OPEN LETTER TO BOORTZ/LINDER (FairTax)

U.S. Representative John Linder
1026 Longworth House Office Building
Washington, DC 20515
Phone: 770-232-3005
Fax: 770-232-2909

I have met you before and briefly discussed your FairTax proposal years ago in downtown Norcross at a street festival. I also campaigned for you in my neighborhood when you were running against Bob Barr.

I have read your book, and I have spent quite a bit of time researching the FairTax. As a small businessman who lives in Norcross, naturally I am interested in anything that will reduce taxes and assist our economy, so the idea of a FairTax sounds good. But reading your book, the bill itself, studying the fairtax.org website, and reading the House Ways and Means Committee testimony of Dr. Jorgenson back in 1995 and 1996 as well as your most recent testimony, I am disturbed by the way the FairTax plan is being presented.

I don't think you fully understand the "embedded taxes" concept-- you are double counting this money by both giving wage earners their full 100% paycheck and still expecting their employer to be able to reduce their prices by about 23% on average.

Let's look at a wage earner-- call him George-- that grosses $1000 per week under our current system. You claim that, under FairTax, George will keep all his income (the full $1000) plus everything he buys at retail will cost about the same as George pays now. This is implausible.

Businesses will not be able to pay 100% of their paychecks to their employees, because they need these "embedded tax" savings to be able to lower their selling prices.

George currently gets $1000 a week from which his employer withholds $200 in FICA and fed taxes and $50 in state taxes, leaving George with $750 to spend. Right now, let's say loaves of bread are $1. Today, George can buy 750 loaves of bread for $1.00 each with his take-home pay.

Under the FairTax, you claim George will get his whole check, which is the same $1000 less George's $50 state taxes, for a take-home of $950. If your FairTax logic is correct, the price of the bread will quickly drop to about $0.77 (when Bob's Bakery gets rid of his "embedded taxes") and when they add the 30% FairTax at the register the final price will still be $1.00. George can now buy 950 loaves of bread with his $950 take-home.

You have increased George's purchasing power by 200 loaves of bread which is a 26.7% increase in his purchasing power. And you claim that FairTax will do this on average for every wage earner in America.

This is dishonest to make everyone think they will get a 25%+ increase in purchasing power. ("Get a 25% pay raise, and prices stay the same")

It is obviously illogical that every wage earner in America, with no change in productivity can increase purchasing power by even ten percent, let alone 25%.

The fallacy in your understanding of the "embedded taxes" is that Bob's Bakery cannot give his employees their full paycheck AND still reduce his costs by $0.23 per loaf of bread as you claim. He can do one or the other, but not both.

The baker could reduce his price by about 25%, but only if he keeps his bakery employee taxes that are currently withheld and going to the government. If he gives these "embedded taxes" to his employee, then his overall labor costs haven't gone down and he has no saving to pass along in his prices. His only big difference is he writes a check to his employee for $950 instead of two checks- one to his employee for $750 and one to the IRS for $200.

If our baker instead kept the taxes, his labor cost would now be $800, and the baker could now maybe drop his price to around $0.77 per loaf as you expect. George would still have his same $750 take-home income and he would still be able to buy 750 loaves of bread for $1 each ($0.77 cents price plus $0.23 taxes). George's purchasing power would still be 750 loaves of bread as it is now.

I think this is the honest way to look at the FairTax plan, but this is not what you are claiming.

The only other alternative is that George gets his full $950 and the price of bread drops to say $0.90 to reflect Bob's Bakery's savings on the employer portion of FICA (7.65%) for his labor costs and a few percentage savings for IRS compliance costs. When sold, the $0.90 loaves of bread will get $0.27 FairTax added for a total selling price of $1.17. Under this scenario, George has $950 take-home, which allows him to purchase 811 loaves of bread, a slight increase in purchasing power which is mainly due to the elimination of the employer portion of the FICA. (assuming Bob's Bakery kept that employers half of FICA which is really his employees money but that is another discussion)

But this second "inflationary" scenario would put retired persons, or anyone with accumulated wealth or any person on a fixed income at a relative disadvantage to wage earners because things would cost more in absolute dollars. So, this scenario won't work in practice.

