Flat Tax Revisited

Along Marangu Trail Kilimanjaro - photo by JoAnn Sturman

Scott Sturman
fliesinyoureyes.com

Skip a rope skip a rope...

Cheat on your taxes don't be a fool
Now what was that they said about the golden rule
Never mind the rule just play to win
And hate your neighbor for the shade of his skin

Skip a rope skip a rope...

Henson Cargill 1968

Every so often I have the pleasure of exchanging emails with Warren Coats, a University of Chicago trained economist, who retired from the IMF in 2003 and currently serves as an advisor to the IMF for the central banks of Afghanistan, Iraq, and Kenya. I thank him for discussing consumption and flat taxes and suggest reading his article regarding consumption taxes:

US Federal Tax Policy

In 1994 I wrote an essay entitled Flat Tax for the newsletter “Common Sense Solutions.” At the time it was apparent the tax code was fraught with so many loopholes, deductions, credits, and exemptions that is was impossible to fix it without major reform. Equally insidious, it allowed lawmakers to socially engineer the country by either encouraging or discouraging economic activity to suit their needs but often leading to inefficient economic consequences. The prodigious waste of time, resources, and expenses to compute the income tax weighed heavily in the decision. Seventeen years after the original article and mired in a recession, the tax code is more complicated and must be scrapped in favor of a better alternative.

Taxation should be simple, reproducible, fair, and transparent, and to attain these goals necessarily devoid of rules which complicate its computation. The two options which provide these advantages are the flat tax based on income and the consumption tax. There are huddles to overcome with the implementation of both, but either one is preferable to the current tax system. In both cases all other forms of federal taxation would be discarded.

Value Added Tax (VAT) or consumption tax is the most popular form of taxation in the world. It has a number of advantages including the relative ease in which taxes are collected and an inherent neutrality between specific economic activity and taxation, where tax law neither rewards of penalizes individual financial behavior. Under the program everyone who consumes pays taxes and “has skin in game.” Most of the VAT systems provide rebates to all tax payers in the form of a monthly check from the government which is intended to soften the impact on low income groups. In the United States the major impediments to its implementation are unfamiliarity and the potential for lawmakers to easily increase the general tax rate. It remains to be seen whether the American public would be willing to pay 20% more for each and every transaction for the benefit of not having to pay income tax, capital gains tax, inheritance tax, etc. This may have been the case when a supermajority of Americans paid income tax, but with only about 50% currently contributing it would be surprising to see a ground swell of support for a consumption tax.

The flat tax is based on income, and without accurate income reporting some advantages are lost. This problem is becoming more acute with the globalization of the economy and the ability of major investors to hold substantial assets in off shore locations. The vaunted simplicity of the flat tax is not so simple, since income can vary substantially depending on it is treated by accounting rules. Unlike the consumption tax, any form of income is subject to taxation albeit at a lower level than currently charged. Flat tax lacks some of the philosophical purity of the consumption tax, since there are penalties for saving and investment. However, the flat tax is an easier sell to the public, where the income tax concept is ingrained firmly.

Whether a consumption tax or flat tax is preferable should form the national debate and not how to put more duct tape on the federal income tax system. The best way to overcome special interests, promote efficient taxation, and enhance personal economic freedom is to keep it simple. It is looking more and more that the consumption tax is the solution.