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September 30, 2008
A FairTax Primer: Part 1
Filed in: Current Affairs, Politics, Tax Policy

I said I was going to become an activist. To me, there seems to be nothing more timely than this as we are at nexus on our entire economy.

A key question we must address is: Do we provide taxpayer funds to continue to do what has brought us to where we are in the first place? Or is there some other way to avert the crisis?

It appears that even the general public gets that the bailout proposal that has been under discussion - and voted down for that matter - has been a demand to continue the activities and behavior that have gotten us to where we are in the first place. Demanding more governmental power doesn't solve the crisis - it extends it.

And, in some grass roots efforts, it appears that the general public is getting that we must link stimulus with managing the crisis.

What we should all really face up to is that it is the back-breaking tax system that is just as much at fault in where we are economically - primarily because the tax code encourages a debtor society, secondarily because there is a severe lack of accountability built into the progressive income tax and payroll tax system (which thus contributes to the oversight problem that allowed Fannie and Freddie to happen) - and that the logical conclusion is that complete tax reform has the opportunity to maximize stimulus.

Eliminate the capital gains tax? Of course. But why not eliminate all current federal taxes?

Let's examine the FairTax proposition. The best thing to do is to read the books. While you're waiting for your books to come in (if you only get one book, get the second one), let's talk about the initial concept to grasp when contemplating this idea.

Here it is:

Everything you buy today (we're talking as a consumer) has the cost of the tax code - the income tax, the payroll tax, and the cost of tax compliance for the organization (and all of the individuals) that you are making the purchase from - as well as all of the taxes from the entire supply chain that the organization you are buying from does business with - embedded in the price of the goods or services your are buying.

I believe that this is the key initial concept to grasp before diving in to the details of the proposed FairTax legislation.

Let's take an example: loaf of bread.

You go to the grocery store and buy bread. You pay, let's say, $2.00 for that loaf of bread. The retailer charges you that price which includes the cost of the loaf of bread from their supplier as well as all of the tax costs - payroll, income, and profitability for that retailer. At the risk of a bit more detail: A bakery company manufactured that bread. For that bakery company to stay around, they have to charge enough for that loaf of bread to make a profit and pay the taxes on that profit. (Some of the left over profit over the long term has to go into new ovens, perhaps other bakery plants and other capital requirements.) Part of what you pay covers the payroll taxes - both employee and employer contributed for the people that work at the bakery company. Part of what you pay covers the income taxes for the people that work at the bakery company. Part of what you pay covers the cost of tax compliance that the bakery company has to spend to meet the regulations - tens of thousands of pages of tax code that has been changed tens of thousands of times in the last twenty years - that cover the company's tax obligations. Additionally, the bakery purchases flour as a key component of the loaf of bread. The bakery bears the costs of the same embedded taxes in the price it pays for flour to the mill, which pays the cost of the embedded taxes in the prices that it pays for the grain to the grower. Additionally raw materials like oil, baking equipment, cleaning chemicals, etc, etc all have the same characteristic tax burden built in to the price paid along the supply chain.

Brilliant economists have studied all of this and conclude that when you buy a loaf of bread for $2.00 right now you are paying about $0.50 in embedded federal taxes. If you find yourself not grasping this or disbelieving this, please go back and read the above over again.

In as simple terms as I can put it, the FairTax legislation proposes this: Eliminate the IRS, repeal the progressive income tax, the payroll tax, the capital gains tax, the death tax - all federal taxes and replace them with a consumption tax that's embedded into the price you pay at retail (managed by existing mechanisms that exist for the collection of sales taxes) with a federal tax revenue neutral result. In addition, include a socially conscious aspect that fairly excludes the purchase of staples to the poverty level so that anyone of any political disposition can support the legislation.

But before we proceed to discuss what the ultimate results are for adopting such a plan - and in our collective current economic state perhaps offer the only real opportunity to shrug off the current malaise - make sure that you completely understand the facts about the facts of the embedded costs that you are already paying - i.e. see above.

Most any confusion that you will experience in contemplating the FairTax legislation that is before the House and Senate will be a result of not keeping at the forefront of your thinking the existing embedded tax that you already pay. (Have I stressed this enough?)

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People Pulling

Uh, sorry, but you are completely off base about the "embedded taxes."

The concept of embedded taxes was developed by Harvard economics professor Dale Jorgenson. He did, in fact, conclude that approximately 22% of the cost of manufacturing goods in the US could be allocated to a federal tax component. Thus, the FairTax advocates -- particularly Boortz and Linder -- jumped on this and started saying that prices would drop by 22% as soon as the federal income tax was eliminated. And, since we would keep 100% of our paychecks, this would amount to "virtual raises" for all of us. This is exactly what they said in the hard-back edition of the FairTax book.

Jorgenson then called them and explained that they they were misrepresenting his work. Most of the so-called "embedded taxes" are taxes employees pay from their salaries. In order for these "embedded taxes" to disappear from the price of goods and services, then our salaries would need to be reduced by the amount we currently pay in taxes.

Or, to put it another way, assume you currently make $100,000 per year. Your employer has to cover that $100,000 in the price of goods and servies it sells in order to make a profit. Let's assume you pay $30,000 in taxes out of your salary. That $30,000 becomes part of the "embedded taxes".

Now, under the FairTax, your income and payroll tax obligations go away, but if your employer continues paying you $100,000 per year, the employer can't reduce prices because it still needs to cover your $100,000 salary. The only way your employer can reduce it's prices is if it reduces your salary by $30,000, i.e., the taxes you USED to pay under ouor current tax system.

Thus, your salary would drop to $70,000 per year. The employer could redue prices by 30%, but since the FairTax would be 30%, it would immediately raise prices back up to where they were.

Since Jorgenson (who, by the way, does NOT support the FairTax) apparently threatened to publicly admonish Boortz and Linder for misrepresenting his work, they very subtly changed the wording of the paper-back edition of the FairTax Book to reflect this, and clarified it even more in their subsequent book. (However, when they give speeches, they still claim that "you'll keep 100% of your paycheck" and prices will go down, so.)

Now, nobody who's actually studied the FairTax believes that Americans will accept an immediate 30% reduction in their wages, so virtuall all economists assume that wages and salaries will stay the same, which means the "embedded taxes" won't go away. Thus, prices will NOT drop under the FairTax and, in fact, will rise by the full tax-exclusve FairTax rate. (Which the FairTax folks claim is 30%, but everyone else who's looked at it believes it would be 50%-60%).

Hope this helps clarify things a bit.

Posted by: Truth Detector at Oct 1, 2008 8:10:48 AM

Uh, Truthy, so are you just hoping that you or your firm will get hired by the RE industry? Or do you just take it on yourself to troll little sites like this instead of actually building your own site? I like that construction sign!

Please stay tuned. Your tired old criticisms will be answered. See where it says 'Part 1' above? That means there's going to be more.

'Course we don't expect you to stay around. You dropped your little truth to power demiurge and are Googling away for the next great opportunity...

Posted by: MC at Oct 1, 2008 4:08:15 PM

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