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November 03, 2005
Flat Tax
Dangerous Dan has a good post on Bush's Tax reform package here. Dan writes:
Hmmm three-fourths of all Americans would fall into the 15% tax bracket. That sounds pretty similar to a flat tax in which four-fourths of all Americans would be taxed at 15% (exceptions made for low earners, of course). One of the touted benefits of a flat tax is that it is a major simplification of the tax code. Not only does it make it easier for people to figure their taxes, but it also closes gaping loopholes. The thing about those loopholes is that the folks who really exploit them are usually rich. They can afford smart accountants who will tuck money away in all sorts of different investments and tax shelters. Without such loopholes, though, the rich would be forced to pay up.
I have mixed feelings about the flat tax although it seems like a more just system overall compared to our current tax system because it does not distinguish between how people spend their money. Under a flat tax spending money on charity or education spending or student loan insterest is equal in the eyes of the law of a flat tax to spending your money on beer and nachos, unlike the current system. For instance the flat tax stops unequal treatment in deducations between home owners with mortgages versus renters and home owners without mortgages. As the government should not be rewarding or penalizing people for how they spend their money (as long as they are spending it legally), the flat tax is more just.
I am unsure of how much it will reduce the complication of taxes, although it would reduce it some. One of the main complications of our current system is what counts as income and I doubt that would change, but how you report income might. Right now the tax code distinguishes between dividends, wages, capital gains, farm income, etc. The new flat tax code would still probably make you figure these all out (except perhaps dividends) and that would still be a hassle. Businesses would still have to keep track off expenses to deduct from revenue to figure how much income was taxable for instance. The flat tax would eliminate the complications that arrise from figuring out deductions.
I like the idea of dividends no longer being taxed as they are already taxed as corporate profits first and as a result corporations are reluctant to pay dividends. Share holders would often rather see the money reinvested since capital gains have a lower tax rate than dividends. This might also give us a more accurate picture of many corporations finances as historically dividends were used to show how well corporations were doing.
All this does not mean that the flat tax can not be progressive. Both proponents and opponents make the mistake of thinking it has to be. You can have a flat tax that taxes different incomes at different rates. The flatness has to with how you count different sources of income and determining deductions, not on the tax rates.
There will also be lots of unintended consequences depending on how far the tax reform goes. If taxes on most dividends and capital gains are eliminated, then what is the future of IRAs and 40l(k)s? Without the tax shelter of IRA’s there is no point in having them. I do not know if the flat tax will pass, but it would probably be an improvement over our current tax system. So far other countries like Russia have had great success with flat taxes.
I think a better idea for tax reform might be the consumption tax. Eliminate the income tax entirely and replace it with a tax on how much people consume that is equal for every single item (with possible exceptions for things like unprepared food). This may sound regressive, but if you include a per person automatic refund on say the first $250 in consumption taxes people pay each month, then that eliminates the regressiveness and makes it in fact progressive. Prices would go up fairly substantially, but you would no longer have any federal income tax withholdings and each person in the country would get a check at the beginning of the month from the government. A rich guy buying a luxury car and eating at fancy restaurants would still pay a lot more in taxes than a poor single parent with three kids struggling to get by. Poor families might even get a bigger refund check than the amount they spent on taxes that month depending on how the automatic refund is. The unintended consequences of this sort of tax might be an increase in investments, a decrease in consumption, and inflation problems.
Posted by Pete at November 3, 2005 08:01 AM
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