Flat tax
From Wikicpa
A flat tax taxes all income and profits, at the same marginal rate. A flat tax usually refers to the taxation of incomes but can be applied to consumption.
Flat taxes are uncommon in advanced economies, whose nationwide taxes typically include a graduated tax on household incomes and corporate profits, such that the marginal tax rate rises as the income or profit of the taxed entity rises. Flat taxes, implemented as well as proposed, exempt from tax household income below a statutorily determined level that is a function of the type and size of the household. As a result, a flat marginal rate is entirely consistent with a progressive average tax rate. Otherwise, all income or consumption is taxed at the same marginal rate.
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Fairness
This is a hotly debated aspect of flat taxes. Real and perceived fairness hinges crucially on what tax deductions are abolished when a flat tax is introduced, and who profits the most from those deductions.
Proponents of the flat tax claim it is fairer than progressive taxation, since "everybody pays the same." Opponents point out that for the state to raise the same amount of money under a flat rate tax requires that the rich pay less and the poor pay more than they would under a progressive tax system. The issue comes down to how one defines "fair". Proponents claim that since everybody pays the same rate, it treats everyone equally and thus is "fair" to everyone. Opponents of the flat tax, on the other hand, claim that since the marginal value of income declines with the amount of income (the last $100 of income of a family living near poverty being obviously considerably more valuable than the last $100 of income of a millionaire), taxing that last $100 of income the same amount despite vast differences in the marginal value of money is "unfair". Many flat-tax proponents actually concede this premise since most proposals are not truly totally flat but have a threshold where income below that threshold is not taxed at all. Therefore, with the exception of flat-tax proponents who argue for no deductions and taxation of all income at one flat rate, both proponents and opponents agree in principle if not in degree with the basic premise of this concept.
Arguments in favor
In addition to the controversy over which kind of tax system is fairest to both high and low income earners, there are other arguments favouring or opposing a flat tax.
Simplicity
A flat tax taxes all income once at its source. From this fact huge gains in simplicity flow. Hall and Rabushka (1995) includes a proposed amendment to the US Revenue Code implementing the variant of the flat tax they advocate. This amendment, only a few pages long, would replace hundreds of pages of statutory language. As it now stands, the USA Revenue Code is over 9 million words long and contains many loopholes, deductions, and exemptions which, advocates of flat taxes claim, render the collection of taxes and the enforcement of tax law complicated and inefficient. It is further argued that current tax law retards economic growth by distorting economic incentives, and by allowing, even encouraging, tax evasion. With a flat tax, there are fewer incentives to create tax shelters and to engage in other forms of tax avoidance.
Under a pure flat tax without deductions, companies could simply, every period, make a single payment to the government covering the flat tax liabilities of their employees and the taxes owed on their business income [1]. For example, suppose that in a given year, ACME earns a profit of $3 million, pays $2 million in salaries, and spends an added $1 million on other expenses the IRS deems to be taxable income, such as stock options, bonuses, and certain executive privileges. Given a flat rate of 15%, ACME would then owe the IRS (3M + 2M + 1M)x0.15 = $900,000. This payment would, in one fell swoop, settle the tax liabilities of ACME's employees as wells as taxes it owed by being a firm. Most employees throughout the economy would never need to interact with the IRS, as all tax owed on wages, interest, dividends, royalties, etc. would be withheld at the source. The main exceptions would be employees with incomes from personal ventures. The Economist claims that such a system would reduce the number of entities required to file returns from about 130 million individuals, households, and businesses, as at present, to a mere 8 million businesses and self-employed.
This simplicity would obtain even if, contrary to the spirit of the flat tax, realized capital gains were subject to the flat tax. In that case, the law would require brokers and mutual funds to calculate the realized capital gain on all sales and redemptions. If there were a gain, 15% of the gain would be withheld and sent to the IRS. If there were a loss, the amount would be reported to the IRS, which would offset gains with losses and settle up with taxpayers at the end of the period.
