There is no question that no matter how much we detest taxation and government, there is a need for both. This chapter discusses an alternative taxing structure as put forth by Congressman John Linder and supported by the talk master, Neal Boortz, as well as legions of enlightened followers.

Taxes are far too high, as evidenced by the disproportionately disturbing increase in the federal government's share of Gross Domestic Product as compared to the citizen's share. GDP is simply the money spent during the year. We are approaching 50% today, that means that only half of the economy is controlled by the citizens. In 1900, the government spent 7%, and we had the other 93%.  No wonder we can't make ends meet anymore, we only have half our money.

Despite the harm the Federal Reserve has done, we do have to concede that at this point in history, there may be no way to return to an unregulated competitive banking system as we had prior to 1913. That said, if we can eradicate the other Evil Twin, the Federal Reserve will have less power as well. Just because we reluctantly surrender here, doesn't mean we lost the war of taxation too.

THE FAIR TAX

Tax reduction is the great ultimate goal, but the Fair Tax does not reduce government spending, or overall taxation. It is a revenue neutral approach which projects to generate as much money as government is now absorbing out of the economy  through the myriad of income and payroll taxes currently levied.

Embedded in everything we buy today is income and payroll tax. Like an ingrown toenail to a ballet dancer, the income tax is a constant irritation to not only the businessman, but the employee as well.  There are better ways to fund a government.

THE MIRACLE GIZMO EXAMPLE

When a product comes to market, let's call it the Miracle Gizmo. It is an electronic device the size of a garage door remote opener. The Gizmo electronically locates all of those pesky things we constantly temporarily lose for hours or days at a time. It works either with different color lights, or an increasing sound or your choice. The closer you get to your lost item, the louder the sound, or the closer the color gets to red, you know you're getting warmer. Your keys, your glasses, TV remotes - whatever you program, pocketbook or wallet, your spouse  - whatever you might lose, this handy dandy little hi tech doohickey will, after proper programming, locate your habitually lost items.

Each producer of any commercial item naturally tries to make a profit. (It doesn't matter what is manufactured, "Widget" is a little overused in these types of examples, old, so we made something up a little more interesting we hope.)

In order to bring a Gizmo to market, costs must be calculated to arrive at a price they believe they can charge for it to and be profitable enough to make production worthwhile. It goes something like this - keep in mind this is a very simple example; there could be many more cost categories. This is not meant to be an advanced accounting course.

                                           
                                                                      Current                           Fair Tax
                                                                         Cost                                Cost

Plastic Molding                                                $10                                  $10
Electronic Components                                      15                                     15
Marketting and sales                                           5                                       5
Payroll (employee wages)                                  25                                     25
Payroll and other taxes                                      23                               - NONE -
Plant Expenses                                                  10                                     10
                                                                     ---------                              ---------
Total Production Costs                                      $88                                  $65

Required Profit per unit                                      12                                    12

FAIR TAX AT POINT OF SALE                   - NONE -                              23

COST ON SHELF TO CONSUMER             $100                                 $100


In order to estimate the cost of bringing the Miracle Gizmo to market, we have to consider taxation in several forms, some of which are already pre-considered by our suppliers in advance to arrive at the price they charge us for our raw materials.

First, there is the payroll tax the employer must pay on behalf of the all employees. Employers pay over 7% in tax for every employee for Social Security and Medicare.

Next, there is corporate income tax, which can vary, but would be around 25% of profits, sometimes lower, sometimes higher.

Next are accounting and payroll expenses. In order to comply with the tax laws, these can be another 5% or sometimes more.

Don't forget the taxes along the way paid by the suppliers. The plastic manufacturer also pays payroll taxes, as do all of the other providers to get the Gizmo on the shelf. These come to about another 5% or so. They are already in our costs or purchasing materials from other companies, but are real costs none-the-less.

The total cost of taxes paid but unseen at the sales register in the production of the Miracle Gizmo is about 22-24%  per unit. This does vary, but according to very expensive research done by top economists this comes to about 23% of everything we buy. We use $23 in this example because that isapproximately the average nationwide.

