The Fair Tax

I know you’ve all been spending this last day examing the Fair Tax idea. So what do you think?

I think it’s great. It’s simple and it’s transparent. These are two great angles. Simple means that everyone can understand it. Transparent means everyone can see exactly how it’s working. Between them, it means that everyone can see the worth of the idea, and how it’s being used at any time. Handouts to various consituents can’t be disguised. I think I am a big fan already.

However… one piece does stick in my craw. No purchase is taxed except actual consumption. Corporations are not taxed at all. The reasoning seems to be that their money is either going to people who use it to consume something and are taxed then, or is being reinvested in the business which is worthy of tax-free status. I don’t agree with either of those arguments. First, that people will eventually get the money and consume it. This line of thought gives companies a reason to never disperse profits. Much like non-profits today, they are incentive driven to put all the money in the company, whether or not that is a productive use of that money. I am reminded of Stanley Kaplan. They somehow got a non-profit status. They make huge huge amounts of money, but since they are technically a non-profit, they keep pouring that money into luxuries. Take a look here. Or here. Or here. Is there any reason any other company wouldn’t do the same?

Let’s imagine a hypothetical. Imagine you are the owner and manager of a company. You have $60,000 in corporate profits. You really want to get one of those sweet new C6 Corvettes. If you give yourself a salary of $60,000 and buy the car, you pay the tax (about $15,000). If you pay it to yourself in any form and then buy it, you pay taxes. But, if your company buys the car, you don’t pay anything. That’s a business transaction and isn’t covered. Now this happens in this example because the shareholder/owner (who would otherwise get the money) and the employees (who get the benefits of the money) are the same. Nevertheless, it illustrates that this creates a warped incentive to keep as much money in the business as possible.

It is also a double-standard. Why is the assumption that businesses keeping money is reinvestment, but not so for families? If I go down to Home Depot and buy a new gate, that is an investment in my house. The carpteting I am buying is also and investment in the value of my house, not to mention a safety feature form my toddler son when he falls down the stairs. But these are fully taxed, regardless of how it will be used.

The best analysis of double taxations I’ve ever seen is this brilliant cartoon.

This a gaping flaw, however I still would have to come out for The Fair Tax. Looking for comments on this one, please.

6 thoughts on “The Fair Tax”

  1. So far, this is the biggest downfall I’ve seen of the FairTax. I wrote Linder’s office and the EVP of about this to clarify and to see if there are any provisions to protect from this type of abuse. Still, its better than income tax regardless of whether or not this loophole is plugged.

  2. People already do this very same thing under the current system. Instead of paying the income tax, payroll tax, social security tax, medicare tax and compliance costs when you give yourself a salary to but that car you just pay yourself less and have the company buy the car. It’s still tax evasion under either system.

    This may seem like it would be a huge loophole. However, think about this. The IRS will admit to currently almost 30% non-compliance. Other estimates state as many as 45% of filers cheat on their taxes.

    Under the FairTax, the highest estimates of non-compliance are at 10%. This is a drastic reduction.

    Also consider this; the collection authority is no longer the fed. The states will be collecting the sales tax like they currently do. Make no bones about it, it is a well known fact that the states are VERY effective at collecting sales tax. They also have good systems for flagging all tax ID numbers. If you start a corporation to make a purchase tax free and you are not sending in any reciepts to the state they WILL flag you for audit and you will eventualy get caught.

    We can all agree that some percentage of people will always try to evade paying their share no matter what their socio-economic background. Under the FairTax the reduction of non-compliance combined with the much broader tax base equates to a much tighter system of taxation without the intrusion of the federal government on our civil liberties and paychecks.

    I can see why from certain angles it may look like a flaw but it’s really not a problem. I hope I was able to answer some concers.


  3. Public corporations give money to their shareholders in order to boost or maintain their stock price which allows them to raise capital by selling more stock. This is why companies ‘disperse their profits’ and would not change under FairTax.

    As far as loopholes are concerned, I could care less if businesses use their exemption status to ‘cheat’. If your business wants to give a bonus brand-new corvette to every employee in the company, I say ‘Go for it’. The issue that’s important is that the company keep making a profit (and they will or go out of business). The tax is collected from the consumer and the cost of all those corvettes (without tax) will be there in the pretax price so will be taxed when your final product is sold.

    The part you forgot about in your hypothetical situation above is that your company (that made 60,000 profit) has already paid the sales tax (presumably you made 78,000 gross sales – 18,000 sales tax).

    Here’s a hypothetical to match yours. Let’s say I incorporate and tell my employer that from now on I am a corporation. He’s not going to pay me any more money (he’ll probably get a chuckle though). O.K. now I get my paycheck, pay my sales tax (on services rendered to my employer (23% of what I earn)) and whatever is left I can now spend as a company tax-free or I can be an idiot and pay myself cash and pay sales tax on that money again as I spend it.

  4. Please ignore everything after the first paragraph on my previous post. My bad. That only works in a purely retail world. I’m sure I wouldn’t be required to charge sales tax to my employer as he is a business as well.

    The standard reply I’ve heard so far on this ‘loophole’ is that cheating would be far harder because there are far fewer entities that pay the tax to oversee. Also there is a lot of cheating by current taxpayers and there will be cheating under any tax system.

    This loophole would be there under the FairTax and only honesty coupled with stiff fines and careful oversight by the states will be able to stem it.

  5. Casey, I take issue with your first paragraph. Corporations do not grant dividends to raise more capital. They grant dividends because the owners (stockholders) want the money more than they want that money to be retained by the corporation. Corporations can give stockholders value by:
    (1) Disbanding (usually not enough money to be worth it)
    (2) Granting dividends
    (3) Keeping the money in the business, in the expectation that in the future shares will be worth more.

    I believe standard economic theory is that the granting of dividends versus the retaining of that money ends up increasing the stock value equally. It is not a tactic for a hypothetical future day when they need to raise more money.

    I won’t address any of your other points since you retracted them 🙂

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