Tax day is coming up soon, which makes me think (again) about how stupid and complicated our tax system is. I’ve always thought a flat tax system was logical, but I’m frankly not educated enough to know whether I’m right. So I’ll lay out my argument and let ya’ll tear into it. The disclaimer is that I have an economics degree but no accounting training. I have experience paying individual taxes (who doesn’t) (don’t answer that) but not from the business side of things. So this may be a way more complicated issue than I’m making it, but whatever.
Let’s assume any tax system has two goals - to raise revenue for the government, and to incentivize (or dis-incentivize) certain behavior. Let’s also assume the level of involvement in legislating behavior should be inversely proportional to the level of government, i.e., the national government should have relatively little to do with behavior, the state should be more involved, and local governments should be the most involved (if at all) when it becomes to behavioral issues.
We’ll use current data to get some sort of baseline. We’ll assume for the sake of discussion that the government is running on a balanced budget, which could be true if certain spending cuts were made (but that’s a topic for another time). That would mean the total amount collected (assuming 100% compliance) would equal the total amount needed by the government.
According to the IRS Statistics of Income Bulletin for Winter 2006-07 (March 12, 2007), total income tax for tax year 2005 was $928.3 billion. According to the Federal Reserve, GNP on the first day of 2006 was $13,276.5 billion. That means the government collected (or should have collected) 6.9921% of the country’s GNP as income taxes. To make the math easy, let’s give the government an extra $1.055 billion, to make it an even seven percent.
Now, raise your hand if you gave more than 7% of your income to the federal government. (Hint: if you are an individual who made ONE MEASLY DOLLAR in 2006, your marginal tax rate is 10%, and the higher your income, the higher your rate.)
I thought so.
Seems to me, if everybody paid 7% (or even 8% or 9%) of their income, the federal government would have the same amount of money, at a lower cost to the rest of us. Say what? How is it we’re all paying less again? Obviously, if you and I are paying less, someone is paying more. For example, lots of the loopholes favoring corporations and the wealthy would be gone, but I don’t think they’d suffer all that much (they still have 93% of their income before paying state and local taxes). Churches would have to pay, but I think they’ve had it way too good for way too long at this point. Charities would have to pay, but only if they show any income. Remember, this is not a receipts tax, it’s an income tax. So if a charity makes $1.1M and gives $1M to a hospital for cancer research, then it only pays taxes on the other $100K.
Wikipedia has a pretty good article on flat taxes. Is it me, or do the arguments against a flat tax system look pretty flimsy? The two biggest ones seem to be (a) that the overall system would be “regressive”, or disproportionally burdening the poor, because of the non-flat-tax parts, and (b) it couldn’t ever be enacted in the first place because of the special interests, and even if it was, it would eventually become corrupted for the same reason. The latter argument is easily countered with the following sentence: “So what’s your point?” The current system is fucked up because of special interests. That just means we need to make an effort to leave the special interests out of it. As for this “it can’t work because the rest of the system is also broken” argument, that just seems like dumb logic to me. If the rest of the system screws the poor, then fix the rest of the system, too.
There are two other arguments against a flat tax that aren’t particularly well treated in my opinion. One is the effect on charitable giving. Simply put, it is unclear which of the following two effects would be stronger: (a) increased disposable income (through lower taxes) allows households and business to increase charitable giving, but (b) removal of the tax break associated with charitable giving may decrease charitable giving. My gut tells me the former would prevail. As far as church tithing, etc., I don’t think the tax consequences of those gifts are even relevant to most tithers (I actually know people who won’t take the tax break because they feel like it cheapens their gift to God, which is stupid, but to each his own).
I’m also not sure what to do about the global economic impact. With a flat tax, imports have an automatic advantage compared to domestic products. Tariffs would solve that problem, though. I know tariffs get a bad rap, but I think they have their place. Maybe I’ll write more on that another day.
So the only problem remaining would be the government incentivizing behavior, but as I said, I think that should be up to the local governments (and to a lesser extent, the state), not the federal government. If we want to encourage people not to buy certain products (anything from cigarettes to porn), then have a sales tax on those products. If we want to encourage people to buy certain things, then give a subsidy. For example, if we move to a flat tax system now, the biggest harm to me personally will be the loss of the mortgage interest deduction. But what if I could refinance my loan with a (state or local) government subsidy, which would be paid back to the government over the next X years along with the loan? I can still afford my house, the government gets paid, and we’ve created some more business in the lending industry. As for investment by the government, if the government has the same revenue with fewer costs (associated with the administration of the tax system, for one), then shouldn’t the government be able to invest the savings in anything it wants? So I really don’t see that the government loses the ability to incentivize or disincentivize behavior by moving to a flat tax system.
So to sum up, my ideal would be for the federal and state governments to implement flat-tax systems, then local governments can enact whatever special-purpose sales and other taxes their voters will support. Does anybody see a problem with any of that?