Pursuit of Truthiness

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Flat Tax

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I was listening to a talk by Alvin Rabushka, one of the first advocates of a flat tax, available at http://www.econtalk.org/

I had of course heard of the idea before; we replace the current 66,000 page tax code, with all of its exemptions, loopholes and varying marginal rates, and we implement instead a single, simple rate that applies to everyone. Under the current system, people can get a net refund, or pay as much as 35% of their income; depending on how much they make, or really how much it looks like they make after all the allowances and exemptions are made.

In order for the tax to be “revenue-neutral”, that is, for that government to take in the same amount of revenue under a flat tax as it does now, the rate would have to be about 19%. The corporate tax rate, currently at 35%, would also be reduced to 19%.

It sounds great; but I’m sure you can think of some objections. Maybe some of those exemptions were there for a good reason; like charitable deductions and mortgage interest-rate deductions. Secondly, it is not a progressive tax. It amounts to raising taxes on the poor and middle-class, while lowering them on the rich.

Rabushka addresses the deductions; but I never thought they were that important. The progressivity though is a big deal, especially when you consider the politics of actually getting it passed. So until I listened to this, I never thought that a flat tax could happen in the US.

But I didn’t quite understand the system. It is not truly flat- there is still an allowance for those who make under $40,000. So the poor and the lower-middle class pay 0% income tax. Does this mean a lot of companies will start paying $39,999; not so! I thought so before, but the idea is that you would only start paying income tax on the income earned after the first $40,000; So someone making $50,000 would pay not $10,000 but $2,000. In fact, no one would really pay the flat tax rate on all their income; they would just asymptotically approach the rate as their incomes approached infinity.

Even after these allowances, 19% is revenue-neutral. That’s how many deductions we have under the current system! Imagine all the changes this could bring- people could file their taxes, literally, in five minutes using a postcard. Tens of thousands of very intelligent people who work as tax consultants would be forced into more productive occupations. A great source of corruption and interest-group lobbying will be cut away; corporate welfare will have to occur in the open. All sorts of inefficiencies incentivized by the current system will disappear.

All that said, I think I’m for it now.

It’s great to hear about how much success flat tax systems are having abroad; they have been adopted mostly by former Soviet states, starting with Estonia. They have been most effective in combatting two things which are issues in America and huge problems in many developing countries- capital flight and tax evasion. Rabushka seems to see himself as a sort of king in exile, raising support abroad in the hopes that he will be able to return triumphantly to his home one day. If Americans see it succeed in enough foreign countries, he hopes, they will one day see the light.

Written by James Bailey

June 6, 2007 at 2:51 am