Tag: flat tax

Fiscal Fights with Friends, Part I: Responding to Reihan Salam’s Argument against the Flat Tax

In my ultimate fantasy world, Washington wouldn’t need any sort of broad-based tax because we succeeded in shrinking the federal government back to the very limited size and scope envisioned by our Founding Fathers.

In my more realistic fantasy world, we might not be able to restore constitutional limits on Washington, but at least we could reform the tax code so that revenues were generated in a less destructive fashion.

That’s why I’m a big advocate of a simple and fair flat tax, which has several desirable features.

  • The rate is as low as possible, to minimize penalties on productive behavior.
  • There’s no double taxation, so no more bias against saving and investment.
  • And there are no distorting loopholes that bribe people into inefficient choices.

But not everyone is on board, The class-warfare crowd will never like a flat tax. And Washington insiders hate tax reform because it undermines their power.

But there are also sensible people who are hesitant to back fundamental reform.

Consider what Reihan Salam just wrote for National Review. He starts with a reasonably fair description of the proposal.

The original flat tax, championed by the economists Robert Hall and Alvin Rabushka, which formed the basis of Steve Forbes’s flat-tax proposal in 1996, is a single-rate tax on consumption, with a substantial exemption to make the tax progressive at the low end of the household-income distribution.

Though if I want to nit-pick, I could point out that the flat tax has effective progressivity across all incomes because the family-based exemption is available to everyone. As such, a poor household pays nothing. A middle-income household might have an effective tax rate of 12 percent. And the tax rate for Bill Gates would be asymptotically approaching 17 percent (or whatever the statutory rate is).

My far greater concerns arise when Reihan delves into economic analysis.

Grading the Rubio-Lee Tax Reform Plan

In my 2012 primer on fundamental tax reform, I explained that the three biggest warts in the current system:

  1. High tax rates that penalize productive behavior.
  2. Pervasive double taxation that discourages saving and investment.
  3. Corrupt loopholes and cronyism that bribe people to make less productive choices.

These problems all need to be addressed, but I also acknowledged additional concerns with the internal revenue code, such as worldwide taxation and erosion of constitutional freedoms an civil liberties.

In a perfect world, we would shrink government to such a small size that there was no need for any sort of broad-based tax (remember, the United States prospered greatly for most of our history when there was no income tax).

In a good world, we could at least replace the corrupt internal revenue code with a simple and fair flat tax.

In today’s Washington, the best we can hope for is incremental reform.

But some incremental reforms can be very positive, and that’s the best way of describing the “Economic Growth and Family Fairness Tax Reform Plan” unveiled today by Senator Marco Rubio of Florida and Senator Mike Lee of Utah.

A Bumpy — but Hopeful — Road Ahead for Ukraine

Even when one tries to ignore the current developments in the East of the country, Ukraine is in a pickle. With one of the lowest incomes per capita among the transitional economies of Eastern Europe, rampant corruption, and quickly depleting foreign reserves, the country is overdue for a reform package in many areas, including fiscal and monetary policy, the judiciary system, bankruptcy law, energy policy, state ownership, to name just a few.

While there is no shortage of foreign experts offering their views on what policies Ukraine needs or does not need, the future of Ukraine is for Ukrainians to decide. Still, the outside world can help. The Cato Institute, for example, is teaming up with the Atlas Network and the Kyiv-based European Business Association this week, hosting an emergency conference on Ukrainian economy.

Instead of policy wonks from Washington, the conference convenes a stellar group of policymakers from the region, who have direct experience with reforms enhancing economic freedom. The speakers include Einars Repse, the former Prime Minister of Latvia, Ivan Miklos, author of Slovakia’s flat tax revolution, Kakha Bendukidze, who as Minister of the Economy was the driving force behind economic reforms in Georgia, Sven Otto Littorin, the former Minister for Employment of Sweden, who assisted with the liberalization of the country’s labor markets, Jan Vincent-Rostowski, until recently the Minister of Finance of Poland, as well as Cato’s very own Andrei Illarionov.

