A $5,OOO Cat? - The NRST and Real Estate

NRSTA - Virginia Chapter ^ | N/A | Steve Hayes

[Remember_Salamis]

A $5,OOO Cat? The NRST and Real Estate

By Steve Hayes President, Citizens for an Alternative Tax System

Once Johnny came home with a puppy that he had found at the park. His father told Johnny that he couldn't keep the dog. Johnny protested but his father was unrelenting.

Tearfully, Johnny agreed. He took the puppy and left and was gone about an hour. When Johnny returned his father asked what became of the puppy. Johnny said that he sold it for $10,000.

The father demanded an explanation. Johnny said that he had gone to the neighbor's home and sold the puppy for two $5,000 cats.

Many in Washington explain everything that they do for us in glowing terms. They refer to the great benefits reserved for us in the tax code.

However, often when we examine the manna from Washington we find that the supposed benefit isn’t as good as we were promised. The benefit from Washington all too often really resembles one of the boy's $5,000 cats.

An example of this is the mortgage interest deduction. The fact that this benefit will be repealed by the national retail sales tax ("NRST") is one of the major objections used by opponents of the NRST.

Is the mortgage interest deduction really a "great" benefit or a $5,000 cat? The mortgage interest deduction is a provision in the federal income tax code which permits the deduction of the amount of mortgage interest paid on your home mortgage from taxable income, the amount of income on which federal income taxes are calculated.

Washington bureaucrats and realtors trumpet the tax advantages that accompany home purchases. "Buy a home and get a 'tax shelter' like the 'big guys' ". Alas, the "mortgage interest tax shelter" is, for many Americans, a $5,000 cat.

Here is an illustration of the home mortgage deduction. Fred and Joan Jones have two children and an annual income of $60,000. On January 1st, they buy a home a home for $140,000, pay $14,000 down and obtain a $126,000 30-year mortgage at 7 percent interest. The monthly mortgage payments are $838. Fred and Joan will pay mortgage payments of $10,059 in year one. Of the $10,059, $8,780 is interest and $1,279 is principal, which under the present federal income tax is not deductible. {1}

At the end of the year, eager to take advantage of this great "tax shelter, the Jones family deducts the mortgage interest paid of $8,780 from its taxable income of $60,000 and $10,600 of personal exemptions {2} leaving a new taxable income of $40,620. By deducting the $8,780 of mortgage interest the Jones family will pay $6,094 in federal income tax. {3}

At first glance, this would seem to be a real benefit. Fred and Joan were able to reduce their taxable income by the amount of the mortgage interest they paid. They know that their top marginal federal income tax rate is 15% so they appear to have received 15% of $8,780, or $1317, of the money that they would have paid in federal income taxes back from the government. However, in order to utilize the "mortgage interest tax shelter", they must file a 1040 return and itemize deductions. Interestingly, most real estate agents don't explain this fact but, without itemizing, the Jones family would have been able to take what is called the standard deduction that is available to everyone whether they pay mortgage interest or not.

"65,400,000 Americans are home owners but only 29,396,016 Americans take the mortgage interest deduction. For many of these 29,396,016 Americans the benefits of the mortgage interest deduction are marginal and more illusory than real."

If they had not deducted the $8,780 in mortgage interest payments but simply taken the standard deduction, Fred and Joan would have paid $6,551 in federal income taxes. This means that the mortgage deduction actually only saved them $457 in federal income taxes over what they would have paid if there was no mortgage deduction. On top of this, filing a return and taking the standard deduction generally means that you are less attractive to the IRS for an audit. So, the Jones family filed a more complicated return and increased their odds of an IRS audit to save $457. {4}

Another point that needs to be understood is the idea of "after tax expenditures." These are expenditures which, unlike the mortgage interest deduction, are not subtracted from our taxable income when computing taxes. These are items for which we have to earn enough to enable us to pay the income tax and still retain the net amount to be spent. Since the Jones family is in the 15% marginal tax bracket, in order to have a dollar to spend they will have to earn $1.18 and pay 18¢ in federal income tax (15% of $1.18) to net $1.00. As stated earlier, $1,279 of the total mortgage payments in year one is principal which is not deductible. The $1,279 of principal payments in year one is paid from the money that Fred and Joan have after payment of their taxes. To Fred and Joan, this means that they had to earn $1,505, pay $226 in federal income taxes (their marginal income tax rate is 15%) in order to net $1,279, the amount they paid in principal on their mortgage.