OK, you're wondering why if we have 5% here, 7% there another 5% here and 25% there why isn't the imbedded tax cost over 40% and not just 23%? Some of those costs are born by others, and passed on in the form of pricing. So a 10% cost to the manufacturer of the electronic components for example may only be an additional cost to Marvel of 3% or so in additional expense. These circular calculations are tough - even for Excel, so we rely on the Beacon Hill Institute at Suffolk University and Dr. Lawrence Kotlikoff, Professor of Economics there to provide the boring details. Suffice it to say, the number is 23% for more details, see the report from Suffolk University. They've spent over $20 million dollars analyzing this. Since I personally came up with a similar tax cost of production and sale using my own crude analysis techniques, I am very comfortable with their number. 

The Miracle Gizmo costs consumers the same

The Miracle Gizmo you buy in Wal-Mart will be very close to the same price under the Fair Tax as under our current unintelligible complex system. Rather than offering the Gizmo for $75, they must price it at around $100. If they earn $12 on each one sold, they would have to pay tax of about three dollars, which is also embedded in the price of the unit - somewhere.

That settles it. The Gizmo will be priced at $100 per unit because imbedded in the cost of production is about $23 in tax that must be paid. This is a real cost of production and must be included, otherwise, Miracle Gizmo will lose money on every sale, or the profit margin will not be acceptable enough to produce the gadget. They can't survive losing money on every sale, after, they are not General Motors. They must count all the beans.

Many of you have heard of the Fair Tax, for those who haven't the following is a brief description:

The "Fair Tax" is a national sales tax expected to be set at 23% to be collected by the seller on every new item or service purchased, no exceptions. It is to replace all of the income and payroll taxes currently on the books, it is not in addition to them. When implemented, all income taxes and payroll taxes will be repealed.

Because it is believed that no one should pay tax in the necessities of life, a "PREBATE" will be sent in cash to each citizen with a valid social security number every month. This amount will be calculated and be set at the amount determined to be the sales tax that would be paid at the poverty level. Current estimates indicate that would amount to a check for about $175 per person per month declining slightly as the family increases due to the fact a family of 6 does not have necessities equal to twice the level of a family of three. So a family of four would receive approximately $560 every month in addition to whatever they may have been able to earn.


Rather than force 175 million individuals and businesses the expense and aggravation to file income tax returns in order to raise money for governmental operations, instead we will imbed that 23% at the point of original sale. Like the state sales taxes that are so prevalent, the money will be collected at the register or retail stores, or at the point of service when other goods and services are sold.

Now if you've followed the logic, you will realize that this is not an additional expense of 23% it is replacing the 23% previously imbedded. So rather than offering the Gizmo at $100, Marvel Enterprises, parent company that manufactures the Miracle Gizmo can offer it at $77 because the imbedded tax of $23 or so is not part of their cost equation, and their profit is still $12 per unit sold.

You go into the store, and see the gizmo on the shelf. Its price tag reads $100.  You wonder why because you thought it would be cheaper. Well, the Fair Tax has been added at the shelf, so you pay the $100, about the same as you did before. There is not an additional 23% more at the register. It is still $100. Then add your state sales tax if any to the price - just like before.

So what's in it for me you say? If I have to pay the same for the item, where is the consumer advantage? Simple. You're taxes were also a part of the imbedded tax that has been eliminated in favor of the Fair Tax. This is a very complex circular calculation.

Maybe you work for a company that provides the electronic components Marvel bought to make the Gizmo. No tax has been withheld from your pay. Maybe you work for a company that delivers to Marvel. Since that company paid no embedded tax, Marvel paid less for the deliveries. It is made up at the point of sale.

The portion of our pay we have been accustomed to calling "take-home" pay will be an expression of the past. If your gross pay is $1,000 per week, that is what is in your check. You will now deposit into your bank account the full $1,000 instead of the $725 or so that you were used to clearing. So the wages you are allowed to keep has risen to the level of your gross pay. You will have more money to spend.

Fair Tax Opponents purposely lying, or just misinformed? We think lying.

Don't be fooled by opponents of the Fair Tax. They like to tell us that it is some kind of boondoggle for the wealthy, and another steak in the neck of the poor. Even Steve Forbes, who apparently has his own agenda, is spouting this nonsense and, rather than attacking his motivation, let's just say we believe he is one who probably knows better. So we have to defend it.
 
Every item sold new from real estate, to Miracle Gizmos will have this Fair Tax attached to it. It is a replacement of a previously imbedded tax, not an additional tax. To the purchaser, it would result in nearly identical cost as before except for the fact that the purchaser would have more in his personal paycheck every week to buy more.

ARGUMEMMENTS AGAINST:

OBJECTION: I won't receive any more in pay check because my employer will reduce my pay to take home levels since that is what I am used to receiving and he can get away with it. If that happens, I won't benefit me at all.

