Wednesday, April 19, 2006

debunking FairTax

I recently got into an argument about FairTax - the proposal for a national sales tax to replace "all" other federal taxes, written by Boortz and Linder. I remembered I have my own barrel of ink, so I'll spill a bit here.

As folk may recall, the authors make several claims about their proposal. What I thought I'd do is take most of them on, but only one per post. No, sometimes I have to take on a couple as they're intertwined. Today's writing is such as case, but I think it is the one most damning to their proposal. You get to keep all your pay, and it does a better job of making EVERYONE pay their fair share.

Let us begin by setting up a sample company. Most details don't matter, but the ones that do are:
The company grosses $100,000 per month;
The company nets $10,000 per month pretax;
The company has ten employees, each of which have a gross paycheck of $3,000 per month. They're claiming four dependents on the withholding form, which has a total of $337.83 withheld each month. (OASDI $186.00; Medicare $43.50; Federal Tax 108.33.)
The company has to match the FICA (OASDI and Medicare), that's $229.50 more per employee in expenses.
Finally, our $120,000 per year profit puts us in the worst tax bracket (if we tripled our gross our tax rate goes down - another post). We'll pay $22,250 plus 39% of 20,000 or another $7,800 or a total of $30,050, giving us an annual profit of $89,950 after taxes. Our monthly profit after taxes is $7,495.83 (rounded), with the monthly tax bill being $2,504.17.

Now let's apply the FairTax proposal. The first thing that happens is that the company quits paying everyone's federal taxes. That's $337.83 + 229.50 for each of our ten employees, plus another $2,504.17. We gain $5,675.80 per month. And we have our first conundrum - do we keep it as more profit, or do we give it to the employees, or do we pass along the savings to the next level. Offhand, I believe that what would normally happen is a combination of all three - the company gets a bit more, the employees get a 'raise' in their takehome, and the overall cost goes down. But there's this fly in the ointment, and it's our new fact to add. Specifically, are we retail or wholesale?

Let's assume for the first example that we're wholesale. Since we're not selling to the end user, we don't charge sales tax. In this case the preceding options are as already stated - we can split everything three ways. Again for easy math let's share equally, which means the company's gross sales are $98,108 and change, but our employees take home an extra $184 apiece and the company (meaning me, the owner) keeps an extra $1891. And everyone is happy, right?

Wrong. What if we're retail.

Remember that we no longer pay $5675.80, so we start with a profit margin of $15,675.80. But the FairTax says that 23% of our profit - our "embedded" tax - goes to the federal government. That's a bill of $23,000, giving us a NET LOSS of $7324.80 - neither the customer nor our employees nor we get to keep ANY of the money. Oh, wait - our costs of goods reduced, so maybe we made it up there. Oops, we already decided that everything was so good that the total reduction was 1.891% (1,891 out of the original $100,000). Since our payroll related costs are (now) $26,621.70, our other costs before this began were $63,378.30. The reduction is a whopping $1,198.48, meaning we're STILL short over 6,000.

But, says the FairTax, Everyone should pass along their reduction. Sorry, folk, that only works if EVERYONE passes it all along, and even then it's suspect. Go back up this post, and notice the total savings of our wholesale company. $5,675.80. That doesn't make up for the $7324.80 increased loss.

Our company goes broke. But the wholesale company - at least while we're still selling to the retail company - gets to give everybody more money. Bottom line, the FairTax puts companies out of business unless everybody earns less money.

And that's just a bit different from "you get to take home all your money." Unless, of course, they're being disingenuous -- after all, you get it all, it's just less than it was when the Feds took a Federal Income Tax withdrawal.


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