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Does anyone support a true flat tax?

October 25, 2010

The right’s opposition to progressivity in income tax rate has made it into the Tea parties’ Contract From America, whose fourth point calls for the US to “adopt a fair and single-rate tax system.” But something funny happens along the way from flat-tax rhetoric to specific flat-tax proposals: a deduction or exemption or personal allowance gets built in. The result is a tax with two rates. Consider an example where 0% is paid on income in the first bracket, ending at $40,000, and then 25% on income beyond that:

    income total tax paid effective tax rate
    $40,000 $0 0%
    $60,000 $5,000 8%
    $80,000 $10,000 13%
    $100,000 $15,000 15%
    $120,000 $20,000 17%
    $400,000 $90,000 23%

The effective tax rate increases with income. It is progressive. That is the effect of having two brackets. Those who remember high-school math will recognize effective tax rate as a continuous, monotonically increasing function on income that starts at 0% and asymptotically approaches 25%. Another bracket or two provides some variation in how that S-shaped curve ramps up. But all such curves are quite distinct from a flat tax.

The above is simple math. Two political points follow. First, having four or five brackets instead of two has nothing to do with the complexity of income tax. It changes a two-minute arithmetic exercise for a fifth grader into a three-minute exercise. Assuming anyone still does their taxes by hand. The income tax carries significant complexities and compliance burden: tracking one’s income (and payments that are others’ income), determining what counts as expense toward producing income, maintaining records, and similar accounting work. The number of brackets has no effect on this.

Second, the reasons the income tax has always been progressive from its creation are the same that prevent the pretend proponents of a flat tax from turning it into a concrete proposal without that first bracket, however labeled. Victuals, clothing, fuel, and other basic needs on the store shelf are priced the same no matter one’s income, putting more necessity in how one spends one’s first dollar than in how one spends one’s millionth dollar of the year.

Those calling for a flat tax need to grow a backbone. If they want to tax the dishwasher earning $9,000 a year at the same rate as the lawyer earning $400,000 — which is what a flat tax does — they should forward concrete proposals that tax the first dollar of income the same as the last. Or else, they should admit that they also favor progressive taxation, and stop using that characteristic of a tax system as a political whipping boy. And if their concern is complexity, compliance costs, and avoidance costs, they should recognize that has nothing to do with tax rate, and that addressing those problems is much more difficult than changing five brackets to two. There are plenty of serious issues regarding our tax system. And some serious proposals for reform. A flat tax is not one of them.

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12 Comments leave one →
  1. November 1, 2010 2:05 pm

    Yes.

  2. November 1, 2010 2:17 pm

    Yes and — such a tax is probably the ONLY structure which leaves the decision about how to spend each marginal post-tax dollar in the hands of the person that earned it. Alll others distort the incentives at different points along the curve.

    You might reply that such a decision does not exist for those lower on the income curve, and you would be partially correct. But it is circumstance rather than unnecessary and arbitrary legal machinations that make it so. It is for this reason that some flat tax pragmatis throw a bone to the bleeding hearts by being willing to exempt th first X dollars, not some weak-kneed crypto-progressivism. In any case, even such a two tiered system, absent all the other complications, would be superior to what we now have.

    It is not the brackets that lead to the absurd, untenable complexity of the tax code. It is all the exemptions, deductions, different classifications of “income,” alternative methods ala AMT, different taxable events, etc. The only benefit to all that complexity is employment for tax collectors and advisors.

    • rturpin permalink*
      November 1, 2010 6:00 pm

      It is for this reason that some flat tax pragmatists throw a bone to the bleeding hearts by being willing to exempt the first X dollars, not some weak-kneed crypto-progressivism.

      Which is to say, makes them stop supporting a flat-tax. Can you point to specific proposals from think-tanks or politicians that don’t exempt some amount of income?

      Agree completely on the AMT, and mostly with the comment about complexity, with this caveat: there’s always going to be a good deal of complexity involved in an income tax, because it of necessity involves knowing what dollars received are income (salary, but not repaid loans), and what dollars spent are expenses (business travel, but not commuting costs, business equipment, maybe, uniforms, but not normal business attire, etc.)

      • November 3, 2010 5:22 pm

        It’s a matter of realpolitik. In theory, there’s no difference between theory and practice. In practice, there is. It’s rather thin rhetoric to simultaneously criticize a clear, uncompromised statement of principles while simultaneously criticizing the practical compromises made by those who would take a glass half-full over an empty one.

        I.e., those who advocate a flat tax are either so dogmatic that they cannot make practical compromises that might improve the status quo, or you attack them for being weak-kneed (or at least not being clear about what they support.) You’re confusing theory and practice.

        jb

      • rturpin permalink*
        November 3, 2010 5:45 pm

        But they’re not compromising. They’re shrugging their shoulders and saying, “ok, let’s have a steeply progressive tax, after all.” A steeply progressive tax is what comes from an exemption for any meaningful amount of first income. A compromise would be to call for a less steeply progressive tax, a flatter tax, say, 15% on first dollars, and 20% on final dollars. The point of my post is that the flatness of a tax has nothing to do with the number of brackets, and is more related to the difference in rates between brackets. The interesting thing is the proponents instead are suggesting a reduction in brackets, still starting from zero, and still calling it it a flat tax proposal. Which suggests to me that the principle isn’t so important, as the appearance of it. Either that, or they can’t do basic math.