ANSWER:  It is true to a certain extent that an owner may want to reduce employee pay because employees may well be able to accept reduced wages. It would be very unlikely that any possible reduction would be worse than current take-home pay because of normal competition. Salary is a negotiated agreement. Most employers will likely leave wages where they are because their profit margins won't be negatively impacted. If employers try to take advantage and reduce pay, the improving economic competition will bring more and better jobs at higher wages and your employer will either come in line or lose their work force to a competitor. It is more likely that very soon wages will likely increase at greater rates, not decrease.

Don't forget the Prebate. When you add the Prebate to your wages, you will very likely have far more to spend each month.

OBJECTION: There should be exceptions to sales taxes.  All new items or services sold will be taxed. This includes medical care, food and clothing and all other necessities of life. How callous is that? It just isn't fair to the poor.

Answer: Since the price of these necessities should not increase due to the substituted imbedded tax, there would be no additional cost and so it would not be relevant. Second, the Pre-bate is designed to allow for United States citizens to receive a check every month for each person in the household equal to the amount of tax to be expected to be spent on the necessities of life. The framers of the Fair Tax believe family comes first and no tax should be paid until household necessities have been taken care of first. The Prebate handles this well by reimbursing for those taxes every month.

OBJECTION: The wealthy won't pay their fair share. Interest and dividend income won't be taxed.

Answer: The wealthy are usually wealthy because they are smart, they arrange their affairs to pay as little in tax as possible now. Yes they pay a lot now, but often they legally manipulate their finances to pay as little as possible by investing in municipal bonds and tax deferred or other tax exempt income. Many very wealthy retired people pay little in income tax. They consume a lot, and so it is very possible that their effective tax rate will be higher under the Fair Tax because they will be paying 23% on everything they purchase, which, since they buy a lot more will be far more far more in tax than most of the rest of us. It is a progressive tax because the more we spend, the more we pay.

Under the current system, the wealthy spend far more, and are not taxed at all on what they spend. The money used for spending is often income tax free.

Some working wealthy will see their taxes cut because they could be as high as 40%. If the goal to punish all wealthy; then this isn't the tax for us. If the goal is to generate the same government revenues easier and more effectively while benefiting everyone, then it is.

OBJECTION: People will cheat. They will buy things and not pay the tax. Sellers will cheat, they will sell things without registering to pay.

Answer: People will always try to find creative ways to cheat on taxes, but it will be more difficult. Currently 175 million people and businesses must file tax returns. Many of them cheat now. Another millions work under the table and pay no tax at all. Your friendly neighborhood drug dealer or Mafia hit-man generally works "off of the books", and so does not pay very much tax - but they do go to Wal-Mart. Through normal personal consumption they will pay taxes lust like the rest of us.

So, next time you see your local hit-man at the grocery store, (you'll recognize him, he is the one in the nice suit with the bulge under his coat near his breast pocket) you can smile and say to yourself; "Finally they have to pay taxes too." Behind him in line may be your underground town pharmaceutical dealer - (he is the one with the tattoos of dragons on his neck, the white residue just beneath his nose-ring). You shake his hand and say "Thank you for shopping at Wal-Mart and paying taxes just like me."

OBJECTION: All kinds of jobs will be lost. Accountants, IRS agents, bookkeepers will become largely unnecessary and will have to go on unemployment or worse, welfare.

Answer: It is true. Though many businesses still will need to keep books and records -  maintaining sales tax records won't be nearly as tedious or time consuming and so specific jobs will be lost in the shift, particularly in the tax preparation and related areas. Consider though that we are not talking about unskilled workers here, these are professional people who could do a many number of different things. The market will be so stimulated by the elimination of the income tax and the resurgence of the economy that most of these people will find it relatively easy to make a transition.

Don't forget that when the automobile was introduced, it was a real bummer for the horse drawn carriage industry. The same fate became the candle manufacturers when electricity was invented. Yet we somehow survived it.

OBJECTION: The wealthy will get the Pre-bate just the same as the poor. That isn't fair.

Answer: The wealthy spend money on necessities too, they will receive the Prebate. First, if Medical, food and clothing were exempted, they would garner an even greater benefit because they tend spend more in those areas simply because they can. Instead of Rahman Noodles, maybe they buy Filet Mignon. Instead of buying a $10 shirt at Target, maybe they buy one for $500 at Nieman Marcus. But their Prebate is not any more than the poorest of the poor even though they may spend and pay tax on many times the value spent by the poor.

