Friday, June 21, 2013

The Income Tax is a Sales Tax on Labor

Proponents of the Fair Tax want to replace the income tax with a national sales tax on goods and services.

The proponents of the Fair Tax seem to have forgotten that the income tax is a sales tax.

When you are employed by a company, you are selling a service to the company. The income tax is a tax on the service that you are selling.

Income tax is a tax placed upon the service that people sell to their employer.

The Fair Tax is unlikely to achieve the positive effects its supporters imagine because the Fair Tax simply replaces one sales tax with another sales tax.

People who realize that employees are selling a service to the employer and that all jobs are a service performed by individuals to employers are apt to reject the Fair Tax.

The absurdity of the Fair Tax becomes clear if you look at it from the perspective of an individual contractor. Imagine for a moment that you were an handy man or plumber. The Fair Tax will create the following economics. If you sell your service to an individual, you will be required to pay a 23% tax. If you provide the same service to a corporation, you will not.

The people who created the sales tax realized that everyone engaged in the economy is selling a service. The selling of a service at an individual level is the most equitable place to place a tax.

One historical oddity is that the income tax system was designed by a radical free market thinker named Milton Friedman. Milton Friedman is the author of Free To Choose and founder of the Chicago School of Economics.

Milton Friedman realized that an individual sales tax on the sale of labor would be extremely difficult to collect; so he devised the withholding system.

The withholding system requires that employers take money from workers' paychecks. Each year, workers fill out a tax return. The annual tax return is the actual point that finalizes the payment of taxes.

Since the money flows from the business to the government, most people see the income tax as a tax on their employer. But the employer is simply withholding money on behalf of the employees. The income tax is a tax on the services sold by workers.

The income tax and the Fair Tax are both sales taxes. The Fair Tax simply changes the trigger for the tax.

The Fair Tax shifts the tax from the point where individuals sell services to employers to the point businesses sell products and services to individuals.

This change will relieve voters of the responsibility of paying their tax. It will put the entire burden of taxation onto the backs of business. Business associations will respond to the Fair Tax by demanding different tax rates for their members. The Fair Tax will quickly devolve into an unfair tax with businesses receiving different tax rates (based partially on the aggressiveness of business association lobbyists). A case in point is that state sales tax has different rates for different types of business.

The Fair Tax does not get rid of the IRS as its proponents claim. The accounting for a national sales tax will be as tricky if not more tricky than the income tax. The Fair Tax only charges a tax on business to consumer spending. But businesses will need to keep a full itemization (with tax id) of every business they do business with. The IRS will cross check the tax returns of each business against all other businesses giving the government a full matrix of all business to business spending in the nation.

This matrix will be misused.

Switching the point of taxation from income to the point of sale does not really accomplish anything. It will create a period of extreme disruption and opens American business for abuse.

A better approach to tax reform is to create a replacement for the tax withholding system.

My tax reform proposal creates an alternative to payroll withholding called a Tax Aware Account.

An employer would deposit employees entire paycheck into the Tax Aware Accounts. People would pay their taxes when they withdraw funds from the account. This reform will eliminate payroll withholdings and the need to file an annual tax return.

I would replace the capital gains tax by allowing traders to buy and sell stock through a Tax Aware Account. Investors would pay a full progressive tax when the withdraw money from their Tax Aware Account for consumption. The program would do away with inheritance tax by allowing people to inherit the tax status of the assets. The children would inherit a tax aware account from their parents. They would pay money when they withdraw the funds.

In conclusion. The income tax is a sales tax. It is a tax collected on the sale of labor. The Fair Tax simply shifts the point at which the sales tax is collected. Doing so will create disruption and complications.

A better reform is to simplify the payroll withholding system.

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