The Most Insidious Tax

Foundation for Economic Education ^ | July 2004 | Dale Haywood

[LowCountryJoe]

The Most Insidious Tax

People don’t generally spend and invest other people’s money as carefully as they do their own. This single, simple fact goes a long way toward explaining why capitalism works and statism doesn’t.

Private property, which enables people to spend and invest their own money, is a central feature of capitalism. Indeed, private property is the key feature of capitalism.

But property can be eroded subtly. Specifically, people’s money can be quietly shifted from the private sector to the public sector. That constitutes a transfer of resources from profit-seeking investors to vote-seeking politicians.

This process weakens capitalism and strengthens statism. On balance, it is eroding the ability of millions of savers to buy homes, finance their children’s education, pay their bills during retirement, and, in myriad other ways, assume responsibility for themselves.

It’s usually in January and February that I’m reminded of this insidious transfer of wealth. For it’s typically during these months that thrifty people receive notices from the financial institutions to which they’ve entrusted some of their savings. (The official IRS designation for these notices is form 1099 INT.) The institutions send out these forms to remind their customers how much interest they earned on their deposits during the prior calendar year. They admonish savers to be sure to report this “income” on their tax returns.

This is, of course, when the reduction of private property and expansion of communal property begins. Imagine this hypothetical, but realistic, situation: On December 31, 2002, a saver invests $1,000 in a one-year certificate of deposit paying 2 percent a year. The certificate matures on December 31, 2003. Its maturity value is $1,020—$1,000 principal plus $20 interest. So in January or February of 2004, the financial institution mails a 1099 INT to the saver showing $20 interest. The saver, in turn, dutifully reports that $20 on his 2003 federal and state tax returns just as he is required to.

If the taxpayer is in, say, the 27 percent federal tax bracket and the 4 percent state tax bracket, his total tax on this income will be $6.20, or $20 times .31.

There’s nothing subtle about this aspect of the wealth transfer. The taxpayer may not like these taxes, but he’s not confused. Yes, he might even fervently resent what’s happening. And that’s understandable. For he knows politicians will spend the money on undertakings at least some of which he strongly disapproves. He also knows how differently he would have spent or invested the $6.20 if he had retained control over it. He clearly understands this wealth transfer that shrinks the private sector and expands the public sector by about 31 percent of his earnings on the certificate of deposit.

But, if we look more closely, we find there is another aspect to the wealth transfer. It is more subtle. We understand this feature of the transfer when we take inflation into account. And if an investor is realistically to maintain or increase his purchasing power, he surely must allow for inflation. (For the record, “inflation” originally referred to the expansion of money or credit by government fiat, which, other things equal, causes prices to rise generally. Today the term is usually applied to the effect, with the cause overlooked.)

Illusory Gain

Suppose there was 1.9 percent rise in prices during 2003. In that case, our hypothetical saver would need $1,019 on December 31, 2003, to have the same purchasing power he had with $1,000 on December 31, 2002. So, before paying the $6.20 in taxes, his real income on his $1,000 one-year certificate of deposit would be just $1 (The $1,020 maturity value of the certificate minus $1,019). After allowing for inflation, we find this saver’s combined federal and state effective tax rate on real income is 620 percent ($6.20 divided by $1).

That is worse than slavery! A master can’t tax his slave more than 100 percent, because he has to devote some of the slave’s production to feeding, clothing, and housing him.

The consequences of inflation are insidious. It is, in effect, a subtle second tax. However, our present tax laws don’t allow investors to take it into account when they report interest “income.” When we do take inflation into account, we discover that the private sector is contracting and the public sector is expanding at much faster rates than it first appears. Using the numbers in our example, we see that capitalism is eroded and socialism is fueled not by 31 percent of nominal income from fixed-dollar investments such as certificates of deposit, but rather by 620 percent of real income.

Surely it is irrational to expect to continue to get the benefits of capitalism if we acquiesce in either the overt or the covert erosion of private property.

[BenLurkin]

bump

[sixmil]

Yes, inflation is the hidden tax. But, I think you'll have trouble finding a corporate conservative here that would be in favor of keeping inflation at 0% for fear of deflation. Inflation is not only how gov'ts pay off debt, it is also a corporate subsidy, and a subsidy for debtors.

[Remember_Salamis]

bump!

[Remember_Salamis]

Instead of doing that, how about just support the FairTax, which eliminates the Capital Gains tax, among other things?

[Principled]

It also eliminates the estate tax, among others...

BTW HR 25 has a new cosponsor. I guess that's 54 or so now....