Another reason not to restrict Prebates is it would take another administrative department in government to oversee and determine who is rich, and who is poor. This would mean accounting expense for everyone perhaps requiring something similar to an income tax return for everyone to prove eligibility. The poor would also have to bear this expense to justify and prove that they are in fact poor enough to receive the Prebate.

Keep it simple. Every legal citizen with a valid social security number gets the Prebate.
 
OBJECTION: The deduction for real estate mortgage interest will be lost. People won't be able to afford their mortgage and will lose their homes.

Answer: Well, yes, there will be no mortgage interest to deduct from your taxable income - Turn your light on in Marblehead. There no longer will be taxable income, so of course there can be no deductions from a tax that no longer exists.

But is it better or worse to own and pay for a house? Lets assume you earn $100,000 today and pay $10,000 interest on your home mortgage, generating maximum benefit from those interest payments. Under current law, your mortgage interest payments would save $2,500 in tax. If the Fair Tax were implemented, your savings would be $20,869.
Don't believe it? See the table below:

                                                                  Income Tax                   Income Tax              Fair Tax
                                                               No Deductions                Mortgage Int           Alternative
                                                                
Earnings                                                  $100,000                        $100,000              $100,000
Standard/Itemized Deduction                        11,400                            21,400                - NONE -
2 Exemptions                                                 7,300                              7,300                - NONE -
Taxable Income                                           81,300                             71,300                - NONE -
                                                                -------------                       -----------               ------------
Income Tax Liability                                  $11,906                           $9,406                   - NONE -

DON'T FORGET:
           Social Security Tax                              6,200                                6,200              - NONE -
           Medicare Tax                                      1,450                                1,450               - NONE -
                                                                -------------                         -----------               ------------
           Total Tax Paid                                 $19,556                          $17,056                - NONE -

           INCOME TAX SAVINGS                 -   0   -                               $2,500               $20,896


The table above depicts a married couple filing jointly earning $100,000 in wages, (and no other income for simplicity sake). They pay mortgage interest of $10,000. It assumes that in addition to the $10,000 in mortgage interest, that their other itemized deductions are equal to the standard deduction, allowing for maximum benefit in a 25% bracket, which is not always the case.

Here we add the mortgage interest to the $11,400 standard deduction and so they are allowed a total $21,400 in deductions. If they only have $5,000 in other deductions (like taxes, contributions and medical expenses), their savings would be less. We show maximum benefit here so we can compare to the Fair Tax and without hesitation conclude that there is no comparison.

Which would you prefer. A mortgage deduction and a savings of $2,500 or the Fair Tax and a savings of almost $20,000? Is there really any question?

OBJECTION: My state has an income tax. I will have to do just about as much accounting as I ever did. It won't save me much in the way of tax prep fees.

Answer: If the states don't change and do something like the federal Fair Tax, they will very soon have a tax revolt and a non-compliance issue of biblical proportions. They will find it has become much better governmental policy to do what the people want and employ a similar method. It is possible a state could do nothing, but if they do, plenty of other states will change and open their gates to refugees abandoning income tax sates.

OBJECTION: Real Estate prices will go through the roof when adding 23%, combined with the non-deductibility of mortgage interest, this will lead to a meltdown in real estate prices.

Answer: Which is it? A meltdown or inflation through the roof? First we explained that the mortgage deduction will be irrelevant. When there is no income tax, there is no relevancy to any deductions.

The Fair Tax only taxes sales of new property. When you sell your "used" house, the tax does not apply. (It is the same with cars and trucks. New cars and trucks would have the tax, just as they had all of the imbedded taxes along the way to manufacture them, so their prices should remain about the same as well). So when the developer builds a house and sells it to its initial owner, there will be that 23% tax, similar to his current embedded tax. Like any widget or Miracle Gizmo, the embedded tax disappeared and is replaced NOT ADDED TO the cost of manufacture - or in this case building. So real estate prices should be about the same, just like everything else.

OBJECTION: Sure, you say the prices will drop and then adding back the fair tax will bring them to the same level as today. What about sellers and companies who want to profiteer from this. What is to stop sellers from just adding the fair tax and increase their profits at our expense?

Answer: First, a major retailer has already pledged to reduce all of its prices by 23% so that the sticker price you see on their shelves won't change. Since they are one of the biggest retailers in the world, there should be no worries from other retailers who must compete with them or die.