To recap, Fred and Joan have earned $60,000 and the examples shown in figure 1 illustrate the actual benefits they received from the mortgage interest deduction.

With Mortgage Deduction Without Mortgage Deduction

$60,000 $60,000

- 4,590 FICA {5} - 4,590 FICA

- 6,094 Federal Income Tax - 6,551 Federal Income Tax

- 10,059 Mortgage Payment - 10,059 Mortgage Payment

$39,257 Net Amount Remaining $38,800 Net Amount Remaining

Figure 1.

Assuming their income goes up at 3% per year, in 5 years they will be making $67,531 but will only be saving $406 more than they would be saving if they utilized the standard deduction. {6}

The amount of income tax savings is decreasing because the amount of interest is less each year and the amount of principal increases each year. The amount of mortgage interest paid in the fifth year will be $8,367 and the amount of principal will be $1,692.

The Jones family cash flow will then be:

$67,531 - 5,166 FICA {7} - 8,245 Federal Income Tax - 10,059 Mortgage Payment $44,061 Net Amount Remaining

However, if Fred and Joan want to actually own their home they will see a rapidly decreasing benefit from the mortgage interest deduction as they pay down the loan. In fact, by the 14th year, it will be better for Fred and Joan to take the standard deduction of $6,900 rather than the standard deduction of $6,900 rather than the mortgage interest deduction of $6,888. {8} Moreover, if Fred and Joan had purchased a home with a mortgage of $99,000 instead of $126,000, they would have saved nothing from the mortgage interest deduction.

This is one of the primary reasons that 65,400,000 Americans are home owners {9} but only 29,396,016 Americans take the mortgage interest deduction.{10} For many of these 29,396,016 Americans the benefits of the mortgage interest deduction are, like for Fred and Joan, marginal and more illusory than real.

If they actually pay the mortgage on their $140,000 home, Fred and Joan will have paid $175,781 in interest and $126,000 in after-tax principal for which they would have had to earn $148,000 and pay $22,000 of federal income taxes to net $126,000.

Contrast the above scenario with the situation if Fred and Joan purchased their home after the passage of the NRST using the same purchase price and 30-year mortgage at 7% interest.

Fred and Joan will receive their income without any income tax withholding. They, not the bureaucrats in Washington, will decide how much income tax they pay by how much they elect to spend on retail purchases. No longer are Fred and Joan treated as children or mentally deficient adults but as adults capable of making their own decisions.

Fred and Joan receive $58,234 in income, which is the earnings of $60,000 reduced by $4,590, the amount of the FICA withheld and increased by $2,824, the amount of the NRST rebate {11} to a family of four. Like under the federal income tax, the NRST will tax the principal of the house purchased by Fred and Joan. Under H.R. 2001, the bill introduced by Congressmen Dan Schaefer (R-CO) and Billy Tauzin (R-LA) that replaces the income tax and the IRS with an NRST collected by the states, the $140,000 purchase price of the house will be taxed by the NRST, resulting in a tax owed of $24,706. This tax can be paid either at the time the house is purchased or over a 30-year period. If the election is made to pay the $24,706 over 30 years then Fred and Joan will pay $73 per month or $876 per year.

The $8,780 of mortgage interest will not be subject to the NRST. {12} At the end of year one we see the results shown in figure 2.

NRST Federal Income Tax

$60,000 $60,000

- 4,590 FICA - 4,590 FICA

- 876 NRST Payment on the Principal - 10,059 Mortgage Payment

- 10,059 Mortgage Payment $44,991 Net Amount before Income Tax

+ 2,824 NRST Rebate - 6,094 Federal Taxes

$47,299 Net Amount before NRST --

- 6,345 Estimated NRST {13} --

$40,954 Net Amount Remaining $39,257 Net Amount Remaining

Figure 2.

After 5 years under the NRST, and assuming a 3% increase in their income, Fred and Joan would have the following net amounts of money under the NRST and the present income tax as shown in figure 3.

