Subject: H.R. 2717 Frequently
Asked Questions
The Individual Tax Freedom Act of 2001 (H.R.
2717)
Frequently Asked
Questions
Table of
Contents:
Question #1: How will the
Tauzin-Traficant bill affect the poor?
Question #2: How will the
NRST apply to homes?
Question #3: Isn't it an
unfunded mandate to make states collect and enforce
the NRST?
Question #4: Don't you have
to repeal the 16th Amendment first?
Question #5: The sales tax is
hidden. You won't know how much you're paying in
taxes!
Question #6: Doesn't the rate
have to be much higher (25 percent to 30 percent) to
raise enough revenue?
Question #7: Shouldn't
necessities like food, clothing and housing be
exempted from the sales tax?
Question #8: Why don't
businesses have to pay taxes and pay their fair
share?
Question #9: How can I
afford anything if a sales tax is piled on top of the
price of everything I buy?
Question #10: Won't seniors be
hurt by the NRST because they are consuming
everything, saving nothing and have no income tax
withheld to offset the new tax?
Question #11: Wouldn't
after-tax savings that existed on the date of
enactment be double taxed when consumed under an
NRST?
Question #12: The IRS won't
really go away because you would still need some
federal enforcement agency. Just the name would be
changed.
Question #13: How is insurance
treated under the NRST?
Question #14: How are
employer-provided benefits treated under the
NRST?
Question #15: What about yard
sales or private sales? Are they taxable?
Question #16: Is used property
taxed?
Question #17: The NRST will be
too easy to evade and too hard to enforce.
Question #18: Which taxes are
repealed by the NRST?
Question #19: How is education
and training treated under the NRST?
Question #20: How are
financial services handled?
Question #21: How will the
rights of taxpayers, especially retailers, be
protected under the NRST?
Question #22: How will the
government collect the self-employment tax?
Question #23: Like the Flat
Tax, this is just a scheme to give tax breaks to the
rich and stick it to the poor and middle
class.
Question #24: A flat rate tax
either on income or consumption is not fair because
it is not progressive. Only a progressive tax can be
a fair tax.
Question #25: How is rent
treated?
Question #26: With no IRS,
what will happen to the state income tax?
Question #27: Is the purchase
of collectibles taxed (i.e. artwork, jewelry, gold
coins, etc.)?
Question #28: What will the
combined state and federal sales tax rate be if we
have to replace the state and federal income taxes?
Won't the combined rate be so high the system will be
unworkable?
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Question #1: How will the
Tauzin-Traficant bill affect the poor?
Answer: First, it is
important to note that the federal income tax is much
more regressive than we think. The fact is the poor
and middle class carry a substantial hidden income
tax burden.
When a welfare recipient goes to buy a loaf
of bread even though they pay no income taxes
directly they will end up paying the income taxes and
substantial compliance costs of the farmer, miller,
baker, distributor, transporter and retailer that are
hidden in the cost of that loaf.
Second, the sales tax is much less regressive than
is commonly believed.
Ultimately, all income is consumed. Savings is
simply a deferral of consumption. If you look at
life-time tax rates rather than artificial annual
rates the rich pay at least as much in sales taxes as
the poor.
Third, the federal government already spends
hundreds of billions of dollars on direct payments to
the poor.
A recent study shows that workers must earn $8-10
per hour to make as much as they would on welfare.
How much more can we do and maintain any incentive to
work?
It is critical that we keep the National Retail
Sales Tax (NRST) rate extremely low. The lower the
rate, the less regressive is the impact of the
tax.
Ironically, the more you do to offset whatever
regressive impact the NRST may have, the higher the
rate climbs and the more regressive the tax
becomes!
Everybody should pay some tax and have a stake in
the system.
If we exempt half of all Americans from paying
taxes as the Flat Tax does they will have every
incentive to see taxes and spending go up, since they
only stand to benefit from wasteful government
spending.
The tax code should only raise revenue for the
government. Tax policy should be divorced from social
policy.
If, after all those considerations are taken into
account, we still must provide some benefit to low
income individuals, here is the best way to do
it:
The Tauzin-Traficant bill provides a credit equal
to the NRST rate times poverty level against a
workers Social Security payroll taxes. Therefore, all
workers will pay no taxes up to the poverty rate.
Those below the poverty rate will pay no taxes at
all.
