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The case for a flat tax -- and the arguments against

It's that time of year. And, by "that time," I mean, "time to talk about the flat tax again."

Thursday is tax day, and every year -- as regular as the cherry blossoms -- tax day causes another debate on replacing the United State's highly complicated and befuddling tax system with a simple flat tax.

No more itemized deductions. No more loopholes. No more pages and pages and pages of forms. No more tax attorneys(!) A lot fewer audits. A much less powerful IRS. (We can all agree on that, right?) The hope that individuals and businesses that have to pay less money in taxes will use that money to create jobs and prosperity.

Twenty-four countries now employ a flat tax but, to be fair, none of them has an economy that rivals the size and complexity of ours.

Here's one way it could work, as proposed by Daniel Mitchell, senior fellow at the libertarian Cato Institute: the two-postcard system.

Families get one postcard, on which they write their labor income from their W-2 form. Then they subtract some amount of allowance based on family size. The remaining amount is taxable income. In Mitchell's system, they pay tax at a 17 percent rate.

Businesses get an equally simple postcard. They start with their total revenue, then subtract wage costs, input costs and investment costs. The IRS gets 17 percent of the remaining amount. Probably the most consistent, highest-profile advocate of a flat tax is former presidential candidate Steve Forbes.

In a piece this week in U.S. News & World Report, Mitchell writes:

"The current system is a crapshoot riddled with corrupt provisions, and the tax treatment of upper-income households is a good example. Sometimes rich people are hit with punitive tax rates. This is not good for them, but it also hurts the rest of us by reducing investment and entrepreneurship. Many wealthy taxpayers, though, scam the system by using lawyers, lobbyists, and accountants. That also is bad for the rest of us since funds are allocated inefficiently.With a flat tax, by contrast, there are no special preferences or special penalties based on income. If Bill Gates has 100,000 times as much income as the average taxpayer, he'll pay 100,000 times as much tax. Not more, not less."

Flat-tax advocates argue that the current system, called a progressive system, is inherently unfair because wealthy people pay taxes at a higher rate than poor people. People who oppose the flat-tax oppose it for that very reason: they believe rich people should have a higher percentage of their income taxed, because they say it's the right thing to do. Conservatives and libertarians call this punitive taxation and government-directed redistribution of income.

Arguing against the flat tax in the same issue of USN&WR is Clemson University economics professor Holley Ulbrich, a longtime foe of the flat-tax, who asks: how would you feel about losing your mortgage-interest deduction on your taxes? She warns of:

"...the disruptive effect of eliminating deductions, credits and exclusions that benefit the middle class as well as the rich and that play important roles in our lives—pension contributions, employer-provided healthcare, and deductions for mortgage interest, property taxes, and charitable contributions that support everything from soup kitchens to education to the arts. A flat tax would shift tax obligations from the rich to the poor, and especially the middle class, and eliminate desirable tax incentives for retirement savings, home ownership, and charitable contributions. Simple? Yes. Efficient and equitable? Not so much."

I don't know anyone who pays taxes who thinks, "Wow. This system is terrific! It's easy to figure out and fair to me, my family and my business!"

There is some movement underway to reform the U.S. tax code, even from non-flat-taxers. Today, the Bipartisan Policy Group is hosting a seminar on the topic. A flat tax should fairly be included in any reform discussion, and not simply discarded as the ravings of extremists.

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By Frank Ahrens  |  April 14, 2010; 12:54 PM ET
Categories:  The Ticker  | Tags: Cato Institute, Clemson University, Economic, Internal Revenue Service, Itemized deduction, Steve Forbes, Tax, U.S. News & World Report, United State, regressive tax  
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Comments

We need a Fair consumption based tax. One in which you collect 100% of your income and only pay taxes when you buy something/consume something.

Posted by: AlbyVA | April 14, 2010 2:28 PM | Report abuse

Flat taxes and consumption taxes are attempts to increase the tax burden on the poor and middle class, who will lose their deductions and tax credits and spend a large part of their income. The rich get richer, via a even lower tax rate. The result, especially with the end of the estate tax, is a aristocracy with no social mobility.

Why do people want to believe in these tax reforms? Because they have hope that tomorrow they'll be rich. These ideas are marketed towards them ("when you finally hit the motherload, you'll have even more!!!"), even though the ideas are more than likely to prevent them from actually seeing the benefits themselves.

What's the solution? Real leadership in DC, with an eye towards fiscal management and the social impacts of tax reform. Pity we're unlikely to see this. There's too much money at stake (and too many people looking to get a cut of that money) to expect fair tax reform.