NRST Federal Income Tax

$67,531 $67,531

- 5,166 FICA - 5,166 FICA

- 876 NRST Payment on Principal - 10,059 Mortgage Payment

- 10,059 Mortgage Payment $52,306 Net Amount before Income Tax

+ 2,824 NRST Rebate - 8,245 Federal Income Tax

$54,254 Net Amount Remaining --

- 7,388 Estimated NRST {14} --

$46,866 Net Amount Remaining $44,061 Net Amount Remaining

Figure 3.

Now, we have assumed that the interest rate to be paid by Fred and Joan would be the same under the present income tax and the NRST.

This is really not the case. Economists agree that interest rates under the NRST will decline by at least as much as the difference between the municipal bond rate and the standard, non-tax free bonds. Some believe that the reduction will be much greater as America becomes the greatest place for investment and funds flood into the United States from all around the world. However, if we just assume the smaller reduction this will mean that the mortgage rate will be not 7% but 5.5%. {15}

This would mean that the mortgage payments and total cost of the mortgage for Fred and Joan would be reduced. Below are comparisons of the present income tax and the NRST with the lower interest rate. Here is a recap of the new costs and the comparison shown in figure 4.

NRST Federal Income Tax

$60,000 $60,000

- 4,590 FICA - 4,590 FICA

- 876 NRST Payment on the Principal - 10,059 Mortgage Payment

- 8,585 Mortgage Payments $45,351 Net Amount before Income Tax

+ 2,824 Rebate - 6,094 Federal Income Tax

$48,773 Net Remaining before NRST --

- 6,166 Estimated NRST {16} --

$42,607 Net Amount Remaining $39,257 Net Amount Remaining

Figure 4.

This means that the total cost of paying off the mortgage under the NRST is $131,548 of interest, $126,000 of principal and $24,705 NRST tax for a total of $282,253. Contrast this to $323,781, the amount that would have to be earned and spent under the federal income tax, a difference of

$41,258.

Yet another factor we have not addressed is that under the NRST, it will be much easier for Fred and Joan to save the money needed to purchase their home. Under the present income tax in order for Fred and Joan to save the $10,000 that they need for the down payment on their home, they will have to earn $11,765 and pay income taxes of $1,765 to net $10,000. If they deposit the money in a savings account then the interest will also be taxable.

However, under the NRST, Fred and Joan will only have to earn $10,000 and save that amount because earnings are not taxable under the NRST. Any interest earned on a savings or investment will not be taxed under the NRST. The NRST gives Fred and Joan the ability to keep all the money that they don't spend whether the source is earnings or a return on their savings and investment.

There are a number of other things that we have not taken into account when we do our comparison. The foremost of these is that the economic studies that have been done on the affect on the rate of growth in the economy after the enactment of the NRST all show increased rates of growth and increased rates of productivity. This is very important because increases in income are derived from increases in productivity.

What does the increased economic growth mean to each of us? If the economy had grown at the same rate since 1973 as it did prior to 1973, the average family would have an additional $10,000 per year in disposable income.

It is time for Americans to quit accepting $5,000 cats and demand a tax system that really works for America, the NRST.

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FOOTNOTES

{1} This is omitting the cost of any private mortgage insurance.

{2} Each family member receives a $2650 personal exemption or $10,600 for a family of four.

{3} For purposes of our example we are not considering any deductions that might be available would increase the amount of itemized deductions because these vary widely among taxpayers.

{4} The $457 in savings would be increased if there were additional itemized deductions like real estate taxes, state income taxes and charitable donations. For example, if Fred and Joan had an additional $1000 of deductions then they would have saved an additional $150 in their 15% income tax bracket.

{5} Federal Insurance Contributions Act

{6} This actual savings from the mortgage deduction will likely be less because the standard deduction will also have been increased.

{7} This assumes that the FICA will be assessed on $67,531.

{8} Again, this is assuming that the standard deduction for a family--of four remains at $6,900 which it will not. Therefore, the standard deduction will likely exceed the mortgage interest several years earlier.

{9} U.S. Census Bureau

{10} Statistics of Income Bulletin, published by the Internal Revenue Service

{11} The NRST rebate is determined by family size. It provides a rebate to Americans equal to the NRST on their purchases up to the poverty level. For a family of four this would be a rebate on the first $16,000 of purchases.