The formula is easily adjustable for non-working
spouses and children.
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Question #2: How will the NRST
apply to homes?
Answer: The NRST will
treat housing in exactly the same manner as it is
treated today under the income tax.
The NRST maintains the home mortgage interest
deduction. (Since interest payments are not
consumption, they cannot be taxed.)
Under the income tax, the principal portion of a
mortgage payment is paid in after-tax dollars. In
other words, home mortgage principle is taxed today.
Home mortgage principle would be treated the same
under the NRST.
To pay $1,000 of after-tax mortgage principal
today, a taxpayer in the 28 percent income tax
bracket has to earn $1,400 in income because the
government takes its cut first. Under the NRST, the
government doesn't get its cut until the mortgage
payment is made.
Under the NRST, taxpayers would be able to pay the
tax on the principle residence over the life of the
mortgage.
Because of the used-property tax credit
established under the NRST, home owners get a 100
percent credit for the sales tax when they sell their
house. That credit can be applied to a new house.
Therefore, taxpayers only pay the NRST on the
difference between the old and new house.
All homeowners on date of enactment are deemed to
have paid the NRST on their home in full. Therefore,
they will only be liable for the sales tax on the
incremental increase in the value of any new home
they purchase.
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Question #3: Isn't it an
unfunded mandate to make states collect and enforce
the NRST?
Answer: No. Under the
Tauzin-Traficant bill, states will be able to keep a
percentage of what they collect to compensate them
for their service. (In addition, all retail
businesses will be able to keep a percentage of
collections to offset their paperwork costs.)
Also, there is no requirement that states collect
the tax, although the incentives will be such that
most will.
States already have 60 years of experience and the
mechanisms in place to do this job.
Unless we pay the states to do it, we will have to
recreate a huge, duplicative bureaucracy here in
Washington to do it. We don't need another IRS!
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Question #4: Don't you have to
repeal the 16th Amendment first?
Answer: No. It would be
nice, but it is not necessary.
The 16th Amendment does not require an income tax.
It simply allows one. (The Founding Fathers
prohibited a direct income tax.)
It is unlikely that the income tax will grow back
after the NRST is implemented. There will be no IRS,
for one thing. So re-creating the income tax would be
very hard.
The NRST bill requires a 2/3rd supermajority vote
of Congress to raise taxes, including re-creating the
income tax.
Representative Sam Johnson (R-TX), a member of the
House Ways and Means Committee, has introduced a
resolution to repeal the 16th Amendment.
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Question #5: The sales tax is
hidden. You won't know how much you're paying in
taxes!
Answer: The NRST is very
visible; even more so than the Flat Tax.
Taxpayers will see the NRST hundreds or thousands
of times a year every time they make a retail
purchase.
All corporate income taxes are hidden in the
costs of goods and services. The bread bought by a
taxpayer even if he or she is too poor to pay
individual income taxes contains the income taxes and
compliance costs of the wheat grower, miller, baker,
distributor, transporter and retailer.
Because of income tax withholding, the income tax
is also largely invisible to taxpayers. They only
know how much refund they got last year, not how much
they actually paid.
Under the NRST, all taxes and compliance burdens
will be above-board and explicitly stated in the tax
rate. There will be no more hidden income
taxes.
If you want to see how much you paid in total
taxes for the year, simply subtract your savings and
investments (and your state and local taxes) from
your salary leaving how much you consumed and
multiply by the NRST rate. That is certainly much
simpler than filling out a form.
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Question #6: Doesn't the rate
have to be much higher (25 percent to 30 percent) to
raise enough revenue?
Answer: The
Tauzin-Traficant bill eliminates the personal and
corporate income tax, capital gains taxes, estate and
gift taxes, and most excise taxes. Using 1994 data,
that totaled $685 billion in tax revenue. That is
12.7 percent of the $5.4 trillion in consumer
spending which took place that year.
Therefore, a revenue neutral rate is roughly 13
percent. If we exempt certain products or provide
low-income rebates, the rate will start to climb!
Since the tax base of the NRST and the Armey Flat
Tax is roughly the same all consumed goods and
services the tax rate will also be roughly the same
(provided the same policy decisions are made). In
reality, the NRST base will be somewhat broader than
the Flat Tax base, so our rate should actually be
lower.