Double taxation
A flat tax can eliminate the double taxation to which certain forms of income from capital are subject under the present corporate income tax, such as stock dividends and realized capital gains. Under the flat tax, dividends and interest paid by businesses would be taxed once, at the business level. Under the flat tax, there would be no reason to tax Social Security benefits, if FICA tax liabilities are not a deductible expense for employers. There is no necessary connection between flat taxes and estate or bequest taxes, as reforming one does not necessarily entail the reform of the other.
Increased tax revenues
Some claim the flat tax will increase tax revenues, by simplifying the tax code and removing the many loopholes corporations and the rich currently exploit to pay less tax. The Russian Federation is a claimed case in point; the real revenues from its Personal Income Tax rose by 25.2% in the first year after the Federation introduced a flat tax, followed by a 24.6% increase in the second year, and a 15.2% increase in the third year [4]. The Laffer curve predicts such an outcome, but for different reasons.
Arguments against
Overall tax structure
Some taxes other than the income tax (for example, taxes on sales and payrolls) tend to be regressive. Hence making the income tax flat could result in a regressive overall tax structure. Under such a structure, those with lower incomes tend to pay a higher proportion of their income in total taxes than the affluent do. It is a fact that the fraction of household income that is a return to capital (dividends, interest, royalties, profits of unincorporated businesses) is positively correlated with total household income. Hence a flat tax limited to wages would leave the wealthy much better off. Similarly, the loss of deductions will adversely affect some middle income households. The upshot could be a regressive shift in the tax burden. Hence opponents of the flat tax conclude that it is deceptive to advertise that tax as fair, when in fact it shifts the tax burden from the well off to the middle class. The real issues are deductions and what money counts as taxable income, not the flatness of the tax rate schedule.
Conflating Concepts
It is invariably argued that a flat tax will greatly simplify tax compliance and administration. In fact, simplicity does not so much stem from the structure of tax rates (a progressive rate structure is nothing more than a look-up table filling at most one page) as from the definition of what is subject to tax. Tax simplification - getting rid of all the deductions, exemptions, and special rules added over the years - is an issue wholly separable from that of the rate structure. A nation can vastly simplify its tax code while keeping its rate structure progressive: New Zealand is a case in point.
Ensuring Simplification
Adopting a flat tax with its attendant simplicity may be all well and good, but how will it be kept simple over time, given the realities of interest group politics? While all flat tax proposals propose to eliminate nearly all deductions and credits, most envision keeping the mortgage interest deduction and possibly some others (note that Hall and Rabushka 1995 do not). Will Congress be able to resist, year after year, the temptation to tinker with the tax code in order to advance certain policy objectives and to buy votes?
Influence on particular investments
Through tax deductions and credits, the government can stimulate investments in activities it deems worthy, for example, renewable energies. Under a flat tax without deductions, the government loses this option.
Border adjustable
A flat tax system and the current system are not border-adjustable. Unlike other taxation systems such as a national sales tax or value added tax, a flat tax is based on income and the tax component is embedded in the prices of goods and services. American exports are at a disadvantage because they contain these embedded taxes. Domestic products are at a disadvantage to foreign imports as countries remove their tax component. Such a system greatly impacts the global competitiveness of U.S. products.
References
- Steve Forbes, 2005. Flat Tax Revolution. Washington: Regnery Publishing. ISBN 0-89526-040-9
- Robert Hall and Alvin Rabushka, 1995 (1985). The Flat Tax. Hoover Institution Press.
External links
- The Laffer Curve: Past, Present and Future: A detailed examination of the theory behind the Laffer curve, and many case studies of tax cuts on government revenue in the United States
- STUDY: Tax Reform for Growth and job creation, Lessons from the Irish Fair Tax
- Editorial - "Legacy Time: Get to Work on the Flat Tax"
- TheVanguard.Org Flat Tax Center
- FreedomWorks Flat Tax Issue Homepage
