Quick! Call 999!

Herman Cain has sparked a welcome interest in revising the tax code. Rick Perry now makes a flat tax one of his campaign platform’s main planks. Steve Forbes advocated it long before either of these two dallied with the idea. So what are the particulars of the flat tax debate and why is it garnering attention once again?

One reason is that almost no one supports our current tax structure. It is complex, costly to comply with, and a playground of corrupt legislators given to handing out illegitimate favors to their friends. The arguments come when we try to decide just how to set the rate and to whom to apply it.

A true flat tax is one rate for everyone with no deductions. Whatever you make is taxed at the same rate as everyone else. It’s apparent simplicity is belied by a couple of issues, though. Not all incomes are equal. For example, should dividend income, which has already been taxed at the corporate level, be taxed again at the personal level as it is now? Any viable proposal must also include an explanation of how business and personal income are to be treated. Are self-employed people who really only “make” what is left after expenses to be taxed on revenues or on profits? Other than these complications, the true flat tax has the merit of simplicity and a straightforward moral foundation–everyone pays the same.

A modified flat tax has largely the same structure, but includes at least one deduction. One plan offered by Milton Friedman some time ago would not only exclude the first $XX,XXX of income, but would refund the tax rate for households earning below that figure. This “negative income tax” would replace the current welfare and other social programs, which often penalize people for bettering themselves. Instead of experiencing a disincentive to earn more, recipients of the negative tax would have every reason to move up. This type of plan also has the virtue of simplicity. The moral argument is more convoluted, though. The threshold for the income tax could be highly regressive (say $20,000) or highly progressive (say $1,000,000). Any decision on the threshold includes a value judgment about whether rich people should pay more accordingly.

Other “flat” tax proposals are increasingly complex. Herman Cain wants people to pay 9% on business and personal income as well as a 9% national sales tax. The first two of these are adjustments to the income tax already in place, but the last is a new tax entirely. Some find it objectionable not only in substance, but in its creeping toward a VAT (Value-Added Tax). Cain wants this to be a step toward the Fair Tax, a one-rate national sales tax with a “prebate” for the poor.

As for Perry, we just don’t know yet, and one suspects he does not know himself. No other candidate to my knowledge has made a big campaign issue of the flat tax. It is good to see this in the center of our political conversation once again, and here are the reasons.

The current tax code is an abomination. Some flat tax structures may have flaws, but they have the virtue of eliminating government’s ongoing interference with business decisions. Underneath any flat tax proposal is the idea that individuals should decide how to allocate their expenditures and how to make money. Anything that reduces government meddling is good.

A flat tax also removes the envy factor from taxation. People who make more pay more, but at least they pay at the same rate as others. It eliminates the soak-the-rich political posturing that precipitates class warfare.

I believe that a flat tax with a negative income tax provision makes the most sense. Frankly, I might wind up paying more than I do currently. That’s OK with me if it means that Washington no longer dominates the way capital is allocated in this country. I know that left to their own devices, individuals will work together to provide more things at a higher quality and a lower price. In the end, I would be a lot better off. You would too.

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About Terry Noel

I am an Associate Professor of Management and Quantitative Methods at Illinois State University. My specialty is entrepreneurship.
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