Sometimes, to explain why something that makes no sense indeed makes no sense, it is useful to come up with analogies that can be applied more directly to our lives. And since one of the more ridiculous things that we all deal with is the Federal Income Tax code, let's imagine a world in which we get our wages from our employers the same way the government gets taxes from us.

Real Life		Our Example (To show why the real life situation makes no sense)

The Tax Code

As we all know, we all have a responsibility as citizens to pay our taxes. But the amount of taxes we all pay are computed with an incredibly long, hard to determine and hard to enforce set of formulas known as the Tax Code. The organization that enforces the Tax Code by collecting the money we owe the government is the Internal Revenue Service. Because the Tax Code is so complex, it costs American citizens and businesses as much as $692 billion a year (which is about 5% of our national GDP) just to figure out what we owe the government - not including the cost of the taxes themselves.

It costs the government 44 cents for every $100 we pay in taxes for them to figure out what we owe them and to make sure we pay it. But, because of the complexity of the Tax Code, it's easy for us to make mistakes or to cheat and it's also easy for the government to not notice. And so the government fails to collect $300 billion of what we owe it.  By its own estimation, it only manages to take in 88 cents for every dollar it is owed.

And we know that the complex tax formula is based on a percentage of the income we make and that that as we earn more money, we have to pay an even higher percentage of our wages in taxes. Because of this, people try to earn as much money as they can without earning too much - to avoid falling into a higher tax bracket. But because the Federal government taxes income and the economy grows by spending, the system itself also suffers when people try to earn less than they are capable of earning.

Sound pretty accurate so far? So, let's miniaturize the Federal Income Tax system into an example that fits even more into our everyday lives. We'll imagine a world in which we get our paychecks in the same way that the Federal Government gets paid by us. This will help to see why our current system works against everyone's best interests.

In both cases, both the payers and the payees have to do a lot of work in order to figure out what is owed. In both cases, it costs a lot of money for both parties to do the math and paperwork associated with the payment. It costs the payers as much as 5% of their total spending and it takes the payees $0.44 off of every $100 collected. In both cases, the payer pays a graduated amount based on the amount of the payee's income. This gives the payer a disincentive from earning too much money. This ultimately hurts both the payer and the payee. And in both cases, because of the incredible complexity of the formula for figuring out what is owed, the intermediary is unable to collect all that the payer actually owes to the payee. They only manage to collect about 88 cents on the dollar. In our fictitious system, everybody loses.Just like the one we have in place today.

The Salary Code

Imagine the following scenario: we're all employed by a particular company. Our employer has a responsibility to pay us for working just as we have a responsibility as citizens to pay our taxes to the government. But let's pretend that the amount of our salaries is no longer a nice and easy-to-understand rate. And instead of being paid by the hour, week or year, our employers have to use an extremely complex set of rules for each of us in order to figure out what to pay us. We'll call these rules the Salary Code. And because the code is so complex, we need to use an intermediary (we'll call it the Individual Revenue Service) to make sure that our companies are paying us what we've really earned. It costs our employer a ton of money to figure out what they owe us. In fact, the company spends 5% of all its expenditures just to do all the payroll math and paperwork.

If our salary ended up being the U.S. Median Household Income, it would cost us $213 a year to pay the Individual Revenue Service to try to check the complex math and ensure our company pays us what it should. However, because the Salary Code is so complicated, it is possible for our employer to underpay us, either accidentally or intentionally. And although our Individual Revenue Service tries hard to make sure we get our full wages, it only collects an average of 88% of what we should get. This inefficiency costs us $5,741.22 a year.

The Salary Code computes our paychecks based on a small percentage of the company profits. However, as the company earns more money, the higher the percentage of the company profits we get to take, which is great for us. However, the company execs know this, are smart people, and want to give away as little money as possible. So they try to manage the company so that while it is profitable, it doesn't earn too much money. They try to keep the profit level lower than the point at which they'd have to give us a higher share of the earnings. This tendency of theirs hurts us because since we get a percentage of the profits and they try to keep the profits from getting too high, our paychecks don't grow as much as they could.

Another bad thing is because the company has to spend the 5% of all the money it spends on everything just to compute and prepare our paychecks according to the Salary Code - not including what they actually pay us - they really don't have money to give us raises when we need more money. And if we were to all demand a raise from them, they'd have to cut back on spending for other things. They couldn't invest in the things that might otherwise make the company more profitable. And because we get a percentage of the company's profits, when the company can't spend to invest in things to make the company grow, we don't take in as much money as we otherwise could.

Does this make sense?

Can you see the problems that this crazy pay scheme would cause if our company were to implement it? We, the workers, have such a complex salary structure that we've got to spend time and money to meticulously check the math to make sure that our companies are not cheating us. It's so complicated that we need an intermediary to help collect it for us. And even then, we miss a significant part of what we're owed.

Our company suffers because they have to spend even more time and money in making sure that they comply with the very complicated rules for computing our salary. They can face heavy fines and potential legal trouble if they're wrong and so they dedicate a significant amount of resources to figure out what they owe us. Their commitment to the massive payroll math takes away from the time and money they could be using to make the company even more profitable. And because they're not as profitable as they could be, this also hurts our bottom line, along with the fact that they're given a disincentive for earning too much money (because they'd have to pay us a higher share).

A better idea

Now here is a great idea. What if our company instead simply chooses to "pay as they go" and pay us per hour/day/week/year that they employ us. The nice thing about this is that the salary is a lot easier to figure out both for them and for us than the Salary Code, which takes both them and us a lot of effort to double check. And although we don't get a teensy-weensy portion of the company profits - something that would actually hurt us if we did get because the bosses might try not to earn too much so they don't pay us a bigger teensy-weensy portion - we at least know that we're going to get paid.

The company doesn't have to spend such a massive amount of investment in just figuring out what to pay us. So, this means that they might have money to eventually give us raises or at least to invest in the things that will help the company be more stable - which could help us to have better job security.

We don't need to constantly worry that the company is playing games with us and trying to cheat us out of money. We no longer need a middleman to pour over the extremely long Salary Code and figure out what we are owed and trying to resolve discrepancies. And because there is no longer a salary code but just an easy-to-understand salary that we get paid as we work, we don't miss out on lots of money that we otherwise would. I say this because as good as the Individual Revenue Service is, they still only manage to collect from the company eighty eight percent of what our salary should be. Now, we'll get all of it.

Do you think this simpler idea, which is probably how you get paid now, is better than the insanely complex system that we described above? If you like the simpler system, whether you realize it or not, you are in firm agreement with some of the main ideas of the Fair Tax.

Just because we're all used to the Income Tax and have been living with it for 95 years doesn't mean that it makes any sense.