Some estimates of the sales tax rate assume the
Social Security payroll tax would also be eliminated,
resulting in a 30 percent rate. The Tauzin-Traficant
bill does not attempt to replace the payroll tax with
the NRST.
Because of the economic growth and efficiencies of
the NRST, the rate could actually go down over a
number of years and still collect the same amount of
revenue. (Likewise, the Armey Flat Tax starts at 20
percent and declines to 17 percent.)
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Question #7: Shouldn't
necessities like food, clothing and housing be
exempted from the sales tax?
Answer: If we exempted
food, clothing and housing which represents about
one-half of the nations economy from the sales tax,
the tax rate would double.
Exempting entire categories of goods or services
inevitably leads to either: 1) needlessly benefiting
the rich; or 2) an administrative nightmare of
definitions.
For example, take the suggestion to exempt food.
One of two unacceptable outcomes would result:
1. The caviar and roast beef purchased by a rich
family to throw a party would be tax free; or
2. Very messy definitional issues would arise over
what food should be taxable. States have long
struggled to define what is and is not a "snack
food," which generally is not taxable (i.e. Cheetos
are taxable but Fritos are not.)
If we feel we must address the distributional
effects of the sales tax in the tax code itself, it
is much better to provide a targeted or means-tested
rebate or credit to the working poor.
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Question #8: Why don't
businesses have to pay taxes and pay their fair
share?
Answer: Under any
tax system - income or consumption - businesses do
not pay taxes. Businesses only collect taxes
for the government in the form of higher prices or
lower wages. Business taxes and compliance costs are
simply costs of doing business that are reflected in
their bottom line.
Under any tax system, only consumers pay
taxes. (Only consumers have no one else to
whom they can pass the cost of the tax along.)
If businesses only collect taxes, and only
consumers pay them, we should set up our tax system
to reflect that economic reality.
By eliminating the business taxes and compliance
costs hidden in the price of every good or service
and exposing those burdens in a single, flat sales
tax rate that consumers pay, the NRST creates the
simplest and most economically efficient system yet
proposed.
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Question #9: How can I afford
anything if a sales tax is piled on top of the price
of everything I buy?
Answer: With no income
tax withholding, take home pay will increase
substantially, offsetting the addition of the
NRST.
With no business taxes hidden in the price
of all goods and services, prices will go down -
again, offsetting the addition of the
NRST.
To see how much more you will be taking home under
a NRST, look at your last pay check stub. Then do the
following calculations:
1. Add the amount of income tax withheld today to
what you take home.
2. Divide the amount of income tax withheld today
by what your new take home pay would be under the
NRST (the result from (1)).
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Question #10: Won't seniors be
hurt by the NRST because they are consuming
everything, saving nothing and have no income tax
withheld to offset the new tax?
Answer: The impact on
senior citizens will be largely offset by the
following factors:
1. Most senior's pensions and savings are in
tax-deferred accounts defined benefit plans, defined
contribution plans, IRAs, etc.) and would be taxed
anyway under the current system.
2. The NRST will eliminate the capital gains tax
and the estate tax, which hits seniors particularly
hard.
3. Many seniors must pay income taxes on their
Social Security benefits (which were increased by the
1993 tax bill). That tax is also eliminated under the
NRST.
4. Prices for all items will decrease, once hidden
corporate income taxes and compliance burdens are
removed from those prices. This will offset the new
tax.
5. Special transition rules, such as credits, can
be created to ensure that after-tax savings that
existed on the date of enactment are not subject to
double taxation once those dollars are consumed.
6. If, after all those factors are accounted for,
there would still be a net impact on seniors from the
NRST, Social Security benefits could be increased by
a small amount to offset the new tax. (Ironically,
however, doing so would increase the NRST rate,
making the elderly even worse off.)
It is important to note that Social Security
recipients would not be subject to double taxation
under the NRST. While Social Security contributions
were made in after-tax dollars, and therefore were
already taxed once, the actual percentage of the
average Social Security benefit that represents this
after-tax contribution is so small as to be almost
meaningless. Therefore, almost all Social Security
benefits represent dollars that have never been
taxed.
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Question #11: Wouldn't after-tax
savings that existed on the date of enactment be
double taxed when consumed under an
NRST?
Answer: In theory, that
would be the case. It would be relatively easy to
establish a transition rule that would allow a credit
for the consumption by such old wealth under the new
system.
