Sensible Tax Reform--Simple, Just and Effective



C. FAQs: Federal Consumption Tax (FCT)


A. What and who to tax--and at what Rate under Sensible Tax      Reform?
(A-1) What is the federal consumption tax?
(A-2) Who will pay the tax?
(A-3) What will be taxed?
(A-4) Will services be taxed?
(A-5) Will used goods be taxed?
(A-6) What will the federal consumption tax rate be?
(A-7) An alternative proposal, the Fair Tax, claims that their tax rate
           would be much lower than with Sensible Tax Reform. How could
           they be so different
?

B. Impact upon the Poor of the Federal Consumption Tax under      Sensible Tax Reform
(B-1) What taxes do the poor now pay?
(B-2) What taxes will the poor pay under Sensible Tax Reform?
(B-3) Isn’t a sales tax regressive, with the rich paying a much lower tax relative to
           their income than do the poor and middle-income groups
?
(B-4) What is the federal consumption tax rebate?
(B-5) Who will receive the rebate?

C. Non-Taxed Expenditures under Sensible Tax Reform
(C-1) Will investments be subject to the federal consumption tax?
(C-2) Will charitable donations be subject to the tax?
(C-3) Will taxes paid to state and local governments be subject to the FCT?
(C-4) Will payments of mortgage principal or credit-card debt be taxable
           under the federal consumption tax
?
(C-5) Will the purchase of insurance be taxed?

D. Special Purchases under Sensible Tax Reform
(D-1) Will there be any exceptions to the taxation of the purchases of goods
            and services under Sensible Tax Reform
?
(D-2) How would the costs of higher education be taxed?
(D-3) How would the purchase of automobiles be taxed?
(D-4) How would the purchase of housing be taxed?

E. Miscellaneous Categories of Purchases under Sensible Tax      Reform
(E-1) Will interest payments and related fees be taxable under the federal
           consumption tax
?
(E-2) Will Internet and mail-order purchases be taxed?
(E-3) Will sales by street vendors and in flea markets be taxed?
(E-4) Will barter and countertrade be taxed?
(E-5) Will yard and garage sales be subject to the tax?
(E-6) Will baby sitting, grass cutting and snow shoveling by kids be taxed?
 


A. What and Who to Tax?

(A-1) What is the federal consumption tax (FCT)?

The FCT that Sensible Tax Reform (STR) will introduce will be a federal tax on retail purchases for consumption. It will only apply to retail markets. Businesses, non-profits and governments will not pay it.

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(A-2) Who will pay the tax?

Everyone who makes retail purchases in this country will be subject to the FCT. For both justice and in order to keep the FCT tax rate as low as possible, it is very important that the tax be as close as possible to a universal taxation of all retail customers. Working people and the retired, rich and poor, honest people and crooks, American residents and foreign visitors will all pay the tax. The tax rules will be very simple and all customers will be treated the same.

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(A-3) What will be taxed?

Most retail purchases will be subject to the tax: Both goods and services, both new and used goods. For both justice and in order to keep the FCT tax rate as low as possible, it is very important that the STR system be as close as possible to universal taxation of retail expenditures that are bought for consumption. The tax base must be as broad as possible.

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(A-4) Will services be taxed?

Under STR, one of the goals is to minimize the FCT rate, treat all taxpayers the same and apply the same rules of taxation to all categories of retail purchases. There are only a few exceptions to this rule (discussed in Sections C and D below). Where any exceptions exist, the reasons why and the rules that apply will be very specific and limited. As always, the same rules will apply to everyone.

The purchase of both goods and services will be subject to the FCT. Whenever any form of consumption is excluded from a tax, the overall tax base of the economy is reduced. To compensate for that, the tax rate on all other purchases would need to be higher. [The sales-tax rates currently imposed on goods by states and cities would be much lower if services were also taxed.] For example, if food is excluded from the FCT, then the tax on clothing and haircuts would need to be higher.

The government should exercise great caution in offering special treatment to any category of purchases or any group of customers. Sensible Tax Reform will treat all customers alike. With only a few special exceptions, all categories of purchases (services as well as goods) will also be treated alike. That will help to keep the tax rate as low as possible.