Could a company just try to profit unreasonably from this? Sure, but competition would drive their prices back down, or could force the more stubborn out of business. There is a profit margin each company strives to earn. In some businesses is more than others, but in general, if one company finds a way to reduce costs and maintain its acceptable profit margin, its competitors better do the same or they will lose sales to them and eventually go out of business. 

WE LIE: FAIR TAX IS MORE

OBJECTION: You're lying. I read that The Fair Tax is closer to 30% or more. If something costs 75 cents and is charged a dollar, that 25 cents represents 1/3 the cost, or 33%, not 23%.

Answer:  True and not true. The reason we calculate it as we do is because the current tax included in everything we buy is an "imbedded" tax cost. So although the Fair Tax is an add-on tax and is not embedded as is the payroll and income taxes to which it is compared, we have to mathematically equalize the equations for accurate comparisons. We go to the final price paid at the register of a store and "back out" both taxes for comparison.

If you prefer to claim that the Fair Tax costs 30% and not 23%, you will have to also agree that the payroll and income tax and expenses are also 30%. Suggesting that the Fair Tax is really 30% and the imbedded income and payroll tax and related expenses is only 23% is completely inaccurate. The conclusion is that the Fair Tax and the embedded tax is the same, give or take a few pennies. The following table shows the tax calculated both ways:

                                                                               CURRENT                        FAIR TAX

Sales Price At Store                                               $100                                 $100
FAIR TAX (Included in price)                               - NONE -                                23                              
Embedded Current Taxes                                         23                                - NONE -
Price if no tax                                                          77                                       77

Tax as Percentage of Price                                      23%                                   23%

Tax as Percentage of Cost                                       30%                                   30%



If anyone claims that the Fair Tax Rate is not 23%, but in reality much higher than the embedded tax it is to replace, you now have the answer.

OBJECTION: If the government is funded by a sales tax, what happens if everyone decides to stop consuming, or to save their money and buy less stuff? Wouldn't that be a big problem?

Answer: Consumption has proven to be a much more stable and reliable source for taxation than has income. A good example is after the attack on September 11, 2001. Quite a few people lost their jobs, and the economy fell drastically. These job losses resulted in reduced tax revenues as all times of unemployment tend to do. Income tax revenues fell sharply for several quarters after that attack because fewer people were working at the level they were previously.

Consumption did not suffer as serious a decline. Think about it. Working or not, we still must consume. Sometimes we borrow to do it; usually we can do it from earnings. In the absence of earnings, we still must consume. Consumption levels dipped slightly in the aftermath of the attacks, but not nearly as much as taxable income.

A consumption tax is a far more reliable source for government revenue than an income tax because it is far more consistent. The tax base is far larger and includes not only citizens, but also previously underground businesses, illegal ventures, state governments and foreign visitors as well.

Wouldn't it be nice to see foreigners on our soil and smiling happily with them because we know they are contributing to our social security and welfare system?

OBJECTION: What about my tax refund. I get $4,000 every year as an earned income credit. I don't pay any income taxes, and look forward to my refund every year.

Answer:  First or all, though they call it a "Tax Refund" you are not getting a refund. By definition, a "refund" is a "return of some or all a previously payment". Since you did not make a payment, the refund must be something else. Lets call it what it is - government subsidy. Your government checks will more than likely increase. The Prebate will replace it and will come every month. A family of four any age would receive about $560 per month. $560 X 12 = $6,700 per year. You just wouldn't get it at the end of the year because you would file no taxes, it would be received at the beginning of every month

If you are one of those people who are outraged that the Fair Tax is good for the wealthy as well as the poor, we have no response. If you are not satisfied with having a better opportunity for yourself and more money in your pocket unless the wealthier correspondingly suffer as a direct result of your good fortune, well, I guess this wouldn't be for you. Both the poor and the wealthy will benefit from the Fair Tax. The poor benefit more, but the wealthy benefit too. If you are willing to sacrifice yourself so that the wealthy continue to experience onerous taxation, well, maybe you should work on your own priorities. To support a system that sacrifices yourself and family just so that others suffer ever greater difficulty and wealth confiscation is a morally corrupt and ethically fraudulent position.

Hope we addressed the questions about the Fair Tax. It is clearly a far better approach than the behavior manipulation through taxation approach congress has been employing for years.

May your tax liability be light,