I'm a big fan of the flat tax because a low tax rate and no double taxation will result in faster growth and more upward mobility.
I also like the flat tax because it gets rid of all deductions, credits, exemptions, preferences, exclusions, and other distortions.
And a loophole-free tax code would be a great way of reducing Washington corruption and promoting simplicity.
Moreover, keep in mind that eliminating all favors from the internal revenue code also would be good for growth because people then will make decisions on the basis of what makes economic sense rather than because of peculiar quirks of the tax system.
Sounds great, right?
Well, it's not quite as simple as it sounds because there's a debate about how to measure loopholes. Sensible people want a tax code that's neutral, which means the government doesn't tilt the playing field. And one of the main implications of this benchmark is that the tax code shouldn't create a bias against income that is saved and invested. In the world of public finance, this means they favor a neutral "consumption-base" tax system, but that's simply another way of saying they want income taxed only one time.
Folks on the left, however, are advocates of a "Haig-Simons" tax system, which means they believe that there should be double taxation of all income that is saved and invested. You see this approach from the Joint Committee on Taxation. You see it from the Government Accountability Office. You see it from the Congressional Budget Office. Heck, you even sometimes see Republicans mistakenly use this benchmark.
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.
In my 2012 primer on fundamental tax reform, I explained that the three biggest warts in the current system:
- High tax rates that penalize productive behavior.
- Pervasive double taxation that discourages saving and investment.
- 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.
Allister Heath, the superb economic writer from London, recently warned that governments are undermining incentives to save.
And not just because of high tax rates and double taxation of savings. Allister says people are worried about outright confiscation resulting from possible wealth taxation.
It is clear that individuals, when at all possible, need to accumulate more financial assets. ...Tragically, it won’t happen. A lack of trust in the system is one important explanation. People simply don’t believe the government – and politicians of all parties – when it comes to long-terms savings and pensions. They worry, with good reason, that the rules will keep changing; they are afraid that savers are an easy target and that they will eventually be hit by a wealth tax.
Are savers being paranoid? Is Allister being paranoid?
Well, even paranoid people have enemies, and this already has happened in countries such as Poland and Argentina. Moreover, it appears that plenty of politicians and bureaucrats elsewhere want this type of punitive levy.
Here are some passages from a Reuters report.
Germany's Bundesbank said on Monday that countries about to go bankrupt should draw on the private wealth of their citizens through a one-off capital levy before asking other states for help.
Since data from the IMF, OECD, and BIS show that almost every industrialized nation will face a fiscal crisis in the next decade or two, people with assets understandably are concerned that their necks will be on the chopping block when politicians are scavenging for more cash to prop up failed welfare states.
Though to be fair, the Bundesbank may simply be sending a signal that German taxpayers don't want to pick up the tab for fiscal excess in nations such as France and Greece. And it also acknowledged such a tax would harm growth.
"(A capital levy) corresponds to the principle of national responsibility, according to which tax payers are responsible for their government's obligations before solidarity of other states is required," the Bundesbank said in its monthly report. ...the Bundesbank said it would not support an implementation of a recurrent wealth tax, saying it would harm growth.
Other German economists, however, openly advocate for wealth taxes on German taxpayers.
...governments should consider imposing one-off capital levies on the rich... In Germany, for example, two thirds of the national wealth belongs to the richest 10% of the adult population. ...a one-time capital levy of 10% on personal net wealth exceeding 250,000 euros per taxpayer (€500,000 for couples) could raise revenue of just over 9% of GDP. ...In the other Eurozone crisis countries, it would presumably be possible to generate considerable amounts of money in the same way.
The pro-tax crowd at the International Monetary Fund has a similarly favorable perspective, relying on absurdly unrealistic conditions to argue that a wealth tax wouldn't hurt growth. Here's some of what the IMF asserted in its Fiscal Monitor last October.
Read the rest of this post »
The sharp deterioration of the public finances in many countries has revived interest in a "capital levy"— a one-off tax on private wealth—as an exceptional measure to restore debt sustainability. The appeal is that such a tax, if it is implemented before avoidance is possible and there is a belief that it will never be repeated, does not distort behavior (and may be seen by some as fair).
