Fair tax

Economics is a fascinating subject to me. I heard about Fair Tax on the radio today, a tax scheme supported by Huckabee. It is a national sales tax with a fixed amount returned to taxpayers every year to offset it from being a regressive tax. It is supposed to be a simpler replacement for income tax.

I found an informative and honest article on factcheck about it. The main points I got were:

1. The proposed rate of 23% is deceptive because it is 23% of the total cost of a good/service including the tax, not 23% added on as is customary for sales tax. This makes the number look smaller than it actually is.

Let f = the fairtax percentage, or the tax applied to the total cost paid. If we paid 50 cents on a $1 item, then this would be 50 cents out of the total price $1.50, or .3 (one third)
Let p = The pre-tax, e.g. percentage of the tax actually paid. If we pay 50 cents on a $1 item, then this would be .5 (one half)

The fairtax is then the percentage of the tax actually paid, divided by the total amount paid. Here 1 represents the percentage of the retail price, while p is proportionate to that.

f = p / (1 + p)
f = 1 / (1/p + 1)
(1/p + 1) * f = 1
1/p + 1 = 1 / f
1 / p = 1/f -1
1 / p = 1 – f / f
p = f / (1-f)

So for a fairtax rate of .23, the equation yields .2987. With significant digits, this is .30 or a 30% tax.

2. The 30% rate is a low-ball figure and likely insufficient to break even. 35% is more realistic. It also assumes 100% compliance, which is unrealistic.

3. This tax applies to all goods and services (food/rent) not just things we are normally taxed on.

4. Criminals tend to end up paying tax when they spend their ill-gotten gains, where before they did not.

Some points the article didn’t bring up, but occur to me, are:

5. Business as a rule try to avoid/hide making a profit since they have to pay tax on profit. In the game industry this is evident in the publisher business model. The typical model is to give very bad deals to game developers such that publishers make nearly all the profit on a blockbuster. However, this is offset because 90% of games fail. The failed games are write-offs and for tax purposes make a queer sense because then taxes do not have to be paid on the profit from that one blockbuster. In the national sales tax model publishers would be taxed on expenses, rather than income. The first thing I believe this will do is to make it now make sense to buy and run moderately profitable companies. This would otherwise be undesirable because the money would be tied up in slow gains, rather than shooting for the big payoff. It’s sort of like playing the penny slots vs. the $20 slots. The second thing I believe this will do is to make publishers more risk-adverse, since they no longer get ~30% of their money back.

6. Currently one of the difficulties of lying on taxes are that there are two records. I don’t want to report my income because my incentive is to not want to pay taxes on it. My employer wants to report my income because their incentive is to use it as a write-off. So both of us have an incentive to rat each other out, and thus both of us stay honest. But when taxing expenses only, the record is one-way only, with a strong incentive to lie about it.

7. According to this site it costs taxpayers 22 cents for every dollar collected. This system is much easier on the taxpayers, since you no longer have to save receipts and so forth. It’s just a higher payment on your final bill.

8. The goverment is very good at hiding taxes. Rather than hitting a 100K earner with a 33K tax all at once, it’s taken out evenly over bi-weekly paychecks over the year. And the cost is split up into different categories (Social Security tax, etc), so it’s hidden even further. What is funny is people are excited to get a refund of their own money back, while neglecting to notice that they are just paying less. My point is that most people don’t notice just how much they are getting taxed on income tax alone (don’t forget you also pay inflation tax, tarrifs, subsidies, etc!). But with Fair Tax, that $40,000 car you wanted is now listed for $52,000 and you are going to be freaking outraged at the $12,000 tax on the car. This is a good thing, since more transparency is good, and I think will reduce compliance and put tremendous pressure on the goverment to reduce taxes. Or then again maybe not so good, since they will just hide the taxes elsewhere.

I think I would support this system. It’s more transparent, it’s simpler, and the economic distribution is roughly the same. Of course I still hope Ron Paul wins, since no income tax is even better.