Good read on flat tax.

[Gilligan]

The case for one tax rate
Alan Reynolds


November 18, 2004


President Bush appears serious about tackling "fundamental tax reform" within the next four years, although enhancing alternatives to Social Security and Medicare may well deserve his first turn at bat.

Whenever we do get down to talking seriously about serious changes to the tax system, one question that will inevitably arise is whether there should be one individual tax rate or several. Smart people often form hasty opinions on this topic. Some may be surprised to learn that the most rigorous case for a single tax rate did not come from proponents of various "flat tax" proposals, who treat the topic as self-evident, but from President Clinton's chief economist Joe Stiglitz in his "Economics of the Public Sector."

The main economic reason for a single, low marginal tax rate is that graduated tax rates impose rising penalties on additions to income, and therefore on additions to national output. Punish added income and you punish added output -- economic growth. A single tax rate puts a lid on marginal tax rates -- on the share of added earnings a worker, saver or entrepreneur gets to keep.

In terms of incentives, however, there is no clear reason to prefer a flat tax of 25 percent to progressive rates of 15, 20 and 25 percent. A flat tax is not necessarily better than a low tax. Yet there are at least seven technical reasons for preferring a single tax rate, regardless how the tax base is defined (consumption, income or both). These reasons have to do with making the tax system simpler, fairer, more efficient, less vulnerable to political manipulation, and less prone to tax avoidance and evasion.

First, a single tax rate makes it much easier to integrate business and individual taxes. Income originating in business (and used to pay interest and dividends to investors) can be taxed at the business source, rather than distributed to individuals and taxed at different rates depending on what their annual salaries happen to be that year.

As Stiglitz explained, "the uniformity of (flat) marginal tax rates means that income can be taxed at its source; taxing income at its source will reduce compliance costs and increase compliance rates."

If we all paid the same tax rate on interest income and dividends, there would be no need for individuals to report every detail about dividend or interest income -- the tax could simply be withheld by banks, brokers and mutual funds. If business and personal tax rates were the same, then interest expense would be deducted from corporate income at the same tax rate that interest income was taxed to individuals who own corporate bonds. These simplifications would plug notorious leaks in the tax system, raising more revenues at lower tax rates.

Second, a single tax rate makes tax deductions equally valuable to all taxpayers with taxable income, not most attractive to those with the most income. Ironically, this eliminates a common argument against deductions -- that they mainly benefit those in high brackets.

Third, a single tax rate avoids imposing a brutal tax rate on second earners. The current system taxes the first dollar of the second earner's income at the same tax rate as the last dollar of the first earner's income, regardless how modest the second earner's income may be.

Eliminating the whole idea of "tax brackets" that rise with income would eliminate the most egregious "marriage penalty" (actually a work penalty). It makes it unnecessary to have different tax schedules for married couples who benefit from a joint return and gay couples who do not. And it would greatly improve lifetime work incentives for second earners, expanding employment and therefore enlarging the tax base for all federal, state and local taxes.

Fourth, a single tax rate eliminates arbitrary legal distinction between Subchapter C corporations and other businesses, such as partnerships and proprietorships. This does away with tax avoidance strategies that involve setting up legal entities to create tax losses (shelters), or to take deductions not allowed on individual forms, or to defer taxes on savings. A single tax on all individuals and businesses ends such loopholes, raising greater revenues and thus allowing a lower tax rate.

Fifth, a single tax rate eliminates possibilities of "tax arbitrage" designed to shift the tax base from taxpayers in high tax brackets to those in low tax brackets. In a system with high and low tax rates, tax arbitrage can involve people and firms in higher tax brackets borrowing from those in lower tax brackets, while the latter deposit the interest they receive in low-yield money market funds and end up paying low tax rates on low interest.

Tax deductions for mortgage, business and investment interest thus lose more revenue from taxpayers in higher tax brackets than the government can possibly collect from the other side of the transaction -- interest income received by those in lower tax brackets. Arbitrage strategies also involve shifting income and assets toward family members in lower tax brackets, particularly in small businesses.

Sixth, a single tax rate eliminates timing distortions. Many professionals, salesmen, brokers, farmers and small businesses owners have highly volatile incomes from one year to the next. Graduated tax rates distort the efficient timing of economic activity by inducing people to bunch their deductions into years when tax rates are high, and realize income or capital gains in years when taxable income is low.

Retirement savings plans also aim to defer income at middle age, when earnings usually peak, and then pay the tax after retirement, when income falls into a lower tax bracket.

All problems of income averaging and indexing also disappear when there is a single tax rate, and businesses are taxed on current income less expenses. For those with variable incomes, a single tax rate is fairer than graduated rates. As F.A. Hayek observed, "No practicable system of averaging incomes can do justice to the author or inventor, the artist or actor, who reaps the rewards of perhaps decades of effort in a few years." Averaging should be over a lifetime, and a single tax rate does just that.

Seventh, a single tax rate is inherently more stable, not so tempting for politicians to change. Adding a "surtax" at higher incomes would be a conspicuous violation of the rule, as would adding additional tax brackets. Increases in the single tax would be less politically tempting than periodically increasing the tax rates of different smaller groups of taxpayers every few years (picking them off one at a time), since most voters would feel the increase.

Tax systems with more than one tax rate are inherently subject to frequent change, as Princeton economist David Bradford explained in "Untangling the Income Tax":

It is always possible to find a majority coalition of individuals in one or more marginal tax brackets who would gain by the imposition of higher rates on those outside the coalition, and therefore instability and wasteful political competition seem all too likely.

