legacy time: get to work on the flat tax

(this article first appeared in GlobalPolitician on 21 November 2004)

What do Hong Kong and Estonia have in common? Well, for starters, they’re among the most economically free states on earth, according to the Heritage Foundation’s 2004 Index of Economic Freedom (communist-occupied Hong Kong is #1, former Soviet Republic Estonia #6 -- consider that the United States, supposedly keeper of the capitalist flame, is #10).

Hong Kong and Estonia also have a flat tax, and they are making it work for them.

As America breathes a sigh of relief that the election is over and the administration begins to steel itself for the dizzying array of tasks ahead, there are a lot of folks out there who hope that Bush, relieved of the oppressive yoke of a looming re-election campaign, will choose as his legacy a truly revolutionary change: radical reform of the U.S. tax code and introduction of a flat tax.

U.S. income tax rules are, as most Americans know, labyrinthine, ever-changing and capricious. According to some estimates, the tax code is over 50,000 pages long, and US citizens spend a billion hours (literally) every year reading, re-reading and re-re-reading the rules as they fill out their 1040 forms.

It’s a fair bet that there isn’t a soul in America who knows the whole code off the top of his head. But that doesn’t stop lawyers, accountants, and drive-through tax-preparation outfits from capitalizing on the confusion of Americans. Those citizens who can’t afford professional assistance are left to fend for themselves -- hardly a progressive or equitable system.

What current problems would a flat tax system solve?

- Confusion: there are hundreds if not thousands of exemptions and “if this but not that except if this…” rules. They make it difficult if not impossible for ordinary Americans to get a fair shake on April 15th.
- Inequity: One rate for all. No loopholes, no dodges, no accountants, no lawyers. You and Donald Trump pay the same portion of your incomes, the same way.
- Bureaucracy: When the rules are simple enough for even mere mortals to understand, there is no need for a bloated, expensive, and often oppressive IRS bureaucracy. The IRS would continue to exist, but it would need a much smaller building and would siphon off many fewer taxpayers’ dollars.
- Gamers: Why are so many companies moving their main offices offshore? Why do investors sell off stocks at the end of the year? Why do big-money businessmen open Swiss bank accounts? Because they are trying to game the system to reduce their tax exposure. With rates lowered, there are fewer incentives to play (and less effort spent playing) these games. And greater overall transparency, which exposes cheaters.
- Revenue: According to the UK’s Adam Smith Institute, states that adopt a flat tax “have found the low flat rate produces more tax revenue than the complex system which went before.” Low rates stimulate investment and achievement, which leads to growth, more profits, and more tax revenue. Q.E.D.

In fact, the concept of a flat tax is gaining popularity abroad, ironically in tax-happy Europe. Despite attempts by EU heavyweights France and Germany to impose their beliefs on incoming member states, many new EU countries have moved to a flat or near-flat tax. The Adam Smith Institute’s Andrei Grecu did a survey of nine countries with a flat tax, and found that almost without exception, the system has been beneficial. All three Baltic States (Lithuania, Latvia and Estonia) have a flat tax, as do Russia, Serbia, Slovakia and Ukraine. These last three are recent additions to the flat tax club, but the Balts have been making it work for a decade and have some of the highest GDP growth rates in Europe. Even Russia, economic basket case that it is, has experienced significant GDP growth since adopting the flat tax (and, moreover, has doubled tax receipts – notable in a country where tax evasion was a popular pastime).

Flat tax detractors will drag out the usual litany of scare tactics about poor people paying more taxes. They will complain that this is yet another example of greedy Republicans giving breaks to Corporate America. And they will worry that the flat tax won’t be applied fairly. What really galls them, though, is that they believe rich people should pay more.

Which is why the Bush Flat Tax has to be done right. It must:

- Be fair: All income must be eligible. Work income, capital gains, dividends, interest, the whole lot. This was the Achilles’ Heel of earlier flat tax proposals.
- Be flat: Three brackets do not a flat tax make. The code might be simpler, but it would not be flat, and it would not accrue as many benefits as a truly flat tax.
- Have a floor: Those below a minimum income level (we’ll leave it to the economists to sort out where that line is) must be exempt. But nobody should be paying a larger percentage of his income when the flat tax goes into effect, least of all the working poor.
- Be reasonable: Excepting the lowest earners, a flat rate of approximately 21-24% would end up being less than most households currently pay and well within what they are willing to pay. Americans are eminently reasonable and don’t expect to go from paying 28% to 5% overnight. Moreover, over time the rate will decrease as revenues rise (this assuming that Congress and the White House are able to finally exercise some fiscal restraint on matters other than the War on Terror).

On the domestic front, President Bush could do far worse than have a revitalized and simplified tax structure as the cornerstone of his second term. As in the first term, he can lower taxes for all Americans. Make payment less of a chore. Create a more equitable system; stop punishing success. And above all, stimulate growth rather than bureaucracy. All in all, not a bad legacy.

The second term hasn’t begun, but the clock is already ticking.


Marc posted this at 21.11.04 | Permalink