Such a transition rule would, however, result in a
higher NRST rate. This issue is currently under
study.
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Question #12: The IRS won't
really go away because you would still need some
federal enforcement agency. Just the name would be
changed.
Answer: Under the
Tauzin-Traficant bill, the IRS is de-authorized in
fiscal year 2003, giving it time to close out
previous tax years.
The NRST will be primarily administered by the
states, 45 of which already have the mechanisms in
place.
If a state chooses not to administer the tax, or
has done a poor job of it, the Secretary of the
Treasury is responsible for collecting the tax. It is
intended that the Secretary create a small office
within the Treasury not an agency separate from it to
write the rules and administer the tax where
necessary.
As an alternative, a state without a sales tax
(like Oregon) could contract with a state with a
sales tax (like California) to do its collections for
it.
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Question #13: How is insurance
treated under the NRST?
Answer: Insurance can be
a service, an investment and a reimbursement all at
once! Its treatment in a sales tax world is
admittedly a little tricky.
A sales tax system must either: 1) tax the full
amount of the premium and exempt purchases made with
insurance claims; or 2) tax purchases made with
insurance claims with the tax also being reimbursed
by the insurance company. The Tauzin-Traficant bill
generally follows option 2, to avoid the
administrative problems associated with exempting
insurance-reimbursed purchases! Here are three
examples:
1. Life Insurance: Life insurance premiums have
two parts, an investment component and a service
component. The investment portion is not consumption
and would not be taxed. (When a life insurance claim
is paid, it will be taxed when those dollars are
consumed.) The service component, which represents
the overhead of the insurance company necessary to
provide the insurance service a relatively small
portion of the premium would be taxed.
2. Casualty Insurance: An auto or homeowners
policy premium would: 1) have to cover the costs of
the NRST on the repair parts and services of a
damaged car or the replacement of stolen jewelry, for
instance; and 2) be taxable on the portion of the
premium that represents the intermediate service.
3. Health Insurance: Likewise, health insurance
premiums would have to cover the reimbursement for
the taxes paid on health care services and be taxable
on the service portion of the premium. NOTE:
Employer-provided health care benefits would still be
deductible to the employer.
The treatment of insurance outlined above is
really just like insurance is treated today under the
income tax, if you think about it. Today, insurance
premiums are paid in after-tax dollars - meaning they
are taxed.
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Question #14: How are
employer-provided benefits treated under the
NRST?
Answer: Employer-provided
benefits, such as pension contributions and health
care plans, are not retail consumption and,
therefore, are not taxed. (Pension contributions and
health care benefits are taxed when they are spent on
retirement living or health care services, for
instance.)
In effect, therefore, the NRST maintains the
deduction for employer-provided benefits.
Under the Flat Tax, most employer-provided
benefits are not deductible.
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Question #15: What about yard
sales or private sales? Are they
taxable?
Answer: Attempting to
enforce the NRST on yard sales or private sales (i.e.
selling a bicycle to a friend) would be nearly
impossible and breed cynicism about the system. It
would make everybody a de facto criminal, much as the
income tax does today.
The Tauzin-Traficant bill exempts casual and
isolated sales from the NRST. Such a sale is defined
as a sale by any person not engaged in active trade
or business and that does not exceed $2,500 in any
one instance and does not exceed $10,000 in a
year.
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Question #16: Is used property
taxed?
Answer: The purchase of
used property is taxable. However, an important rule
of the NRST is that the government only gets to tax a
good once. Therefore, the Tauzin-Traficant bill
creates a used property tax credit. The seller of the
used property gets a credit for the un-consumed value
of the used good. A couple of examples help to
clarify:
1. A taxpayer buys a $10,000 car. For the
sake of simplicity, assume a 10 percent NRST
rate, making the tax due on the car equal
$1,000. If the taxpayer sells the car for $7,500 a
year later, the new buyer will pay a tax of $750.
Because the original owner only "consumed" of the
value of that car, he will get a credit for the
"un-consumed" portion, or $750, which can be applied
to a new car. Therefore, the government does not get
to tax that same vehicle over and over again.
2. This also applies to appreciating assets.
Assume a taxpayer buys a home for $100,00. As
explained in the Q&A on housing, a tax of $10,000
will be paid over the life of the mortgage. If the
owner later sells the home for $125,000, he will
receive a credit for $10,000 that can be applied to
his new home.