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(A-5) Will used goods be taxed?

Under STR, the purchase of all goods and services of the same sort will be subject to the same tax rules. Thus, used as well as new goods will be taxed. To tax new goods but not used goods would involve the government making a social and economic choice that it should not make--namely that used items have preference over new items. Also, it would encourage scams to categorize new goods as used. Such preferential treatment could cause very serious economic distortions. For example, more than half of all cars and 85% of all houses are bought used. To tax new cars and houses, but not used, would cause very serious damage to the manufacturers, and their employees. It would also drive up the price of used cars or houses.

Some observers argue that, since taxes have already been paid on used items, it would be unfair to tax them again. At first glance, this might appear reasonable. However, the fact that a previous buyer paid his/her tax on a purchase does not affect the appropriateness of a subsequent purchaser also paying his/her tax. The tax applies to the buyer, not to the seller or the object purchased. It is a user’s fee, like property taxes. No one argues that property taxes should only be paid once or should not be paid on a used home because the previous owner also paid those taxes. Used goods should be taxed exactly the same as new goods for several reasons:

  • To treat all businesses alike;
  • To treat all purchasers alike;
  • To keep the tax base as large as possible in order to keep the tax rate as low as possible; and
  • To avoid disruption in key, high-value industries (e.g., housing and automobiles).
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(A-6) What will the federal consumption tax rate be?

There will be only a single federal consumption tax rate that will likely be about 30%. Although that is a high nominal rate, it replaces most other federal taxes that individuals are paying now: Social Security tax, Medicare tax, personal income tax, alternative minimum tax and estate tax, as well as the embedded tax costs which businesses include in their prices. In addition, all federal tax-compliance costs will be eliminated for most of us. And the prices of most goods and services that we buy will decline. Most Americans will be paying much less in taxes and tax-compliance costs under STR than they do now--even at such a high FCT rate.

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(A-7) An alternative proposal, the Fair Tax, claims that their tax rate would be much lower than with Sensible Tax Reform. How could they be so different?

Proponents of the Fair Tax employ a very non-conventional calculation for a sales-tax rate. All other sales taxes in the world (whether conventional state sales taxes or the very common value-added tax (VAT) that most countries in the world employ) are calculated as the rate that will be added to the sales price. The ‘Fair” Tax proponents do not do that. Instead, they calculate what percentage of the total cost (price plus tax) is tax, which makes the tax rate seem lower. The amount of the tax is the same in either case, but the method of calculating its percentage impact varies.

For example, if you buy a $1 candy bar, you would pay a 30% tax of $0.30 for a total cost of $1.30. The Fair Tax calculation uses the same numbers but calculates the tax rate differently: Since the total cost of the candy bar will be $1.30 of which $0.30 is tax, they argue that the tax represents 23% of the total cost (i.e., $0.30 / $1.30 = 0.23 or 23%).

Their use of 23% is mathematically correct. However, since their way is not how sales taxes are calculated by everyone else, it is confusing to most people. Thus, what they claim to be a 23% tax is identical to a 30% federal consumption tax. [The cost of the candy would be exactly the same under either calculation: $1.30.]

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B. Impact upon the Poor

(B-1) What taxes do the poor now pay?

  • Many of the poor actually pay an income tax.
  • They all pay 7.65% of their earned income in Social Security and Medicare taxes.
  • The poor also pay embedded taxes, which often exceed 10% and sometimes even 20%, that are included in the prices of the goods and services that they buy.
  • The poor now commonly pay total taxes of between 15-25%, although special tax credits (especially the Earned Income Tax Credit) rebate some of the taxes.
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(B-2) What taxes will the poor pay under Sensible Tax Reform?

Most of the existing federal taxes on the poor will be eliminated. Instead of those taxes, the poor along with the rest of the population will instead be subject to the federal consumption tax on most of what they spend. However, the FCT rebate (explained below), which applies to purchases up to the poverty level, will completely “un-tax” the poor under STR. The poor will enjoy increased income and living standards.

