Remember the flat tax proposals of the 1990s? Well, they're ba-a-a-ck! Both Kansas Senator Sam Brownback and Arkansas Governor Mike Huckabee have adopted the federal flat tax as part of their 2008 presidential campaign platforms. Neither candidate has released details, but usually such plans consist of a fixed percentage tax levied on all incomes over a basic deductible which varies by the number of dependents a taxpayer has. All other deductibles would be discontinued and all "tax loopholes" closed.
In such a plan the poorest will pay no income taxes. All income above the basic deduction is taxed at the same percentage rate. Many plans also want to tax income only once, at its source (though this does not apply to income from working, which would still be taxed twice: once in income taxes and once in payroll taxes). Under such a plan, those taxpayers who live solely on dividend and interest income would pay no taxes, because this income has already been taxed at the corporate level. That creates an interesting pairing of people who pay no taxes: The very poor and the very wealthy who live on unearned income.
The commonly stated benefits of flat tax plans are "fairness," simplicity, and economic growth. These are plans that are usually proposed by conservatives, which might suggest to a cynical person that there is something extra for the conservatives in these plans. And there is: flat taxes would, on the whole, benefit the richest.
A simple thought experiment shows this to be the case. Suppose we replaced the current mildly graduated marginal income tax rates in the United States with the average tax rate, and then applied this average to all income groups except the poorest. Suppose we did this while holding government expenditures constant. Who would pay less under the flat tax scheme, and who would pay more? Even with all deductibles abolished (except for the basic one such plans allow) it is pretty clear that the wealthiest would benefit and the middle class would suffer. Is this part of the fairness that flat-tax believers are always touting?
Perhaps, though mostly I've seen conservatives argue it's fair for all people to pay the same percentage of their incomes in taxes. But this is only one of many possible fairness formulations that could be used in taxation. Another one argues that the felt burden of taxes should be the same for all tax payers (or almost all, if the poor are given a pass). If the value of each additional dollar of income to a person falls as his or her income rises, it's possible that only progressive taxes mean fair taxes in terms of equally felt sacrifices.
The most appealing aspect of flat-income tax schemes is undoubtedly their simplicity. Wouldn't it be wonderful to be able to do the taxes in five minutes flat? Wouldn't it be great to get rid of the vast bureaucracy that is the Internal Revenue Service? Of course. But simplifying the tax system is not linked to the use of flat taxes except through the advertising efforts of the conservatives. There is nothing to stop us from simplifying the current tax structure by removing all deductibles and by closing all loopholes while retaining a set of progressive tax rates. It is not the progression of the income taxes that cause the complications so deplored by the flat-taxers.
Not only are flat taxes not the only means to simplification, they are not the only way to collect taxes from the rich more efficiently. Closing the tax loopholes would work at least as well while having the advantage (for the rest of us) of larger tax payments from the wealthy.
So much for the fairness or simplicity of the flat tax. What about the economic growth argument? There are at least two versions of this, but they both maintain that it is the adventurous engines of the economy, entrepreneurs and the investors, who deserve to keep more of their income. This income is then used in either vaster consumption by the same groups or greater savings and investment, especially as the flat tax plans mostly don't plan to tax dividends and interest income. This greater consumption or greater saving rate (isn't it wonderful how it works either way?) will ultimately cause a "trickle-down" effect, meaning the earners of the lower incomes who can now get jobs working in the firms the adventurers created or making the products the adventurers wish to buy. Note that in these scenarios the poorer taxpayers don't save enough to make a difference to the savings argument. And should they consume more under the progressive tax scenario than under the flat tax scenario? Well, then we just won't use the consumption argument.
Ultimately, the touted economic-growth benefit from flat taxes is an empirical one. We need to find out what happens in a country when it changes into a flat tax system, and nothing else relevant is changed at the same time (or at least held constant in our analyses).
The conservative reader might brighten at this point and marshal along all the evidence of the Eastern European countries with high growth rates and also brand new flat-tax systems. But the requirement about nothing else changing at the same time is not fulfilled in the case of these countries. For one thing, they are all recent entrants into the market system, with very low initial Gross Domestic Products. A rapid growth in low numbers is not unexpected, whatever the tax system of a country might be. Russia, for example, did not only change into a modified form of flat taxes but also revamped the way taxes are collected in general (by, for example, introducing withholdings by the employers).
Whatever the actual advantages of a flat income tax might be, the conservatives surely must appreciate the fact that flat taxes make government redistribution of income much, much harder. This could well be the real reason why this misguided proposal has cropped up again.
J. Goodrich is a recovering economist and the sole proprietor of the political blog Echidne of the Snakes. She also blogs for TAPPED.
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