 

Fair Tax proponents brag that under their proposal Capital Gains and Estate Taxes no longer exist.  That is true.  Who does that benefit?  This is a much bigger benefit to wealthy Americans than to the poor and middle class.

The overwhelming majority of Americans will never be subject to the Estate Tax.  Our families simply are not nearly wealthy enough.

I’ve heard all the arguments in favor of eliminating the Capital Gains tax.  Capital gains are currently taxed at a much lower rate than earned income.  The idea of this is to spur investment.  It has really worked well so far hasn’t it?  Ask yourself this: who is more likely to be concerned about capital gains – a guy making $40,000.00 a year or a guy making $5,000,000.00 a year?  To most guys making $40,000.00 a year capital gains is irrelevant.  There are a lot more $40,000.00 guys than $5,000,000.00 guys in America.

In another case of the “haves” and the “have-nots”, the tax on earned interest disappears.  Who derives the greater benefit, the single mom working two jobs while trying to raise her kids with a few of her hard earned dollars in a savings account or the heiress with her inheritance that she lives off of?  Lucky sperm cell club wins again.

What deductions go away under the Fair Tax?

 

The short answer is all of them.  Since there is no longer an income tax there is no tax to deduct from.  Well you say the solution to that is simple just exempt them from the new sales tax.

The only thing that is exempt from the sales tax is education.  I assume that will be limited to tuition.  I’m not sure how a retailer is going to determine if the laptop you bought is for home use or a student’s use at school.  The deductions for interest on your mortgage payment, charitable donations, medical expenses, state and local sales tax, property tax and military reservists travel expense all gone.

The Fair Tax advocates insist that any other exemptions would throw the Fair Tax out of balance of its goal of being revenue neutral.

It will be interesting to watch the number of Fair Tax advocates who will attack President Obama’s plan to decrease the rate at which charitable donations can be deducted.  A decrease will be a disaster for the charities but an all out elimination will have little effect.  If you can understand the logic behind that one please explain it to me.  A word of caution – don’t use Boortz’s logic I heard him and rejected his explanation.

Foreign tourists

 

The Fair Tax people rail against those nasty foreign tourists who come over here and use our facilities without paying taxes.  Under the Fair Tax they will pay taxes because it is a consumption tax.  They even make an argument that tourists will flock to the new legal tax haven they have created.  They are adamant that we adopt the Fair Tax first so as to get the jump on the rest of the world that is sure to follow.  This is among their most unbelievable assumptions.

The Fair Tax will hurt foreign tourism.  It will simply make a visit to America more expensive.  You can debate the relative merits of that outcome but the net result of less tourism is indisputable.

The underground economy

 

The Fair Tax proponents say one of the features of their plan is that it will do away with the underground economy.  Their reasoning is that if your income is derived from illegal activity, which is not taxed, that your consumption would still be taxed.  There is something to be said for this.  However, the Fair Tax proponents are again naïve and do not even begin to explore the other side of this coin.

The example they like to use is the drug dealer buying a Jaguar with his ill gotten and untaxed income.  This example would occur; however reading University of Chicago economist Steven Levitt’s book Freakonomics would give these people a real world not Hollywood look at drug dealing.  A more likely example is the street level dealer buying a pack of cigarettes.  Underground to underground transaction would still escape taxation.  The common occurrence of a street prostitute who buys crack comes to mind.

One of the assumptions of the Fair Tax people is that tax cheating would all but disappear.  Since the vast majority of retail transactions take place with large retailers it is assumed they will be totally honest because they have too much to lose.  Big companies that would never cook the books – and one of their founders did a 1.5 billion dollar deal with Enron – I rest my case.

Turning to smaller business:  State tax officials catch businesses cheating in the environment of relatively low rates of 5, 6 and 7 percent.  It is unreasonable to assume that cheating would stay the same or go down in an environment of 23% plus taxation?  The Fair Tax people’s 23% can easily be considered 30% add to that say a 7% state and local sales tax.  Sounds like plenty of temptation to me.

What will State and local municipalities do under the Fair Tax?

 

Almost without exception State and local governments across the nation are hurting for revenue.  If the Fair Tax were to subject many goods and services that are now exempt from sales tax to the national sales tax how long do you think it would be before the states would lift the exemption?  Your $100.00 grocery tab could very easily become more like $135.00 to $140.00.

Some of the things that are now exempt perhaps should be taxed.  That is a debate for another time.  However, the Fair Tax will increase the tax burden of the average American.

The philosophy of taxation

 

The Fair Tax proponents view taxation as a way for government to raise revenue and a way to punish the people.  I agree with the former but disagree with the later.  I feel taxation should encourage certain economic behaviors and discourage others.

That spirit of encouraging desired behavior is the idea behind the tax exemption for the interest on home mortgages.  It is in the best interest of society that Americans own their homes where possible.

At this point in time we, for the most part, do not tax Internet sales.  The Fair Tax proposes to do that.  This is one of the few points of the Fair Tax I agree with, in principle at least.  In the past I felt that Internet sales should go untaxed because the industry was in its infancy and we had to give it time to mature.  That time may have passed or certainly soon will.

If you noticed my qualified agreement it is because the second reason I favored leaving Internet sales untaxed still exists.  I’m not sure how we would collect and enforce it.  That is a logistic that will soon need to be worked out.  It is not fair to bricks and mortar stores to operate at a disadvantage and the industry is now well established and the governments need the revenue.

The incentives have to be changed often.  The World Wide Web celebrated its twentieth birthday in 2009.  In my adult lifetime I saw the amazing impact of the fax machine and its obsolescence.  When managed properly our current progressive tax code is the perfect vehicle for this dynamic marketplace.

Taxes as punishment

 

Let’s assume that the Fair Tax proponents are onto something and taxes are a punishment.  They assert that our current progressive income tax system is a punishment of high achievers and earners.  Well that would be true in a system that got to the point that it cost you money to earn money.  That would be a tax rate approaching or exceeding 100%.  None of us want to go there.  I am requesting stories from employers who had employees turn down raises because the tax implications would leave them better off without the raise.  I decided not to open up a new Post Office box for the flood of letters that won’t be coming in.

Cut through the rhetoric, (in this case a polite word for something coming out of the back end of a bull), and we have not created a disincentive for earnings.

Now let’s look at the effect of the proposed Fair Tax.  We would impose a tax of at least 23% on virtually all consumption.  It would be totally naive and illogical to assume that would have anything other than a negative effect on consumption.  Discretionary Disposable Income (DDI) takes on a whole new importance in this proposed economic environment!  If the Fair Tax is not anti-consumption than I don’t know what is.

Let me remind all these supposed friends of small business that there is no positive bottom line, (profit), without a top line, (sales/revenue).  If you sell an absolute necessity of life you may be unaffected under the Fair Tax.  If you sell something discretionary it doesn’t look pretty.

The bottom line

 

If you make a lot of money and you spend only a small portion of it the Fair Tax is great for you.  If you make a moderate amount of money and spend a good part of it the Fair Tax is a bad deal for you.  If you spend most, all, or more than you make you will get killed under the Fair Tax.  Most Americans fall into the second or third category.

The Fair Tax is like a beautiful poisonous flower.  It is fine to look at it but don’t touch it.

Larry Marciniak

April 2009

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