The conference website is here, and you can follow my live twitter feed at this link. Notwithstanding the pessimism of the daily news coming from that part of the world, the recent events in Ukraine have given its people and its leaders a unique window of opportunity to make a departure from the country’s post-Soviet legacy and to put in place institutions that will lead to economic opportunity, freedom, and shared prosperity.

Grading the Camp Tax Reform Plan

To make fun of big efforts that produce small results, the Roman poet Horace wrote, “The mountains will be in labor, and a ridiculous mouse will be brought forth.”

That line sums up my view of the new tax reform plan introduced by Rep. Dave Camp (R-Mich.), chairman of the House Ways and Means Committee.

To his credit, Chairman Camp put in a lot of work. But I can’t help but wonder why he went through the time and trouble. To understand why I’m so underwhelmed, let’s first go back in time.

Back in 1995, tax reform was a hot issue. The House Majority Leader, Dick Armey, had proposed a flat tax. Congressman Billy Tauzin was pushing a version of a national sales tax. And there were several additional proposals jockeying for attention.

To make sense of the clutter, I wrote a paper for the Heritage Foundation that demonstrated how to grade the various proposals that had been proposed.

The Great Hillsdale College Debate: Flat Tax or Fair Tax?

I’m at Hillsdale College in Michigan for a conference on taxation. The event is called “The Federal Income Tax: A Centenary Consideration,” though I would have called it something like “100 Years of Misery from the IRS.”

I’m glad to be here, both because Hillsdale proudly refuses to take government money (which would mean being ensnared by government rules) and also because I’ve heard superb speeches by scholars such as Amity Shlaes (author of The Forgotten Man, as well as a new book on Calvin Coolidge that is now on my must-read list) and George Gilder (author of Wealth and Poverty, as well as the forthcoming Knowledge and Power).

My modest contribution was to present “The Case for the Flat Tax,” and I was matched up - at least indirectly, since there were several hours between our presentations - against former Congressman John Linder, who gave “The Case for the Fair Tax.”

I was very ecumenical in my remarks.  I pointed out the flat tax and sales tax (and even, at least in theory, the value-added tax) all share very attractive features.

  • A single (and presumably low) tax rate, thus treating taxpayers equally and minimizing the penalty on productive behavior.
  • No double taxation of saving and investment since every economic theory agrees that capital formation is key to long-run growth.
  • Elimination of all loopholes (other than mechanisms to protect the poor from tax) to promote efficiency and reduce corruption.
  • Dramatically downsize and neuter the IRS by replacing 72,000 pages of complexity with simple post-card sized tax forms.

For all intents and purposes the flat tax and sales tax are different sides of the same coin. The only real difference is the collection point. The flat tax takes a bite of your income as it is earned and the sales tax takes a bite of your income as it is spent.

That being said, I do have a couple of qualms about the Fair Tax and other national sales tax plans.

First, I don’t trust politicians. I can envision the crowd in Washington adopting a national sales tax (or VAT) while promising to phase out the income tax over a couple of years. But I’m afraid they’ll discover some “temporary” emergency reason to keep the income tax, followed by another “short-term” excuse. And when the dust settles, we’ll be stuck with both an income tax and a sales tax.

As we know from the European VAT evidence, this is a recipe for even bigger government. That’s a big downside risk.

I explore my concerns in this video.

To be sure, there are downside risks to the flat tax. It’s quite possible, after all, that we could get a flat tax and then degenerate back to something resembling the current system (though that’s still better than being France!).

My second qualm is political. The Fair Tax seems to attract very passionate supporters, which is admirable, but candidates in competitive states and districts are very vulnerable to attacks when they embrace the national sales tax.

On dozens of occasions over the past 15-plus years, I’ve had to explain to reporters that why anti-sales tax demagoguery is wrong.