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Question #17: The NRST will be
too easy to evade and too hard to
enforce.
Answer: Compliance is a
concern with any tax system. Under the current income
tax system, the IRS itself estimates that it loses
$150 billion a year to the underground economy. It is
hard to imagine it could be worse under the NRST.
The NRST will not suffer from compliance problems
for the following reasons:
1. There will be dramatically fewer collection
points to watch. Instead of having to audit and
collect information on 250 million taxpayers and
millions of businesses, the government will have to
watch a much smaller universe of collection points
(i.e. retailers).
2. Even among the much smaller retailer universe,
states can focus their attention on the largest
retailers. In California, for instance, 90 percent of
the revenue is collected by only 10 percent of the
retailers. (These retailers are already used to
dealing with this burden and will be compensated for
it.)
3. The states already have the mechanisms and
experience in place to enforce the sales tax. Local
administration will mean better compliance rates.
4. States will have incentives to enforce the
sales tax because: 1) the more they collect, the more
they can keep in their administrative allowance; and
2) since the bill requires administering states to
conform their sales tax base to the federal base,
states will have to collect the federal tax in order
to collect their own tax.
5. VATs are generally regarded as being
self-enforcing compared to the sales tax. The
Tauzin-Traficant bill replicates the enforcement
features of a credit-invoice VAT - without the hidden
tax burdens associated with a VAT.
6. The issue of non-profit purchases is still
under review. If such purchases are to be exempted, a
much narrower definition of a "non-profit" will be
needed. (Under current law, the NFL is a
"non-profit," for instance.)
The Flat Tax eliminates the deduction for
contributions to non-profit organizations.
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Question #18: Which taxes are
repealed by the NRST?
Answer: The
Tauzin-Traficant bill repeals the following
taxes:
1. Personal income tax;
2. Corporate income tax;
3. Estate and gift taxes;
4. Income taxes on non-resident aliens and foreign
corporations;
5. Retail excise taxes;
6. Manufacturers excise taxes; and
7. Alcohol, tobacco and certain other, non-trust
fund, excise taxes.
The NRST legislation does not attempt to repeal
the Social Security payroll tax or the
self-employment tax (both of which will be
administered by the Social Security
Administration).
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Question #19: How is education
and training treated under the NRST?
Answer: It is fairly easy
to see that education and training expenses are not
"consumption." They are inputs into the creation of
taxable goods or services at a future date.
Therefore, tuition and training expenses either paid
for by an individual or an employer are not
taxable.
Under the Flat Tax, tuition is not deductible, in
effect continuing to double tax education as it is
today once when tuition is spent and once when income
resulting from that education is realized.
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Question #20: How are financial
services handled?
Answer: Financial
services pose a unique challenge to any
consumption-based - tax including the Flat Tax, the
USA tax, and the NRST.
To illustrate a simple example of this challenge,
take a checking account that charges $5 a month in
fees and pays five percent interest. Under the NRST,
that $5 fee would be taxed. Banks would likely
eliminate the fee, and lower the interest rate to
three percent to compensate. The same situation
applies to brokerage fees, insurance premiums and
every other financial service.
If we do not want the entire financial services
sector to drop out of the tax base which would be a
significant part of the economy - special rules must
be developed for financial services.
Under the Tauzin-Traficant bill, any explicitly
stated financial service fee (such as a checking
account or brokerage fee) is taxed, as would be
expected. However, an implicit financial service fee
is also defined and then taxed, to prevent the
situation described above.
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Question #21: How will the
rights of taxpayers, especially retailers, be
protected under the NRST?
Answer: The
Tauzin-Traficant bill makes some very important
reforms when it comes to taxpayer rights.
Most importantly, the burden of proof is shifted
from the taxpayer to the government. Under the income
tax today, the burden of proof is on the taxpayer to
prove he does not owe a tax. Under the NRST, the
burden of proof is on the government to prove that a
taxpayer - either an individual or a business - does
owe the tax. (The burden of document production still
lies with the taxpayer, of course.)
Also, the government must pay the attorneys and
accountants fees in any case the government cannot
show its case was substantially justified.
In addition, the bill creates a problem resolution
office at the Department of Treasury to investigate
taxpayer complaints and stop collection activities if
not in compliance with the law.
