The Flat Tax

The Flat Tax


Many people would like you to believe that flat tax is so named because it will flatten your finances. That at the least is the intended conclusion. By eliminating personal deductions like mortgagee interest payments, the study claims, the flat tax would reduce housing values in this country by upwards of 10 percent. The study’s methodology is shaky at best, and the jury on housing values is still o ut.

Despite the forces allied against the flat tax, tax reform has grown steadily because the current tax system is so unpopular and the alternatives promise so much. But in addition to the possibility of lower housing values, the flat tax poses several oth er serious problems too easily dismissed by its advocates. Businesses may be the flat tax’s second biggest obstacle. By reducing the cost of compliance with the tax laws and removing uncertainties about the tax situation, the flat tax would eventually benefit businesses. However, they would see their tax burde n rise by about two-thirds, on average, from 31 percent of the total tax burden to around 50 percent. This tax increase on businesses would result from the loss of deductions for state and local taxes and for employee fringe benefits, among other things.

Though businesses will try to pass on these costs to consumers and employees-by raising prices and trimming fringe benefits, for example-shifting the nations tax burden to the business community will not produce successful tax reform. Next, the flat tax initially would raise taxes on the middle class by 20 percent. On average, a family with between $40,000 and $50,000 in adjusted gross income would see there taxes rise about $700 to about $7.500.

The flat tax also appears to have a major fairness problem. For example consider two families. The Jones have a combined salary of $50,000 in wages. Under the flat tax, a 20 percent rate would cost this family $3,700. Now consider the Smiths, who in r etirement consume every dollar of their $1 million in dividend income. Under the flat tax, the Smiths owe no tax at all because capital income is excluded from the tax base. To be sure, their dividend income was taxed at least once at the business level before they received it. But the perception would persist that a high income family would pay no tax. Will tax fairness be defined so that individuals consuming significant amounts of capital income would pay little or no tax?

Though difficult issues, they are not impossible to resolve. Moreover, the system’s advantage could well outweigh it’s drawbacks. The flat tax could prove a boon for the economy by eliminating a passel of convoluted tax disincentives to saving and inve sting. Economists will quibble over exact estimates, but there can be no question that savings and investment will improve in both the short and long run under a flat tax. Advocates are correct to insist that the flat tax would be much simpler than the current tax system. The new system would tax only the income derived from individual labor, after allowing for personal exemptions. There would be no deductions. The fla t tax would tax businesses’ net cash income at the same rate that applies to individual income, while eliminating all the apical tax provisions that penalize some businesses while benefiting others.

One big problem with the current system is that it costs from $150 billion to $300 billion annually to operate. The flat tax, by contrast, would cost about 1/5th as much once fully phased in. These cost savings are equivalent to more than a $100 bil lion tax cut for the American people.

No tax system is perfect, and no tax reform proposal is without flaws. In the end, the flat tax’s greatest strength is that it would remove the current tax system’s depressing effect on the economy. This over time, could make up for all the problems me ntioned above. But before it can pass the problems must be addressed.