Ask Dr Walby

Ask Dr. Walby - Some questions submitted by visitors to our website regarding the FairTax

Dr. Karen Walby has been the Director of Research at the FairTax.org national headquarters in Houston for over 4 years.  She has 20 years experience in federal/state tax policy analysis, having worked in that capacity for 3 Florida Governors (2 Democrats and 1 Republican), and the Taxation  and Budget Reform Commission in the Florida Legislature.  Other prior private sector experience includes serving as the Director of Research for Florida TaxWatch, Inc., a tax and spending watchdog organization, as a Senior Consultant for Price Waterhouse Coopers, and as a governmental affairs consultant.

The FairTax is a tax on the final use our consumption of all goods and services.  Business to business purchases are not taxed.  Therefore under the FairTax businesses pay NO taxes — no corporate income taxes,no individual income taxes, no self-employment taxes, no employer payroll taxes, no capital gains taxes, no estate & gift taxes — and no longer bears any compliance costs dealing with these taxes.

Since there are no taxes on business, the concept of tax deductions goes “out the window” so to speak.  Businesses pay no tax on income so there is no tax to claim a deduction against.  The same thing with individuals, there is no need for deductions since there is no tax on income.  The prebate makes sure that each family can purchase essentials tax free — which functions the same as the standard deduction and personal exemptions under the current system.

Any business who sells either goods or services must be a “registered seller”.  Registered sellers can purchase goods and services without paying tax.  The business that is selling to them, however, has to keep a copy of their registered seller certificate, so when they are audited, they have back up to show that it was a nontaxable sale.

If however, the seller you are purchasing from does not want to go to the trouble of keeping your registered seller certificate on file, then you can purchase the good or service and pay the tax. Then when you file your monthly or quarterly (depending on sales volume) sales tax return, you can deduct any sales taxes paid by your business from the amount of sales taxes that you collected on your taxable sales and remit to the government.

As to FairTax compliance costs, you just have the cost of reporting total gross sales and total taxable sales to the state sales tax administering authority that collects the FairTax on behalf of the federal government.  Employers will also have to report wages paid to employees to the Social Security Administration for the purposes of social security benefit calculations.

 

Rental payments for the personal consumption of housing services are taxed. Rental payments for business purposes are not taxed.

Residential real estate is a fixed asset that generates consumption services is its “yield”. In taxing residential real estate, either the asset itself or the consumption services yield of the asset can be taxed. If the asset is taxed, the taxes are essentially pre-paid at the time of purchase of the asset; on the other hand, consumption services are taxed as they are consumed.

In present value* terms, the pre-paid taxes and the sum of the taxes paid on monthly rents over time are the same (assuming the market is efficient). This is analogous to the differential tax treatment of a Roth IRA and a regular IRA. In the Roth IRA, the asset is taxed but not the yield, whereas, with a regular IRA, the asset is not taxed by the yield is. The current income tax taxes both the asset (it is purchased with after tax dollars) and the yield.

The MI FairTax treats renter-occupied residential real estate and owner-occupied residential real estate in a substantially similar fashion. But it uses the tax pre-payment method for owner-occupied housing and the consumption services approach (pay as you go) for renter-occupied housing. The consumption services approach could be used as well for owner-occupied housing but it would require an annual assessment of the imputed rent** of every owner-occupied house in the country each year, an administrative nightmare and certainly not compatible with the “simplicity” of the MI FairTax.

In general, the MI FairTax treats real property like other property. If the property is purchased by a consumer for personal use (i.e. consumption), it is taxed. If the property is purchased by a registered business for a business or investment purpose, it is not taxed. Likewise, the rental of real property is taxed like the rental of other property (e.g., a car, equipment, or a hotel room). If the property is rented by a consumer for personal use, it is taxed. If the property is rented by a registered business for business purposes, it is not taxed. In all cases, the legal dividing line as to whether a transaction is taxable or not, is whether or not the property is being purchased or rented for a business or investment purpose, or by a consumer for personal use. If it is the former, then it is not taxed. If it is the latter it is taxed.

*Present value – the amount that a future sum of money is worth today given a specified rate of return. An investment that earns 10% per year and can be redeemed for $1000 in five years would have a present value of $620. In other words, $620 today is worth $1000 in five years.

**Imputed rent – he amount that the owner could charge if he rented out his home rather than lived in it. The annual taxation of imputed rent has been advocated in Australia.

The purchase of business inputs that lead to the selling of a product/service to a consumer are not taxable. Only the final sale of the product to the consumer is taxable. This is the same with a rental apartment. There would be no tax on the sale to the buyer of the apartment building. Just like there would be no tax when the apartment owner would hire a plumber to fix a leaky faucet. Business inputs are not taxed because the sale of the final good/service is taxable to the consumer.