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Question #22: How will the
government collect the self-employment
tax?
Answer: The
self-employment tax, which represents the employers
share of the Social Security payroll tax for
self-employed individuals, will be collected - like
FICA - by the Social Security Administration.
Obviously, this is a compliance burden on the
self-employed that others do not face. The
legislation does, however, try to make that burden as
light as possible, and rewrites the self-employment
tax section of the tax code to operate in a sales tax
world.
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Question #23: Like the Flat Tax,
this is just a scheme to give tax breaks to the rich
and stick it to the poor and middle
class.
Answer: While it is not
really the case, the Flat Tax does makes it appear as
if the rich pay no taxes.
1. The "coupon-clipper" who lives off investment
income pays no income tax directly under the Flat
Tax, but those dollars will have been already taxed
once at the business level. The problem with the
income tax code today is that such investment is
taxed twice - at the business and individual
level.
2. Under the NRST, even the rich have to directly
pay tax on their consumption every day. (The Flat Tax
and NRST have the same economic effect, however.)
3. All income is eventually consumed. Savings and
investment are simply deferred consumption.
Therefore, all income will ultimately be taxed.
We must all realize that the income tax today is
much more regressive than we think. The fact is
the poor and middle class carry a substantial hidden
income tax burden.
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Question #24: A flat rate tax
either on income or consumption is not fair because
it is not progressive. Only a progressive tax can be
a fair tax.
Answer: Throughout most
American history, "fairness" has meant "equal
treatment under the law.
1. With the introduction of a so-called
progressive income tax, this definition was abandoned
for the idea of fairness as "ability to pay." Thus,
the tax code stopped being simply a mechanism to fund
the operation of the federal government.
Instead, it became a tool for politicians to
redistribute wealth and fuel class
conflict.
The NRST levies a single, flat rate on all final,
end-use consumption of goods and services. It meets
the original and constitutional basis for "fair
taxation."
The NRST is a proportional tax - meaning
that those who consume the most pay the most.
Those who consume the least pay the least. But
everybody pays something and has a stake in the
system.
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Question #25: How is rent
treated?
Answer: Residential rent
clearly falls in the category of a final retail good
or service, and is therefore taxable.
Commercial rent, which is a business input, it not
taxable - otherwise the tax would simply be hidden in
the cost of the final good or service produced at
that location.
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Question #26: With no IRS, what
will happen to the state income tax?
Answer: Most states with
income taxes piggy-back off the federal system.
States generally do not have their own independent
income reporting systems in place and rely on the IRS
for most income data.
States will have one of two options: either they
will have to establish their own income reporting
system or they will have to convert the income tax to
a sales tax base.
The Tauzin-Traficant bill will have language
permitting states to work with each other to collect
and report income data, which may or may not be legal
otherwise, if they choose to stick with the income
tax.
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Question #27: Is the purchase of
collectibles taxed (i.e. artwork, jewelry, gold
coins, etc.)?
Answer: While these are
generally regarded as investments, attempting to
determine whether a tangible good is used for
consumption or investment purposes is an
administrative nightmare we don't want to get
into.
However, the used property tax credit makes it
work out fine.
In this context, the used property tax credit
would work as follows:
1. A painting is purchased for $1,000. If the tax
rate (for simplicity's sake) is 10 percent, a tax of
$100 is paid. When that painting is sold for $2,000,
the buyer pays $200 in tax. The government gets $100
and the seller gets a full $100 credit.
2. The rule is that the government only gets paid
a tax on the value of an item once.
Also, "casual and isolated sales" among private
parties are not taxed under $2,000 (but no more than
$5,000 annually).
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Question #28: What will the
combined state and federal sales tax rate be if we
have to replace the state and federal income taxes?
Won't the combined rate be so high the system will be
unworkable?
Answer: Yes, that
combined rate will be high, probably at least 20
percent, if not much higher, depending on the
state.
But the fact is, this is how much the government
costs our country. Government is so big that it
accounts for nearly one-half of our economy.
Whether these taxes are in the form of a sales tax
or not, every consumer still pays them - no matter
how they are disguised. (Only consumers pay
taxes, businesses only collect taxes.)
If the taxes we pay to support this behemoth
are not explicitly stated in a sales tax rate, they
will be hidden in the cost of every good or service
we buy.
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