Wednesday, July 10, 2013

Direct Taxation

I just read The FairTax book by Neal Boortz. I was extremely disappointed. There were only four pages on the actual administration of the tax. The rest was simply criticism of our current bloated system.

The difficulty with the Fair Tax arises when one tries to impose a 29.87% national tax on top of existing sales tax. (NOTE: the FairTax is 23% of the final price. (NOTE: If an item cost $77 the tax would be $23 bringing the total price to $100. It is really 29.87% additional tax.)

The Tax only applies to the end purchase of new goods and services by consumers. This creates an extremely confusing business climate in which B2C purchases get whacked with a 30% tax and B2B purchases are tax free. The rich and powerful will be able to avoid their tax because they live their lives so that most of their expenses appear as B2B expenses.

I really dislike how Boortz dismisses criticism of the tax simply by attacking the motives of critics.

My main objection with the Fair Tax is that the proposal replaces a direct tax on individuals with a tax placed on businesses. Surprisingly, on page 32 of the book Boortz says:
"There is only one entity in this country that actually pays taxes, and that entity is the individual. Businesses and corporations merely collect the taxes from individuals and poss them on to the government."

The Fair Tax is a business tax. It turns our retailers and B2C service providers into tax collectors. The money from the tax flows directly from the business to the government. Businesses pass the tax onto the consumer indirectly through increased prices.

It is better to have the money flowing directly from the consumer to the government so that people can see the full impact of taxes on their wallet. Later on the same page, Boortz repeats the observation that businesses pass on taxes:
"Businesses and corporations don't pay taxes, they merely collect taxes and pass them on."

To make matters worse, the FairTax uses money collected directly from business to fund a new entitlement called a prebate. The prebate is money that flows directly from the government to the voter. The FairTax creates a negative tax structure in a direct tax is placed on business which they indirectly pass on to consumers. This tax on business funds a prebate that flows directly from the government to the voter.

The Fair Tax replaces a direct tax with an indirect tax. It creates a new entitlement funded by coercive taxes on business. My criticism is that the Fair Tax accomplishes the exact opposite of what the Fair Tax crowd wants the tax to do.

NOTE, the Object Tax solves this problem. This proposal uses Object Design techniques from the software world to transition the income tax into a consumption tax.

My main criticisms of the Fair Tax are that the Fair Tax replaces a direct tax on individuals with a direct tax on business. By changing the point of taxation, they will accomplish the opposite of what they desire. I dislike the prebate entitlement, and the literature on the tax ignores the difficulties of imposing a national sales tax.

But I will end this critique by pointing out a math error that the author makes repeeatedly.

The book correctly points out that the income tax becomes embedded in the price of goods. If you traced a product through the supply chain, you would find that about 22% of the money went to pay income tax.

Boortz repeatedly claims that, with the removal of the income tax, prices will fall 22%. He also claims that people will keep the sum total of their income. He is actually counting the same money twice. Income tax is embedded in income. The removal of the income tax would only show up as a price drop if wages fell in reaction to the removal of the income tax. If people keep their full wages, then there is no price drop.

By counting the money twice, Boortz makes the Fair Tax appear rosier than it actually is.

I hate when pundits dismiss critics by attacking their motives. I dislike when politicians use stunts like counting money twice to make their proposal sound more intriguing.

The FairTax has compelling sound bites. But the devil is in the detail. This disruptive tax is likely to be as bad as the income tax. By replacing a direct tax with an indirect tax and by creating a new entitlement, the Fair Tax just might make things substantially worse.

As one of the greatest and wisest tax theorists of all time (Neal Boortz once said): "Businesses and corporations don't pay taxes, they merely collect taxes and pass them on."

Boortz then did the opposite of what he said. So maybe he is actually one of the greatest fools of all time.

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