  3. November 3, 2010 6:58 pm

    “But they’re not compromising.”

    Of course they are. They know that the everybody’s going to get up in arms about taking all those ‘po folk, so fine, whatever, let’s draw the line and say “you ‘po folk, y’all keep on payin’ nuthin. The rest of us, we’re going to have a sane tax system beyond that.”

    The distribution of taxes under a system that exempted e.g. the first $40k / person of income (or pick your number…) but imposed a flat tax beyond that would still be FAR less “progressive” in effect than the present system, which however it is constructed results in the top few percent paying the a disproportionate share of all individual tax revenues (and further, a indirect but equally disproportionate share of corporate tax revenues due to concentration of equity ownership — in essence double taxation.)

    “…proponents instead are suggesting a reduction in brackets, still starting from zero, and still calling it it a flat tax proposal.”

    You make a lot of assertion about what people are and are not suggesting, but have apparently either lost or suppressed the reasonable tendency to distinguish between what is said and what is likely meant.

    Stop confusing theory and practice, or rhetoric and realpolitik. Principle and compromise coexist in almost everyone (except buffoons, and then we skewer them — deservedly.)

    If you want to negotiate a compromise, you lead with something you know the other side can’t swallow — in principle true, though in practice something you’re willing to compromise, yet you don’t want to immediately show your hand. Then you can “magnanimously” later give the compromise you actually were willing to give to begin with in order to get, in effect, most of what you wanted in practice anyway.

    jb

    • rturpin permalink*
      November 3, 2010 8:21 pm

      The distribution of taxes under a system that exempted e.g. the first $40k / person of income (or pick your number…) but imposed a flat tax beyond that would still be FAR less “progressive” in effect than the present system, which however it is constructed results in the top few percent paying the a disproportionate share of all individual tax revenues.

      That’s just not the math. If you take the example and add a middle bracket of 12.5% from $30K to $50K, it doesn’t change at all what people earning more than $50K pay. All it does is increase a bit what people earning $30K to $40K pay, and decrease a bit what people earning $40K to $50K pay. $40K is close enough to median (45th percentile) that it’s unlikely to much change total taxes collected, either. So long as there is a zero rate for any substantial first amount of income, the effect is strongly progressive, and the top few percent will pay a disproportionate share of tax revenues. Two brackets achieve that just as easily as five.

  4. November 3, 2010 7:00 pm

    By the way, that “probably” in my first comment was supposed to be “provably.” I don’t know if “rturpin” edited this for his own purposes or whether it was my own fat fingers on an i-device… but yes, *provably.*

  5. November 5, 2010 1:10 am

    @jb, if you want to go after the taxes that are ruining the poor rich people’s weekend trips to Norway, why not aim at the capital gains tax system, which is much more egregiously broken?

    Having two tiers is *not a flat tax*, as rturpin suggests. It’s not a compromise. It just *isn’t*. It’s exactly what flat taxers should be against. If you want to complain that the % over $N is too high, that’s fine. You’re probably right. But a flat tax proponent should be against all of it. You can’t be anti-skub only on weekends.

  6. William F. Quinlivan permalink
    November 19, 2010 1:21 am

    Nice thread. Alternative – a true flat tax, but a tax on net worth, not on income. You might think this drastic, but imo the move to tax *consumption* in addition ot income is pointed in the wrong direction. You got two flows – income and consumption, and one stock – net worth. Why do we put NW off the table for taxation? I wonder what a flat tax on net worth would have to be to be revenue-neutral.

    • rturpin permalink*
      November 19, 2010 4:25 am

      In my view, there are several good reasons for keeping net worth “off the table.” First, I think it is a desirable thing, both socially and individually, for people in their middle years to build a substantial net worth, to expand their freedom and cushion their well-being in their later years, when possibilities are not quite so open ended as when they are young. Taxing net worth puts a real head wind to what ought to be normal financial planning. Second, and related, net worth is strongly related to age. An eighteen year-old with a net worth of a million dollars is ridiculously rich. A sixty year-old with a net worth of a million dollars has a nice kitty for retirement, but doesn’t really count as wealthy. There are significant inequities both in taxing them at the same rate, and in taxing them at different rates. Third, real property — and much else — already is subject to a variety of property taxes.

      On the other hand, I think it’s quite appropriate to view inheritance as income. The notion that it is double taxation overlooks the fact that the deceased and heir are different individuals.

  7. November 19, 2010 4:35 am

    Number one reason that we don’t tax net worth? Because then all the people that count will just leave. I mean, even moreso.

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