{12} Fred and Joan are paying the NRST on the principal over 30 years.

{13} Fred and Joan would not pay NRST on the FICA payment, the NRST payment and the mortgage payment. We are assuming that the family has savings or expenditures of an additional $5,000 not subject to the NRST - like charitable donations, education expenses or savings.

{14} We are making the same assumptions as in footnote 13.

{15} Many economists believe that the mortgage interest rate will likely be even lower because of the increase of savings and the infusion of vast amounts of capital from around the world.

{16} This assumes that the family saves or spends a total of $5,000 on items not subject to the NRST.

[rolling_stone]

"OK, since the NRST proponents think we have use the same terms to compare the sales tax to the income/payroll tax, my effective tax rate (income and payroll) on my income last year was 19.77%. The NRST is 23%. Does that mean I'll be paying more with the NRST?"

Does the 19.77 include your employers portion of payroll or just yours? So will your employer pass the savings on to you, just like the reduced cost of articles you will purchase?

Are you just concerned with how much you will be paying or the overall effect of the change in law? Imagine cutting out the amount of waste we currently have in accounting and taz preparation (compliace estimated at $300 billion per year) along with cutting the power given our legislators and lobbyist to social engineer the current system, can you place a dollar amount on that aspect of the NRST?

http://www.salestax.org/

[Your Nightmare]

I'm trying to compare the actual percentages (and thus why they both have to be tax inclusive). So I still have the question: how does my 19.77% income/payroll tax compare to the 23% NRST? By comparing these numbers (thank God they are both tax inclusive!), it seems I will be paying more.

[rolling_stone]

1) do you spend all your income on NRTST taxable idems or do you save some or buy some used items? ? If not your actual percentage of tax to income would drop.

2) you will receive a rebate up to the poverty level (or income if less)to compensate for consumption of necessities, that would also lower the effective consumption tax rebate.

[Mr. K]

Now wait just a minute... are you trying to tell me that the 'tax inclusive' figure is not more difficult to calculate??

A yes or no answer would be nice.

[kevkrom]

my effective tax rate (income and payroll) on my income last year was 19.77%. The NRST is 23%. Does that mean I'll be paying more with the NRST?

Almost certainly not. With the FCA ("rebate"), your effective tax rate will be less than 23%. Anything you are currently financing will not be taxed (since it was considered taxed when you bought it) under the NRST. Any money you save/invest will not be taxable. Any money you spend on used items would not be taxed.

How many people are in your family? I can use that number to calculate how much you can spend and still break even at your old rate.

[Your Nightmare]

How many people are in your family?

3

[Your Nightmare]

Please post any calculations you use. I'm really interested in why both percentages have to be tax inclusive to compare them.

[Remember_Salamis]

If you save or invest 0% of your income, spend 0% of your income on education, and spend 0% of your income on a mortgage on a used home (remember, used homes aren't taxed, so there would be no taxes on it), you'd still pay much less than 23%. Remember, there's a rebate up to the poverty line. So, if you're the statistically average American family of four and make $63,000 a year and consume 100% of your income (as listed above), you'd still only pay 14.6%. Here's the math:

The Rebate would cover taxes for $23,000 for every family of 4 in America (rates different depending on household size). So, subtract $23,000 from $63,000, and you have $40,000 of consumption that will be taxes. 23% of $40,000 is $9,200. Divide $9,200 (the amount you pay in taxes) by your income ($63,000) and you pay 14.6%.

($63,000 - $23,000) x .23 = $9,200
$9,200/$63,000 = .146 (or 14.6%)

In reality, almost nobody would consume 100%. So if you saved 10% of your income and spent 15% on your mortgage on your used home, you'd only pay 10.9%. Save 10% and pay 25% on your mortgage (which is a more realistic representation of housing costs compared to income level), and you'd only pay a 9.4% rate. See how it works?

[CliffC]

Hi geezer, et al:

This AFFT website has been recently updated with some new info. Have a look....

GoTo: AFFT!  and preuse the Links there.

Here's the FairTax INFO!   website that I packed full of useful info about this fantastic new way to fund the Gov't and rid ourselves of the abominable Income Tax System (and IRS).

