Economics Made Economical

23% or 30%?

Some of the confusion with the Fair Tax arises from there being two quoted sales tax rates. Is the sales tax going to be 23% or 30%? It turns out, the percentages are two different ways of saying the same thing. This is where some basic understanding of math comes into play. Remember how to do percentages?

Let’s look at the number 100 to provide a simple example of what seems to be the completely illogical idea that 23% and 30% can both be the same amount.

What is 23% of 100?

What is 30% of 100?

Easy enough, right? 23% of 100 is 23 and 30% of 100 is 30.

In discussing sales tax, the price you see when you’re shopping is generally the price before the tax is added in. If we’re buying an item whose price tag says $10, we’ve already become accustomed to having to add on an extra amount for the final price that we’ll be paying at the register.

Let’s assume a current sales tax of 10%. On an item that has a $10 price tag, a 10% tax would be an added dollar.

So the final price of the good is $11 because 10% of $10 is $1 and $1 + $10 = $11.

This must mean that 10% of $11 is $1, right? Not quite. 10% of $11 is actually $1.10.

The first equation, $10 label price + $1 sales tax = $11 total price is an example of Exclusive Taxing, which is how our current sales tax is tabulated.

The second equation, $11 income – $1.10 income tax = $10, is an example of Inclusive Taxing, which is how most of our current taxes are tabulated. Income tax, Social Security and Medicare withholdings, and other taxes fall into this category.

This example shows that having 10% of your money removed from a total amount results in a more expensive tax than having 10% added on to a price.

Following in this way, we come to see that if we purchase a good for $100 with a 30% sales tax to be added on (exclusive taxing), the total paid is $130 and $30 of that total is tax.

However if we get a paycheck of $100 with 30% to be removed in taxes (inclusive taxing), we earn $70. Again in this situation, we paid $30 in taxes, but only end up with $70.

In both cases, the government brings in $30. But in the first example, we have $100 to spend and in the second we only have $70. Another way of looking at it would be to compare what we make with what the government makes.

The exclusive case is pretty straightforward. We have made $100 (which we’re now spending) and the government makes $30. In other words, the government makes 30% of the amount we’re spending, which is how sales tax is currently advertized.

The inclusive case is far less straightforward. We have made, at the end of the day, only $70. The government still makes $30. Now let’s do some division to find out what the comparable exclusive tax rate would be. 30/70 = 43%! So what is advertized to us as a 30% income tax being removed from our paycheck would actually be comparable to a 43% sales tax being added to our purchases.

Fortunately for us, the Fair Tax isn’t 30% exclusive and 43% inclusive. Instead it’s 30% inclusive, which translates to 23% exclusive.

Remember our earlier example? 23% of 100 is 23. So if 23% of your paycheck is being taken by the government for tax, Social Security, and Medicare, $23 is taken for every $100 earned. You’re left with $77 and the government has $23.

The exclusive rate? 23/77 = 30%! Therefore what’s shown on your pay stubs before a 23% income tax is removed is actually an amount 30% greater than what you’re left with at the end of the day.

If you earn a paycheck that is $130 before tax is removed, a 23% tax rate will leave you with $100 to spend.
If you spend the $100 an added 30% sales tax brings the total cost to $130. So whether it’s an inclusive 23% income tax payment or an exclusive 30% sales tax added on, the government makes $30 from you on every $100 you earn or spend.

What if we had such a system in place? You earn $130. The government takes 23% ($30) of your pay. You’re left with only $100 to spend with a 30% tax added on. So you can really only buy an item whose price tag is $77 to stay under $100 when the 30% sales tax is added in. In this hypothetical example, both the income and sales tax rates are the same (23% inclusive/30% exclusive) and you are being forced to pay both taxes. Therefore your initial $130 becomes $100 after income tax is removed but ultimately only allows you to buy $77 worth of things because for every $77 you spend $23 gets added on as sales tax. In this situation, you have had $130 reduced to $77.

Think about this. You earn $130 working. The government takes $30 and pays you $100. You spend $77 and the government takes the other $23. With both sales and income taxes in place, out of the initial $130 you get to buy $77 worth of goods and the government gets the other $53. This is, of course, an extreme exaggeration of most people’s realities. Most people don’t pay both 23% income tax and 30% sales tax or anything close to it.

But most of us do pay both forms of tax at one rate or another. The Fair Tax eliminates the income tax, Social Security, and Medicare portions at the very least.




    1. Why Is The Fair Tax Fair? « econprofessor
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    3. What Is The Fair Tax? « econprofessor
    4. What The Fair Tax Is Not « Econoblog
    5. Even More Benefits of the Fair Tax « Econoblog

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