So let’s assume it is 2015 and the Neal Boortz Fair Tax is the law of the land. To keep the math simple, let’s assume the flat tax rate is 20%.
Here is your assignment if you think you understand Neil’s plan. Your task is to identify who collects the flat tax, who pays the flat tax and how much they pay.
Meet Dr Smith, a proctologist
- Dr Smith bills third party providers (insurance, Medicare, Medicaid) a total of $2 million dollars
- Those parties pay him $750,000 for his services
- Non-insured patients who aren’t deadbeats and deductibles are another $50,000 in income
- He writes off $100,000 for bills from people he can’t collect (charity cases)
- He pays $100,000 for his malpractice insurance
- He pays $25,000 towards his student loans from medical school ($10k interest, $15k paying down the loan)
- He pays $40,000 for rent to acme realty for his office(s)
- He pays his receptionist, nurses and assistants $200,000 including their benefits
- He pays $10k for leases on his xray machine and other equipment
- He buys $10k worth of medical supplies – xray film, tongue depressors, bandages, rubber gloves
- He puts $50k into his SEP/IRA pension plan.
- He pays $10k a year to lease a Chevy Volt to use for making house calls
I was running a calc – until I saw “making house calls”. The IRS gets $20. Dr. Smith pays $300,000 and the tax preparer pockets $299,980.
Okay, here we go…
* Those parties pay him $750,000 for his services.
Tax paid by Smith = $150,000. (He pays the tax only on the actual transaction, not on the $1.25 million additional he invoiced but did not receive.)
* Non-insured patients who aren’t deadbeats and deductibles are another $50,000 in income. Tax paid by Smith = $10,000.
* He writes off $100,000 for bills from people he can’t collect (charity cases)
No impact on Smith’s taxes. The write-off is for bookkeeping purposes only to show lost income.
* He pays $100,000 for his malpractice insurance
No impact on Smith’s taxes. His insurance company pays a tax of $20,000 (20%) on the premiums they receive from Smith.
* He pays $25,000 towards his student loans from medical school ($10k interest, $15k paying down the loan)
No tax for Smith. No “deduction” either. I’m not sure if loan interest constitutes a “sales transaction” for fair-tax purposes. I don’t think it does because that would be a double tax. The interest income received by the loan vendor will be spent and eventually taxed somewhere else in a final transaction.
* He pays $40,000 for rent to acme realty for his office(s)
No tax for Smith. Acme Realty pays $8000 tax (20%) on this transaction.
*He pays his receptionist, nurses and assistants $200,000 including their benefits. No tax for Smith. No tax for employees until the buy goods or services with their earnings. Benefit providers pay the tax on whatever benefits Smith purchased for his employees.
* He pays $10k for leases on his x-ray machine and other equipment
No tax for Smith. The equipment vendor pays a tax of $2000 (20%) on the lease payment received. Leases are treated same as sales for tax purposes.
* He buys $10k worth of medical supplies – x-ray film, tongue depressors, bandages, rubber gloves.
No tax for Smith. The medical supply vendor(s) pay the 20% tax totaling $2000.
* He puts $50k into his SEP/IRA pension plan.
No tax for Smith. Savings interest and dividends are not taxed.
* He pays $10k a year to lease a Chevy Volt to use for making house calls
No tax for Smith. The lease provider pays 20% tax ($2000) on the lease payments.
Total tax paid by Dr. Smith’s business: $150K + $10K = $160K
Tax paid by vendors providing goods and services to Smith: $34K. Plus additional tax paid on unspecified premiums by benefits providers for Dr Smith and his employees.
Net income to Dr. Smith after expenses: $339,000.
Cash income to his employees: $200,000 minus cost of benefits paid by Smith. Assume benefits cost $20,000, so $180,000 net to his employees?
Additional 20% tax paid by Dr Smith and his employees if they spend ALL their earnings: $103,800. The tax is less if they save or invest it.
“Tax prebate” received by all (regardless of income) to reimburse taxes on basic cost of food, medical, shelter, clothes, transportation, etc: $30,000 per person x 20% = $6000 per person.
The above does not include anything for state and local taxes, but the 20% federal tax does cover Medicare and Social Security. So everyone would still be paying local sales taxes and property taxes. Hopefully the states would get the hint and abolish their income taxes since it would be almost impossible to compute incomes without the federal income tax system in place to force all the computations and record-keeping.
