Tuesday, September 28, 2004

Inclusive vs Exclusive tax rate

The FairTax is a 23% inclusive sales tax. It's important to understand what that "inclusive" means so that you understand what the rate really means. When you compute a tax on a dollar you can either compute it inclusively or exclusively.

For example, the sales tax you are used to at the cash register today is an exclusive rate. The rate is applied to the price you pay exclusive of the tax applied. So if you are used to a state sales tax rate of 8% and you purchased something that was worth a dollar you would pay $1.00 + 8% of $1.00 = $1.08.

The income tax you pay is usually computed as an inclusive rate, it is applied against the dollar you earn inclusive of the amount you are paying in taxes. So if your income tax rate is 25% and you earn $1.00 then your tax is $0.25 and you get to keep $0.75.

The FairTax 23% sales tax rate is an inclusive rate. What this means is that I hand the cashier $1.00 to pay for something then $0.77 goes to pay for the good, and $0.23 of goes is paid in taxes. This is different than the way you are used to thinking about sales taxes. The reason the FairTax rate is quoted this way is to assist in comparison with current payroll and income taxes.

If you earn $1.00 but pay 15.3% in payroll tax and 10% in income tax, but have no federal sales tax then your purchasing power per dollar earned is $0.747.

If you earn $1.00 under the FairTax but and pay 23% inclusive in sales tax for a retail purchase of a new good or service then your purchasing power per dollar earned is $0.77. Please note however that your purchasing power per dollar earned for used goods is $1.00. Also remember that for every dollar that you earn and choose to save or invest you get $1.00 worth of savings and investment.

So quoting the FairTax rate inclusively makes it easier to compare the FairTax with the existing income tax, but makes it harder to compare it with the existing sales taxes. Just to make things clear, the exclusive rate for the FairTax is 30%.


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