So I hope it’s clear that I’m not opposed to the concept. Heck, I’ve testified before Congress about the benefits of a national sales tax and I’ve debated on C-Span about how the national sales tax is far better than the current system.

I would be delighted to have a national sales tax, but what I really want is a low-rate, non-discriminatory system that isn’t biased against saving and investment.

Actually, what I want is a very small federal government, which presumably could be financed without any broad-based tax, but that’s an issue for another day.

Returning to the issue of tax reform, there’s no significant economic difference between the flat tax and the sales tax debate. What we’re really debating is how to replace the squalid internal revenue code with something worthy of a great nation.

And if there are two paths to the same destination and one involves crossing an alligator-infested swamp and the other requires a stroll through a meadow filled with kittens and butterflies, I know which one I’m going to choose. Okay, a slight exaggeration, but I think you get my point.

The ‘National Taxpayer Advocate’ at the IRS Is Advocating for the Government, not Taxpayers

I’m not a big fan of the Internal Revenue Service, though I try to make sure that politicians get much of the blame for America’s convoluted, punitive, and unfair tax code.

Heck, just look at these three images—here, here, and here—and you’ll find startling evidence that politicians make the tax system worse with each passing year.

But there is an office at the IRS that ostensibly exists to defend the interests of taxpayers. The Taxpayer Advocate Service is, according to the government website, “an independent organization within the IRS and helps taxpayers resolve problems with the IRS and recommend changes that will prevent the problems.” The head of this office, Nina Olson, has the title of National Taxpayer Advocate.

Sounds good, right?

Well, not so fast. The TAS does some good things, but Ms. Olson spends at least part of her time advocating for the government.

The TAS just released its annual report, and here’s some of what the bureaucracy recommended, according to a Bloomberg story.

Among the other problems Olson identifies in the report are … the underfunding of the Internal Revenue Service … The IRS, which Olson compares to the accounts receivable department of a company, should be fenced off from more budget cuts by Congress, she writes in the report.

Don’t rub your eyes or clean your glasses. You read correctly. The folks at the IRS who supposedly are advocating for you are instead advocating for a bigger IRS budget.

I debunked this silly argument last year, explaining why Congress should reject the Obama Administration’s assertion that more money for the IRS would be an “investment” that would yield big returns.

But I want to be fair. Some of what the TAS does is worth applauding. The report also discusses the grotesque levels of complexity in the code. Here’s more of the Bloomberg story:

Estonia and Austerity: Another Exploding Cigar for Paul Krugman

I have great fondness for Estonia, in part because it was the first post-communist nation to adopt the flat tax, but also because of the country’s remarkable scenery.

Most recently, though, I’ve been bragging about Estonia (along with Latvia and Lithuania, the other two Baltic nations) for implementing genuine spending cuts. I’ve argued that Estonia is showing how a government can reignite growth by reducing the burden of government.

Not surprisingly, some people disagree with my analysis. Paul Krugman of the New York Times criticized Estonia yesterday, writing that the Baltic nation suffered a “Depression-level slump” in 2008 and has only managed an “incomplete recovery” over the past few years.

He blames this supposedly weak performance on “austerity.”

I have a positive and negative reaction to Krugman’s post. My positive reaction is that he’s talking about a nation that actually has cut spending, so there’s real public-sector austerity (see Veronique de Rugy’s L.A. Times column to understand the critical difference between public-sector and private-sector austerity).

This is a sign of progress. In the past, he launched a silly attack on the U.K. for a “government pullback” that never happened, so what he wrote about Estonia at least is based on real events.

My negative reaction is that Krugman is very guilty of cherry-picking data. If you look at the chart that accompanies his post, Estonia’s economic performance isn’t very impressive, but that’s because he’s only showing us the data from 2007-present.

The numbers are accurate, but they’re designed to mislead rather than inform (sort of as if I did a chart showing 2009-present).

