The (Un) FairTax

The FairTax, as called by its supporters, is the solution supported by a number of the remaining Presidential candidates. In fact, it is not fair and really only benefits the poor and rich. While some aspects are interesting and it would probably save me some money on taxes, I can't support it as a real solution. It also has zero chance of being passed by Congress. From their website:

The FairTax plan is a comprehensive proposal that replaces all federal income and payroll based taxes with an integrated approach including a progressive national retail sales tax, a prebate to ensure no American pays federal taxes on spending up to the poverty level, dollar-for-dollar federal revenue replacement, and, through companion legislation, the repeal of the 16th Amendment. This nonpartisan legislation (HR 25/S 1025) abolishes all federal personal and corporate income taxes, gift, estate, capital gains, alternative minimum, Social Security, Medicare, and self-employment taxes and replaces them with one simple, visible, federal retail sales tax -- administered primarily by existing state sales tax authorities. The IRS is disbanded and defunded. The FairTax taxes us only on what we choose to spend on new goods or services, not on what we earn. The FairTax is a fair, efficient, transparent, and intelligent solution to the frustration and inequity of our current tax system.

Kind of sounds great at first, doesn't it? Well, here are the bullet points and counter points

• No taxes on income of any kind, instead it is replaced with a 23% consumption sales tax on new goods and services for personal use - no tax for businesses. So business purchases are exempt, sounds like a nightmare to enforce and book keep, not impossible but a big undertaking to implement. Also, hard to believe all the taxes collected from businesses can be eliminated and pushed to the consumer. Can the average consumer get used to paying 23% more for everything? There is a big psychological barrier here.
• The prebate makes the FairTax progressive. The prebate is provided monthly to every worker with a Social Security number to offset necessities at a rate equal to the poverty income rate.
• Retail prices no longer hide corporate taxes or their compliance costs, which drive up costs for those who can least afford to pay. So theoretically the consumption tax will be offset by the drop in prices. How long before a thriving black market springs up? I can see people flocking to buy goods from Canada and Mexico tax free.

UnFairTax

The wealthy make out really well with this plan because this is a consumption plan. Typically the poor and middle class spend 100% of their income every month on goods and service, while the wealthier and upper middle class save and invest a portion of their income. The current 2007 tax schedule for an individual is:

Someone making an adjusted gross income (AGI) of $500,000 currently pays $154,074.25 or 30.8% in Federal income tax plus social security or 32%. Moving to the FairTax, they would only pay a maximum of 23%, but most likely would be at least saving and investing some portion of their income, say 50%. Their tax rate under the FairTax would only be 11.5%. Now the same calculation for the middle class, a family living off of AGI $65,000. For most families that is just enough to get by and they are not saving or investing any portion. For 2007, they pay $16,771 or 25.8%. Under the FairTax they will pay 23%, since they spend 100% of their income. So in this example, the poor pay 0% (because of the prebate), the middle class pay 23% minus the prebate and the wealthy pay 11.5% minus the prebate. Does this still seem fair?

The last evidence of unfairness is what about all the people who have utilized Roth IRAs, Roth 401k, 529 plans, etc.? They have already pre-paid the tax on their investments with the reward of withdrawing it tax free. Now they will again be taxed when they use it for purchases in retirement or for school. In fact, all retirement plans are made obsolete, as there will be no need for tax sheltered growth.

So who supports this? Of the candidates that are left:

Mike Huckabee

Ron Paul

The chances of a change in tax policy like this are worse than slim to none. Even if it mathematically made sense, the industry lobbyist for accountants and tax prepares would fight this like never before, as we're talking about eliminating an entire industry. Also, with very little support in Congress in either party, there is no way this would pass a vote.

By the way, I do like a few aspects of this proposal.

• No tax on earnings, effectively taking the capital gains and tax on dividends to 0%
• Only prebates for those with documented jobs and a Social Security number, remove the incentives for illegal immigrants
• Eliminates the advantages of being "off the books"
• Eliminates all estate planning issues, AMT, and many other types of taxes, but that is also why I find it unlikely to be fiscally feasible

Bob Brinker Commentary

I don't know why, but one of my favorite radio shows and podcasts to listen to is Bob Brinker on MoneyTalk, find the radio station nearest you. The podcast are not free however. I never miss a show, but I can't help but feel he and his guest hosts give out incorrect or not the best advice quite often. Mostly it is due to the fact that they don't fully grasp the question and are on the spot to answer live. In general, Bob preaches the long term index based investing philosophy that I follow. However, he also claims to be a market timer, which is in direct contradiction to many of his guests and recommended readings. But that is a topic for another day...

I want to try something here and comment each week on a few questions and answers and/or topics discussed on the show. Hopefully this will spark some lively discussions in the comments section.

Was 2007 really so bad for investors?

Now that 2007 is over, let's look at the year in review. To listen to some people discuss the economy and the markets, you would think it was a horrible year. In fact, you would think the last 8 years have been terrible, but anyone invested in the market knows that is not true. Focusing just on 2007 for now, here are the numbers:

S&P500: 3.53%
DJIA: 6.46%
Nasdaq: 9.63%
Wilson5000: 3.94%

Those numbers do not take into account revinvesting dividends and, if you did, the S&P500 had a total return of 5.49%. These are certainly not stellar returns, but nonetheless performed comparable to more conservative investments such as CDs and Treasuries.

There were two real issues in 2007 and that was the real estate market and volatility. If your only investments were in real estate, financial companies, or your house, then at least on paper, you are looking at losses. The S&P Financials were down over -20%. Likewise, the DJ Wilshire REIT Index was off -17%. Meanwhile, the energy and emerging markets sectors were the real winners up 32.38% and 42% respectively. You should have owned all of these as investors in Index Funds or ETFs.

Quicktip: if you are sick of increasing gas and energy costs, invest a little in the energy markets, at least as your bills go up, so does your investment

The volatility in 2007 meant it took a lot of courage to stay in the market amidst the wild swings. However, fighting the urge to bailout is the right move to make, as I will discuss in future posts.

Finally, inflation year over year for CPI core was 2.3% as of November (that excludes energy and food). CPI-U, which includes it all, was at 4.2%. The core inflation is what is usually quoted and used for your Social Security calculations.

So what do all these numbers mean?

• First, if you were a diversified investor in the overall markets, you owned all of the good, bad, and ugly performing stocks, and came out ahead, which is what I will be pushing in future posts


• We are reminded that Real Estate does not always go up and should only be a part of your investment strategy


• By definition, we are not in a recession, as evidenced by moderate inflation, economic market growth, and GDP growth

I look forward in 2008 to discussing how we can ride out the volatility. We should be investing for the long term and ignoring the short term swings.