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(B-3) Isn’t a sales tax regressive, with the rich paying a much lower tax relative to their income than do the poor and middle-income groups?

All flat taxes, whether flat income or flat sales tax, are regressive: the tax burden falls disproportionately heavy on the poor and middle-income groups with a FCT. This is because the poor and middle classes spend all or most of their income, and pay the federal consumption tax on most of it. The rich, on the other hand, may spend only a small part of their income and therefore only pay the FCT on that part of their income. The following chart indicates what portion of different income levels (horizontal axis) might be subject to the FCT (vertical axis).

The removal under Sensible Tax Reform of Social Security and Medicare taxes, which are very regressive as well as their income taxes, benefits the poor and middle classes comparatively much more than the rich. Also, a rebate of the federal consumption tax on essentially all of the purchases of the poor and much of the purchases of the lower middle class will also help to reduce the regressiveness of the FCT. However, to fully offset the regressiveness, a simple-and-just tax on very-high incomes will be necessary. These three actions offset what would indeed be a very regressive tax otherwise.

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(B-4) What is the federal consumption tax rebate?

All flat taxes, including a federal consumption tax, are regressive. A critical provision of Sensible Tax Reform involves a refund of all FCTs up to the poverty level of income. For example, a married couple with two children and annual income of $20,000 is considered to be below the poverty level in the United States. At that income level, most families would spend all of their income. The 30% FCT on that amount of purchases would be $6,000. An annual rebate of that amount will be paid to the family. Payment will be made monthly ($6000 ÷ 12 = $500) to families at the beginning of each month.

Thus, although the poor would have to pay the FCT on their purchases, they would receive the necessary funds at the beginning of each month to pay their FCT--without suffering any decline in real income or in their standard of living. Indeed, since their Social Security, Medicare and income taxes income will have been eliminated and prices have fallen, the poor will be much better off under STR.

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(B-5) Who will receive the rebate?

The rebate is designed to protect the poor and middle classes. However, under STR, everyone will be treated alike. We must end the current practice of giving special tax treatment to different groups. Therefore, everyone will qualify for the rebate. The rebate will be the same for comparable families (for example, a couple with two children), regardless of their income or wealth.

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C. Non-Taxed Expenditures

Expenditures that will not be taxed under Sensible Tax Reform are:

  • Investments
  • Charitable donations
  • Taxes paid
  • Principal of debt
  • Insurance

(C-1) Will investments be subject to the federal consumption tax?

Investments, while a form of expenditure, are not for consumption. Indeed, they are deferred consumption. America has a low savings rate compared to other industrialized countries. For our nation’s economic well-being, we must make every effort to increase savings. Also, with the underfunding of Social Security and Medicare and the weakness of many corporate retirement programs, Americans must learn to save more for their futures. STR will make saving much easier.

Sensible Tax Reform will increase the real incomes and standards of living of the poor and middle America, as well as of the wealthy. The latter two groups will be in a much better position than now to save and invest.

Since investments are not consumption, they will not be taxed. STR will encourage and greatly increase savings.

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(C-2) Will charitable donations be subject to the tax?

The FCT will be a consumption tax. Financial donations are not consumption. Therefore, generally monetary donations will be completely tax-free.

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(C-3) Will taxes paid to state and local governments be taxed under the FCT tax?

State and local sales, income and property taxes are not payments for consumption. They are involuntary government levies. STR will not tax the payment of taxes.

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(C-4) Will payments of mortgage principal or credit-card debt be taxable under the federal consumption tax?

The FCT will be charged on the purchase of goods or services for consumption, such as the purchase of a home or the items bought with a credit card. It will also be charged on the interest paid to finance the purchase. However, paying the principal of a mortgage or any other loan is not consumption, but rather the repayment of funds advanced to make the purchase possible. [Indeed, paying to reduce debt is actually a form of savings.] The purchase was already taxed. The loan to finance the purchase will not be.

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(C-5) Will the purchase of insurance be taxed?

The purchase of insurance will generally not be taxed.