Posted by: pppp1 | April 14, 2010 2:48 PM | Report abuse

The whole discussion is stupid. Rich people hold and manage their assets inside personal companies which pay tax based on business rules instead of personal rules. That means they're taxed after costs like "company" purchases of goods and stocks. And when they finally transfer ownership of the personal company, which happens rarely, they pay a simple capital gains, if that.

The only difference between a flat tax and the tax system we have today is that the poor and middle class get equally screwed instead of just socking it to the middle class.

Posted by: Bill64738 | April 14, 2010 3:02 PM | Report abuse

So, if a family is only taxed on income from labor, then families who derive all of their income from investments pay no tax at all???? Sounds like a great deal for the wealthy...

Posted by: spmom1 | April 14, 2010 3:16 PM | Report abuse

I'm all for the flat tax! If your goal is "social justice," then everyone should pay the same percentage.

In addition, I'm all for eliminating ALL corporate income taxes. Corporations can't "pay" taxes. Any taxes collected from corporations are passed along as higher prices, lower wages, and/or lower returns to investors. As such, corporate income taxes are hidden taxes.

Charge corporations fees for direct services they get from the government.

Posted by: pmendez | April 14, 2010 3:23 PM | Report abuse

The bottom line of this topic is, do you believe that the tax code should be used to encourage/discourage certain behavior? And, should people be taxed based on their ability to pay, or on their total income (even if it's very very small)? Without some reasonable discussion as to where we are, as a nation, on the answers to these questions, the tax system will always be a mess.

Posted by: shannonc1 | April 14, 2010 3:33 PM | Report abuse

Sure, just write down your income. The question is: What is income?

Steve Jobs, among a few other billionaires, would get to put down $1, because that's his salary. So you'd probably want to broaden the definition. I'll guess that at least 30% of the current tax code is just various definitions of "income".

Of course a tax code that is 1/3 the size of the current one would be a good start. Just don't kid yourself that this is going to be as simple as a line or two of instructions on a postcard.

Also, the mortgage deduction does not actually improve home ownership rates (Australia has no deduction, but the same ownership rates). And it doesn't make houses more affordable because, over time, prices rise to match the benefit people get from the deduction.

So the deduction could be removed without economic harm. But not in 1 year, it would require a transitional period. Since most mortgages are 30 years long it would take at least 15 years for a fair transition. And Congress rarely honors promises it made 15 months ago, much less 15 years in the past, so it seems unlikely that we will ever get rid of it.

Posted by: iMac77 | April 14, 2010 3:52 PM | Report abuse

Something to consider is tax BURDEN or the amount of tax you have to pay out of non-discretionary income.

With that understanding, the rich have it fairly easy today.

Posted by: Pebble1776 | April 14, 2010 4:11 PM | Report abuse


Like so many others posting comments, this whole "flat tax" scam is just that ... a scam created by the wealthy to shift tax burdens from the investors to the workers.

If you want simple, a simple progressive rate for each $100,000 of GROSS income (no deductions) would be just as easy to understand.

But, unfortunately, that doesn't get the wealthy out of paying taxes so it won't happen either.

..

Posted by: DEFJAX | April 14, 2010 4:23 PM | Report abuse

I did not see anything on how investment earnings would be taxed so I assume it would be taxed as ordinary income. If not this would continue to favor the rich as much as the current system does.

We do not really tax wealth in this country, we tax income. While this may be unfair in some ways, it turns out to be a good approximation to having the wealthy actually pay their fair share as their property goes relatively untaxed. It would be good to see a flat tax advocate who would include wealth in the equation somehow (I know this could be disruptive, but property is real wealth and often hidden income).

Posted by: mgferrebee | April 14, 2010 4:24 PM | Report abuse

It seems to me that folks that want to scrap the current tax code really just don't want to pay any taxes. I don't enjoy taxes, but I enjoy most of what the taxes pay for.

The funny thing is the Alternative Minimum Tax (ATM) is just what the flat taxers say they want, but they complain when the ATM hits them. Why is that? If they want what they say, just lower the threshold of the ATM.

As soon as you say, "no deductions", every religious leader, non-profit exec, etc says, "except for donations to charities".

As soon as you say no mortgage deduction, every real estate or mortgage company employee says, "except for mortgage deductions".

I would rather the tax code be simple, but the tax code is complex because companies and individuals find ever more complex loopholes that are then shut with more complexity.

Posted by: cyberfool | April 14, 2010 4:26 PM | Report abuse

mgferrebee suggests taxing wealth, not just income. First, I don't think that would pass constitutional muster. Second, you have some people that have wealth because they are earning so much income they can't spend it fast enough. Then you have "old money" folks & farmers and others that might have all their wealth tied up in real estate and other illiquid assets. If you want to see the real estate market really crash, just slap a small national property tax on everyone. Owners of big old mansions would be forced to sell, flooding the market. Total chaos!