Thus, when the sales tax is charged on the rent (purchase of housing services) it is the first and only time that tax is collected on that consumption.

With a new house bought for a personal residence, the tax is paid on the price of the house, up front; even though the services provided by that house are consumed over time. That is also why “used” homes are not taxed, as the entire amount of tax has been “pre-paid”. It would be too difficult administratively to tax the monthly consumption of owner-occupied housing so, by collecting the tax on the entire value of the house when it is purchased the homebuyer is essentially pre-paying all tax for the consumption of housing services; whereas the renter does it on a “pay as you go basis”

In general, the FairTax treats real property like other property. If the property is purchased by a consumer for personal use (i.e. consumption), it is taxed. If the property is purchased by a registered business for a business or investment purpose, it is not taxed. Likewise, the rental of real property is taxed like the rental of other property (e.g., a car, equipment, or a hotel room). If the property is rented by a consumer for personal use, it is taxed. If the property is rented by a registered business for business purposes, it is not taxed. In all cases, the legal dividing line as to whether a transaction is taxable or not, is whether or not the property is being purchased or rented for a business or investment purpose, or by a consumer for personal use. If it is the former, then it is not taxed. If it is the latter it is taxed.

Tax Justice Network (TJN): The Price of Offshore

In March 2005, TJN published The Price of Offshore, based on data from Boston Consulting Group; McKinsey’s; Merrill Lynch/Cap Gemini, and the Bank for International Settlements. This document estimated that the world’s High Net Worth Individuals (HNWIs) held around $11.5 trillion of assets offshore, which would generate a return of about $860 billion a year at a 7.5% rate of return, and a consequent tax loss of $255 billion (let’s call it $250 billion as it’s hard to be precise on this secret data) as a result of it being held offshore, more than three times the OECD countries’ official development assistance to the entire world.

According to TJN, this figure was considered extremely conservative: it did not include tax losses arising from tax competition or  trade mispricing; the surveys on which the data was based tended to exclude holdings of individuals with liquid assets below $1 million, and corporations, which reportedly pass more money through tax havens than individuals. Moreover, very large rises in global asset markets and in rates of return on assets since then would also suggest a significantly higher figure today. We must also stress that this is part of a much bigger global picture. Much tax is also lost through transfer mis-pricing (see below,) loopholes in domestic tax schemes that do not use offshore, and so on. See below for some of the other estimates that make up the global picture.

Academic & market research

Backed by research from some of the best tax economics minds in the country, includingleading researchers from Boston University, Harvard University, MIT, National Bureau of

Economic Research, Rice University, and Stanford University, the FairTax is one of themost thoroughly studied public policy issues ever to be introduced in Congress. Similar market efforts went into making sure the legislation implements a tax American citizens consider fair and are willing to pay.

Millions of dollars and years of work went into the development of the FairTax before it was ever introduced into Congress or into public debate. The academic research results were constantly exposed to real life taxpayers, which created an interactive process between the academics and taxpayers. In short, the plan was developed like any successful product — with both market acceptability and theoretical efficacy.

Market research: A diverse array of methodologies thoroughly tested the FairTax with the public, and many rounds of testing were done.  

Polling: A number of national public opinion polls were conducted, always combining Republican and Democratic polling groups to ensure strict non-partisanship. Results consistently demonstrate high acceptance rates of the general concept (up to 85 percent acceptance levels), and an ever-increasing level of specific FairTax support (surpassing any alternative).

Focus groups: A thorough series of focus groups was conducted in various geographic regions of the country, with data being fed back continuously to academic research coordinators.

Paid advertising: Television, radio, and print advertising campaigns were conducted in severalparts of the country and the results were phenomenal. Americans For Fair Taxation (FairTax.org) began with three test markets and conducted polling before and after each mediaexposure to determine its precise effects on taxpayers. This positive test led to increasingly

larger numbers of markets, culminating in a large, multi-market, multi million dollar test campaign that overwhelmed FairTax.org with phone calls, faxes, e-mails, and visits to the website. A final test was conducted to determine whether this outpouring of sentiment could be directed to Members of Congress, and this test was also a complete success.

 

The FairTax does not address any state taxes. FairTax is simply a replacement for the existing income tax system. Florida and every other state will still have their sales tax, income tax or property tax unless the state chooses to make an adjustment.
It is thought that the states will adjust their tax system to be compliant with the FairTax. In doing so their existing tax will be adjusted downward compensating for the broader tax base under the FairTax scheme.
There is no assurance this will happen. The states being sovereign can tax any way they choose.