Tax systems with different tax rates on different people and on different types of businesses are inherently unstable, incapable of settling down to a satisfactory equilibrium. As Stiglitz explained, "If we restrict the set of tax schedules over which voting occurs, for instance to tax schedules with an exemption level and a fixed marginal rate (these are called flat rate tax schedules), there may be a majority voting equilibrium."

It may be possible to make major improvements in the tax system without going to a single tax rate, or by applying a single tax only to income from investments (as we already do with dividends and capital gains). Unfortunately, as Stiglitz warned, the many advantages of a flat-rate tax would then be lost, and for no good reason.

http://www.townhall.com/columnists/a...20041118.shtml

[Grim Bongmaster]

That was a good read! Did you get that from boortz? I found this on his website.

"A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves money from the public treasure. From that moment on the majority always votes for the candidates promising the most money from the public treasury, with the result that a democracy always collapses over loose fiscal policy followed by a dictatorship. The average age of the world's great civilizations has been two hundred years. These nations have progressed through the following sequence: from bondage to spiritual faith, from spiritual faith to great courage, from courage to liberty, from liberty to abundance, from abundance to selfishness, from selfishness to complacency from complacency to apathy, from apathy to dependency, from dependency back to bondage." - Alexander Tyler

[Gilligan]

It was from townhall.com, but i got the link through neals nuez yesterday.

From what i hear, Dubya is going to push the idea this term.

[Gilligan]

WASHINGTON -- The power to tax involves, as Chief Justice John Marshall said, the power to destroy. So does the power of tax reform, which is one reason why Rep. John Linder, a Georgia Republican, has a 133-page bill to replace 55,000 pages of tax rules.

His bill would abolish the IRS and the many billions of tax forms it sends out and receives. He would erase the federal income tax system -- personal and corporate income taxes, the regressive payroll tax and self-employment tax, capital gains, gift and estate taxes, the alternative minimum tax and the earned income tax credit -- and replace all that with a 23 percent national sales tax on personal consumption. That would not only sensitize consumers to the cost of government with every purchase, it would destroy K Street. ``K Street'' is shorthand for Washington's lawyer-lobbyist complex. It exists to continually complicate and defend the tax code, which is a cornucopia from which the political class pours benefits on constituencies. By replacing the income tax -- Linder had better repeal the 16th Amendment, to make sure the income tax stays gone -- everyone and all businesses would pay their taxes through economic choices, and K Street's intellectual capital, which consists of knowing how to game the tax code, would be radically depreciated.

Under his bill, he says, all goods, imported and domestic, would be treated equally at the checkout counter, and all taxpayers -- including upward of 50 million foreign visitors annually -- would pay ``as much as they choose, when they choose, by how they choose to spend.'' And his bill untaxes the poor by including an advanced monthly rebate, for every household, equal to the sales tax on consumption of essential goods and services, as calculated by the government, up to the annually adjusted poverty level.

Today the percentage of taxpayers who rely on professional tax preparers is at an all-time high. The 67 percent of tax filers who do not itemize may think they avoid compliance costs, which include nagging uncertainty about whether one has properly complied with a tax code about the meaning of which experts differ. But everyone pays the cost of the tax system's vast drag on the economy.

Linder says Americans spend 7 billion hours a year filling out IRS forms and at least that much calculating the tax implications of business decisions. Economic growth suffers because corporate boards waste huge amounts of time on such calculations rather than making economically rational allocations of resources. Money saved on compliance costs would fund job creation.

Corporations do not pay payroll and income taxes and compliance costs, they collect them from consumers through prices. So the 23 percent consumption tax would allow taxpayers to stop paying the huge embedded cost of corporate taxation. Linder says the director of the Congressional Budget Office told him it costs individuals and businesses about $500 billion to remit $2 trillion to Washington. And studies show that it costs the average small business $724 to collect and remit $100.

In 1945, corporations paid more than one-third of the government's revenues. Now they pay only 11 percent because corporations, especially multinationals, are voluntary taxpayers. In a world increasingly without borders that block capital movements, corporations pay where the burden is lowest. Linder says $6 trillion in offshore accounts would have an incentive to come home under his plan.

Furthermore, by ending payroll and corporate taxes, America would become the only nation selling goods with no tax component -- such as Europe's value added tax -- in their prices. With no taxes on capital and labor, multinationals would, Linder thinks, stampede to locate here, which would be an incentive for other nations to emulate America. ``This,'' Linder says, ``would unleash freedom around the globe.''


ritics argue that ending the income tax, with its deductibility of charitable contributions, would depress giving. Linder says: Piffle. In 1980, when the top personal income tax rate was 70 percent, a huge incentive for giving, individual charitable contributions were $40.7 billion. In 1986 the top rate was reduced to 28 percent, and by 1988 charitable giving was $86.7 billion. The lesson, says Linder, is that we give more money when we have more money.

When Speaker Dennis Hastert published a book last year, he was startled that interviewers were most interested in talking about Linder's bill, which then had 54 co-sponsors. This year Hastert added Linder to the Ways and Means Committee. Linder cheerfully says his bill would reduce Ways and Means to ``a B committee'' by ending the political fun of making the tax code ever more baroque for the benefit of K Street's clients. Bliss.


http://www.townhall.com/columnists/georgewill/gw20050331.shtml

[CloseToModern]

I really like this idea... but for some reason I doubt something this revolutionary would actually happen in these times of complacency and regression towards the norm in the political world.