A Rounded Look at the Flat Tax

It’s an election cycle AND it’s the close of tax season, so what’s more appropriate than talking taxes?  Taxes are a funny thing when it comes to election time – everyone has an opinion, and they can make or break elections for a politician.  Taxes pay for the services we want (and some we don’t), and they are a necessary function for a well-functioning government. Stop laughing. . . well-functioning might be a stretch, but it’s no lie that taxes are inevitable, depressing, and sometimes incredibly useful for the common good.

1040 document for taxes

Still Needed With a Flat Tax?

This post isn’t about to describe the merits of taxes or even get into a tongue tied argument about which tax funded programs are useful or bloated; rather, I’m here to talk about what a flat-tax is and is not.  Most of you are familiar with our current income tax system – with tax rates split up into brackets –  but did you know in this election cycle Carly Fiorina, Rick Perry, John Kasich, Ben Carson, Chris Christie, Rick Santorum, Rand Paul, and perhaps most importantly since he’s still in the race, Ted Cruz have all put out plans for a flat tax?  It’s important to understand the differences and effects of a flat vs an income tax as we could have a very new system to deal with coming up in just a few months.

Flat Tax: What It Does, What It Is, What It Isn’t

A Flat Tax is, simply put, applying the same tax rate to all earners, regardless of income.  Whether you make $50,000 or $100,00 you would owe the same marginal rate.  There are really only two types – a consumption tax or an income tax.  If you’ve paid a sales tax, you’ve paid a flat consumption tax.  If you live in the state of Colorado, Illinois, Indiana, Massachusetts, Michigan, Pennsylvania, or Utah, you’ve also paid a flat income tax.  The goal of a flat tax is to reduce government revenues and to simplify the tax code.  At its core, that’s the gist of a flat tax and that’s the point.  It’s easy, it’s clean and it’s incredibly easy to market because it’s so easy to understand.

Now, if you look at the tax plans of most of these politicians pushing this tax, they still have deductions and credits; thus, they’re not a “true” flat tax, but rather a modified flat tax.  Fun fact, a modified flat tax is the actual name of those types of plans.  Economists and policy analysts aren’t known for their creative flair.  Now these deductions usually come in the form of a standard deduction, for instance the first $20,000 of income faces no taxes – mortgage interest and charitable contributions are also usually included because they make voters happy; as an aside, charitable contributions also produce an economic social good by providing a better return on investment than the government could through a like social program.

When talking about a legitimate plan for a flat tax, they generally have to include three different things.  First, they have to define specifically what is considered taxable income.  Investments, wages, dividends, business earnings, they all need to be specifically included to describe how they are treated.  Secondly, taxes and conversely credits, are excellent policy tools for Congress.  With a flat tax you essentially strip Congress of a tool to enforce change.  We don’t like cigarettes so we add a sin tax, we like charity, so we provide tax incentives    .  In the case of investments, short term and long-term gains are considered separately – short term gains are taxed at your top marginal rate currently whereas long-term gains are taxed at 15%.  The government is seeking to promote long term investment by doing this, so it’s a very serious question if we were to switch tax policy.  Finally, the government needs to specifically address the deductions, if any, that will be in the included.  Do they institute a true flat tax and tax all income equally, or are there allowances, prebates, deductions and credits allowed?  Without all of these facts completely covered the government faces major holes and shortfalls when it comes to instituting a flat tax.

Where Does the Cash Flow Celt Stand?

Personally, I’m against the flat tax.  From a purely economic perspective it’s a regressive tax – that is, it disproportionately hurts the poor.  Consider a flat consumption (sales) tax.  You make $100,000 a year, and I make $40,000 a year and we both spend roughly $700 on food and household supplies a month – with tax you’re paying $805, $105 in taxes.  Over the year I, making $40,000, pay 3.15% of my yearly income on taxes in just food.  Making $100,000 you would pay 1.26% in taxes for the year on just food.  To expand that, I’m giving up 1.89% more of my disposable income in taxes, for necessities, than you are and my sensitivities to cash flow changes are much higher than yours.  Further, after a certain income, consumption drops sharply and investment goes up significantly.  Once people pay for food, mortgage, a generous entertainment budget, and incidentals, there really isn’t a lot else to spend money on except other things that make money.  If you look at the income tax, it’s the same principle.  Because costs are essentially fixed for either the $40,000 or $100,000 family taking 15% hurts the smaller amount more – and when you consider how the current system is structured, with effective taxes closer to 9% taking a 15% chunk is a large increase in taxes.

Furthermore, I like social programs.  I think Medicare, Social Security, veteran’s assistance, unemployment insurance, subsidized education, road construction, public good research, and a standing military are awesome things.  The focal point of a flat tax is to reduce government revenue.  We already face a federal deficit.  While a deficit for a government isn’t necessarily a bad thing, there does come a point where America becomes Greece, and adding $3.5 Trillion to the deficit of 10 years is the fast track to get there.  Let’s face it, candidates talk about instituting this policy, but they never talk about what we will give up – what the opportunity cost of it all is – because that’s how you lose voters.  If you say “You’ll pay less in taxes under the flat tax” sounds good, adding “but you’ll give up public education and a functioning judiciary to do so”, not so much.

What do you think readers, would you be okay with a flat tax?  How would your taxes be affected if we instituted a 15% income instead of the marginal rate income structure we have now?  What sort of programs would you be willing to cut back substantially or lose to make a flat tax feasible?

Cash Flow Celt

I'm just a local business and finance nerd looking to help people get educated about small business, marketing, and personal finance! I write about anything and everything that I can tie into those themes. I'm also Central Florida's only Kilted Realtor, so I write about Real Estate too! Check out my About Me page to see the origins of Cash Flow Celt.

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2 Responses

  1. Catherine J Colangelo says:

    I do not understand how a flat tax would/should/or is supposed to reduce revenue. If so many of the ultra-rich (and corporations) pay little or no tax, wouldn’t a flat tax greatly increase revenues? As you said yourself, the reason you are against the flat tax is because it would increase your tax. Please clarify.

    • Cash Flow Celt says:

      That’s one of the gripes I have about common tax conversations. The rich pay an enormous amount of taxes. The Pew Research Foundation keeps pretty up to date on tax logs, and those earning over $100,000 a year pay about 77.7% of the government’s personal income tax receipts. If you just want to include the “rich” (By Obama’s standards that’s over $200,000) then they still pay approximately 55% of all personal income receipts. The issue then is of course the percent of income they pay – their effective rates – as Warren Buffett noted in his push for the Buffett Tax, he pays less, as a proportion to his income, than his secretary. The vast majority of those people pay over 15% effective rates, generally closer to 23%, so lowering that down which greatly reduce the revenues. Just looking at my income and getting a $20,000 prebate, which is a common theme among Republican platforms, I would actually reduce my effective rate down to 6%. That 15% I quote in the article would be sans prebate.

      As far as corporations go, some get out of rates but it’s not the norm. Depending on who you ask, the average effective tax for corporations is between 23-32%; and that accounts for about 10% of government revenues.

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