Recently, a group of friends and I debated the relative merits of the flat tax. The debate was initiated as follows:
I was talking to my friend the other day, and he was all excited about this book he read called The Fair Tax Book that advocates replacing all income taxes with a flat sales tax. I told him that wasn’t a new idea, and that I was sure it had been bandied about in Congress and policy circles for a long time before this book came out. He seemed to think this was different, and that it’s a panacea for the individuals and the government of the U.S.
My response was that, despite the title, a tax on consumption isn’t fair for at least one reason: it results in a disproportionately high leval of tax (in relative, not absolute terms) on those who have to spend most of their income on goods and services (i.e., largely those who have the lowest incomes). I guess the proposal would provide exclusions for people with taxes up to the poverty level. But isn’t this then just a graduated tax in disguise? There’s also a federalism problem (like the states reserved the power to tax goods? not sure if that’s right).
Anyway, I’d like to hear your thoughts and what you think of the consumption tax in general and this new book. My main question is–how does this purport to stimulate the economy by taxing less AND raise revenues–is it another long-term lower taxes/raise more money thing, or is it something different? Begin.
Responses to this query varied from a primer on flat taxes to a comment that we need to differentiate between a flat income tax and a flat consumption tax, where the latter actually provides an incentive to save. The general consensus, I would say, was wariness about the redistributive impact of a flat income tax, even if other offsets can be put in place to mitigate these negative consequences (see my argument below).
My response was as follows:
My understanding is that a “flat tax” refers to the broad set of tax policies which would apply one tax rate to all Americans. In common parlance, it typically refers to a flat income tax rate, as pioneered in the former Soviet Republics of Eastern Europe and the Baltics. The benefit behind a flat income tax is simplicity of administration as well as an inherent sense of fairness. If you can reduce the costs associated with tax dodging and tax preparation (both billion dollar industries), then you can use some of these savings to fund more pro-poor programs to alleviate the burden of a less progressive income tax system.
The Economist offers an even-handed assessment of the flat tax system to-date.
The article also notes that flat tax systems are not always as flat as their opponents make them out to be—taxes on capital gains, corporate income, etc. can be used to maintain the progressive nature of the tax system while still having a flat tax on personal income.
The you are referring to argues in favor of replacing all taxes with a national income tax. This has many compelling benefits—simplicity of administration and offering a tax on consumption (and therefore, an incentive to save, as Amit points out). For those of us who are not baby boomers, we should also love it—it avoids the inherent “age-ism” in the current tax system, which favors AARP members, who have a large wealth base but little income, at the expense of younger, bread-winners, who are currently earning a lot of money, though not necessarily spending that much. Having said that, the majority of economists share concerns that a flat sales tax would (1) have to be so large as to be debilitating to the national economy if it is going to effectively replace the income tax and (2) have seriously regressive consequences on income distribution. See an assessment of the book by economist Joel Slemrod which points out some serious flaws.
My take is as follows:
A sales tax has clear benefits, in terms of simplicity, incentivizing savings, and helping us maintain our tax base as the U.S. population continues to age. Some legitimate economists have supported a limited national sales tax to support the transition to privatized social security (See especially The Coming Generational Storm, an amazing book that will scare the pants off you and make you fear your future tax burden). Moreover, the regressive issue can be addressed fairly simply—for example, make “key items” tax exempt, thereby, maintaining a pro-poor element to the tax regime. Milk, eggs, bread, OJ, are all tax-free…. Having said that, it’s unrealistic that a sales tax should REPLACE the income tax system. No one else has ever done it, and the U.S. has a functioning tax system, so the “if it ain’t broke, don’t fix it” argument is enough to kill that idea. If I had my preference, we would have drastically lower income taxes, possibly flattened, though not necessarily, combined with a national sales tax equivalent to 5-10%. We would also have privatized social security accounts with mandatory contributions, and government-subsidized top-up accounts for those below the poverty line.
What I didn’t say in the note above, that I would add now, is that arguments can be made both ways for a flat income tax system, but it’s hard to argue that it’s a real “panacea” for what errs the U.S., be it our lack of savings, income inequality, or huge current account deficit. It’s a good idea in theory, and seems to be working elsewhere, but given how much time and political capital it would burn to put it in place, is this really the issue one would choose to focus on? Probably not. Having said that, I believe that tax reform more broadly is one of our most pressing issues, and one not addressed nearly often enough, as more immediate concerns always take precedence. Simplifying the tax regime for millions of Americans is, unfortunately, an issue that will have to wait until a President is able to muster bi-partisan support for fiscal responsibility, something we have not been able to do since the Clinton-led debt reduction plan.
Posted by econophile 
Posted by econophile 
Posted by econophile 
