Academic journal article Policy Review

Even Money: A Friendly Critique of the Flat Tax

Academic journal article Policy Review

Even Money: A Friendly Critique of the Flat Tax

Article excerpt

The flat tax is the vanguard of tax reform, and for good reason. It is sound economically and easy to explain. It corrects some long-standing problems with the current tax system: complexity, high costs of administration and compliance, a depressing effect on the economy, and the unfairness of double taxation of income from capital. Its strengths have gained the flat tax many ardent fans and have brought it from an obscure oddity debated by economists to the forefront of the tax-policy debate.

Flat-tax advocates are nearly evangelistic in their drive to replace the current tax system, often as an integral part of their broader agenda to reshape government. They are also often unwilling to acknowledge that, despite its strengths, the flat tax also has some weaknesses and some serious obstacles to overcome before it can go from tax concept to tax code.

What Is a Flat Tax?

Any tax with a single tax rate could be considered a flat tax. A flat tax on labor and business income has been popularized by professors Robert E. Hall and Alvin Rabushka of the Hoover Institution. A flat tax on labor and business income is also embodied in legislative proposals advanced by Congressman Dick Armey, the majority leader in the House of Representatives, and Senator Arlen Specter, a presidential contender. These flat-tax proposals do not tax income from saving; they are therefore a form of consumption tax.

One of the great advantages of a flat tax is its neutrality. It taxes all forms

of income only once and does so at a single rate. It taxes individuals' labor income at a single rate after allowing for personal exemptions, and it taxes business's net cash flow at the same rate that applies to individuals. The flat tax thus gives no relative advantage to any means of earning income. It favors neither capital nor labor, neither physical nor intellectual capital, neither manufacturing nor real estate. By contrast, under current law, the federal government uses the tax code to micromanage the economy, distorting the allocation of resources such as capital and labor, and thereby diminishing both the level of economic activity and the standard of living.

The flat tax is also vastly simpler than the current system and thus virtually transparent to taxpayers -- that is, taxpayers need not become lawyers or CPAs to understand the intent and application of the tax system. Such transparency is important for individuals and businesses making economic decisions, for taxpayers' confidence in the fairness of the system, and for assuring taxpayers that the tax code will not become a tool of deliberate or accidental oppression by government. Much of the distrust bred by the federal tax system derives from a suspicion that it conceals traps to snare the unwary taxpayer and torture him with tax penalties, interest charges, tax liens, and possibly jail. The flat tax aims to

be so simple and transparent that taxpayers could shelve their fear of the tax man.

Individuals under a flat tax. Taxable income under a flat tax includes all wages and salary, and excludes all capital income such as dividends, interest, rental income, and capital gains. In addition, all nonwage forms of labor compensation are also excluded, such as employer-provided health insurance and subsidized parking. The tax on individuals, therefore, is essentially a payroll tax collected at the employee level. Most flat-tax proposals also allow the taxpayer to take personal exemptions and an additional exemption for each child in the household, effectively creating a zero tax rate for low-income filers. Under the Armey version of the flat tax, for example, a single filer is allowed a $13,100 exemption ($26,200 for married, filing jointly), and the plan allows for a $5,300 exemption per dependent. Having calculated taxable income net of the personal and child exemptions, a flat tax imposes a single tax rate on any remaining taxable income.

The most striking feature of a flat tax is that it eliminates the special deductions, phase-outs, and credits in the federal income tax, ensuring that most individuals could calculate their tax liability easily -- hence the claims by flat-tax advocates that a tax return could be filed on a postcard. …

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