Posted by: cyberfool | April 14, 2010 4:32 PM | Report abuse

I like to call my version the "20/20" plan: The first $20,000 of income, from all sources, is tax-free. Everything above that is taxed at 20%.

Posted by: Ralphinjersey | April 14, 2010 4:34 PM | Report abuse

The key to the flat tax is what the deduction would be. It makes a big difference if it's 10,000, 15,000 or 20,000 per person in the household. It would have to be 20,000 per person for me to pay the same amount of tax that I do now (120,000 joint income, 2 kids). If the deduction is less than 20,000 per person, my taxes will go up with a flat tax of 17%. Like all tax proposals, the details are EVERYTHING.

Posted by: NMModerate1 | April 14, 2010 4:57 PM | Report abuse

Not being an economist, I don't understand why businesses and individuals are treated differently for tax purposes.

As the flat tax proposal suggested in the article states "Families get one postcard, on which they write their labor income from their W-2 form. Then they subtract some amount of allowance based on family size. The remaining amount is taxable income. In Mitchell's system, they pay tax at a 17 percent rate. Businesses get an equally simple postcard. They start with their total revenue, then subtract wage costs, input costs and investment costs. The IRS gets 17 percent of the remaining amount."

So as I understand it, companies get taxed on their income less actual costs to operate, while individuals get taxed on income less an allowance which is likely less than actual living expenses. If I am a minimum wage worker who spends all of my income on necessities - food, clothing, shelter and transportation - why should I pay any tax. After all, these expenses are what are necessary to generate my income.

For a flat tax (or any income tax) to even be marginally equitable, either everyone (individuals and businesses) should be taxed on their gross income, or everyone should be taxed only on their profit (income less expenses). After all if businesses want the same rights as individuals, they should be treated the same as individuals. And just imagine how much of that 10+ billion in untaxed profits that Exxon just made would be flowing to the US Treasury

Posted by: LeftCoastReader | April 14, 2010 5:14 PM | Report abuse

"Families get one postcard, on which they write their labor income from their W-2 form. Then they subtract some amount of allowance based on family size. The remaining amount is taxable income."

The deduction is the key to the whole thing and it's the figure you won't hear anyone who is in favor of the flat tax say what it is. If they did say, "the deduction will be 10,000 per family member", people would quickly pull out their last years taxes and do the math and see that their taxes would be going up. The ensuing protests against the flat tax would prevent it from ever coming to a vote. That is why you won't hear any "serious" proponent of the flat tax put an exact figure on the amount of the deduction.

Posted by: NMModerate1 | April 14, 2010 5:34 PM | Report abuse

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Posted by: linlinmeihua | April 14, 2010 11:27 PM | Report abuse

Ahrens doesn't read his own writing.

He says a good system would deduct a certain amount of taxes. Dick Armey had proposed 32,000. The average US salary: 46 grand. Gates made 617,000 in taxable income. (about 15x as much, not 100,000). [Most flat taxers do away with all other taxation, maybe Ahrens doesn't, but that'll mean more forms and audits!] After the deduction of 32,000, they make 14,000 and 585,000. Bill pays 41 times as much.

The flat tax is NOT linear.
Ahrens doesn't understand his topic and I find it curious the Post can't find an economist that DOES willing to write more useful analyses.

Posted by: toowearyforoutrage | April 15, 2010 9:19 AM | Report abuse

Better yet we should let the wealthy pay at a lower flat rate. W made a good start in this direction by giving these oligarchs 50% more of a tax cut in reducing their taxes from 39.5% to 35%, a 4.5% point decrease. All other brackets were reduced by 3 percentage points or 50% less. It’s only fair that God’s elect should pay less taxes.

Ronald Reagan, while he was governor of California, tried in 1968 to impose a sales tax on food, the most regressive type of tax. These were all good steps in the right direction. As the Bible says, “To those to whom much has been given, much is expected”.

Posted by: fedupindc | April 15, 2010 11:36 AM | Report abuse

Better yet we should let the wealthy pay at a lower flat rate. W made a good start in this direction by giving these oligarchs 50% more of a tax cut in reducing their taxes from 39.5% to 35%, a 4.5% point decrease. All other brackets were reduced by 3 percentage points or 50% less. It’s only fair that God’s elect should pay less taxes.

Ronald Reagan, while he was governor of California, tried in 1968 to impose a sales tax on food, the most regressive type of tax. These were all good steps in the right direction. As the Bible says, “To those to whom much has been given, much is expected”.

Posted by: fedupindc | April 15, 2010 11:37 AM | Report abuse

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