Your answers side step the distinction between who pays the tax and who collects and remits the tax. Today, if I buy $1 of something, I pay $1.06. I’m paying the tax, but Walmart is remitting it to the state.
The answers you’ve provided seem to all suggest that it is the seller of a good or product is the one who is going pay the tax – the old “I
Support any tax that someone else is paying” idea
So if I go to Dr Smith and get a $100 procedure (paying cash), do I pay him $120 and then he sends the $20 into the IRS?
What I’m wandering into, but it could get boring pretty fast is that the tax would have 1000s of unintended consequences and contradictions.
One would be to incentivize vertical integration. If GM buys $5k of steel to make a $25k car, the $5k of steel will be taxed (right?) and then when I buy the car, the $25k is taxed. Ford has it’s own steel mills in River Rouge, so it doesn’t pay tax on the steel it makes for itself, only the finished product.
The VAT addresses that problem by only taxing the value added by the company – so the $5k of steel is taxed, but only $20k for the car, as the amount paid for materials is rebated.
Now, what if GM imports the $5K of steel from Japan? Do they have to pay a 20% import duty?
Let’s go in a different direction – let’s say I want to build a house. The lot will cost $50k and the house itself will cost $200k. At closing, do I pay a tax, and if so how much? Did my contractor have to pay taxes when he bought the lumber? What if I have trees on my land and contractor cuts them down and makes mr a log house and doesn’t buy the lumber?
5 years from now, I sell my $250k house for $300k – is the house taxed again, or only the difference or not at all? If I die and the house goes to one child, do they have to pay a tax, or do they avoid the tax because they got the house for free?
You think I am kidding below? Not a chance. The way the flat tax works is one thing while the fair tax is another. The goal seems to be a consumption tax. Your answer is: Everyone pays tax at each consumption. Don’t look for fair-mindedness and don’t look for a single tax event. These do not work that way. Your contractor pays tax on the lumber for building your house and you pay tax on the purchase of the house. Each party responsible for paying the tax will reimburse Uncle Sam. The concept was – at one time – to eliminate income tax. Everything else would remain largely the same. The IRS would shift focus to auditing Home Depot and the Doctors. The tax preparers will make out like money growing on trees and we will all be as bereft of money then as we are now.
Unintended consequence: the citizen-consumer is even more confused and loses more money.
You are wise to point out that the fair tax is totally different than the flat tax. The flat tax is still taxing income, while the fair tax taxes consumption. The “model” for calculating the rate necessary to have it be “revenue neutral” is extremely dubious and riddled with untested theories about people’s behavior.
If the fair tax was 3%, people might just shrug their shoulders. At 23%, people will arrange their lives to avoid creating taxable events.
The single most alarming thing I read on fairtax.org was that each year, the 23% rate will be adjusted to cover the expenses of the government the prior year. That’s exactly backwards. The way it should work is the maximum percent with no weasel word escape clauses should be written into the Constitutuon in exchange for repealing the 16th amendment – and the spending budget for the following year is capped at the actual revenue collected the prior year. The only way for the government to increase spending is if the economy grows, and that lagging by a year.
“5 years from now, I sell my $250k house for $300k – is the house taxed again, or only the difference or not at all? If I die and the house goes to one child, do they have to pay a tax, or do they avoid the tax because they got the house for free?”
Answer from:
http://www.fairtax.org/PDF/PromotingHomeOwnership.pdf
“The FairTax completely untaxes preexisting homes.
Perhaps most important is that preexisting homes are not taxed under the FairTax. … The FairTax does not tax used homes because it assumes that previously owned homes were taxed upon their construction, and the price of those homes already includes the taxes that were imposed upstream.”
So I’ll take a stab at answering my own question.
http://www.fairtax.org/
(assuming their explanation is the authoritative one)
“The FairTax is a single-rate, federal retail sales tax collected only once, at the final point of purchase of new goods and services for personal consumption. Used items are not taxed. Business-to-business purchases for the production of goods and services are not taxed. ”
So…. Dr Smith says your exam costs $250, you say you have insurance. He says he’ll be glad to submit the paperwork. He presents you with a bill for $300 ($250 + $250×0.20) [This is all assuming Obamacare is repealed]… He requires you to pay the $50 sales tax since you are the consumer at the final point of purchase. Per his contract with the insurance company, they pay him $100 for your exam. There is no tax on that, since it is a business to business transaction.
