Fairtax Rate - effective fair tax rate is better than current tax system

As you can see from my site (right columns) I am an avid fairtax supporter. This week I read an interesting presentation of the effective fairtax rate, which I thought was compelling and would be supported by most Americans. I wanted to share this because you won't hear the media or nagging fairtax bloggers sharing the fairtax from this angle.

The source of the quote below comes from The Fairtax Solution - Financial Justice For All Americans (Ken Hoagland).

What caught my attention are three factors

  1. You would have to spend over $900,000 to reach the 23% limit.
  2. Middle class will have a lower effective tax rate than what we are paying now.
  3. The poor would not pay any taxes, including no embeded taxes in the price of goods (like all of us pay now).

If you look at the bigger picture of the fairtax; jobs, higher savings rates, simpler tax system, no embeded taxes (in price of goods) and no more bribes for more complicated tax code for corporations. I am even more convinced America needs this type of tax system.

I will share more about this author and the fairtax as I continue reading.

I could not get the chart to scan decently (mentioned near the end of text), see the book for the illustration.

Chapter 1 - pages 13 - 16

Under the FairTax, a 23 percent tax is collected on the retail sale of all new goods and services at the time of purchase. To clarify, that 23 percent is the amount collected on the sum of two amounts: the tax and the price of the purchased item. When you go into a shoe store, for example, you might see a $100 price tag on a pair of shoes. That $100 price includes a $23 FairTax that goes to the federal government (minus a small fee paid to the retailer). The other $77 goes to the shoe store. Out of the $100 dollars, you pay a highly visible $23 tax, which is noted on your receipt. To most people this is a 23 percent tax,  but others are quick to note that $23 represents 30 percent of a $77 purchase.

If this seems confusing, don’t feel alone, because sales-tax rates are usually expressed "exclusive" of the tax amount; in other words, the tax is not part of the total upon which the percentage rate is calculated. If income-tax rates were calculated this way (exclusive of the tax itself), there would be no confusion and the FairTax would be described as a 30 percent retail consumption tax. But, as is doubtless surprising to many, income-tax rates are not calculated this way. Here is how the inclusive income-tax rates would change if calculated exclusively (like sales-tax rates): 15 percent inclusive = 18 percent exclusive; 20 percent inclusive = 25 percent exclusive; 25 percent inclusive = 33 percent exclusive; 33 percent inclusive = 50 percent exclusive; and 50 percent inclusive = 100 percent exclusive.

The FairTax is calculated the same way your income-tax rate is calculated—inclusively. In other words, a 15 percent income-tax bracket really means you pay 15 percent of the total of your taxes and your earnings added together or, put another way, 18 percent of just the earnings amount. The seemingly lower percentage figures of the FairTax rate and income-tax rates result from the inclusive method of calculation, which includes both the tax paid and the earnings amount in a single sum—and then calculates the ratio between the tax and that combined sum.

The "tax-inclusive" FairTax rate of 23 percent simply makes it easier to compare the FairTax rate to current income tax rates. Without stating the rate this way, it would be very difficult for average people to compare the annual cost of the FairTax with what they pay today under the income-tax system. In one sense, the difference between a 23 percent tax-inclusive  rate and a 30 percent tax-exclusive rate is similar to the nonexistent difference between measuring an object in centimeters and measuring it in inches—whichever measurement you use, the distance (or tax amount) is the same.

It should be noted that the FairTax only replaces the federal  tax system, and therefore, state and local taxes still exist under this new system. State sales and income taxes and local property taxes remain as they are, although federal taxes formerly hidden as "embedded" taxes are shifted into the open.

While a 23 percent or 30 percent rate may seem high at first glance, it actually amounts to a lower percentage of income than what most Americans now pay in federal taxes. Under our current system, in addition to income taxes, we pay Social Security and Medicare taxes, embedded taxes added to the price of consumer goods, and the significant cost of compliance with the federal income-tax system. The FairTax eliminates all personal tax-compliance costs.

If you work for an employer, the amount of FICA taxes (for Medicare and Social Security) withheld from your paycheck equals 7.65 percent of your earnings up to about $102,500. Your employer pays an equal amount to the federal government. If you are self-employed, you pay the full freight—15.3 percent—which is why this is sometimes called the "self-employment tax." The FairTax eliminates and replaces these taxes.

Since the FairTax is based on consumption, those who spend more pay more taxes. Those who spend less pay less. Those who purchase only the necessities of life will be compensated by the prebate reimbursement. Because the wealthy typically spend more than lower- or middle-class Americans, they will pay more taxes over the year on their purchases. Because everyone will have more control over their money and more disposable income with increased take-home pay, the FairTax will have a  rapid, dramatic, and positive effect on job creation and the overall economy.

Let’s look at high-, medium-, and low-income Americans and see how they are treated under the FairTax. When a billionaire spends $10 billion, she pays a tax of $2.3 billion and gets a prebate of $4,697 (assuming she is married and has no children). Her effective tax rate as a percentage of spending is 22.95 percent. If a middle-income married couple with no children  spends $50,000, they pay $6,803 (net of their prebate), for an effective tax rate of 13.6 percent. The effective tax rate increases as spending increases but never exceeds 23 percent. If this same couple earns $50,000 in wages today, under the current tax system, they pay $4,093 in income taxes and $3,825 in payroll taxes, for a total of $7,918 in taxes (15.8 percent)—a tax burden significantly higher than under the FairTax. Mr. and Mrs. Middle owe even more than these figures indicate because under the income tax system they pay hidden income tax costs embedded in the price of American-made goods and services every time they make a purchase (which I will discuss a little later in some depth). Finally, under the FairTax, a low-income couple at or below the poverty line who spends everything they earn pays no net FairTax at all. Today, under the income-tax system, they not only pay almost 8 percent of earnings in payroll taxes (the employee’s share), but they also pay hidden taxes—arising from corporate taxes, private-sector compliance costs, and payroll taxes passed on to consumers and embedded in the price of everything they buy.

The following chart makes clear that this national tax never exceeds 23 percent of spending. But to get to that full level of taxation you would have to spend more than $900,000 on personal consumption! For most Americans, annual tax costs under the FairTax are significantly less than 23 percent.



excellent post. i yearn for the Fairtax to be tried. In my home state of Missouri it has a real chance of being passed into law. In my case I believe I would pay very little tax because I mostly buy just the necessaries and things that would be covered by the prebate. I have a tv I expect to last several years,when I buy cars they are always late model,low mileage , used cars. In other words things either exempt under the Fairtax or covered by the prebate,plus,the government isn't skimming my pay! Go FairTax!!

A state level fairtax won't really effect your income as a federal level fairtax would. But, in a macro (state level) it would help the economy, create jobs etc... Since state level corporate tax goes to 0.