[sixmil]

Instead of doing that, how about just support the FairTax, which eliminates the Capital Gains tax, among other things?

I think the founding fathers had it right, stick to tariffs and excise taxes (sin and green taxes). We already pay 8-9% sales tax in big cities, so adding 20% or more to that would really pack a punch, which would lead to black markets. Sure it would be more fair, but 30% is too high for any tax. How many people actually pay the full 30+% tax on income? You'd just end up with a mulititude of ways around it and exceptions passed out by congress critters. I would like to see income taxes flattened, but you know they would choke on the earned income credit. I don't think the tax problem will be solved until our country is run nearly into the ground. So in the mean time, teach your kids accounting and tax law so that you can make your own tax breaks.

[Capitalism2003]

Every Freeper should have some money in gold and silver as a hedge against inflation. I personally prefer the white metal (it's cheap!), but you can't go wrong with either one.

It is real money, and the morons in Washington can't print endless amounts of it.

[ancient_geezer]

, so adding 20% or more to that would really pack a punch

 

First understand, since the both business income and payroll taxes are repealed, the shelf price of goods and services on which you pay the NRST would actually be lower than what you see today. All products have significant federal taxes & costs of tax compliance embedded into their prices that with introduction of the NRST are removed with the market competition with for both investment dollars (which are taxfree under the NRST) and positioning for market share. Shelf prices are expected to generally fall in the range of 20-25%. The actual total amount paid for goods and services will work out to be roughly the same, with the NRST, as you pay today for any give basket of products.

All goods and services are subject to the NRST, not exceptions. To avoid exceptions that become a political football, the NRST is prepaid each month to the povertyline of expenditure by a demogrant to each household based on the number of people in the household. As a consequence, while everyone pays the same rate at the cashregister, the tax as regards necessity level spending is offset much the same way that the personal exemption and standard deductions of the income tax offsets the "zero-bracket" of the income tax.

All legal residents will receive a FCA equivalent to the FairTax paid on essential goods and services. The FCA will be paid in advance, in equal installments each month. The size of the monthly FCA will be determined by the government's Poverty Level for a particular family size, multiplied by the tax rate.

Every year, the Department of Health and Human Services [HHS] determine the "poverty level" for each family size.

The 2001 "FairTax" Family Consumption Allowance Figures
Family Size	HHS Poverty Level	Annual FCA	Monthly FCA
One	$8,590	$1,976	$165
Two	$17,180	$3,951	$329
Three	$20,200	$4,646	$387
Four	$23,220	$5,341	$445
Five	$26,240	$6,035	$503
Six	$29,260	$6,730	$561
Seven	$32,280	$7,424	$619
Eight	$35,300	$8,119	$677

1) Federal Register: February 16, 2001, Pages 10695-10697).

[ The monthly FCA for each adult is .23 * (HSS poverty level for a single person)/12 to assure no marriage penalty due to the manner in which the poverty level is dependant on family size. The monthly FCA for each child is .23 * (the incremental increase of HSS poverty level for a family with one child over no child) ] A. Geezer

A family of four, for example, could spend $23,220 per year free of tax because they will have received over the course of the year rebates totaling $5,341. $5,341 is the amount of sales tax paid on $23,220 in expenditures. A family spending double the "poverty level" or $46,440 per year will effectively pay tax on only half of their spending and, therefore, have an effective tax rate of 11 ½ percent or half the FairTax rate.

The beauty of the FairTax is that you can control how much you pay in taxes. If you happen to save, invest or spend a portion on used [previously taxed] items, you can get your effective tax rate below 9%.

To illustrate examine the tax burden that a family of four will have at various annual expenditure levels.

H.R.25 "The FairTax Act

[ancient_geezer]

A Taxreform bump for you all.

If you would like to be added to this ping list let me know.

John Linder in the House & Saxby Chambliss Senate, offer a comprehensive bill to kill all income and payroll taxes outright, and provide a IRS free replacement in the form of a retail sales tax:

H.R.25, S.1493
A bill to promote freedom, fairness, and economic opportunity by repealing the income tax and other taxes, abolishing the Internal Revenue Service, and enacting a national retail sales tax to be administered primarily by the States.

Refer for additional information: http://www.fairtax.org & http://www.salestax.org

[tuliptree76]

tax ping

[Taxman]

Great answer Geezer bump!

[Doctor Stochastic]

People don’t generally spend and invest other people’s money as carefully as they do their own.

It's even more problematic. People (in general) cannot manage other people's money as well as they do their own.