Please think about what you are promising here when you say that people will get their whole pay checks and at the same time all prices will be about the same. It cannot happen-- there is no 22-25% "embedded tax" savings once you give wage earners their entire paycheck.

It doesn't' actually matter how you file as a small business!! Whether you are an LLC, a Soleproprietor or anything else, you don't pay taxes. Let's take an example with Bob the Baker:

Bob sells 1000 loaves of bread at $100 each (it's really good bread)
His revenue is therefore $100,000.

His total expenses are $50,000

His profit is $50,000 and he is taxed a personal income tax of 15% and therefore pays $7,500 in taxes. Now at first glance it seem that Bob has$42,500 in take-home pay but we must remember that he is a small business and there is research to show that for every $100 in taxes small businesses pay they spend $724 in compliance costs (figures according to The Tax Foundation). Well let's say the baking industry is simpler than average and that Bob only spends half of that, or $362 per $100 in compliance costs. Well that's an additional $27,300 in compliance costs. You may think that's ridiculous but talk to some small business owners. I speak with them daily and yesterday spoke with one who said he spends an entire month out of the year working on taxes. That's in addition to the time he has to spend quarterly, the amount he has to pay his accountant, AND all the time he spends worrying about the tax implications of every decision he makes. This is real time, effort, energy, and money that could instead go towards GROWING his business.

So... his true take home pay: $15,200.

Along comes the Fairtax....
On the first day the Fairtax goes into effect Jill's bakery lowers her prices 23%. Bob lowers his price to $77 per loaf as well to stay competitive. Bob still sells 1000 loaves for revenue of $77,000
Bob's expenses (rent, supplies, flour) all decline by about 23% as his suppliers realize the tax and compliance savings.
Expenses: $36,500

True take home pay: $40,500 (over 2.5 times what it was before).

The bottom line with the fairtax is that true profit is true profit. It doesn't matter what kind of corporation you may be or even a sole proprietorship. You could be an LLC and pay out the 40,500 as a salary with no taxes or you could be a sole proprietorship and just take the 40,500 with not taxes. Under the current structure people constantly game the system (creating a corporation and then using corporate dividends to then avoid taxes) for their advantage and constantly worry about the structure. The current system is actually the must unfair to small businesses because they bear most of the burden of tax compliance and have the fewest resources to avoid it (unlike the major corporations which can hire tax evasion experts).

Your statement that "If Bob doesn't get to keep his personal income taxes, like everyone else does, then that puts Bob at a disadvantage to everyone else." is simply a misunderstanding of the full picture. Dig deeper.

"Businessess pay no taxes under the Fairtax. That is his main source of savings that he would be able to pass on to his customers."

For many businesses it is not just the income taxes that they pay but the cost of keeping records for the IRS, tax accountants, tax lawyers, and all the other overhead that is eating them up. As a part time electrical contractor my wife did the book keeping but her time is worth something. Tax accountant: $5375.13 + IRS: $3291.04 + bookkeeper + FICA was all money out of my profit that I would not pay under the FairTax. However, the money I would save by not paying my portion of the FICA would not go to my customers but to my employees. Then again, I would no longer be paying self employment taxes and that is another savings could be passed on to the customers.

I totally agree. That's why I said "main" source of savings. There are so many other sources of savings, beyond not paying income tax, as you have so clearly illustrated. I try to keep my reasoning simple for people who don't own a business or don't understand the burden of the current tax code.

I also like that you think the employer portion of FICA is simply something that you would pay the employee if you could. Most people don't get that employers consider wages as only part of the "cost" of employing someone.

Dear gpburdell1195,

The sole proprietor or S corp or LLC with just one worker - the owner, has the same compensation burden as for any other worker. Whether the employer side of payroll taxes eventually goes back to the worker or the customer (in the form of reduced prices), it's the same thing for the owner.

And, as a sole proprietor or an S Corp or LLC, if one doesn't officially pay oneself a salary reported on a W-2, as long as the owner pays both sides of payroll taxes, one doesn't pay unemployment insurance. That actually saves the owner a very small amount.

sitetest

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