by Brock J. Oliverio, M.D.
You may not realize it, but the federal government already collects a tax on the things you buy. You don't realize this because they don't collect the tax at the time you buy it. They collect it at the time you earn it. This is your federal income and payroll taxes that come out of your check each pay period. What it boils down to is this: in order for you to afford an item you have to earn enough money to cover the price of the item plus the taxes that will be witheld from your income. For example, if you want to buy a new cell phone that costs $77, you can't just earn $77, right? You have to earn $77 plus the taxes that will be witheld from your income.

The calculation to buy the cell phone works the same under a FairTax system. The difference is that under a FairTax system you take home your entire paycheck. There aren't any federal income or payroll taxes witheld. Instead the tax on the things you buy is collected at the time you buy it. The dollar amount of the tax collected under the FairTax and the income tax is exactly the same. The percentage is just different depending on whether you are witholding the money from income (23%) or whether you're charging it at the time you buy something (30%). The following senario explains it all.

Living under our current income tax system, Fedup Smith (see my power point presentation to find out more about the adventures of Mr. Smith and his lovely wife, Mrs. Smith) wants to buy a $77 cell phone. Under our current income tax system how much does he have to earn to buy the cell phone? Asume that he pays 23% income tax.

EQUATION 1:
AmountEarned = ItemPrice + (AmountEarned * IncomeTaxRate) where AmountEarned is called x.
x = $77 + (x * 0.23)
x = $77 + 0.23x
x - 0.23x = $77
0.77x = $77
x = $77/0.77
x = $100

Fedup has to earn $100 to buy the $77 cell phone. Why is that? Because his employer is going to withold $23 in taxes from his income. He earns $100, they withold $23, and he has $77 left to spend. The effective federal tax he pays on the cell phone is 23% of his income calculated like so:

EQUATION 2:
IncomeTaxRate = AmountWitheld/AmountEarned where IncomeTaxRate is called x.
x = $23/$100
x = 0.23
0.23 * 100 = 23%

Next question: What percentage of his spending does he pay for the cell phone?

EQUATION 3:
ItemPrice * SpendingTaxRate = AmountWitheld where AmountWitheld is called x.
$77 * x = $23
x = $23/$77
x = 0.30
0.30 * 100 = 30%

The tax he pays on the cell phone is 30% of his spending under the current income tax system.

Now let's see what it would be like in a FairTax world.

Fedup wants to buy a $77 cell phone. Since the FairTax is revenue neutral, he still has to pay $23 in taxes. So he has to earn $100 ($77 + $23) just like before. So what is the difference? The difference is that the $23 in taxes is collected at the retail counter rather than witheld from his income. This means we need to give the seller a percentage of the sale price that he needs to charge at the counter in order to collect the $23. Well, we already figured this out under the old system! It's EQUATION 3. This won't change under the FairTax. So we just use that rate! So he pays 30% of his spending just like before! There is no difference in the percentage of his spending whether it is under the income tax system or the FairTax system.

Just to bring this home answer this question What percentage of his income does he pay in taxes for the cell phone under the FairTax? Simple. It's 23% just like before. We even use the same equation, #2!

So you see that you are currently paying federal taxes on anything you buy because you have to earn the price of the item PLUS the amount of taxes that will be witheld from your income in order to buy it. Under the FairTax you would also have to earn the price of the item plus the amount of taxes needed. The tax is just collected at the time you buy the item rather than from your income. So now young taxhopper email me your answer to this question: Is the FairTax rate 23% or 30%? (Don't forget to include your email so I can tell you how smart you are!)

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