The same person paying their own medical bills pays Dr Smith $300 – $250 he keeps and $50 he sends to the IRS.
A third person gets the exam, agrees to pay the $300 bill, then doesn’t. Does Dr Smith pay the $50 fair tax at the time he sends the bill out or when the patient pays the bill? What if the patient wants to pay it off $20 a month?
One detail I didn’t include in my scenario was whether Dr Smith is an individual or a corporation. Most doctors are corporations, and if they aren’t the fairtax will force them to become one.
So the $100k in insurance premiums – that’s a “service”. Is malpractice insurance a service used in the production of the service he is providing as a business? If the answer is “Yes”, then there is no tax.
Paying off the student loan is a non-taxable event. There is no tax and no tax benefit related to payment of interest. He would have paid the 20% tax on the tuition and room and board when he went to medical school. (right?)
Paying rent is a service that would normally be taxable, but since it is a businses to business transaction necessary to provide the service to you, it is not taxed.
If you rent an apartment, you would pay the 20% tax on your rent, but if you owned your apartment, there would be no tax on the mortgage payment. There would a tax on the fee you pay to your homeowner’s association to provide you with the services of picking up the garbage, cutting the grass, running the swimming pool, plowing the snow, etc…
What he pays his employees is not taxable. Even if he hired them from a temp agency and paid them, that’s not taxable – as it falls into the business to business exemption. If he hires a cleaning service to clean up his office, that is not taxable. If he hires the same cleaning service to clean his home, that is taxable.
The Xray machine leases and supplies are not taxed as they are consumed/used to create the final product that is taxed – the $250 exam.
The SEP/IRA is the red herring. If income is not taxed, there is purpose to having a formal retirement plan. Interest isn’t taxed, neither are payments or withdrawals from a pension plan. You only pay the tax if you spend the money.
The Chevy Volt leased to make house calls would not be taxed as it is a business purchased used to supply the service. The consumer is paying the tax when the doctor charges for the house call.
If Dr Smith partly uses the Chevy Volt for non-business purposes, then that portion of the lease payment should be taxed. [The idea that the FairTax is going to put accountants out of work is extremely naive]
Regarding my later house example…. the basic answer is that when a new house is built, the 20% price will be paid once and only once on the sales price. So for the $250,000 new house, the builder will collect $50,000 in fair tax and send it in. From that point on, as the house is sold and sold again, there is no new tax.
So imagine you’re looking at houses in a development. The brand new house will cost you $300k including the tax. The house next door which was sold a year ago, is now up for sale. Is the house worth $300k because the tax has already been paid, or is it worth only $250k? If the house is for sale for $250k, why would I pay $300k for the “new” house? If the “used” house was built before the FairTax went into effect, does it get taxed the first time it is sold after the FairTax went into effect, even though it is “used”?
Wikipedia says that educational tuition would not be taxed, as it is an “investment”, not a service. That sounds like a political compromise to not alienate young people. Presumably the Room, Board and fees would still be taxed.
If you think my answer about having to pay the tax on what the doctor bills, not what the insurance company pays is wrong – I’ll draw your attention to the example of automobile rebates today.
If you buy a car for $25,000 and it has a $2,000 manufacturer’s rebate, if you look at the paperwork, you’ll see you paid sales tax on $25,000, not $23,000. The $2,000 was part of how the $25,000 car was paid for. Sales tax is paid on the gross price, not the net.
I’m toying with the idea of a Fairtax blog…. anyone want to play? 🙂
Apparently we need a blog because this whole thread reminds me of the four blind men trying to describe an elephant.
Despite the explanation at
http://www.fairtax.org/site/PageServer?pagename=about_faq_answers#1,
the fair tax will never work if business-to-business services and purchases are exempted. I’ll use my own business as an example. I’m a consulting engineer and I’m incorporated. My entire income comes from other corporations purchasing my services. Someone like me would pay no tax at all until I buy something for personal use. But since I can read fine print, I would then declare every capital item I purchase (cars, computers, boats, airplanes, phones etc.) as being for “business use”. There would be no easy way to prove I wasn’t using using it all for business because the IRS is pretty much eliminated by the fair tax proposal. Over time, nearly every working citizen would incorporate so as to claim the business-to-business exemption loophole and avoid paying the tax on all major capital purchases.