  • Life insurance will not be taxed. But, when the life-insurance proceeds are received, they will be treated as part of the recipient’s income and taxed accordingly.
  • Medical insurance will also not be taxed, although medical costs will be taxed.
  • Likewise, property and casualty insurance will not be taxed since the goods and services purchased with the insurance proceeds will be taxed.
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D. Special Purchases

(D-1) Will there be any exceptions to the FCT rate under Sensible Tax Reform?

Sensible Tax Reform was designed with simplicity, justice and economic effectiveness as its key goals. The ideal is to be as close to universal taxation of all retail consumption purchases by all retail buyers as possible However, justice and common sense demand special treatment for three special categories of consumption: education expenses and the purchase of cars and homes. Each of these is discussed separately in the FAQs that follow.

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(D-2) How would the costs of higher education be taxed?

Primary and secondary are mandatory, and public education is available free for all.

Post-secondary education, however, is a very special category of expenditure. It is not free and it is very expensive. But such higher education is generally less consumption than it is investment in our family’s and nation’s future. That is vital to the well-being of our entire nation. Accordingly, most higher education will be partially exempt from the FCT.

Post-secondary education that is career oriented will be exempted from the FCT on $15,000 annually of tuition and mandatory academic fees per individual. In addition, mandatory expenses (such as textbooks or lab supplies) will also be exempted from the FCT.

University, college, community college and vocational programs will all qualify. However, recreational and other courses that do not meet the career-oriented criterion (e.g., basketball camp, golf lessons or a personal investment program) will not generally be exempt from the tax even if offered to the public by an institution of higher education. [The $15,000 exemption is based upon a survey of the annual tuition and fees of the best public universities. It will be indexed to inflation.]

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(D-3) How would Sensible Tax Reform affect the purchase of automobiles?

America has a lousy public transportation system in most cities and towns, and between cities. As a result, we are very dependent upon cars for transportation. Other than housing, automobiles are generally the major cost for most families. For both that reason and because of the high price, the purchase of cars receives special tax treatment under Sensible Tax Reform.

Both new and used cars will be subject to the tax. However, under STR the first $10,000 of the purchase price of any car will be excluded from the FCT tax. In addition, 50% of the remaining price of any car, new or used, will be excluded as well. This will completely protect the poor, students and others who are willing to buy low-cost vehicles.

The following table illustrates these special provision for cars of different prices.

(1) (2) (3) (4) (5) (6)
Price Exclusion Net Pricea Tax Baseb Tax Duec Averaged
$10000 ($10000) $         0 $       0 $      0    0.0%
$20000 ($10000) $10000 $ 5000 $1500    7.5%
$30000 ($10000) $20000 $10000 $3000 10.0%
$50000 ($10000) $40000 $20000 $6000 12.0%

a. Column (3) = Column (1) - Column (2)
b. Column (4) = Column (3) * 0.5         [50% exclusion]
c. Column (5) = Column (4) * 0.3         [30% tax]
d. Column (6) = Column (5) ÷ Column (1)
 

Thus, someone buying a $10,000 car would pay no tax (Column 5). Someone buying a $30,000 car (Line 3) would owe $3,000 in federal consumption taxes. That would be an effective tax rate of only 10% (Column 6). Under this special provision, each driver in a family could qualify for one car to be used for commuting and other ordinary transportation purposes. [The $10,000 exclusion will be indexed for inflation.]

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(D-4) How would the purchase of housing be taxed?

Housing is the single largest expenditure that most families make. The housing industry, including both construction and the resale market, is one of the most important industries in the country. [Fortunately, most of it cannot be imported, so American jobs in the housing industry are secure.]

A retail tax on the purchase of homes will be part of the very broad tax base of the STR tax system. It will apply to both new and used homes. [If only the 15% of homes that are bought new were to be subject to the tax but not used houses, the new-home market would collapse and the price of used homes would be driven up sharply.]

