Wednesday, March 3, 2010

The Flat Tax

It seems as if every few year’s a discussion of the flat income tax comes back into the public debate. It is an idea that was thrust into the public spotlight with Steve Jobs’ failed presidential run in 1996, and has been supported by politicians like Sam Brownback, Dick Armey, and aspects of the tea-bagging movement in the years since. It is a tax policy that is both very simplistic and contentious in structure. The concept is easy to understand, the system is based upon the idea that each current tax payer would pay the same tax rate regardless of income, in this manner it is a truly proportional tax. Specifics on implementation of the actual policy can differ depending on which group of proponents are speaking on the subject, but supporters point to the same general benefits: an increase in tax fairness, an increase in the simplicity of the tax code to increase compliance and decrease administration costs, and an overall decrease in tax levels to increase competition and spur economic growth. Typically the proposed tax rates range anywhere from 13% - 25%, though Iceland has broken the norm by having a 37.5% tax rate. Individual proposals have other unique intricacies; some have an exemption for income under a certain amount of money, some have corporations exempt completely, and others have the alleged forms of “double taxation” such as the estate tax and capital gains taxes eliminated.


The flat tax has only recently become a popular policy, since 1994 twenty-four countries/territories, as well as seven US states, have adopted the system. This system of taxation has been especially popular in the former communist regimes of Easter Europe, where countries such as Russia, Ukraine, Czech Republic and others have adopted it. The so-called “Baltic Tigers” of Estonia, Latvia, and Lithuania have been pointed to by proponents as proof that the flat tax can stimulate economic growth. These countries experienced the fastest economic growth of any country in Europe in the years following the institution of the flat tax, with an average growth rate of near 8%. The US states that have such a system of taxation are a politically diverse group that includes: Colorado, Illinois, Indiana, Massachusetts, Michigan, Pennsylvania, and Utah.


The flat tax also attracts very strong opposition. The primary basis of the point of contention is based upon the proponent’s claim that the flat tax is a more fair tax than traditional progressive income taxation. The critics claim that the flat tax is actually an extremely regressive tax on the working and middle classes of the population. An extremely important concept to understand in support of the critics is the idea of diminishing marginal utility, which, in short, states that the useful/satisfaction of a good decreases as the amount available to a person increases. In the context of the flat tax, opposition to the flat tax use this principle to suggest (assuming a tax rate of 15%) a person who makes $500,000 per year and would pay $75,000 in taxes does not feel the same tax burden as a person who makes $35,000 per year and pays $5,250 in taxes. Critics also point out that the flat tax hurts the upward mobility of the working middle class, as the national share of the tax burden shifts more to those groups from the wealthy, and also that this form of taxation would serve to perpetuate the ownership of wealth amongst the elite.

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