Friday, August 18, 2006

(Fair)Tax Evasion

This is a letter i received from Karen Walby, Director of Research for AFFT. She is a brilliant woman, and I love reading her responses to questions and concerns.

I plan on making this blog a bit more organized soon. I just need to learn how to create folders and sub-folders in the language this site uses. If anyone knows how, shoot me a line please!

I want to categorize all my blogs and any articles, letters, or comments I find into areas of interest.



Question: Since business purchases are not taxable, how does the FairTax keep
individuals from pretending to have a business so they can buy things tax-free?


Answer: Under the FairTax the entire income tax code is repealed and along with it the various designations of subchapter S corporations or C corporation. There would be no longer be a tax reason to incorporate or not to incorporate.

Under the FairTax, any business can purchase goods & services for business purposes tax free if they meet certain criteria and certain responsibilities which are explained in the paragraphs below.

The FairTax has several features that make it difficult and very risky for persons to have a scam business in order to purchase items tax-free. First, in order for any person to purchase items tax-free for business purposes, the business has to be a registered business and possess a registered business certificate issued by the state sales tax authority. Registered businesses will be expected to file monthly or quarterly sales tax returns with the state if retail sales are made. The registered business certificate will enable the business to purchase tax-free from wholesale vendors, but the wholesale vendor must retain a copy of the registration certificate to justify not having collected tax on the sale. When a business purchases items for business use from a retail vendor, it will have to pay the tax on the purchase and take a credit against the tax due on their monthly sales tax return. If the business has no retail sales it will receive a cash refund. The business must keep invoices/receipts to document what it purchased, the amount of the purchase, and the business purpose.

Also, registered businesses will be subject to the possibility of being audited by the state sales tax authority. During such an audit they will have to produce the invoices for all the "business purchases" that they did not pay sales tax on, and will have to be able to show that they were bona fide business expenses. If they cannot prove this, then they will have to pay the taxes that should have been paid when the items were purchased, plus interest, and penalties. The probability of being audited will be much greater than it is under the current system with its over 140 million tax filers. Under the FairTax, there will be less than 20 million businesses who will be filing sales tax returns and thus subject to the possibility of being audited. Thus the probability of tax cheats getting caught will be much greater than it is today, making tax evasion riskier than it is today. Additionally, while the FairTax has much stronger taxpayer rights than does the current tax system, the FairTax legislation provides for a number of fines and penalties for non-compliance. It also authorizes a mechanism for reporting tax cheats and obtaining a reward. An example would be
1-800–TAX-CHET.

Another potential scam is to have a “fake” family business in order to buy things for family members tax-free. The FairTax has a specific provision to prevent this. Although it does not prohibit businesses from providing taxable property or services as gifts, prizes, rewards or as remuneration for employment; the gift, reward, etc. is considered to be the conversion of property or services from business use to personal use and therefore taxable. Likewise, there is a similar provision to prevent abuse of employee discounts. Under the FairTax, employer-provided employee discounts over 20 percent are taxable. The term “employee discount” means an employer’s offer of taxable property or services for sale to its employees or their families for less than the offer of such taxable property or services to the general public. If the employee discount amount exceeds 20 percent of the price to the general public, then the sale of such taxable property or services by the employer to the employee is considered the conversion of property or services to personal use and subject to tax. The taxable amount is the amount by which the discount exceeds 20 percent of the price to the general public.




Karen Walby

Director of Reasearch, Ph.D.

FairTax.org

Friday, August 11, 2006

Tax Reform Concerns

Today, through a bit of inspiration in reading the posts on the FairTax Groups forum, I have decided to make a chart of concerns about taxation in this country, and then rate the level of that concern for each type of tax reform idea. So, here is the first phase of the chart:

P.S. I cannot figure out why, but the chart wants to be REALLY far down the page. I can't get rid of the extra spaces. If someone who knows programming sees this and knows how to fix it, by all means, reply and tell me how. Otherwise, just scroll down and check it out. Tell me of any concerns you think should be on there and if you agree/disagree with my risk/concern level.














Concern
FairTax
Flat Tax
VAT
Current
VAT w/Prebate


Hurts the Poor 2 7 9 4 3


Evasion
2
6
3
7
3


Revenue Neutral
2
3
2
3
3


Fair
1
3
4

7


3


Transparent
1
2
7
9
7


Price Increase
6
4
7
2
6


Higher than Propsed/Current Tax Rate
3
3
4
6
4


Hurt Business
2
4
3
7.5
2.5


Black Market Causing Less-than-Expected Revenue
2
4
3
7.5
2.5


Fix Social Security & Welfare
3
5
3.5
6.75
3.5





Tell me of any concerns you think should be on there and if you agree/disagree with my risk/concern level.

Monday, August 07, 2006

Its been a while!

Hey everyone, thanks so much for you positive and negative feedback! I enjoy hearing that people appreciate the fact that I have a blog on the FairTax, and I also am happy that there are those of you out there who care enough understanding the issue of the FairTax to debate it with me. Even if your heart is dead-set against it, I am still happy that you would have an intelligent, informed discussion about it, rather than demagogue it to death.