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.
I'm a big proponent of tax reform, so at first I was very excited to learn that Senators Max Baucus (D-MT) and Orrin Hatch (R-UT) were launching an effort to clean up the tax code.
But on closer inspection, I don't think this will lead to a simple and fair system like the flat tax. Or even a national sales tax (assuming we could trust politicians not to pull a bait-and-switch, adding a new tax and never getting rid of the income tax).
But judge for yourself. Here's some of what's contained in a letter they sent to their colleagues, starting with some language about the growing complexity of the tax code and the compliance cost for taxpayers.
...since then, the economy has changed dramatically and Congress has made more than 15,000 changes to the tax code. The result is a tax base riddled with exclusions, deductions and credits. In addition, each year, it costs individuals and businesses more than $160 billion to comply with the tax code. The complexity, inefficiency and unfairness of the tax code are acting as a brake on our economy. We cannot afford to be complacent.
Sounds good, though they also could have mentioned other indicators of nightmarish complexity, such as the number of pages in the tax code, the number of special tax provisions, or the number of pages in the 1040 instruction manual.
I'm a bit mystified, however, at the low-ball estimate of $160 billion of compliance costs. As explained in this video, there are far higher estimates that are based on very sound methodology.
But perhaps I'm nit-picking. Let's see with Senators Baucus and Hatch want to do.
In order to make sure that we end up with a simpler, more efficient and fairer tax code, we believe it is important to start with a “blank slate”—that is, a tax code without all of the special provisions in the form of exclusions, deductions and credits and other preferences that some refer to as “tax expenditures.”
I don't like the term "tax expenditure" since it implies that the government taking money from person A and giving it to person B is equivalent to the government simply letting person B keep their own money. These two approaches may be economically equivalent in certain cases, but they're not morally equivalent.
Once again, however, I may be guilty of nit-picking.
That being said, there is a feature of the "blank slate" approach which does generate legitimate angst. There's a footnote in the letter that states that the Joint Committee on Taxation is in charge of determining so-called tax expenditures.
A complete list of these special tax provisions as defined by the non-partisan Joint Committee on Taxation.
This is very troubling. The JCT may be non-partisan, but it's definitely not non-ideological. These are the bureaucrats, for instance, who assume that the revenue-maximizing tax rate is 100 percent! Moreover, the JCT uses the "Haig-Simons" tax system as a benchmark, which means they start with the assumption that there should be pervasive double taxation of income that is saved and invested.
This is not nit-picking. The definition of "tax expenditure" is a critical policy decision, not something to be ceded to the other side before the debate even begins.
As illustrated by this chart, the tax code is very biased against saving and investment.
Between the capital gains tax, the corporate income tax, the double tax on dividends, and the death tax, it's possible for a single dollar of income to be taxed as many as four different times.
This is a very foolish policy, particularly since every school of thought in the economics profession agrees that capital formation is a key to long-run growth. Even the Marxists and socialists!
As a long-time advocate of tax reform, I'm not a fan of distortionary loopholes in the tax code. Ideally, we would junk the 74,000-page internal revenue code and replace it with a simple and fair flat tax - meaning one low rate, no double taxation, and no favoritism.*
The right kind of tax reform would generate more growth and also reduce corruption in Washington. Politicians no longer would have the ability to create special tax breaks for well-connected contributors.
But we won't get to the right destination if we have the wrong map, and this is why a new report about "tax expenditures" from the Congressional Budget Office is so disappointing.
As you can see from this excerpted table, CBO makes the same mistake as the Tax Policy Center and assumes that there should be double taxation of income that is saved and invested. As such, they list IRAs and 401(k)s as tax expenditures, even though those provisions merely enable people to avoid being double-taxed.
Likewise, the CBO report assumes that there should be double taxation of dividends and capital gains, so provisions to guard against such destructive policies also are listed as tax expenditures.