Wednesday, August 03, 2011

Flat tax flounders

By Carl 

Inherent in the current sooper sekrit budjit soopercommittee Congress is setting up in response to the budget crisis, a re-write of the tax code is inevitable.

The time has come for an overhaul of the tax code, to be sure. Right now, taxes on the rich are the lowest they have ever been since Herbert Hoover was president (You'll notice the bookend of terrible unemployment and low taxes on the wealthy, too.) The effective tax rate on the wealthiest one percent (i.e., the rate the wealthy actually pay in total, after deductions, deferrals and exemptions) is the lowest it's ever been.

In turn, deductions that are available to the middle class that promote what had been good public policy (for example, the mortgage interest deduction in order to encourage home ownership) have become warped and twisted to such an extent that they actually create bad public policy. The recent collapse in the housing market is a terrific example of too much of a good thing, in terms of taxes. It only occured after the right to deduct the first $125,000 off the gain on the sale of a home, which had been limited to senior citizens as a one-time-only deal, was expanded to include practically the sale of any residence.

The alternative minimum tax (AMT), originally devised to ensure that the wealthiest pay a fair share of their income in taxes, has become a bane of the middle class. It was never indexed when first implemented in 1986 (at the $30,000 threshold for individuals, $40,000 for a married couple) and only peaks this year at $48,450/$75,000. It drops again next year to $33,750/$45,000. The AMT penalizes people who live in expensive states with high taxes, people who own homes (it phases out the mortgage interest deduction,) and/or have children, and people who like to give money to charity to lower their tax burdens.

It is, in other words, effectively a flat tax of 26% (28% if your income is over $175,000).

Which leads me to today's topic: the flat tax.

Now, given that there are so many "libertarians" who would call for a flat tax in the midst of this rigamarole, I thought it would be a useful prophylaxis to examine why it's a bad idea.

First and foremost, the flat tax is highly regressive, penalizing the poor while subsidizing the wealthy. On it's face, it seems fair (this is part of why many have euphemistically called it a "fair tax"). After all, dollar one gets taxed at, say, 10%, dollar one hundred at 10%, dollar one million at 10%. The guy making a million pays $100,000 in taxes. The guy making $100 pays $10.

Flip the numbers, though. The guy making $100 is left with $90 to buy food, clothing, shelter. The guy making a million is left with $900,000 to buy the same things. Granted, the millionaire is likely to buy more expensive stuff, but here's the thing: he has a choice as to how much he can spend, but not how little. It's that last part, how little to spend, that comes into play.

The guy left with $90 has to meet a threshold to feed, house and clothe himself. Let's say that will cost him, in total, $80. He's left with $10, and must make a choice what to do with the rest of his money: put it away for retirement, splurge on a movie, save it for a rainy day. The guy making a million, also spending that $80, is left with $899,920 to just go nuts.

How is this subsidizing the wealthy? Glad you asked. Unless you want to assume private roads and private infrastructure, the government is going to be the one who wires the community, who paves the roads, who builds the subways. You'll notice the poor soul can't afford a car and walks to work, yet his taxes are paying for things he can't possibly avail himself of, much less benefit from.

A guy making a million bucks is part of a population that is less than one half of one percent of the whole. Good thing, too, because it will take 10,000 people making $100 bucks to equal his income (and to be fair, his tax liability).

None of whom can benefit from the spending that he benefits from.

So it's regressive in terms of the actual taxation, but also regressive in terms of the benefits derived from that taxation. The poor will receive less from the government than the rich under a flat tax system, by definition.

Too, the income tax helps mask another annoying fact of the American tax code, which is that other taxes are highly regressive: sales taxes, property taxes, excise taxes, tolls on highways, mass transit fares, all have to be paid by rich and poor alike in direct proportion to the value of the benefit obtained, which means the rich skate by yet again on the backs of the poor.

There are other reasons the flat tax is a ludicrous proposition. For one thing, it discourages savings, since that would become effectively a double tax: you're taxed on the wages and the interest earned on the money you've socked away. It discourages investment in businesses, for similar reasons. It discourages saving for retirement, since the income that is building towards that is taxed now.

Some might argue, well, Social Security would be off the table. OK, except that the employer portion is taxable at the corporate level (since we're flat taxing all income, no restrictions) so you're double taxing the same money. Revenue is fungible. It doesn't matter how it's apportioned.

Plus, you'd have to raise Social Security taxes to cover the now-heavily-reliant population. And that means wages would now be double taxed even more heavily (you pay SSI and Medicare tax on gross income. You pay income taxes on gross income).

In other words, a flat tax would kill the few American businesses still left.

Lower the corporate tax rate to compensate? American corporations already pay a marginal rate that's among the lowest in the world, and the effective tax rate of the corporatocracy is (based on the Fortune 500) about 18%. So if anything, a flat tax would raise taxes on corporations. Not a bad thing, in my book, but you can bet your bottom dollar ExxonMobil would disagree vehemently, and continue to offshore money.

Proponents of the flat tax point to the success it's had in other countries (Montenegro and the bankrupt Iceland, neither of which is an economic model I'd choose to follow in any other respect), conveniently forgetting that no state that currently has a flat tax had to transition from a progressive taxation to the flat tax.

And in many of these countries, adding in the equivalent of the Social Security tax raises their tax levels *higher* than many if not most states with progressive rates.

It seems to me the Clintonian shibboleth about welfare -- "mend it, don't end it" -- applies to the progressive tax system, too.

(Cross-posted to Simply Left Behind.)

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