[sixmil]

First understand, since the both business income and payroll taxes are repealed, the shelf price of goods and services on which you pay the NRST would actually be lower than what you see today.

That sounds rational, but I have to see it to believe it. Companies fight pretty hard to protect their price points, so any changes would have to come from increased supply. I just have a hard time understanding how a 4-5% tariff kills trade, yet a 30% sales tax would not kill sales. People argue that tariffs run up the cost of goods, so why wouldn't this tax? A lot of people here talking down tariffs are the same people talking up a national sales tax. If their rhetoric on taxes were more consistant, I would not be as suspicious.

[Remember_Salamis]

"How many people actually pay the full 30+% tax on income?"

--Hardly Any. First, every person will get a Family Consumption Allowance (FCA) Cequivelant to sales taxes up to the poverty line. Second, only the consumption of NEW goods and services will be taxes. So, money saved, invested, spent on education, or spent on used items (including homes or cars bought or homes and cars used or bought BEFORE implementation of the FairTax).

Take a look at the breakdown for a family of 4 who makes $75,000 a year (6,250/mo.)

FCA for family of 4 = $25,000 ($2083.33/mo.)

$4,166.67 of possible taxable consumption after FCA.

$1,500 is spend on the mortgage and $500 a month on two car payments.

So, $2,166.67 of possible taxable consumption after FCA, mortage, and car payment.

10% of income is saved (10% of $6,250 is $625).

So, $1,541.67 of possible taxable consumption after FCA, mortage, car payment, and savings.

With this spending pattern, this family's marginal sales tax rate is ($1,541.67 x 23% tax-inclusive) = $354.58

$354.57/$6,250 = 5.67%

So, an average Family ($75k income, two kids, a mortage, and two used car payments, and a modest savings rate) will only pay 5 1/2% in taxes. Not too bad.

[ancient_geezer]

I just have a hard time understanding how a 4-5% tariff kills trade,

From the reaction of the nations being hit by tariffs. It is one thing to apply an across the boards sales tax, other nations have their own in fact in the form of VATs, it is another problem altogether to impose tariffs on imports specifically, that tends to induce trade wars and rising tariffs.

Furthermore, I don't know anyway you are going to get a 4-5% tariff to replace all income and payroll taxes do you?

yet a 30% sales tax would not kill sales.

The same tax in the form of income & payroll taxes hit available dollars for spending as it is. The NRST is not a tax added on, it is in replacement of what already is. The essential difference is the tax is made visible to the voter, on his sales receipts instead of check stubs, 1040's, and for a large part not at all because a solid half of the federal tax burden is embedded in price and indistinguishable from inflation.

How can sales be killed when a companies all up and down the production chain are relieved of tax liabilities for both income and payroll taxes both. When those taxes are expressly repealed the cost associated with complying with them (both payment of the tax and the overhead that goes with the tax reporting, paying, planning, litigation, research, ... all go away).

That means lower costs to the manufacturers and supplyiers that allow companies to compete more strongly without loss of net profit margins they experieced before the NRST was implemented. The reduction in costs allow lowering of prices for increasing market share, application of freed up dollars to productivity improvements (as well as an enhanced investment market opening up), even application of some of those dollars towards retaining or enticing better workers with better pay or benefits. The potential for improvement is across the board actually, a substantive proportion of which will go towards price reductions in maintain market and grow where possible.

People argue that tariffs run up the cost of goods, so why wouldn't this tax?

As a consequence they become embedded into and add on to producer & ultimately consumer prices. Generally, tariffs are an addon tax, not a replacement, furthermore tariffs generally induce like response from the nation we trade with on our exports to them tending to induce an upward spiral in taxes on imports specifically.

Under the NRST neither manufacturers nor individuals pay income or payroll taxes. Federal taxes we pay now, would be transfered from the income and the consumption side(hidden in price along with the costs of compliance), to where it is all made visible at where it all accumulates anyway, in the price of goods and services.

Families income ultimately derives from the retail sale of goods and services. From raw materials through manufacturing, transport, warehousing, and ultimate consumption sale, it all must reflect in consumer price or the chain breaks for lack of profitability along the line of production and the product can not be produced in the first place.

The net result due to lower costs of tax compliance as much as relief from paying the taxes per-se, results in the capacity to lower shelf price such that (NRST with taxfree shelf price) comes out int equilibrium for (embedded taxes plus taxfree price) at approximately the same total expenditure you have now.

[Pagey]

bttt

[LowCountryJoe]

In general you're right. However, Ron Muhlenkamp manages a portion of my portfolio quite well.