While visiting there, you're invited to sign the Petition calling for enactment of the Fairtax.

Onward & Upward!

Cliff Cofer - West Des Moines, Iowa

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Bye, bye... Income Tax (and IRS)!  We won't miss ya' at all!

---

[CliffC]

Hi geezer, et al:

This AFFT website has been recently updated with some new info. Have a look....

GoTo: AFFT!  and preuse the Links there.

Here's the FairTax INFO!   website that I packed full of useful info about this fantastic new way to fund the Gov't and rid ourselves of the abominable Income Tax System (and IRS).

While visiting there, you're invited to sign the Petition calling for enactment of the Fairtax.

Onward & Upward!

Cliff Cofer - West Des Moines, Iowa

---

Bye, bye... Income Tax (and IRS)!  We won't miss ya' at all!

---

[Your Nightmare]

It looks like you used the tax inclusive rate to figure how much sales tax I would have to pay on my consumption (23% of $40,000 is $9,200). Should you have used the tax exclusive rate (29.87% of $40,000 is $11,948)?

[Your Nightmare]

should have said: Shouldn't you have used the tax exclusive rate (29.87% of $40,000 is $11,948)?

[kevkrom]

Ok... 3 people (I'm assuming married couple with one child, but I'll run the numbers both ways). Under a worst-case scenario, i.e., you spend every dollar you earn, the break-even point is:

( RNRST * N ) - F = ( RIRS * N )
( RNRST - RIRS ) * N = F
N = F / ( RNRST - RIRS )

Where N is the break-even income/expenditure point, F is the NRST FCA, RNRST is the NRST tax-inclusive rate, and RIRS is the effective income/payroll tax rate. The first formula states that for the effective amount of tax to be equal, the income/expenditure is multipled by the rate, with an offset to the NRST side for the FCA. The remaining formulas just regroup terms to solve for N.

Substituting the numbers in your case:

N = 4853 / ( .23 - .1977 ) = 150,248 (married, one child)
N = 3510 / ( .23 - .1977 ) = 108,669 (single, two children)

Any expenditure under this amount would yield in a lower effective tax rate under the NRST than under the income tax, anything higher would yield a higher rate. Note that this does not take into account any purchases made of non-new goods, investment/savings, or any taxes currently embedded into the price of goods and services under the current income tax system.

Now, why use tax-inclusive? As you'll see, the numbers compare evenly when doing so. We'll use just the first number, but the results are the same either way. The total amount of tax paid under the NRST in this example is:

T = ( .23 * 150,248 ) - 4853 = 29,704

Under the income tax:

T = ( .1977 * 150,248 ) = 29,704

The tax works out exactly the same under either system.

[ancient_geezer]

I'm really interested in why both percentages have to be tax inclusive to compare them.

They have to be in the same units of measure to be numerically comparable or you will come up with erroneous answers in numerical analysis.

For example, 2.54cm = 1 inch. Yet both are the same length. 1 common length but a different unit from which each measure is taken.

The cm case is in length/(metric standard) vs the english case of length/(english standard) to do any numerical operation on them such as substraction to see which is large in absolute terms, one must first convert measurements to a common base

Likewise with tax exclusive vs tax inclusive systems.

The tax exclusive base is (price), thus the measure it tax/price.

The tax inclusive base is (price + tax), thus the measure is tax/(price +tax)

To be able to add or substract or compare between the two measures you have to first convert them to the same base.

For the computation of

tax1/(price1) - tax2/(price + tax2)

denominators must the same, thus to compare tax systems numerically you must covert them into the same base.

[Your Nightmare]

There are a few problems with your equation, the main one is you are assuming a fix expenditure rate inclusive of taxes. If a person's expenditures are consistent, then the inclusive rate makes sense. But that's not what we are talking about. We are talking about shifting taxes from income to consumption. A person's expenditures will go up to pay for the sales tax, but so will their take-home pay. Prices being equal (and if you don't think they will be equal, you need to add that to the equation) and consumption being consistent, my tax inclusive expenditures will go up 29.87%. The tax exclusive rate.

Let me try.