I think the fairtax.org website is oversimplifying the answer. Ultimately the tax has to be paid on the “end transaction”. It shouldn’t matter whether the end purchaser is an individual or a business. If you buy a toaster you pay the tax, period. If you’re buying copper to make toasters, you don’t.
Regarding the 23% sticker shock factor, people forget that they’re already paying 16% on all earned income (8% of it is hidden if you’re an employee) for medicare, social security, and unemployment insurance. The 23% fair tax supposedly covers all that. The net result is a 7% tax (23%-16%) but applied only to dollars you spend, not to every dollar you earn. That seems like a pretty good deal to me, especially when I know that under the current system I’ll probably never see a dime of all the social security and medicare payments I’ve made over the years.
Almost commented yesterday, but didn’t have the time.
In many ways, the ‘Fair Tax’ is not simple enough and attempts to keep too many of the loopholes or ‘exceptions’ in place.
What I’ve toyed with (for at least 10 years) is a combination which I refer to as a National Sales & Transaction Tax, with a much lower rate of 2 or 3 percent… but charged at -every- exchange of money and goods or services.
Sales tax = whenever tangible goods exchange hands, be it a TV or a factory.
Transaction tax = everything else, excepting double taxation on a transaction.
The -recipient- of any payment or ‘consideration’ is responsible for submitting the tax.
A few exceptions on -who- submits the tax could be made on wages/salaries for employees (employer can deduct & submit it, as is done now). Exempt loan repayments, since a transaction tax would be assessed at origination.
e.g. on the Chevy Volt (lease) there are two transactions:
Smith pays transaction tax, owner (lessor) pays sales tax.
If you’re buying copper for toasters, you DO pay a tax.
College tuition? Pay a transaction tax, and learn a lesson!
Forget the notion of business or personal usage, or ‘cost of business’ write-offs… there would be no Schedule C, etc.
The question of who ultimately must actually pay the extra 2-3% is fairly obvious, the customer… whether it’s Joe Sixpack buying a toaster or Reardon Steel buying Pig iron.
Of course, this assumes a free enterprise market and competition, without any gov’t meddling, mandates, subsidies, etc.
The problem with taxing business transactions (as I alluded to elsewhere) is it would incentivize vertical integration. Whether or not you think that’s a good or a bad thing is a different question.
GM is a pretty good example, partly because I’m fairly familiar with it. At least when I was doing work for them, they had a facility in Saginaw that cast engine blocks. That plant shipped the engine blocks to the engine plant in Flint. (do we tax that?) The plant in Flint then assembled the engines – put in the pistons, valves, camshafts, etc… The completed engines were then loaded on trucks to be sent to an assembly plant in Canada (do we tax that?). The cars were assembled in Canada, and then the finished car was brought back to the United States for sale… (do we tax it again?)
Now, whatever your answer to that is, GM has the option instead to import finished engines from their factory in Brazil. It’s a foreign subsidiary of GM. Do we tax the engine with an import duty equal to the fair tax? and then tax the finished car again? [Keep in mind the engine is being put into the car in Canada – not exactly sure how you tax components being assembled outside the united states]
That’s the issue the VAT tries to address – but for manufacturing, it creates an entire new bunch of paper shuffling to compute the “value added” at each step of the process.
If you forumulate the rule “Okay, we don’t tax the parts used to make a finished product IF those parts are made by the company themselves”, then you put a 23% incentive on GM to buy up all its suppliers – but up Lear/Siegler seating, Pittsburgh Plate Glass, DuPont Chemical’s paint division, an aluminum smelting facility in Canada, Firestore Tires… GM just got through trying to divest itself of the AC/Delco parts business to get them outside the UAW contract that applies to the assembly plants. Ultimately, Delphi went into its own backruptcy, which GM had to buy them out of (with tax money)… so the batteries, spark plugs, air filters, radios, etc… are back “in house” essentially
If you tax services (like consulting engineers) but don’t tax employee wages, then you’ve encouraged businesses to do all the work “in house” by employees – more vertical integration. Presumably, there are benefits today for both the engineer and the company by having the services not being done by an employee.
Another useful exercise to think about – whatever tax plan you’re considering – how would it affect the Amish people who mostly avoid using money to do what they do. Would the tax plan you have in mind have the effect of driving the country to be more like the Amish? (and is that a bad thing?)