I regret that I have not been able to make a post for so long. I have been SOOOOOOO busy. A project deadline is coming up at work, AND I am moving into a new apartment. I still have no more time than I have had for the past week, but I need to write something here. I am addicted to blogging! I love it! I am glad to be back!


Today I will talk about my experiences on the forum FairTaxGroups.com

My name is the same on that site, and because it take much less of a commitment to make a simple post on the forum than it does to write a whole blog, I have not neglected the forum as much as I have this site. I have made a few posts, and responded to many concerns about the FairTax.

I will be referencing data that is contained on this PDF. It is a rebuttal to a report filed by ITEP from AFFT.
ITEP Rebuttal

Of the various disagreements that arise on the forum, I believe the most common concern is that the FairTax will not raise enough revenue at 23% inclusive tax. They provide a variety of reasons for this claim...

tax evasion...
black markets...
confusion over who pays what...

... But none of them have ever been able to hold water with me. I will address the issue that the FairTax, as written, will be able to raise the necessary revenue to fund our government as it is today, and then I will respond to a few common concerns about why the expected amount may not be the collected amount.


First, in 2003, the Federal Government collected $1.67 trillion in revenue from the income tax, payroll taxes, estate tax, gift taxes, capital gains taxes, etc. This amount is 15.24% of Nominal GDP for that same year, which was $10.961 trillion. The Federal Government collected, through various forms of income taxation, just over 15% of our GDP in 2003. For that same year, consumption (as currently defined, which will be modified once the FT is in place, but it is an overall wash in the total amount) was $9.5 trillion. The tax rate required to raise the same revenue for taxing consumption would be 17.6%. Thus the tax rate would need to be, at least, 17.6% to remain revenue neutral. After adding in the cost of the prebate, the rate of 23% sounds reasonable.

This, of course, is assuming that all of the taxes are collected and that spending continues on its current general trend from one year to the next. Today I will address the issue that, assuming spending stays on its current trend, a large enough portion of the taxes will be collected to fund the government effectively.

The reason why taxes wouldn't be collected would be tax evasion. Under the current system, several hundred billion dollars are evaded in taxes every year. This is because of the complex nature of the tax, and the ability to hide income in off-shore accounts and various other holdings. Under the FT, income is no longer reported, and there is no longer a need for those off-shore accounts. What is reported is the business's sales and business to business expenditures that the business paid tax on. These are reported monthly. The business will report that it had $10,000 in sales this month, and it made $8,000 in taxed business to business transactions, thus it paid $1,840 in taxes. The company owes $2,300 in taxes because of the $10,000 in sales. So, reporting the expenditures and the sales, the total amount of taxes the company owes to the government is $2,300-$1,840=$460.

If, say, this company made it a habit to sell things cheaper without collecting the tax, and not reporting that sale so the government won't have a record of it. This leads to its overall sales numbers declining. Instead of $10,000 in sales and $8,000 in B2B expenditures, it ends up being $8,500 in sales and $8,000 in expenditures. What will happen to this $1,500 that is left? The owner will most likely pocket the money.

Purchasing 800 widgets for $10 each will add up to $8,000. Selling those widgets for a total sales revenue of $8,500 means an average price of $10.63, or a profit of $0.63 each.

If one was to calculate the numbers again, it will become obvious that something is just not right. $8,500 in reported sales is $1,955 in taxes, and $8,000 in expenditures is still $1,840 in tax credit. Thus total taxes owed is $115. This leaves only $385 for other expenses. This business is just barely scraping by with a 4.5% profit margin, but it is still profiting, and no red flags have yet gone up.

The warning will come from outside the company. The red flag will be from the widget manufacturer. This will most likely be a very large factory that sells to more than this small widget retailer, and will be under a large deal of scrutiny, so they will pay their taxes by the book. Only small businesses will be able to possibly think they can slip under the radar. The sales that the widget company reports will go to the government. The number of widgets sold to every customer will be documented to be sure there is no lying about the tax credit. The manufacturer will report that it sold 800 widgets to our aforementioned retailer so the retailer can get its proper credit. The retailer will be selling the products as if it were collecting the tax, but will not be turning it in, so its prices will be higher than the average price calculated when using the total reported revenue and the number of widgets sold. The company will be audited and caught.

If the company decides to report the correct price for the products, but decides to not include certain purchases so he can keep the tax as profit, it will show in the report as the wrong number of widgets sold.

The system, by forcing businesses to report sales to get tax credits, ensures the system will be hard to avoid.


Even if the retailer decides to not charge the tax or remit it, and does not ask for the tax credit, he will then be in the hole, and the tax will be paid anyway.



It is not worth it to a company to try and avoid this tax. The penalties for getting caught are severe, and the ease of getting caught is obvious. Illegal sales that do not give the government the tax will need to be kept to a minimum in order to avoid detection, and this will prevent abuse. Over 80% of all sales in this country are through major companies who would never dare cheat on the taxes like this, and so a small percent of the 20% will be miniscule. Eventually, the tax will be a way of life, and paying it will no longer be considered a burden, but just what happens. The black market idea will simply not happen because there is little incentive and great deal of risk.