Dano: The Flat Tax is Fair, Necessary

This week, Reed and I are discussing the flat tax concept for tax reform. I am arguing in favor of a flat tax. In the interest of full disclosure, I have to tell you that I cannot locate an "objective" web site that argues either for or against a flat tax. This is because, in modern politics, flat tax proposals are almost always championed by Republicans, and criticized as either unfair, unworkable, or irresponsible by Democrats. Even sources that are typically fairly neutral on most policy issues seem to show their conservative/liberal biases on this topic. To locate the reasons that a flat tax is good, therefore, it was necessary to consult fairly conservative sources - I chose The Heritage Foundation (http://www.heritage.org/research/taxes/) and the National Center for Policy Analysis (http://www.ncpa.org/pi/taxes/tax71.html#1). There were many more, but they almost all agree on the features of a flat tax system, so I chose these two for their fairly well-laid-out approach. Most of what follows, therefore, comes from these sources. I suspect that Reed will have had to do the opposite to argue against the flat tax.

Many people don't know what a flat tax is, so I'll give just a brief description. The truest form of flat tax is one that taxes everyone and every business at the same, fixed rate; usually, there are no deductions or exemptions in such systems. A single mother of four making $18,000 a year would pay the same percentage of her income as would someone making $500,000 a year with no children to support. This is patently a bad idea, because it burdens the poor disproportionately. Why? Because each dollar of a poor person's income is worth more to them than each dollar of a wealthy person's income. This is why our current tax system is graduated such that as a person's income increases, the rate at which each additional dollar (within given brackets) is taxed increases.

Assume a flat tax rate of 17%. The $3060 tax burden on the single mother is a more critical insult to the single mother's (and her children's) welfare than the $85,000 tax bill is for the half-million dollar earner with no kids. Because of this inequity, no serious flat tax proposals are true flat taxes - instead, they incorporate an income threshold below which there is one flat tax rate, 0%, and above which there is another flat rate, usually something under 20%. They also provide personal exemptions and exemptions for number of dependents. In such a system, with a taxable income threshold of $30,000 and the dependent exemptions, the aforementioned single mother would pay no income tax, while the wealthier worker with no children would pay the 20% flat rate. In this way, such a flat tax is progressive, or graduated, though it could be argued that there is still only one tax rate, and that those below the income threshold (or who have enough exemptions) simply aren't subject to the tax system. In any case, no serious proposals eschew the minimum taxable income "loophole."

The benefits of a flat tax are many. The most obvious benefit is simplicity. Our current tax code is some nine million words in length, and there are between eight and nine hundred forms necessary to deal with all of the exemptions, deductions, credits, exclusions and other complexities. More than 80% of the tax code deals with these issues. Under a flat tax, there would be two forms - one for individuals, and one for businesses. Both these forms would be so simple they could be placed on a post card (see, e.g., http://www.cse.org/flattax/index.php).

A related benefit, one that represents an almost immediate increase in personal and business wealth, is the money that would be saved by this simplification of the code. It has been calculated that Americans spend around $600 billion per year on income tax compliance; they feel compelled to hire tax accountants and lawyers and financial analysts to help navigate through the IRS rules. This expenditure would be unnecessary under a flat tax.

But there are more goodies. Without going into exhaustive detail, the following are several of the other beneficial features of a flat tax system:

• No double taxation or asset taxation. The flat tax system taxes only income, and only when it is first earned. Unlike the current system, it does not tax savings, capital gains, interest income, or dividends. There is no death tax, either. Because of this feature, a flat tax would instantly increase the value of assets held by Americans.

• Less IRS intrusion. Under a flat tax, the IRS has no need to know what your assets and liabilities are - just income. Because of the lack of deductions, exclusions, loopholes, and related audits, the IRS can be simplified and downsized, further saving Americans' tax dollars.

• Increased global competitiveness. The current tax structure makes the U.S. one of the world's most expensive nations in which to do business. It is therefore attractive to migrate jobs and capital to countries with lower tax rates. A flat tax system, with a much lower tax rate, would eliminate this incentive to leave our shores, and would actually make the U.S. a more attractive operating arena for foreign owned companies as well. This is because the flat tax is based on "territorial taxation," meaning that only income earned within our borders is taxed. Eliminating "worldwide taxation" should make the U.S. much more competitive on the world economic playing field.
  

• No marriage penalty. The flat tax would apply to all earners, so both a husband and wife would get taxed at the same flat rate. It would no longer be possible for one spouse's income to push the couple into a higher tax bracket. Moreover, because a married couple's family-based allowance is twice as high as a single person's, there would be no penalty for being married and filing jointly.

• Reduction in political corruption. Much of what lobbyists and special interest groups do in the halls of Congress has to do with currying favor with regard to tax breaks and other loopholes. Under a flat tax, because of the lack of exemptions and exclusions, politicians would no longer be able to engage in the corrupt practice of trading favors with big business. This would greatly reduce corruption, but would also save corporations the immense cost of lobbyists and, thus, aid in business growth.

Fundamentally, the current Revenue Code is so complex and so flawed that some kind of tax reform is both desirable and necessary - particularly in light of the fact that world governments are jumping on the flat tax bandwagon in droves. The former communist nations in Eastern Europe have almost all adopted a flat tax system, and have achieved remarkable economic gains.

Representative Dick Armey (R-TX) has the most promising flat tax proposal here at home, and it has garnered the most support in Washington (http://www.ncpa.org/ba/ba136.html). While it is unlikely to pass under a Democratically-controlled Congress, Democrats would be wise to give more attention to the concept of the flat tax. Because it taxes all earners at one flat rate, but gives valuable and necessary income threshold exemptions to the poorest taxpayers, it is ultimately fair. Moreover, in the increasingly competitive global marketplace, America cannot continue to maintain a tax system that provides disincentives for businesses, jobs, and capital to remain within our borders.