Issues, Tax

The Flat Tax, Now More then Ever

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On December 24, I wrote that all I wanted for Christmas is a spending cap.

Alas, Santa did not manage to stuff that long-overdue policy down my chimney.

But I’m not surprised. For years, the flat tax was on my Christmas list and that never happened either. I guess I must have been bad. Or maybe Santa is a leftist or socialist.

So instead of simple and fair tax system under the tree, I kept getting lumps of coal in my stocking, which are cleverly disguised as new provisions of a metastasizing internal revenue code.

I’m still allowed to dream, however, so I want to share a new video about the flat tax from Prager University. It’s narrated by Steve Forbes, who (along with Dick Armey) helped popularize the flat tax in the 1990s.

Very compelling. Perhaps even more so than my video on the flat tax.

So what are the chances that we’ll ever get this type of reform?

In a column she wrote last year for Time, Amity Shlaes was somewhat optimistic that a flat tax has untapped support. She cited the fact that most GOP candidates either endorsed some form of flat tax or proposed changes that would move us closer to a flat tax.

The simple levy hasn’t been this popular since 1996, when Steve Forbes campaigned with the promise of a universal 17% income tax rate. Several of this campaign’s flat taxers are actually out-Forbesing Forbes. Ted Cruz is calling for a flat 10%. Ben Carson, Mike Huckabee and Rand Paul also propose some kind of flat rate. Jeb Bush, Marco Rubio and Donald Trump pay their respects with plans that reduce the number of tax brackets.

She explains why the current approach is arbitrary and unfair.

…tinkering is the great weakness of a progressive structure. For if one authority wins license to tinker, so may another. Eventually every interest group convinces others that it is only fair to introduce its ornaments, its exceptions, or its doodads to a tax code. A progressive structure grows organically and disproportionately, becoming a monument to…crony capitalism.

And even though people get tricked when they equate “progressivity” and “progress,” there’s an underlying belief in equal treatment that pushes them in the direction of a flat tax.

In a paper recently presented at the American Accounting Association, scholars Michael and Theresa Roberts report that nearly 8 in 10 business students they polled believe a progressive income tax to be fairer than a flat tax. Still, when asked to actually ascertain a fair amount for a tax payment, the vast majority of the same pollees, even self-identified liberals, picked an amount that correlated to a flat, or even a regressive, rate. This suggests that while Americans like the sound of the word “progressive,” even educated citizens don’t necessarily love progressivity’s effect. Whatever they say at a party, people may quietly prefer proportionality to disproportionality… The Roberts-Roberts paper concludes that “a majority of both liberal and conservative Americans may view a flat income tax rate as fairer than progressive income tax rates.”

Amity’s point about “self-identified liberals” is a natural segue to a Forbes column by Rick Ungar. He approaches the topic from a left-of-center perspective and has considerable sympathy for the flat tax. Not because he likes proportionality, per se, but because he recognizes that the current system has been perverted by special interests.

I’ve long been open to the possibility of trying something new… How can a progressive come to the conclusion that the flat tax might be a better way to go? …American progressives have long had an allergic reaction to the very notion of a flat tax…and with good reason. On it’s face, a flat tax (and the many variations of policy included under the name flat tax) is, indeed, a regressive system more likely than not to benefit the wealthy at the expense of the less wealthy. …However, you have to ask whether or not our current progressive system is truly progressive or, in reality, a system that has been so perverted by special interest tax breaks and benefits as to no longer be legitimately described as progressive. …what do you think is contained in all of those 74,000 plus pages in the United States tax code? …When the higher earner is, in reality, paying at a lower tax rate than her employees who earn far less, thanks to all the special interest perversions built into the tax code, that is very much a regressive tax system. …maybe the time has come to try something new.

Though Ungar isn’t quite willing to embrace the flat tax.

There are, however, some conditions to my willingness to get on board—two to be exact. First, I worry about how the flat tax would impact on those who do not earn much money and have to support their families on a salary that makes both feeding and housing that family a constant, painful challenge. …my second concern…what assurances do we have that this new system will not be corrupted just as the present system was corrupted?

The first concern is easy to address. Every flat tax plan has a generous allowance for all households based on family size. This “zero-bracket amount” would be more generous than the combined standard deduction and personal exemptions in the current tax system. Indeed, because of my concerns about people viewing government as being free, I actually think the amount of tax-free income people would be able to earn is too large. So Mr. Ungar probably can relax on that point.

The second concern, though, is much harder to solve. The risk of a flat tax is that the system somehow will get compromised and degenerate back to the mess we have now. I like to think the American people, after finally being freed from today’s awful system, would vigorously fight to preserve the flat tax. But I also confess there are no guarantees. But here’s the deal. The worst thing that happens is that the current system re-emerges. That obviously would be a big disappointment, but that downside risk is rather tame compared to the downside risk of a national sales tax or value-added tax, which is that politicians would pull a bait and switch, never get rid of the income tax, and then we wind up with a French-style tax system (and the bloated government it finances).

Let’s close by considering a new argument for the flat tax.

Preston Cooper of E21 explains that a single rate protects people in expensive parts of the country from disproportionately harsh taxation.

…data from the Bureau of Economic Analysis (BEA) show that in states such as Arkansas and Mississippi, $100 can buy $115 worth of goods, while in New York and Hawaii, the same dollar value will only get you $86 worth. …This provides yet another argument for a flat tax. …areas with higher prices also tend to have higher incomes, because employers must compensate for their employees’ reduced purchasing power. Therefore, people earning $44,000 in West Virginia can afford the same standard of living as someone earning $58,000 in Hawaii, despite the gap in nominal income. But the federal government does not account for these regional price disparities when setting tax policy. The progressive federal income tax means that those who earn a higher income in nominal terms will pay a higher tax rate. However, the varying cost of living across the United States means that those who earn a higher nominal income may not actually be any richer, yet will still have to pay the taxes for it. This violates an important goal of tax policy known as horizontal equity: people with the same income ought to pay the same amount in taxes.

Using the example of a single adult, Cooper shows that people living in high-cost-of-living states can pay hundreds of dollars in extra tax compared to people with similar levels of purchasing power in low-cost-of-living states.

 

Looking at this data, I’m temped to say “serves them right” since the list is dominated by blue states that routinely elect politicians who support class-warfare tax policies and lots of redistribution.

But that knee-jerk reaction is misguided. A fundamental libertarian principle is that the law should treat everyone equally.

So how can this work?

A potential solution is to adjust federal tax brackets in different states for differences in purchasing power. But price disparities do not end at the state level: prices also differ by metropolitan area. People in New York City pay higher prices than people in Buffalo. This phenomenon exists even within cities, as anyone who has compared apartment prices in Manhattan and Queens can attest. There are far too many jurisdictions to effectively adjust tax brackets for cost-of-living differences. A better remedy is to apply a flat income tax at the federal level. Under such a tax everyone would pay the same proportion of their income to the federal government, eliminating the interregional redistribution that comes with progressive taxation.

This makes sense.

When I argue for the flat tax, I tend to focus on the economic benefits (low rate, no double taxation, and no loopholes) and the moral benefits (less corruption, more fairness, and better compliance).

Now I can augment that fairness argument because the government shouldn’t arbitrarily penalize people based on where they live.

So, yes, we should have a flat tax. Other nations shouldn’t have all the fun.

This is a guest post by Dan Mitchell “a high priest of light tax small state libertarianism”

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