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.
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?