For those who don’t know about the FairTax, a little background:The FairTax Plan is a comprehensive proposal that replaces all federal income and payroll taxes with an integrated approach including a progressive national retail sales tax on new items only, a rebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, repeal of the 16th Amendment. This nonpartisan legislation (HR 25/S 25) abolishes all federal personal, gift, estate, capital gains, alternative minimum, Social Security, Medicare, self-employment, and corporate taxes and replaces them with one simple, visible, federal retail sales tax – collected by existing state sales tax authorities. The FairTax taxes us only on what we choose to spend, not on what we earn. It does not raise any more or less revenue; it is designed to be revenue neutral. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system. More details can be found at www.fairtax.org
A simplified example
We are off to the shoe store to buy a new pair of all purpose hunting /hiking /work boots. The store has many styles and the one we like is made by AmeriBoot model Brown 3 and sells for $100.00. Next to it is a “knock-off” version from ChinaBoot model BRIII at $77.00
Our desire and sense of duty says “buy American made!”…but our wallet says “save money, by the China-Boot”.
Now let’s put in some numbers here. ChinaBoot sells 10,000 pairs a year of BRIII and AmeriBoot sells 2,000 pairs of Brown 3. AmeriBoot has enough brand loyalty to overcome the higher price.
Under our current tax system, the income tax, American products have somewhere between 20 to 30 % of their product price as embedded corporate taxes and compliance costs. Foreign products do not. 23% is the working average (see:Taxing Sales under the FairTax – What Rate Works? footnote below) Now we leave Income Tax land and step into FairTax land.
Remember, under the FairTax plan H.R. 25, we remove all income taxes and compliance costs (23% inclusive) from the production side and add it back to the consumption side of the equation (30% exclusive)
The income tax equation is income- taxes-compliance dollars = spending
The Fair Tax equation is income = spending + taxes+ compliance dollars, so here we are taxed as we spend and keep the compliance costs
AmeriBoot can now remove 23% from its price structure ($100-23) and are now able to bring its product to retail at $77.00 ChinaBoot never had that 23% in their price so they can’t do anything. So now AmeriBoot is the same price as ChinaBoot. ($77.00 + the 30% exclusive tax), both are now $100.00
What do you think Americans will do now?
You guessed it, switch to AmeriBoot. In fact let’s say AmeriBoot takes half of ChinaBoot’s market share.
Sales now: AmeriBoot 7000 vs. China boot 5000. AmeriBoot has so much new business, it has to expand the factory (capital outlay) and /or add another shift ( labor outlay).
Great for everyone but ChinaBoot !
Wait, wait, wait, No way, some say! Those fat-cat American corporate executives won’t drop the price. They will just keep the same price and take the savings in profits and higher bonuses. Believe it not, that is what many of the FairTax nay-sayers cry. They don’t understand the invisible hand of market forces.
So let’s play devil’s advocate and pretend that is true.
AmeriBoot decides it will keep the removed 23% cost and apply it to profits. They are sure that brand loyalty will keep their sales constant. So now we add the 30% FairTax exclusive rate to AmeriBoots’s $100 price and to ChinaBoot’s $77 price and now we have $130 vs. $100.
Still a $30 spread and both prices are higher. Consumers are now faced with higher prices and the ChinaBoot is still cheaper.
AmeriBoot is wrong. Since both prices are now higher, AmeriBoot ends up losing half its market share to ChinaBoot. Sales now: AmeriBoot 1,000 pairs, ChinaBoot 11,000.
AmeriBoot is now faced with lower sales and has to shut down a machine or layoff workers. Not good.
There is hope. This scenario can only last for a while until market forces step in.
This is a dynamic economy. Remember that 23% comes off of all industries, including banks. There are now banks willing to loan money at lower costs now.
A handful of folks come together with a business plan and a loan. Perhaps even ex-employees of AmeriBoot. They start a company called TexasBoot and come up with their own version Brown3 called Rocky8. They can bring their product to market at $77 and promote the American made label.
That makes 3 brands on the shelf with an end retail price and tax of, AB at $130, CB at $100 and TB at $100
TexasBoot sales soar. They take half of the market share from each AmeriBoot and ChinaBoot.
Sales now TexasBoot 6000, ChinaBoot 5500 and AmeriBoot now at 500.
TexasBoot, being new, was able to invest in newer and more efficient machinery than AmeriBoot ever had. They even hire away some of AmeriBoot’s workers. The new plant and equipment is so efficient that they can now bring their boot to market for $60.00!
Wow, now we have a no brainer!
TexasBoot at $60 x 1.30 = $78.00
ChinaBoot at $77 x1.30 = $100.00
AmeriBoot at $100.00 x 1.30 = $130.00
What do you think will happen to market share now? Your guess is as good as mine but I guarantee you it won’t be good for ChinaBoot and AmeriBoot.
The above is an example with just two original competitors. Think how quickly prices will change with multiple competitors.
Taxing Sales under the FairTax – What Rate Works? http://people.bu.edu/kotlikof/BHI-LK%20Taxing%20Sales%20under%20the%20FairTax-%20What%20Rate%20Works%209-25-06%20FINAL.pdfby Paul Bachman Director of Research, Beacon Hill Institute, Suffolk University Jonathan Haughton Associate Professor of Economics Senior Economist, Beacon Hill Institute Suffolk University Laurence J. Kotlikoff Professor of Economics, Boston University Research Associate, National Bureau of Economic Research Alfonso Sanchez-Penalver Economist, Beacon Hill Institute, Suffolk University David G. Tuerck Chairman and Professor of Economics Executive Director, Beacon Hill Institute Suffolk University September 2006 When income tax rates are quoted, economists call that a tax-inclusive quote: “I paid 23 percent last year.” For every $100 earned, $23 went to Uncle Sam. Or, “I had to make $130 to have $100 to spend.” That’s a 23-percent tax-inclusive rate.We choose to compare the FairTax to income taxes, quoting the rate the same way, because the FairTax replaces such taxes. That rate is 23 percent.Sales taxes, on the other hand, are generally quoted tax-exclusive: “I bought a $77 shirt and had to pay that same $23 in sales tax.” This is a 30-percent sales tax. Or, “I spent a dollar, 77¢ for the product and 23¢ in tax.” This rate, when programmed into a point-of-purchase terminal, is 30 percent.Note that no matter which way it is quoted, the amount of tax is the same. Under an income tax rate of 23 percent, you have to earn $130 to spend $100.Spend that same $100 under a sales tax, you pay that same tax of $30, and the rate is quoted as 30 percent.
Perhaps the biggest difference between the two is under the income tax, controlling the amount of tax you pay is a complex nightmare. Under the FairTax, you may simply choose not to spend, or to spend less.