However, a 30% tax upon such an expensive item would be very expensive. And, since Americans typically own homes for less than five years on the average, having to pay the tax every time they buy a home would be very onerous. A 30% tax would be especially difficult for the poor. Therefore, as with automobiles, Sensible Tax Reform provides for special tax treatment of the purchase of homes:

  • The first $100,000 of the purchase price of a home will be excluded from the FCT (e.g., only $150,000 of a $250,000 house would be subject to the tax).
  • Half of the balance (e.g., $150,000 / 2 = $75,000) will also be excluded. That will mean that the 30% FCT will only apply to $75,000--a total tax of $22,500 on the entire purchase price of $250,000 (equivalent to 9%).
  • In addition, at the buyer’s option, the tax can be amortized along with the monthly mortgage payments. The deferred amount will be financed at 6% interest. The first payment ($2250) will be due when the house is bought, with the balance being paid evenly over the following nine years ($2809 per year or $242 per month).
  • Finally and very importantly, the annual or monthly payments will be due only for the years in which the homeowners actually own the house.

The poor will be completely protected under STR with the $100,000 exclusion. Everyone else will also be protected by (a) the exclusion, as well as (b) the amortized payments and (c) limiting those payments to the period of ownership. Consider the following house prices:

(1) (2) (3) (4) (5) (6)
Price Exclusion Net Pricea Tax Baseb Tax Duec Average Taxd
$ 100000 ($100000) $            0 $            0 $          0    0.0%
$200000 ($100000) $100000 $  50000 $ 15000    7.5%
$300000 ($100000) $200000 $100000 $ 30000 0.0%
$500000 ($100000) $400000 $200000 $ 60000 12.0%
$1000000 ($100000) $900000 $450000 $135000 13.5%

a. Column (3) = Column (1) - Column (2)
b. Column (4) = Column (3) * 0.5
c. Column (5) = Column (4) * 0.3
d. Column (6) = Column (5) ÷ Column (1)

For example, if a couple purchases a $300,000 house or condo (Line 3), they would pay a 30% tax but only on the tax-base price (Column 4) of $100,000. That tax (Column 5: $30,000) would effectively be only 10.0% of the total purchase price. If the purchasers opt for ten amortized payments, the initial payment at the time of purchase would be $3000, with nine annual payments of $3745 each or monthly payments of $323.

If they lived in the house for four years, they would only need to make the tax payments for those four years. When they sold the house, the remaining tax would no longer be due. If they owned the house for the full nine years, they would no longer need to pay the FCT on the house.

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E. Miscellaneous Categories

(E-1) Will interest payments and related fees be taxable under the federal consumption tax?

Rental activities of any sort will be taxed. Hotel rooms, rental cars and apartments will all be taxed. Interest payments and other loan fees are likewise rental costs--the cost for renting money. Under STR, interest rates are likely to fall significantly, but individuals will owe taxes on the interest that they pay.

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(E-2) Will Internet and mail-order purchases be taxed?

The purchase of all goods and services will be treated alike under STR--regardless of who purchases them and regardless of where, how or by whom they are sold. To do otherwise would place local retailers at an unfair disadvantage. Justice to all participants is a critical goal of Sensible Tax Reform. Therefore, Internet and mail-order purchases will be subject to the tax.

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(E-3) Will sales by street vendors and in flea markets be taxed?

Such sales will be taxed. All retailers will be treated alike under Sensible Tax Reform. It would be grossly unjust to require a local retailer to charge the FCT while excluding comparable sales by competing vendors. Justice is a critical component of STR.

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(E-4) Will barter and countertrade be taxed?

Most bartered retail transactions will be fully taxable--as they generally are now. Justice demands that comparable transactions should be taxed comparably, regardless of how they are paid. We must bring an end to the type of dishonest tax system that we have now wherein some groups have been able to garner special tax treatment. Under Sensible Tax Reform, all such unjust tax treatment will be destroyed. All retail transactions, unless exempted under one of the few categories detailed above (e.g., the purchase of insurance or a car), will be subject to the same taxation rules and the same tax rate. This includes bartered goods and services.

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(E-5) Will yard and garage sales be subject to the tax?

If the sales are indeed informal small size, and not part of an organized business, such sales will not be taxed.

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(E-6) Will babysitting, grass cutting and snow shovelling by kids be subject to the federal consumption tax?

Informal sales, as with the garage sales above, with not be subject to the FCT. However, if the service becomes a business, it will become subject to the FCT.

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