What would you say is an excessive tax rate? Whether it's an income tax, a sales tax, or any other type of tax, if you don't take the time to examine the details of any tax, then you might think that a 23% tax rate is excessive.
In fact, that's the specious and narrow view of the FairTax that's promoted by the big-government politicians, in Washington DC. They want to keep the current system that they routinely game to their advantage, so they promote that narrow and inaccurate view of the FairTax. But basing a decision on such a limited view would be like buying a car based on the size of tires. You have to step back and look at the whole picture.
In the case of the FairTax, both HR-25 and S-122 call for a 23% sales tax on all retail purchases of new products or services. Sure. This may at first, sound excessive. But the truth is that not a single U.S. citizen would pay the full 23%. That's a fact.
So where does the 23% come in? Why does the FairTax call for a 23% sales tax if nobody pays it?
Actually, everyone initially pays the 23% sales tax, but every U.S. citizen family will receive a "prebate" (that's a rebate, paid one month in advance) equal to the amount of tax that a family of that size would pay in a month, if they were spending at the poverty level. So the very poor, who spend at or below the poverty level, will receive a prebate that completely wipes out their FairTax payments for the month, meaning that they will pay effectively zero percent (0%) tax. People who spend only slightly more will pay very little tax, while those who spend really big, will pay something closer to 23%. But not one U.S. citizen will pay the full 23%.
Think of it like buying a new camera, TV, or computer, where the manufacturer offers a manufacturer's rebate. Let's say that you go to the store and pay $1000 for a TV. You take it home, remove the proof of purchase from the packaging and mail it to the manufacturer. Two weeks later, you receive a check from the manufacturer for $100. How much did that TV cost you? In the end, it cost you only $900. Granted, you might brag to your friends that you paid $1000. But in reality, your bank account is down by only $900 for that purchase.
That's how the prebate works. There are two notable differences, however. The FairTax prebate is all automatic and you get it before you make the purchase, rather than after. No calculations. No forms. It just happens.
So, as in the case with the manufacturer's rebate, where your true purchase price was less than the listed price, your FairTax rate is less than the listed 23% rate. In fact, in most cases, it's a whole lot less. But let's clarify that statement. By "in most cases," I mean more than 95% of all U.S. citizens.
According to the latest IRS Collections Data, to be in the top 10% of income earners, a family must earn at least $116,623 per year. However, since roughly 50% of U.S. citizens pay no U.S. income tax, either because they are retired or just don't earn enough money, that top 10% of taxpayers is really the top earning 5% of U.S. citizens. So let's do the math for a family at the top end of the bottom 95% of U.S. citizens - a family who earns one dollar less than what it takes to be in the top 5%.
For our purpose, we'll assume that this family is very irresponsible and spends every penny that they earn, putting nothing aside for savings. Remember, if a family spends less, they pay a lower effective FairTax Rate. So we're really creating a worst case scenario for the FairTax. Since this calculation is for a family that is at the top of the bottom 95% of U.S. citizens, we'll assume spending to be $116,622 per year or $1 less than the threshold for the top 5%.
For our prebate calculation, we'll assume an average family size of two adults and two children. We'll also use the 2013 Health and Human Services published poverty levels of $11,490 per adult and $4,020 per child. These are the numbers that the Treasury Department would use to calculate your FairTax prebate, if the FairTax were in effect this year. It may sound complex. But just remember that everything about the FairTax is all automatic. This is only to for educational purposes, to determine the actual FairTax rate for this family. Here's the math.
We'll start by calculating the prebate:
1) Poverty Level Spending is calculated by multiplying the poverty level for each adult by the number of adults and the poverty level for each child by the number of children.
Poverty Level Spending: (2 x $11,490) + (2 x $4,020) = $31,020
2) The Prebate is therefore 23% of poverty level spending, as determined in step 1.
Total Annual Prebate ($): 23% x $31,020 = $7,134.60
Now we'll calculate the FairTax Rate:
3) The total tax paid in dollars, at the time of purchase, is simply 23% of annual spending, which we are assuming to be $116,622.
Tax Paid at Purchase ($): 23% x $116,622 = $26,823.06
4) From that, we subtract the annual prebate, as determined in step 2, to get the total FairTax paid in dollars.
Total FairTax ($): $26,823.06 - $7,134.60 = $19,688.46
5) Finally, to determine the Real FairTax Rate, we divide the dollars paid in FairTax, as determined in step 4, by the total spending, assumed to be $116,622.
Real FairTax Rate (%): $19,688.46 / $116,622 = 16.9%
So you can see that under the FairTax, 95% of U.S. citizens will pay nowhere near the advertised 23% rate, but rather, less than 17%. Furthermore, that rate drops much lower, as you proceed further down the spending scale.
This list shows the real FairTax rate at various annual spending levels, for a family of two adults and two children (calculated using the method described above).
$31,020 - 0% (Poverty Level)
$40,000 - 5.16%
$69,126 - 12.68% (Cut-off for Top 12.5%)
$80,000 - 14.08%
$100,000 - 15.86%
$116,622 - 16.88% (Cut-off for Top 5%)
$161,579 - 18.54% (Cut-off for Top 2.5%)
$369,691 - 21.07% (Cut-off for Top 1/2%)
$1,000,000 - 22.29%
So the next time some big-government politician tries to convince you that the FairTax rate will be 23% for everyone and suggests that we should just keep the income tax and IRS, you'll know that he either doesn't know what he's talking about or he's lying, because he doesn't want to give up the power that the current system gives him.
Full Disclosure Note: In all fairness, I should mention that there is one group that will pay the full 23%. They're illegal aliens. Since illegal aliens will not receive the prebate, the effective FairTax rate for them will be the full 23% on every retail purchase of new goods and services. This will increase their cost of living by around 23%. It will have the further effect of giving poor working U.S. citizens a 23% advantage over the illegal aliens, with whom they compete for jobs, since those illegal aliens will no longer be able to afford to work for below minimum wage.
When you hear people talk about the 23% FairTax rate, just remember that 23% is nothing more than a "base rate" that is just a starting point.
Do you want to know what your FairTax rate would be? Here's a very rough method to calculate your FairTax rate. It's really simplified. But it should get you close.
Start with your total household annual income. Subtract the total of ALL taxes paid to every level of government. Subtract that portion of your income that you put into savings. Subtract any investment losses that you had to cover from your income. Subtract the cost of any used items that you bought (the FairTax is not collected on used items). What you have left should be fairly close to what you spend in a year on new retail goods and services, from clothing to electricity. Then apply that number to step 3 in the above formula, with the size of your family in step 1. If you're like the vast majority of Americans, your FairTax rate won't be anywhere close to 23%. In fact, most U.S. citizens will actually pay less than 10%.
The FairTax replaces the income tax, payroll tax, capital gains tax, FICA and in fact, every item on your IRS Form 1040, with a national retail sales tax that is collected only at the point of final retail sale of new products or services. Moreover, it eliminates the IRS. As you have seen above, while it is a single rate at the cash register, the actual effective rate of the FairTax varies, based on spending. To learn more, visit FairTax.org.
To learn more about how the FairTax will solve other issues relating to our economy, read, "The Rich Don't Pay Tax! …Or Do They?" in print, Kindle, and Nook formats. Order it through Amazon, Barnes and Noble, or other booksellers or visit http://TheRichDontPayTax.com/