January 4, 2006
WRTA
 Brown
Shoes Diary
The Flat Tax
On Open Mike Too with Doug Herendeen today (1/3/06) Bob Beam asked me about the flat tax and I more or
less botched my answer. I know a seasoned professional as myself
shouldn't make such mistakes, but Bob started out by referring to me as a
young man and that got my head spinning. Anyway, there are a few clear
things that can be said about the flat tax, the income tax system whereby
every dollar earned is taxed at one specific rate.
The first thing to say about the flat tax is that it could eliminate most of
the compliance costs that are part of the current system. Compliance
costs are the expenditures in money, time, and effort of citizens in
complying with government dictates. Filling out IRS forms, documenting
deductions, maintaining records, and paying accountants, financial planners,
and lawyers are just some of the costs we incur in dealing with the income
tax. It's not easy to deal with a code that is more than 9,000 pages
long and growing. (For comparison purposes, my Bible is only 800 pages
long and it's hard enough to live up to.) The estimates of how much an
economic drag the tax collection process is on our country range from 200 to
300 billion dollars, which is 2% to 3% of the entire GDP or 20% to 30% of
revenue collected. (See The Cost of Complying with the Federal Income Tax, by
J. Scott Moody, Tax Foundation, Special Report No. 114, July 1, 2002.)
That's what we pay for the privilege of paying taxes. (The previous
sentence is sarcasm if you were wondering.)
A single tax rate with no deductions of any sort would greatly reduce
compliance costs, which would result in a bonus of nearly $1,000 every year
for the average American. Hmmm. That bonus, if invested, could take
care of just about everybody's retirement needs, so we could do away with the
Social Security program altogether. Curiously, Social Security and
Medicare are flat tax plans--everybody pays the same rate with every dollar
earned.
Two other advantages of a flat tax regime are related to how it would allow
our economy to grow. First, the very bright people who now make their
livings helping the rest of us deal with the Great Satan (my cute little
nickname for the I.R.S.--just a joke, Mr. Commissioner) could spend their
time doing productive things instead of fending off the Evildoer. Now,
I know it's the Lord's work to keep money out of the hands of the Great Satan,
but if Satan's hands are chopped off, then these servants of the Lord could
do some really positive things instead of just fighting off setbacks.
The second way a flat tax would bring about economic growth is one of
incentives. Let me show this with a simple example. Suppose a
person earns $40,000 per year and there are two tax rates--one of 10% for the
first $20,000 of income and the other of 30% for income over $20,000.
(This generalizes to any progressive rate structure.) The person in our
example would pay $8,000 in taxes (.1 x 20,000 plus .3 x 20,000) and would
get to keep the remaining $32,000. Now, what would happen if we went to
a flat tax with a single rate of 20%? You might think that the result
would be identical--$8,000 (.2 x 40,000) for government and the remaining
$32,000 for the citizen. But that almost certainly wouldn't be the
case. In the first regime of two rates, the person was keeping only 70
cents for every dollar he earned above $20,000. Now, under a single
rate, he's keeping 80 cents and so has additional economic incentive to work
more hours and earn even more than before. The single rate increases
the output of the economy, increases the take-home pay of the citizen, and
increases government's take. (I'd like to change that last effect, but
I can't, and besides, many people think it's a plus.)
So the flat tax is obviously a more efficient system than having multiple
rates and it would have very significant incentive effects of a positive sort
for the overall economy. Sounds great, so why don't we have it and why
won't our esteemed leaders push it through?
My guess is that the flat tax is too efficient. There are some powerful
special interests (such as accountants, lawyers, and legislators) who make
their gravy, so to speak, off the inefficiency of the current system.
The complexity of the current system also works to increase the power of
incumbents who can do favors and tailor the code for heavy contributors to
their campaigns. The tax code also gives those in power control over
the rest of us with tax breaks and penalties for particular assets and
behaviors. One thing you have to know about Satan, I mean politicians,
is that they aren't willingly going to cede any power over anybody or
anything.
The Tax Reform Act of 1986 is instructive. It ostensibly simplified the
tax code, removing many deductions and creating just two low rates (15% and
28%). Within a few years the number of rates expanded to five with a
top rate of 39.6%. A cynic would view the "reform" as a
bait-and-switch strategy, where Congress removed the loopholes in exchange
for lower rates, then shortly after put higher rates back in place.
The main lesson to understand is that the type of tax regime we have is not
of great importance. If we let government spend more and control more
of our lives, then the price is going to be high no matter how we decide to
pay the bill. The only hope is for Americans to relinquish their claims
to entitlements and welfare and that goes for everybody--corporations,
retirees, developers, and educators. Especially the educators!
Contact John D McGinnis
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