Friday, June 13, 2014

Rather than Repeat the Mistakes of 1986, How About a Flat Tax?

Carl Leubsdorf's Tax deadline, and no reform in sight says "it’s time to repeat the mid-1980s exercise that simplified the [income tax] system and helped spur economic growth."

That's a start. Short of full repeal, which should be done but which is politically unfeasible today, the abominable Federal income tax needs desperately to be reformed or replaced.

For guidance to reform, Leubsdorf looks back:
The 1986 bill reduced the number of tax brackets and eliminated many special-interest provisions, while raising capital gains and corporate taxes and providing a modest increase in revenue. Since then, many new deductions and credits have complicated the tax code and exacerbated inequities in which some wealthy taxpayers pay a lower real rate than middle-class Americans.

Why the return of complications and inequities? Precisely because the 1986 bill merely "reduced the number of tax brackets and . . . special-interest provisions. . ."

The big problem with the current graduated income tax is that it is a magnet for special interest lobbies seeking to pressure lawmakers into inserting tax provisions that favor them. As long as multiple tax brackets and deductions and credits and the like exist in any form, the door can never be closed to special interests lobbies. On what basis does congress grant one pressure group its special provision, while denying to the next group its special provision?

Leubsdorf highlights the problem for reformers. He notes that Rep. Dave Camp of Michigan outlined a plan that . . .

would restore three tax rates (15 percent, 25 percent and 35 percent), reduce corporate taxes, place an excise tax on banks, repeal state and local tax deductions, and place an income ceiling on deductions for mortgage interest and charitable contributions.

The response to Camp's plan was predictable:

It was buried by criticism from groups unwilling to accept broad-based tax cuts in return for elimination or reduction of some special-interest provisions.

How to overcome this problem? A flat tax that eliminates all  special tax provisions save for a single personal deduction for each individual, no exceptions. No more special interests: The door would be slammed on deductions, credits, and the like. No more fighting over tax rates, particularly the unseemly spectacle of people demanding tax increases, but only rate increases that effect the other guy: Everyone pays the same, and any change in rates would effect everyone who pays taxes, because the code is locked in to only one rate.

Steve Forbes laid out a plan worth considering in his book "Flat Tax Revolution." In Forbes' plan, there would be one rate of 17%, after a single but generous personal exemption for every taxpayer and every dependent. Under Forbes' plan, the hypothetical "family of 4" would pay no income tax on approximately the first $46,000 of income, and then 17% on every additional dollar of income.

Leubsdorf notes that "the only bipartisanship that Camp’s plan produced was both parties’ criticism." No wonder. But something along the lines of Forbes' plan would be an entirely different animal. The only areas for debate would be the tax rate and the size of the personal exemption.

On paper, the Forbes' plan would look (roughly) something like this; 

  • a family making $50,000 would pay $680.00 yearly on an effective tax rate of 1.4%; 
  • a family making $100,000 would pay $9180.00 or 9.2%; 
  • $150,000=$17,680 or 11.8%; 
  • $300,000=$43,180 or 14.4%; 
  • $1,000,000=$162,180 or 16.2%.

Since compromise is the holy grail these days, this is one tax reform proposal that every honest politician Left or Right should be able to live with. It's a plan that only politicians who love seeking votes by promising tax favors could hate.

It's progressive, but justly so. The millionaire pays 238 times as much as the lower income family in dollar terms, and 11 times as much in percentage terms. It's fair: Every dollar of taxable income is treated the same--i.e., no income discrimination. It's pro-growth: Economic success is not penalized by higher marginal rates.

The same principles can and should be applied the corporate income tax.

While I strongly disagree with Leubsdorf that tax reform should increase overall taxes, or taxes aimed only at one group (such as the "rich"), I agree that we should have tax reform. This time, let's have real reform that is both meaningful and more fair (or as I, an opponent of the income tax would put it, less unfair).

Related Reading:

Toward Less-Unfair Corporate Taxes


Mike Kevitt said...

You ask, "How to overcome this problem?...The door would be slammed on deductions, credits, and the like."

Wouldn't this undercut your program to privatize education and make it free market, since the phase in uses tax credits for education outside the public education system?

principled perspectives said...

No, because education tax credits (in my conception) means essentially to opt out of a government function.

The government taxes you to fund its schools. If you choose to sponsor the education of a child on your own, you shouldn't have to pay government for doing what its not doing.

All of the special tax provisions of the federal income tax are there to manipulate behavior or favor one group over another.

Also, education tax credits really only apply on a state level. For more on this aspect, see my letter reply to "Would the Federal Government Permit States to Implement a Tax Credits Program?".