Currently, my income can be figured:

I = (RINCOME * I) + C + S

Where I = gross income, RINCOME = my effective income tax rate, C = consumption, and S = savings.

Under the NRST, my income would be:

I = (RNRST * C) + C + S + A

Where RNRST = tax exclusive sales tax rate and A = FCA.

Since we are comparing taxing income to taxing consumption (again, if you think prices will go down, you need to add that to the equation, but you would still use the tax exclusive rate) they should be consistent for both equations, so let's solve for savings.

With an income tax my savings is figured as follows:

S = I - (I x RINCOME) - C

Under the NRST savings is as follows:

S = I - (C x RNRST) - C + F

So let's figure this out for a couple with 1 child making $100,000, their consumption is $77,500/year (~3% savings rate), and they will get a $4,853 allowance. Under the income tax:

$100,000 - ($100,000 * 19.77%) - $77,500 = $1,730 savings

Under the NRST:

$100,000 - ($77,500 * 29.87%) - $77,500 + $4,853 = $4,203 savings

This type of comparison (the one's individuals will be making) is more difficult with the inclusive rate. But, IMO, promoting the inclusive rate is just marketing. It does nothing but confuse people and make them believe the rate is less than it is.

Some might say "What's you problem, you're coming out ahead with the NRST." My problem is that the 29.87% rate is BS. It includes the federal government taxing itself which is Enron accounting and it taxes the activities of the state government which may be unconstitutional. (Doesn't anyone here believe in federalism? This is a conservative forum, isn't it?) If you remove the government taxing itself, the rate would have to be 33.35% and the savings this family would have is $1,506 (below the income tax). If you take out taxing the states the rate would have to be 42.75% and this family would actually have to reduce their consumption by ~$5,000.

[Your Nightmare]

thus to compare tax systems numerically you must covert them into the same base.

OK. Compare the tax systems numerically and show us the computations. My effective tax rate (inclusive) is 19.77% The NRST is 23% (inclusive). Show me how these compare.

[RockyMtnMan]

Under the current tax system can you control how much you pay without giving up more of your disposable income (charity)? Under NRST you can control your effective tax rate by controlling spending, this is exactly what we want our government to do why wouldn't we want this for ourselves?

NRST encourages saving/investing and the number one venue for long term savings is mutual funds. This means more capital to corporations for reinvestment back into the economy and the creation of jobs.

All foreign nationals here legally or illegally will pay the tax alongside US citizens. Tax loopholes will be gone and an enormous and expensive bureaucracy will vanish (IRS). The state of Texas does not have an income tax, only a state sales tax. Texas enjoys one of the most successful economies in the nation at the moment and did reasonably well during the recent recession.

I really do not see a downside tax exclusive or inclusive issues aside. Even though exclusive is better I can still see my effective tax rate dropping and I'll be able to apply more income to equity in my home. My money will grow tax free and I'll have more disposable income as a result.

[ancient_geezer]

My effective tax rate (inclusive) is 19.77%

Taxes on what specifically?

Recall that consumer prices that you pay out of your consumption spending contain a 20-25% corporate income/payroll tax related burden within them as well. Have you included that burden in your calculation of your "effective tax rate"?

The NRST encompasses all corportate taxes you pay through your expenditures now, as well as income and payroll taxes paid by the individual.

The NRST "effective tax rate" (inclusive) is dependant upon your household size and amount you spend.

 

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The NRST is 23% (inclusive). Show me how these compare.

Give us the paramaters to work with to determine how the two systems compare with your particulars if you really want an accurate comparison for your individual case.

The NRST maximum marginal rate is 23% (inclusive).

OTOH the NRST "effective tax rate" that any particular individual may experience is generally much lower than that.

For example: examine the tax burden that a family of four will have at various annual spending levels

H.R.25 "The FairTax Act

 

[Your Nightmare]

Recall that consumer prices that you pay out of your consumption spending contain a 20-25% corporate income/payroll tax related burden within them as well. Have you included that burden in your calculation of your "effective tax rate"?

Include them, I don't care. My effective tax rate (income tax + FICA) on my income is 19.77% Compare that to 23% sales tax and show my the computations to make the comparison. Assume family of three (husband, wife, and child) making $100,000, current consumption is $77,500. Compare the 19.77% to 23%.