We Already Have a Flat-Tax System

Article excerpt

The quadrennial alignment of the tax preparation and presidential primary seasons can he relied on to produce stinging criticism of the federal income tax. Regardless of how much a candidate may personally have had to do with writing the current tax code, each wants nevertheless to convey that he feels the pain of the voters as they confront their Form 1040s. Routine as this is, the stakes seem much higher this year.

We're not hearing about three-martini lunches anymore; we're hearing that the entire income tax should be replaced. It seems reasonable to ask: With what? Most of the options suggested involve some type of consumption tax, with the so-called "flat tax" appearing to have the lead as we file our returns. Let's look briefly at consumption taxes in general, all then at the "flat tax" particularly.

Consumption taxes have two great attractions. First, by removing tax burdens from income that is not consumed, they could be expected to stimulate private savings. The appropriate measure of national savings is subject to debate, but all analysts agree that the United States has one of the lowest savings rates among developed nations, and nearly all analysts think that this is a regrettable situation. The second, related attraction of consumption taxes has to do with the moral qualities associated with thrift, and correspondingly with a tax system that encourages that virtue. Whatever we tax we tend to discourage. Income represents the return on productive deployment of labor and capital; why would we want to discourage that? Consumption, in contrast, is a necessary but essentially destructive activity. It quite literally consumes resources, making them unavailable for the future use of current taxpayers, or for future generations. Burdening that activity as a means of simultaneously financing the government and sending the right signals to taxpayers has considerable appeal. What's wrong with consumption taxes? In a word, they tend to be regressive, taking a higher percentage of income from lower-income taxpayers than from higher ones. This is so simply because lower-income taxpayers, on average, spend more of their income and save less of it than higher-income taxpayers do. The tendency toward regressivity can be mitigated by, for example, exempting some categories of consumption, such as food. Generally, however, the mitigation mechanisms are rather crude, providing too much relief in some places and not enough in others. And they inevitably complicate a tax system whose simplicity is supposed to be one of its primary virtues. The flat tax attempts to preserve the atttractive incentives of a consumption tax while incorporating a novel (those who like ii would say ingenious) method of mitigating regressivity. The flat tax begins with a tax on business that resembles a value-added tax. A value-added tax assesses a flat rate - 17 percent is frequently mentioned - against the revenues of a business, minus its purchases. However, the usual value-added tax doesn't recognize wages paid to employees as "purchases." But the flat tax does, effectively removing wages from the base of the business part of the flat tax. …

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