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The Flat Tax is for Flat Heads

You’ve heard the pitch: With a flat tax everybody pays 15 percent. Check a couple of boxes on a post card, mail it in, and you’re done with taxes. What could be fairer or simpler? Some advocates would also eliminate the IRS and let you mail in your check to the U.S. Treasury just to satisfy the negative perception most of us have of an agency that enforces the federal income tax laws.

In fact I cannot think of any tax scheme that would be more unfair or have more diabolical consequences than a flat income tax. Such a tax would have a crushing impact on the poor and the middle class, it would set our nation’s accounting system back to the early days of an agrarian society, and ours would become a third world economy. It would also lock in permanent poverty status for the poor, and permanent wealthy status for the wealthy virtually forever. There is also a long list of omissions and distortions that the flat tax advocates do not talk about that you almost certainly would not accept.

For perspective, taxes come in many forms and from many sources. The federal income tax is just one of those taxes. There are also state and local income taxes, sales taxes, a gasoline tax, Social Security, Medicare, cigarette, liquor, and…almost too many to list. There are nearly 100 different taxes that you and I are subject to. Some are not called a tax, but a tax by any other name is just as costly. [1]

When they are all summed up and assessed, we find that nearly everyone pays about the same percentage of their pay in taxes. And that rate comes to about 35 percent. And by the way, that rate for everyone is eminently unfair. It hits the poor far too heavily.

And speaking of different impacts, taxes fall into three different categories: they are regressive, proportional, and progressive. A regressive tax hits the poor the hardest, a progressive tax hits the wealthy the hardest, and a proportional tax is uniformly applied to all.

A progressive tax is justified by a concept known in economics as the “diminishing marginal utility of money.” I know. But if you think that term is unwieldy, think of all those medical terms that throw you into a steady state of word-a-logical bewilderment. That economic concept means that as our incomes rise beyond a level needed to sustain us, each additional dollar brings less and less utility, thus it can be taxed at a higher and higher rate without imposing a burden on that person. An example would be: You buy a house. It satisfies many basic needs. Your income rises so you buy a second house, but it does not satisfy those same needs as much simply because it is difficult to live in two houses—even on alternate days or weeks. Your 10th house brings you almost no utility at all, etc. Now compare two incomes: $10,000 per year and $100 million per year. We all know that $10,000 is not enough to sustain us today, and it probably should not be subject to income tax at all. But if $100 million were taxed at 50 percent, that rate would have almost no effect on that person’s lifestyle, thus the two different rates are fair.

The federal income tax, although it is labeled a progressive tax because the rates increase as incomes increase, turns out to be approximately proportional when exceptions and exclusions are considered. For example, the top income tax bracket is 39.6 percent. But that rate applies to the “adjusted gross income,’ not to gross income. Thirty percent of a wealthy person’s income may be omitted entirely if they have a private foundation. And if most of their income derives from capital gains, that portion is subject to a maximum rate of 15 percent if the assets at issue are held for one year or more. And then there is “carried interest” that receives special treatment at 15 percent, and income that is filtered through one or more family trusts that can be deferred or excluded entirely by clever lawyers and accountants. There are other techniques called a “step up in basis” for inherited wealth tax assessments. Put them all together, and the wealthy pay approximately a 17 percent rate on their income now. But if the top income bracket were lowered to 15 percent, the tax they pay on the portion of their income subject to that rate would fall from 39.6 percent to 15 percent under the 15 percent flat tax rate. The wealthy would retain their exclusions to income, and would have the top rate reduced by 24.6 percent. How nice…for them.

With respect to “revenue neutrality” (the notion that the Treasury would receive the same revenue under present rates or a flat tax), that assertion borders on the absurd. How can any schedule reduce taxes on everyone yet collect the same amount of taxes before and after those changes? That notion boggles my 3rd grade arithmetic reasoning.

Moreover, the same advocates for a flat income tax also want to eliminate the inheritance tax. In another essay (U.S. Inheritance Laws and Wealth Accumulation posted on AuthorsDen), I argued that inheritance laws account for 96 percent of all wealth in America, either directly or indirectly. Locking in a permanent flat tax rate at 15 percent while also eliminating the inheritance tax would establish the widest wealth and income gaps in our history—forever, or until the next revolution, whichever comes first.

[1] Taxation in America, Wikipedia