But before exposing that bit of trickery, there’s another mistake worth noting. Krugman presumably wants us to think that the downturn coincided with spending cuts. But his own chart shows that the economy hit the skids in 2008 - a year in which  government spending in Estonia soared by nearly 18 percent according to EU fiscal data!

It wasn’t until 2009 that Estonian lawmakers began to reduce the burden of spending. So I guess Professor Krugman wants us to believe that the economy tanked in 2008 because of expectations of 2009 austerity. Or something like that.

Returning now to my complaint about cherry picking data, Krugman makes Estonia seem stagnant by looking only at data starting in 2007. But as you can see from this second chart, Estonia’s long-run economic performance is quite exemplary. It has doubled its economic output in just 15 years according to the International Monetary Fund. Over that entire period - including the recent downturn, it has enjoyed one of the fastest growth rates in Europe.

This doesn’t mean Estonia is perfect. It did experience a credit/real estate bubble, and there was a deep recession when the bubble burst. And the politicians let government spending explode during the bubble years, almost doubling the budget between 2004 and 2008.

But Estonia reacted to the overspending and the downturn in a very responsible fashion. Instead of using the weak economy as an excuse to further expand the burden of government spending in hopes that Keynesian economics would magically work (after failing for Hoover and Roosevelt in the 1930s, Japan in the 1990s, Bush in 2008, and Obama in 2009), the Estonians realized that they needed to cut spending.

And now that spending has been curtailed, it’s worth noting that growth has resumed.

What makes Krugman’s rant especially amusing is that he wrote it just as the rest of the world is beginning to notice that Estonia is a role model. Here’s some of what CNBC just posted.

Sixteen months after it joined the struggling currency bloc, Estonia is booming. The economy grew 7.6 percent last year, five times the euro-zone average. Estonia is the only euro-zone country with a budget surplus. National debt is just 6 percent of GDP, compared to 81 percent in virtuous Germany, or 165 percent in Greece. Shoppers throng Nordic design shops and cool new restaurants in Tallinn, the medieval capital, and cutting-edge tech firms complain they can’t find people to fill their job vacancies. It all seems a long way from the gloom elsewhere in Europe. Estonia’s achievement is all the more remarkable when you consider that it was one of the countries hardest hit by the global financial crisis. …How did they bounce back? “I can answer in one word: austerity. Austerity, austerity, austerity,” says Peeter Koppel, investment strategist at the SEB Bank. …that’s not exactly the message that Europeans further south want to hear. …Estonia has also paid close attention to the fundamentals of establishing a favorable business environment: reducing and simplifying taxes, and making it easy and cheap to build companies.

Good policy makes a difference. But it also helps to have rational citizens (unlike France, where people vote for economic illiterates and protest against reality).

While spending cuts have triggered strikes, social unrest and the toppling of governments in countries from Ireland to Greece, Estonians have endured some of the harshest austerity measures with barely a murmur. They even re-elected the politicians that imposed them. “It was very difficult, but we managed it,” explains Economy Minister Juhan Parts. “Everybody had to give a little bit. Salaries paid out of the budget were all cut, but we cut ministers’ salaries by 20 percent and the average civil servants’ by 10 percent,” Parts told GlobalPost. …As well as slashing public sector wages, the government responded to the 2008 crisis by raising the pension age, making it harder to claim health benefits and reducing job protection — all measures that have been met with anger when proposed in Western Europe.

It’s worth noting, by the way, that government is still far too big in Estonia. The public sector consumes about 39 percent of economic output, almost double the burden of government spending in Hong Kong and Singapore.

But, unlike certain American politicians, at least the Estonians understand the problem and are taking steps to move in the right direction. I hope they continue.

P.S. The President of Estonia, a Social Democrat named Toomas Hendrik Ilves, used his twitter account to kick the you-know-what out of Krugman yesterday. For amusement value, check out this HuffingtonPost article.

P.P.S. A few other nations, such as Canada and New Zealand, also imposed genuine spending restraint in recent decades and they also got good results.

Pages